The origins of GAAP or Generally Accepted Accounting Principles go all the way back to 1929 and the stock market crash that caused the Great Depression. Faith in the economy was at an all-time low and the government of that time decided that something had to be done to rebuild that faith. Thus, the Securities and Exchange Commission or SEC was formed with a mission to regulate financial practices. The SEC in turn asked the American Institute of Accountants for help in order to examine financial statements and 1936 the concept of GAAP was spoken about for the first time.
The evolution of these accounting standards has taken more than half-a-century and changes are being made even today. Along the way, the governing boards have changed as well and in the current era, it is the Financial Accounts Standards Board or FASB that decide the rules of accounting. But the SEC still continues to have enforcement powers.
A business is a separate entity in the eyes of the law. All its activities are treated separately from that of its owners. In legal terms, a business can exist long after the existence of its promoters or owners.
A currency is specified for reporting the financial statements. In the United States, all the numbers have to be expressed in US dollars. Companies who conduct parts of their businesses in foreign currencies have to convert the amounts in US dollars using the prevalent exchange rate while reporting their financial statements.
Financial statements always pertain to a specific time. Income statements have a start date and an end date. Balance sheets are reported on a certain date. This way the readers know during which period the business transactions were conducted.
Historical costs are used for valuing items. The prices at which items were brought and sold are used for the valuations. Real values do change during the course of time due to inflation and recession, but these are not considered for reporting purposes.
The full disclosure principle is always in keen focus what with all the accounting scandals in the news nowadays. It is required that companies reveal every aspect of the functioning in their financial statements.
There is also the recognition principle which states that companies reveal their income and expenses in the same time period in which they were accrued.
The accounting principles assume that businesses will continue to function eternally and have no end date as such.
The matching principle states that the accrual system of accounting be used and for every debit, there should be a credit and vice versa.
Then there are a couple of principles that require the bookkeepers to use their judgment rather than sure shot rules. There are inaccuracies in all accounting records. After all, nobody is perfect. But when errors are made how important are they for the bookkeeper to break his head over. A ten-dollar error can be ignored, but not a thousand dollars one. This is where the principle of materiality comes in and this is where the accountants have to use their judgments.
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Conservative accounting is another principle to be adopted for the good of the company. When expenses happen they are to be recorded immediately, but incomes are to be recorded only when the actual cash has been received. Of course, what policies companies follow depend on their own internal strategy.
Companies need to know the GAAP rules thoroughly. In these times when the banking sector and indeed the whole financial world is under so much scrutiny regulators are taking compliance issues, accounting principles, and business practices very seriously. That is why it is essential that every individual in the organization adhere to these rules and principles. Having an effective Finance and Accounting Services team is critical to ensure the accuracy of financial statements.
Related Reading: Importance of Accurate Financial Statements for Business