1.3 - Generally Accepted Accounting Principles (GAAP)

Ethics

Beliefs that help us differentiate right from wrong, in the application of underlying accounting concepts or principles.

GAAP

The underlying accounting concepts and principles that represent the ethics of a business’s economic activities. Based on International Financial Reporting Standards (IFRS) for publicly accountable enterprises. IFRS are issued by the International Accounting Standards Board (IASB).

IASB’s Mandate

To promote and adopt a single set of global accounting standards through a process of open and transparent discussions among corporations, Financial Institutions, and accounting firms around the world.

What characteristics is GAAP comprised of?

Qualitative characteristics.

The two primary characteristics are

1. Relevance

   has the ability to make a difference in the decision-making process.

2. Faithful Representation

   is complete, neutral and free from error.

Additional qualitative characteristics that make up GAAP

1. Comparability

   tells users of the information that businesses utilize similar accounting practices.

2. Verifiability

   means that others are able to confirm that the information faithfully represents the economic activities of the business.

3. Timeliness

   is available to decision-makers in time to be useful.

4. Understandability

   is clear and concise.

What are the Nine Principles that Support the Qualitative Characteristics of GAAP?

1. Business Entity

2. Consistency

3. Cost

4. Full Disclosure

5. Going Concern

6. Matching

7. Materiality

8. Monetary Unit

9. Recognition

Business Entity

Requires that each economic entity maintain separate records.

• Ex. A business owner keeps separate accounting records for business transactions and for personal transactions.

Consistency

Requires that a business use the same accounting policies and procedures from period to period.

• Ex. A business uses a particular inventory costing method. It cannot change to a different inventory costing method in the next accounting period.

Cost

Requires that each economic transaction be based on the actual original cost (also known as historical cost principle).

• Ex. The business purchases a delivery truck advertised for $75 000 and pays $70 000. The truck must be recorded at the cost of $70 000, the amount actually paid.

Full Disclosure

Requires that accounting information communicate sufficient information to allow users to make knowledgeable decisions.

• Ex. A business is applying to the bank for a $1 000 000 loan. The business is being sued for $20 000 000 and it is certain that it will lose. The business must tell the bank about the lawsuit even though the lawsuit has not yet been finalized.

Going Concern

Assumes that a business will continue for the foreseeable future.

• Ex. All indications are that Business X will continue so it is reported to be a ‘going concern’. Business Z is being sued for $20 000 000 and it is certain it will lose. The $20 000 000 loss will force the business to close. Business Z must not only disclose the lawsuit, but it must also indicate that there is a ‘going concern’ issue.

Matching

Requires that financial transactions be reported in the period in which they occurred/ were realized.

• Ex. Supplies were purchased March 15 for $700. They will be recorded as an asset on March 15 and then expensed as they are used.