GENERALLY ACCEPTED

ACCOUNTING PRINCIPLES
(GAAP)
– ACCOUNTING CONSTRAINTS,
CONCEPTS, ASSUMPTIONS, AND
PRINCIPLES
 WHAT IS GAAP?

• GAAP2= Generally Accepted Accounting Principles

• Definition: Rules of accounting created by the

Financial Accounting Standards Board (FASB) for

use in the United States of America.
• Purpose: To ensure companies produce financial information that is useful to
existing and potential users of the financial information in making decisions
for or about the company.
• For financial information to be useful, it must possess two characteristics:
1) Relevance – makes a difference in decision making
2) Faithful representation – fully depicts the economic substance of business activities

• Why do we need GAAP?

It ensures consistency in reporting and presentation of financials

 WHAT IS GAAP?

• Generally Accepted Accounting Principles

• Defined as the set of accepted industry rules,
practices and guidelines for financial accounting
• Includes the standards, conventions, and rules
accountants follow in recording and summarizing
transactions, and in the preparation of financial
statements
 4 METHODS OF ACCOUNTING
Cash Basis
• Recording revenues when cash is
received and recording expenses
when cash is paid
• Does not accurately present the true
financial picture of the company at
a given time
• NOT allowed under GAAP
Accrual Basis
• Recording revenues when earned and
recording expenses when incurred,
regardless of the timing of cash receipts
collected or cash payments made
• More accurately reflects the financial
position of the company at a point in
time
• The only acceptable method of
financial reporting under GAAP
 5 BASIC GAAP PRINCIPLES

1. Revenue Recognition Principle

2. Expense Recognition Principle
3. Historical Cost Principle
4. Consistency Principle
5. Disclosure Principle
 FUNDAMENTALS OF ACCRUAL
6 ACCOUNTING
• Revenue Recognition Principle
• Revenues should be recognized when they are earned
• Once the company has fulfilled its obligation to the customer/patient by doing what it promises
to do
• Typically this occurs at the point of delivery of goods or services

Example Journal Entries

If payment received at the DEBIT: Accounts Receivable
time services are provided: CREDIT: Revenue
DEBIT: Cash When payment is received:
CREDIT: Revenue DEBIT: Cash
If payment is not received at the time CREDIT: Accounts Receivable
services are provided:
 7 FUNDAMENTALS OF ACCRUAL
ACCOUNTING
• Expense Recognition Principle (The “Matching Principle”)
• Expenses should be recognized in the same period that revenues with which they can be reasonably
associated
Example: RN salary expense should be recorded in
the same period that revenue from the nursing visit
is recorded

Example Journal Entries

To record nursing visit revenue
(cash not received at time of service): To record RN salary expense:
DEBIT: Accounts receivable DEBIT: Salary expense
CREDIT: Revenue CREDIT: Accrued payroll
OTHER
8 PRINCIPLES OF GAAP

• Historical Cost Principle

Assets should be recorded at their actual cost,
measured on the date of purchase

• Consistency Principle
The same accounting methods of recording transactions should be used
by a company from period to period

• Disclosure Principle
A company’s financial statements should report enough information for
the user to make informed decisions about the company
 ACCOUNTING ESTIMATES
Sometimes
9 estimates are required in financial statements in order to
record certain transactions when the value is uncertain

Definition: An approximation in the

amount recorded for a financial
statement item when there is no
precise means of measurement.

Estimates are based on

management’s judgment and
specialized knowledge derived
from past experience.
 10 ALLOWANCE FOR DOUBTFUL
ACCOUNTS
• One common estimate in the health To record estimate for AR
care industry is to estimate the net allowance:
realizable value of accounts receivable
DEBIT: Bad debt expense
• Since we know that some receivables
CREDIT: Allowance for
never actually get collected 
doubtful accounts
Example Journal Entry

Less: Allowance Net

Gross Accounts for Accounts
Receivable Receivable
Doubtful Accounts
ALLOWANCE FOR DOUBTFUL ACCOUNTS
• A typical method to estimate for potentially uncollectible
11
receivables is to reserve a percent of the aging “buckets” by
payer

• Management should tailor these percentages based on

historical collection and write-off experience
• Other methods of estimation are acceptable but should be
consistent from period to period
FINANCIAL STATEMENT OVERVIEW

12Sheet
Balance

(Statement of Financial Position)

Reports the amount of assets,

liabilities, and owner’s equity (for-
profit) or net assets (non-profit) of
an entity at a point in time.

Asset = Liabilities + OE/NA

 13 BALANCE SHEET LINE ITEMS

ASSETS
Current
• Cash
• Investments
• Accounts Receivable
• Inventory
• Prepaid Expenses
Non-Current
• Property and Equipment
• Investments
• Intangible Assets
 14 BALANCE SHEET LINE ITEMS

LIABILITIES
Current
• Accounts Payable
• Accrued Expenses
• Deferred Revenue
Long-Term
• Notes Payable
• Capital Lease Obligation
 15 BALANCE SHEET LINE ITEMS

For-Profit
Not-For-Profit
EQUITY
• Stock NET ASSETS
• Additional Paid-in-Capital • Unrestricted
• Retained Earnings (Deficit) • Temporarily Restricted
• Distributions • Permanently Restricted
FINANCIAL STATEMENT OVERVIEW

16
Income Statement
(Statement of Operations)

Reports the revenues and

expenses of an entity
during a period of time.

Revenues – Expenses =
Net Income (Loss)
 INCOME STATEMENT LINE ITEMS: REVENUES
17

Operating Revenue
Patient Service Revenue
Less: Contractual Adjustments
Net Patient Service Revenue
Other Operating Revenue

Non-Operating Revenue/Other Income

Contributions/Donations
Investment Return
 INCOME STATEMENT LINE ITEMS: EXPENSES
18

Direct Expenses
Expenses directly related to the Indirect Expenses
care of patients Expenses not directly related to
• Professional salaries the care of patients
• Benefits attributed to these • Administrative salaries & benefits
salaries • Rent & utilities
• Medical supplies • Office supplies
• Mileage reimbursement/ • Depreciation
transportation for field staff • Marketing
• Contract labor • Bad debts
 19 PERFORMANCE MEASURES
How do we measure financial success?

Gross Profit
Net operating revenue – direct expenses
Operating Income (Loss)
Net operating revenue – operating expenses
Net Income (Loss)
Total revenue – total expenses
EBITDA
Earnings Before Income Tax,
Depreciation & Amortization
 20 KEY PERFORMANCE
INDICATORS

Profitability

• Gross Profit Margin = Gross profit / Net revenue

• Net Profit Margin = Net income (loss) / Net revenue
• Return on Assets = Net income (loss) / Total assets
• Return on Equity = Net income (loss) / Total equity
Other Operating Indicators

• Labor as a % of Revenue
• A&G as a % of Revenue
 21 KEY PERFORMANCE
INDICATORS

Cash Flow
• Days in AR = Accounts receivable / (Net revenue / 365)
• Days Payable Outstanding = Accounts payable / (Operating expenses /365)
• Days Cash On Hand = Cash balance / (Cash expenses / 365)
• Days Cash & Investments On Hand = Cash + Investments / (Cash expenses / 365)
 Cash Expenses = Operating expenses excluding non-cash expenses, such as depreciation,
amortization, loss on sale of asset (no cash paid for these)
 22 KEY PERFORMANCE
INDICATORS

Liquidity

• Current Ratio = Current assets / Current liabilities

• Working Capital = Current assets – Current liabilities
• Debt to Equity = Total liabilities / Total equity
 23 BENCHMARK TARGETS
The table below includes certain suggested revenue cycle benchmark targets
GOVERNING BODIES OF GAAP

•MASB -
•AICPA
•FASB
•SEC
• Define: Security
• Securities Act of 1933
• Securities Act of 1934
•GASB
 MALAYSIA ACCOUNTING
STANDARD BOARD (MASB)
• Accounting standards are issued by the Malaysian Accounting Standards Board (MASB) by virtue of
the power conferred by the Financial Reporting Act, 1997.
• The Financial Reporting Act also establishes the Financial Reporting Foundation, which is the body
that is responsible to oversee MASB's performance and financial arrangement.
• The MASB had announced the effort to bring Malaysia to be in full convergence with the 
International Financial Reporting Standards (IFRS) by 2012.
• In February 2014, the MASB issued Malaysian Private Entities Reporting Standard (MPERS) and this
sets a new milestone for financial reporting of private entities in Malaysia. MPERS is based
substantially on the International Financial Reporting Standard for Small and Medium-sized Entities
(IFRS for SMEs) issued by the IASB in July 2009.
• The new reporting framework, known as the MPERS Framework, is effective for financial statements
beginning on or after 1 January 2016, with early application permitted.
AICPA

• American Institute of Certified Public Accountants (CPA)

• Founded in 1887
• Sets ethical standards for the CPA profession
• Sets U.S. auditing and GAAP standards
• Develops and grades the Uniform CPA Examination
• http://www.aicpa.org
FASB

• Financial Accounting Standards Board

• Established in 1973
• Establishes and improves standards of
financial accounting by non-governmental
entities (GAAP)
• www.fasb.org
SEC

• Securities and Exchange Commission

• Created by the Securities Act of 1933 and the Securities and
Exchange Act of 1934
• Holds the primary responsibility for:
• Enforcing federal securities laws
• Regulating the securities industry
• Regulating the stock market and
• Preventing corporate abuse of investors
HIERARCHY OF QUALITATIVE INFORMATION
Cost/Benefit

Understandability

Decision Usefulness

Relevance Reliability

Timeliness Verifiability
Discussed
in PPT #2

Feedback Neutrality
Value

Predictive Representational
Faithfulness
Value
Comparability and Consistency

Materiality

www.fasb.org
ACCOUNTING 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 user’s

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.
ACCOUNTING 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
ACCOUNTING 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 owner’s 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 entity’s 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.
ACCOUNTING PRINCIPLES

• 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.