Financials to accurately interpret

In accounting, the term relevance means it will make a difference to a decision maker. For example, in the decision to replace equipment that has been used for the past six years, the original cost of the equipment does not have relevance. In other words, the original cost is irrelevant or is not relevant in the decision to replace the equipment. What will have relevance are the future amounts, such as the cost of the new equipment, and the savings that will occur when the old equipment is replaced.

Here’s another expression of relevance: Costs that will differ among alternatives. Costs that will not differ among alternatives do not have relevance. In order to have relevance, accounting information must be timely. Financial statements issued three weeks after the accounting period ends will have more relevance than financial statements issued several months after the period ends. Having timeliness and relevance may mean sacrificing some precision or reliability.

Consistency Principle : The consistency principle is just as the name suggests. It requires that accounts be prepared using the same method from period to period. Changes are inevitable, however when these changes are made the accountant is required to explain the change in the notes to the financials. This principle is very important, as different methods of preparing the accounts may render completely different results. This would make it difficult for users of the

Financials to accurately interpret the financial results. Without the consistency principle, unscrupulous accountants would be able to change methods in an attempt to manipulate the Accounting principles 5 results. The consistency principle also ensures that the method used to allocate cost is the same method used to establish the value of assets. Separate Legal Entity Concept : It is important that the accounts of the business be kept separate from the personal accounts of the owners.

The business is what is referred to as a separate legal entity and maintains its separate accounts. For those with advanced knowledge in accounting, you will realize that this applies not only to small companies but to large complicated companies as well. For example, the payment of dividends which is a transaction between the business and its owners (basically the owners withdrawing cash or other assets from the business) is not treated as an expense, but as distribution to owners.

The Matching Principle : The great and mighty matching principle! This principle is the one to remember, because it cuts deep into what accounting is all about. This principle states simply that the expense incurred to generate the revenue earned in this period should be expensed in this period as well. So the expense should be recorded in the same period the revenue is earned. Keep that info close to your heart, it’s that important.