3 Basic Real Estate Accounting Principles

Basic accounting principles dictate that the financial statement report information be primarily useful by being understandable to financial statement users.

Accountants need to follow certain principles when drawing up the financial statement – what to measure, when to measure and how to measure. This gives a standard guideline so that lenders, investors and other financial statement users can compare, analyse and trust the information reported. Otherwise these statements can report on information differently, and give interested parties very distorted results.

Here are three basic accounting principles for real estate businesses to follow:

  1. Accounting information must be useful to the user of the information.
    Information can be useful only if it’s relevant and reliable.Relevance means the data must help the user determine the value and performance of the company. This is, in fact, the very purpose of having a financial statement. One must be able to draw an accurate inference from the data presented.

    If information is not reliable it can be of no use to anyone and only result in fraud. Reliable information can be verified independently. The way to vet reliability of financial statements is through audits. This is the main reason companies are audited in the first place. Auditing tests and verifies the financial information presented in the statements for accuracy, reliability and to vouch for the claims made therein so that anyone depending on the statement to make financial decisions can do so confidently.

  2. Accounting information must be comprehensible.
    Financial statements are intended to be understandable by readers who have a reasonable knowledge of business and economic activities and accounting, and who are willing to study the information diligently. If the financial statement can’t be easily understood, again it defeats its own purpose. The objective of financial statements is to provide information about the financial position, performance, and changes in the financial position of an enterprise that is useful to a wide range of users in making economic decisions. For it to be understood it must have clarity and be consistent with past reports of the company. Aside from being relevant and reliable, it should also be comparable to other companies. Reported assets, liabilities, equity, income and expenses are directly related to a real estate organization’s financial position.
    A good financial statement can serve different purposes:

    • Owners and managers use it to make important business decisions that affect continued operations.
    • Employees need them to make collective bargaining agreements with the management, or for individuals in discussing their compensation, promotion and rankings.
    • Prospective investors make use of them to assess the viability of investing in the business.
    • Financial institutions (banks and other lending companies) use them to decide whether to grant the company with fresh working capital or extend debt securities (such as a long-term bank loan or debentures) to finance expansion and other significant expenditures.

  3. Financial Statements are the primary means of communicating useful financial information.
    Naturally the financial statement needs to communicate a value to the party interested. This value is financial information about a property or company. It is a formal record of the financial activities and position of a business. It employs balance sheets, the income statement, and the statement of cash flows. The balance sheet (also referred to as a statement of financial position) reports on the company’s assets, liabilities, and the owners’ equity at a given point in time. The income statement reports the company’s financial performance over a specific accounting period. The cash flow statement reports on a company’s cash flow activities, particularly its operating, investing and financing activities. Financial performance is assessed by giving a summary of how the business incurs its revenues and expenses through both operating and non-operating activities.

So if this information is unintelligible, either it won’t convey the required information, or, worse, it can miscommunicate information.

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