1.

01 Generally Accepted
Accounting Principles
Accounting Constraints,
Concepts, Assumptions,
and Principles
GAAP PowerPoint #3

Hierarchy of Qualitative
Information
Cost/Benefit

Understandability

Discussed in
PPT #2

Decision Usefulness

Relevance

Reliability
Verifiability
Verifiability

Timeliness
Timeliness
Feedback
Feedback
Value
Value

Neutrality
Neutrality
Representational
Representational
Faithfulness
Faithfulness

Predictive
Predictive
Value
Value

Comparability and
Consistency

Materiality
www.fasb.org

Constraints
A constraint is a limit, regulation, or
confinement within prescribed bounds.
This term refers to the accounting
guidelines that border the Hierarchy of
Qualitative Information
They consist of:
Cost Effectiveness
Materiality
Conservatism

Cost Effectiveness
Constraint
Also called Cost Benefit Constraint
The cost of providing accounting
information should not exceed the benefit of
the information it is reporting.
Example: Your checkbook register and
bank statement differs by $0.10. Rather
than waste time to find the $0.10, the
accountant should record the amount as
miscellaneous expense or income.

Materiality Constraint

Material means big enough to make a difference

in the users decision-making process.
States that the requirements of any accounting
principle may be ignored when there is no
effect on the decisions of the user of financial
information.
Example: A company purchases a Trashcan for
$10. Per GAAP, this amount should be
capitalized as an asset and depreciated.
Because the amount is immaterial, the $10 can
be recorded as an expense.

Conservatism Constraint

Accountants use their judgment to record

transactions that require estimation.
Conservatism helps the accountant choose
between 2 equally likely alternatives.
Requires the accountant to record the
transaction using the less optimistic choice.
Example: There is the potential for a
customer to sue the company. Although, the
customer may choose not to sue, the
accountant will disclose this potential lawsuit
to investors.

Concepts
Concepts are the ground rules of
accounting that should be followed when
preparing financial statements.
These are:
Recognition Concept
Measurement Concept

Recognition Concept

States that an item should be recognized

(recorded) in the financial statements when:
It can be defined by GAAP assumptions and
principles
It can be measured
It is relevant to decision-making by users
It is reliable

Measurement Concept
States that every transaction is measured
by the stated unit of measurement, such as
the dollar
The stated procedure of valuing assets,
liabilities, equity, revenue, and expenses as
defined by GAAP

Assumptions
Assumptions are agreed upon rules of
accounting, and are basic, understood
beliefs.
There are Four Basic Assumptions of
Accounting:

Economic Business Entity

Going Concern
Monetary Unit
Time Period

Economic Business Entity

Assumption
All of the business transactions should be
separate from the business owners
personal transactions
There should be no co-mingling of personal
funds with business funds.

Going Concern Assumption

Financial statements are prepared under the
assumption that the company will remain in
business indefinitely unless there is
sufficient evidence otherwise.
If there is evidence that a company may
possibly have a going concern issue, this
must be disclosed in the financial
statements.

Monetary Unit Assumption

Assumes a stable currency is going to be
the unit of record.
FASB accepts the nominal value of the US
Dollar as the monetary unit of record
unadjusted for inflation.

Time Period Assumption

The entitys activities are separated into
periods of time such as months, quarters or
years.
Transactions must be accounted for within
the time period they occur regardless of
when cash is exchanged.

Principles of Accounting
Principles are accounting rules used to
prepare, present, and report financial
statements.
Principles dictate how events should be
recorded and reported.

Cost Principle
Assets are recorded at historical cost, not
fair market value.
For example, if a company purchases a
building for $500,000 it should be recorded
as such, and should remain on the books for
that amount until disposed of.
If the building appreciates to $700,000 in
the next few years, no adjustment should
be made.

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.
Circumstances and events that make a
difference to financial statement users
should be disclosed.

Revenue Recognition
Principle
Revenue is earned and recognized upon
product delivery or service completion,
without regard to when cash is actually
received.
Also called accrual basis accounting
Example: A customer purchases inventory
from a company on credit. Even though no
cash has yet been received, the sale is
recorded.

Matching Principle
The costs of doing business are recorded in
the same period as the revenue they help
generate, regardless of when the money is
actually paid.
Also called accrual basis accounting
Example: A company orders merchandise
on credit and has 30 days in which to pay.
This purchase is recorded immediately,
even though no cash has been paid.

Questions for
Understanding/Discussion
Explain what is meant by The benefits of
accounting information must exceed the costs.
What is meant by the term materiality in
financial reporting?
What is meant by the term conservatism in
financial reporting?
Explain the Going Concern assumption.
Explain the Time Period assumption.
Explain the accounting principles that guide
accounting practice.