Financial statements are prepared according to agreed upon guidelines. In order to understand these guidelines, it helps to understand the objectives of financial reporting.
To prepare the financial statements, it is important to adhere to certain fundamental accounting concepts. Going Concern, unless there is evidence to the contrary, it is assumed that a business will continue to trade normally for the foreseeable future.
Accruals and Matching
Revenue earned must be matched against expenditure when it was incurred
If there are two acceptable accounting procedures, choose the one that gives the less optimistic view of profitability and asset values.
Similar items should be accorded similar accounting treatments.
A business is an entity distinct from its owners.
Accounts only deal with items to which monetary values can be attributed. This helps existing investors, potential investors, creditors, and other users to assess the amounts, timing, and uncertainty of prospective net cash inflows to the enterprise. Separate valuation of each asset or liability must be valued separately.
Only items material in amount or in their nature will affect the true and fair view given by a set of accounts.
Transactions are recorded at the cost when they occurred.
Revenue and profits are recognized when realized. Every transaction has dual effects.