Generally Accepted Accounting Principles (USA)

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Generally accepted accounting principles or US GAAP are the accounting rules used to prepare financial statements for publicly traded companies and many private companies in the United States. Generally accepted accounting principles for local and state governments operates under a different set of assumptions, principles, and constraints, as determined by the Governmental Accounting Standards Board (GASB).

In the United States, as well as in other countries practicing under the English common law system, the government does not set accounting standards, in the belief that the private sector has better knowledge and resources. The GAAP is not written in law, although the U.S. Securities and Exchange Commission (SEC) requires that it be followed in financial reporting by publicly traded companies. Currently, the Financial Accounting Standards Board (FASB) sets accounting principles for the profession. The US GAAP provisions differ somewhat from International Financial Reporting Standards though efforts are underway to reconcile the differences so that reports created under international standards will be acceptable to the SEC for companies listed on US markets.

[edit] Basic objectives

Financial reporting should provide information that is:

• useful to present or potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
• helpful to present or potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
• about economic resources, the claims to those resources, and the changes in them.

[edit] Fundamental qualities

To be useful and helpful to users, financial statements must be:

• Relevant: relevant information makes a difference in a decision. It also helps users make predictions about past, present and future events (it has predictive value). Relevant information helps users confirm or correct prior expectations (it has feedback value). It must also be available on time, that is before decisions are made.
• Reliable: reliable information is verifiable (when independent auditors using the same methods get similar results), neutral (free from bias), and demonstrate representational faithfulness (what really happened or existed).
• Comparable: information must be measured and reported in a similar manner for different enterprises (allows financial statements to be compared between different companies).
• Consistent: the same accounting methods should be applied from period to period and all changes in methods should be well explained and justified.

[edit] Basic concepts

To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints.

[edit] Assumptions

• Economic Entity Assumption assumes that the business is separate from its owners or other businesses. Revenues and expenses should be kept separate from personal expenses. This applies even for partnerships and sole proprietorships. As corporates, they are considered separate legal entities.
• Going Concern Assumption assumes that the business will be in operation for a long time. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain this assumption is not applicable.
• Monetary Unit Assumption 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.
• Periodic Reporting Assumption assumes that the business operations can be recorded and separated into different periods (most common periods are months, quarters and years). This is required for comparison between present and past performance.

[edit] Principles

• The historical cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values.
• The revenue recognition principle requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting.
• The matching principle. Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost can be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle.
• The full disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information.

[edit] Constraints

• Cost-benefit relationship: the benefit of providing the financial information should also be weighed against the cost of providing it.
• Materiality: 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.
• Industry practices: accounting procedures should follow industry practices.
• Conservatism: when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

[edit] Setting GAAP

These organizations influence the development of GAAP in the United States.

• United States Securities and Exchange Commission (SEC)

• American Institute of Certified Public Accountants (AICPA)

• Financial Accounting Standards Board (FASB)

• Governmental Accounting Standards Board (GASB)

• Other influential organizations (e.g. American Accounting Association, Institute of Management Accountants, Financial Executives Institute)

[edit] House of GAAP

[edit] External links

• GAAP Mathematically Described

[edit] See also

• Generally Accepted Accounting Principles