After finishing what is really my second accounting course, I can say that I finally understand the framework behind accounting.

Things that one simply must accept as true

In mathematics, one has a set of givens that they simply accept before proving a statement is true or false. In accounting, it is similar. There are things that just need to be accepted, like what is the definition of a credit or a debit. In the shareholders equity formula (Assets = Liabilities + Shareholders equity), then, you simply accept that on the left side of the formula you add credits and subtract debits, and on the right you add debits and subtract credits. Why the left or the right? Simply just because historically, this is how it was always done. It’s best to not argue and accept these premises.

Principles

Secondly, accounting rules are derived from a set of principles. As accounting transactions get more complex, rules are more difficult to follow, so it’s best to fall back on the agreed principles.

The principles we learned are conservatism, relevance and reliable, consistency, materiality, entity concept, money measurement, and going concern.

Conservatism

Conservatism says that one must recognize and record expenses and liabilties even when one is uncertain of them, but one only recognizes and records revenues and assets when they are received. This is in effort to protect investors.

Relevance and Reliable

One must provide valid, verifiable, unbiased information. For example, you can’t change value of assets unless a transaction takes place — they are marked as historical cost. Certain exemptions can be marked to market, and some are even required to be updated.

GAAP rules say to protect the shareholder first by being conservative, and by using relevant and reliable information. For all else, use historical cost.

Consistency

Firms cannot change how they record transactions or else managers could opportunistically change the records for their gain. Consistency is constant throughout time, not across corporate departments.

Materiality

Trivial matters do not have to be reported in detail in the financial statements. Something is considered trivial if it doesn’t impact investment decisions. This varies from business to business.

Entity concept

A business is a separate identifiable identity. Otherwise, it is easy to conceal fraud.

Money measurement

This is motivated by reliability and historical cost. Only things that can be measured in monetary terms can be recorded, and for which transactions that took place.

Going concern

Going concen refers to the fact that the business with continue to operate unless you have evidence that will suggest otherwise. Accounting requires this assumption to build financial statements without writing off merchandise that could expire in the next few days if the business went suddenly out of business.

Memorize, memorize, memorize

Lastly, many parts of accounting are things you will simply have to memorize. For example, is interest paid i nthe operating or financing section of the Statement of Cash Flows? It depends on the company, and it depends on whether they are adhering to GAAP or IFRS standards.