Generally Accepted Accounting Principles - Essay Example

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES Introduction Generally Accepted Accounting Principles can be defined as the accounting conventions, rules and standards, which accountants follow when making financial statements. Within different economic jurisdictions, the accounting principles have been standardised for easy translations and comparison of financial statements. Various countries have different requirements which limited companies utilise in making the financial statements (Ampofoa & Sellanib 2005). Financial statements enable directors and proprietors of companies and businesses to understand and constantly monitor the financial performance of their enterprises. When making the presentation of these financial statements, uniformity becomes essential in enabling different business entities to be compared, financially to each other. Development of these financial reports follows established guidelines which form the GAAP. The principles remain based on different basic accounting concepts, which are coordinated to create uniformity in the financial reporting aspect of accounting. Basic concepts of GAAP Accounting procedures for financial reporting remain essential elements for assessment of a company performance for duration of time. The standardisation of the reporting procedures creates the GAAP, which remains the commonly utilised approach towards financial reporting (Maines et al. 2003). Business entities and companies remain obligated, within many economic jurisdictions, to make public their financial performance annually in a manner which can be understood by auditors. In achieving this, the accountants must follow a developed set of regulations and conventions which define their conduct in presenting the financial statements. Accounting standards have been fundamental in ensuring businesses can be undertaken between different entities because they can compare their financial statements. Professionalization of accounting has necessitated the creation of an ethical code of conduct which individuals must adhere to, when working within the accounting profession. The codes of conduct become the guidelines in enabling individuals to undertake their responsibilities accurately and with an element of professionalism. Financial reporting could be identified as the measure of the accounting outcomes of a business entity. Despite the requirement for financial reports to be neatly presented, uniformity in the reporting becomes an essential aspect. The reports are utilised in measuring performance of organisations and business entities, hence there must be comparable aspects within the financial reports. The need to undertake comparisons necessitates the establishment of standards, which seek to ensure uniformity (Shortridge & Smith 2009). Financial reports are commonly presented to individuals with limited accounting knowledge, as accounting summaries. Accountants must stick to these guidelines for the generated reports to become sensible to individuals who are not accountants. The basic concepts of GAAP are based on different elements of business operation which include assumptions, principles and constrains within the business entities. Assumptions There are numerous financial elements of business operations which cannot become accurately defined, yet they must be presented within a financial report, for clarification. Many of these assumptions have been fundamental in the establishment of the regulations which define the GAAP utilised in financial reporting. The major assumptions made in the establishment of these principles include the ones discussed below. Accounting entity This is a fundamental assumption in the determination of accounting requirements for financial reporting. Businesses become clearly distinguished from their proprietors and have the capability to undertake their actions independently. This establishment of corporates as separate entities presents the requirement for businesses to present their financial reports periodically, and independently, for those of other entities. The accounting principles require the presentation of financial statements to become clearly separated between the business and the owners. This element however remains an assumption that the presented financial statements are complete reflection of the company’s statements (Weygandt et al. 2010). The financial statements presented by business directors always influence the statements since equity funds become reflected in the company financial statements. Factors regarding owners’ equity share and capital investments form part of the financial statements making accounting entity remain only an assumption. Going concern Organisations must always present their financial statements in regard to elements of future operations. The element of going concern remains an assumption that businesses will continue without facing closure for the next 12 months. Businesses must present their forecasted expenditures in the future with the assumptions that they will remain operational. This fundamental assumption remains based on the assumption of indefinite operation by businesses (Barth et al. 2012). The aspect of going concern is presented in financial reporting through factoring depreciation and amortisation when undertaking financial reporting. Loans and other liabilities owned by companies become evenly spread into the future accounts based on the assumption of going concern. Businesses are expected to make declarations of going concern and present their financial statements, unless an imminent liquidation process has been established. Monetary unit principle Another fundamental element of assumption within the GAAP remains the principle of monetary unit, which assumes the value of currency will remain unchanged. When making comparisons of financial statements from different trading periods, this remains the fundamental assumption as currency values keep on fluctuating. The monetary units are controlled by economic elements like inflations. Inflation cannot be indicated within a financial report according to the fundamental accounting concepts. Despite the failure to recognise the role of inflation in changing the monetary unit, comparisons are still undertaken for financial statements from different trading periods (Weygandt et al. 2010). It always remains advisable to utilise the figures presented in percentages other than the monetary values indicated within financial statements. The monetary values could be affected by economic factors, while the percentage representations remain relative to each other. Time-period principle This principle remains based on the assumption of the economic activities being divided into artificial periods of time. While financial reporting is commonly undertaken periodically, the events being reported are commonly continuous, with some occurring across different trading periods. Since the reporting requires all economic activities for a business to be reported, profitability of organisations becomes considered when establishing which period to indicate activities running through different periods (Kothari et al. 2010). This principle remains validated through reporting financial activities through specific periods of business. It is a common practice to make financial statements, monthly, quarterly, bi-annually or annually. These time periods are often utilised in seeking to ensure organisations can easily monitor their performance. Despite the periodic reporting of financial activities, business activities remain continuous. Principles Within the provisions of any guideline, the governing elements of the profession define the regulations implemented. The principles are the general guidelines, which accountant must follow when making financial reports, for various business entities. These principles form the requirements which organisations and business entities must conform through financial reporting (Barth et al. 2012). Going against these principles could constitute accounting malpractices or gross professional misconduct. Organisations must ensure these principles are achieved through financial reporting. The fundamental principles of GAAP include the following principles Historical cost principle The historical costs refer to historical values of items based on current economic evaluation. They remain based on the assumption of stable measuring units for value of commodities. The concept of historical costs has been immensely criticised as being inaccurate, but is still commonly utilised within many accounting aspects (Barlev & Haddad 2003). This remains so because the value of items continuously changes with economic changes. This aspect of costing becomes validated through factoring aspects of depreciation and appreciation of liabilities, assets and equity investment. Without factoring the elements of inflation, depreciation and appreciation, the figures presented on balance sheets could be irrelevant and with serious errors. When utilising the historical cost principle it remains very rare to make upwards adjustments of values, and the figures presented could be adversely misleading. Revenue recognition principle This principle is commonly supported over the cost principle because it factors revenues and expenses according to their respective period of generation. The revenues become recognised when they are realised by an organisation or become realisable. A contract which a company establishes with another might not be considered since the revenues might not have been realised despite the existence of a contract. Within the context of this principle, there are accrued revenues and deferred revenues. These refer to revenues before cash is received and those realised after cash is received, respectively. This principle recognises advance payments as liabilities commonly referred as deferred income (Barth et al. 2012). These payments are not recognised as sufficient to suffice sales; hence become recorded only when the sale becomes completed. Matching principle This principle remains closely related to the revenue recognition principle described above. This principle requires revenues to be recorded at the same period as the expenses incurred in gaining the revenue. This enables all losses and profits to be accurately established through the application of accrual accounting approach (Shim & Larkin 2011). Where there is a cause-effect relationship, the revenue and expenses incurred become recorded within the same trading period. The matching principle could be identified as being objective to establishing a firm’s profitability within a trading period. Since financial statements are presented in periodic durations, the application of the matching principle remains highly accurate in establishing profits. This accounting principle allows accountants to distribute depreciation through an entire duration in which an object is anticipated to remain functional. Principle of full disclosure The costs incurred in presenting financial statements to stakeholders become a fundamental consideration for the accountants when making the financial statements. While the accounting principles require the financial statements to disclose all the information, consideration of costs for disclosing the information commonly limits the information. The principle however, requires balance between the information presented and the costs incurred the disclosed information should be enough to enable stakeholders make decisions based on the information acquired from the financial statements (Barlev & Haddad 2003). Supplementary information can be provided in footnotes within the financial statements. The information disclosed should be information, which remains pertinent to the financial position of the corporation. This could include non-financial information like existing disputes or lawsuits which could affect the financial position of the organisation. Constraints These have been defined as elements presenting challenges to organisations in undertaking financial reporting. They are mainly financial requirements which organisations and businesses utilise during the development of financial reports. These constraints enable the reports to become generated with uniformity despite the changing attributes of economic settings for the business. The cost constrain describes the various elements which business must achieve in financial reporting, and which require the utilisation of financial resources from the business entity. The constraints become limitations to organisational objectives being achieved. Constrain accounting principle remains based on the fundamental constraints of cost benefit relationship and materiality of the financial reporting. Analysis of the various contains presents organisations with a possibility of optimizing the resources available at the disposal of the organisation. Constrain accounting involves the financial reporting of the progress made in the improvement of processes utilised by an organisations (Shim & Larkin 2011). Some of the constraints occur from the previously discussed basic concepts of GAAP. Objectivity of reporting requires reports to be generated from objective evidence. Presentation of this objective evidence remains a constraint which continuously must be addressed. Changing financial and economic functions commonly present a constraint in the aspect of adhering to the consistency principle of financial reporting. This includes the presentation of figures in a consistent manner for comparison. Government policies sometimes have detrimental impact of consistency of financial reports, and consequently create unforeseen constraints. Businesses operating within the European Union for example, had to change their financial reporting from using local currencies to using the euro, when the currency was adopted. This created inconsistencies within the financial reports as they utilised different currencies and the exchange rates could not be established as the currency was not in existence during the previous years. While financial auditing can be undertaken irrespective of the currency utilised in the presentation of the report, comparison becomes extremely difficult when different measures are utilised. Conclusion The generally accepted accounting principles provide fundamental guidelines to financial reporting within business entities. Despite the existence of differences in the GAAP regulations within different economic jurisdictions, all these principles remain based upon some basic concepts of assumptions, principles and constrains, within financial reporting. When undertaking financial reporting all these basic accounting concepts become factored in delivering the information contained within financial statements to stakeholders. Despite the requirement for information to be presented in an objective manner, assumptions must be made to ensure the information can be utilised effectively by stakeholders(Maines et al. 2003). These assumptions become essential in establishing the fundamental principles utilised in making financial statements. The principles on the other hand present a fundamental constraint in cost, which must remain relevant and consistent with previous accounting principles utilised in the financial reporting. References Ampofoa, A.A. & Sellanib, R.J., 2005. Examining the differences between United States Generally Accepted Accounting Principles (U.S. GAAP) and International Accounting Standards (IAS): implications for the harmonization of accounting standards. Accounting Forum, 29(2), pp.219–231. Barlev, B. & Haddad, J.R., 2003. Fair value accounting and the management of the firm. Critical Perspectives on Accounting, 14(4), pp.383–415. Barth, M.E. et al., 2012. Are IFRS-based and US GAAP-based accounting amounts comparable? Journal of Accounting and Economics, 54(1), pp.68–93. Kothari, S.P., Ramanna, K. & Skinner, D.J., 2010. Implications for GAAP from an analysis of positive research in accounting. Journal of Accounting and Economics, 50(2), pp.246–286. Maines, L.A. et al., 2003. Evaluating concepts-based vs. rules-based approaches to standard setting. Accounting Horizons, 17(1), pp.73–89. Shim, E. & Larkin, J.M., 2011. Towards Relevancy in Financial Reporting: Mark-to-Market Accounting. Journal of Applied Business Research, 14(2), pp.33–42. Shortridge, R.T. & Smith, P.A., 2009. Understanding the changes in accounting thought. Research in Accounting Regulation, 21(1), pp.11–18. Weygandt, J.J. et al., 2010. Accounting principles. Issues in Accounting Education, 25(1), pp.179–180.  Read More