Basics of Generally Accepted Accounting Principles (GAAP)
Basic objectives
- Financial reporting should be rich with information that is
- Useful to provide information to potential investors and creditors and other financial market users in making rational investment, credit, and other financial decisions.
- Helpful to assess the amounts, timing, and uncertainty of prospective cash receipts.
- Key to make financial decisions.
- About economic resources, the claims and the changes in those resources.
- Improving the performance of the business
- Provide information to make long-term decisions.
- Useful in maintaining records
Basic concepts
GAAP has four basic assumptions, four basic principles, and four basic constraints to achieve its basic objectives and implement fundamental qualities.
Assumptions
- Accounting Entity: Business has a separate existence from its owners and revenue and expense should be kept separate from personal expenses.
- Going Concern: Business will be in operation indefinitely.
- Monetary Unit principle: Assumes a stable currency is going to be the unit of record.
- Time-period principle: Economic activities of a business can be divided into artificial time periods.
Principles
- Historical cost principle – Companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities.
- Matching principle – Expenses have to be matched with revenues.
- Full Disclosure principle – Information disclosed should be enough to make decisions.
- Revenue recognition principle – Requires companies to record in accrual basis accounting.
Constraints
- Objectivity principle: The financial statements should be based on objective evidence.
- Conservatism principle: When choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.
- Consistency principle: The company uses the same accounting principles and methods from year to year.
- Materiality principle: The significance of an item should be reported when considering.
