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What are the GAAP?


The Generally Accepted Accounting Principles are the most widely used framework for accountants when preparing financial statements and analyzing the finances of a company or business entity.  These provisions will likely become obsolete in 2014, as per se the guidelines set by the Security and Exchanges Commission in favor of the adoption of the International Financial Reporting Standards accounting principles.  The GAAP accounting standards consist of a number of pronouncements for the accounting of certain transactions as well as several accounting principles that define the duty of the accountant in preparing financial statements for the entity.

What were the principles of accounting set in the GAAP?

Economic entity assumption – in terms of accounting, a sole proprietor’s finances are separate from business transactions and finances.  This differs from the legal status of sole proprietors, which treats the owner’s assets as one entity.  The fiduciary duty of the accountant under of the most basic accounting principles here is to create a distinction between personal and business finances, simplifying the accounting of assets and liabilities.

Monetary unit assumption – all transactions are in US dollars and must be expressed as such in finance records.  There is not accounting for inflation when comparing two transactions from different time periods.

Time period assumption – this principle of accounting specifies that accountants must be consistent in the periods of time they use to generate financial statements and anticipate needs that require further allocation, based on the chosen period of time.

Cost principle – all assets of the company must be in terms of the amount spent to obtain it originally.  There is no accounting for inflation or the market value of the item if sold at present day.

Full disclosure principle – this basic accounting principle obligates the accountant to note important and relevant policies, liabilities and other information in footnotes on financial statements.

Going concern principle – this accounting principle is the assumption that the company will operate indefinitely which will obligate the accountant to disclose is her or she believes that the financial status of the company prevents it from operating indefinitely.  This is also referred to as the rule of continuity.

Matching principle – expense and revenue amounts must be matched in the same financial reporting period so that the value of the expense can be ascertained.

Revenue recognition principle – for accounting purposes, revenue is considered in financial statements as soon as it is accrued, regardless of when the amount is actually received.

Materiality – this allows the accountant to break the other accounting principles for items that are insignificant in the larger scale of the company operations.  This also allows for rounding to the nearest determined unit on financial statements.

Conservatism – allows the accountant to pick the accounting principle that would reflect the least net income.  This is to account for potential losses and provide conservative estimates on company assets and liabilities, rather than overstating these amounts.  This principle is also known as the principle of prudence, which obligates the accountant to provide the most realistic picture of the entity’s finances.

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