10 Generally Accepted Accounting Principles (GAAP) are guidelines used in financial reporting. These are the standards, methods, and legalities of business in accounting. 10 GAAP Principles are important in accounting. It assures us of the reliability of financial statements.
1.) Principle of Regularity
Talks about the principles that accountants should use systematic policies. Otherwise, rules and regulations. The absence of such creates different directions. It also creates diverseness. As a result, financial statements are misleading. For instance, the recording of income. Recording of income has two options that are outright or staggered. If agreed to record income outright, accountants of a company should follow the rules. That being the case, every accountant next to the old will understand the history of records. Moreover, the accountant will relate the next recording of transactions.
2.) Principle of Consistency
This principle is about the consistency of standards used throughout the financial reporting process. For instance, a company used an accrual basis of accounting. The accrual basis of accounting means the financial statements have accounts receivables and payables accounts. This accrual method should be used throughout the financial reporting. Or else, it violates the principle of consistency so as the principle of regularity. The result is unreliable financial statements. Investors and Entrepreneurs don’t want to invest in unreliable financials.
3.) Principle of Sincerity
The principle of sincerity is GAAP compliance. Accountants are committed to accuracy and impartiality. For instance, the accuracy of recording of transactions. It is a mortal sin for an accountant to force the balances of accounts. Accountants make sure that they record the exact amount stated in documents or receipts to the best of their knowledge and ability.
With regards to impartiality, accountants follow records objectively. The power is in the accountants. They have recording options that are acceptable. That being the case, they might record income early or expense late. Especially if it’s preferring the benefit of one person over another for improper reasons. But because of this principle, accountants follow the rules and records transaction objectively regardless of whether it’s beneficial to the company or not. That’s why sometimes it’s advisable that entrepreneurs have knowledge of accounting. So that they can understand their business and manage it well. Moreover, they can assess if the accountant is messing up with them. It’s stressful if an accountant messes up with records. It cost money and so much time just to fix the mess. In reality, it rarely happens but it’s a serious thing.
4.) Principle of Permanence of Methods
The principle of Permanence of Methods talks about fixed or permanent records. For instance, the historical cost principle. Under the historical cost principle, fixed assets are recorded at acquisition price. The acquisition price on fixed assets is permanent. The company cannot change its price whatever happens. That’s why there is a depreciation process in accounting to decrease the price of fixed assets indirectly.
5.) Principle of Non-Compensation
This principle reports the company’s performance whether positive or negative. For instance, the pandemic fortuitous event. The accountant knew that putting allowances for a doubtful account will result in a net loss to the company. Even if the accountant knew, he/she will still record allowances to all doubtful accounts during this pandemic event.
6.) Principle of Prudence
The principle of Prudence talks about the fair presentation of financial data. The accountant takes into account the identified and expected risk and losses. For instance, no record of impairment loss on land. Although under the record is the acquisition price, it should be appraised every now and then as needed to meet the criteria of fair reporting of financial statements. Another example is the retirement benefits especially if it’s in the policy to give retirement pay to employees. Even though it takes time before this obligation arises, it should be recorded because it is expected. Otherwise, the understatement of financial liability.
7.) Principle of Continuity
It talks about continuity. The assumption is that the company will operate continuously regardless of events or circumstances. Management usually formulates a continuity plan. For instance, fortuitous events like earthquakes, heavy storms, recent pandemic events, and others. Management has plans to execute at times like these. They might divide employees into two teams. Another is they might set up a backup server in a different place far from the existing one. Usually, a continuity plan is good for 3-6 months. This is an exemption to the pandemic event that took years.
8.) Principle of Periodicity
This talks about the standard accounting period of reporting. For instance, the recording of income and expenses. The company may record weekly, monthly, quarterly, or annually based on appetite.
9.) Principle of Materiality
This principle is one of the most observed in 10 GAAP principles in accounting. This principle talks about the cost impact of assets, liability, or capital. The cost is material if the cost will have a significant impact on the company. If so, then the cost can be capitalized. Capitalized means instead of recording as an expense, it is recorded as an asset subject for amortization or depreciation. With regards to liability, the retirement benefit example, the company may record it on a staggered basis. Retirement benefits have a significant impact on the company. Another example is the purchase of IT expenses like computer parts. Some IT expenses have minimal cost but some have significant value like computer memory. Materiality is also based on how small or big the business is.
10.) Principle of Utmost Good Faith
The principle that talks about honesty. All involved parties are assumed to be in good faith. Good faith when it comes to starting the business, running the business, and so on. For instance, selling the business. All information in selling the business should disclose to the buyer regardless of how good or bad the operation is. Some buyer does due diligence before buying. To assure that all figures in the financial statements exist and are correct.
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