Accounting principles refer to the basic agreements regarding the recognition, measurement and presentation of economic life, reflected in the accounting system. In other words, these are the guidelines that need to be followed by entities while reporting to the superior bodies. Accounting principles facilitate examining financial data as expressions and methods are standardized.
There exist the International Financial Reporting Standards that are accepted all over the world. But the U.S. has a specific set of accounting principles called the GAAP.
Essence of the term
The key objective of accounting principles is to make sure that the enterprise’s financial statements are intact, unambiguous, and equitable. This approach assists in evaluating and retrieving valuable information from the firm’s reports, especially in the dynamics of factors in the course of time. Moreover, accounting principles prevent financial statements from being involved in fraud. So that increased transparency and red flag indicators are applied.
Generally Accepted Accounting Principles
The GAAP are known as the "ground rules" for financial reporting practiced on the U.S. market. These principles provide a general framework for information that is included in the statements, and the way it should be presented.
The Financial Accounting Standards Board (FASB) is the most authoritative source of accounting principles. It is an independent entity of seven members: accounting professionals, industry representatives, government officials and education agents.
Despite the fact that privately owned enterprises aren’t obliged to adhere to the GAAP, publicly traded firms must submit reports in order to be admitted to official listing. Thus, executives of such companies, along with independent accountant auditors have to confirm that there is a full compliance of financial statements to the established guidelines.
Therefore, the set of key accounting principles is listed below:
- Regularity. Bookkeepers follow the GAAP closely.
- Consistency. Unitary standards should be used throughout the whole accounting period.
- Sincerity. The principle implies correctness and objectiveness of the financial reporting process.
- Materiality. Financial statements provide an insight into the enterprise’s monetary standing to the full extent.
- Comparability. Users are able to review the reports of various firms. It ensures that the same accounting principles are followed.
There is no doubt that the number of accounting principles exceeds the above-listed ones.
The FASB also issues "Regulations on Financial Reporting Standards", which are the formal expression of the GAAP. So far, over 100 editions have been published.
In counterpart to issuing regulations, the FASB has completed a draft description of the conceptual framework for financial reporting, which includes:
- purpose of financial statements;
- desirable features of accounting data (relevance, reliability and clarity);
- elements of these statements;
- criteria for reporting information;
- concepts related to calculating the totals.
Loan suppliers and investors are able to require a filing procedure in compliance with the GAAP from private businesses and non-commercial entities. For instance, even for receiving a loan it is necessary to fill in the financial statements according to the established accounting principles. That’s the reason most enterprises comply with the GAAP, although there are no statutory requirements.
International Financial Reporting Standards
As a rule, accounting principles depend on geographic location. Anyway, there are internationally established ones, for example, the IFRS, which operate in more than 120 states.
The Securities and Exchange Commission is a government agency that has the legal authority to set accounting principles and financial reporting requirements for public corporations. Lately, the SEC has shown an increased interest in adopting the IFRS. Provided that these two standards differ greatly, a transition from the GAAP is unlikely to happen on the immediate horizon.
Nevertheless, as a necessity to address new accounting issues arises, regulatory bodies proceed to make collaborative efforts to solve them. Investors have to be scrupulous while comparing enterprises’ reports from around the globe because accounting principles for financial statements differ greatly from state to state.