Fundamentals of Accounting

What are the Five Fundamentals of Accounting?

Are you interested in starting an entry-level position as an accounting specialist or bookkeeper? If so, you may be interested in an Accounting diploma or degree program at Interactive College of Technology. Our programs can prepare you with fundamentals of accounting that you will need to perform your role. With this knowledge, you can help your organization do things like balance the books, implement payroll, or manage vendor expenses. So, what are the most common fundamentals of accounting?

There are five most referenced fundamentals of accounting. They include revenue recognition principles, cost principles, matching principles, full disclosure principles, and objectivity principles.

Fundamental #1: Revenue Recognition Principle

This principle states that revenue should be recognized in the accounting period that it was realizable or earned. So, revenue is recorded when products or services are rendered. This is important because stakeholders need to know the true financial position of the company so they can make more informed decisions. It also helps companies comply with Generally Accepted Accounting Principles (GAAP), while still adhering to regulations and laws.

Accounting Period is a specific period of time used to record financial transactions and prepare financial statements. This period can be a month, quarter, or year depending on the start and end dates of the accounting period. At the end of the period, the accounting specialist or bookkeeper will prepare financial statements. This helps the business measure their success, track investments, and plan for the future.

Revenue – The representation of the money a business has earned in sales during an accounting period, revenue is calculated by subtracting the business costs from the total revenue.

Financial Position – Also known as the balance sheet, thisis a statement that shows the company’s financial health. The financial position includes assets, liabilities, income, and equity.

• Assets – material items that can be converted into cash.
• Liabilities – obligations of the business, including accounts payable, taxes, interest, and wages.
• Income – the company’s revenue minus expenses of an accounting period.
• Equity – the net worth of the business, calculated by subtracting liabilities from assets.

GAAP – The Generally Accepted Accounting Principles (GAAP) are a set of guidelines used by a business to prepare and present financial statements. It is developed and regulated by the Financial Accounting Standards Board (FASB). GAAP is based on double-entry accounting. It also regulates the income statements, balance sheets, debt, equity, and expenses.

• Double Entry Accounting – a system of bookkeeping to record financial information in debits and credits. For every transaction, two entries are made, helping to measure profit and losses accurately.
• Income Statement – a financial statement that records income, expenses, and profits over an accounting period to understand a business’s performance and identify opportunities for improvement.
• Balance Sheet – a financial statement used to summarize business assets, liabilities, and equity. A balance sheet can help a business understand their financial stability, liquidity, and overall financial health.
• Debt – an amount that a business is obligated to pay back. This can include a loan or debt from a credit card. Failing to make payments can have consequences.
• Expenses – the cost associated with running a business. Expenses can include things like advertising, rent, utilities, employee wages, and business insurance. Fixed expenses remain constant, while variable expenses can change depending on the amount of business completed.
• Profit and Loss – the measurement of business profitability. This is calculated by subtracting all expenses from the total business revenue.

Fundamental #2: Cost Principle

The cost principle requires a business to record transactions at their original cost. The cost is determined at the time the transaction is completed, and not adjusted if changes occur after that. This principle applies to all assets including things like land and equipment. This helps record a business’s tangible assets, without reflecting market value or depreciation. The cost principle also requires the business to record liabilities when cash is initially exchanged.

The cost principle makes recording assets and liabilities easy, offers objective proof of transactions like sales receipts, bank reconciliation or invoices.

• Tangible Assets – physical items with monetary value used as collateral or exchanged for products and services. Tangible assets include items like cash, stocks, bonds, real estate, office equipment, and furniture.
• Intangible Assets – assets with no physical form, including intellectual property and financing.
• Market Value – the estimated value of an asset or property on the open market. For example, market value can be used to determine the value of a business’s stock market shares.
• Bank Reconciliation – the process of comparing bank statements with financial records to make sure transactions are accounted for.

Fundamental #3: Matching Principle

The matching principle states that expenses should be matched to the revenue they help generate. Expenses should be recognized in the same period as the associated revenue instead of when they are billed. The principle makes sure that the business net income is accurate and a reflection of real performance. It also makes sure that the expenses are not artificially inflated in one accounting period to offset revenue from a previous accounting period

Net Income – the final result of a business’s income statement. Net income is difference between total income and total expenses for a given accounting period. It is also used to calculate ratios that show the health of the business including return on assets, return on equity, and price-to-earnings.

Return on Assets Ratio – is calculated by dividing the business net income by its total assets. The ratio provides an indication of how efficiently the business is usings assets to generate income. The return on assets ratio can also be used to compare the business to its peers in the industry.

Return on Equity Ratio – measures a company’s profitability. It is calculated by dividing business net income by shareholder’s equity and represented as a percentage. The higher the ratio, the more profitable the business is.

• Shareholder’s Equity – the portion of a business’s assets that are owned by its shareholders. It represents the difference between a business’s total assets and total liabilities. It is calculated by subtracting the business’s total liabilities from its total assets, and then divided by the business’s total number of common shares outstanding.
• Common Shares – ownership of a company where the holder is entitled to a portion of the business’s profits and assets.
• Preferred Shares – ownership of a company where the holders have a fixed dividend rate that has priority over common stock.

Price-to-Earnings Ratio – P/E ratio, is a measure of a company’s stock price relative to its earnings per share. It is calculated by dividing the current market price of shares by its earnings per share (EPS). The P/E ratio can help investors understand if a stock is under or overvalued.

• Earnings Per Share – a measurement of a business’s financial performance. It is calculated by dividing the business’s total earnings by the number of outstanding shares of stock. This measurement allows investors to compare businesses of different size.

Fundamental #4: Full Disclosure Principle

The full disclosure principle in accounting states that essential information must be disclosed to all owners and stakeholders, regardless of the nature of the information, whether it is positive or negative. Financial information must be disclosed in a timely, accurate, and complete manner. This financial information can include assets, liabilities, income, expenses, and other important financial indicators. This information may be reflected on public company filings, inventory valuation, or depreciation.

Full Disclosure principles do not usually apply to internally generated financial statements, to not overwhelm management. Management is assumed to already have full knowledge of the positive and negative information. Also, to reduce the amount of disclosure, a business may only disclose information about things that are likely to have a material impact on a business’s financial position.

Public Company Filings – the regulator filings that a business must make with organizations like the SEC. This includes a business’s quarterly and annual reports.

• SEC – The U.S. Securities and Exchange Commission is an independent agency of the U.S. federal government. The SEC works to protect investors through federal security laws. It is responsible for regulating securities markets including stocks, bonds, and mutual funds. The SEC also oversees stock exchanges, brokers, dealers, and investment advisors.

Inventory Valuation – helps determine the current market value of a business’s inventory. This is done by assigning a dollar value to each item in inventory based on its purchase price or production cost.

Depreciation – helps spread the cost of an asset over its lifespan. For example, when a business buys a car, it can right off the value that is lost each year based on its depreciation.

Fundamental #5: Objectivity Principle

The objectivity principle of accounting requires that financial statements are prepared based on objective evidence and reflect only facts. This principle helps ensure that financial statements are accurate, impartial, and free from bias. This stops an accounting specialist or bookkeeper from changing financial statements based on opinions or rumors. Any changes to the financial statement must be clearly documented. This is a foundational principle of GAAP.

Objective Evidence – evidence based on facts and can be verified independently.

Subjective Evidence – evidencebased on personal opinion and cannot be validated.

How Can You Become an Accountant?

If you want to become an accounting specialist and learn more about the five fundamentals of accounting, it is recommended that you attend some form of official education. A proper education offers a complete curriculum, while the use self-study methods or working as an assistant to an accountant may leave knowledge gaps and inhibit your ability to do your accounting job. At Interactive College of Technology, you have two options, an Accounting diploma and degree program.

Accounting Diploma Benefits

• The diploma training period is quicker and focuses on what you need to be an accounting specialist or bookkeeper.
• The number of required classes is fewer than a degree program. However, you can work toward a degree at Interactive College of Technology after completing the diploma program.
• Diploma classes are focused on the training you will need to successfully acquire and advance in an accounting position.
• You will also enroll in other classes that will help ensure your success in an accounting career. Some of these classes include office automation and Microsoft Office Certification Training.

Accounting Degree Benefits

• Accounting degree programs offer additional classes that are not represented in the diploma program. These classes focus on topics like federal taxes, cost accounting, principles of entrepreneurship, and auditing.
• The degree may also offer you advancement opportunities and give you a competitive advantage when applying to accounting positions.

Final Thoughts

Did learning about the five fundamentals of accounting interest you? If so, take the time to learn more about Interactive College of Technology. We can prepare you to become an accounting specialist or bookkeeper. So, record all your personal assets and liabilities and then make the decision to attend Interactive College of Technology’s Accounting and Professional Business Applications program today.

Want to Learn More?

Ready to start working in an entry-level role as a bookkeeper or accounting specialist? At Interactive College of Technology (ICT), our Accounting & Professional Business Applications program will teach you the fundamentals of accounts payable/receivable, payroll, general ledgers, reporting/data entry, and office automation. You will be prepared to support any size organization and make a difference in your accounting department.

Let’s take the first step together! Contact us now to learn more.

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