Chapter 12 Accounting Principles

GAAP (Generally Accepted Accounting Principles)

1. Rules & Regulations that accountants follow in the preparation of

financial information and presentation of financial statements.

2. Makes the financial statements more uniform and understandable.

3. Must be consistently applied from period to period.

4. Any departures from GAAP are acceptable if deemed immaterial.

5. Gains uniform acceptance through the use of the concepts and

principles by educators, practitioners, and inclusion in academic
textbooks.

Business Entity Principle

1. Business is deemed to be separate and distinct from the owners.

2. Business is responsible for its own assets, liabilities and maintenance

of the books and records.

3. Any financial transactions must have clear business purpose.

4. Business and personal assets should not be comingled

Going Concern Assumption

1. The business is deemed to have an indefinite level.

2. Is the justification for historical cost reporting.

3. A going concern review should be conducted annually.

4. If the going concern assumption is violated, then we should use

market or liquidation value when presenting financial statement
information.

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 5. The results of the going concern review should be disclosed in the
footnotes to the financial statement.

Objectivity Concept

1. Any financial transaction should be supported by objective and

verifiable source documents (Example: invoice, canceled check, bank
statement, purchase order, receiving report etc.)

2. Two accountants reviewing a financial transaction should come to the

same conclusion based upon a review of objective source
documentation. A financial transaction cannot be valued based upon a
subjective opinion and review.

Matching Principle

1. Revenue and expenses must be reported in the period that they were
earned and /or incurred.

2. Supports the use of accrual basis accounting, and monthly adjustments

to accurately and consistently present the financial statements on a
monthly basis.

3. Five types of adjusting entries which should be made on a monthly

basis:

(1) prepaid expenses

(2) unearned revenue
(3) depreciation
(4) accrued revenue
(5) accrued expenses

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Accrual Basis

1. Revenue is recorded when earned and expenses recorded when

incurred.

Cash Basis

1. Revenue is recorded when received and expenses recorded when paid.

Methods of Revenue Recognition

(1) Point of Sale Method

Revenue is earned when title passes to the buyer, which is usually when
the sale is made and the merchandise is shipped.

(2) Receipt of Payment Method

Corresponds to the cash basis of accounting. Revenue is recorded when

received regardless of when the sale is made.

(3) Installment Method

If the sales collection of the receivable is not reasonably assured then this
method would be used.

The gross profit is recorded and calculated as the cash is received. Income
tax is calculated on the amount of the gross profit received and included in
income for the year.

Cash Received 10,000

Gross Profit x 25%
Income 2,500

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 The 7,500 is deemed to be a recovery of cost (10,000 x 75%)

Sales 100 %
COGS x 75%
Gross Profit 25%

Consistency Concept

1. GAAP should be reported and applied from period to period with no

material departures.

2. Enhances the predictive and feedback value of the data.

3. Makes the financial statements uniform and understandable.

4. Any change in operating performance, should be attributable to the

business operating performance and not to changes in GAAP from
period to period.

Materiality

1. An item or transaction is deemed to be material if by its inclusion or

exclusion; it impacts the interpretation of the financial statements by
the reader.

2. Is a subjective indicator based upon each individual circumstance and

the impact on the company’s financial statements and financial
strength and size.

3. Can be quantified in terms of monetary value or percentages.

Conservatism

1. If there is a choice between two alternatives the accountant should

choose the alternative that would understate assets and/or income.

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 2. Record or provide for all losses and anticipate no gains.

Adequate or Full Disclosure

1. The financial statements should be accompanied by footnotes, which

disclose items that supplement and clarify the financial statement
information.

2. Certain information must be disclosed:

- Summary of significant accounting policies.
- Long-term debt disclosure.
- Supplement income statement and balance sheet information.
- Commitments and contingencies.
- Segment Information.
- Significant Customers
- Income taxes
- Subsequent events review - must begin from the date of the
financial statements that are being reported through the last date
of fieldwork. (This is the date of the auditors report)

Auditors Opinion

(1) Introductory Paragraph

(a) Lists all the financial statements being audited.
(b) States that management is responsible for the financial statements.
(c) States that the auditors’ responsibility is to express an opinion on the
financial statements.

(2) Scope Paragraph

(a) Audit is in conformity with GAAS (Generally Accepted Auditing
Standards).
(b) Audit tests provide reasonable assurance that the financial statements
do not include material misstatements.

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(3) Opinion Paragraph
(a) Financial statement present fairy the results of operations of the
company and the company’s financial position.
(b) Financial statements are in conformity with GAAP.

Types of Opinions

(1) Unqualified or “Clean”

No material departures from GAAP. The financial statements fairly
present the operation performance of the company on a consistent basis.

(2) Qualified
Some aspects of the financial statements do not conform to GAAP, but
“except for” or “subject to” these departures, the financial statements fairly
present the operational performance of the company on a consistent basis.

(3) Adverse or Negative

The financial statements have serious departures from GAAP.

(4) Disclaimer
The auditor is unable to render an opinion on the financial statements.