GAAP Principles: Generally Accepted Accounting Practice

Elaborate GAAP Principles with suitable examples.

 GAAP

GAAP stands for Generally Accepted Accounting Practice. It is a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. GAAP is a combination of authoritative standards issued by Financial Accounting Standards Board and the commonly accepted way of recording and reporting accounting information. GAAP improves the clarity of the communication of financial information.

Relevant Information: Affects the decision of its users

Reliable Information: Is trusted by users

Comparable Information: Used in comparisons across years and companies

 GAAP Principles

There are eight GAAP principles which are explained below:

Concept of Adequate Disclosure

Concept of adequate disclosure is the sixth GAAP Principle. This principle states that all essential information should be included in a financial statement. Adequate disclosure refers to the ability for financial statements to provide a comprehensive and clear description of a company's financial position. Readers of a company's financial statements, including investors and creditors, should be able to determine the company's financial health by reviewing a financial statement with adequate disclosure.

Adequate disclosure in accounting practices mandates that all readers of a financial statement have access to relevant data that would be believed essential to understanding a company's financial position. Adequate disclosure requires that key facts are included within the financial statement to help investors and creditors adequately assess the financial situation of a particular company.

Example

Details of contingent liabilities, contingent assets, legal proceedings, etc. are relevant to the decision making of users and hence need to be disclosed.

Details of property, plant and equipment cannot be presented on the face of the balance sheet, but a detailed schedule outlining movement in cost and accumulated depreciation should be presented in the

Matching Principle

Matching principle is the seventh GAAP Principle. The matching principle states that expenses should be recognized and recorded when those expenses can be matched with the revenues those expenses helped to generate. In other words, expenses should not be recorded when they are paid. Expenses should be recorded as the corresponding revenues are recorded. This matches the revenues and expenses in a period. In this sense, the matching principle recognizes expenses as the revenue recognition principle recognizes income.

Example

Commission: A salesman earns a 5% commission on sales shipped and recorded in January. The commission of $5,000 is paid in February. You should record the commission expense in January.

Depreciation: A company acquires production equipment for $100,000 that has a projected useful life of 10 years. It should charge the cost of the equipment to depreciation expense at the rate of $10,000 per year for ten years.

Employee Bonuses: Under a bonus plan, an employee earns a $50,000 bonus based on measurable aspects of her performance within a year. The bonus is paid in the following year. You should record the bonus expense within the year when the employee earned