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Accounting principles and guidelines

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Introduction to Accounting Principles
There are general rules and concepts that govern the field of accounting. These general
rulesreferred to as basic accounting principles and guidelinesform the groundwork on
which more detailed, complicated, and legalistic accounting rules are based. For example,
the Financial Accounting Standards Board (FASB) uses the basic accounting principles and
guidelines as a basis for their own detailed and comprehensive set of accounting rules and
standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three
important sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed
rules and standards issued by FASB and its predecessor the Accounting Principles Board
(APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow generally
accepted accounting principles in the preparation of those statements. Further, if a
company's stock is publicly traded, federal law requires the company's financial statements
be audited by independent public accountants. Both the company's management and the
independent accountants must certify that the financial statements and the related notes to
the financial statements have been prepared in accordance with GAAP.
GAAP is exceedingly useful because it attempts to standardize and regulate accounting
definitions, assumptions, and methods. Because of generally accepted accounting principles
we are able to assume that there is consistency from year to year in the methods used to
prepare a company's financial statements. And although variations may exist, we can make
reasonably confident conclusions when comparing one company to another, or comparing
one company's financial statistics to the statistics for its industry. Over the years the
generally accepted accounting principles have become more complex because financial
transactions have become more complex.
Basic Accounting Principles and Guidelines
Since GAAP is founded on the basic accounting principles and guidelines, we can better
understand GAAP if we understand those accounting principles. The following is a list of the
ten main accounting principles and guidelines together with a highly condensed explanation
of each.
1. Economic Entity Assumption
The accountant keeps all of the business transactions of a sole proprietorship separate from
the business owner's personal transactions. For legal purposes, a sole proprietorship and its
owner are considered to be one entity, but for accounting purposes they are considered to
be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be expressed
in U.S. dollars are recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing power
has not changed over time. As a result accountants ignore the effect of inflation on recorded
amounts. For example, dollars from a 1960 transaction are combined (or shown) with dollars
from a 2013 transaction.
3. Time Period Assumption
This accounting principle assumes that it is possible to report the complex and ongoing
activities of a business in relatively short, distinct time intervals such as the five months
ended May 31, 2013, or the 5 weeks ended May 1, 2013. The shorter the time interval, the
more likely the need for the accountant to estimate amounts relevant to that period. For
example, the property tax bill is received on December 15 of each year. On the income
statement for the year ended December 31, 2012, the amount is known; but for the income
statement for the three months ended March 31, 2013, the amount was not known and an
estimate had to be used.

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It is imperative that the time interval (or period of time) be shown in the heading of each
income statement, statement of stockholders' equity, and statement of cash flows. Labeling
one of thesefinancial statements with "December 31" is not good enoughthe reader needs
to know if the statement covers the one week ended December 31, 2012 the month ended
December 31, 2012 the three months ended December 31, 2012 or the year ended December
31, 2012.
4. Cost Principle
From an accountant's point of view, the term "cost" refers to the amount spent (cash or the
cash equivalent) when an item was originally obtained, whether that purchase happened last
year or thirty years ago. For this reason, the amounts shown on financial statements are
referred to ashistorical cost amounts.
Because of this accounting principle asset amounts are not adjusted upward for inflation. In
fact, as a general rule, asset amounts are not adjusted to reflect any type of increase in
value. Hence, an asset amount does not reflect the amount of money a company would
receive if it were to sell the asset at today's market value. (An exception is certain
investments in stocks and bonds that are actively traded on a stock exchange.) If you want
to know the current value of a company's long-term assets, you will not get this information
from a company's financial statementsyou need to look elsewhere, perhaps to a third-party
appraiser.
5. Full Disclosure Principle
If certain information is important to an investor or lender using the financial statements, that
information should be disclosed within the statement or in the notes to the statement. It is
because of this basic accounting principle that numerous pages of "footnotes" are often
attached to financial statements.
As an example, let's say a company is named in a lawsuit that demands a significant amount
of money. When the financial statements are prepared it is not clear whether the company
will be able to defend itself or whether it might lose the lawsuit. As a result of these
conditions and because of the full disclosure principle the lawsuit will be described in the
notes to the financial statements.
A company usually lists its significant accounting policies as the first note to its financial
statements.
6. Going Concern Principle
This accounting principle assumes that a company will continue to exist long enough to carry
out its objectives and commitments and will not liquidate in the foreseeable future. If the
company's financial situation is such that the accountant believes the company will not be
able to continue on, the accountant is required to disclose this assessment.
The going concern principle allows the company to defer some of its prepaid expenses until
future accounting periods.
7. Matching Principle
This accounting principle requires companies to use the accrual basis of accounting. The
matching principle requires that expenses be matched with revenues. For example, sales
commissions expense should be reported in the period when the sales were made (and not
reported in the period when the commissions were paid). Wages to employees are reported
as an expense in the week when the employees worked and not in the week when the
employees are paid. If a company agrees to give its employees 1% of its 2013 revenues as
a bonus on January 15, 2014, the company should report the bonus as an expense in 2013
and the amount unpaid at December 31, 2013 as a liability. (The expense is occurring as the
sales are occurring.)

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Introduction to Accounting Principles There are general rules and concepts that govern the field of accounting. These general rules–referred to as basic accounting principles and guidelines–form the groundwork on which more detailed, complicated, and legalistic accounting rules are based. For example, the Financial Accounting Standards Board (FASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards. The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules: (1) the basic accounting principles and guidelines, (2) the detailed rules and standards issued by FASB and its predecessor the Accounting Principles Board (APB), and (3) the generally accepted industry practices. If a company distributes its financial statements to the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company's stock is publicly traded, federal law requires the company's financial statements be audited by independent public accountants. Both the company's management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP. GAAP is exceedingly useful because it attempts to standardize and regulate accounting definitions, assumptions, and methods. Because of generally accep ...
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