IGCSE Accounting Ch 26: Accounting Principles

Chapter 26

Accounting Principles

Accounting principles are common rules, concepts or conventions used when preparing financial statements. They help businesses prepare accounts in a consistent way so that users can compare and understand the information more easily.

MatchingBusiness entityConsistencyDualityGoing concernHistoric costMaterialityMoney measurementPrudenceRealisation

Overview of the ten accounting principles

Topic 1: Why Accounting Principles Matter

Common principles stop businesses from preparing accounts in completely different ways and make comparison less difficult.

1. What are Accounting Principles?

Accounting principles are common rules used when preparing financial statements. They are also called accounting concepts or accounting conventions.

Without common principles, businesses could prepare accounts in different ways, making comparison difficult.

No.	Principle	Easy idea
1	Matching	Match income with related expenses.
2	Business entity	Business and owner are separate.
3	Consistency	Use the same methods each year.
4	Duality	Every transaction has two effects.
5	Going concern	The business is expected to continue.
6	Historic cost	Record assets at original cost.
7	Materiality	Focus on items significant enough to matter.
8	Money measurement	Record only items measurable in money.
9	Prudence	Be cautious under uncertainty.
10	Realisation	Record revenue when earned.

Topic 2: Matching, Business Entity, Consistency, Duality and Going Concern

These principles explain the timing of income and expenses, the separation of owner and business, double entry and the assumption that the business will continue.

2. Matching Principle

The matching principle states that revenue and the expenses incurred in earning that revenue should be recorded in the same accounting period. It does not matter exactly when cash is received or paid.

Example:
Commission relating to December sales = $4,000.
It is not paid until March of the following year.
The $4,000 must still be included as an expense in the year in which the December sales were earned.

This explains accrued expenses, prepaid expenses, accrued income and prepaid income.

Include income and expenses in the year to which they relate, not simply when cash moves.

3. Matching Principle and Stationery

Unused stationery is treated as a current asset because it belongs to the next accounting period.

Stationery Used = Opening Stationery + Purchases − Closing Unused Stationery

Opening stationery = $100
Purchases = $170
Closing unused stationery = $70
Stationery used = $100 + $170 − $70 = $200
Therefore, $200 is charged as the stationery expense and the unused $70 belongs to the next period.

4. Business Entity Principle

The business entity principle states that the business is treated separately from its owner. Personal transactions of the owner must not be treated as business transactions.

This applies to sole traders, partnerships and limited companies.

Example: A dentist rents a three-bedroom property for $6,000 per month. One room is used for the dental business and two rooms are used personally. Business rent = $6,000 ÷ 3 = $2,000. Only $2,000 is treated as a business expense. The remaining $4,000 is personal.

5. Owner's Capital and Drawings

The business entity principle also explains the entries for capital and drawings.

Owner action	Entry idea	Reason
Owner introduces money	Credit Capital	The business now owes more to the owner.
Owner takes business money or goods privately	Debit Drawings	Drawings reduce the owner's capital.

Business electricity includes $500 used in the owner's home.
Correction: Dr Drawings $500 and Cr Electricity $500.
The $500 is not a business expense.

6. Consistency Principle

The consistency principle states that accounting methods should normally be used consistently from one accounting period to the next.

If a business uses the straight-line method of depreciation, it should not suddenly change to the reducing balance method simply to alter its reported profit.

Consistency allows meaningful comparison between years. If a method is changed for a valid reason, the change and its effect should be properly disclosed.

7. Duality Principle

The duality principle is the basis of double-entry book-keeping. Every transaction has two effects. Therefore, for every debit there must be an equal credit.

Machinery purchased for cash = $5,000.
Machinery increases: Dr Machinery $5,000.
Cash decreases: Cr Cash $5,000.

8. Going Concern Principle

The going concern principle assumes that the business will continue operating for the foreseeable future rather than closing down soon. The textbook treats this as normally meaning at least the next 12 months.

If the business is expected to continue

Assets can continue to be used in the business.

If the business is going to liquidate

Assets would be valued at net realisable value, and the textbook states that all assets would be treated as current assets.

Topic 3: Historic Cost, Materiality and Money Measurement

These principles explain how assets are recorded, when items matter enough to record separately and why only monetary items appear in financial statements.

9. Historic Cost Principle

The historic cost principle states that assets are recorded at the amount originally paid to acquire them. The original purchase price is not changed simply because market prices rise or fall.

Premises bought in 1953:
Historic cost = $40,000
Current value = more than $150,000
The accounting record still begins with the original cost of $40,000.

Advantage

Historic cost is objective, known and verifiable.

Limitation

It may not show the asset's current economic or market value.

10. Materiality Principle

Information is material if it is important enough to affect the decisions of users of financial statements. An item that is very small and unimportant may be treated more simply.

A laminator costs only $30 and is expected to last three years. Technically, it could be treated as a non-current asset and depreciated. However, because $30 is insignificant, the business may simply record the whole $30 as an expense. This saves unnecessary accounting work without misleading users.

11. Materiality Depends on the Business

The same amount may be material to one business but not another.

A filing cabinet costing $2,000 may be insignificant for a very large multinational company. For a small business, $2,000 may be significant and therefore treated as a non-current asset.

Materiality depends on the size of the item, nature of the item, size of the business and importance to users.

12. Money Measurement Principle

The money measurement principle states that only transactions and events which can be measured reliably in money are recorded in the financial statements.

Items such as customer satisfaction, brand recognition, employee skills and efficiency of management processes are normally excluded. Even though these may be extremely valuable, there is no generally acceptable way to give them a reliable monetary value.

13. Non-Financial Factors May Still Affect Profit

Although customer loyalty is not shown as an asset, it may indirectly improve financial results.

1Customer loyalty

2Repeat purchases

3Higher sales revenue

Financial statements do not place a direct monetary value on the loyalty itself.

Topic 4: Prudence and Realisation

Prudence prevents overstatement of profit and assets. Realisation explains when revenue should be recognised.

14. Prudence Principle

The prudence principle requires accountants to be cautious when there is uncertainty.

Assets should not be overstated.
Income should not be overstated.
Liabilities should not be understated.
Expenses should not be understated.

In simple words: do not anticipate uncertain profits, but provide for probable losses.

15. Examples of Prudence

Provision for Doubtful Debts

Some customers may fail to pay, so a provision is created rather than assuming every debt will definitely be collected.

Depreciation

Non-current assets lose value. Accumulated depreciation is deducted so that assets are not overstated.

Inventory

Inventory is valued at the lower of cost and net realisable value. This also applies prudence.

16. Prudence When Principles Conflict

The textbook states that where there is a conflict between accounting principles, the prudence principle should be applied.

17. Realisation Principle

The realisation principle determines when revenue should be recognised. Revenue from a sale is recognised when it has been earned, normally when legal ownership and the risks and rewards of the goods have passed from the seller to the buyer.

A sale is not necessarily recognised when the customer places an order, promises to buy, or pays cash in advance.

18. Cash Sale and Credit Sale

Revenue can be recognised whether the sale is a cash sale or a credit sale. In a cash sale, the seller receives cash. In a credit sale, the seller receives a trade receivable.

The important point is that the sale has been realised, not whether cash has already been collected.

19. Sale or Return

Under sale or return, goods may be sent to a retailer who can return them if they remain unsold. The seller still owns the goods until the conditions for the sale are satisfied. Therefore, sending the goods does not immediately create sales revenue.

A wholesaler sends goods worth $2,000 to a retailer on sale or return. Until the retailer sells or accepts the goods under the arrangement, no sale is recognised by the wholesaler.

20. Payment Received in Advance

If a customer pays $2,500 in advance for custom-made furniture, the business does not immediately recognise the $2,500 as sales revenue. In the textbook's example, revenue is recognised when the completed furniture is delivered to the customer.

Topic 5: Exam Tables and Memory Guide

Use the principle, easy meaning and example to identify the correct concept in exam questions.

21. Quick Principles Table

Principle	Easy meaning	Example
Matching	Match income with related expenses.	Accrued expense included.
Business entity	Business separate from owner.	Personal expenses → drawings.
Consistency	Use same methods each year.	Same depreciation method.
Duality	Every transaction has two effects.	Debit + credit.
Going concern	Business expected to continue.	Assets used rather than immediately sold.
Historic cost	Record at original cost.	Building recorded at purchase cost.
Materiality	Focus on significant items.	$30 asset treated as expense.
Money measurement	Record only monetary items.	Staff skills not recorded as asset.
Prudence	Be cautious under uncertainty.	Provision for doubtful debts.
Realisation	Record revenue when earned.	Sale recognised when ownership passes.

Common Exam Clues

If the question says...	Principle
Accruals or prepayments	Matching
Owner's private transaction	Business entity
Same method every year	Consistency
Two entries for every transaction	Duality
Business expected to continue	Going concern
Original purchase price	Historic cost
Small insignificant amount	Materiality
Cannot measure in money	Money measurement
Do not overstate profit/assets	Prudence
Revenue recognised when earned	Realisation

Remember

Matching

Same accounting period.

Business Entity

Owner ≠ Business.

Consistency

Same methods.

Duality

Two effects.

Going Concern

Business will continue.

Historic Cost

Original cost.

Materiality

Significant enough to matter.

Money Measurement

Must be measurable in money.

Prudence

Do not overstate assets or profit.

Realisation

Revenue recognised when earned.