Accounting is not a static system; it is a dynamic process that incorporates generally accepted accounting principles (GAAP) that evolve to suit the needs of financial statement readers, such as business managers, equity owners, creditors, and governmental agencies with meaningful, dependable information. The general principles and concepts discussed in this text will include business entity, monetary unit, going concern, cost, time period, conservatism, consistency, materiality, full disclosure, objectivity, and matching principle. In addition, the gain or loss recognition on the disposal of depreciable assets will be discussed.
BUSINESS ENTITY PRINCIPLE
From an accounting, if not from a legal, point of view, the transactions of a business entity operating as a proprietorship, partnership, or corporation are considered to be separate and distinct from all personal transactions of its owners. The separation of personal transactions of the owners from the business entity must be maintained, even if the owners work in or for the business entity. Only the effects to assets, liabilities, ownership equity, and other transactions of the business entity are entered to the organization’s accounting records. The ownership’s personal assets, debts, and expenses are not part of the business entity.
MONETARY UNIT PRINCIPLE
The assumption of the monetary unit principle is that the primary national monetary unit is used for recording numerical values of business exchanges and operating transactions. The U.S. monetary unit is the dollar. Thus, the accounting function in our case records the dollar value of sales revenue inflows and expense outflows of the business entity during its operations. The monetary unit of the dollar also expresses financial information within the financial statements and reports. Information provided and maintained in the accounting system is recorded in dollars.
GOING CONCERN PRINCIPLE
Under normal circumstances, the going concern principle makes the assumption that a business entity will remain in operation indefinitely. This continuity of existence assumes that the cost of business assets will be recovered over time by way of profits that are generated by successful operations. The balance sheet values for long-lived assets such as land, building, and equipment are shown at their actual acquisition cost. Since there is no intention to sell such assets, there is no reason to value them at market value. The original cost of a long-lived physical asset (other than land) is recovered over its useful life using depreciation expense.
The assumption made by the monetary concept is tied directly to the cost principle, which requires the value of business transactions be recorded at the actual or equivalent cash cost. During extended periods of inflation or deflation, comparing income statements for different years becomes difficult, if not meaning-less, under the stable dollar assumption. However, some exceptions are made with the valuation of inventories for resale, and also to express certain balance sheet and income statement items in terms of current, rather than historic, dollars.
TIME PERIOD PRINCIPLE
The time period principle requires a business entity to complete an analysis to report financial condition and profitability of its business operation over a specific operating time period. An ongoing business operates continuously. Electrical power in reality flows continuously to the user, yet in theory the flow stops when the service meter data is recorded. The billing statement records that ser-vice for the time period technically ended at a certain date, although service continued without interruption. This example relates to a monthly period; how-ever, the theory applies to any time period—daily, weekly, monthly, quarterly, semiannually, or annually. An accounting year, or fiscal year, is an account period of one year. A fiscal year is for any 12 consecutive months and may or may not coincide with a calendar year that begins on January 1 and ends on December 31 of the same year. In the hospitality business, statements are frequently prepared on a monthly and, in some cases, a weekly basis.