Prior to reading the standard on Accounting Fundamentals – Accounting Principles, it is beneficial to review the below sections to gain foundational information:
- Roles and Responsibilities Section
- Accounting Fundamentals – Accounting Terminology Section
- Accounting Fundamentals – Normal Balances Section
This section discusses fundamental concepts as it relates to recordkeeping for accounting and how transactions are recorded internally within Indiana University. Information presented below will walk through the five main accounting principles which acts as the pillar for financial recording and reporting at IU. Additionally, examples will be provided to help illustrate how the principles are used within the university.
Introduction to Accounting Principles
What are Accounting Principles?
Accounting principles are general rules and guidelines that entities must follow in order to accurately report their financial statements. There are many frameworks of accounting principles used for various types of business entities around the world. Indiana University must follow guidelines from two separate governing organizations – US Generally Accepted Accounting Principles (GAAP) and Governmental Accounting Standards Board (GASB). Because Indiana University receives funding from the local, state and federal level, IU follows both US GAAP and the generally accepted accounting principles issued by GASB.
Why are Accounting Principles Important and Needed?
Accounting Principles are important to ensure that financial information is acceptable, accurate, and understandable to both internal and external users. These principles are needed in order to standardize and regulate various accounting methods and assumptions. Standardized accounting principles ensure consistency for multiple fiscal periods to more accurately analyze comparative financial data. They also ensure consistency from entity to entity which is essential when comparing numerous financials within a given industry. As an example at IU, it is important for the external financial statements to be accurate and consistent as they are audited by the State Board of Accountancy who have a major impact on state appropriation, executive decision making, external ratings for funding, etc. Internally it is important for accurate financials to be available for executive leadership to compare units within the university.
What Are the Five Basic Accounting Principles?
The revenue recognition principle ensures consistency when recording revenue on an entity’s income statement. This principle is intended to eliminate and mitigate against any overstatements in revenue. IU uses accrual accounting where revenues are recognized when realized and earned, not based on when cash is received (cash basis). In order to properly recognize revenue under accrual accounting, users must ensure the below criteria have been met:
- Performance – The service and/or saleable item ownership must be transferred to the buyer and IU (the seller) must no longer have control over the saleable item or the service had been performed.
- Collectability – IU must be reasonably assured that it is going to be paid a set amount. This means that IU must feel confident that the money will be received after the service is performed or the item is sold. If there are questions on the collectability of service/saleable items, direct them to the Accounts Receivable department for all non student related questions or the campus bursar's office if they are student related.
- Measurability – Both the cost of the service provided/saleable item and the expense to provide the service/saleable item must be set. This means an amount has been set to provide the service/sell the item – the cash does not have to be received to book the revenue earned.
An IU basketball fan purchases season tickets for the upcoming season for a total of $400 and there are 20 home games a season. To properly recognize the revenue related to the basketball season tickets, IU would ensure the below criteria are met:
- Have the tickets been sold to the customer (Performance)? When the fan purchased his season tickets online, the service had been sold to the customer and a record of sale (confirmation email or receipt) has been sent to confirm the purchase.
- Will the amount be collectable (Collectability)? Since IU processes payment via credit card or through a student bursar account most typically, there is reasonable assurance that the money will be received as payment is automatic.
- Are the costs to provide and the sales cost of the basketball games known (Measurability)? Yes, the fan was aware of the price the season tickets were being sold for, $400, before purchasing the tickets.
Since all the criteria has been met to recognize the revenue, the $400 of ticket revenue will be recognized evenly across all 20 home games as they occur.
As another example, the fall semester has started and the student tuition is due to bursar. Each in-state undergraduate student tuition is $15,000 per semester. To properly recognize the revenue related to the student’s fall tuition, IU would ensure the below criteria are met:
- Has the student started fall semester classes (Performance)? Students are on campus for the fall semester and classes have resumed.
- Will the amount be collectable (Collectability)? Since IU typically requires payment, either in lump sum or in installment payments, prior to and during the semester, in order to attend classes, collectability is assumed.
- Does bursar know how much tuition revenue they will receive for the fall semester per student (Measurability)? Yes, the student and bursar department are aware of the cost per semester as rates are set by the university prior to the start of classes at $15,000 per undergraduate student.
As all the criteria has been met to recognize the revenue, the $15,000 of tuition revenue will be recognized for the fall semester.
The matching principle is used to accurately record expenses within an accounting period. The proper recognition of expenses is important as it impacts how the revenue is recorded. Under the matching principle, expenses and revenues that are related to one another should be recorded in the same period. This principle impacts the income statement and is intended to help accurately report an entity’s profitability in a specified period.
Expenses are reported in the period which the related revenues are earned. If an expense is not directly correlated to revenues, the expense should be recorded in the accounting period in which it has been used up.
A common example of the matching principle in use is recording the related expense and revenue on grants. IU receives a grant to assist international students with adjusting to life in the United States and at IU. The grant is received in May of 20XX, but students do not arrive until August 20XX. IU staff purchases tickets to the Indiana University Cinema to take students to a movie their first week on campus in August. To properly record this expense and related revenue from the grant, the movie ticket expense will be recorded when the students attend the movie and the related reimbursement for the movie tickets from the grant (revenue) will be recorded in the same period.
Another example of the matching principle is related to re-coding expenses and revenue related to research based grants. The animal behavioral lab received a grant from the US federal government to conduct studies on mating behaviors of chimpanzees. The grant started in May 20XX and scheduled to end in November 20X1. Initial supplies were purchased in June 20XX to set up the lab, but testing was not performed until January 20X1. The cost of the lab supplies is reimbursed by the federal government and the related revenue and expense for the lab set up should be recorded in the period it was purchased, i.e. May 20XX. Expense and the related revenue should be recorded as the research is performed and the expense is reimbursed.
The full disclosure principle ensures transparency on an entity’s financial statements. This principle is intended to guarantee all information is complete and relevant. Complete and relevant information includes anything that could change a user’s outlook on the entity’s financials.
The full disclosure principle requires entities to disclose all relevant information within their financial statements that may impact the reader’s view of the entity and further decision making. This principle is generally geared towards protecting external stakeholders as they do not know insider details about the entities books, deals, contracts, loans, and other pertinent information. However, internal IU fiscal officers must also be aware of the full disclosure principle to ensure that they are reporting complete and relevant financial information within their specific department. This will allow for IU’s finance team to better review financials, prepare budgets, and allocate resources to departments.
To ensure the full disclosure principle is being implemented throughout all units at IU, a list of common disclosures is included below:
- Subsequent events
- Natural disaster disclosures
- Material accounting errors
- Contingencies related to class action lawsuits
- Events that are unusual or infrequent in nature
- Other material and pertinent information that could have a major impact on the financials
The historical cost principle is used primarily for consistency and reliability among financial statements. The intention of this principle is to be able to verify an item’s cost at date of purchase. According to the historical cost principle, an entity must report and account for items at their original cost when the asset was purchased. The amount reported should include all costs necessary to acquire the asset and prepare it for use including delivery and handling costs, site preparation fees, and installation costs.
This principle is used commonly throughout IU’s financials, for example, IU’s Bloomington campus purchased a new residence hall (this excludes land) in 2015 for $40,000,000. Today, in 2020, the fair market value (how much the residence hall would cost if purchased today) is worth $80,000,000. Although the market value of the land has increased, IU would continue to account for the building at its historical cost of $40,000,000 on its financials.
Another example of the historical cost principle is when IU purchases art for the museums housed within the university. IU purchased a rare piece of art for $250,000 in April 2008. Today, in 2020, the fair market value of the artwork is $310,000. Although the market value of the artwork has increased, IU would continue to account for the piece at its historical cost of $250,000 on the financial statements.
The objectivity principle is used to confirm that the financial statements are free of opinions and biases. The intention of this principle is to increase the transparency and reliability of financial statements. In the process of following the above principles, all units will in turn be objective. It is important for all fiscal officers and those employees who enter financial data to be objective and free of pressure from management and external parties. It is the fiscal officer’s responsibility to ensure that their financial statements are both transparent and objective.
Ensuring that accounting information is objective requires entities to report financial statements that are independent. IU fiscal officers can be independent from the financials of their department by reporting with integrity and not letting personal opinions or biases sway their reporting. To ensure this, financials should be supported with strong, unbiased evidence and research.
IU is trying to secure financing to open up a new athletics facility. The bank asks for a copy of IU’s financial statements before they will agree to loan them the money. If IU’s CFO sends only the income statement instead of the complete and audited financial statements for the current year, IU is unlikely to receive the funding. The auditing, both internal through unit self-audits and internal auditors and external through the State Board of Accountancy, is an important part of the objectivity principle and helps avoid potential biases and accurately states the financial position of the entity.
Another example is IU renovating the Maurer School of Law and attempting to secure new financing to make updates to the current building. IU chooses to issue a new bond offering and only provides potential investors the consolidated cash flow statement. Providing this financial statement only gives investors an idea of the cash flows of the university for one year and neglects to highlight other pertinent information such as current asset balances, especially focused on existing capital assets. Investors are also missing income generation which is key in understanding the value of the bond. Investors are unlikely to provide the funding.
Requirements and Best Practices
This section outlines general requirements and best practices related to Accounting Fundamentals - Accounting Principles. While not required, the best practices outlined below allows users to gain a better picture of the entity’s financial health and help identify potential issues on a more frequent basis. This allows organizations to identify errors, mistakes and pitfalls which can be remedied quickly and prevent larger issues in the future.
- Review all the Accounting Principles standard listed within the document to gain pertinent knowledge of accounting at IU. After reviewing, if users have questions, reach out to the campus office or the Accounting and Reporting Services team at firstname.lastname@example.org.