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Accounting Principles

Candlefocus Editor

Generally Accepted Accounting Principles (GAAP) are the framework of rules that determine how financial information is reported to the public, stakeholders, and other interested parties. Entities use GAAP to maintain consistency in financial reporting and ensure transactions are accurately reflected in a company’s financial statements. GAAP is a kind of internal language that organizations use to maintain clarity and accuracy in their records. This can be beneficial for businesses to see if their budgets are accurate or to which areas of their company may need improvement in terms of finances.

The FASB sets US GAAP codes, which are guidelines that must be followed, however businesses are given leeway to customize their financial reports in accordance to the rules set. GAAP consists of ten core principles and these are:

1. Relevance: Relevant financial statements must give important information that is helpful in decision-making.

2. Reliability: Reliable financial statements must be free from material misstatement and errors and give a true and fair view of the company performance.

3. Comparability: Comparability is a fundamental part of financial reporting because companies should be able to compare financial reports from previous years as well as compare with other companies.

4. Understandability: Financial statements should be easily understood by the stakeholders and other users of the financial statements.

5. Consistency: Companies should use the same accounting principles from one year to the next and within the same time period. This will provide a clear and consistent record of financial performance

6. Substance Over Form: Companies should focus on recording transactions that have economic substance over transactions that have only legal form.

7. Cost Benefit Principle: This principle suggests that the accounting information that is available should have economic benefits that cost less than the information itself.

8. Consistency of Reporting: All different kinds of companies should report information in a comparable form.

9. Materiality: All financial information should be disclosed if it is thought to have a significant effect on the overall financial performance.

10. Conservatism: This principle states that when there are two estimates of an outcome, the most conservative one should be recorded.

These foundational accounting principles provide the necessary clarity and organization to business operations and help ensure proper reporting for stakeholders and users of the financial statements. The principles also encourage organizations to be ethical when dealing with financial information. The use of GAAP allows for better transparency into the financial statements of companies, thus creating confidence among stakeholders and giving potential lenders a clear view of the company’s financial position.

Thanks to the GAAP, companies can compare its financial position and performance to that of other organizations and make accurate records of transactions. Without reliable accounting methods, organizations wouldn't have a basis to compare and make their own decisions.

In summary, GAAP is an accounting method implemented by the Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) to maintain consistency of financial reports. This helps companies and their stakeholders to make accurate decisions in terms of budgeting and financial operations. GAAP is also beneficial for gaining the confidence of potential lenders, investors and other organizations. The framework of GAAP, consisting of 10 core principles, help companies build an ethical and transparent accounting framework for the organization.

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