Introduction
Accounting principles are the fundamental rules and guidelines that govern the field of accounting. They provide the framework for recording, analyzing, and reporting financial transactions, ensuring consistency, accuracy, and comparability across financial statements. These principles have evolved over centuries and are now standardized through frameworks like Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). This cheatsheet provides a comprehensive reference to these essential principles, their applications, and their impact on financial reporting.
Core Accounting Principles
Foundational Principles
| Principle | Definition | Application | Impact on Financial Statements |
|---|---|---|---|
| Accrual Basis | Record revenues when earned and expenses when incurred, regardless of when cash changes hands | Revenue recognized when goods delivered or services performed; expenses recorded when resources consumed | More accurate matching of revenues and expenses to the periods they relate to |
| Going Concern | Assumes that a business will continue to operate indefinitely | Assets valued based on ongoing use rather than liquidation value; allows for depreciation of assets over useful life | Affects asset valuation, liability recognition, and disclosure requirements |
| Monetary Unit | Financial information recorded and reported in a stable currency unit | All transactions converted to the reporting currency; requires consistent monetary measure | Enables aggregation and comparison of financial data across time |
| Time Period | Financial activities divided into specific time periods (month, quarter, year) | Requires clear cutoffs at period ends; necessitates accruals and deferrals | Allows for periodic assessment of business performance |
| Historical Cost | Assets and liabilities initially recorded at original acquisition cost | Provides verifiable, objective basis for valuing transactions | Creates reliability but may not reflect current market values |
GAAP Principles (US-Based)
| Principle | Definition | Examples | Exceptions |
|---|---|---|---|
| Revenue Recognition | Revenue recorded when realized or realizable and earned | Service company records revenue when service performed; retailer when goods delivered | Percentage of completion for long-term contracts |
| Matching | Expenses recorded in same period as related revenues | Commissions expense recorded in same period as sales revenue; direct materials matched with product sales | Period costs (rent, utilities) expensed regardless of revenue generation |
| Full Disclosure | All relevant financial information presented in financial statements or notes | Related party transactions, contingent liabilities, accounting method changes | Information can be excluded if cost of providing exceeds benefit |
| Materiality | Information is material if its omission or misstatement could influence decisions | Large asset purchases capitalized; small items expensed | Immaterial items can be handled in ways that simplify accounting |
| Conservatism | When uncertainty exists, use least favorable estimates | Inventory valued at lower of cost or market; contingent losses recorded, contingent gains not | Modern standards moving toward “neutrality” rather than pure conservatism |
| Consistency | Same accounting methods applied from period to period | Consistent depreciation methods, inventory valuation techniques | Methods can change if new method is preferable and change is disclosed |
| Cost-Benefit | Benefits of accounting information should exceed costs of providing it | Simplified methods for small entities; practical expedients | Not a basis for omitting required disclosures in formal reporting |
IFRS Principles (International)
| Principle | IFRS Approach | Key Difference from GAAP | Practical Impact |
|---|---|---|---|
| Substance Over Form | Economic reality takes precedence over legal form | More explicit than in GAAP | More principles-based judgments in transaction classification |
| Fair Value | Greater emphasis on current market values | More extensive use than historical cost model | More assets and liabilities measured at current value |
| Principles vs. Rules | Broader principles requiring professional judgment | Fewer detailed rules and bright lines | More focus on economic substance, less on technical compliance |
| Prudence | Exercise caution in making judgments under uncertainty | Similar to but less rigid than GAAP conservatism | More balanced approach to uncertainty |
| Comparability | Similar transactions treated consistently across entities | Core objective in both systems | Enables meaningful comparison between companies |
Accounting Constraints & Modifying Conventions
| Constraint | Definition | Application | Impact |
|---|---|---|---|
| Objectivity | Information based on verifiable evidence | Requires documentation, receipts, contracts | Increases reliability but may reduce relevance |
| Industry Practices | Special methods for unique industry situations | Specialized accounting for insurance, banking, oil and gas | Enhances relevance for specific industry contexts |
| Periodicity | Financial information reported at regular intervals | Necessitates allocations across artificial time boundaries | Creates need for estimates and accruals |
| Reliability | Information must be verifiable and faithful to what it represents | Prioritizes transactions with clear evidence | May limit recognition of intangible values |
| Timeliness | Information available when needed for decision-making | Trade-off between accuracy and promptness | Influences reporting deadlines and estimate usage |
Accounting Equation & Double-Entry System
The Fundamental Accounting Equation
Assets = Liabilities + Equity
| Component | Definition | Subclassifications | Balance Sheet Presentation |
|---|---|---|---|
| Assets | Resources owned or controlled with expected future benefits | Current vs. non-current; tangible vs. intangible | Listed in order of liquidity (most to least liquid) |
| Liabilities | Present obligations from past events | Current vs. non-current; operating vs. financing | Listed in order of maturity (shortest to longest term) |
| Equity | Residual interest in assets after deducting liabilities | Contributed capital vs. earned capital; retained earnings vs. reserves | Capital stock, additional paid-in capital, retained earnings |
Expanded Accounting Equation
Assets = Liabilities + Contributed Capital + Revenue – Expenses – Dividends
| Component | Impact on Equation | Financial Statement | Normal Balance |
|---|---|---|---|
| Revenue | Increases equity | Income statement | Credit |
| Expenses | Decreases equity | Income statement | Debit |
| Dividends/Withdrawals | Decreases equity | Statement of changes in equity | Debit |
Double-Entry Accounting Rules
| Account Type | Debit Effect | Credit Effect | Normal Balance | Examples |
|---|---|---|---|---|
| Asset | Increase | Decrease | Debit | Cash, accounts receivable, inventory, equipment |
| Liability | Decrease | Increase | Credit | Accounts payable, notes payable, accrued expenses |
| Equity | Decrease | Increase | Credit | Common stock, retained earnings |
| Revenue | Decrease | Increase | Credit | Sales, service fees, interest income |
| Expense | Increase | Decrease | Debit | Rent, salaries, utilities, cost of goods sold |
Accounting Concepts in Financial Statements
Balance Sheet (Statement of Financial Position)
| Section | Underlying Principles | Key Classifications | Measurement Approaches |
|---|---|---|---|
| Assets | Historical cost, matching, monetary unit | Current vs. non-current | Cost, amortized cost, fair value, recoverable amount |
| Liabilities | Full disclosure, conservatism, monetary unit | Current vs. non-current | Present value, amortized cost, settlement value |
| Equity | Entity concept, historical cost | Contributed vs. earned | Historical amounts, revaluation surpluses |
Income Statement (Statement of Comprehensive Income)
| Section | Underlying Principles | Key Classifications | Recognition Approaches |
|---|---|---|---|
| Revenue | Revenue recognition, matching, realization | Operating vs. non-operating | Point in time vs. over time recognition |
| Expenses | Matching, conservatism, accrual | Cost of sales, operating, financial, tax | Direct expensing vs. capitalization and allocation |
| Comprehensive Income | Full disclosure, all-inclusive income | OCI vs. net income | Items bypassing net income (revaluations, some FX) |
Statement of Cash Flows
| Section | Underlying Principles | Key Classifications | Presentation Methods |
|---|---|---|---|
| Operating Activities | Cash basis override of accrual | Direct vs. indirect methods | Working capital adjustments to net income (indirect) |
| Investing Activities | Asset acquisition and disposition | Capital expenditures vs. financial investments | Gross cash flows reported separately |
| Financing Activities | Capital structure changes | Debt vs. equity transactions | Gross cash flows reported separately |
Specialized Accounting Principles
Revenue Recognition Principles (ASC 606/IFRS 15)
| Step | Principle | Application | Challenges |
|---|---|---|---|
| 1. Identify Contract | Legally enforceable agreement with commercial substance | Evaluate whether collection is probable; consider combination of contracts | Multiple agreements; verbal arrangements |
| 2. Identify Performance Obligations | Distinct goods or services promised | Separate obligations that can be used independently or with readily available resources | Bundled products and services; customized solutions |
| 3. Determine Transaction Price | Amount entity expects to be entitled to | Consider variable consideration, financing components, non-cash consideration | Variable prices; rebates; returns; royalties |
| 4. Allocate Price to Obligations | Based on relative standalone selling prices | Use observable prices when available; estimate otherwise | Products never sold separately; highly variable pricing |
| 5. Recognize Revenue | When performance obligation satisfied | Point in time (control transfers) or over time (customer benefits as performed) | Determining when control transfers; measuring progress |
Leasing Principles (ASC 842/IFRS 16)
| Aspect | Principle | GAAP Approach | IFRS Approach |
|---|---|---|---|
| Lease Definition | Contract conveying right to control use of identified asset | Substantially similar to IFRS | Substantially similar to GAAP |
| Recognition | Lessees recognize right-of-use assets and lease liabilities | Two classifications: finance and operating leases (different expense patterns) | Single model: all leases treated as finance leases |
| Measurement | Present value of lease payments, plus certain costs | Include reasonably certain extension periods | Same as GAAP |
| Exemptions | Practical expedients for certain leases | Short-term leases; election for non-separation of components | Short-term and low-value asset leases |
Financial Instruments (ASC 320, 321, 326/IFRS 9)
| Aspect | Principle | Classification Categories | Measurement |
|---|---|---|---|
| Classification | Based on business model and cash flow characteristics | Amortized cost; fair value through OCI; fair value through profit/loss | Initial: transaction price; Subsequent: depends on classification |
| Impairment | Expected credit loss model | GAAP: CECL (lifetime losses at inception); IFRS: three-stage approach | Based on probability-weighted outcomes, time value of money |
| Hedge Accounting | Economic hedging relationships reflected in financial reporting | Cash flow hedges; fair value hedges; net investment hedges | Effectiveness testing; rebalancing; qualifying criteria |
Accounting for Specific Items
Inventory
| Principle | Methods Allowed | GAAP vs. IFRS | Impact on Financial Statements |
|---|---|---|---|
| Cost Flow Assumptions | FIFO, LIFO (GAAP only), weighted average | IFRS prohibits LIFO | Choice affects COGS, gross profit, ending inventory, taxes |
| Lower of Cost or Market | Compare carrying value to market value | GAAP: “market” = replacement cost (with ceiling and floor); IFRS: “net realizable value” | Creates write-downs that reduce income in period of decline |
| Capitalization of Costs | Include all costs to bring inventory to present location and condition | Both include purchase price, conversion costs, other direct costs | Affects gross margin; capitalizing more costs increases assets |
Property, Plant & Equipment
| Principle | Recognition Criteria | Measurement Models | Depreciation Approaches |
|---|---|---|---|
| Initial Recognition | Cost includes purchase price plus costs to bring to working condition | Historical cost model universal under GAAP; IFRS allows revaluation model | Component approach for significant parts with different useful lives |
| Subsequent Costs | Capitalize if future economic benefits probable and cost reliably measured | Major overhauls and replacements capitalized; repairs expensed | Judgment required for borderline expenditures |
| Depreciation | Systematic allocation of cost less residual value over useful life | Straight-line, diminishing balance, units of production | Method should reflect pattern of expected benefit consumption |
| Impairment | Write down when carrying amount exceeds recoverable amount | GAAP: two-step process; IFRS: one-step process | Recognized in income statement; may be reversed under IFRS |
Provisions & Contingencies
| Principle | Recognition Threshold | Measurement | Disclosure Requirements |
|---|---|---|---|
| Provisions | Probable obligation from past event; reliable estimate | Best estimate of expenditure required | Nature, timing, uncertainties, possible reimbursements |
| Contingent Liabilities | Possible obligation or cannot be measured reliably | Not recognized but disclosed | Nature, estimated financial effect, uncertainties |
| Contingent Assets | Not recognized until virtually certain | Disclosed when probable | Nature, estimated financial effect when possible |
Common Challenges & Solutions
Challenge: Principle Application Conflicts
| Conflict | Principles in Tension | Resolution Approach | Example |
|---|---|---|---|
| Relevance vs. Reliability | Current value info vs. verifiable historical cost | Supplemental disclosures; notes to financial statements | Historical cost on balance sheet with fair value disclosures |
| Conservatism vs. Neutrality | Prudence in uncertainty vs. unbiased representation | Professional judgment; consideration of substance | Asset impairment testing uses reasonable, not worst-case, assumptions |
| Consistency vs. Improved Methods | Same methods over time vs. adopting better techniques | Change when benefits justify; disclose impact | Change in depreciation method with quantified effects disclosed |
Challenge: Complex Transactions
| Transaction Type | Accounting Challenge | Principle-Based Solution | Example |
|---|---|---|---|
| Multiple-Element Arrangements | Separating components with different accounting treatments | Substance over form; look to underlying economics | Software sale with installation and updates – separate performance obligations |
| Hybrid Financing | Debt vs. equity classification | Analysis of contractual terms for substance | Convertible bonds separated into liability and equity components |
| Business Combinations | Fair value allocation; goodwill recognition | Acquisition method; identifiable assets and liabilities at fair value | Purchase price allocated to tangible and identifiable intangible assets, remainder to goodwill |
Challenge: Accounting Policy Selection
| Policy Area | Options Available | Guiding Principles | Strategic Considerations |
|---|---|---|---|
| Inventory Methods | FIFO, weighted average, LIFO (GAAP) | Consistency; matching | Tax effects; industry practices; operational alignment |
| Depreciation Methods | Straight-line, accelerated, units of production | Matching; pattern of consumption | Asset nature; tax planning; financial metric impact |
| R&D and Intangibles | Expense vs. capitalize (limited) | Matching; conservatism | Industry norms; financial ratio effects; predictability |
Best Practices & Practical Tips
- Documentation Framework: Establish thorough documentation for judgment-intensive areas
- Accounting Policy Manual: Develop and maintain a comprehensive manual addressing entity-specific applications
- Materiality Guidelines: Define quantitative and qualitative thresholds for significant items
- Technical Update Process: Maintain regular review of evolving standards and interpretations
- Disclosure Effectiveness: Focus on clear communication rather than technical compliance alone
- Cross-Functional Collaboration: Engage operations, legal, and other departments in complex accounting decisions
- Principle Hierarchy: Establish decision trees for resolving conflicts between principles
- Professional Skepticism: Challenge assumptions and estimates for potential bias
- Consistency Reviews: Periodically assess treatment of similar transactions across entity
- Economic Substance Focus: Always prioritize reflecting economic reality over technical form
Resources for Further Learning
Standard Setting Bodies
- Financial Accounting Standards Board (FASB) – www.fasb.org
- International Accounting Standards Board (IASB) – www.ifrs.org
- American Institute of CPAs (AICPA) – www.aicpa.org
- Securities and Exchange Commission (SEC) – www.sec.gov
Professional Resources
- Deloitte IAS Plus – Technical resource for accounting developments
- EY Financial Reporting Developments – Comprehensive guides on specific topics
- PwC Inform – Technical accounting guidance and tools
- KPMG Accounting Research Online – Interpretive guidance on standards
Educational Resources
- CPA review courses (Becker, Wiley, Roger CPA)
- Continuing Professional Education (CPE) providers
- University accounting programs with advanced courses
- Industry-specific accounting guides
Research Tools
- Accounting Standards Codification (ASC) – Authoritative source for US GAAP
- eIFRS – Electronic International Financial Reporting Standards
- Technical Inquiry Service (AICPA) – Guidance on specific accounting questions
- Professional accounting journals and publications