What are Accounting Principles?
Accounting principles are the rules and guidelines that companies must follow when
reporting financial data. The Financial Accounting Standards Board (FASB) issues a
standardized set of accounting principles in the U.S. referred to as generally accepted
accounting principles (GAAP). Some of the most fundamental accounting principles include
the following:
Accrual principle
Conservatism principle
Consistency principle
Cost principle
Economic entity principle
Full disclosure principle
Going concern principle
Matching principle
Materiality principle
Monetary unit principle
Reliability principle
Revenue recognition principle
Time period principle
Understanding GAAP
GAAP helps govern the world of accounting according to general rules and guidelines. It
attempts to standardize and regulate the definitions, assumptions, and methods used in
accounting across all industries. GAAP covers such topics as revenue recognition, balance
sheet classification, and materiality.
The ultimate goal of GAAP is ensure a company's financial statements are complete,
consistent, and comparable. This makes it easier for investors to analyze and extract useful
information from the company's financial statements, including trend data over a period of
time. It also facilitates the comparison of financial information across different companies.
These 10 general concepts can help you remember the main mission of GAAP:
1.) Principle of Regularity
The accountant has adhered to GAAP rules and regulations as a standard.
2.) Principle of Consistency
Accountants commit to applying the same standards throughout the reporting process, from
one period to the next, to ensure financial comparability between periods. Accountants are
expected to fully disclose and explain the reasons behind any changed or updated
standards in the footnotes to the financial statements.
3.) Principle of Sincerity
The accountant strives to provide an accurate and impartial depiction of a company’s
financial situation.
4.) Principle of Permanence of Methods
The procedures used in financial reporting should be consistent, allowing comparison of the
company's financial information.
5.) Principle of Non-Compensation
Both negatives and positives should be reported with full transparency and without the
expectation of debt compensation.
6.) Principle of Prudence
Emphasizing fact-based financial data representation that is not clouded by speculation.
7.) Principle of Continuity
While valuing assets, it should be assumed the business will continue to operate.
8.) Principle of Periodicity
Entries should be distributed across the appropriate periods of time. For example, revenue
should be reported in its relevant accounting period.
9.) Principle of Materiality / Good Faith
Accountants must strive to fully disclose all financial data and accounting information in
financial reports.
10.) Principle of Utmost Good Faith
Derived from the Latin phrase “uberrimae fidei” used within the insurance industry. It
presupposes that parties remain honest in all transactions.
Compliance with GAAP
If a corporation's stock is publicly traded, its financial statements must adhere to rules
established by the U.S. Securities and Exchange Commission (SEC). The SEC requires
that publicly traded companies in the U.S. regularly file GAAP-compliant financial
statements in order to remain publicly listed on the stock exchanges. GAAP compliance is
ensured through an appropriate auditor's opinion, resulting from an external audit by
a certified public accounting (CPA) firm.
Although it is not required for non-publicly traded companies, GAAP is viewed favorably by
lenders and creditors. Most financial institutions will require annual GAAP compliant
financial statements as a part of their debt covenants when issuing business loans. As a
result, most companies in the United States do follow GAAP.
If a financial statement is not prepared using GAAP, investors should be cautious. Without
GAAP, comparing financial statements of different companies would be extremely difficult,
even within the same industry, making an apples-to-apples comparison hard. Some
companies may report both GAAP and non-GAAP measures when reporting their financial
results. GAAP regulations require that non-GAAP measures be identified in financial
statements and other public disclosures, such as press releases.
