A Primer on Generally Accepted Accounting Principles
Accountants are the keeper of the standards. They make sure that a financial statement is comparable with other audited financial statements of other companies when it comes up for review.
It sounds daunting but it is not impossible. All of this can be handled by an chartered accountants professional.
The accounting profession is self-regulated. They determine the best way for company activity to be recorded on the financial records of record. This is done by an elite board of professionals called the Accounting Practices Board of American Institute of Certified Public Accountants. This group is responsible for defining what is called “Generally Accepted accounting Principals” (GAAP), which public accountants must observe on behalf of their clients.
While the process to change or introduce new GAAP is beyond this paper’s scope, it is a lengthy one with many review opportunities.
GAAP is essential to maintain consistency within an accounting practice, not just within a company but across all regulated entities. Every publicly held company must be audited annually by a Certified Public Accountant. The CPA ensures stockholders that the financial information of the company is compliant with GAAP and can be relied upon by them.
Prepare all financial information in accordance to GAAP
o The records can be relied upon by management to make course corrections within their department or for the whole company for the benefit of the entire company.
o Based on the financial records of the company, investors and lenders can make sound business decisions.
o The financial health of the company is shown to stockholders and prospective stockholders.
Stocks can be priced fairly on the market
o The use of deceptive, unfair, and even criminal practices is minimized.
Here are some basic principles on which GAAP is based. While this is by no means a complete description, GAAP is extremely detailed and requires extensive study to master, but it shows the underlying purpose of all that detail.
1. Historical Cost Principle: A company’s asset value is generally the original cost of the assets less appropriate depreciation and amortization. Companies are not allowed to state their assets at their market value. This is difficult to determine and subjective. The actual cost can be compared to historical costs, which is objective.
2. Revenue Recognition Principal: This simply means that revenue is recognized as earned. However, it may not be recognized until it is received. If you provide a service to your customers at the end December but they don’t pay you until January next year, the December revenue total will include this amount. Even though it is the month that you received the payment, January will not.