GAAP Principles Flashcards
What Does GAAP stand for
-Generally Accepted Accounting Practice
What is Gaap
- is a collection of rules, procedures and guidelines for accountants to follow when recording and reporting financial information
- Without it, it be extremely difficult to accurately evaluate and compare businesses
What is the businesses entity concept
- a business functions separately from its owners, or any other organizations
- the affairs must be kept separate
Example of businesses entity concept
- the owners insurance cannot be recorded as a business expense in the books of the business
- besides being financially in accurate, this is also illegal as it would result in the business paying less tax than it should
What is the historical cost concept
- that assets should be value at historical cost
- are recorded as the amount originally paid for the asset
What is the advantage of historical cost concept
-is that the cost is determined objectively
Example of historical cost concept
-ATP Suppliers bought their business premises for R200 000 in 1996. A local estate agent has estimated that the property is currently worth R800 000. Even though, the property may be valued at four times its historic cost, there is no guarantee that that value would be realized until it is actually sold. So the accountant of ATP Suppliers should continue to record the property at its historic cost of R200 000.
What is the Going concern concept
- The going concern concept provides that the financial statements of a business should be prepared based on the assumption that the business will continue to operate for the foreseeable future.
- assets are simply valued in accordance with the historical cost concept.
Example of Going concern concept
-Jack & Jill Ltd ordered corporate stationery (paper, envelopes and business cards bearing the company logo and details) at a cost of R10 000. By the end of the year they estimated that they had only used about 10% of this stationery.
Since it is assumed that Jack & Jill Ltd is a going concern, the company will be able to use this stationery in future years, and so the accountant would reflect this by showing stationery valued at R9 000 (R10 000 less 10%) in the books at the end of the year. If the business was about to close, this same stationery would be worth almost nothing.
What is the Matching concept
- The matching concept provides that income and expenses are recognized and recorded in the correct time period
- In other words, income and expenses are matched to the period in which they are earned or incurred, irrespective of whether the income has actually been received or the expenses actually paid.
Example of Going concern concept
-Tata Traders signed an advertising contract that stipulates that the newspaper will place Tata Trader’s advertisement everyday for six months, starting on 1 October 2010, at a cost of R18 000. On 1 October 2010, Tata Traders paid to the local newspaper the R18 000.
Although the advertising expense was paid in full during the financial year ending on the 31 December 2010, the benefit from the advertising (additional sales due to the advertising) will, in fact, be realised over the entire six month period. Three of these months are part of the financial year ending on the 31 December 2010; while the other three months (January, February and March 2011) are in the next financial period. Thus, in accordance with the matching principle, half of the advertising expense should be allocated to the financial year ending on the 31 December 2010 and the other half to the next financial period (ending on the 31 December 2011
What is Materiality principle
- The materiality principle provides that all significant information must be included in the financial statements, while items which are insignificant need not be disclosed in detail
- The aim is to ensure that financial statements include any information that is of importance, but that they should not become unnecessarily long and confusing or difficult to read.
Example of Materiality principle
-Joe Mali owns Mali Traders a mail order business. He works out of a small office at his home and posts catalogues and order forms to hundreds of customers each month. The expenses of Mali Traders for the financial year amount to R90 000, which includes R25 000 for postage and R85 for cleaning materials.
In the financial statements of Mali Traders, the amount for postage expense is significant and would be shown separately, however the R85 for cleaning materials would be grouped with other small miscellaneous expenses and listed together as Sundry expenses.
What is Prudence concept
- The prudence concept provides that accountants should be conservative in the preparation of financial statements and should take care not to overstate assets or income and not to understate liabilities and expenses.
- In other words, the accountant should adopt a pessimistic approach and should not include any income that has not been earned beyond all doubt and should provide for any possible loss even if the amount is uncertain
What is the The relationship between GAAPand ethics
- ensure that the information recorded in the financial statements of an enterprise is accurate and reliable
- the statements of GAAP are guidelines and thus it is often up to the accountant to judge how best to record certain information
