1.01 Study Guide
I.
Generally Accepted Accounting Principles (GAAP) is defined as the set of
accepted industry rules, practices, and guidelines for financial accounting. GAAP
includes the standards, conventions, and rules accountants follow in recording and
summarizing transactions and in the preparation of financial statements.
A. Governing organizations behind Generally Accepted Accounting Principles
1. American Institute of Certified Public Accountants (AICPA)
2. The Financial Accounting Standards Board (FASB)
3. The Securities and Exchange Commission (SEC)
a. Two laws, the Securities Act of 1933 and the Securities Exchange
Act of 1934, give the SEC authority to establish reporting and
disclosure requirements.
b. Holds primary responsibility for:
(1) Enforcing federal securities laws
(2) Regulating the securities industry
(3) Regulating the stock market
(4) Preventing corporate abuse of investors
c. Given enforcement authority by Congress to:
(1) Bring civil enforcement actions against individuals and
companies who:
(a) Commit accounting fraud
(b) Provide false information
(c) Engage in insider trading
(d) Violate securities laws
(2) Bring criminal enforcement actions against individuals and
companies for criminal offenses.
4. The SEC usually operates in an oversight capacity, allowing the FASB
and the Governmental Accounting Standards Board (GASB) to establish
these requirements.
B. Primary qualities that make accounting information useful for decision
making
1. Relevance – The information is capable of making a difference in a
decision. Information should have predictive or feedback value, and it must
be presented on a timely basis.
2. Reliability - Information must be verifiable, a faithful representation, and
reasonably free of error and bias (neutral).
C. Secondary qualities that make accounting information useful for decision
making
1. Comparability - Information has been measured and reported in a similar
manner for different enterprises.
2. Consistency - Information is created and reported using the same
accounting treatment to similar events from period to period.
II.
There are thirteen basic accounting constraints, concepts, assumptions, and
principles that GAAP is founded upon.
A. Constraints:
1. Cost Effectiveness Constraint: The cost of providing accounting
information should not exceed the benefit of the information it is
reporting.
2. Materiality Constraint: The requirements of any accounting principle
may be ignored when there is no effect on the decisions of users of
financial information (immaterial).
3. Conservatism Constraint: Accountants must use their judgment to
record transactions that require estimation. This concept helps
accountants choose between 2 equally likely alternatives. Therefore,
the less optimistic estimate will be chosen when two estimates are
judged to be equally likely.
B. Concepts:
1. Recognition Concept: An item should be recognized (recorded) in the
financial statements when:
a. It can be defined by GAAP assumptions and principles.
b. It can be measured.
c. It is relevant to decision making by users.
d. It is reliable.
2. Measurement Concept
a. Every transaction is measured by the stated unit of measurement,
such as the dollar
b. The stated procedure of valuing assets, liabilities, equity, revenue
and expenses as defined by GAAP
C. Assumptions:
1. Economic Business Entity Assumption: All of the business
transactions are separate from the business owner’s personal
transactions.
2. Going Concern Assumption: Financial statements are prepared
under the assumption that the company will remain in business
indefinitely unless there is sufficient evidence otherwise.
3. Monetary Unit Assumption: The accountant assumes a stable currency
is going to be the unit of record. The FASB accepts the nominal value of
the U.S. dollar unadjusted for inflation as the monetary unit of record.
4. Time Period Assumption: The entity's activities are separated into
periods of time, i.e.: months, quarters or years.
D. Principles:
1. Cost Principle: Assets are recorded at historical cost, which equals
the value exchanged at the time of their acquisition, not at Fair Market
Value.
2. Full Disclosure Principle: All information pertaining to the operations
and financial position of the entity must be reported within the period of
time in question.
3. Revenue Recognition Principle: Revenue is earned and recognized
upon product delivery or service completion, without regard to the
timing of cash flow. This is also called accrual basis accounting.
4. Matching Principle: The costs of doing business are recorded in the
same period as the revenue they help to generate.
III. Statements Required by GAAP
A. Balance Sheet: shows information about the organization’s resources at one
given time.
1. Shows Assets, Liabilities, and Equity
2. Details about cash including cash in the bank, amount owed to creditors,
and the value of the company’s assets.
B. Income Statement: Shows the flow of revenues over a given period of time,
typically a month, quarter, or year.
1. Shows revenue and expenses
2. Shows profit or loss of a company
C. Statement of Cash Flow: shows the movement of cash in and out of the
business over a specified period.
1. Details cash flows from operating activities, investing activities, and
financing activities
2. Shows how changes in the balance sheet and income statement affect
cash and cash equivalents
D. Statement of Stockholders Equity: shows the changes in the company’s
equity throughout the reporting period.
1. Reports profit or loss from the company
2. Reports dividends paid
3. Reports other items that are debited/credited to retained earnings
IV. International Financial Reporting Standards (IFRS)
A. Principles-based standards, interpretations, and the framework adopted
by the International Accounting Standards Board (IASB)
B. Due to numerous companies operating globally, standards that are applicable
to all countries need to be developed.
C. Framework of IFRS
1. States the basic principles of IFRS
2. Currently being updated and converged with the IASB and FASB
3. The objective is to create a sound foundation for future accounting
standards.
D. US GAAP becoming IFRS
1. In February 2010, the SEC voted unanimously to publish a statement to
reaffirm its longstanding commitment to the goal of a single set of highquality global accounting standards. Additionally, the SEC expressed its
continued support for the convergence of US GAAP and IFRS.
2. Beginning in October 2010, the SEC will begin to work on a plan to
combine GAAP and IFRS.
3. U.S. companies may move to IFRS in approximately 2015 or 2016