The accounting principles are the basic guidelines that govern the field of accounting. These principles have been developed over time and are constantly evolving as the accounting profession adapts to the changing needs of business and society.
The general accepted accounting principles (GAAP) are a set of norms and procedures used by accountants to prepare financial statements. GAAP is designed to make financial reporting more consistent and transparent.
The GAAP guidelines are enforced by Financial Accounting Standards Board (FASB), which is primary body responsible for setting standard of accounting in the U.S.
There are 10 main principles of GAAP:
- Revenue recognition
- Expense recognition
- Asset valuation
- Liability valuation
- Equity valuation
- Full disclosure
- Materiality
- Conservatism
- Consistency
- Objectivity
- Revenue acknowledgment: Revenue should be acknowledged when it is earned, rather than received. This is because revenue represents the value that a company has provided to its customers.
- Expense recognition: Expenses should be recognized when they are incurred, not when they are paid. This is because expenses represent the cost of resources used up in the process of generating revenue.
- Asset valuation: The lower of an asset’s cost or reasonable price should be used to determine its worth. This is because assets are meant to be used for future economic benefits and should not be overvalued.
- Liability valuation: Liabilities should be worth at their cost or reasonable price, whichever is higher. This is because liabilities represent future obligations that must be paid.
- Equity valuation: Equity should be valued at its par value or book value, whichever is higher. This is because equity represents the residual ownership interest in a company.
- Full disclosure: All material information should be disclosed in financial statements. This is to ensure that investors and creditors have all the information they need to make informed decisions.
- Materiality: Only information that is material should be published in financial statements. This is because financial statements are meant to show the right position of organization’s financial position.
- Conservatism: In case of doubt, financial statements should err on the side of conservatism. This is because financial statements should not overstate a company’s financial position.
- Consistency: Consistency between periods is required for financial statements. This is because investors and creditors need to be able to compare financial statements over time.
- Objectivity: Financial statements should be free from bias. This is so because the purpose of financial statements is to give an accurate and unbiased picture of an organization’s financial situation.
Importance
The accounting principles are important because they provide accountants and businesses a common language. They also provide guidance on how financial statements should be created, which helps ensure that financial statements are accurate and consistent.