Accounting principles are a set of guidelines and rules that govern the preparation and presentation of financial statements. These principles provide a framework for recording, analyzing, and reporting financial transactions of an organization. They ensure financial information is accurate, reliable, and consistent across different organizations and industries.
What are accounting principles?
Accounting principles are categorized into two main types
- Generally accepted accounting principles (GAAP): GAAP refers to the standard accounting system, principles, and guidelines that are widely accepted and used in a particular jurisdiction or country. They provide a common framework for financial reporting and analysis, making it easier to compare and interpret the financial statements of different organizations. Examples of GAAP include the Generally Accepted Accounting Principles in the United States (US GAAP) and the International Financial Reporting Standards (IFRS).
- Specific industry accounting principles: Besides GAAP, certain industries may have specific accounting principles tailored to their unique characteristics and requirements. These principles address industry-specific issues and ensure accurate and relevant financial reporting. Examples include accounting principles for banks, insurance companies, nonprofit organizations, and government entities.
Read About: 9 Best Accounting Software for Small Business
Role of accounting principles in financial reporting and analysis
Accounting principles play a crucial role in financial reporting and analysis by providing a standardized framework for recording and presenting financial information. Some key roles of accounting principles include:
- Consistency: Accounting principles promote consistency in financial reporting, ensuring that similar transactions are recorded and reported in a consistent manner. This allows for meaningful comparisons between different accounting periods or companies, aiding stakeholders in making informed decisions.
- Accuracy and reliability: By following accounting principles, financial statements are prepared accurately and reliably. These principles dictate financial transactions’ proper measurement, recognition, and disclosure, reducing errors and misrepresentations.
- Transparency and disclosure: Accounting principles require organizations to disclose relevant information in financial statements, providing transparency to stakeholders. This includes details about significant accounting policies, contingent liabilities, related party transactions, and other crucial information that may impact decision-making.
- Comparability: Standardized accounting principles enable comparability across different organizations and industries. Stakeholders can analyze the financial statements of various companies within the same industry or across different sectors, facilitating benchmarking and performance evaluation.
- Regulatory compliance: Accounting principles serve as a foundation for regulatory compliance. Companies must follow the applicable accounting principles in their jurisdiction, ensuring adherence to legal and regulatory requirements.
- Decision-making: Accurate and reliable financial information, prepared in accordance with accounting principles, assists stakeholders in making informed decisions. Investors, creditors, and managers rely on financial statements to evaluate financial performance, assess risks, and determine the viability of investment opportunities.
Importance of applying accounting principles
Applying accounting principles is crucial for maintaining the integrity and credibility of financial information. It ensures accuracy, comparability, transparency, and legal and regulatory requirements compliance. The following points highlight the importance of applying accounting principles:
- Ensuring the accuracy and reliability of financial information: Accounting principles provide guidelines for accurately recording and reporting financial transactions. By following these principles, organizations can enhance the accuracy and reliability of their financial information, leading to informed decision-making.
- Facilitating compatibility and consistency: Standardized accounting principles enable comparability across different organizations and industries. This allows stakeholders to analyze financial statements and make meaningful comparisons, aiding in benchmarking and performance evaluation.
- Enhancing transparency and accountability: Accounting principles promote transparency by requiring organizations to disclose relevant information in the financial statements. This transparency increases accountability to stakeholders and helps them understand the financial position and performance of the entity.
- Compliance with legal and regulatory requirements: Accounting principles serve as a foundation for regulatory compliance. By adhering to the applicable accounting principles, organizations ensure compliance with legal and regulatory requirements, maintaining their legal standing and reputation.
Basic accounting principles
Basic accounting principles are fundamental concepts and guidelines that form the basis of accounting practices. They provide a framework for recording, measuring, and reporting financial transactions.
The following are some of the essential basic accounting principles:
1. Accrual principle
The accrual principle states that revenues and expenses should be recognized when they are earned or incurred, regardless of when the cash is received or paid.
2. Consistency principle
The consistency principle requires organizations to consistently use the same accounting methods and principles from one period to another. This ensures comparability and allows stakeholders to make meaningful comparisons.
3. Materiality principle
The materiality principle states that financial information should be presented and disclosed if its omission or misstatement could influence the economic decisions of users. It helps determine what information is significant and should be included in the financial statements.
4. Going concern principle
The going concern principle assumes that an entity will continue to operate indefinitely unless there is significant evidence to the contrary. It allows for preparing financial statements under the assumption that the business will continue its operations in the foreseeable future.
5. Entity concept
The entity concept separates the financial affairs of a business from those of its owners. It treats the business as a separate accounting entity, ensuring that the personal transactions of the owners do not mix with the transactions of the economic entity.
6. Monetary unit concept
The monetary unit concept states that financial transactions should be recorded and reported in a common monetary unit, such as the local currency. It allows for the meaningful measurement and comparison of financial information.
7. Time period concept
The time period concept divides the financial life of an entity into specific periods, such as months, quarters, or years. Financial statements are prepared for these periods, providing timely and periodic information to stakeholders.
8. Matching principle
The matching principle states that expenses should be recognized in the same period as the revenues they help generate. It ensures that the costs associated with earning revenue are properly matched with those in the financial statements.
9. Historical cost principle
The historical cost principle requires assets and liabilities to be recorded and reported at their original cost. It provides a reliable and objective basis for measuring and reporting financial information.
10. Revenue recognition principle
The revenue recognition principle determines when and how revenue should be recognized in the financial statements. It guides the timing and measurement of revenue, ensuring that it is recognized when it is earned and can be reliably measured.
11. Expense recognition (matching) principle
The expense recognition principle states that expenses should be recognized in the same period as the revenues they help generate. It aligns with the matching principle and ensures expenses are properly matched with the related revenue.
12. Full disclosure principle
The full disclosure principle requires organizations to provide all relevant and necessary information in the financial statements and accompanying notes. It ensures transparency and helps users make informed decisions.
Suggested Read: 10 Best Expense Reporting Software Systems and Tools
1. Generally accepted accounting principles (GAAP)
Generally accepted accounting principles (GAAP) refer to the standard accounting principles and guidelines that are widely accepted and used in a particular jurisdiction or country. They provide a common framework for financial reporting and analysis, ensuring consistency and comparability in financial statements. Following GAAP helps maintain the integrity and reliability of financial information.
Overview of GAAP
GAAP encompasses a set of principles, concepts, and standards established by accounting standard-setting bodies. It guides the recording, measurement, recognition, and presentation of financial transactions in accordance with accepted accounting practices.
Importance of following GAAP for businesses
Businesses adhere to GAAP for several reasons:
- Consistency: Following GAAP ensures that financial statements are prepared and presented consistently, allowing for meaningful comparisons between different periods or companies.
- Accuracy and Reliability: GAAP provides guidelines for accurate and reliable financial reporting, reducing errors and misrepresentations in financial statements.
- Transparency and Accountability: GAAP promotes transparency by requiring organizations to disclose relevant information in the financial statements, increasing accountability to stakeholders.
- Compliance: Adhering to GAAP ensures compliance with legal and regulatory requirements, maintaining the organization’s legal standing and reputation.
Role of GAAP in standardizing financial reporting
GAAP plays a crucial role in standardizing financial reporting by:
- Providing a common framework: GAAP provides a standardized framework that ensures consistency and comparability in financial reporting across different organizations and industries.
- Promoting consistency: By establishing uniform accounting principles, GAAP ensures that similar transactions are recorded and reported consistently, facilitating accurate comparisons.
- Enhancing transparency: GAAP requires organizations to disclose relevant information, promoting transparency and providing stakeholders with a clear understanding of the entity’s financial position and performance.
- Facilitating decision-making: Standardized financial reporting under GAAP assists stakeholders in making informed decisions based on reliable and comparable financial information.
Key Components of GAAP
The key components of GAAP include:
- Financial accounting standards board (FASB): FASB is the primary standard-setting body for GAAP in the United States. It establishes and updates the Accounting Standards Codification (ASC), including authoritative accounting principles.
- Generally accepted auditing standards (GAAS): GAAS provides guidelines for auditors to conduct and issue audit reports.
- Governmental accounting standards board (GASB): GASB sets accounting standards for state and local governments in the United States.
- International financial reporting standards (IFRS): Although not part of GAAP in the United States, IFRS is widely used in many countries and plays a significant role in global financial reporting.
- SEC reporting: The Securities and Exchange Commission (SEC) in the United States requires companies to follow specific regulations and disclosure requirements in their financial reporting.
Benefits and limitations of GAAP
The benefits of GAAP include:
- Promotes consistency and comparability in financial reporting.
- Enhances the reliability and accuracy of financial information.
- Provides transparency and accountability to stakeholders.
- Ensures compliance with legal and regulatory requirements.
However, GAAP also has some limitations:
- Complexity and cost of implementation for smaller businesses.
- Differences in GAAP requirements across jurisdictions may hinder global comparability.
- It may not always reflect the economic substance of certain transactions or events.
- It may require subjective judgments and estimates, introducing some level of subjectivity.
Comparison of GAAP with other accounting frameworks
GAAP is primarily used in the United States, while other countries may have their own accounting frameworks. Some commonly compared accounting frameworks include:
- International financial reporting standards (IFRS): IFRS is a globally recognized accounting framework in many countries. It focuses on principles-based standards and aims for global comparability.
- International public sector accounting standards (IPSAS): IPSAS provides accounting standards for public sector entities, focusing on the unique characteristics and needs of the public sector.
- Chinese accounting standards (CAS): CAS is the accounting framework used in China, reflecting the specific requirements and characteristics of the Chinese business environment.
Learn About: 10 Best Financial Management Tools for CFOs
2. International financial reporting standards (IFRS)
International financial reporting standards (IFRS) are a set of accounting standards and principles developed by the International Accounting Standards Board (IASB). IFRS is widely used in many countries and aims to enhance the comparability and transparency of financial reporting globally.
Adoption and implementation of IFRS
The adoption and implementation of IFRS vary across countries. Some countries have fully adopted IFRS as their national accounting standard, while others allow or require the use of IFRS for specific types of entities or industries.
Key differences between IFRS and GAAP
Used in many countries globally, including Europe
Primarily used in the United States
LIFO (Last In, First Out) not allowed
LIFO permitted (in certain circumstances)
Development Costs Capitalization
Generally, development costs expensed
Capitalization of certain development costs common
There is no separate category for extraordinary items
Extraordinary items are presented separately
Research and Development Costs
Expensed as incurred
Capitalization is allowed under specific criteria
Goodwill Impairment Testing
Impairment at the reporting unit level
Impairment at the reporting entity level
Reversal of Impairment Losses
Allowed if criteria met
Generally not allowed
Lower of cost and net realizable value
Lower of cost or market
Measurement of Investments
Equity method or fair value through profit or loss
Various methods, including equity and cost method
Single lessee accounting model
Dual lessee accounting model (finance vs. operating leases)
IFRS 15 (IFRS 18 for construction contracts)
ASC 606 (formerly ASC 605 for revenue recognition)
Intangible Asset Recognition
More strict criteria for recognition
Broader criteria for recognition
Presentation of Financial Statements
Statement of comprehensive income
Income statement and separate statement of other comprehensive income
Treatment of Earnings Per Share (EPS)
IFRS uses basic and diluted EPS
GAAP uses basic and diluted EPS
Global Impact of IFRS
The adoption and implementation of International Financial Reporting Standards (IFRS) have significantly impacted financial reporting. IFRS has helped enhance financial information’s comparability, transparency, and quality across countries and industries.
Which accounting principles does India follow?
The accounting principles followed in India are primarily based on the Indian Accounting Standards (Ind AS) and the Companies (Accounting Standards) Rules. These standards are aligned with the International Financial Reporting Standards (IFRS) to ensure consistency and comparability in financial reporting. The Ministry of Corporate Affairs (MCA) in India is responsible for formulating and enforcing these accounting principles.
Financial Statements and Accounting Principles
Financial statements are key reports that provide information about an organization’s financial performance and position. These statements are prepared following specific accounting principles. The main financial statements include the following.
1. Balance Sheet
The balance sheet, also known as the statement of financial position, presents the financial position of an organization at a specific point in time. It provides information about the organization’s variable and fixed assets, liabilities, and shareholders’ equity.
2. Income Statement
The income statement, also called the statement of profit and loss, reports the organization’s revenues, expenses, gains, and losses over a specific period. It shows the net income or net loss generated by the organization during that period.
3. Statement of Cash Flows
The statement of cash flows presents an organization’s cash inflows and outflows during a specific period. It categorizes cash flows into operating, investing, and financing activities, providing insights into the organization’s liquidity and cash management.
4. Statement of Shareholders’ Equity
The statement of shareholders’ equity shows changes in the shareholders’ equity of an organization over a specific period. It includes information about capital contributions, net income, dividends, and other changes that impact shareholders’ equity.
Must Read: 6 Best Cash Flow Management Software
Application of Accounting Principles in Financial Statements
Accounting principles are applied in preparing financial statements to ensure accuracy, consistency, and transparency. Some key principles applied include:
Financial statements provide relevant information that is useful for decision-making purposes. This principle ensures that the information included in the financial statements is significant and assists stakeholders in making informed decisions.
2. Faithful representation
Financial statements aim to present the financial information faithfully, representing the substance of economic transactions and events. This principle emphasizes the importance of accurate and unbiased reporting.
Financial statements should be prepared to allow for meaningful comparisons, both within the organization’s historical periods and with other entities. This principle enables stakeholders to evaluate the organization’s performance and position relative to others.
Consistency is essential in financial reporting. It requires organizations to consistently apply the same accounting principles and methods from one period to another. This ensures comparability and facilitates trend analysis.
Application of accounting principles in different industries
While accounting principles generally apply across industries, specific considerations and guidelines may exist for different sectors. Here are some examples:
1. Manufacturing industry
In the manufacturing industry, accounting principles may address cost accounting, inventory valuation, and revenue recognition for long-term projects or contracts.
2. Service industry
Accounting principles in the service industry may focus on revenue recognition for services rendered, measuring the value of intangible assets, and accounting for customer contracts or subscriptions.
3. Retail industry
In the retail industry, accounting principles may cover inventory valuation methods, revenue recognition for sales and returns, and lease accounting for store locations.
4. Nonprofit organizations
Nonprofit organizations have specific accounting principles that address fund accounting, contributions, grants, and program expenses. These principles focus on transparency and accountability for funds received and expended.
Ethics and professional judgment in accounting principles
1. Ethical considerations in accounting
Ethics plays a vital role in accounting practices. Accountants must adhere to ethical principles such as integrity, objectivity, professional competence, confidentiality, and professional behavior. Ethical considerations ensure that accounting information is prepared and reported honestly and transparently.
2. Professional judgment and accounting standards
Accounting standards provide guidance, but professional judgment is often necessary in applying these standards. Accountants use their expertise and professional judgment to interpret accounting principles and make informed decisions when there is ambiguity or complexity in a particular situation.
3. Challenges and controversies in applying accounting principles
Applying accounting principles can face challenges and controversies due to evolving business practices, complex transactions, and subjective judgments. Examples include accounting for fair value measurements, revenue recognition in long-term contracts, and determining the recoverability of assets. These challenges require careful analysis, professional judgment, and stakeholder collaboration for appropriate accounting treatments.
Benefits and challenges of accounting principles
Benefits of accounting principles
Accounting principles offer several benefits to organizations and stakeholders:
- Consistency: Accounting principles provide a consistent framework for recording, analyzing, and reporting financial transactions, ensuring uniformity and comparability.
- Accuracy and reliability: Financial information is prepared accurately and reliably by following accounting principles, reducing errors and misrepresentations.
- Transparency: Accounting principles promote transparency by requiring organizations to disclose relevant information in the financial statements, enhancing stakeholder understanding and trust.
- Compliance: Adhering to accounting principles ensures compliance with legal and regulatory requirements, safeguarding the organization’s legal standing and reputation.
- Informed decision-making: Accounting principles provide stakeholders with reliable and comparable financial information, facilitating informed decision-making about investments, lending, and other financial matters.
Challenges of accounting principles
Despite their benefits, accounting principles can present challenges:
- Subjectivity: Some accounting principles require professional judgment and subjective assessments, leading to potential variations in interpretation and application.
- Complexity: Accounting principles can be intricate, especially in areas such as revenue recognition, fair value measurements, and accounting for complex financial instruments.
- Evolving business practices: Accounting principles may struggle to keep pace with rapidly evolving business models and innovative transactions, leading to gaps or delays in guidance.
- Global harmonization: Achieving global harmonization of accounting principles remains challenging due to the diversity of accounting frameworks across jurisdictions.
- Cost and resources: Implementing and complying with accounting principles may require significant resources, particularly for small businesses, which may face challenges regarding expertise and costs.
Emerging Trends and Updates in Accounting Principles
The field of accounting principles is constantly evolving to address emerging trends and challenges. Some notable trends and updates include:
- Focus on sustainability: Accounting principles adapt to incorporate sustainability considerations, reflecting the growing importance of environmental, social, and governance (ESG) factors in financial reporting.
- Enhanced disclosures: There is an increased emphasis on improving the quality and quantity of disclosures in financial statements, providing stakeholders with more detailed and relevant information.
- Technology integration: The integration of technology, such as artificial intelligence, machine learning, and automation, is transforming accounting processes, improving efficiency, and enabling real-time reporting.
- Increased international convergence: Efforts towards international convergence of accounting standards continue, with ongoing collaboration and alignment between standard-setting bodies.
- Focus on integrated reporting: Integrated reporting frameworks are gaining prominence, encouraging organizations to provide a comprehensive view of their financial, environmental, social, and governance performance.
Sustainability accounting and reporting
Sustainability accounting and reporting involves measuring, disclosing, and analyzing an organization’s environmental, social, and governance (ESG) performance. It gives stakeholders insights into the organization’s sustainability practices and their impact on financial performance. Sustainability accounting goes beyond traditional financial reporting by considering the broader implications of an organization’s activities on society and the environment.
Integrated reporting framework
The Integrated Reporting Framework is a reporting approach that combines financial and non-financial information to provide a holistic view of an organization’s value creation over time. It encourages organizations to consider various forms of capital, including financial, manufactured, intellectual, human, social, and natural capital, in their reporting. The framework promotes a comprehensive understanding of an organization’s performance, strategy, and governance.
Technology’s impact and accounting principles
Technology has had a significant impact on accounting principles and practices. Some key ways technology has influenced accounting include:
- Automation: Technology has automated many routine accounting tasks, reducing manual efforts, improving accuracy, and increasing efficiency.
- Data Analysis: Advanced data analytics tools enable accountants to process and analyze large volumes of data, uncover insights, and support decision-making.
- Cloud Computing: Cloud-based accounting software provides real-time access to financial data, facilitates collaboration, and enhances data security.
- Artificial Intelligence (AI) and Machine Learning (ML): AI and ML technologies have the potential to automate complex accounting processes, enhance fraud detection, and improve forecasting and predictive analytics.
- Blockchain: Blockchain technology offers opportunities for enhanced transparency, traceability, and security in financial transactions and auditing processes.
As technology advances, it will likely further shape and transform accounting principles and practices, driving innovation and efficiency in the field.
In conclusion, accounting principles form the bedrock of financial reporting and analysis, ensuring accuracy, consistency, and transparency in the world of business. These principles, such as GAAP and IFRS, provide a standardized framework that allows organizations to record, measure, and report their financial transactions meaningfully and reliably.
Accounting principles provide the framework and guidelines that dictate how financial transactions and events are recorded, measured, and presented in financial statements. They ensure consistency, comparability, and transparency in financial reporting. By following accounting principles, organizations can accurately report their financial performance, position, and cash flows, enabling stakeholders to make informed decisions based on reliable information.
Accounting principles are not static and can be subject to change. The accounting field evolves to address new business practices, technological advances, and regulatory requirements. Changes in accounting principles can be driven by standard-setting bodies, such as the Financial Accounting Standards Board (FASB) in the United States or the International Accounting Standards Board (IASB) globally, as they strive to enhance the relevance and reliability of financial reporting.
In general, companies are expected to adhere to the established accounting principles. However, certain circumstances may allow for deviations, particularly when specific industry practices or regulations require it. Companies must disclose any material deviations from accounting principles in their financial statements and provide a justification for such deviations.
Accounting principles play a crucial role in financial reporting for several reasons. They ensure consistency and comparability of financial information across different entities, facilitating meaningful analysis and decision-making by investors, creditors, and other stakeholders. Accounting principles also enhance the transparency and integrity of financial statements, fostering trust and confidence in the reported financial information.
Accounting principles and accounting standards are closely related but distinct concepts. Accounting principles refer to the fundamental concepts, assumptions, and rules that guide the recording and reporting of financial transactions. On the other hand, accounting standards are specific guidelines and rules established by standard-setting bodies to address particular accounting issues and ensure consistency in financial reporting.
GAAP (Generally Accepted Accounting Principles) and IFRS (International Financial Reporting Standards) are two sets of accounting principles used worldwide. The main difference between them lies in their jurisdiction and applicability. GAAP is primarily used in the United States, while IFRS is adopted by many countries globally. Although they share similar objectives, there are differences in specific accounting treatments and disclosure requirements between GAAP and IFRS.
Several fundamental accounting principles serve as the foundation for financial reporting. These principles include the accrual principle, revenue recognition principle, matching principle, historical cost principle, materiality principle, consistency principle, and others. While there is no fixed number of accounting principles, these fundamental concepts guide the preparation of financial statements.
Accounting principles are established and updated through the efforts of standard-setting bodies, such as the FASB in the United States and the IASB globally. These bodies engage in rigorous research, consultation, deliberation, and public exposure to develop new accounting standards or revise existing ones. The standard-setting process involves input from various stakeholders, including accounting professionals, regulators, investors, and the public.
Certain industries may have specific accounting practices and regulations that are tailored to their unique characteristics. While the fundamental accounting principles apply universally, industry-specific guidelines and regulations may introduce variations in the application and disclosure of accounting principles. These industry-specific practices ensure that financial reporting accurately reflects the particularities of the industry and provides relevant information for decision-making.
Accounting principles and financial regulations are closely related. Financial regulations, set by regulatory authorities and government bodies, establish legal requirements and frameworks for financial reporting. Accounting principles provide the foundation and guidelines for preparing financial statements in accordance with these regulations, ensuring compliance and consistency in financial reporting practices.
Accounting principles promote comparability in financial statements by providing consistent rules and guidelines for recording, measuring, and presenting financial information. When organizations follow the same accounting principles, stakeholders can compare financial statements across different entities and time periods. This comparability enables investors, creditors, and other users of financial information to make meaningful analyses and evaluations.
Transparency in financial reporting is essential for building trust and confidence in the reported financial information. Accounting principles are critical in promoting transparency by ensuring consistent and accurate financial reporting practices. Transparent financial statements, prepared in accordance with accounting principles, provide stakeholders with clear and reliable information about an organization’s financial position, performance, and cash flows.
Yes, changes in accounting principles can impact financial statement analysis. When accounting principles change, it may result in differences in financial information recognition, measurement, and presentation. These changes can affect key financial metrics and ratios, making it important for analysts and users of financial statements to consider the impact of accounting principle changes when conducting financial statement analysis.
Professional judgment plays a crucial role in applying accounting principles. In certain situations, accounting standards may allow for the exercise of judgment to determine the appropriate accounting treatment for a specific business transaction or event. Professional accountants use their expertise, knowledge of accounting principles, and consideration of relevant facts and circumstances to apply professional judgment and make informed decisions in accounting practices.
While many accounting principles apply universally to financial statements, there can be specific requirements and guidelines for different types of financial statements. For example, financial statements prepared for public companies may have additional disclosure requirements compared to those prepared for private companies. Additionally, specialized financial statements, such as cash flow statements or segment reporting, may have unique accounting principles governing their preparation.
The conservatism principle, also known as the principle of prudence, is an accounting principle that guides financial reporting by encouraging caution and the recognition of potential losses or expenses. It suggests that when faced with uncertainty, accountants should err on the side of caution and record potential losses or liabilities as soon as they are probable but delay the recognition of potential gains until they are realized.
Depreciation is an accounting method used to allocate the cost of tangible assets over their useful lives. It represents the gradual decrease in the value of an asset due to factors like wear and tear, obsolescence, and aging. By recognizing depreciation expense, business entities reflect the reduction in an asset’s value on their financial statements over time.
No, accounting concepts and accounting principles are not the same, although they are related. Accounting concepts, also known as accounting assumptions or fundamental accounting concepts, are the underlying principles and guidelines that form the basis of accounting practices. On the other hand, accounting principles refer to the specific rules, standards, and guidelines that are developed and established by standard-setting bodies, such as the Financial Accounting Standards Board (FASB) in the United States or the International Accounting Standards Board (IASB) globally.
Accrual accounting, also known as the accrual basis of accounting, is a method of recording financial transactions and recognizing revenue and expenses based on when they are earned or incurred, regardless of when the cash is received or paid. Under accrual accounting, revenue is recognized when it is earned, and expenses are recognized when they are incurred, regardless of the timing of cash flows. This method provides a more accurate depiction of a company’s financial position and performance by matching revenues and expenses in the period in which they are related, enabling better analysis and decision-making.