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Generally Accepted Accounting Principles (GAAP)

See Also:
Accrual Based Accounting
Modified Accelerated Cost Recovery System MACRS
10 Q
Asset
History of Accounting
Full Disclosure Principle

Generally Accepted Accounting Principles (GAAP) Definition

Generally Accepted Accounting Principles (GAAP) are a set of standards, guidelines, and regulations for financial accounting. Companies should follow GAAP rules when preparing financial statements.

GAAP rules were established to provide consistency in financial reporting and accounting practices. The rules evolve over time. Therefore, they reflect the most relevant and applicable accounting practices.

GAAP Meaning

Generally Accepted Accounting Principles (GAAP), in short, means the rules which provide the basis of all accounting decisions for financial institutions, businesses, and organizations. In the U.S., several organizations influence what GAAP rules, including the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), the Securities and Exchange Commission (SEC), and the Internal Revenue Service (IRS). U.S. GAAP differs from other international accounting standards, but organizations like FASB and the International Accounting Standards Board (IASB) are working to establish acceptable international accounting standards.

Overall, accountants calculate in two ways: for a financially stable or financially instable company. This is referred to as the Going Concern; unstable companies calculate assets by estimated value of the item when liquidated.

GAAP Standards

Generally Accepted Accounting Principles (GAAP) uses many standards and protective measures to ensure reliable and useful accounting statements. For example, accounting is done in fiscal periods which may not coincide with actual calendar periods. They instead coincide with the relevant events that happen to the company with respect to accounting standards.

Worst Case Scenario

Many GAAP standards account for the worst-case scenario. When you record past events in their value at the given time, call this the historical monetary unit. Additionally, subtractions from company cash are made when possible whereas additions are made only when the product is sent and cash is received.

Do Not Consider Intangibles

Under GAAP, do not consider intangible values, such as workforce knowledge or brand goodwill, an asset. Do not record these in the balance sheet. Furthermore, always make an effort towards consistency. Expectations like depreciation or inventory are accounted for in the same way across all periods which they occur. You must make any changes to one period, under this concept, to all periods past. Also, make these changes completely clear to the reader of the statement, providing the necessary background to understand the true meaning of the document.

Lastly, the scope of the company comes into play. An example of this would be a laptop computer: the accidental destruction of a single laptop means much more to a small business than a multinational one. The company scope is essential to relevant and readable financials.

GAAP Example

For example, Natalie is the CFO at a large, multinational corporation. Her work, hard and crucial, effects the decisions of the entire company. She must use Generally Accepted Accounting Principles (GAAP) to reflect company accounts very carefully to ensure the success of her employer.

Natalie begins her process of creating GAAP compliant statements. First, she looks at past records. These provide the crucial understanding of where her company has been. From here she can expand her accounting to meet the current and future needs of the company.

Natalie makes sure to to keep statements consistent. With the recent change in company policy from LIFO to FIFO, she has a lot of work ahead to correct past balances as well as make the change clear in the body text of the document.

When Natalie creates financials she ignores the value of the company name and brand, despite the fact that they sell a product which is in many ways a commodity. Her concern is tangible rather than intangible assets.

Bad News

Finally, the executive salesperson enters her office with the bad news that he has been in a car accident with the company car. The accident destroyed the vehicle beyond repair. Though Natalie is concerned for the health of her co-worker she is not concerned with the value of the vehicle: with a vehicle fleet valued at over $25 million a single car is not the concern of Natalie.

Natalie finally completes her assignment. She has faith in her work due to her training and expertise in her field. She has confidence that she has prepared sound GAAP complaint statements.

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History of Accounting

See Also:
History of Factoring
Generally Accepted Accounting Principles (GAAP)
International Financial Reporting Standards (IFRS)
Financial Accounting Standards Board (FASB)
Certified Public Accountant (CPA)

History of Accounting

Below is the history of accounting timeline is a general overview of larger events which have all contributed to modern day accounting. It encompasses primitive accounting, with the use of an abacus, to the accounting software and regulation that we use today.

History of Accounting Timeline

The history of accounting timeline starts in 2500 B.C.

2500 B.C.

Historical accounting records have been found in ancient civilizations like the Egyptian, Roman, and Greek Empires as well as ancient Arabia. Back then, rulers kept accounting records for taxing and spending on public works.

1000 B.C.

The Phoenicians created an alphabet with accounting so that they were not cheated through trades with ancient Egyptians.

500 B.C.

Egyptians carried on with accounting records. They even invented the first bead and wire abacus.

423 B.C.

The auditing profession was born to double check storehouses as to what came in and out the door. The reports accountants took were given orally, hence the name “auditor.”

1200 – 1493

The first requirement for businesses to keep accounting records spread across many of the Italian Republics in the 13th century. They took these records mainly to keep track of the day to day transactions and credit accounts with other businesses.


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1494

Luca Pacioli, the father of accounting, writes his famous paper “Everything about Arithmetic, Geometry, and Proportion.” The treatise that he writes is mainly a study that Pacioli performs on the common practices of merchants in Venice, Florence, and Milan. He revealed that several merchants kept books of debits which means “he owes” as well as credits which means “he trusts.” With this early double entry accounting system merchants were able to maintain records so that they could improve the efficiency of their businesses. With these records came the primitive income and balance sheet statements.

1500 – 1700

As the time progressed, double entry records had large and small innovations added. For example, the East India Company develops invested capital and dividend distribution during the 17th century. This also created the need for a change in financial accounting and managerial accounting. They used the first presentation to gain investors, while they used the next presentation for business efficiencies.

1700 – 1900

During the Industrial Revolution, accounting really took off as industrial companies sought out to gain financing and maintain efficiency through operations. Several of the double entry accounting methods was truly developed in this area as there was a focus on business as never before. Shortly after, the first accounting organization was developed in New York in the year 1887. The title and professional license of the Certified Public Accountant followed shortly in the year 1896.

1920 – 1940

The 20s accounting really became important to reduce the amount of fraud and scandals that were performed in businesses around the country. U.S. GAAP was developed shortly after by the American Institute of Certified Public Accountants (AICPA) and the Financial Accounting Standards Board (FASB) in the year 1939.

1940 – Present

Since this time the AICPA and FASB have been working together with the Securities Exchange Commission (SEC) to develop accounting standards for business. Through the help of technology and computer systems all standards created for U.S. GAAP have been centrally located into what is known as the “codification.” The codification reveals all of the current practices and standards, and even reveals developing areas of standards of accounting that are currently being debated upon.

Several accounting systems like Peachtree and Quickbooks have also made the accounting profession automated. These programs ease the reporting of transactions, but also comply with GAAP. Because of this there is a lesser need for accountants to post transactions, and more of a need for the review of these transactions. In some firms, they don’t realize the change as they still employ a full accounting staff. As time moves forward it is necessary for accountants to move into a role of reviewing transactions rather than posting them.

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Certified Public Accountant (CPA)

See Also:
American Institute of Certified Public Accountants – AICPA
How to Choose An Independent CPA/Auditor
Generally Accepted Accounting Principles (GAAP)
Financial Accounting Standards Board (FASB)
The Future of the Accounting Workforce

Certified Public Accountant (CPA) Definition

A CPA or certified public accountant is a person in the United States who has passed the uniform certified public accountant examination as well as met all other requirements. Typically accounting careers range from work for public accounting firms who perform audits or tax work for companies, or several others perform their work “in-house” for companies in a certain industry. In addition, these in-house accountants are ultimately responsible for the financial statements that are audited by the public accounting firms. Furthermore, many CPAs join the AICPA or American Institute of Certified Public Accountants. This institution provides rulings and discussion on many business practices as well as state societies or organizations for CPAs.

Certified Public Accountant Education Requirements

CPA requirements by state differ on the number of education hours needed to sit for the uniform CPA exam as well as work experience. There is also a requirement that each and every CPA obtain continuing education (CE) after he/she passes the exam. If an accountant were to quit CE after passing the exam, then he/she would fall under the CPA designation “CPA Inactive.” Generally speaking, the certified public accountant requirements are as follows to gain a CPA degree:

1) 150 hours of education including a bachelor’s degree
a) at least 24 hours of accounting-related courses
b) at least 24 hours of business-related courses

2) Passed all 4 Sections of the CPA exam

3) One year of accounting work experience under a CPA

4) Continuing education as required

Note: This is a general summary for most states. However, some states have more/less requirements than the above bullet points.

CPA Exam

The certified public accountancy exams are given in the following sections:

1)Auditing and Attestation

2)Financial Accounting and Reporting

3)Regulation

4)Business Environment and Concepts

Note: A person must score a 75 or higher on the exam to pass. If a section has been failed, then a person is not required to take all the sections again, but just the section that has been failed.

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American Institute of Certified Public Accountants – AICPA

American Institute of Certified Public Accountants (AICPA) Definition

The American Institute of Certified Public Accountants (AICPA) is a professional organization for Certified Public Accountants (CPAs). Furthermore, this organization is based in the United States. The organization dates back to 1887.

The AICPA creates the CPA examination. Then, they grade the CPA examination. In addition, it is also the organization that authored many of the original financial accounting and reporting standards included in GAAP; however, FASB is now responsible for GAAP.

The AICPA’s primary objectives include the following:

  • Advocacy on behalf of members
  • Certification and licensing of new members
  • Promoting public awareness of CPA professionalism
  • Recruiting and educating prospective CPAs
  • Establishing professional standards

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AICPA Website

If you want more information on the AICPA, then go to: AICPA.org.

See Also:
Statement of Financial Accounting Standards – SFAS
Sensitivity Analysis Definition
Standard Chart of Accounts
Problems in Chart of Accounts Design
Future of the Accounting Workforce

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New Financial Reporting Framework for Small Businesses

The AICPA just released a new financial reporting framework for small businesses. It aims to save small business owners both time and money. According to aicpa.org, the FRF for SMEs (Financial Reporting Framework for Small to Medium Sized Entities) is “a new accounting option for preparing streamlined, relevant financial statements for privately held owner-managed businesses that are not required to use GAAP.  The FRF for SMEs framework draws upon a blend of traditional methods of accounting with some accrual income tax methods.”

Financial Reporting Framework for Small Businesses

Examples of how the new framework reduces the complexity and cost of financial reporting for small businesses include the following:

  • The use of historical cost rather than the onerous fair value measurement basis
  • No requirement for complicated accounting for derivatives, hedging or stock compensation
  • Targeted disclosure requirements, providing users of financial statements with the relevant information they need while recognizing that those users can obtain additional information from management if they desire

Definition of SME

So what is the definition of a SME? A standard definition doesn’t exist in the United States. According to the AICPA, “the term is intuitive, widely recognized, and effectively descriptive of the scope of entities for which the FRF for SMEs accounting framework is intended.”

FRF for SMEs Accounting Framework

The task force and staff deliberately did not develop quantified size criteria for determining what is a small-and medium-sized entity. They decided that developing quantified size tests is not feasible. It is also not an effective way of describing the kinds of entities the framework is intended for. Rather, the AICPA has developed a list of characteristics of SMEs to guide companies in determining whether to adopt the new framework.

Excerpt of FRF for SMEs Report

Here is the list excerpted from the FRF for SMEs report:

  • The entity does not have regulatory reporting requirements that essentially require it to use GAAP-based financial statements.
  • A majority of the owners and management of the entity have no intention of going public.
  • The entity is for-profit.
  • The entity may be managed by the owner; owner-managed is a closely held company where the people who own a controlling ownership interest in the entity are substantially the same set of people who run the company.
  • Management and owners of the entity rely on a set of financial statements to confirm their assessments of performance, cash flows, and of what they own and what they owe. vii FRF-SME
  • The entity does not operate in an industry where the entity is involved in transactions that require highly-specialized accounting guidance, such as financial institutions and governmental entities.
  • The entity does not engage in overly complicated transactions.
  • Key users of the entity’s financial statements have direct access to the entity’s management.
  • The entity does not have significant foreign operations.
  • Users of the entity’s financial statements may have greater interest in cash flows, liquidity, statement of financial position strength, and interest coverage.
  • The entity’s financial statements support applications for bank financing when the banker does not base a lending decision solely on the financial statements but also on available collateral or other evaluation mechanisms not directly related to the financial statements.

Conclusion

Since the use of the framework is optional, there is no effective date. So, businesses can use the framework immediately.

While the framework should simplify the financial reporting process for small businesses, only time will determine the ripple effect. How will this affect the learning curve for CFOs changing jobs between companies reporting under different frameworks? Furthermore, will lenders accept financial statements prepared under the new framework? How will CPA firms deal with the cost of educating staff on the auditing standards for the new framework?

Here’s a link to the full FRF for SMEs report.

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Financial Reporting Framework for Small Businesses

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Compare IFRS vs US GAAP for SME’s

Do you want to know what is going to change when the new international standards are adopted? The AICPA has now created a wiki comparing the streamlined and complete version of the international standards using IFRS vs US GAAP for SME’s (Small and Medium Sized Entities). All of the sections of the IFRS will be updated in a wiki format on a go forward basis.

Compare IFRS vs US GAAP for SME’s

You can now see how the new rules will apply to private companies. As the rules become evident and adoption more likely, this site will be a great resource for navigating change. To see the comparison, go to the following site: wiki.ifrs.com.

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direct cost vs indirect cost

IFRS vs US GAAP

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