GAAP stands for “generally accepted accounting principles”. GAAP is an international convention of good accounting practices. It is based on a few core principles. Some circumstances would allow an accountant to be held liable for deviating from these principles:

The basic objectives of GAAP:

  • Useful to present the financial state of the business to potential investors, creditors and users.
  • Assessing all the financial activities must be easier.
  • Financial decisions are made easily.
  • Long-term decisions and event can be planned more accurately.
  • The performance of the business will improve considerately.
  • Records are better maintained.

The basic concepts of GAAP:

Assumptions

  • Accounting Entity: It is assumed that the business is separate from its owners or other businesses.
  • Going Concern: It is assumed that the business will be in operation indefinitely.
  • Monetary Unit principle: assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation.
  • Time-period principle: This implies that the economic activities of an enterprise can be divided into artificial time periods.

Principles

  • The historical cost principle requires companies to account and report based on purchasing costs rather than fair market value for most of its assets and liabilities.
  • Revenue recognition principle holds that companies may not record revenue until it is realized or realizable and when it is earned.
  • Matching principle. Expenses should be matched with revenues as long as it is reasonable to do so. Expenses are recognized when the work or the product actually makes its contribution to revenue.
  • Full disclosure principle. The amount of information that is disclosed should be enough to make a judgment but it should also keep the costs reasonable.

Constraints

  • Objectivity principle: The company’s financial statements that are provided by the accountants should be based on objective evidence.
  • Materiality principle: the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.
  • Consistency principle: The same accounting principles are used from period to period.
  • Conservatism principle: the solution that has the less favorable outcome is the solution which should be chosen. This applies when  a solution must be implemented.