What are GAAP Principles?
You might have heard the term GAAP used before in reference to financial conduct, but not understood what it means or where the term originated from. GAAP stands for ‘Generally Accepted Accounting Principles’. Originating from a need for finance industry regulation in post-Great Depression USA; GAAP is an important collective of fundamentals off of which the standard of practice is based within the accounting industry. GAAP is a conceptual guideline for good practice within accounting and is not a set of distinct ‘rules’ which a body or organisation is obliged to follow.
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The Cost Principle
The first principle of GAAP is ‘cost’. The cost principle refers to the fact that all listed values are accurate and reflect only actual costs, rather than any market value of the cost items. This simple clarification may seem minute and unimportant, but it is this that creates a definitive and unmistakable understanding of what is meant by the term ‘cost’, creating less room for error.
The Revenues Principle
The second principle of GAAP is ‘revenues’. Revenues refers to the requirement that when revenue is recognised, it is reported. The way in which revenue reporting is enacted can vary depending on each company’s individual methods of revenue acquisition, although there is generally a widely recognised manner and time span within which it is considered acceptable.
The Matching Principle
The third principle of GAAP is ‘matching’. Contextually it is defined as the matching of revenue with coinciding expenses. Matching describes the process of reporting expenses incurred from methods of revenue production when said revenue has been generated, instead of the reporting taking place when the service or product is invoiced for or paid for.
The Disclosure Principle
The final principle of GAAP is the principle of ‘disclosure’. Disclosure entails that companies declare necessary information when reports on financial status are conducted, to whomever is undertaking the assessment. The primary reason for this is so a policy of honest communication can be expected across the board.
Why are GAAP Principles important?
Whilst there is no obligation to follow the principles of GAAP, it does encourage a consistently standard of practice. It is highly recommended that where it is relevant, your business should endeavour to utilise these ideas. The benefit of this is that it will keep your conduct in line with the accepted standard of the day.
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