Guide to Understanding Generally Accepted Accounting Principles (GAAP)

Its Origins and Importance

In revisiting the history of American trade and commerce, one could come across information about laws enacted in order to avoid, if not prevent, the recurrence of financial frauds. The founding of the Securities and Exchange Commission, for one, stems from the enactment of the Securities and Exchange Act. The SEC was established as the federal government’s arm for setting straight the rules that governed stock trading in the capital market.

The implementation of generally accepted accounting principles (GAAP) became necessary,in line with the SEC’s goal to set a uniform standard for financial statements preparations. It came into focus that most stock investors relied heavily on financial reports for their investment decisions.

However, prior to GAAP’s implementation, accounting procedures were merely adopted as norms. Back then, they were modified in ways that could make the financial condition of a company appear enticing to investors.

The first step to understanding the generally accepted accounting principles is to have a clearer perception of its origins and importance. This guide gives readers further information through the following articles:

• The Evolution of Performance Cost Measures
• Financial “Rescue” or “Bailout” in Times of Financial Crises: The Early 20th Century
• Why is GAAP Important?
• Accounting Audit Irregularities in Financial Statement Fraud Includes Violation of GAAP Rules

GAAP Principles Explained

Basically, the rules set forth are mainly concerned with ensuring that there is a uniform measurement of economic activities determined at a consistent period of time. Their values should be calculated based on a standardized monetary unit and with full disclosure about material changes that took place from period to period. Accounting procedures should be applied consistently in order to produce financial reports that present a fair representation of the economic entity’s income, expenses and cost of ownership based on the same conservative standards observed by every entity operating as a going-concern.

The most basic among GAAP’s many rules and principles are: (1) Economic Entity, (2) Assumption of Monetary Unit (3) Historical Cost Recognition, (4) Revenue Recognition, (5) Matching of Revenue and Expenses (6) Time Period, (7) Materiality, (8) Conservatism, (9) Consistency, (10) Full Disclosure, ( 11) Reliability and (12) Going Concern.

Discover more information pertaining to these tenets and find selected explanations about their interpretations:

• The Basics of Generally Accepted Accounting Principles
• How are GAAP Rules Determined?
• The Revenue Recognition Principle: Explanation & Examples
• The Matching Principle: Explanation & Examples
• Revenue Recognition Principle vs. Matching Principle
• What is the Historical Cost Principle?
• Explaining the Concept of Going Concern in Accounting
• GAAP Principles Governing Accounts Payable and Accrued Expenses

Examples of Specific Accounting Rules

Application of some basic accounting rules tend to be ambiguous due to the differences in operational activities of various business industries. These are the instances, which require specific clarifications on how the GAAP principles are applied.

Here are some articles that feature such clarifications to help readers gain more knowledge about the procedures involved:

• Generally Accepted Accounting Principles for Cost Capitalization
• How to Calculate Manufacturing Overhead Based on GAAP Rules
• GAAP Accounting for Revenue Earned in a Prior Period
• Accounting for Treasury Stock Purchases in Accordance with Generally Accepted Accounting Principles
• Accounting for Obsolete Inventory as Required by Generally Accepted Accounting Principles
• IRS & GAAP Views on Guaranteed Payments: How to Post Them in a General Ledger
• Explaining Lower of Cost or Market (LCM) in Tune with GAAP Rules
• Audit Reports of Private Companies: Includes Extent of Compliance with GAAP Rules

What Happens If Uniform Procedures Are Not Applied?

During the latter part of the 20th century, numerous business organizations succeeded in deceiving the public by way of financial misrepresentations despite SEC’s monitoring. However, such misrepresentations were made possible through the connivance of independent public accountants. GAAP-compliance certifications were issued, even if the entity exhibited questionable accounting practices that did not conform to the prescribed standards.

Find examples of these accounting manipulations and their discovery by reading the following:

• A Detailed Look at the Enron Accounting Scandal
• Unraveling the Details of 10 High-Profile Accounting Scandals
• Sarbanes Oxley Act & Accounts Receivable Fraud of World.Com

Globalization and The Need to Adopt International Standards

In view of the current globalization trends, global business communities are finding it necessary to establish and to recognize a single set of standards on which to base their financial reports. Although the International Financial Reporting Standards (IFRS) has been instituted, many regard the U.S. GAAP rules as more definitive and conservative. Hence, the difference between the two sets of standards are currently being fleshed-out for the purpose of converging the IFRS and the U.S. GAAP into one international set of guiding principles.

Increase your awareness of convergence issue with the following articles that complete this essential guide to understanding the generally accepted accounting principles:

• US GAAP vs. International GAAP
• Is IFRS SEC Reporting Appropriate?
• Pension Accounting: IFRS vs. US GAAP

References

• Image: Assets by Albian19 under CC BY SA 3.0
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• Image: Arthur Andersen Witnesses by Source: http://gopher.house.gov/stearns/Issues/Energy_Commitee/Enron/Enron-Main.html under public domain.
• Image: rental agreement by Albian19 under CC BY SA 3.0