What Are Accounting Principles?

Accounting principles are the rules and guidelines that companies and other bodies must follow
when reporting financial data. These rules make it easier to examine financial data by
standardizing the terms and methods that accountants must use.

The International Financial Reporting Standards (IFRS) is the most widely used set of
accounting principles, with adoption in 167 jurisdictions. The United States uses a separate set
of accounting principles, known as generally accepted accounting principles (GAAP).1

International Financial Reporting Standards (IFRS) Foundation. “Who Uses IFRS

Accounting Standards? ”
KEY TAKEAWAYS

 Accounting standards are implemented to improve the quality of financial information

reported by companies.
 In the United States, the Financial Accounting Standards Board (FASB) issues generally
accepted accounting principles (GAAP).
 GAAP is required for all publicly traded companies in the U.S.; it is also routinely
implemented by non-publicly traded companies as well.
 Internationally, the International Accounting Standards Board (IASB) issues International
Financial Reporting Standards (IFRS).
 The FASB and the IASB sometimes work together to issue joint standards on hot-topic
issues, but there is no intention for the U.S. to switch to IFRS in the foreseeable future.
Ryan Oakley / Investopedia

The Purpose of Accounting Principles

The ultimate goal of any set of accounting principles is to ensure that a company’s financial
statements are complete, consistent, and comparable.

This makes it easier for investors to analyze and extract useful information from the company’s
financial statements, including trend data over a period of time. It also facilitates the comparison
of financial information across different companies. Accounting principles also help mitigate
accounting fraud by increasing transparency and allowing red flags to be identified.

The ultimate goal of standardized accounting principles is to allow financial statement users to
view a company’s financials with certainty that the information disclosed in the report is
complete, consistent, and comparable.

Comparability

Comparability is the ability for financial statement users to review multiple companies’
financials side by side with the guarantee that accounting principles have been followed to the
same set of standards.

Accounting information is not absolute or concrete, and standards are developed to minimize the
negative effects of inconsistent data. Without these rules, comparing financial statements among
companies would be extremely difficult, even within the same industry. Inconsistencies and
errors also would be harder to spot.

What Are the Basic Accounting Principles?

Some of the most fundamental accounting principles include the following:

 Accrual principle
 Conservatism principle
 Consistency principle
 Cost principle
 Economic entity principle
 Full disclosure principle
 Going concern principle
 Matching principle
 Materiality principle
 Monetary unit principle
 Reliability principle
 Revenue recognition principle
 Time period principle
The most notable principles include the revenue recognition principle, matching principle,
materiality principle, and consistency principle. Completeness is ensured by the materiality
principle, as all material transactions should be accounted for in the financial statements.
Consistency refers to a company’s use of accounting principles over time.

When accounting principles allow a choice among multiple methods, a company should apply
the same accounting method over time or disclose its change in accounting method in
the footnotes to the financial statements.

Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles (GAAP) are uniform accounting principles for private
companies and nonprofits in the U.S. These principles are largely set by the Financial
Accounting Standards Board (FASB), an independent nonprofit organization whose members are
chosen by the Financial Accounting Foundation.2

A similar organization, the Governmental Accounting Standards Board (GASB), is responsible

for setting the GAAP standards for local and state governments.3 And a third body, the Federal
Accounting Standards Advisory Board (FASAB), publishes the accounting principles for federal
agencies.4

Although privately held companies are not required to abide by GAAP, publicly traded
companies must file GAAP-compliant financial statements to be listed on a stock exchange.
Chief officers of publicly traded companies and their independent auditors must certify that the
financial statements and related notes were prepared in accordance with GAAP.5

Privately held companies and nonprofit organizations also may be required by lenders or
investors to file GAAP-compliant financial statements. For example, annual audited GAAP
financial statements are a common loan covenant required by most banking institutions.
Therefore, most companies and organizations in the U.S. comply with GAAP, even though it is
not a legal requirement.

Accounting principles differ around the world, meaning that it’s not always easy to compare the
financial statements of companies from different countries.

International Financial Reporting Standards (IFRS)

The International Accounting Standards Board (IASB) issues International Financial Reporting
Standards (IFRS). These standards are used in more than 120 countries, including those in the
European Union (EU).6

The Securities and Exchange Commission (SEC), the U.S. government agency responsible for
protecting investors and maintaining order in the securities markets, has expressed interest in
transitioning to IFRS. However, because of the differences between the two standards, the U.S.
is unlikely to switch in the foreseeable future.5

However, the FASB and the IASB continue to work together to issue similar regulations on
certain topics as accounting issues arise.7 For example, in 2014, the FASB and the IASB jointly
announced new revenue recognition standards.8

Since accounting principles differ around the world, investors should take caution when
comparing the financial statements of companies from different countries. The issue of differing
accounting principles is less of a concern in more mature markets. Still, caution should be used,
as there is still leeway for number distortion under many sets of accounting principles.

Who sets accounting principles and standards?

Various bodies are responsible for setting accounting standards. In the United States, generally
accepted accounting principles (GAAP) are regulated by the Financial Accounting Standards
Board (FASB). In Europe and elsewhere, International Financial Reporting Standards (IFRS) are
established by the International Accounting Standards Board (IASB).

How does IFRS differ from GAAP?

IFRS is a standards-based approach that is used internationally, while GAAP is a rules-based
system used primarily in the U.S. IFRS is seen as a more dynamic platform that is regularly
being revised in response to an ever-changing financial environment, while GAAP is more static.

Several methodological differences exist between the two systems. For instance, GAAP allows
companies to use either first in, first out (FIFO) or last in, first out (LIFO) as an inventory cost
method. LIFO, however, is banned under IFRS.910

When were accounting principles first set forth?

Standardized accounting principles date all the way back to the advent of double-entry
bookkeeping in the 15th and 16th centuries, which introduced a T-ledger with matched entries
for assets and liabilities.11 Some scholars have argued that the advent of double-entry
accounting practices during that time provided a springboard for the rise of commerce and
capitalism. What would become the American Institute of Certified Public Accountants (AICPA)
and the New York Stock Exchange (NYSE) attempted to launch the first accounting standards to
be used by firms in the United States in the 1930s.12

What are some critiques of accounting principles?

Critics of principles-based accounting systems say they can give companies far too much
freedom and do not prescribe transparency. They believe because companies do not have to
follow specific rules that have been set out, their reporting may provide an inaccurate picture of
their financial health. In the case of rules-based methods like GAAP, complex rules can cause
unnecessary complications in the preparation of financial statements. These critics claim having
strict rules means that companies must spend an unfair amount of their resources to comply with
industry standards.

The Bottom Line

Accounting principles are rules and guidelines that companies must abide by when reporting
financial data. Whether it’s GAAP in the U.S. or IFRS elsewhere, the overarching goal of these
principles is to boost transparency and basically make it easier for investors to compare the
financial statements of different companies.

Without these rules and standards, publicly traded companies would likely present their financial
information in a way that inflates their numbers and makes their trading performance look better
than it actually was. If companies were able to pick and choose what information to disclose and
how, it would be a nightmare for investors.

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ARTICLE SOURCES
PART OF
Guide to Accounting

Accounting Explained With Brief History and Modern Job Requirements
1 of 51


What Is the Accounting Equation, and How Do You Calculate It?
2 of 51


What Is an Asset? Definition, Types, and Examples
3 of 51


Liability: Definition, Types, Example, and Assets vs. Liabilities
4 of 51


Equity Definition: What it is, How It Works and How to Calculate It
5 of 51

Revenue Definition, Formula, Calculation, and Examples
6 of 51


Expense: Definition, Types, and How Expenses Are Recorded
7 of 51


Current Assets vs. Noncurrent Assets: What's the Difference?
8 of 51


What Is Accounting Theory in Financial Reporting?
9 of 51


Accounting Principles Explained: How They Work, GAAP, IFRS
10 of 51


Accounting Standard Definition: How It Works
11 of 51


Accounting Convention: Definition, Methods, and Applications
12 of 51


What Are Accounting Policies and How Are They Used? With Examples
13 of 51


How Are Principles-Based and Rules-Based Accounting Different?
14 of 51


What Are Accounting Methods? Definition, Types, and Example
15 of 51


What Is Accrual Accounting, and How Does It Work?
16 of 51


Cash Accounting Definition, Example & Limitations
 17 of 51


Accrual Accounting vs. Cash Basis Accounting: What's the Difference?
18 of 51


Financial Accounting Standards Board (FASB): Definition and How It Works
19 of 51


Generally Accepted Accounting Principles (GAAP): Definition, Standards
and Rules
20 of 51


What Are International Financial Reporting Standards (IFRS)?
21 of 51


IFRS vs. GAAP: What's the Difference?
22 of 51


How Does US Accounting Differ From International Accounting?
23 of 51


Cash Flow Statement: What It Is and Examples
24 of 51


Breaking Down The Balance Sheet
25 of 51


Income Statement: How to Read and Use It
26 of 51


What Does an Accountant Do? Duties, Rules, Skills, and History
27 of 51


Financial Accounting Meaning, Principles, and Why It Matters
28 of 51

How Does Financial Accounting Help Decision-Making?
29 of 51


Corporate Finance Definition and Activities
30 of 51


How Financial Accounting Differs From Managerial Accounting
31 of 51


Cost Accounting: Definition and Types With Examples
32 of 51


Certified Public Accountant: What the CPA Credential Means
33 of 51


What Is a Chartered Accountant (CA) and What Do They Do?
34 of 51


Accountant vs. Financial Planner: What's the Difference?
35 of 51


Auditor: What It Is, 4 Types, and Qualifications
36 of 51


Audit: What It Means in Finance and Accounting, and 3 Main Types
37 of 51


Tax Accounting: Definition, Types, vs. Financial Accounting
38 of 51


Forensic Accounting: What It Is, How It's Used
39 of 51


Chart of Accounts (COA) Definition, How It Works, and Example
40 of 51
 
What Is a Journal in Accounting, Investing, and Trading?
41 of 51


Double Entry: What It Means in Accounting and How It's Used
42 of 51


Debit: Definition and Relationship to Credit
43 of 51


Credit: What It Is and How It Works
44 of 51


Closing Entry
45 of 51


What Is an Invoice? It's Parts and Why They Are Important
46 of 51


6 Components of an Accounting Information System (AIS)
47 of 51


Inventory Accounting: Definition, How It Works, Advantages
48 of 51


Last In, First Out (LIFO): The Inventory Cost Method Explained
49 of 51


FIFO: What the First In, First Out Method Is and How to Use It
50 of 51


Average Cost Method: Definition and Formula with Example
51 of 51

Related Terms
Accounting Principles Board (APB): What it Means, How it Works
The Accounting Principles Board, now defunct, was a precursor to the
Financial Accounting Standards Board (FASB).
more
Generally Accepted Accounting Principles (GAAP): Definition, Standards and
Rules
GAAP is a set of generally accepted accounting principles widely used in the
U.S. for financial reporting by corporations and government entities.
more
What Does an Accountant Do? Duties, Rules, Skills, and History
An accountant is a certified financial professional who performs functions
such as audits or financial statement analysis according to prescribed
methods.
more
Handelsgesetzbuch (HGB): The Commercial Code of Germany
Handelsgesetzbuch is a law that governs the commercial code for German
companies and includes regulations on the preparation of financial
statements.
more
Understanding International Accounting Standards (IAS)
International Accounting Standards (IAS) were a set of rules for financial
reporting that were replaced in 2001 by International Financial Reporting
Standards (IFRS).
more
Accounting Standards Executive Committee (AcSEC)
Accounting Standards Executive Committee (AcSEC) is now called the
Financial Reporting Executive Committee.
more