Without a common set of accounting standards, businesses would be on their own to show that they are reporting revenue and costs or losses correctly to investors or shareholders. These standards, known as generally accepted accounting principles (GAAP), provide certain guidelines that accountants must follow to avoid auditing or penalty from government entities. Students seeking a Master of Accountancy degree learn about these principles and how best to apply them to the businesses they will serve in the future. There several common principles that students need to understand.
What is GAAP?
GAAP is not a required practice for all businesses. However, any accountant who works for a publicly-traded company must follow GAAP accounting standards for all financial statements. While GAAP is not a government institution, it is regulated by the U.S. Securities and Exchange Commission (SEC). There are 12 basic types of principles, in three different categories:
These rules come from pronouncements made by the Financial Accounting Standards Board (FASB). There are over 100 pronouncements since the establishment of GAAP in 1973. While any publicly-held business with dealings in the U.S. must adhere to these standards, any businesses with dealings in other counties must also follow international accounting standards, as well as any other regulation specific to the region.
Within GAAP there are a certain number of assumptions that an accountant or auditor can or should make with regard to the business. For example, the business entity principle assumes that the business and its functions are separate from other businesses and the owner. Under this principle, accountants should establish whether the business entity definition is:
- a corporation
- a partnership
- run by a sole proprietor
Similarly, the Going Concern Principle makes a fundamental assumption about the near future of the business. Under this principle, the accountant operates as if the business will continue to survive for the foreseeable future. This means that the assets will be assessed at cost, not at liquidation values, and that revenues will be reported as normal. Of course, if evidence indicates that the business may not survive to the next year, the reporting standards change.
The section of principles under GAAP standards regulates the way businesses report their revenue, expenses, and how accountants must document this information. Revenue recognition and the Matching Principle are two important guides for businesses to keep their revenue in line. Simply put, recognizing revenue means to create a report of the business’s income. This typically relates to a product or service that that the company provides, indicating a contract for service or the sale of a product. The fundamental idea behind revenue recognition is accrual accounting, that revenue may be recorded independent of when the business actually receives payment, in the event that the two are not closely related. The Matching Principle deals with the timing in which expenses tied to that revenue are recorded. Unlike revenue, which is recorded when it is received, expenses are only recorded when they make a contribution to revenue. Whenever possible, accountants should match expenses to related revenue in the same period.
There are many constraints under which companies are bound to limit the types of information they use to create reports. The Materiality Principle governs the ability for businesses to override certain standards in the reporting of immaterial items. For example, businesses should typically depreciate assets that last for several years. However, if the item is of very little value, the accountant may choose to simply expense the cost of the item instead of depreciating it. The SEC strongly suggests that accountants not make this a general practice, however, since misstatements may affect the reported earnings of the company. The Conservatism Principle calls for accountants to select the right form of accounting standards, if more than one is available. Specifically, businesses must choose the form of reporting that has the least-favorable immediate impact. The reporting style has the ability to significantly increase or decrease a business’s or even a government entity’s reported income and liabilities.
Exceptions to GAAP
There are many exceptions to following generally accepted accounting principles, primarily concerned with other reporting entities. For example, some industries have specific reporting standards that are generally accepted but fall outside GAAP guidelines. Local and state governments fall under the Government Accounting Standards Board (GASB), not the FASB. Plus, any business with financial interactions in other countries may be subject to International Financial Reporting Standards (IFRS). This organization oversees the International Accounting Standards Board, which sets guidelines for international companies. In general, students seeking a master’s degree in accountancy should research the types of regulation based on the region and industry where they intend to serve businesses.
Companies benefit from their accountants following generally accepted accounting principles as a means to make their financial information clear to shareholders and prospective investors. People who plan to work as accountants should consider a Master of Accountancy program that provides detailed instruction in the principles and methods of accounting, following GAAP and all international accounting standards. To learn about the online Master of Accountancy program at The University of Scranton, visit our website or request more information.