Lesson 2 – General Accepted Accounting Principles (GAAP)

General Accepted Accounting Principles (GAAP)

Accounting is simply a measurement. Measurements allow for consistency. Just like everyone knows what one foot (or 30 centimeters) of distance is, the business owner (or CEO) and all stakeholders should be confident that they know what a company’s assets are. The accounting concepts and standards that govern consistency are called generally accepted accounting principles (GAAP).

There can be slight differences between regions, but GAAP typically includes the following principles:

• Comparability among different companies
• Reliability of information
• The business entity concept: A business is a separate distinct entity from its owner/owners.
• The matching principle: Earnings and expenses must be recorded in the same accounting period that they relate to each other.
• The cost principle: Assets and service, and the resulting liability, are taken into the accounting records at cost.
• The consistency principle: A company’s accounting procedures need to remain consistent over time. If they are changed, the reasons for the change and the financial impact of the change must be documented in detail.
• The time period principle: The operating period of the business is divided into equal periods of time, such as a month or a quarter.
• The going-concern principle: The business will continue to operate, using its assets to carry on its operations and, with the exception of merchandise, not offering the assets for sale that are necessary to run the business.
• The objectivity principle: Whenever possible, the amounts used in recording transactions are based upon objective evidence rather than on subjective judgments.
• The stable currency assumption: The idea that the purchasing power of the unit of measure used in accounting (such as the dollar or the euro) does not change. (In other words, a dollar bill will not become worthless overnight.)
• The realization principle: This principle defines revenue as an inflow of assets (not necessarily cash) in exchange for goods or services. It requires the revenue to be recognized at the time, but not before it is earned.