What is the difference between accounting principles and accounting standards?

There are various accounting standards, some of them are AS 1 disclosure of accounting policies, AS 3 cash flow statements, AS 6 Depreciation accounting etc.

Accounting concepts

• There are various accounting concepts and they are customary and flexible in nature.

• It offers liberty to follow various methods.

• It is less responsible as compared to accounting standards.

• It is independent of evolving needs of investment community.

• Relevance, reliability, materiality, comparability, understandability, constraints of timeliness fall under accounting concepts.

  Policies are the norms, rules, directions, methods that a business decides for themselves. Policies are not universal, they can differ from one organization to another. Accounting policy for an organization basically defines “their” way of accounting for transactions.

  For example, I can decide that I am going to charge depreciation on the straight line method. Some other company can decide to charge it using the written down value method. That company has it’s own ‘policy’ of charging depreciation, which is different than my ‘policy’.
  But accounting policies cannot be arbitrary or random. For example, I cannot randomly say that I will charge depreciation based on the card that my parrot picks from the deck of cards! Even though accounting policies can differ from person to person, they still have to fall within an overall framework in order to be acceptable.
  That framework is defined by accounting “principles”.
  For example, “matching” is a principle. As per this accounting principle, the costs should be matched with the benefits. Hence, if you purchase an asset for $100 million, you should not charge all of that to your cost in the first year itself, and should match it with the benefits that the asset will generate over time. Hence, we should depreciate the asset over time.
  So, accounting principle tells us that costs should be matched with benefits. Based on this principle, I can decide that my benefits will flow in a straight line, and hence I charge depreciation in a straight line method. But, I could also say that the benefits will be higher in the starting years, which is why I charge depreciation using the written down value method.
  The point is - accounting principles are like guiding lights. They can tell you the broad direction (‘go North, not South’), but then using this broad direction, you need to decide the exact way yourself (one person could ‘go North’ using ships, while the other could ‘go North’ on a horse).
  The ‘ships’ or ‘horses’ are like accounting policies, but ‘go North’ is the principle. The principle is same for all, the policies could differ between organisations, but should still follow the principle broadly.

  These three are definitely different but connected and their connection is critical in accounting. Under International Financial Reporting Standards (IFRSs) IASB Framework sets out accounting concepts in terms of:

  • Objectives of financial statements: it is simple financial statements should be prepared in a manner that users can use the underlying financial information relating to entity in their economic decisions especially investment decisions. However, it must be noted that objective of financial statements is not just recording and reporting past events rather the resulting performance and position of the entity. Also financial statements prepared under IASB Framework and IFRSs caters only general needs of users.
  • Qualitative characteristics of financial statements are what makes financial statements relevant and reliable. IASB framework chalks out qualitative characteristics a set of financial statements must have which are as follows:
    • Relevance is one of the two qualities framework requires financial statements must possess. Only relevant financial statements can help users. Relevance is the capability of the information to be useful. An information is said to be useful if information can be used:
      • either to predict another information
      • or to confirm another information

  Another factor that affects information to be relevant is materiality. If an information is materially misstated or omitted than information is rendered irrelevant.

  • Faithful representation require outcomes of business operations must be reported faithfully. Information is said to be faithfully served if it is:
    • complete
    • without any bias i.e. neutral
    • accurate or error free

  Based on the concepts that sets out the basis of accounting for elements of financial statements IASB Framework defines accounting principles for recognition and measurement of such elements of financial statements. Although many would believe that there are five elements of financial information (statement) but in reality there are only two. Whole of the accounting revolves around two things:

  • What entity has towards itself i.e. assets
  • What entity has towards others i.e. liabilities

  The other three elements are resultant of these two:

  • Equity is a residual of assets above liabilities
  • Income is an increase in assets or decrease in liability
  • Expense is decrease in assets or increase in liability

  With these elements defined, framework provides accounting principles:

  Recognition principles for assets, liabilities, income and expenses. Recognition is a process of embedding a transaction in financial statements if it meets the definition of one of the elements of financial statements.

  Measurement principle provides basis of establishing money values of transactions to be recognised in the financial statements. The measurement principles or basis as mentioned by IASB Framework are as follows:

  • Historical cost principle
  • Current cost principle
  • Realisable value principle
  • Present value principle

  Presentation and Disclosure principles provides guidance on how such items pertaining to each element must be presented and disclosed in the financial statements. It is an important task as wrong presentation can seriously hamper understandability or even altogether misstatement. For example repair expenditures of sales staff will be presented as part of selling cost in the income statement.

  Accounting rules on the other hands are simply accounting standards. Accounting standards are based on the guidelines set by framework in other words on the basis of accounting concepts and accounting principles. That is the reason why we sometime name accounting standards or IFRSs as rule based framework whereas IASB framework provides conceptual framework.

  So its like a hierarchy or a pyramid that on top we have accounting concepts and then in the second accounting principles and lastly accounting rules. One after the other where successor is developed under the light of the predecessor.

  
  Courtesy IFRS

  Another thing to remember is that accounting rules include not just standards but also their interpretations, application recommendations and practice statements that are sometimes served separately with relevant standards.

  

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  Hasaan Fazal

  Teaching professional business subjects to the students of FIA, ACCA, CIMA, CA etc. He also found ACCA LIVE which is Pakistan's first portal to provide online classes and distance learning solutions to FIA/ACCA students. At PakAccountants.com he is busy making study material for different qualifications. Beside writing articles he answers questions asked using ASK TUTOR!

  Is accounting principles and accounting standards are same?

  Accounting principles are the set guidelines and rules issued by accounting standards like GAAP and IFRS for the companies to follow while recording and presenting the financial information in the books of accounts. These principles help companies present a true and fair representation of financial statements.

  What is the difference between principles based and rules based accounting standards?

  A rules-based approach mandates the same benchmark for all projects, whereas a principles-based approach implies different benchmarks, based on judgment and contextual information.

  What are accounting principles?

  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.

  What are the functions of accounting principles and accounting standards?

  Accounting standards specify when and how economic events are to be recognized, measured, and displayed. External entities, such as banks, investors, and regulatory agencies, rely on accounting standards to ensure relevant and accurate information is provided about the entity.