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10 GAAP Principles

Generally Accepted Accounting Principles (GAAP) are the foundational accounting standards and guidelines that all public companies must follow when reporting financial information. There are 10 major GAAP principles: [1] Single Entity, [2] Monetary Unit, [3] Specific Time Period, [4] Recognition, [5] Going Concern, [6] Full Disclosure, [7] Matching, [8] Materiality, [9] Conservative Accounting, and [10] Historical Cost. These principles provide consistency and transparency in financial reporting.

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395 views

10 GAAP Principles

Generally Accepted Accounting Principles (GAAP) are the foundational accounting standards and guidelines that all public companies must follow when reporting financial information. There are 10 major GAAP principles: [1] Single Entity, [2] Monetary Unit, [3] Specific Time Period, [4] Recognition, [5] Going Concern, [6] Full Disclosure, [7] Matching, [8] Materiality, [9] Conservative Accounting, and [10] Historical Cost. These principles provide consistency and transparency in financial reporting.

Uploaded by

Dhez Madrid
Copyright
© © All Rights Reserved
We take content rights seriously. If you suspect this is your content, claim it here.
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Download as PDF, TXT or read online on Scribd
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10 GAAP Principles – Meaning, Importance and More

Generally Accepted Accounting Principles or GAAP are the set of accounting principles, concepts, and
guidelines that guide the more detailed and comprehensive accounting rules, practices, and standards.
There are ten major GAAP principles that have evolved over decades and serve as the foundation of
accounting. In the US, every company that releases its financial statements to the public and companies
that publicly trade on stock exchanges need to follow GAAP guidelines.

ORIGIN OF GAAP PRINCIPLES


The origin of GAAP goes way back to 1929 and the stock market crash that led to the Great Depression.
At the time, faith in the economy was at an all-time low. Thus, the government decided to rebuild the
faith and the Securities and Exchange Commission (SEC) was formed. The SEC asked the American Institute
of Accountants for help and this gave rise to the concept of GAAP.

Over time, many changes have been made to these accounting standards. Also, the governing boards have
changed. Presently, the Financial Accounts Standard Board (FASB) decides the accounting principles under
GAAP, but the Securities and Exchange Commission (SEC) still has enforcement powers.

GAAP covers a range of topics, such as revenue and expenses, assets and liabilities, financial statement
presentation, equities, foreign currency, hedging, business combinations, derivatives, and non-monetary
transactions. To understand GAAP, it is important to understand the ten GAAP principles.

Discussed below are ten major GAAP principles;

SINGLE ENTITY PRINCIPLE


The business as a single entity concept states that all financial records of the business should be separate
from the owners or other businesses. A company must report the assets and liabilities of different
subsidiaries separately and not mix with the books of another company. In the absence of this principle,
the records of multiple entities would get mixed, making it unfeasible from the point of view of financial
audit or tax purpose.

MONETARY UNIT PRINCIPLE


There should be a specific unit of currency in which the company should record transactions. All the
transactions in the financial statements should be in the same currency unit, be it the US dollar, Euro, Indian
Rupee or any other currency. It would be wrong to record some transactions in one currency and some
in another currency.

SPECIFIC TIME PERIOD PRINCIPLE


Financial statements are always related to a specific time, usually towards the end of the financial
accounting period. All three financial statements – Income, Balance Sheet and Cash Flow Statement have
a start, as well as, the end date. It is done to ensure that stakeholders are aware of the time period for
which the company is reporting numbers.

RECOGNITION PRINCIPLE
This principle, as the name suggests, states that a company should record both revenue and expenses when
earned and not when it gets the cash. Therefore, the income statement of the company includes accrued
income and expense. In case there is any doubt on the suppliers regarding the payment, the accountant
should put the item under the allowance for doubtful accounts.
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GOING CONCERN PRINCIPLE
As clear from the name, everyone expects a business to run eternally with no end date. It also means that
the business must not to cease operations and liquidate the assets in the near future at very low fire-sale
prices. Because of this principle, a company can defer certain expenses to a future date.

If an accountant believes that the company might no longer be a going concern, the accountant must detail
the same in his or her assessment. In case of liquidation, the accountant must write-down the value of the
assets to their liquidation value. A point to note is that the value of a going concern firm is perceived to
be higher than the liquidation value. This is because, in the former, there are chances that the company
would turn profitable.

FULL DISCLOSURE PRINCIPLE


Every company must make full disclosure and ensure that all the details and financial numbers are open to
the public. This principle ensures that companies do not hide any material information, which can impact
the investment decision of the stakeholders. Also, this principle ensures that the companies do not indulge
into any unethical operations and businesses. And, no financial information that should be in the public
domain is hidden intentionally.

MATCHING PRINCIPLE
It is one of the most basic principles. And, requires a company to report an expense in the period in which
it earns the corresponding revenue. The matching principle depends on the accrual basis of accounting and
adjusting entries. In case, an expense is not directly related to the revenue, then it should be reported on
the income statement when it expires or is used up. And, if the future benefit of a cost cannot be
determined, it should be charged to expense immediately.

PRINCIPLE OF MATERIALITY
As per this GAAP principle, it is important for the bookkeeper to think materialistically. An accountant
should be able to differentiate between the important and not so important issues. Errors are inevitable in
accounting. However, it is up to the bookkeeper to decide on whether the error is important enough to
give more time to it, or can be ignored. For example, it is up to the accountant to decide if a $10 error
can be ignored or not.

PRINCIPLE OF CONSERVATIVE ACCOUNTING


The principle suggests that an accountant must record expenses as and when they occur. On the other
hand, the accountant should only record income when there is actual cash flow. This principle helps while
recording transactions that are uncertain.

HISTORICAL COST PRINCIPLE


As per this principle, a company should record the purchase the goods, services, or capital assets at the
price they actually paid for it. On the balance sheet, companies keep showing the asset at the historical
without adjusting for any fluctuation in the market value.

Though the objective of these GAAP principles is to improve transparency, there is no guarantee that the
financial statements of the companies following these principles are free from errors and omissions (both
intentional and unintentional). There have been plenty of cases where companies following GAAP distort
figures to mislead investors. So even if a company follows GAAP, it is always better to scrutinize its financial
statements.

Source:
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Kumaran S. The Ten Generally Accepted Accounting Principles (GAAP) – Invensis Technologies. Invensis
Technologies. October 2019.
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