Accounting Principles

Accounting follows a certain framework of core principles which makes the information generated
through an accounting system valuable. Without these core principles accounting would be
irrelevant and unreliable.

These principals include:

1. Accrual Concept
2. Going Concern Concept
3. Business Entity Concept
4. Monetary Unit Assumption
5. Time Period Principle
6. Revenue Recognition Principle
7. Full Disclosure Principle
8. Historical Cost Concept
9. Matching Principle
10. Relevance and Reliability
11. Materiality Concept
12. Substance Over Form
13. Prudence Concept
14. Understandability Concept
15. Comparability Principle
16. Consistency Concept

These principles are the building blocks that form the basis of more complex and specialized
principles called GAAP or generally accepted accounting principles such as the International
Financial Reporting Standards, US GAAP, etc. They deal with matters like accounting for revenue,
accounting for income taxes, accounting for business combinations, etc

What Is GAAP?
First of all, I should tell you that GAAP is actually my nickname. My full name is Generally
Accepted Accounting Principles. My name refers to a specific set of guidelines that have
been established to help publicly-traded companies create their financial statements. Publicly-
traded companies are companies that have made stock in their organization available for sale to
the public. Unlike some superheroes that are made up of plutonium and kryptonite, I am made
up of 10 basic accounting principles. They are:

1. Economic Entity Assumption

2. Monetary Unit Assumption
3. Time Period Assumption
4. Cost Principle
5. Full Disclosure Principle
6. Going Concern Principle
7. Matching Principle
8. Revenue Recognition Principle
 9. Materiality
10. Conservatism

Let's take a minute to look at what each of my parts mean:

The economic entity assumption means that any activities of a business must be kept
separate from the activities of the business owner.
The monetary unit assumption means that only activities that can be expressed in dollar
amounts can be included in accounting records.
The time period assumption means that business activities can be reported in distinct time
intervals. These intervals may be in weeks, months, quarters, or in a fiscal year. Whatever the
time period is, it must be identified in the financial statement dates.
The cost principle refers to the historical cost of an item that is reported on the financial
statements. Historical cost is the amount of money that was paid for an item when purchased
and is not changed to account for inflation.
The full disclosure principle means that all information that is relative to the business be
reported either in the content of the financial statements or in the notes to the financial
statements.
The going concern principle refers to the intent of a business to continue operations into the
foreseeable future and not to liquidate the business.
The matching principle refers to the manner in which a business reports income and
expenses. This principle requires that businesses use the accrual form of accounting and match
business income to business expenses in a given time period. For example, a sales expense
should be recorded in the same accounting period that sales income was made.
The revenue recognition principle addresses the manner in which revenue, or income, is
recognized. This standard requires that revenue be reported on the income statement in the
period in which it is earned.
The materiality principle refers to the measure of importance of a misstatement in accounting
records. For example, if the price of an asset is understated by $10.00, will that misstatement
have enough effect on the financial statements to matter? This is a gray area in accounting
standards that requires professional judgment to be used.
The last principle that makes me up is conservatism. Conservatism is the principle that calls for
potential expenses and liabilities to be recognized immediately if you are unsure whether they
will actually occur or not, but potential revenue not to be recognized until it is actually received.

History of GAAP
Now that you know what I am made of, let's talk about why I was created. Way back in 1929, a
significant event in American history occurred. It was called the Stock Market Crash of 1929,
and it affected not only those people who had placed their hard-earned money into corporate
stocks and bonds but also every single person in America. The 1929 stock market crash was a
precursor to one of the hardest economic times that has ever been known, the Great
Depression.
During this time, many people lost faith in the stock market and in the American economy. The
government decided that there needed to be some way to rebuild that lost faith, and so, in the
early 1930s, the Securities and Exchange Commission (SEC) was created.
The purpose of the SEC was to regulate financial practices among publicly-traded companies.
In 1934, the SEC asked for assistance from the American Institute of Accountants, or
the AIA, in examining the formation of financial statements. Two years later, in a report on
financial statement formation, the concept of GAAP was mentioned for the very first time.
In the late 1930s, the AIA created a subcommittee to specifically create the GAAP principles. It
was called the Committee on Accounting Procedure, or CAP, and comprised 18 accountants
and three accounting professors. Shortly after CAP was formed, the first set of GAAP standards
was created. In 1973, the SEC decided to replace CAP with the Financial Accounting
Standards Board (FASB), which is still in place today.