What Is Accounting
Theory?
It’s essential for accountants and business
owners alike to understand basic
accounting concepts. The principles
behind these theories have given rise over
time to the actual practices employed by
accountants to ensure finances are
properly managed and tracked. There are
several principles considered part of basic
accounting theory, including cost principle,
matching principle, materiality,
conservatism and monetary unit
assumption.
Cost principle: This principle
requires recording assets as soon as they
are acquired. These can range from things
as simple as office supplies and factory
equipment to new franchises. Depending
on the sorts of assets you are recording,
it’s possible that they will depreciate over
time. However, they should still be
documented when you acquire them.
Matching principle: This principle
requires that all transactions associated
with a particular type of revenue be kept
together and reported as a unit. Under the
matching principle theory, expenses are
always reported in the same period, such
as a month, quarter or year, and the
associated income is recorded. This theory
exists only in the accrual method of
accounting. For instance, if your company
has a salesperson who earns $2,000 in
commissions for work done in January, the
expense for this should be recorded in
January, even if you do not pay the
employee until the next month. This
principle requires accountants to be careful
and always consistent in their
documentation.
Materiality: The notion of materiality
states that a standard of accounting can be
ignored, as long as the net result of doing
so will have a small enough impact on the
books that no one reviewing them would
be misled. Careful judgment must be
exercised when determining whether a
specific transaction is important enough
since materiality does not outline
specifically which transactions are deemed
most impactful.
For instance, if you have a minor expense
that will be spread out over a period of a
year, such as your wireless internet
charge, it might not matter whether that
$240 is accounted for when you first sign
the contract versus split into $20
increments over the 12 months it will
impact. Materiality changes depending on
the size of the company in question, too,
since smaller budgets require that more
attention is paid to each amount spent, as
it represents a larger portion of the whole.
The Securities and Exchange Commission
suggests that a line item that represents
less than 5 percent of a budget need not
be accounted for, but that anything over
that amount should be.
Conservatism: This principle deals
with liabilities. To ensure that your
business holds on to enough of its money
for the bills it has on the horizon,
conservatism requires that all liabilities and
potential liabilities be recorded as soon as
they are anticipated. In this way,
companies can plan for expenses that crop
up in the future.
Monetary unit assumption: This
high-level accounting principle is
appropriate for large or global companies.
It considers the value of the dollar and
whether this value might remain consistent
or change over time. By anticipating the
potential fluctuations of currency, it can
help businesses plan for future ramping up
of business, expansion of production
facilities or investment opportunities.