GAAP Principles
A. GAAP PRINCIPLES
In this topic, learners should be able to:
· Define and explain the following Generally Accepted Accounting Practice (GAAP) principles
· Apply GAAP principles to all the relevant topics
Generally Accepted Accounting Principles (GAAP) are standard accounting rules for reporting on financial statements.
In accounting, GAAP provides businesses with a uniform way to prepare financial statements and perform accounting tasks. GAAP helps small business owners and accounting professionals track a business’s finances. Presenting a business’s finances to outside entities (e.g., banks) becomes easier with GAAP. While all businesses are not required to use GAAP, you may want to consider preparing your financial statements with these principles.
a) Historical cost
The concept historical a cost means that assets purchased by a business must be recorded in the books at cost price (purchased price).
Example: If we bought Land and buildings three years ago at a total cost of R500 000 and entered it into the books at that price and the asset is re-valued today at R650 000, the amount that will be entered in the Financial Statements will still be R500 000 (the price that we originally bought it for).
b) Prudence
This rule implies that the company’s financial results should be reported in a conservative manner and should never be overstated.
Example: If a debtor is in financial difficulty, the accountant may write his account off even though the business will continue to do everything possible to receive the money the debtor owes them.
c) Materiality
This concept states that information that is important to readers and users of financial statements must be shown separately, and that notes must be shown. This also means that unimportant items may be shown as one item.
Example: All interest expense items should be shown separate in the Financial Statements as this will be important (material) to a decision on how to raise additional funds.
d) Business entity rule
This rule states that the financial affairs of a business/company must be kept separate from that of the owners/shareholders personal financial affairs.
Example: If the owner inherited R500 000 from his/her grandfather, the money will be deposited in the owner’s personal bank account and not in the business’s bank account.
e) Going concern
A going concern means that the financial statements prepared are based off on the assumption that that the company will continue to trade/operate for the foreseeable future.
Example: Stock, fixed deposit and land and buildings are not valued on the basis of the amount that would be received for them if they were sold immediately.
f) Matching
This principle implies that the full revenue earned and the full expenses incurred during a specific financial year must be recorded in the financial statements of that financial year, regardless of whether the full amount was received or paid.
Example: If a building is rent from somebody and we only paid R55 000 (R5 000 per month) for 11 months, the R5 000 will be match with the R55 000 because it is part of this financial year. The amount recorded in the Financial Statements will be R60 000