Generally Accepted Accounting Principles are standards set by an external body governing how a business prepares financial statements. GAAP accounting makes it possible for external parties to have a fair look on financial position of a company in the manner in which the company presents and treats its assets, liabilities, income and expenses in the financial statements.
GAAP accounting is important to businesses since it provides a basis for making long term decisions and policy framework. It is also important to users of financial statements since they can make a comparison between two or more business entities of interest. It is also important to note that GAAP is applicable by businesses in the United States while Internationally Financial Reporting Standards is applicable to most countries globally. We shall look at common provisions as per GAAP below.
Historical Cost Principle
Historical cost is the price or original cost used in purchasing a fixed asset. GAAP provides that recording of fixed assets in a company should be as per their respective historical cost. This is despite any significant change in value occurring over time for instance asset impairment or depreciation.
Principle of Prudence
According to the principle of prudence, a financial statement should present a true and practical discretion without exaggeration. This means that there should be no attempt to make situations appear pretty or attractive than the real situation. According to this principle, a business should not overestimate its revenues nor underestimate its expenses.
Principle of Full Disclosure
This principle requires a business to report necessary information in the financial statements to aid users of such statements in making informed decisions. In case of any disclosure in the financial statements, the business should indicate it in the notes section.
Principle of Consistency
According to this principle, if a business decides to use a specific accounting principle or treatment of transactions, the same treatment will serve all accounting transactions.
Revenue Recognition Principle
Revenue recognition principle gives the conditions of treating revenue received in different accounting periods. It states that recognition of revenues should be in the period in which it occurred and not when cash payments are made.
Monetary Unit Principle
Monetary unit principle provides for the currency to apply in presentation of financial statements i.e US dollar. It also provides for the recording of transactions that are only measurable in monetary terms.
Principle of Periodicity
Allocation of each transaction should be on the respective trading period when it occurred or partitioned accordingly in cases where it covers more than one trading period.
The matching principle requires a business to match expenses and related revenue in the same period. This means that for every expense reported in financial statements there should be a corresponding income that it generated.
GAAP principles are not rigid and strict rules that every accountant must follow in their day to day activities. Rather, they provide a basis of judgment and direction when recording different kinds of financial transactions. GAAP principles have evolved over time to provide guidance on how financial statement should be prepared and presented.