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GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Generally Accepted Accounting Principles


Generally accepted accounting principles (GAAP) are rules established in preparing
financial statements. GAAP was established by the Financial Accounting Standards Board
(FASB). Health care organizations hire certified public accountants (CPA) to determine the
accuracy of the organizations financial statements. The CPA performs an audit which examines
the financial records; evaluating the accounting system, looking for errors, and deciding if the
financial statements have been prepared according to generally accepted accounting principles.
(Finkler, Kovner, & Jones, 2007). The GAAP principles to be discussed in this paper, are; entity
concept, going concern concept, matching principle and cash vs accrual accounting, cost
principle, objective evidence, materiality, consistency, and full disclosure.
The entity concept refers to the organization or person that is the focus of attention. A
hospital is an entity. The different departments within the hospital are subentities. Financial
records must be maintained for the entity as a whole and separately for each of the subentities.
When preparing financial statements, it is important to clearly identify the entity related to the
financial statement. (Finkler et al., 2007) For example, the nutrition service department
purchased fresh produce from a local farmer. On the financial records of the nutrition service
department entity, there would be an account payable to indicate the obligation to pay the farmer.
The farmers entity record would show as account receivable because the farmer has not been
paid for the product he provided.
The going concern principle is a presumption that the entity is going to remain in
business into the future when the accounting records are prepared. A special indication is
required if there is a strong likelihood that the entity is going to go out of business. Assets are

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

valuable for an organization that is in business but have much less value if the organization goes
out of business. (Finkler et al., 2007)
The third principle is the matching principle and cash vs. accrual accounting. This
principles allows organizations to provide a complete representation of a current fiscal years
activities. Cash transactions are the simplest ways to record revenues and expenses; payment is
received, revenue is recorded and when money is paid, expense is recorded. Problems arise for
organizations when care is given toward the end of the fiscal year and expense is recorded during
the new fiscal year. This causes profit to be overstated in the new fiscal year because the cost of
providing care is not reflected in the new fiscal year. (Finkler et al., 2007)
To avoid this problem, accountants devised the matching principle using accrual
accounting. This principle expects health care organizations to match revenues with the expenses
acquired to earn those revenues, and the organizations report them both at the same time. The
revenue record does not represent the receipt of payment, it is the implied promise of payment to
the health care organization. (Finkler et al., 2007) For instance, Dr. Smith provides a flu shot to
Mr. Jones. At the time of the visit, Dr. Smith collects Mr. Jones copay of $10 and bills Mr. Jones
insurance $20. The entire $30 is recorded as revenue at the time of care, even though the $20 is
not paid by Mr. Jones insurance company until the new fiscal year. Accrual accounting provides
a fairer picture of what has occurred in each year, it is required for organizations that prepare
their financials in accordance with GAAP (Finkler et al., 2007, p. 105).
Cost principle refers to the value of assets at the time of purchase. Assets are recorded on
the balance sheet at cost, which equals the value exchanged at the time of purchase ("Generally
Accepted Accounting Principles," 2014, para. 10). Some exceptions to this rule pertain to the
depreciation of some assets over a period of years. For instance, equipment owned by the

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

organization may appear on the balance sheet at a lower amount than the original purchase price.
This is referred to as the net book value because it represents cost less the accumulated
depreciation that has been recorded all the years the equipment has been owned. (Finkler et al.,
2007)
Over time many assets may vary from their original cost and may cause serious problems
in the interpretation on the balance sheets. Value of land owned by the organization may rise, yet
remain on the balance sheet at its original cost. This is due to the objective evidence principle.
The principle of objective evidence holds that information reported on financial statements
should be based on objective, verifiable evidence. This is evidence on which a wide group of
different individuals could all be expected to agree (Finkler et al., 2007, p. 105). Most assets are
recorded at the value of their cost, as agreement is easily reached on the exact amount that was
paid to purchase the asset. (Finkler et al., 2007)
Errors in accounting occur and would be costly to a health care organization to eliminate
all errors. Accountants use the materiality principle to decide which errors to ignore. Materiality
principle states that the requirements of any accounting principle may be ignored when there is
no effect on the users of the financial information. ("Generally Accepted Accounting Principles,"
2014, para. 14). A standard dollar amount is not used when deciding on the error. An error in a
financial report that would cause a user of the financial statement to change a decision is
material (Finkler et al., 2007, p. 106). The accountants job is to decide in a given situation what
amount of money is large enough that is would affect decisions of users of the financial
statement. Errors must be discovered and corrected by the accountant prior to the release of the
financial statement. (Finkler et al., 2007)

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Consistency principle refers to how financial information is prepared. Financial


information must be prepared in a consistent manner year to year. Utilizing the same methods
each year allows accurate comparisons to be made between different accounting periods and
between the financial statements of different companies that use the same methods. ("Generally
Accepted Accounting Principles," 2014, para. 12)
GAAP requires financial statements to be a fair representation of the financial position
and results of operations of the organization. Full disclosure principle expects disclosure of any
information that would be needed for the financial statements and accompanying notes, taken as
a whole, to present a fair representation of the finances of the organization (Finkler et al., 2007,
p. 106). Health care organization must include an operating statement, statement of changes in
net assets, cash flow statement, set of explanatory notes, and a balance sheet in the audited
financial statement. (Finkler et al., 2007)
Conclusion
Health care organizations are required to track and report financial information. Using
GAAP principles ensures interpretation of the organizations financial statements are
understandable and prepared in accordance with generally accepted accounting principles
(Finkler et al., 2007, p. 104).

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES


References
Finkler, S. A., Kovner, C. T., & Jones, C. B. (2007). . In Financial management: for nurse
managers and executives (3rd ed.) St. Louis, MO: Saunders Elsevier.
Generally accepted accounting principles. (2014). Retrieved from
http://www.cliffsnotes.com/more-subjects/accounting/accounting-principles-i/principlesof-accounting/generally-accepted-accounting-principles