Generally Accepted Accounting Principles (GAAP) encompass the standards, principles, and procedures companies must follow when compiling financial reports. For starting and small business owners who do their accounting on their own through business accounting software, understanding the GAAP will minimize the risks of erroneous financial statements and make them complete and reliable.
Some private companies and organizations are not required to produce reports that follow GAAP. However, voluntarily adhering to it puts finances in the best possible light. GAAP makes the financial statements fair, transparent, comparable, and consistent. It is also helpful for when the business later decides to expand or scale. When company statements are at par with the acceptable standards, they can easily evaluate current performance with competitors.
GAAP generally consists of assumptions, principles, and considerations.
The application of GAAP relies on four primary assumptions: economic entity, monetary unit, time period, and going concern.
- The entity assumption states that the business is a distinct unit unto itself, so business owners must separate all business activities from personal transactions.
- The monetary unit assumes that all economic events can be expressed or measured in monetary terms by a currency.
- The time period assumption presents that time can be divided into definite time intervals – monthly, quarterly, semi-annually, annually.
- The going concern assumes that the entity will remain in business for the foreseeable future.
- The cost principle provides that the company must record specific assets at their original cost or the cash value when it was purchased. No adjustments should be made for inflation. However, adjustments like depreciation and appreciation are allowed, but only through separate accounts (e.g., accumulated depreciation and revaluation surplus).
- The full disclosure principle requires reports to disclose all relevant situations, circumstances, and events. Examples of significant items that need disclosure are inventory losses, goodwill impairment, and changes in the accounting system. Full disclosure is necessary because it ensures the users of financial information are not misled by lack of information.
- The matching principle instructs that if an expense is directly related to an income activity, the company must report such expense on the same period when its corresponding revenue is earned. Recording of commission, rent, wages, and office supplies expenses are some examples that must follow the matching principle.
- The revenue recognition principle specifies that the recordkeeper should recognize sales and expenses when made, irrespective of when cash was received or paid. This principle is the foundation for using Accounts Receivable, Accounts Payable, Accrued Income, and Accrued Expense.
Accounting considerations are the concepts that bookkeepers must put in mind when applying the prescribed accounting procedures.
- Materiality allows the disregard of a particular accounting standard when the net effect of doing so is negligible and would not mislead readers of the reports.
- Conservatism states that if there are multiple ways to report an item, the bookkeeper must choose the method that results in lesser net income.
Accounting Software for the Convenient Application of Reporting Standards
GAAP guides businesses into making more informative financial reports. Simplify compliance with reporting standards today with the help of the best accounting software for small business. With modern accounting solutions, the application of rules and procedures is automatic and stress-free!
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