Principles of Accounting for Working with QuickBooks 2012 - dummies

Principles of Accounting for Working with QuickBooks 2012

By Stephen L. Nelson

Accounting rests on a rather small set of fundamental assumptions and principles, which you need to understand when working with QuickBooks 2012. People often refer to these fundamentals as generally accepted accounting principles.

Revenue principle of accounting

The revenue principle, also known as the realization principle, states that revenue is earned when the sale is made. The sale is made, typically, when goods or services are provided. A key component of the revenue principle, when it comes to the sale of goods, is that revenue is earned when legal ownership of the goods passes from seller to buyer.

Note that revenue isn’t earned when you collect cash for something. It turns out, perhaps counterintuitively, that counting revenue when cash is collected doesn’t give the business owner a good idea of what sales really are.

Some customers may pay deposits early, before actually receiving the goods or services. Often customers want to use trade credit, paying a firm at some point in the future for goods or services. Because cash flows can fluctuate wildly — even something like a delay in the mail can affect cash flow — you don’t want to use cash collection from customers as a measure of sales.

Besides that, you can easily track cash collections from customers. So why not have the extra information about when sales actually occur?

Expense principle of accounting

The expense principle states that an expense occurs when the business uses goods or receives services. In other words, the expense principle is the flip side of the revenue principle. As is the case with the revenue principle, if you receive some goods, simply receiving the goods means that you’ve incurred the expense of the goods.

Similarly, if you received some service — services from your lawyer, for example — you have incurred the expense. It doesn’t matter that your lawyer takes a few days or a few weeks to send you the bill. You incur an expense when goods or services are received.

Matching principle of accounting

The matching principle is related to the revenue and the expense principles. The matching principle states that when you recognize revenue, you should match related expenses with the revenue. The best example of the matching principle concerns the case of businesses that resell inventory.

Don’t count the expense when you buy inventory. Count the expense when you sell it. In other words, match the expense of the item with the revenue of the item.

Accrual-based accounting, which is a term you’ve probably heard, is what you get when you apply the revenue principle, the expense principle, and the matching principle. In a nutshell, accrual-based accounting means that you record revenue when a sale is made and record expenses when goods are used or services are received.

Cost principle of accounting

The cost principle states that amounts in your accounting system should be quantified, or measured, by using historical cost. For example, if you have a business and the business owns a building, that building, according to the cost principle, shows up on your balance sheet at its historical cost.

You don’t adjust the values in an accounting system for changes in a fair market value. You use the original historical costs.

The cost principle is occasionally violated in a couple of ways. The cost principle is adjusted through the application of depreciation. Also, sometimes fair market values are used to value assets, but only when assets are worth less than they cost.

Objectivity principle of accounting

The objectivity principle states that accounting measurements and accounting reports should use objective, factual, and verifiable data. In other words, accountants, accounting systems, and accounting reports should rely on subjectivity as little as possible.

An accountant always wants to use objective data (even if it’s bad) rather than subjective data (even if the subjective data is arguably better). The idea is that objectivity becomes a protection against the corrupting influence that subjectivity can introduce into a firm’s accounting records.