If a company releases its financial statements to the public, it is required to follow Generally Accepted Accounting Principles, called GAAP, in the preparation of those statements.
“GAAP” consists of three important sets of rules:
- Basic accounting principles and guidelines.
- Detailed rules and standards issued by the Financial Accounting Standards Board (FASB) and its predecessor the Accounting Principles Board (APB).
- The generally accepted industry practices.
If a company distributes its financial statements to the public, it must follow generally accepted accounting principles when preparing of those statements.
if a company’s stock is publicly traded, the company’s management and independent accountants must certify that the financial statements ate prepared in accordance with the GAAP.
Basic Accounting Principles and Guidelines
- Economic Entity Assumption: Accountant keeps the business transactions separate from the business owner’s personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one entity, but for accounting purposes they are considered to be two separate entities. GAAPs role is to regulate accounting definitions and methods so that there is consistency in the methods used to prepare financial statements.
- Monetary Unit Assumption: Economic activity is measured in U.S. dollars, and only transactions e expressed in U.S. dollars are recorded;
- Time Period Assumption: This assumes that it is possible to report complex and ongoing activities of a business in short, distinct time intervals.
- Cost Principle: From an accountant’s perception the term “cost” refers to the amount spent when an item was originally obtained, regardless of when the purchase happened,
- Full Disclosure Principle: If certain information is important to an investor or lender using the financial statements, such as in a lawsuit that information should be disclosed within the statement or in the notes to the statement.