Accounting Concepts and Standards

Accounting Concepts and Standards

Accounting procedures provide the information that is used by companies to measure performance and analyze their financial position. Accounting is used to record a company’s assets, liabilities, shareholder equity, revenues and expenses. A detailed set of rules called the Generally Accepted Accounting Principles (GAAP) are used to oversee financial accounting. GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing transactions. Financial Accounting Standards are the published result of the Financial Accounting Standards Board. The Securities and Exchange Commission (SEC) is the authority that enforces the accounting principles. All publicly traded companies file audited financial statements with the SEC. The difference between standards and concepts is that standards are the rules and provide guidance as to how to handle specific accounting issues and concepts are the underlying principles, e.g. the reason why the standards were written.

The generally accepted accounting principles are not a fixed set of rules. They are guidelines or, more precisely, a group of objectives and conventions that have evolved over time to govern how financial statements are prepared and presented. The Financial Accounting Standards Board, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission provide guidance about acceptable accounting practices. There are four basic principles underlying GAAP including: the historical-cost principle, the full disclosure principle, the revenue-recognition principle and the matching principle.

The historical-cost principle means that assets and liabilities are recorded at their actual historical cost and have a receipt or record of payment made/funds received. The full disclosure principle states that any information that can influence the decision of a user of financial information should be disclosed. The revenue-recognition principle is when cash or claim to cash is received in exchange for a product or service. The matching principle is when expenses are recognized when the revenues are recognized.

In most cases, GAAP requires the use of accrual basis accounting rather than cash basis accounting. Accrual basis accounting, which adheres to the revenue recognition, matching, and cost principles discussed above, captures the financial aspects of each economic event in the accounting period in which it occurs, regardless of when the cash changes hands. Transactions are counted when the order is made, the item is delivered, or the services occur, regardless of when the money for them (receivables) is actually received or paid. Under the cash basis of accounting, revenues are recognized when the company receives cash or cash equivalent, and expenses are recognized only when the company pays with cash or its equivalent.

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