Final answer:
The first step of the accounting cycle is based on the Historical Cost Principle, which mandates recording assets and transactions at their original purchase cost. This principle establishes a consistent basis for accounting records, contributing to the reliability and comparability of financial statements.
Step-by-step explanation:
The first step of the accounting cycle is based on the principle of Historical Cost Principle. The historical cost principle dictates that companies record assets and transactions at their original cost to the owner, not at current market value. This principle is crucial for the first step of the accounting cycle, which involves the identification and recording of transactions and financial events as they occur.
Under the historical cost principle, when a company engages in a transaction, such as purchasing equipment or receiving services, the transaction is recorded in the accounting records at the price paid, at the time of the transaction. This provides a consistent and stable basis for the accounting records, which is essential because it contributes to the reliability and comparability of financial statements.
It's important to note that while the historical cost principle lays the foundation for transaction recording, other principles like Revenue Recognition and Matching principles come into play later in the accounting cycle, for example when recognizing revenues and matching expenses to generated revenues in the period they are incurred.