12 Basic Accounting Principles GAAP

Understanding the basic accounting principles that is very important as it

affects

the

preparation

of

financial

statements.

The

following accounting rules and assumptions dictate what, when and how to
measure financial items.
These rules were created by the Financial Accounting Standards Board
(FASB) and are called General Accepted Accounting Principles (GAAP).
GAAP refers to the standard guidelines for financial accounting used in any
given jurisdiction. GAAP includes the standards, conventions, and rules
accountants follow in preparing and reporting financial statements.

The following are 12 basic but important accounting principles:

1. Accounting Entity is the business unit for which the financial

statements are being prepared.

The

accounting entity recognizes that there is a business entity that is

separate from its owner(s). In addition, the economic unit engages in
identifiable economic activities and controls economic resources.

2. Going Concern Accounts assume that the life of the business entity
is infinitely long and will never dissipate. In some cases, if there is a
clear sign that a business may go bankrupt, the accountant must issue a
qualified opinion stating the potential of a demise.
3. Measurement Accounting only deals with things that can be
measured, quantifiable. Therefore, aspects that are crucial to profits
may be overlooked such as customer loyalty.
4. Units of Measure The US Dollar (USD) is the standard value used in
financial statements for companies in the United States. Any foreign
transactions must be translated to USD based on the current exchange
rate.
5. Historical Cost The transactions that results in what a business owns
and owes are recorded at their original cost. This may cause the
companys books to be understated. For example, a company can own
a manufacturing facility that is valued at $25,000,000 but carry it on the
books for their purchase price of $7,000,000.

6. Materiality The concept of materiality allows you to violate another

accounting principle if the value is so tiny that the financial reports will
not have an impact. Materiality is a judgment call by the accountant.
7. Estimates and Judgments Often times, it is OK to guess due to the
nature that businesses are complex. It is legal, if the accounting is the
best you can do, the expected error would not affect the financial reports
and the guesses are consistent for each period.
8. Consistency Each individual enterprise must choose a single method
of accounting and reporting consistently over time.
9. Conservatism

Accountants

must

agree

more

with

an

understatement than an overvaluation. This accounting guideline states

that if doubt exists between two alternatives, the accountant should
choose the result with a lesser asset amount and/or a lesser profit.
10.

Periodicity Is the activity within the scope of an accounting

period that must be recorded within the time period on a financial

statement. Normally the life of a business can be divided into periods of

time (month, quarter or year).
11.

Substance Over Form This is a concept where the entity is

accounting for items according to their substance and economic reality

and not just its form.
12.

Accrual Basis of Presentation In accrual accounting, if a

business transaction makes money in a period then all of its associated

costs and business expenses should also be reported in that particular
period. All businesses with inventory must use the accrual basis. The
alternative for business that dont carry inventory is cash basis
accounting in which transactions are recorded as they are physically
received or paid out.