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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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generally accepted accounting principles (gaap), GAAP Example

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W2 Form

See Also:
401k
Cash Flow After Tax
Deferred Income Tax
Form 1098
Marginal Tax Rate

W2 Form Definition

The W2 form definition is used by employers to report employees‘ wages to the Internal Revenue Service (IRS). The W-2 is also used to report the amount of taxes that have been withheld from each paycheck.

W2 Form Explanation

The W2 form is required to be filled out by January 31 of every year by employers. The IRS requires this because it wants to measure an employee’s W 2 earnings on a calendar year instead of the company’s fiscal year. Often times an employee is required to fill out more than one w-2 if that employee works in more than one state. Other times two forms are required if a person works in one state, but lives in another. Overall, the W2 is used by the IRS to match up wages and calculate tax amounts for FICA and Social Security.

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w2 form definition

w2 form definition

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S Corporation vs C Corporation

See Also:
S Corporation
C Corporation
Limited Liability Company (LLC)

S Corporation vs C Corporation

Although these two entities are very similar, there has always been a debate between an S corporation vs C corporation. The S corporation vs C corporation debate has been ongoing for a while. The following are some major differences that exist which may help an entity choose the proper class of corporation.

Double Taxation

In a C corporation, the entity is forced to pay Federal Income Taxes at the entity level and again at the individual level when it distributes dividends to its shareholders. This double taxation is a huge disadvantage to the C corporation. It acts as a flow through entity much like a partnership. Each individual is only taxed on their earnings from the s corp at the individual level on schedule E of the IRS form 1040.

# of Shareholders

An S corporation can only have 100 shareholders total. This is good if it is a smaller company. However, for larger companies, this is simply not possible because of the amount of cash flow needed to finance a larger corporation. Consider all family members within the S corporation as only one shareholder. This means that there is a way in which there could be more than 100 shareholders. It also means that S corporation holders can increase their interest in the business without losing the status of an S corp.

Forms of Stock

C corps can issue several different forms of stock to obtain financing for its operations. In comparison, an S corporation can only have one class of stock. The C corporation’s advantage is that it has the ability to issue preferred shares or other classes depending on its needs.

Type of Company

You can form S corps only after you set a company as a C corp or a Limited Liability Company (LLC). This is a disadvantage for entities that would like the S corporation status (i.e. partnerships because of the similarities between the two).

Note: This is by no means all of the S corporation and C corporation differences. However, our list includes some of the main ones that influence a company to go one way or another.


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s corporation vs c corporation

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S Corporation

An S corporation (S-Corp), also called a subchapter S corporation, is a type of business organization that is structured like a corporation but taxed like a partnership. Find the applicable law in Chapter 1, Subchapter S, of the Internal Revenue Code. S-corps do not have to pay corporate income taxes. Instead, include the company’s profits and losses in the tax filings of the individual shareholders. To qualify as an S-corp, a company must be a domestic entity. The company must also have no more than 100 shareholders. The company must meet other specific requirements.

Advantages and Disadvantages of a S Corporation (S-Corp)

The primary advantage of the S-corp is the tax benefit. S-corps do not have to pay corporate income taxes. Also, it offers owners limited liability protection with the S-corp status. On the other hand, establishing an S-corp can involve significant legal and accounting costs. And S-corps are only allowed to issue one type of stock (typically common stock), which can limit the entity’s ability to raise capital.

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S corporation, S-Corp
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S corporation, S-Corp

See Also:

Partnership
General Partnership
Limited Partnership
Sole Proprietorship

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Modified Accelerated Cost Recovery System (MACRS)

See Also:
Straight Line Depreciation
Double Declining Depreciation Method
Accelerated Method of Depreciation
Financial Accounting Standards Board (FASB)
Generally Accepted Accounting Principles

Modified Accelerated Cost Recovery System Definition

The modified accelerated cost recovery system (MACRS) method of depreciation assigns specific types of assets to categories with distinct accelerated depreciation schedules. Furthermore, MACRS is required by the IRS for tax reporting but is not approved by GAAP for external reporting.

MACRS Depreciation Calculation

To calculate depreciation for an asset using MACRS, first determine the asset’s classification. Then use the table (below) to find the appropriate depreciation schedule.

When using MACRS, an asset does not have any salvage value. This is because the asset is always depreciated down to zero as the sum of the depreciation rates for each category always adds up to 100%. When calculating depreciation expense for MACRS, always use the original purchase price of the asset as the depreciable base for each period. Note that you depreciate each category for one year longer than its classification period. For example, depreciate an asset classified under 3-Year MACRS for 4 years. Then depreciate an asset classified under 5-Year MACRS for 6 years, and so on.

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MACRS Example

For example, an asset purchased for $100,000 that falls into the 3-Year MACRS category shown below, would be depreciated as follows:

YearDepreciation Rate     Depreciation Expense
  1     33.33%         $33,330     (33.33% x $100,000)
  2     44.45%         $44,450     (44.45% x $100,000)
  3     14.81%         $14,810     (14.81% x $100,000)
  4      7.41%          $7,410     (7.41%   x $100,000)

MACRS Depreciation Table

Below is the table for Half-Year Convention MACRS for 3, 5, 7, 10, 15, and 20 year depreciation schedules.

Depreciation Rates (%)

Year    3-Year    5-Year   7-Year   10-Year  15-Year  20-Year 

  1     33.33     20       14.29    10       5        3.75
  2     44.45     32       24.49    18       9.5      7.219
  3     14.81     19.2     17.49    14.4     8.55     6.677
  4      7.41     11.52    12.49    11.52    7.7      6.177
  5               11.52     8.93     9.22    6.93     5.713
  6                5.76     8.92     7.37    6.23     5.285
  7                         8.93     6.55    5.9      4.888
  8                         4.46     6.55    5.9      4.522
  9                                  6.56    5.91     4.462
 10                                  6.55    5.9      4.461
 11                                  3.28    5.91     4.462
 12                                          5.9      4.461
 13                                          5.91     4.462
 14                                          5.9      4.461
 15                                          5.91     4.462
 16                                          2.95     4.461
 17                                                   4.462
 18                                                   4.461
 19                                                   4.462
 20                                                   4.461
 21                                                   2.231

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Modified Accelerated Cost Recovery System

Modified Accelerated Cost Recovery System

MACRS and the IRS

For more detailed information regarding MACRS, go to: irs.gov/publications

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Internal Revenue Service (IRS)

See Also:
Cash Flow After Tax
Deferred Income Tax
Ad Valorem Tax
Tax Brackets
Tax Efficiency

Internal Revenue Service (IRS) Definition

The Internal Revenue Service or IRS for short is a government agency underneath the Department of Treasury. Furthermore, it is primarily responsible for administration and collections of federal income taxes.

Internal Revenue Service (IRS) Meaning

President Abraham Lincoln created the Internal Revenue Service during the Civil War and Reconstruction period to fund the war effort. Since then, the agency has been primarily responsible for funding the U.S. Government operations and services. The IRS is responsible for not only collecting from individuals and businesses, but also preparation and distribution of IRS forms. It is also responsible for conducting audits of individuals or businesses to ensure accuracy and that fraudulent activity has not occurred. A commissioner, known as the Commissioner of Internal Revenue, runs the IRS. Furthermore, the President fills this is a position. Like the Securities and Exchange Commission (SEC) the commissioner cannot be fired once appointed. This job security allows the commissioner to perform what is necessary without having to worry about getting fired.

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Internal Revenue Service

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Form 1099

See Also:
Form 1098
W2 Form
401k
Tax Efficiency
Internal Revenue Service (IRS)

Form 1099 Definition

The Form 1099 definition is used by the Internal Revenue Service (IRS) determine the amounts of income that is not in the form of wages, salary, and tips. An individual’s employer fills out the 1099.

Form 1099 Meaning

A form 1099 meaning is very similar to the business form W2. Often times a company will have to fill out hundreds of this form. Its requirements are that the employer submit three copies for every 1099 form. One is for the business, one is for the employee, and the other is for the IRS itself.

Another 1099 requirement is that the company post the forms electronically if the amount per year is in excess of 250 forms. Independent contractors most often use the form because the IRS considers the payments to a contractor to be non-employee compensation. Thus, for each job that an independent contractor performs there must be a form 1099 filled out. If the amount paid is less than $600 then there need not be a form filled out by the employer or business. There are currently 16 types of 1099 which all refer to a different form of non-wage income. These forms range from distributions made from pension funds to real estate transactions.

form 1099, Form 1099 Definition, Form 1099 Meaning

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