Accounting Principles

Generally Accepted Accounting Principles

Tina S
Tina S
Dec 20, 2009
0 Comments | 2831 Views | 0 Hits


There are general rules and concepts that govern the field of accounting. These general rules—referred to as basic accounting principles and guidelines—form the groundwork on which more detailed, complicated, and legalistic accounting rules are based.
For example, the Financial Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards.

The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules:
(1) The basic accounting principles and guidelines,
(2) The detailed rules and standards issued by FASB and its predecessor the Accounting Principles Board (APB), and
(3) The generally accepted industry practices.

The current set of principles that accountants use rests upon some underlying assumptions. More technical standards accountants must follow when preparing financial statements.
 Some of these are discussed later in this book, but other are left for more advanced study.

1. Economic entity assumption:
The economic entity assumption states that the activities of the entity be kept separate and distinct from the activities of the owner and of all other economic entities. For example: it is assumed that the activities of IBM can be distinguished from those of other computer companies such as Apple, Compaq and Hewlett Packard.

2. Monetary unit assumption:
The monetary unit assumption states that only transaction data that can be expressed in terms of money be included in the accounting records.
For example, the value of a company president is not reported in a company’s financial records because it cannot be expressed easily in dollars.

3. Time period assumption:
The time period assumption states that the economic life of a business can be divided into artificial time periods. Thus, it is assumed that the activities of business enterprise can be subdivided into months, quarters or a year for meaningful financial reporting purposes.

4. Going concern principle:
The going concern assumption assumes that the enterprise will continue in operation long enough to carry out its existing objectives. In spite of numerous business failures, companies have a fairly high continuance rate. This principle results in the classification of assets and liabilities as short-term (current) and long-term. Long-term assets are expected to be held for more than one year. Long-term liabilities are not due for more than one year.

5. Revenue recognition principle:
The revenue recognition principle dictates that revenue should be recognized in the accounting period in which it is earned. But applying this general principle in practice can be difficult. For example, some companies improperly reorganize revenue on goods that have not been shipped to customers.
When a sale is involved, revenue is recognized at the point of sale. This sale basis involves exchange transaction between the seller and buyer. The sales price is an objective measures of the amount of revenue realized.

6. Matching Principle:
The matching principle requires that expenses be matched with revenues. For example, sales commissions’ expense should be reported in the period when the sales were made (and not reported in the period when the commissions were paid). Wages to employees are reported as an expense in the week when the employees worked and not in the week when the employees are paid.

7. Cost principle:
Assets are recorded at cost, which equals the value exchanged at the time of their acquisition, whether that purchase happened last year or thirty years ago. For this reason, the amounts shown on financial statements are referred to as historical cost amounts.

8. Full Disclosure Principle:
If certain information is important to an investor or lender using the financial statements, that information should be disclosed within the statement or in the notes to the statement. The full disclosure principle requires that financial statements include disclosure of such information. Footnotes supplement financial statements to convey this information and to describe the policies the company uses to record and report business transactions.

9. Materiality:
Accountants follow the materiality principle, which states that the requirements of any accounting principle may be ignored when there is no effect on the users of financial information. Certainly, tracking individual paper clips or pieces of paper is immaterial and excessively burdensome to any company's accounting department.

10. Conservatism:
If a situation arises where there are two acceptable alternatives for reporting an item, conservatism directs the accountant to choose the alternative that will result in less net income and/or less asset amount. Conservatism helps the accountant to "break a tie." It does not direct accountants to be conservative. Accountants are expected to be unbiased and objective.

11. Relevance, reliability, and consistency:

Relevant information helps a decision maker understand a company's past performance, present condition, and future outlook so that informed decisions can be made in a timely manner.
Reliable information is verifiable and objective.
Consistent information is prepared using the same methods each accounting period, which allows meaningful comparisons to be made between different accounting periods and between the financial statements of different companies that use the same methods.


Keywords: Generally Accepted Accounting Principles,Financial Accounting Standards Board (FASB),Going concern,Cost principle,Conservatism,Relevance, reliability,consistency,Revenue,Time period,Economic entity.

Please Signup to comment on this article