Introduction
US GAAP
What are 'US Generally Accepted Accounting Principles - GAAP'
Generally Accepted Accounting Principles, also called GAAP or US GAAP, are the generally accepted accounting principles adopted by the U.S. Securities and Exchange Commission (SEC).
BASIC CONCEPTS
To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints.
1. Assumptions
Business Entity: The business is separate from its owners and other businesses. Revenue and expense should be kept separate from personal expenses.
Going ConcernThe business is assumed to be in operation indefinitely. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain is this assumption inapplicable. The business will continue to exist in the unforeseeable future.
Monetary Unit:A stable currency is the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record, unadjusted for inflation.
Periodicity: The economic activities of an enterprise can be divided into artificial time periods.
2. Principles
Historical cost principle: Companies must account for and report the acquisition costs of assets and liabilities rather than their fair market value. 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 toward the use of fair values. Most debts and securities are now reported at market values.
Revenue recognition principle:Companies should record revenue when earned but not when received. The flow of cash does not have any bearing on the recognition of revenue. This is the essence of accrual basis accounting. Conversely, however, losses must be recognized when their occurrence becomes probable, whether or not it has actually occurred. This comports with the constraint of conservatism, yet brings it into conflict with the constraint of consistency, in that reflecting revenues/gains is inconsistent with the way in which losses are reflected.
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 may 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.
Full disclosure principleThe 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
3. Constraints
Objectivity principle:The company financial statements provided by the accountants should be based on objective evidence.
Materiality principleThe 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.
Consistency principle: It means that the company uses the same accounting principles and methods from period to period.
Conservatism principle: when choosing between two solutions, the one which has the less favorable outcome is the solution which should be chosen
Cost Constraint:The benefits of reporting financial information should justify and be greater than the costs imposed on supplying it.
REQUIRED DEPARTURES FROM GAAP
Under the AICPA's Code of Professional Ethics under Rule 203 - Accounting Principles, a member must depart from GAAP if following it would lead to a material misstatement on the financial statements, or otherwise be misleading. In the departure the member must disclose, if practical, the reasons why compliance with the accounting principle would result in a misleading financial statement. Under Rule 203-1- Departures from Established Accounting Principles, the departures are rare, and usually take place when there is new legislation, the evolution of new forms of business transactions, an unusual degree of materiality, or the existence of conflicting industry practices.
