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Understanding the Generally Accepted Accounting Principles & Rules

Understanding the Generally Accepted Accounting Principles & Rules

Generally Accepted Accounting Principle (GAAP) refers to a set of rules established to help publicly traded firms establish their financial statement. The rules serve as the foundation for which complex and comprehensive accounting rules are established.

GAAP covers many topics, like liabilities, assets, financial statements, expenses, revenue, foreign currencies, equities, non-monetary transactions, etc. 

Even though the Financial Account Standard Board specifies the overall GAAP, the Government Accounting Standard Board (GASB) mandates GAAP for both local and state governments.

 

Principles of Accounting 

The ten principles of accounting discussed below can help one understand GAAP requirements. 

  1. Economic Entity Principle 

The business is regarded as a distinct entity, which makes it essential to keep the finances of the business owners separate. 

  1. Monetary Unit Principle

With this, only transactions in the US dollar can be included in accounting records. 

  1. Time Period Principle 

The period of reporting business activities could be short and distinct for instance weeks, quarter, month, etc. The heading of the financial statement needs to carry the time interval like income statement, stockholder’s equity statement, etc. 

  1. Cost Principle 

This deals with the historical cost of any item. It also talks about the cash paid for purchasing an item in past years, which is reported on financial statements. 

  1. Full Disclosure Principle

 Every essential information related to a business and crucial to an investor needs to be revealed in the financial statement. This explains why such statements carry a lot of footnotes. 

  1. Going Concern Principle

This is the intention of the business to continue its operation into the future, without any plan to liquidate

  1. Matching Principle

With this, the business must use the accrual accounting basis and also match business income to expenses in the given period. 

  1. Revenue Recognition Principle

For the accrual accounting basis, the revenue has to be reported on the statement of income when it was earned. This means that the payment is immediately recognized immediately there the service is performed or a business is sold. 

  1. Materiality Principle 

This is a wrong statement of accounting records when the amount seems insignificant. The amount needs to be rounded to the nearest dollar based on this principle.

  1. Conservatism Principle

When accountants do not know how to report an item, potential expenses and liabilities have to be recognized immediately based on this principle. The accountant needs to anticipate losses and select the alternative that will generate lower net income.

 

The 10 Principles of Accounting 

This section discusses ten principles that can help shed light on the mission of GAAP, alongside the rules:

  1. Principle of Regularity

This principle reveals that all the rules and regulations of GAAP have been adhered to by the accountant.

  1. Principle of Consistency 

All items should be entered by the accountant the way it was fixed. When similar standards are used for reporting, errors will significantly be limited. 

Should there be any change or update, the accountant is expected to shed light on the reason for the changes.

  1. Principle of Sincerity 

The accountant needs to make available the right financial state of a business.

  1. Principle of Permanence of Method

This principle entails that all financial reporting procedures need to be consistent.

  1. Principle of Non-Compensation 

All complete details of financial information need to be disclosed alongside the negatives and positives. 

  1. Principle of Prudence

The representation of financial data should happen like it is, not based on speculations.

  1. Principle of Continuity

This principle assumes that business operations will continue into the future.

  1. Principle of Periodicity

All entries from accounting are distributed across the period.

  1. Principle of Full Disclosure

There must be full disclosure in the creation of financial reports. 

  1. Principle of Utmost Good Faith

This principle presupposes that all parties are transparent during a transaction.


Even though huge companies employ GAAP principles for reporting financial information, it is essential to adopt this principle early if you believe your small business or startup might be subjected to GAAP, eventually.


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