Every business needs to determine some basic guiding principles for ensuring proper financial dealings and undertaking correct monetary transactions. So, financial institutions have “accountings principles” that serve this purpose. Companies follow these guidelines when reporting all accounts and conveying financial information. These principles help companies communicate in a language deemed acceptable by other businesses. Organizations that make their data public follow accounting principles to prepare their statements. Now, companies follow a set of such principles based on their industry and location. Thus, we’ll discuss GAAP that regulates the behavior of financial organizations in the United States.
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What’s GAAP, and why is it important?
The acronym “GAAP” refers to the Generally Accepted Accounting Principles. The two variations of these rules exist in the UK and the US (though we’re concerned with the American one only). Two sources of these principles exist in the United States. For the federal government, GAAP is defined by FASAB. In comparison, GASB determines GAAP for the local and state governments. Also, AICPA was responsible for setting and improving these principles, but these responsibilities were transferred to FASB in 1973.
Why is GAAP important? Well, it allows publicly traded organizations to create financial statements. It also covers different financial aspects of an institution. Financial information relies on historical data, so this accounting information must obey GAAP. However, organizations need employees who can comply with these principles and have proper knowledge of them. Nowadays, online degree options are soaring to heights, given their flexibility and extensive curricula. And because of this, companies hire professionals who have pursued online masters in accounting to implement these rules successfully. These experts ensure a company’s compliance with GAAP.
Now, let’s review all of these fundamental accounting principles.
14 important accounting principles
- The principle of prudence: – Companies should report financial information factually, honestly, and reasonably.
- The principle of full disclosure: – Your financial statements must convey accurate and complete information to avoid misleading anyone.
- The principle of monetary unit: – Business executives should record transactions using a stable currency, so they must record transactions in the US dollar amounts.
- The principle of economic entity: – The business constitutes a separate entity; hence business activities must be clear of the business owner’s private transactions.
- The principle of cost: – Whenever you purchase something, record its historical (original) cost on the financial statements.
- The principle of materiality: – It states that when your business deals with immaterial amounts of money, you should round them off to the nearest dollar without misleading the company’s financial position.
- The principle of continuing concern: – It simply means that your business plans to stay afloat for some time by committing to keep existing for the foreseeable future and not liquidating. This principle demonstrates your intent to continue operations.
- The principle of matching: – Your expenses must pair up with the associated revenues during the period you incur them and when you earn them. Following an accrual basis, your business should match its income to expenditures for a given time.
- The principle of time Interval: – A company should create financial statements for specific and different time intervals. Express these periods as weeks, months, quarters, or even a year. In an income statement, this time interval furnishes the heading.
- The principle of revenue recognition: – Recognize/record revenue as soon as you sell your product or perform a service. The reason being, you have to report it on the income statement if you operate on an accrual basis.
- The principle of conservatism: – When an accountant encounters two contrary situations, he/she must go with the least favorable one. It allows a business to anticipate future losses instead of future profits. Accountants “play it safe” by recognizing potential expenses/liabilities.
- The principle of consistency: – A business must always follow consistent standards from time to time while creating financial statements. It prevents organizations from changing their rules whenever the need arises. When you’ve agreed to follow a method, it’s essential to stick with it throughout your accounting periods.
- The principle of continuity: – It may sound similar to the rule of continuing concern. It states that accountants must assume the future of the company according to what transpired in the past. He/she must consider that the organization will keep existing and operating the same way. An accountant shouldn’t expect any interruptions.
- The principle of regularity: – Accountants must follow a regular procedure and shouldn’t just create laws principles as they go along. This principle can be described as the mother of all rules since it mandates strict obedience to GAAP. Companies must understand financial accounting vs managerial accounting and why these are two different disciplines. Let’s explain why:
- Financial accountants strictly follow GAAP, but managerial accounts don’t need to adhere to it faithfully.
- Financial accounts deal with historical, accurate, and transparent data, but the managerial ones aren’t rigid regarding the analysis.
- Managerial accountants don’t focus on the big picture; however, their financial counterparts compile reports for the entire business, not individual departments.
Institutions can’t effectively operate without defining a set of rules to follow. These rules encompass the complexities and legalities of corporate accounting. We’ve talked about GAAP as the standard principles American organizations follow. Businesses that are on stock exchanges must obey rules that incorporate the concepts of sincerity, regularity, and consistency. Companies of all kinds and sizes adhere to the FASB-mandated and AICPA-certified regulations. These principles lie at the core of every organization’s accounting transaction. Additionally, they enable companies to gain valuable insights into their practices for better accountability. Hence, GAAP enhances your organization’s overall efficiency.