Why Should We Know the Basics of GAAP?
The Generally Accepted Accounting Principles is a systematic set of practices for presenting financial statements in a more coherent way. Just as English is a common language for businesses worldwide, GAAP works in the same fashion within the accounting field. The basics of GAAP are quite easy to understand to ensure consistency and prevent complications as to reporting finances.
In this article, we’ll be outlining 10 main points under this principle. But first, we’ll find out the basics of GAAP by knowing its origin and purpose.
History of GAAP
The idea behind GAAP originated during a series of notorious financial catastrophes. To be exact, these events were the Stock Market Crash of 1929 and the Great Depression in the US. The federal government believed that the partial cause for such occurrences is the inaccurate financial reporting processes by other corporations.
Countering such acts, the government worked with accounting experts to draft a definitive system which seemingly functions as a mandate for all companies. This set of rules should be followed to improve consistency in the field. Thus, the GAAP came into fruition, along with legislative acts such as the Securities Exchange Act of 1934.
Through the years, GAAP has spread worldwide, serving as a framework for other nations’ accounting practices. In addition, GAAP has diversified further as to its scope. Originally, this pragmatic approach only applied to companies. However, non-profit and governmental entities are also applying GAAP within their operations.
Basics of GAAP: Ten Main Principles
Here are the prevalent practices that revolve around GAAP:
The Business as a Single Entity Principle
This principle indicates that each business is treated as a different entity, separate from its owner. This means it can exist even if the founding member dies, either by a succession of title or purchase of shares.
The Specific Currency Principle
This practice varies from country to country, depending on what currency they have. It entails that every foreign transaction must have its amount relative to the home nation’s conversion rate. For instance, if your currency is in Singaporean dollars, any currency like USD or EUR must be treated in SGD when reporting in financial statements.
The Specific Time Period Principle
Simply put, this principle states that there is a particular date for reporting of financial statements. As such, there has to be a beginning and an end date, which businesses must follow. If possible, they must accordingly and consistently report on the date they have set upon.
The Historical Cost Principle
Every item, product, service, or property has a value. Such valuation may fluctuate due to various economic factors, such as inflation and depression. Regardless of these changes, the value of these items will still stay the same.
The Full Disclosure Principle
Businesses must divulge every transaction that occurs within the course of their operations. This avoids the lack of transparency which some firms have experienced before.
The Recognition Principle
Similar to the Full Disclosure principle, the Recognition principle requires companies to exercise neutrality and prudence in financial reporting. Further, they must report transactions exactly on the date of their accrual.
The Non-Death Principle of Businesses
Akin to the Single Entity concept, this accounting practice assumes that businesses live perpetually. Such is a case even if the founding members have passed away or sold their shares to another.
The Matching Principle
For every action, there’s an equal reaction. This is just what the Matching principle suggests. In every business transaction, there will always be a debit and a credit side.
The Principle of Materiality
As much as possible, accountants must be practice precision in financial reporting. Unfortunately, the system is not infallible due to human error. This principle indicates that accountants should be able to judge situations according to its face value.
The Principle of Conservative Accounting
This principle retains the need for fairness, preserving the company’s good name. Each company follows a specific tactic to up their income and lower their expenses. However, it boils down to practicing goodwill. Actions include recording expense instantly and recognizing income upon receipt.
Practice These GAAP Principles Religiously
These are the basics of GAAP in a nutshell. We are hoping that your business comprehends and applies these principles in real time. They may seem idealistic, but in a world where deception is imminent, following simple rules would make a huge change. It’s just too tempting to resort to fraud, but it’s not worth it, really.
If you need assistance as to managing your financial records, we are here to help. Our company has comprehensive accounting services which you can avail for your convenience. We can also provide you with one-on-one consultation sessions for a more professional approach.
Chai Chung Hoong, Account Manager
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