Generally accepted accounting principles help maintain consistency in the financial reporting of all businesses.
Generally Accepted Accounting Principles, or GAAP as they are more commonly known, are rules and guidelines that help companies prepare financial statements. Exactly what the principles contain varies slightly from jurisdiction to jurisdiction, but in most cases they cover assumptions, basic principles and basic restrictions. They are predominantly used by corporate accountants who prepare public earnings statements and financial reports, and are often intended to provide some level of uniformity across industry sectors.
Main objectives
Most countries require listed companies to disclose annual financial statements to their shareholders and, in many cases, to the general public. These reports are really important to investors, banks and creditors as they in many ways speak to the financial health and profitability of the company, but unless all companies prepare their reports according to the same basic principles, results can be difficult to classify and compare. reasonably. Requiring all company filings to adhere to a standardized set of general assumptions, rules, and restrictions can be a way to improve transparency, as well as streamline reporting on things like taxes, earnings, and executive pay.
main assumptions
The main assumptions of generally accepted accounting principles are divided into four subsets, namely: business entity, going concern, currency, and time period. The “business entity” assumption assumes that the business operates as a legal and financial entity separate from its owners or from any other business. This means that all amounts shown as income or expenses on the financial statements are for the business only and do not include any personal expenses.
“Business continuity” is the assumption that the business will operate for the foreseeable future. This is important when calculating asset values, depreciation, and amortization. The “unit of currency” assumption is that all listed securities use a stable currency and that any value in another currency is clearly listed. The “time period” assumes that all reported transactions actually took place within the stated time period.
basic principles
There are also four basic principles. These are costs, income, correspondence, and outreach. The “cost” principle refers to the notion that all amounts listed and reported are the costs of obtaining or acquiring the asset and not fair market value, while the “income” principle states that all income must find out when they are made and earned. not necessarily when receiving real money. This is also known as accrual accounting. The “matching” principle states that expenses in financial statements must match revenues. Accountants should include the amount of the expense in the financial statements when the work product is sold, not necessarily when the work or invoice is issued. Finally, the principle of “disclosure” establishes that the pertinent information must be included to make a reasonable judgment about the finances of the company, provided that the costs to obtain that information are reasonable.
Main restrictions
When it comes to restrictions, GAAP covers objectivity, materiality, consistency, and prudence. The objectivity restriction establishes that all the information included in the financial statements must be supported by independent and verifiable evidence. What this means is that the materiality of the item must be considered under the materiality constraint when deciding whether to include it in the financial statements. In general, if this information is material to a reasonable third party, it should be included.
The company is required to use the same accounting principles and methods each year under the constraint of consistency and any variation must be reported in the notes to the financial statements. Under the prudential constraint, accountants must choose a solution that reduces the probability of overstating assets and income.
how are they used
Principles are, as the name suggests, simply principles: they are not hard and fast rules, and there is usually some room for interpretation. Companies can more or less choose how they will comply with each area, but by publishing their reports, in most cases, they state that the general assumptions and principles of the rules were followed and present an accurate and truthful picture.
Jurisdictional differences
Most countries have GAAP rules, but they can vary from place to place in terms of specificity and particular procedural requirements. In most cases, special financial accounting standards boards are responsible for writing the rules and can also be tasked with solving common problems in a systematic and consistent manner. These boards are usually housed in the government, but can also be privatized. Much depends on the location.
The different principles and rules from one country to another can pose problems, or at least complications, for companies that operate in several places at the same time. In these cases, professional accountants generally need to be aware of all the relevant principles and sometimes need to publish different forms of their financial reports that are tailored to the rules of particular localities. Several experts encourage the development of a single international board to manage to solve this problem; a single code, they say, would promote a greater level of uniformity in accounting standards around the world.