Sample Critical Thinking On The Economic Entity Principle

Accounting principles are guidelines under which an organization prepares their financial statements. According to Investopedia.com, “Generally Accepted Accounting Principles are the common set of accounting principles, standards and procedures that companies use to compile their financial statements. GAAP are a combination of authoritative standards (set by policy boards) and simply the commonly accepted ways of recording and reporting accounting information. The Financial Accounting Standards Board (FASB) is the body responsible for setting standards in the United States”.
A company which is listed on the US stock market is required to publish their financial statements periodically and have to follow generally accepted accounting principles in the preparation of these statements. GAAP ensures that all organizations prepare their financial statement in the prescribed format. The principles which govern the accounting field are the revenue recognition principle, the historical cost principles, the matching principle, the economic entity principle, the going concern principle, the monetary unit principle, the time period principle and the full disclosure principle.

According to Accounting Tools “the economic entity principle states that the recorded activities of a business entity will be kept separate from the recorded activities of its owner(s) and any other business entities. This means that you must maintain separate accounting records and bank accounts for each entity, and not intermix with them the assets and liabilities of its owners or business partners. Also, you must associate every business transaction with an entity”.

Revenue Recognition Principles

Investorwords.com describes revenue recognition as a type of accrual based accounting whereby it is required that a company show its incoming revenues on its income statement for the time frame in which they are actually earned versus the time frame when the funds are actually collected. Revenues are inflows or other enhancements of assets of an entity or settlements of its liabilities (or a combination of both) from delivering or making goods, rendering services, or other deeds that constitute the entity’s ongoing major or central operations (IASB, 2007).

Historical Cost Principles

Money-Zine.com states that “the financial accounting term Historical Cost Principle refers to a valuation technique used in the preparation of financial statements.  The Historical Cost Principle states the value of an asset or liability is recorded on the balance sheet at its cost at the time of acquisition”.

The Matching Principle

Accounting principles that mandates the organizations to report the expense on the income statement in the same period when revenue associated with it is earned. The matching principal is associated with the accrual accounting propositions and thus, gives more accurate scenario of the financial statements of the company

The Going Concern Principle

The Going Concern Principle means that a company has the necessary resources to continue in the near future. If the company is not a going concern, then this would mean that the company is bankrupt.

The Monetary Unit Principle

Petryni {2010), states that the monetary unit concept assumes that the value of the dollar is stable over time. He posited that this concept essentially allows accountants to disregard the effect of inflation -- a decrease, in relations to real goods, of what a dollar can purchase. He further explained that because of this assumption, past financial statements are usually not updated even if the value of money substantially changes. The perception is normally a practical necessity, even though the assumption can present some serious challenges if the currency is either deflating or inflating quickly.

The Time Period Principle

Accounting Tools states that the time period principle is the concept that a business should report the financial results of its activities over a standard time period, which is usually monthly, quarterly, or annually.Full Disclosure Principle
According to Money-Zine.com, the financial accounting term Full Disclosure Principle refers to the practice of providing information of sufficient importance such that it would influence the decision making process of the investor.

TED Talk- Investment Logic for sustainability

Extending the principle of full disclosure, where we stated that the corporations should engage themselves into providing sufficient information that has the capacity to influence the decisions of the investors, investment manager, Chriss Mcknett, proposes that the corporations should also disclose other metrics that makes importance for risk-return profile of the investor. In other words, he said that the principal of full disclosure is meaningful for the investors when companies are not only expected to disclose their financial performance but also their ESG metrics. Here the term ESG stands for, Environment, Social and Governance metrics. As per Chriss Mcknett, the financial data such as sales growth, cash flow, market growth and other financial fundamentals are important but not enough to fulfill the financial principle of disclosure by the companies. Affirming his point, the speaker confirmed that companies which disclose the ‘ESG’ measures along with the financial metrics are performing better than the one who ignores or do not disclose the ESG measures.
Thus, to summarize the principal of full disclosure, we have something new to offer, that it is not about disclosing the financial metrics only but also the aspects related to corporate sustainability as such measures have a direct relationship with the financial performance of the company, and thus have the capacity to influence the investment decisions of the investors.

Reference

Accruals Accounting. (n.d.).  In Encyclopedia Investopedia. Retrieved from http://www.investopedia.com/terms/a/accrualaccounting.asp
Accounting principles. (n.d.).  In Encyclopedia Investopedia. Retrieved from  http://www.investopedia.com/terms/a/accounting-principles.asp
Full Disclosure Principle. (n.d.).  In Encyclopedia Money Zine. Retrieved from http://www.money-zine.com/definitions/investing-dictionary/full-disclosure-principle/
Historical Cost Principle. (n.d.).  In Encyclopedia Money Zine. Retrieved from  http://www.money-zine.com/definitions/investing-dictionary/historical-cost-principle/
McKnett, C. (n.d.). The investment logic for sustainability. Retrieved February 14, 2015, from You Tube: https://www.youtube.com/watch?v=rpOwTspdwkI&list=PLOGi5-fAu8bG4ceHwP5jX8o1DP-pajg2g
Petryni, Matt. (2011). The Stable Monetary Unit Concept of Accounting. Retrieved from http://www.ehow.com/info_12053293_stable-monetary-unit-concept-accounting.html
Revenue Recognition Principles. (n.d.).  In Encyclopedia Investopedia. Retrieved from http://www.investopedia.com/terms/r/revenuerecognition.asp
The Economic Entity Principle. (n.d.).  In Encyclopedia Accounting Tools. Retrieved from http://www.accountingtools.com/economic-entity-principle