Objective 1.01 - Understand Generally Accepted Accounting Principles.
I.
Generally Accepted Accounting Principles (GAAP)
A. Organizations that develop/format GAAP
B. Primary qualities of GAAP
C. Secondary qualities of GAAP
II.
Essential Accounting Constraints, Concepts, Assumptions, and Principles for GAAP (13)
A. Constraints
1. Cost effectiveness constraint
2. Materiality constraint
3. Conservatism constraint
B. Concepts
1. Recognition concept
2. Measurement concept
C. Assumptions
1. Economic entity assumption
2. Going concern assumption
3. Monetary unit assumption
4. Time period assumption
D. Principles
1. Cost principle
2. Full disclosure principle
3. Revenue recognition principle
4. Matching principle
III. Required Financial Statements for GAAP
IV. ISRF and its Effect on GAAP
6312 Accounting II
Summer 2011 Version 2
Page 1
STUDENT NOTES
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
KEY TERMS















GAAP
AICPA
FASB
SEC
Securities
Securities Act of 1933
Securities Act of 1934
GASB
Relevance
Reliability
Comparability
Consistency
Cost effectiveness constraint
Materiality constraint
Conservatism constraint














Recognition concept
Measurement concept
Economic business entity
assumption
Going concern assumption
Monetary unit assumption
Time period assumption
Cost principle assumption
Full disclosure principle
Revenue recognition principle
Matching principle
Objectivity
IFRS
IASB
APB
Rules in My Life
Rule
Why is it Important
Consequences
Why should people who handle money for others
follow the rules? What are some effects of not
following accounting rules?
6312 Accounting II
Summer 2011 Version 2
Page 7
GAAP – Definition and Governing Bodies
PowerPoint #1 Notes
GAAP
Stands for
Defined as
Rules accountants
Governing
Bodies
American
Institute of
Certified
Public
Accountants
FASB
GAAP – Definition and Governing Bodies
PowerPoint #1 Notes
SEC
Stands for
Created by:
Responsibility for:
Authority:
Granted by:
Civil Enforcement against:
Criminal Enforcement against:
Objectives:
Securities
GAAP – Definition and Governing Bodies
PowerPoint #1 Notes
Securites
Act of 1933
2 Basic Objectives
Securities
Act of 1934
GASB
:
GAAP – Qualities of Accounting Information
PowerPoint #2 Notes
Chart
What do these words mean to you? List your thoughts below:
Objectives of
Financial
Information
To provide
For
To inform about Decision Usefulness Understandability -
Primary Qualities
Relevance -
Reliability -
Relevance
Reliability
GAAP – Qualities of Accounting Information
PowerPoint #2 Notes
Secondary
Qualities
Comparability -
Consistency -
Comparability
Consistency
Questions:
GAAP – Constraints, Concepts, Assumptions, and Principles
PowerPoint #3 Notes
Constraints
Cost
Effectiveness
Constraint
Materiality
Constraint
Conservatism
Constraint
Concepts
Recognition
Concept
GAAP – Constraints, Concepts, Assumptions, and Principles
PowerPoint #3 Notes
Measurement
Concept
Assumptions
Economic
Business
Entity
Assumption
Going
Concern
Assumption
Monetary
Unit
Assumption
Time Period
Assumption
GAAP – Constraints, Concepts, Assumptions, and Principles
PowerPoint #3 Notes
Principles of
Accounting
Cost
Principle
Full
Disclosure
Principle
Revenue
Recognition
Principle
Matching
Principle
Questions
GAAP – Financial Statements
PowerPoint #4 Notes
What are
Financial
Statements?
Balance
Sheet
Income
Statement
Statement of
Cash Flows
Statement of
Equity
Questions:
GAAP and IFRS
PowerPoint #5 Notes
What is
the IFRS
Framework
of IFRS
US GAAP
becoming
IFRS
GAAP – Additional Study Websites
1. Website for quizzes, puzzles, etc. about financial statements and accounting principles:
a. :http://www.accountingcoach.com/online-accounting-course/financial-accounting.html
2. For more information on the accounting hierarchy:
a. http://www.fasb.org/jsp/FASB/Page/SectionPage&cid=1176156317989
i. Click on agreement, select yes
ii. Page 18 will contain the diagram
b. http://highered.mcgrawhill.com/sites/0072994029/student_view0/ebook/chapter1/chapter_opener.html
3. For information on concepts; principles; and financial statements:
a. www.wikipedia.com – Search for your topic.
b. http://www.accountingcoach.com/online-accounting-course/financial-accounting.html
c. http://media.wiley.com/product_data/excerpt/87/04710720/0471072087-1.pdf
4. Compare/contrast IFRC with GAAP
a. http://wiki.ifrs.com/Financial-Statement-Presentation
b. http://en.wikipedia.org/wiki/International_Financial_Reporting_Standards
c. http://www.ey.com/Publication/vwLUAssets/IFRS_vs_US_GAAP_Basics_March_2010/$
FILE/IFRS_vs_US_GAAP_Basics_March_2010.pdf - specifically beginning on Page 7
d. http://www.accountingcoach.com/online-accounting-course/09Xpg01.html
Sample Test Questions
GAAP Governing Bodies and IFRS
1. Lucy has been a Certified Public Accountant for 5 years. One of Lucy’s clients is a public
company whose stock is offered on the New York Stock Exchange. During her audit of the
company, Lucy discovers that several of the assets on the financial statements are deliberately
misstated. Which governing body should Lucy advise of the finding?
A.
B.
C.
D.
FASB
GAAP
AICPA
SEC
Primary and Secondary Qualities
2. Mary Little, CPA, is preparing the financial statements of ABC Corporation. Mary makes sure that
information capable of making a difference in a user’s decision-making is included in the financial
statements. Which quality of accounting information has been followed?
A.
B.
C.
D.
Relevance
Reliability
Comparability
Consistency
Constraints
3. During the preparation of the Toys4U Company’s financial statement, one of the accountants has
to decide between two alternative methods of valuing Inventory. He decides to choose the
method that reports the highest amount. Which constraint did the accountant follow?
A.
B.
C.
D.
Cost Effectiveness Constraint
Materiality Constraint
Conservatism Constraint
Recognition Constraint
Concepts
4. Thomason Corporation is based in the United States. When preparing its financial statements,
the corporation failed to include the purchase of a new tractor-trailer truck in the general ledger,
which was made on December 31st. What concept is Thomason Corporation violating?
A.
B.
C.
D.
Measurement Concept
Recognition Concept
Reality Concept
Materiality Concept
5. Donna Jones is the president and primary stockholder of Jones Enterprises. She keeps her
personal income and her business income in the same checking account. Which of the following
assumptions is she violating?
A.
B.
C.
D.
Business Entity Assumption
Going Concern Assumption
Monetary Unit Assumption
Time Period Assumption
6. Petersmith Corporation purchased a used work van for its business for $10,000. After doing some
minor body work and repainting, the owner estimated that he could sell the van for $15,000.
Therefore, the owner changed the Van amount on the balance from $10,000 to $20,000. Which
principle did he violate?
A.
B.
C.
D.
Cost Principle
Full Disclosure Principle
Revenue Recognition Principle
Matching Principle
7. Jerry Attric, a stock holder of XYZ Corporation, has just received a set of financials. While looking
at these financials, he sees the words Assets, Liabilities, and Stockholders’ Equity on a sheet.
Which financial statement is Stan viewing?
A.
B.
C.
D.
Balance Sheet
Income Statement
Statement of Cash Flows
Statement of Retained Earnings