U.S. generally accepted accounting principles

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Generally accepted accounting principles (GAAP) are the accounting rules used to prepare financial statements for publicly traded companies and many private companies in the United States. Generally accepted accounting principles for local and state governments operates under a different set of assumptions, principles, and constraints, as determined by the Governmental Accounting Standards Board (GASB).

In the United States, as well as other countries practicing English common law system, the government does not set accounting standards, in the belief that the private sector has better knowledge and resources. The GAAP is not written in law, although the U.S. Securities and Exchange Commission (SEC) requires that it be followed in financial reporting by publicly traded companies.

Contents 1 Basic objectives 2 Fundamental qualities 3 Basic concepts 3.1 Assumptions 3.2 Principles 3.3 Constraints 4 Setting GAAP 5 House of GAAP

Basic objectives

Financial reporting should provide information that is:

• useful to present and potential investors and creditors and other users in making rational investment, credit, and other financial decisions.
• helpful to present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts.
• about economic resources, the claims to those resources, and the changes in them.

Fundamental qualities

To be useful and helpful to users, financial statements must be:

• Relevant: relevant information makes a difference in a decision. It also helps users make predictions about the of past, present and future events (it has predictive value). Relevant information helps users confirm or correct prior expectations (it has feedback value). It is also must be available on time, that is before decisions are made.
• Reliable: reliable information is verifiable (when independent auditors using the same methods get similar results), neutral (free from bias), and represent faithfulness (what really happened or existed).
• Comparable: information must be measured and reported in a similar manner for different enterprises (allows financial statements to be compared between different companies).
• Consistent: the same accounting methods should be applied from period to period and all changes in methods should be well explained and justified (allows financial statements of the same company to be compared between different periods).

Basic concepts

To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints.

Assumptions

• Economic Entity Assumption assumes that the business is separate from its owners or other businesses. Revenues and expenses should be kept separately from personal expenses. This applies even for partnerships and sole proprietorships. The entity concept does not necessarily refer to a legal entity.
• Going Concern Assumption assumes that the business will be in operation for a long time. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain is this assumption not applicable.
• Monetary Unit Assumption assumes a stable currency is going to be the unit of record. The FASB accepts nominal value of US Dollar as the monetary unit of record (unadjusted for inflation).
• Periodicity Assumption assumes that the business operations can be recorded and separated into different periods (most common periods are months, quarters and years). This is required for comparison between present and past performance.

Principles

• The historical cost principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values.
• The revenue recognition principle requires companies to record when revenue is (1) realized or realizable and (2) earned, not when cash is received. This way of accounting is called accrual basis accounting.
• The matching principle. Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost can be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle.
• The full disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as larger amount of information costs more to prepare and use. Information disclosed should be enough to make judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information.

Constraints

• Cost-benefit relationship states that the benefit of providing the financial information should also be weighted against the cost of providing it.
• Materiality states that significance of an item should be considered when it is reported.
• Industry practices states that accounting procedure should follow industry practices.
• Conservatism states that when choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

Setting GAAP

Those organizations influence developing GAAP in the United States.

• U.S. Securities and Exchange Commission (SEC)

The SEC was created as a result of the Great Depression. At that time there was no structure setting accounting standards. The SEC encouraged establishment of private standard-setting bodies through AICPA and later FASB, believing that the private sector had the proper knowledge, resources, and talents. The SEC works closely with various private organizations setting GAAP, but does not set GAAP itself.

• American Institute of Certified Public Accountants (AICPA)

In 1939 urged by the SEC, the AICPA appointed the Committee on Accounting Procedure (CAP). During the years 1939 to 1959 CAP issued 51 Accounting Research Bulletins that dealt with a variety of timely accounting problems. However, this problem-by-problem approach failed to develop the much needed structured body of accounting principles. Thus in 1959 AICPA created Accounting Principles Board (APB) which mission was to develop an overall conceptual framework. It issued 31 opinions and was dissolved in 1973 for lack of productivity and failure to act promptly. After the creation of FASB, the AICPA established the Accounting Standards Executive Committee (AcSEC). It publishes:
1. Audit and Accounting Guidelines summarizing the accounting practices of specific industries (e.g. casinos, colleges, airlines, etc.) and providing specific guidance on matters not addressed by FASB or GASB.
2. Statements of Position providing guidance of financial reporting topics until the FASB or GASB sets standards on the issue.
3. Practice Bulletins indicating AcSEC's views on narrow financial reporting issues not considered by FASB or GASB.

• Financial Accounting Standards Board (FASB)

Realizing the need to reform the APB, leaders in accounting profession appointed a Study Group on Establishment of Accounting Principles (commonly known as the Wheat Committee for its chair Francis Wheat). This group determined that the APB must be dissolved and a new standard-setting structure be created. This structure is composed of three organizations: the Financial Accounting Foundation (FAF, it selects members of the FASB, funds and oversees their activities), Financial Accounting Standards Advisory Council (FASAC), and the major operating organization in this structure Financial Accounting Standards Board (FASB). FASB has 4 major types of publications:
1. Statements of Financial Accounting Standards - most authoritative GAAP setting publications. There are more than 150 issued to date.
2. Statements of Financial Accounting Concepts - first issued in 1978. They are a part of FASB conceptual framework project and set forth fundamental objectives and concepts that FASB will use in developing future standards. However, they are not a part of GAAP. There are 7 concepts published to date.
3. Interpretations - modify or extend existing standards. There are about 50 interpretations published to date.
4. Technical Bulletins - guidelines on applying standards, interpretations, and opinions. Usually solves some very specific accounting issue that will not have a big, lasting affect.

In 1984 the FASB created the Emerging Issues Task Force (EITF) which deals with new and unusual financial transactions that have the potential for becoming common (e.g. accounting for Internet based companies). It acts more like a problem filter for the FASB - the EITF deals with short-term, quickly resolvable issues, leaving long-term, more pervasive problems for the FASB.</ul>

• Governmental Accounting Standards Board (GASB)

Created in 1984, the GASB addresses state and local government reporting issues. Its structure is similar to FASB's.

• Other influential organizations (e.g. American Accounting Association, Institute of Management Accountants, Financial Executives Institute)

House of GAAP

	House of GAAP
Category (a) (Most authoritative)	FASB Standards and Interpretations	Accounting Principles Board (APB) Opinions		AICPA Accounting Research Bulletins (ARBs)
Category (b)	FASB Technical Bulletins	AICPA Industry Audit and Accounting Guides		AICPA Statements of Position (SOPs)
Category (c)	FASB Emerging Issues Task Force (EITF)		AICPA AcSEC Practice Bulletins
Category (d) (Least authoritative)	AICPA Accounting Interpretations	FASB Implementation Guides (Q and A)		Widely recognized and prevalent industry practices