Accounting principles and practices

Accounting

Generally Accepted Accounting Principles

As new types of transactions evolved in trade and commerce, accountants develop rules and procedures for recording them. These accounting rules, procedures and practices came to be known as the Generally Accepted Accounting Principles. It encompasses the conventions, rules and procedures necessary to define what are accepted accounting practice. It is conventional, that is they become generally accepted by agreement, often tacit agreement rather than derivation from a set of postulates and basic concepts. The principles have developed on the basis of experience, reason, custom, usage and practical necessity.

Historical Cost

In recognition of asset accounts in the financial statements, inherent is the Historical Cost Principle. This principle requires that assets should be recorded initially at original acquisition cost. This initial cost may be carried out without change, may be changed by depreciation, amortization or write-off, or may be shifted to other categories. This principle is applicable in cash transactions. In non-cash or an exchange transaction, the cost is equal to the fair value of the asset given or fair value of the asset received, whichever is clearly evident. In the absence of fair value, the cost is equal to the book value of the asset given.

C. Accrual Basis vs. Cash Basis Accounting

The preparation of financial statements every accounting period is usually based on accrual accounting - that income is recognized when earned regardless of when received and expense is recognized when incurred regardless of when paid. Cash basis on the other hand, recognizes income only when cash received and expenses only when cash is paid.

D. Current Assets and Liabilities vs. Non-current Items

Assets and Liabilities are classified only into two, current and non-current items. Separate classification is useful by distinguishing between assets and liabilities that are continuously used in determining working capital from those used in long-term operations. Current assets are those resources expected to be utilized for current operations and current liabilities are those expected to be paid within the operating cycle the operating period being usually one year. Assets and liabilities not within the classification of current are deemed non-current items.

Balance Sheet, Income Statement and Cash Flow Statement.

A balance sheet is a formal statement showing the financial position of an enterprise as of a particular date. The balance sheet presents the three elements of financial position namely, assets, liabilities and equity. The balance sheet highlights the accounting equation which provides: Assets = Liabilities + Equity. In a balance sheet presentation, assets and liabilities are further classified into current and non-current to distinguish those used directly for operations as to those for long-term usage. An income statement is a formal statement prepared for a given period of time showing the performance of the enterprise. Performance is primarily measured in terms of the level of income earned by through the effective and efficient use of its resources. An income statement generally follows the equation: Net Sales/Revenue - Direct and Operating Expenses = Income. The Statement of Cash flow provide information about the historical changes in cash and cash equivalents which classifies cash flows during the period from operating, investing, and financing activities.

For the companies Ford Motor Company, Microsoft and ExxonMobil, the preparation of financial statements under the sound basis of accrual accounting would be more useful in the presentation of financial statements. The accrual basis renders a much reliable source of information about the financial position and performance as to the company's financial representations. Such information may be used to a much accurate and meaningful decision making of its users.