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AccountingCoach.com
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Accounting Principles
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All underlined words are defined in the attached Glossary (Pages 11 – 15).
Introduction to Accounting Principles
There are general rules and concepts that govern the field of accounting. These general
rules—referred to as basic accounting principles and guidelines—form the
groundwork on which more detailed, complicated, and legalistic accounting rules are
based. For example, the Financial Accounting Standards Board (FASB) uses the basic
accounting principles and guidelines as a basis for their own detailed and
comprehensive set of accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three
important sets of rules: (1) the basic accounting principles and guidelines, (2) the
detailed rules and standards issued by FASB and its predecessor the Accounting
Principles Board (APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow
generally accepted accounting principles in the preparation of those statements. Further,
if a company's stock is publicly traded, federal law requires the company's financial
statements be audited by independent public accountants. Both the company's
management and the independent accountants must certify that the financial
statements and the related notes to the financial statements have been prepared in
accordance with GAAP.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting
definitions, assumptions, and methods. Because of generally accepted accounting
principles we are able to assume that there is consistency from year to year in the
methods used to prepare a company's financial statements. And although variations
may exist, we can make reasonably confident conclusions when comparing one
company to another, or comparing one company's financial statistics to the statistics for
its industry. Over the years the generally accepted accounting principles have become
more complex because financial transactions have become more complex.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
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on
Basic Accounting Principles and Guidelines
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Since GAAP is founded on the basic accounting principles and guidelines, we can
en
better understand GAAP if we understand those accounting principles. Below is a list of
the ten main accounting principles and guidelines together with a highly condensed
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explanation of each.
1. Economic Entity Assumption
l
The accountant keeps all of the business transactions of a sole proprietorship
separate from the business owner's personal transactions. For legal purposes, a
sole proprietorship and its owner are considered to be one entity, but for accounting
purposes they are considered to be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be
expressed in U.S. dollars are recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing
power has not changed over time. As a result accountants ignore the effect of
inflation on recorded amounts. For example, dollars from a 1960 transaction are
combined (or shown with) dollars from a 2008 transaction.
3. Time Period Assumption
This accounting principle assumes that it is possible to report the complex and
ongoing activities of a business in relatively short, distinct time intervals such as the
five months ended May 31, 2008, or the 5 weeks ended May 1, 2008. The shorter
the time interval, the more likely the need for the accountant to estimate amounts
relevant to that period. For example, the property tax bill is received on December
15 of each year. On the income statement for the year ended December 31, 2008,
the amount is known; but for the income statement for the three months ended
March 31, 2008, the amount was not known and an estimate had to be used.
It is imperative that the time interval (or period of time) be shown in the heading of
each income statement, statement of stockholders' equity, and statement of cash
flows. Labeling one of these financial statements with "December 31" is not good
enough—the reader needs to know if the statement covers the one week ending
December 31, 2008 the month ending December 31, 2008 the three months ending
December 31, 2008 or the year ended December 31, 2008.
4. Cost Principle
From an accountant's point of view, the term "cost" refers to the amount spent (cash
or the cash equivalent) when an item was originally obtained, whether that purchase
happened last year or thirty years ago. For this reason, the amounts shown on
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
tia
en
fid
on
C
, C
on
fid
en
AccountingCoach.com
tia
Accounting Principles
l
All underlined words are defined in the attached Glossary (Pages 11 – 15).
Introduction to Accounting Principles
There are general rules and concepts that govern the field of accounting. These general
rules—referred to as basic accounting principles and guidelines—form the
groundwork on which more detailed, complicated, and legalistic accounting rules are
based. For example, the Financial Accounting Standards Board (FASB) uses the basic
accounting principles and guidelines as a basis for their own detailed and
comprehensive set of accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three
important sets of rules: (1) the basic accounting principles and guidelines, (2) the
detailed rules and standards issued by FASB and its predecessor the Accounting
Principles Board (APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow
generally accepted accounting principles in the preparation of those statements. Further,
if a company's stock is publicly traded, federal law requires the company's financial
statements be audited by independent public accountants. Both the company's
management and the independent accountants must certify that the financial
statements and the related notes to the financial statements have been prepared in
accordance with GAAP.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting
definitions, assumptions, and methods. Because of generally accepted accounting
principles we are able to assume that there is consistency from year to year in the
methods used to prepare a company's financial statements. And although variations
may exist, we can make reasonably confident conclusions when comparing one
company to another, or comparing one company's financial statistics to the statistics for
its industry. Over the years the generally accepted accounting principles have become
more complex because financial transactions have become more complex.
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 1
, C
on
Basic Accounting Principles and Guidelines
fid
Since GAAP is founded on the basic accounting principles and guidelines, we can
en
better understand GAAP if we understand those accounting principles. Below is a list of
the ten main accounting principles and guidelines together with a highly condensed
tia
explanation of each.
1. Economic Entity Assumption
l
The accountant keeps all of the business transactions of a sole proprietorship
separate from the business owner's personal transactions. For legal purposes, a
sole proprietorship and its owner are considered to be one entity, but for accounting
purposes they are considered to be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be
expressed in U.S. dollars are recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing
power has not changed over time. As a result accountants ignore the effect of
inflation on recorded amounts. For example, dollars from a 1960 transaction are
combined (or shown with) dollars from a 2008 transaction.
3. Time Period Assumption
This accounting principle assumes that it is possible to report the complex and
ongoing activities of a business in relatively short, distinct time intervals such as the
five months ended May 31, 2008, or the 5 weeks ended May 1, 2008. The shorter
the time interval, the more likely the need for the accountant to estimate amounts
relevant to that period. For example, the property tax bill is received on December
15 of each year. On the income statement for the year ended December 31, 2008,
the amount is known; but for the income statement for the three months ended
March 31, 2008, the amount was not known and an estimate had to be used.
It is imperative that the time interval (or period of time) be shown in the heading of
each income statement, statement of stockholders' equity, and statement of cash
flows. Labeling one of these financial statements with "December 31" is not good
enough—the reader needs to know if the statement covers the one week ending
December 31, 2008 the month ending December 31, 2008 the three months ending
December 31, 2008 or the year ended December 31, 2008.
4. Cost Principle
From an accountant's point of view, the term "cost" refers to the amount spent (cash
or the cash equivalent) when an item was originally obtained, whether that purchase
happened last year or thirty years ago. For this reason, the amounts shown on
For personal use by the original purchaser only. Copyright © 2009 AccountingCoach.com. 2
