The three important sets of rules of Generally Accepted Accounting Principles (GAAP):
·
Basic accounting principles and guidelines
· Detailed and comprehensive set of accounting
rules and standards issued by Financial Accounting Standards Board (FASB) and
its predecessor the Accounting Principles Board (APB)
·
The generally accepted industry practices
Generally accepted
accounting principles intent to standardize and regulate accounting
definitions, assumptions, and methods. One of the principles is consistency of
accounting methods use to prepare financial statements of the company.
Comparative financial reports provide systematic practice of accounting
principles to have effective implementation.
Accounting Principles
1. Economic Entity Assumption
The business transactions of a company keep separate from any owner’s personal transactions. The owner of the company and the company itself consider to be one entity however in the practice of accounting they consider to be separate entity.
2. Cost Principle
Cost refers to cash or any cash equivalent when an item originally obtained. The financial statements consider the historical cost.
Inflation rate or any adjustments in asset value were not considered in accounting principles. However, there is an exception to the rule in the investment of stocks and bonds, which are actively traded on a stock exchange (for further discussion).
3. Monetary Unit Assumption
Economic activity is measured based of country’s monetary unit during the business transaction. The basic accounting principle is assumed in country’s monetary purchasing power and it will not change over the period of business.
4. Time Period Assumption
This accounting principle assumes the actual occurrence of any transaction based on the recognized period of business transaction. For instance, the coverage of insurance October 01, 2012 expires on September 30, 2013, the financial statement for the year ended December 31, 2012 used the three months transaction dated October 01, 2012 to December 31, 2012 and the remaining months will recognize in the financial statement for the year ended December 31, 2013.
5. Going Concern Principle
Going concern principle is one the fundamental assumptions in accounting based on which financial statements are prepared. Financial statements are prepared assuming that a business entity will continue to operate in the foreseeable future without the need or intention on the part of management to liquidate the entity or to significantly restrict its operational activities. It is assumed that the entity will realize its assets and settle its obligations in the normal course of the business.
The management of a company has to determine whether the going concern assumption is appropriate in the preparation of financial statements. If the going concern assumption is unacceptable, the amount of assets recognize based on realized sales (net of selling cost) in the preparation of financial statements of the entity. Liabilities shall be recognized at amounts that are likely to be settled.
Possible indications of going concern problems:
·
Incapacity of the company to maintain
liquidity ratios
·
Consistent trading losses incurred for
several years
·
Increase in short term loan and overdraft without
positive turnover in the operation of business
·
Insolvency of a major customer of the company
6. Matching Principle
The matching principle is the practice of accrual accounting and the revenue recognition principle. The principle recognizes the revenue and expenses incurred no matter when cash receive and paid out respectively.
For example, the salary of an employee incurred for the month ended April and will pay on May 2, the recognition of expense will be month of April.
7.
Conservatism
The convention of
conservatism, also known as the doctrine of prudence in accounting is a policy
of foreseeing possible future losses but not future gains. The principle
intends to understate rather than overstate net assets and net income.
In this principle provision for bad debt and doubtful accounts are maintained. In the closing stock the value based on cost price or market price, whichever is lower.
The basic accounting principle of conservatism anticipates possible losses, but it does not allow a similar action for gains. For example, potential losses will be reported on the financial statements but potential gains will not be reported. The inventory may write down to an amount that is lower than the original cost, but will not write inventory up to an amount higher than the original cost.
8. Revenue Recognition Principle
An accounting principle under generally accepted accounting principles (GAAP) controls when the revenue becomes realized. Generally, revenue is recognized only when a specific critical event has occurred and the amount of revenue is measurable.
The revenue recognition principle is a foundation of accrual accounting together with matching principle. They both determine the accounting period, in which revenues and expenses are recognized. According to the principle, revenues are recognized when they are realized or realizable, and when the goods sold and service rendered.
9. Materiality
In materiality principle, generally accepted accounting principles allow to ignore the immaterial value. The definition does not provide definitive guidance to determine the material information from immaterial information; it is an exercise judgment to decide if transaction is material.
10. Full Disclosure Principle
The full disclosure principle requires the company to provide the necessary information in the financial statement that can make the interested parties informed decisions concerning the company.
It is important to the third party especially investors who are interested to invest in the company to be able to make a right decision for future benefits. If the information is not possible to show in the financial statement it should be well informed in the footnotes attached to the financial statements.
