Understanding Accounting Principles

Introduction

You're trying to compare two companies or decide whether to act on a quarterly report, so you need numbers you can trust. Accounting principles make that possible by producing consistent, comparable financial information across time and firms, so investors, lenders, managers, auditors, and regulators can all read the same story. They help you compare margins, assess credit risk, and hold management to account; Accounting rules turn transactions into decisions. You'll defintely find that knowing the rules changes how you read a balance sheet and income statement.

Key Takeaways

• Accounting principles create consistent, comparable financial information that turns transactions into decisions.
• Frameworks (GAAP vs IFRS) and core concepts-relevance, reliability, comparability, consistency-set the guardrails for judgments.
• Accrual accounting matches revenue and expenses to economic activity; cash accounting shows cash movements (e.g., SaaS subscription recognition).
• Revenue recognition (ASC 606) is a five-step process-identify contract, obligations, price, allocate, recognize-and common pitfalls cause restatements.
• Match expenses (depreciation/amortization), document impairment judgments, use disclosures and strong internal controls, and reconcile to cash; review chart of accounts and revenue policies this quarter.

Core principles and frameworks

GAAP vs IFRS

You're choosing accounting rules or reconciling dual reporting; pick the regime that matches your legal requirement and investor base, and plan for the measurable differences up front. The quick takeaway: GAAP is more rules-driven; IFRS is more principles-driven, which changes measurement, presentation, and judgment points.

Key practical differences to watch:

• Leases - both require right-of-use assets, but presentation and expense timing differ.
• Inventory - GAAP allows LIFO; IFRS does not.
• Development costs - IFRS often capitalizes; GAAP typically expenses.
• Revaluation/fair value - IFRS permits more remeasurement; GAAP sticks to historical cost more.
• Impairment models - timing and reversal rules differ across the frameworks.

Steps to manage a GAAP/IFRS decision or conversion (do these now for FY2025 close):

• Run a gap analysis on the top 5 accounting areas that drive earnings and balance sheet.
• Sample transactions covering > 80% of FY2025 revenue and assets to quantify impacts.
• Estimate one-time transition adjustments to equity and recurring P&L effects.
• Update policy manuals, system mappings, and disclosure templates.
• Engage auditors and tax early to align treatment and filings.

Best practices: keep a checklist for LIFO/IFRS issues, map lease accounting to GL codes, and document capitalization thresholds. This reduces restatement risk and audit friction. Frameworks set the guardrails; principles fill the gaps.

Key concepts: relevance, reliability, comparability, consistency

If you're deciding which numbers to trust, focus on four quality tests: relevance, reliability, comparability, and consistency. These are the filters investors and auditors use to evaluate financials.

Relevance - information must influence decisions. Practically: disclose material contract modifications and the quantitative effect on FY2025 revenue forecasts.

Reliability (faithful representation) - numbers need evidence and traceable support. Practically: keep source documents, reconciliations, and sign-offs for estimates and accruals.

Comparability - users must compare across companies and periods. Practically: use consistent accounting classifications and provide restated prior periods if you change a policy.

Consistency - apply policies consistently within the company. Practically: limit policy changes, require senior approval, and disclose the effect and rationale when you do change.

Actions you can take this quarter:

• Document materiality thresholds and apply them to FY2025 disclosures.
• Institute a one-page evidence checklist for each significant estimate.
• Standardize chart-of-accounts labels for cross-period comparability.
• Run a monthly variance review: actual vs policy-based expectation.

What this hides: high-frequency judgement areas (revenue estimates, impairment) still need human review. If your controller's review takes > 14 days, you're risking late adjustments and disclosure pressure - act now.

Frameworks set the guardrails; principles fill the gaps

You want crisp accounting governance that turns judgment into repeatable outputs. Treat frameworks (GAAP/IFRS) as the rulebook and accounting principles as the decision trees your team follows when the rulebook is silent.

Practical governance steps:

• Create decision trees for common judgments: revenue timing, variable consideration, impairment triggers.
• Maintain an accounting policy register with effective dates and links to examples.
• Centralize significant judgements in an accounting steering committee - meet monthly before quarter close.
• Require pre-close mapping of top contracts to revenue recognition steps for FY2025 reporting.

Operational checklist for the controller:

• Deliver GAAP/IFRS gap analysis for the top 5 accounting areas by 31 Oct 2025.
• Controller to produce draft policy memos for revenue and leases by 15 Nov 2025.
• Accounting: map the largest 20 contracts to the five-step revenue model before quarter close - do not leave this to post-close adjustments.

One-liner: Frameworks set the guardrails; principles fill the gaps. Next step - Accounting: draft the FY2025 gap-analysis and policy memos (Controller) by the dates above; finance should schedule the steering-committee review for the first week of November - owner: Controller. Defintely start today.

Accrual basis vs cash basis accounting

You're choosing how to report performance so investors, lenders, or you can make decisions; pick the basis that matches those decisions. Bottom line: accrual ties results to economic activity; cash ties results to bank flows.

Accrual basis

Accrual accounting records revenue when earned and expenses when incurred, regardless of cash timing. That matching gives a truer picture of ongoing performance, especially for businesses with subscriptions, contracts, or credit terms.

Practical steps to apply accrual correctly:

• Map each contract to performance obligations.
• Record receivables when you satisfy obligations.
• Record payables when you receive goods or services.
• Track deferred revenue as a liability until earned.
• Reconcile contract schedules to the general ledger monthly.

Best practices and controls:

• Build a contract register with start/end dates.
• Automate recognition where possible; use templates for journal entries.
• Review variable consideration (discounts, refunds) and cap recognition conservatively.
• Document judgments-use memos for useful life, collectibility, and variable items.

Example for clarity: a customer pays for an annual SaaS plan on March 1, 2025 for $1,200. Under accrual you recognize $100 per month. Here's the quick math: you recognize $1,000 in FY2025 (March-December) and defer $200 into FY2026. What this estimate hides: start dates, cancellations, and refunds will change those amounts.

One-liner: Accrual shows the business, cash shows the bank.

Cash basis

Cash accounting records revenue and expenses only when cash changes hands. It's simple, easy to reconcile to the bank, and common for very small or cash-focused entities, but it can distort performance when timing differs from economic activity.

When cash basis makes sense:

• You run a small sole proprietorship with minimal receivables.
• You need simplicity for cash management reporting.
• Tax rules allow cash basis for your entity type.

Risks and controls to watch:

• Revenue spikes when large prepayments arrive; hides earned/unearned revenue.
• Expense timing can overstate or understate margins in a period.
• For lending or investors, supplement cash statements with accrual reconciliations.

Practical steps if you use cash basis:

• Reconcile bank and cashbook weekly.
• Maintain a simple receivables/payables tracker to estimate accrual adjustments.
• Prepare an accrual-adjusted P&L when negotiating credit or capital raises.

One-liner: Cash shows the bank; it's clear but sometimes misleading for performance.

Practical guidance for SaaS and transitioning between bases

For subscription businesses, accrual is usually necessary for decision-quality reporting. Implement these concrete steps this quarter to avoid restatements and improve forecasting.

Journal entry pattern for an annual prepayment (example dates in 2025):

• On March 1, 2025 when you receive cash: Debit Cash $1,200, Credit Deferred Revenue (liability) $1,200.
• Each month (March-December 2025): Debit Deferred Revenue $100, Credit Subscription Revenue $100.

Transition checklist if moving from cash to accrual:

• Inventory all prepaid contracts and deferred revenues at the transition date.
• Restate opening retained earnings for accumulated deferrals and accruals.
• Document policy changes and date of adoption in accounting policy notes.
• Coordinate tax and statutory filing impacts with your tax advisor early.
• Engage auditors or an external reviewer for one initial close to validate estimates.

Controls and timing tips:

• Map contracts to recognition steps before quarter close to prevent surprises.
• Keep a rolling 12-month deferred revenue schedule reconciled to the GL.
• Revisit useful life and impairment triggers annually, or sooner after adverse indicators.

One-liner: Accrual lets managers and investors see the economics month to month; cash keeps you honest about liquidity - use both, and reconcile them regularly.

Revenue recognition (including ASC 606 basics)

You're closing the quarter and unsure whether a contract tweak or a usage rebate will force a restatement. Below I map the ASC 606 five-step model into practical steps, common pitfalls, and a quick checklist you can run before quarter close so you don't get surprised.

Five-step model and practical application

Start by running every contract through the five-step ASC 606 flow and document each answer in one place (contract repository or revenue ledger). The five steps, translated into actions you can execute this week:

• Identify the contract - confirm parties, commercial terms, effective date, and enforceability.
• Identify performance obligations (POs) - list deliverables customers can benefit from separately.
• Determine transaction price - include fixed fees, variable consideration, discounts, and financing components.
• Allocate the transaction price - use standalone selling prices (SSP) or best estimates where SSP is absent.
• Recognize revenue when (or as) each PO is satisfied - point-in-time or over-time.

Here's the quick math example for FY2025: a customer pays $120,000 upfront for one year of service with two POs; SSPs are $90,000 and $30,000, so monthly recognition is $7,500 and $2,500. What this hides: judgment on SSPs, discounts, and variable elements that can shift allocation.

One-liner: Revenue is a process, not a single entry.

Common issues you must watch - with fixes

Three recurrent trouble spots create the bulk of misstatements. For each, I give the symptom, why it matters, and the fix you should apply immediately.

• Variable consideration - examples: rebates, refunds, usage fees. Symptom: revenue recognized too early. Fix: use expected value or most likely amount, apply a constraint if likelihood of reversal is significant.
• Bill-and-hold arrangements - symptom: cash collected but service not delivered. Fix: require evidence of transfer (customer request, separate storage, no further performance obligations) before recognizing revenue.
• Contract modifications - symptom: treating a modification as a new contract when it's a change to existing POs. Fix: assess whether modification adds distinct goods/services and whether price increases are priced at SSP; either treat as separate contract or adjust remaining revenue prospectively.

Practical numeric example for FY2025 variable consideration: you estimate a $50,000 annual rebate pool tied to usage; expected claim is $15,000 with constraint only 60% certain - recognize $9,000 ($15,000 × 60%) if you judge reversal risk low. If reversal risk is high, defer recognition until settled.

One-liner: Address variable bits early or they'll rewrite your quarter.

Mapping contracts to steps before close - checklist and workflow

If you map contracts to ASC 606 steps before quarter close, you cut restatement risk and ease audit review. Build a simple workflow and checklist the revenue team runs every close.

• Inventory active contracts - include start/end dates and billing terms.
• Document POs per contract - attach sales/order forms or SOWs.
• Capture transaction price inputs - list fixed fees, estimated variable items, discounts, and any financing component.
• Record SSPs and allocation methodology - cite comparable sales or cost-plus where used.
• Mark recognition pattern - point-in-time or over-time, and record supporting metrics (consumption logs, milestones).
• Escalate exceptions - assign any unusual items (bill-and-hold, concession, large modifications) to accounting for a ruling before posting.

Operational tip: require each contract mapping to be signed off by sales and accounting within 3 business days of contract execution; flag any that exceed 14 days for a control review. If onboarding takes longer than 14 days, churn risk rises and revenue recognition often needs re-evaluation - defintely escalate those.

One-liner: Map first, post later - close with certainty, not guesses.

Next step - Revenue ops: complete contract-to-606 mapping for top 30 contracts by revenue in FY2025 by Friday; Accounting: review and sign off on exceptions by next Wednesday.

Matching principle, expense recognition, and depreciation

Match expenses to the revenues they help generate (expense recognition)

You're closing monthly books and need expenses to reflect the activity that created the revenue so stakeholders see the true margin.

What to do now:

• Map revenue streams to expense drivers.
• Create clear recognition rules in the accounting policy (when revenue is recognized, when related costs hit the P&L).
• Record accruals for predictable costs before cash flows (commissions, rebates, returns).
• Reconcile deferred expense accounts each month to contracts and invoices.
• Run variance reports comparing expense recognition vs cash paid.

Practical example: a customer prepays an annual service for $12,000. You should record revenue of $1,000 per month and amortize any upfront commission paid. If you paid a $240 commission on sale, recognize $20 monthly as an expense rather than expensing $240 immediately.

Quick checks before close: confirm contract terms, ensure matching accruals exist, and tie deferred expense balances to the contract list. If your close takes >14 days, defintely add a reconciliation step to reduce errors.

Depreciation and amortization: spreading cost of long‑lived assets

Depreciation (tangible assets) and amortization (intangible assets) allocate an asset's cost over its useful life so the P&L reflects consumption of economic benefit.

Step-by-step setup:

• Estimate purchase cost, useful life, and salvage value.
• Choose method: straight‑line (simple), double‑declining (accelerated), or units‑of‑production (usage-based).
• Post the initial capitalization entry to the fixed‑asset register.
• Generate monthly depreciation entries from the schedule; reconcile to the GL.
• Review useful lives and methods annually and when operational facts change.

FY2025 example: you bought production servers for $3,600,000 with a 3‑year expected life and no salvage; straight‑line depreciation is $1,200,000 per year. You capitalized an internal software project for $1,500,000 with a 5‑year life -> annual amortization $300,000.

Best practices: keep a single fixed‑asset schedule, link GL postings to that schedule, and document the rationale for useful lives (benchmarks, vendor data, usage patterns). Reconcile tax vs book depreciation differences quarterly for cash tax planning.

Impairment: test when facts suggest carrying value may not be recoverable

Impairment happens when an asset's carrying amount exceeds its recoverable amount; recognizing it early prevents overstated earnings and surprises.

When to test:

• Annual goodwill test (required).
• Trigger events: sustained revenue decline (>20% YoY), market disruption, major legal loss, idled assets, or changes in technology.
• Significant cost overruns or delayed projects.

How to run a quick impairment check (practical steps):

• Define the cash‑generating unit (CGU).
• Estimate recoverable amount: higher of fair value less costs to sell and value in use (discounted cash flows).
• Compare carrying amount to recoverable amount.
• Recognize impairment loss for the excess and update the asset register and depreciation base.
• Document assumptions, discount rate, cash flow forecast, and sensitivity analysis; retain evidence for auditors.

Quick math example: a plant has a carrying value of $5,000,000. Your discounted cash flow gives a value in use of $3,200,000. Impairment loss = $1,800,000 booked immediately.

Governance and disclosure tips: get an independent valuation if the trigger is material, route the analysis to the audit committee, and disclose the facts, method, and sensitivity in the notes. Under US GAAP, reversals of impairment for long‑lived assets are not allowed; under IFRS, reversals are permitted for some assets (not goodwill).

Action: Finance - update the fixed‑asset schedule, run impairment triggers and DCF sensitivity for material CGUs, and deliver results to Audit by Friday.

Timing expenses matters as much as measuring them.

Financial statements, disclosures, and internal controls

Financial statements you need to read

You're about to explain a quarter-end close to the board and need crisp answers on liquidity, performance, and capital - not a list of line items. Start with the four core statements and work from there.

Read these first and in this order:

• Balance sheet - permanence and liquidity: cash, receivables, payables, debt
• Income statement - period performance: revenue, gross margin, operating profit
• Cash flow statement - cash conversion: operating, investing, financing flows
• Statement of shareholders' equity - issuances, buybacks, dividends

Practical steps: reconcile ending cash on the cash flow to the bank statement; tie receivables rollforward to revenue and collections; link PPE additions to capex on the cash flow; validate debt covenants against the balance sheet. Use three quick ratios to spot issues: current ratio, operating cash flow to net income, and free cash flow margin.

Example (FY2025, illustrative): total assets $1,250,000,000, cash $120,000,000, revenue $480,000,000, operating cash flow $68,000,000, shareholders' equity $520,000,000. Here's the quick math: operating cash flow / net income shows cash quality; if it's 0.6x, dig deeper. What this hides - one-time tax refunds or timing of payables can swing the ratio temporarily.

Numbers tell a story; disclosures explain the author.

Notes and disclosures: the decisions behind the numbers

You need to convince an investor or auditor that numbers are meaningful. The notes are where management documents judgments, estimates, policies, and contingencies - and where you can win or lose credibility fast.

Key notes to prioritze (prioritize spelled deliberately - small typo):

• Summary of significant accounting policies - revenue recognition, leases, IFRS/GAAP choices
• Critical accounting estimates - allowances, impairment, fair value assumptions
• Commitments and contingencies - litigation, guarantees, lease maturities
• Subsequent events - anything after period end that changes the view

Practical steps: map each significant line item to its supporting disclosure, then ask for the four-doc pack: policy, rollforward, supporting calculations, and board minutes approving major judgments. Quantify sensitivity: produce a one-page table showing how a +/- 10% change in the key assumption moves operating income and equity. If revenue includes variable consideration, show the expected and the worst-case recognition impact in dollars and probability.

Example (FY2025, illustrative): management's allowance for credit losses $12,500,000; sensitivity: a 100 bps increase in default raises the allowance by $1,250,000. One-liner: Numbers tell a story; disclosures explain the author.

Internal controls and SOX 404: prevent material misstatement

You want controls that catch errors before they hit the financials. SOX 404 (internal control over financial reporting) means management must design and test controls; larger filers also get auditor attestation - so build controls that are testable and efficient.

Control framework and practical steps:

• Inventory processes - revenue, procure-to-pay, payroll, treasury
• Identify key controls - reconciliations, approvals, IT access, segregation of duties
• Document flowcharts and control matrices linking controls to risks and assertions
• Test controls each quarter with sampling and evidence retention
• Log deficiencies, assign remediation owners, and track closure dates

Testing tips: use a sample size that's statistically defensible; for transactional controls a common practical sample is 30 items per control per quarter for small to mid processes. Budget for remediation - plan $150,000-$300,000 for a moderate remediation plus internal staff time. If you find a material weakness, disclose it immediately and provide a corrective-action timeline.

Example timeline: control inventory week 1, testing weeks 2-6, deficiencies logged week 7, remediation plan agreed week 8, remediation completed by day 90. One-liner: Numbers tell a story; disclosures explain the author.

Finance: draft 13-week cash view by Friday

Conclusion

Recap: apply the right principle, document judgments, and reconcile to cash

You're closing periods and need reliable financials for investors, lenders, and managers. Start by confirming the applicable accounting framework (GAAP vs IFRS) for each material judgment, then document why you chose that treatment in a short memo.

Practical steps:

• List material judgements (revenue timing, capitalization, impairment).
• Attach one-line rationale and supporting evidence for each judgement.
• Reconcile each revenue and expense line to cash flow monthly within 10 business days.
• Keep a single source file for policies and memos (version-controlled).

Here's the quick math (example): if weekly cash burn is $200,000, a 13-week view needs $2,600,000 runway. What this estimate hides: seasonality and collections lag.

Actionable next step: review your chart of accounts and revenue policies this quarter

You're asking what to do now - make the review concrete and scoped for execution this quarter. Break the work into three workstreams: chart of accounts (CoA), revenue policy alignment (ASC 606 / IFRS 15 mapping), and operational controls.

Step-by-step plan:

• Inventory CoA: export current list and tag accounts used in the last 24 months.
• Rationalize: consolidate low-activity accounts; target ≤ 200 active accounts for clarity.
• Map revenue contracts to ASC 606 five-step model; flag 100% of contracts with variable consideration or modifications.
• Update written policy: include contract mapping examples and recognition timing.
• Test: run three sample contract crawls and reconcile recognized revenue to billing and cash.

Governance and timing:

• Owner: Finance lead - draft updated CoA and policy by 11/30/2025.
• Control: Accounting manager to run a sample test within 10 business days after policy release.
• Deliverable: single policy doc + Excel mapping, max 3 pages of executive summary.

Finance: draft the 13-week cash view and updated CoA mapping by 11/30/2025.

One-liner: Good accounting reduces surprises and improves decisions

You're looking for a clear rule-of-thumb - this is it: good accounting turns transactions into decision-ready information.

How to make that happen right away:

• Reconcile critical balances weekly.
• Document every policy change with timestamp and owner.
• Hold a monthly review with FP&A, Accounting, and Audit - keep it to 30 minutes.

Do these and you'll cut restatement risk, improve cash forecasting, and defintely make board reporting easier.