gaap concepts

8/2/2019 Gaap Concepts

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756 Generally Accepted Accounting Principles, Concepts, and Conventions (GAAPs)-----t-

The Principle of ConservatismThe principle of conseiVatism provides that accounting for a business should be fairand reasonable. Accoun tants are required in their work to make evaluations andestimates, to deliver opinions, and to select procedures. They should do this in sucha way that assets or profits are neither overstated nor understated.

The Objectivity PrincipleThe objectivity principle states that accounting will be recorded on the basis ofobjective evidence. Objective evidence means that different people looking at theevidence will arrive at the same values for the transaction. Simply put, this meansthat transactions will be based on fact and not on personal opinion or feelings.

The source document for a transaction is almost always the best objective evi-dence available. The source document shows the amount agreed to by the buyer andthe seller, who are usually independent and unrelated to each other.

The Revenue Recognition ConventionThe revenue recognition convention states that revenue be recorded in the accounts(recognized) at the time the transaction is completed. Usually, this just meansrecording revenue when the bill for it is sent to the customer. I f it is a cash transac-tion, the revenue is recorded when the sale is completed and the cash received.

It is no t always quite so simple. Think of the building of a large project such asan office tower. It takes a construction company a number of years to complete sucha project. The company does no t wait until the project is entirely completed beforeit sends its bill. Periodically, it bills for the amount of work completed and receivespayments as the work progresses. Revenue is taken into the accounts on this peri-odic basis.It is important to take revenue into the accounts properly. I f this is not done, theincome statements of the company will be incorrect and the readers of the financialstatements misinformed.

The Time Period ConceptThe time period concept provides that accounting take place over specific time peri-ods known as fiscal periods. These fiscal periods are of equal length, and are usedwhen measuring the financial progress of a business.

The Matching PrincipleThe matching principle is an extension of the revenue recognition convention. Thematching principle states that each expense item related to revenue earned must berecorded in the same accounting period as the revenue it helped to earn. I f this isnot done, the fmancial statements will no t measure the results of operations fairly.


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Generally Accepted Accounting Principles, Concepts, and Conventions (GAAPs) 757- -+----

The Cost PrincipleThe cost principle states that the accounting for purchases must be at the cost priceto the purchaser. This is the figure that appears on the source document for thetransaction in almost all cases. There is no place for guesswork or wishful thinkingwhen accounting for purchases.

The value recorded in the accounts for an asset is no t changed later if th e mar-ket value of the asset changes. It would take an entirely new transaction based onnew objective evidence to change the original value of an asset.

There are times when the above type of objective evidence is not available. Forexample, a building could be received as a gift. In such a case, the transaction would berecorded at fair market value which mus t be determined by some independent means.

The Consistency PrincipleThe consistency principle requires that a business must use the same accountingmethods and procedures from period to period. When they change a method fromone period to another they must explain the change clearly on the financial state-ments. The readers of financial statements have the right to assume that consistencyhas been applied unless they are notified of some change in procedure.

The consistency principle prevents people from changing methods for the solepurpose of manipulating figures on the fmancial statements.

The Materia lity PrincipleThe materiality principle requires accountants to include in a firm's financial state-ments any information that could be considered material (or important) to the usersof that financial information. For it to be acceptable not to include information inthe financial statements, it must be such that neither the net income nor the finan-cial position of the firm are impacted in any significant way. Excluding particularinformation must not lead statement users to make decisions different from whatthey would make were they to have that information.

The Full Disclosure PrincipleThe full disclosure principle states that all information needed for a full under-standing of a company's financial statements must be included with the financialstatements. Some items may not affect the ledger accounts directly. These would beincluded in the form of accompanying notes. Examples of such items are outstand-ing lawsuits, ta x disputes, and company takeovers.


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