Accounting Best Practice and GAAP Compliance

These are the business’s concerns. If their accounting practice follows the generally accepted accounting principles or GAAP. Generally Accepted Accounting Principles (GAAP) are accounting rules and standards followed in reporting financial statements. GAAP namely Accrual basis accounting, Cash basis accounting, and Revenue recognition principle. In addition, the Matching principle, Materiality principle, and Substance over form principle. Furthermore, Completeness principle, Consistency principle, and Going concern principle.

These are the Accounting Best Practice with GAAP

Accrual and Cash Basis Accounting Practice

Under the accrual basis of accounting, companies record transactions by the time economic events occur. For instance, the companies use accrual to recognize net income. Companies recognize income when earned. Regardless of whether the company receives cash or not. It also recognizes expenses when incurred whether paid or not. Medium and Large companies use the accrual basis of accounting. Because they have several accounts receivables and accounts payable. And, the accrual basis of accounting follows the generally accepted accounting principles (GAAP).

Cash basis accounting – is another accounting practice. Under the cash basis of accounting, companies record income and expenses when cash is received. The cash basis of accounting is easy to use. Because you don’t need to make a complicated computation. Otherwise, allocate amounts over time. Most small business companies use cash basis accounting. Because they have few accounts receivable and accounts payable. But this accounting practice is not GAAP compliance. Because it fails to record income when earned. It also fails to record expenses incurred for which it has paid cash. This practice does not follow revenue recognition principles and matching principles.

Revenue Recognition Principle Vs Matching Principle

These two principles help in determining the number of revenues and expenses. Because some revenues and expenses can be recognized in more than one reporting period. Companies usually use this accounting practice.

Revenue Recognition Principle – this principle talks about income. It dictates that companies recognize revenue in the period it is earned. This principle is mostly used in the service business industry. For instance, application software annual subscription. Income from an annual subscription is not an outright income. Because the payment is good for one year. Moreover, the services are performed within the year. The company can only record income once performed otherwise used. The company will then report the annual subscription as unearned income. Moreover, presented in the liability section of financial statements.

Matching Principle – this principle talks about expenses. This principle is congruent with the revenue recognition principle. Because it follows the revenue. In other words, expenses are a match to its revenue. Companies record expenses related to their revenue. For instance, the application software annual subscription. For the customer to use the application, there is the effort given to make it work. Moreover, there is also maintenance and expenses to make it live and operate. These efforts, maintenance, and expenses are paid. Often called salaries and operating expenses. These expenses are recorded when the related revenue is recognized. This helps the companies determine their net income. Because all efforts (expenses) matched with accomplishments (revenue).

Substance Over Form Principle Vs Materiality Principle

This principle talks about the accomplishment (substance) over receipts (form). For instance, merchandising industry that bill and hold. It happens in several scenarios. One example is the delivery schedule. The company usually record sale upon purchase but hold the inventories. Because of delivery schedules. Another example is the special holidays in some areas while the other area is regular working days. With this, the company will bill and hold. Given these scenarios, income recognition is too early. Though it is early recognition, it is accepted provided that there is agreement. An agreement that even though inventories are in the possession of the seller, the risk is passed to the buyer. This means that whatever happens to the inventories, will be at the risk of the buyer.

Another agreement could be the buyer requesting the seller to keep the inventories due to the buyer has no warehouse. It is acceptable if there is an agreement. The agreement that the buyer will pick up the inventories from the seller. Failure to pick up the inventories is at the risk of the buyer. The substance over form principle is critical because it does not provide the true intent of the transactions. The financial statements might not be reliable because of the possible impact of the economic events.

Materiality Principle

This means the amount has significance. To determine if the amount is significant, it must have an impact on the financials. Otherwise, if the amount is unbearable. The materiality principle measures the correctness of the financial statements. For instance, the amount of error or misstatements in recording income will have an impact on the financials. If it will affect the financials, then it is considered a material amount. Because the impact of the amount may affect the decision making.

Sometimes there is substance over form vs materiality principle. Because of its potential effect on the financials. Some of the buyers don’t want to bear the risk of the inventories when not in possession. Though the agreement is provided, when a difficulty occurs, some buyers resist accepting the risk result. Sometimes when the buyer is a valued customer, they tend to compromise and ask for relief. These scenarios may affect the financials especially when the amount is material enough.

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Completeness Principle

Completeness Principle – this talks about the complete assets of the company. This means that all declared assets in the financial statement are complete and existing. This principle is for auditing purposes. For instance, missing equipment or destroyed machines. Another example is the loss of machines or equipment. Failure to recognize this scenario violates the completeness principles.

Consistency Principle

This principle talks about the consistency of accounting methods used. This principle dictates that once you use an accounting method, you should use it consistently. Otherwise, continue to follow the methods in the succeeding accounting period. So that the end-users can follow the track of records. This principle applies because bookkeepers and other record keepers change from time to time. And without consistency, the financial is misleading, untraceable, and incomparable.

Going Concern Principle Accounting Practice

It talks about the company’s future obligations. If the company can pay its future obligations when they fall due. The usual measurement used is at least one year reporting period. In this principle, the company should be able to pay its liability for the next 12 months. Going concern principle implies that the company will keep operating its activities for the next year. It also means that the company is liquid. This principle protects the creditors. It also prevents the company from bankruptcy.

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Conclusion:

Some accounting practice doesn’t follow the generally accepted accounting principles. Some companies use wrong practice. It is considered if they have few transactions. There should be additional requirements for it to continually use the practice. Otherwise, the company will stop operating. These principles and guidelines are sets not to contribute difficulty to the business. Set to protect parties involves. Moreover, to prevent bad results and worst-case scenarios. That is why some business owners try to learn all these principles. Others hire experts to interpret figures and the impact of every economic event affecting the financials.

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