What are Financial Accounting Principles with Solved Practical Exercises?

Have you ever tried to solve a mathematical problem without knowing the rules for solving it? If the answer is that you cannot reach a solution if you ignore mathematical laws, the same applies to accounting; you can never arrive at correct financial statements and cannot control all accounting operations without following financial accounting principles.

Financial accounting principles are a set of laws and methods that you must apply to your accounting operations. There are two types of internationally declared and agreed-upon financial accounting principles:  
 

• Generally Accepted Accounting Principles (GAAP) are American standards.
• International Financial Reporting Standards (IFRS), which are European or generally non-American standards.

Each country follows one of these two standards according to its laws to regulate accounting. You must know the principles it follows and consider the differences between them. Generally, we can address standards that are considered neutral or more widespread, and you'll find much in common between both American and international principles, while you must pay attention to the precise differences.  

 

What Financial Accounting Principles Should You Know?

Financial accounting principles are fundamental concepts that help ensure accuracy and transparency in accounting records. Learn about financial accounting principles in the following points:  
 

1- Regularity Principle

The accountant must adhere to accounting rules and commonly accepted methods as one of the financial accounting principles.  
 

2- Accrual Principle

The accrual principle is applied to revenue when it is recognized. The principle states that accounting transactions should be recorded when they occur without waiting to receive money in cash form.

If you sell some products on credit or by credit card, you must record these revenues as they appear in the invoices, without waiting for the customer to pay the money, and the same applies to expenses.  
 

3- Matching Principle: Matching Revenues with Expenses

One of the financial accounting principles is the matching principle. In other words, how do you determine net income for a specific accounting period?

The intuitive method is to compare expenses with revenues, and the difference between them is your profit! This intuitive method is considered an extremely important accounting principle that depends on dividing accounting work into financial periods that are closed to begin the next accounting period.

Therefore, the net revenues for this period can be easily determined by listing profits and expenses and matching them, while adhering to other financial accounting principles such as accrual and conservatism.  
 

4- Conservatism Principle

Conservatism means being cautious about recording unrealized revenues or gains, which would mislead the company into believing it is achieving profits and growth while it is actually losing or achieving gains less than those it recorded.

The conservatism principle, one of the financial accounting principles, refers to the necessity of calling on accountants to record expected losses while postponing the recording of profits until they actually occur. When evaluating assets, the valuation with the least effect on realized profits and capital is taken, and therefore, the results of the balance sheet are used.  
 

5- Historical Cost Principle

Of course, the value of assets you purchase as well as liabilities changes over time, as the economic situation is always fluctuating and prices change. You won't find the piece of land on which you built your factory 10 years ago at the same price you bought it for.

Here, the historical cost principle takes the most stable form, even if it's not the most expressive of current value. The accounting principle states that assets and liabilities should be recorded at their value at the time of purchase or transaction, and this value should be calculated in financial statements during all subsequent years to the time of purchase, without the need to continuously revalue and record new prices.  
 

6- Consistency Principle

The consistency principle is also known as the uniformity principle or simply the consistency principle. It is one of the financial accounting principles and states that accounting methods followed should not be changed, and when forced to change them, the change and its effect on accounting and financial aspects must be disclosed.

The reason for this is that changing the accounting methods followed leads to changes in profits and costs, and therefore financial reports and the company's position. This is an entry point for manipulation that can be pursued by the accountant or company management to present incorrect profits or costs and therefore influence those to whom reports are presented, such as managers and investors, convincing them to make decisions based on misleading data, as well as to hide fraud and theft cases.  
 

7- Materiality Principle

All accounting transactions should be accurate and extremely precise, but time is not sufficient to treat all elements with the same degree of attention and effort. What to do if the accountant has 200 elements in front of him, one costing 2 million pounds and another costing 500 pounds, and the time he has is limited, and he must apply accounting rules to all?

Should he give all elements the same time and focus?

The materiality principle states that the most important comes first and deserves effort, and we descend gradually, so that the elements that did not get their share of accuracy are simple elements that can be easily ignored without affecting the results of financial statements and others.  
 

8- Going Concern Principle

Companies may end at any time, but as long as they exist, their continuation forever is assumed, meaning that budget, financial reports, and asset depreciation calculations are prepared on the basis of permanent continuation to avoid falling into the confusion of uncertainty.

Should I calculate asset depreciation over 8 years, or might we not continue? The financial accounting principle states to calculate it and assume that the asset will continue.  
 

9- Full Disclosure Principle

It is known that financial statements are among the types of non-confidential accounting data that investors, employees, and any other person can view. Therefore, when writing financial statements, it is taken into account that disclosure is made completely, so that the institution does not hide some data or manipulate it under the pretext of financial and accounting authority. As long as the statement is available for sharing, sharing is done properly and completely without misleading data.

Also, in internal data, where it is reviewed by financial analysts and accounting auditors, even if the nature of the data is confidential and is not announced to everyone, all details must be mentioned, and no financial statement should be hidden for any purpose.  
 

10- Reliability Principle

The economic entity principle is also called the accounting units principle, and this principle considers the company or institution as an independent entity, so it does not mix the company's revenues, for example, with the company managers' revenues. This principle is also dealt with legally in most types of companies.  
 

13- Monetary Unit Principle

The monetary unit principle means using money as a means of expressing the company's assets, so that it is fixed and unified and can be easily measured. No other value for financial transactions,  such as gold or bartering, is approved, but the monetary currency in its different forms, such as the pound, riyal, or dollar.  
 

14- Time Period Principle

The time period principle is called the accounting period, and it means dividing accounting work into periods, usually a fiscal year, during which accounting operations are calculated, and financial reports are issued and budgets are planned based on this period.

Each organization controls its own fiscal year and start and closing times. Sometimes the periodicity principle is expressed, meaning the issuance of financial reports repeatedly at agreed-upon time intervals, every 3 months, for example, or 6 months.  
 

What is the Difference Between IFRS and GAAP software?

There are many accounting policies or financial accounting principles that institutions follow in various countries around the world, but as we mentioned earlier, the two most famous software are the International Financial Reporting Standards (IFRS) software and the Generally Accepted Accounting Principles (GAAP) software. The following are the most prominent differences between the two software  
 

What is the International Financial Reporting Standards (IFRS) software?

These are a set of global standards that companies must comply with, issued by the International Accounting Standards Board (IASB), which determine how accountants maintain their accounts and prepare their reports.

The primary objective behind creating the International Financial Reporting Standards software is to establish a common accounting language that helps understand business and accounts between companies regardless of the company's domicile; this is to maintain stability and transparency around the world. This software also helps prepare financial reports that enhance the ability of companies and investors to accurately identify the financial position of a company, ultimately contributing to making informed and well-studied financial decisions.

Many countries around the world rely on this software in their economic institutions, such as the European Union and many countries in Asia and South America.  
 

What is the Generally Accepted Accounting Principles (GAAP) software?

Institutions operating within the United States should follow the Generally Accepted Accounting Principles when creating their financial statements, as this software addresses various matters such as revenue recognition, balance sheet, item classification, outstanding share measurements, and others.

This software was created by the Financial Accounting Standards Board (FASB), and GAAP regulations require companies to identify non-GAAP measures in the financial statements and public disclosures they issue, such as press releases.  
 

What is the Difference Between IFRS and GAAP software?

The difference between the two software lies in the fact that the International Financial Reporting Standards software provides much less detail than the Generally Accepted Accounting Principles software, leading to room for interpretation, while making it more logical and better representing business transactions.

The two software also differ in how they treat inventory, where the International Financial Reporting Standards software prohibits the use of the Last In, First Out (LIFO) method when calculating inventory, while the GAAP software allows the use of this method. However, both software agree on using the First In, First Out (FIFO) method and the weighted average cost method.

Regarding investments, when a company holds investments such as stocks, bonds, and others in its balance sheet, those investments and their value changes must be calculated. Both GAAP and IFRS require classifying those investments into separate categories based on the type of asset. However, the main difference between the two software appears in how they recognize income or profits from investment, where GAAP relies heavily on the legal form of the asset or contract, while IFRS does not give the same importance to the legal framework and relies only on the timing of receiving cash flows.  

 

What is the Financial Accounting Principles Book?

If you want to learn about all financial accounting principles in more detail, we encourage you to constantly refer to scientific references and books. We recommend a book that is among the most important accredited books in accounting curricula, containing accounting principles with explanation, detail, and examples. To download the book, click here.

Adhering to financial accounting principles is non-negotiable, and whether you follow the American standard or the international standard, controlling your accounting operations depends on adhering to financial accounting principles and applying them properly, not just formal compliance. One error in one principle may reflect misleading and unrealistic results in financial statements and reports, leading to a series of incorrectly calculated decisions.

The Daftra software provides you with all the programs and tools that help you apply various financial accounting principles. The software is committed to providing and making available all financial information transparently, such as the income statement, financial position statement, and others.
 

Read more: The Importance and Types of Accounting Books.

 

Solved Financial Accounting Principles Exercises

Here is the solution to financial accounting principles problems:
 

On January 1, 2020, Golden Star Company purchased a delivery truck from Taiwan for 10,000 pounds and transportation costs to Egypt:

Shipping costs: 500 pounds Customs fees: 300 pounds Sales tax: 1,000 pounds Operating expenses: 200 pounds

The truck's useful life is 4 years, and when sold as scrap, its price will be 2,000 pounds. On January 1, 2022, some renovations were made for 2,800 pounds, then they reassessed the useful life to become 5 years.

On January 1, 2023, the truck was sold for 6,000 pounds. 
 

• Depreciation using the straight-line method.
• Payment method: Cash.

  Calculate:

Record depreciation entries and other entries for all years Extract the net book value of the truck at the end of each year as in the balance sheet Solution:
 

First Year 2020:

On January 1, 2020, the truck cost is recorded in the books where the purchase price and all expenses = (10,000+500+300+1,000+200=12,000 pounds)  

 At the end of 2020, i.e., December 31, 2020, the depreciation expense is calculated as follows:

Vehicle depreciation expense = (12,000 - 2,000) / 4 = 2,500

The following entry is recorded on December 31, 2020:  

  The net book value of the vehicle appears in the statement of financial position for December 31, 2020, as follows:  

 Second Year 2021:

In the second year, i.e., December 31, 2021, the depreciation entry is recorded as in the first year, so the total accumulated depreciation equals (2,500+2,500=5,000 pounds). The net book value of the vehicle on December 31, 2021, appears as follows:  

Third Year 2022:

On January 1, 2022, the entry for purchasing new parts and renovations is recorded and charged to the vehicle cost as follows:  

On December 31, 2022, the new depreciation expense is calculated as follows:

New depreciation expense = ((7,000+2,800) - 2,000) / 3 = 2,600

The following entry is recorded on December 31, 2022:  

  
The net book value of the vehicle will appear in the statement of financial position as of December 31, 2022, as follows:  

  
Fourth Year 2023:

On January 1, 2023, when the company sells the vehicle, the vehicle account and accumulated depreciation account are closed, and the profit or loss realized from the sale is recorded by comparing the net book value of the vehicle with the selling price, which equals 6,000 - 7,200 = 1,200 pounds (loss). The following closing entry is recorded:  

Frequently Asked Questions

What is the meaning of financial accounting principles?

The meaning of financial accounting principles is a set of principles or rules that standardize the process of recording, documenting, summarizing, and analyzing financial data to achieve a fundamental objective, which is to provide comprehensive and reliable financial information to assist various parties in making optimal administrative and financial decisions.  
 

How do I learn accounting principles?

If you want to learn financial accounting principles, you must first understand the fundamentals of accounting, which are assets, liabilities, and equity.

Second, learn how to read and analyze financial reports such as the income statement, balance sheet, and others.

The third step is watching educational videos that explain accounting concepts. You can follow Daftra accounting software videos on YouTube to learn various sections of the accounting program and gain general benefits from all accounting departments.  
 

What are the fundamentals of financial accounting principles?

The fundamentals of financial accounting principles are summarized in recording, documenting, and analyzing financial data in a standardized way among all companies of different industries and objectives.  
 

What are public accounting principles?

Public accounting principles are fundamental rules used in organizing and managing public funds and ensuring transparency in the use of funds and achieving public interest objectives.  
 

What are the objectives of accounting principles?

The objectives of financial accounting principles are to provide accurate and quality financial information, facilitate comparison between financial reports of different companies, and support reliable financial decision-making. What is the difference between accounting principles and accounting standards? The difference between accounting principles and accounting standards is that accounting standards are based on financial accounting principles. Accounting principles are referred to as general guidelines for applying rules in the accounting software, while standards are specific procedures that must be followed to implement the principles.  
 

How many accounting principles are there?

Financial accounting principles are eight.

Accrual principle, revenue and expense matching principle, historical cost principle, consistency principle, conservatism principle, materiality principle, disclosure principle, and going concern principle.  
 

What are the most important accounting principles for non-accountants?

The most important accounting principles for non-accountants are understanding basic financial statements and how to analyze financial data in prepared statements and reports, and how they affect administrative and financial decisions.