What are the statutory accounting principles and why their statutory interpretation is important?
In this section, we’ll give you a high-level look at the five statutory accounting principles used in preparing statutory company accounts. Despite robust legal systems governing accounting practices, many uncertainties still persist.
If you have a basic understanding of these topics. You’ll be able to better understand your accounts and explain them to the stakeholders. This is especially true in areas where accounting ideas and legal principles touch on the same business issue. But approach it in different ways.
These are the most important accounting rules.
Creating precise financial reports requires adhering to hundreds of pages of rules and laws.
But accountants usually follow the following five rules when they put together financial records.
Accounting methods based on when money is earned (Accruals Concept)
After an event occurs, according to the accrual principle, it should be recorded:
- Revenue should be recorded when secured, not necessarily when received.
- Expenses should be recorded when incurred, not necessarily when paid.
- Equity should be recorded when created, not necessarily when distributed.
In financial accounting, we record transactions according to the dates of economic activity, not the actual money transfers. For example, in the described scenario. The sale would be logged in the accounting period when the products were shipped to the buyer.
The Concept of Matching Principle
The company releases the funds, allowing them to be accounted for. After using one quarter’s savings as a down payment to purchase production equipment usable for the next twenty-five quarters. The matching principle aims to align income and costs more closely. It requires using the same accounting periods to record expenses and income from identical sources. Consequently, your company needs to distribute the equipment’s cost evenly over all 12 months.
Taking into account the Historic Costs
Accounting is a subject that focuses on the past. So you need to be steady and be able to compare different things. Financial statements often employ the concept of “past costs.” This necessitates businesses to maintain records of the prices at which they sold and purchased goods and services. The term “historic cost” denotes the actual value of a resource, such as the amount of money spent or the debt incurred to safeguard an asset. Unless mandated or permitted by the accounting standards in effect, any appreciation in the value of these assets over time remains unrepresented in the financial statements. But when we make the financial statements, we do take into account any assets that have lost their value for good. It is very important to understand what “historical cost” means. Allowing companies to report their assets and liabilities at current values would alter accounting practices.
Complicating comparisons between financial statements from different companies and reducing statement reliability due to fluctuating market values, particularly for property. Hence, your company should not record the rise in value of its headquarters building in the books.
The main idea behind the Conservatism Principles
Your organization is preparing for the likely high cost of legal representation in the event of a major environmental disaster in the future. Should we take into account the possibility that these costs will come up? Various methods can record this type of financial transaction in theory. This means that there are no rules about how different accountants have to keep track of the same thing.To follow the conservative principle, accountants must choose the method that leads to the least amount of net income or net assets. Record anticipated expenses, such as lawyer fees or settlements, immediately. However, refrain from recording future benefits, such as those from a new client contract, until they translate into actual cash flow. Your company’s financial statements should encompass potential legal costs and fines stemming from the environmental disaster.
The idea that what’s inside should be more important than how it looks (Substance Over Form Concept)
Your company rents a large piece of manufacturing equipment for a long time and uses it all the way through the production process. Even though the owner of the equipment will keep the title, the lessee may want to think of it as an asset.
The “substance over form” philosophy says that your business must record the economic importance of all transactions and events, not just their official, legal names, in the company’s financial statements.
If the lease spans a brief period, such as a few months, your company should categorize all rent expenses and remove the asset associated with the lease from the balance sheet.
On the other hand, if your company chooses to rent the equipment over a number of years, it will be like buying it with a loan. Most of the time, this is because the lease term is longer than the asset’s useful life. In this case, accounting rules consider the lease to be a purchase that your business made and a separate obligation that your business owes to the lessor that is related to the purchase.
Why statutory interpretation is important?
Many business accounting and reporting scandals and/or frauds happen when people play with or push the limits of these accounting rules past where they should go. This can be done on purpose or by accident because of ignorance, carelessness, or overconfidence. Some of the things that could lead to this result are trying to cheat the system, being careless, or having too much hope.
The five pillars of accounting theory shape how accounting is performed and how financial statements are crafted. Even though the rules for accountants are pretty general, they always come back to five main ideas. There are five such principles: the accrual principle, the matching principle, the historic cost concept, the conservative principle, and the idea that substance should come before form. It covers both recognizing revenue and adjusting for changes in the value of assets and reserves for unusual expenses. It also addresses the treatment of leased equipment during both short-term and long-term agreements.
Clients should understand “What are the statutory accounting principles?” in order to better understand the accounts and the value of the correct amount of tax payable.
If you require any support in your company accounts, please feel free to contact us at 02071559545 or at firstname.lastname@example.org. We also provide due diligence services if another accountant has completed your accounts and you require a second opinion.