Accounting Concepts; Accounting Principles; GAAP; Generally Accepted Accounting Principles

Understanding fundamental accounting concepts is critical to a comprehensive understanding of customers' financial statements. These basic accounting concepts include:

• The Business Entity: A corporation is a business entity separate and distinct from its owners. 
• The Going Concern Concept: Financial statements are prepared based on an assumption that the company is a going concern. If the auditor has questions about the viability of the company, that information will be reflected in its opinion letter. 
• Historical Cost Basis: Most fixed assets are recorded at their historical cost less accumulated depreciation. The exception involves land.  As a result, the value of an asset as recorded on the balance sheet may have little in common with the market value of that asset. 
• Conservatism Principle: This principle states that given a choice of options, an independent accountant must select an accounting method that has the least favorable impact on the net income or asset value of the company being audited. 
• The Matching Principle: It states that a company must determine revenue, and match the appropriate costs against that revenue. A goal of the matching principle is to make certain companies do not overstate profits by recording a sale but failing to record the expenses associated with making that sale. 
• Full Disclosure Requirement: A requirement that the company disclose all facts relevant to readers of financial statements. 
• The Consistency Principle: It states that companies must normally use the same accounting method from period to period so the company's financial condition can be compared over time. 
• The Objective Evidence Requirement: The requirement involves the fact that financial statements must be based on documentation that reasonable people would interpret in similar ways. 
• The Monetary Unit Assumption: All financial records must reflect foreign currency translations into a business's home currency. 
• Materiality: Only items that are of sufficient size to be relevant to the reader of a company's financial statements will be included in the financial statements and footnotes. 
• Revenue Recognition:  This relates to  a GAAP principle that determines the conditions under which sales and income become realized as revenue. Sales and net income are recognized when a specific critical event has occurred, and the amount of revenue is measurable.  Example:  An acceptance clause in the contract stating that the buyer many inspect and must approve shipments before the customer is obligated to pay for them would put the question of whether the sale should be recognized under the revenue recognition principle.

© 2009 by Michael C. Dennis.  All Rights Reserved. Michael is the author of "Credit and Collection Manager's Manual."