Generally Accepted Accounting Principles are a set of accounting principles, procedures, and standards generally accepted and issued by the Financial Accounting Standards Board adhered to by accountants working in the United States of America. They are also known as GAAP. The accountants follow these guidelines during the compilation of the financial statements. The principles ensure proper communication between potential investors, auditors, and the public by enhancing the clarity, consistency, and comparability of the financial reports. The document aims to highlight some of these principles necessary for accounting.
Principle of consistency
The accountant needs to adhere to all the set rules and regulations set within the organization and state in general. They have to adhere to similar standards throughout the financial statement. In doing so, they can evade committing any errors or have discrepancies. Moreover, when the accountant either updates or changes the formulae applied in the previous reports, they are expected to explain themselves. Hence, restoring the trust between the investors or potential clients since the purpose of the alterations is disclosed.
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Principle of periodicity
It is also known as the period of assumption. According to this principle, the accountants disclose the company's activities periodically the periods for the financial statements to be released either monthly, quarterly, or annually. The assumption is that whether the company deals in complex manufactured items or essential consumer goods, then there some of the activities which will be operational for two years or more. Accountants assume that any revenue or costs incurred will be allocated specific period times. Thus, the company's financial reports, either cash flow or net income, to be made available according to a designated period.
Principle of sincerity
It expects that the accountant will be accurate with the information presented. The balance sheet will be a true reflection of the company's progress to the investors or the stock market. It assumes the accountant will be fair in their representation of the information or the data they are presenting, thus, not defrauding any of the parties interested in attaining the data.
Principle of prudence
The Prudence aspect of accountability expects that the data presented is factual. The company's accountant has not overestimated any activities, revenues, profits, or assets. On the other hand, it expects zero undervaluing of the losses, liabilities, expenses, or debts the institution holds. The accountants have to be keen when reporting the income and the expenses incurred. Hence, it leaves no room for speculation when the data is released to the public as each content awaits its actualization before inclusion in the final financial statement. The necessity of the financial statements to be a factual representation of the company's events is crucial as it impacts the decision-making process that any potential users might have. For instance, several liabilities can occur, but the surety of the amount or date cannot be predetermined. The inclusion of the liabilities in the data with their equivalent expenses avoids undervaluing.
The principle of materiality
The principle expects accounting standards to be upheld and exempt if its impact on the financial reports does not affect its users' decisions. It ensures the accountant does not misinform by either skipping accounts or omitting the debts incurred. According to the stock exchange commission, any item exceeding 5% of the entire company's assets should be displayed differently in the balance sheet. Regardless of how minute an item may appear, its inclusion is essential if it can affect whether the institution records a profit or loss. For instance, a small enterprise would be affected by a million-dollar transaction, hence considering it as material. However, a massive enterprise would consider the same transaction as immaterial as it will not influence decision-making.
In conclusion, while GAAP helps control accounts' operations by providing a set guide, it does not capture modern business complexities. The guidelines control the industry while not giving guidelines to small enterprises' daily operations making such businesses skip the procedure.
References
Bragg, S.M. (2020): Accounting tools series GAAP guidebook (2021 ed.) Accounting Tools Inc.
Marder, A. (2017): What are the Generally Accepted Accounting Principles ? Retrieved from: https://blog.capterra.com/what-are-the-generally-accepted-accounting-principles/#:~:text=Principle%20of%20Sincerity%20%E2%80%93%20This%20means,completed%20accounting%20should%20be%20replicable
