Principles & Concepts Ac

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Generally Accepted Accounting Principles (GAAP) is theamericanized term used to refer tothe standard framework of guidelines forfinancial accounting used in any given jurisdictionwhich are generally known as Accounting Standards. GAAP includes the standards, conventions,and rules accountants follow in recording and summarizing transactions, and in the preparationoffinancial statements.

[edit] OverviewFinancial accounting is information that must be assembled and reported objectively. Third-parties who must rely on such information have a right to be assured that the data are free frombias and inconsistency, whether deliberate or not. For this reason, financial accounting relies oncertain standards or guides that are called "Generally Accepted Accounting Principles" (GAAP).

Principles derive from tradition, such as the concept of matching. In any report of financialstatements (audit, compilation, review, etc.), the preparer/auditor must indicate to the readerwhether or not the information contained within the statements complies with GAAP.

Principle of regularity: Regularity can be defined as conformity to enforced rules andlaws.

Principle of consistency: This principle states that when a business has once fixed amethod for the accounting treatment of an item, it will enter all similar items that followin exactly the same way.

Principle of sincerity: According to this principle, the accounting unit should reflect ingood faith the reality of the company's financial status.

Principle of the permanence of methods: This principle aims at allowing the coherenceand comparison of the financial information published by the company.

Principle of non-compensation: One should show the full details of the financialinformation and not seek to compensate a debt with an asset, a revenue with an expense,etc. (see convention of conservatism)

Principle of prudence: This principle aims at showing the reality "as is" : one should nottry to make things look prettier than they are. Typically, a revenue should be recordedonly when it is certain and a provision should be entered for an expense which isprobable.

Principle of continuity: When stating financial information, one should assume that thebusiness will not be interrupted. This principle mitigates the principle of prudence: assetsdo not have to be accounted at their disposable value, but it is accepted that they are attheir historical value (see depreciationandgoing concern).

Principle of periodicity: Each accounting entry should be allocated to a given period,and split accordingly if it covers several periods. If a client pre-pays a subscription (orlease, etc.), the given revenue should be split to the entire time-span and not counted forentirely on the date of the transaction.

Principle of Full Disclosure/Materiality: All information and values pertaining to thefinancial position of a business must be disclosed in the records.
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Accounting is the language of business and it is used to communicate financial

information. In order for that information to make sense, accounting is based on 12

fundamental concepts. These fundamental concepts then form the basis for all of

the Generally Accepted Accounting Principles (GAAP). By using these concepts as

the foundation, readers of financial statements and other accounting information do

not need to make assumptions about what the numbers mean

For instance, the difference between reading that a truck has a value of $9000 onthe balance sheet and understanding what that $9000 represents is huge. Can youturn around and sell the truck for $9000? If you had to buy the truck today, wouldyou pay $9000? Or, perhaps the original purchase price of the truck was $9000.All of these assumptions lead to very different evaluations of the worth of that assetand how it contributes to the companys financial situation.

For this reason it is imperative to know and understand the eleven key concepts.

ELEVEN KEY ACCOUNTING CONCEPTS

EntityAccounts are kept for entities and not the people who own or run the company.Even in proprietorships and partnerships, the accounts for the business must bekept separate from those of the owner(s).

Money-MeasurementFor an accounting record to be made it must be able to be expressed in monetaryterms. For this reason, financial statements show only a limited picture of thebusiness. Consider a situation where there is a labor strike pending or the businessowners health is failing; these situations have a huge impact on the operations andfinancial security of the company but this information is not reflected in the financialstatements.

Going ConcernAccounting assumes that an entity will continue to operate indefinitely. Thisconcept implies that financial statements do not represent a companys worth if itsassets were to be liquidated, but rather that the assets will be used in future

operations. This concept also allows businesses to spread (amortize) the cost of anasset over its expected useful life.

CostAn asset (something that is owned by the company) is entered into the accountingrecords at the price paid to acquire it. Because the worth of an asset changesover time it would be impossible to accurately record the market value for theassets of a company. The cost concept does recognize that assets generallydepreciate in value and so accounting practice removes the depreciation amount


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from the original cost, shows the value as a net amount, and records the differenceas a cost of operations (depreciation expense.) Look at the following example:

Truck $10,000 purchase price of the truckLess depreciation $ 1,000 amount deducted as a depreciation expenseNet Truck: $ 9,000 net book-value of the truck

The $9000 simply represents the book value of the truck after depreciation hasbeen accounted for. This figure says nothing about other aspects that affect thevalue of an item and is not considered a market price.

Dual AspectThis concept is the basis of the fundamental accounting equation:

Assets = Liabilities + Equity

1. Assets are what the company owns.

2. Liabilities are what the company owes to creditors against those assets

3. Equity is the difference between the two and represents what the companyowes to its investors/owners.

All accounting transactions must keep this equation balanced so when there is anincrease on one side there must be an equal increase on the other side or an equaldecrease on the same side.

ObjectivityThe objectivity concept states that accounting will be recorded on the basis ofobjective evidence (invoices, receipts, bank statement, etc). This means thataccounting records will initiate from a source document and that the informationrecorded is based on fact and not personal opinion.

Time Period

This concept defines a specific interval of time for which an entitys reports areprepared. This can be a fiscal year (Mar 1 Feb 28), natural year (Jan 1 Dec 31),or any other meaningful period such as a quarter or a month.

ConservatismThis requires understating rather than overstating revenue (income) and expenseamounts that have a degree of uncertainty. The rule is to recognize revenue whenit is reasonably certain and recognize expenses as soon as they are reasonablypossible. The reasons for accounting in this manner are so that financialstatements do not overstate the companys financial position. Accounting choosesto err on the side of caution and protect investors from inflated or overly positiveresults.

RealizationRevenues are recognized when they are earned or realized. Realization is assumedto occur when the seller receives cash or a claim to cash (receivable) in exchangefor goods or services. This concept is related to conservatism in that revenue(income) is only recorded when it actually occurs and not at the point in time whena contract is awarded. For instance, if a company is awarded a contract to build anoffice building the revenue from that project would not be recorded in one lump


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sum but rather it would be divided over time according to the work that is actuallybeing done.

MatchingTo avoid overstatement of income in any one period, the matching principlerequires that revenues and related expenses be recorded in the same accounting

period. If you bill $20,000 of services in a month, in order to accurately representthe income for the month you must report the expenses you incurred whilegenerating that income in the same month.

ConsistencyOnce an entity decides on one method of reporting (i.e. method of accounting forinventory) it must use that same method for all subsequent events. This ensuresthat differences in financial position between reporting periods are a result ofchanged in the operations and not to changes in the way items are accounted for.

MaterialityAccounting practice only records events that are significant enough to justify theusefulness of the information. Technically, each time a sheet of paper is used, theasset Office supplies is decreased by an infinitesimal amount but that transactionis not worth accounting for.

By understanding and applying these principles you will be able to read, prepare,and compare financial statements with clarity and accuracy. The bottom-line is thatthe ethical practice of accounting mandates reporting income as accurately aspossible and when there is uncertainty, choosing to err on the side of caution

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Principles & Concepts Ac