Generally Accepted Accounting Principles or simply GAAP are broad general statements that serve as guides not only in record keeping but also in preparing the financial statements. These accounting rules are used to prepare, present, and report financial statements for a wide variety of entities, including publicly- traded and privately-held companies, non-profit organizations, and governments. GAAP assures the statement users that the financial reports are reliable since these are assembled based on acceptable practices by most accountants.

US GAAP is not written in law although the U.S. Securities and Exchange Commission (SEC) requires that it be followed in financial reporting by publicly-traded companies. At present, the Financial Accounting Standards Board (FASB) is the highest authority in establishing GAAP for public and private companies, as well as non-profit entities and Governmental Accounting Standards (GASB) for local and state governments. GASB operates under a set of assumptions, principles, and constraints that are different from those of standard private sector GAAP. The Federal Accounting Standards Advisory Board (FASAB) regulates the financial reporting in federal government entities.

GAAP has four basic assumptions, four basic principles, and four basic constraints.

Assumptions

• Economic Entity: assumes that a business enterprise is separate and distinct from the owner or investor. It is assumed that in preparing the financial statements only the properties, liabilities, income and expenses of the particular business are reported therein. Personal properties and liabilities of the owner/s are not included in the business financial statements.
• Going Concern: assumes that the business is a continuing concern or that it has an indefinite existence. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain this assumption is not applicable.
• Monetary Unit: all business transactions are measured and recorded using only one unit of measurement. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation.
• Periodic Reporting: basic accounting period is one year with interim reports prepared for shorter periods. The business operations can be recorded and separated into different periods (most common periods are months, quarters and years). This is required for comparison between present and past performance.

Principles

• Historical cost principle: assets, liabilities, income and expenses should be recorded based on the price established at the time the exchange took place. It requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values.
• Revenue recognition principle: Revenue is recognized when it is earned regardless of collection. It requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis of accounting.
• Expense recognition principle: Expenses are recognized when incurred regardless of payment. Three classification of expenses are a) expenses recognized when revenue is recognized because it is directly associated to it; b) expenses that will benefit the business over a number of years so that these should be spread out as expenses over the years that will benefit from their use; and c) those that will benefit the business over a short period of time or those with no more future discernible benefit. The Revenue recognition principle and the Expense recognition principle are also called Accrual Principles or Matching Principles.
• Full disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information.

Constraints

• Cost-benefit relationship: the benefit of providing the financial information should also be weighed against the cost of providing it.
• Materiality: the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.
• Industry practices: accounting procedures should follow industry practices.
• Conservatism: when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

Contact our office if you'd like details or assistance with any GAAP concerns. We're here to help.