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Simple Understanding of GAAP

What is GAAP

GAAP (Generally Accepted Accounting Principles) is a collection of commonly followed accounting rules and standards for financial reporting. The acronym is pronounced gap.

What Are the Principles of Accounting?

The best way to understand the GAAP requirements is to look at the ten principles of accounting.

1. ECONOMIC ENTITY PRINCIPLE

The business is considered a separate entity, so the activities of a business must be kept separate from the financial activities of its business owners.

2. MONETARY UNIT PRINCIPLE

The monetary unit assumption means that only transactions in U.S. dollar amounts can be included in accounting records. It’s important to note that accountants ignore the effects of inflation on the recorded dollar amounts.

3. TIME PERIOD PRINCIPLE

The business activities may be reported in short, distinct time intervals which may be weeks, months, quarters, a calendar year, or a fiscal year. The time interval has to be identified in the headings of the financial statements such as the income statement, statement of cash flow, and stockholders’ equity statement.

4. COST PRINCIPLE

The cost principle mentions the historical cost of an item. This refers to cash or cash equivalent that was paid to purchase an item in the past. This asset amount is adjusted for inflation. The historical cost is reported on the financial statements.

5. FULL DISCLOSURE PRINCIPLE

All information that is relative to the business and is important to a lender or investor must be disclosed in the content of the financial statements or in the notes to the statements. This is the reason that numerous footnotes are attached to financial statements

6. GOING CONCERN PRINCIPLE

This accounting principle refers to the intent of a business to carry on its operations and commitments into the foreseeable future and not to liquidate the business.

7. MATCHING PRINCIPLE

The matching principle requires that businesses use the accrual basis of accounting and match business income to business expenses in a given time period.

For example, the commissions for sales should be recorded in the same accounting period that sales income was made (and not when they were paid).

8. REVENUE RECOGNITION PRINCIPLE

Under the accrual basis of accounting, the revenues must be reported on the income statement in the period in which it is earned. This means that as soon as a product is sold, or the service has been performed, the revenues are recognized. This is regardless of whether the money is received or not.

9. MATERIALITY PRINCIPLE

The materiality principle refers to the misstatement in accounting records when the amount is insignificant or immaterial. Because of the materiality principle, financial statements usually show amounts rounded to the nearest dollar.

10. CONSERVATISM PRINCIPLE

If accountants are unsure about how to report an item, the conservatism principle calls for potential expenses and liabilities to be recognized immediately. It directs the accountant to anticipate the losses and choose the alternative that will result in less net income and/or less asset amount.

What Are the 10 Principles of GAAP?

There are ten principles that can help you understand the mission of the GAAP standards and rules.

1. PRINCIPLE OF REGULARITY

The principle states that the accountant has complied to the GAAP rules and regulations.

2. PRINCIPLE OF CONSISTENCY

The accountants should enter all items in exactly the same way that it has been fixed. By applying similar standards in the reporting process, accountants can avoid errors or discrepancies.

If the standards are changed or updates, the accountants are expected to fully disclose and explain the reasons behind the changes.

3. PRINCIPLE OF SINCERITY

As per this principle, the accountant should provide the correct depiction of the financial situation of a business.

4. PRINCIPLE OF PERMANENCE OF METHOD

The focus of this principle is that there should be a consistency in the procedures used in financial reporting.

5. PRINCIPLE OF NON-COMPENSATION

The full details of the financial information should be disclosed including negatives and positives. This should be done without the expectation of debt compensation by an asset or revenue by an expense.

6. PRINCIPLE OF PRUDENCE

The financial data representation should be done “as it is” and not based on any speculation.

7. PRINCIPLE OF CONTINUITY

The principle assumes that the business will continue its operations in the future.

8. PRINCIPLE OF PERIODICITY

The accounting entries are distributed across the suitable time periods.

9. PRINCIPLE OF FULL DISCLOSURE

While creating the financial reports, the accountants must strive for full disclosure.

10. PRINCIPLE OF UTMOST GOOD FAITH

This principle states presupposes that the parties remain honest in transactions.

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