GAAP, which stands for generally accepted accounting principles, is a common set of standards and rules for accountants that are issued by the Financial Accounting Standards Board (FASB). These regulations are extremely important for anyone in the accounting profession. When any public company in the United States has accountants compile their financial statements, those accountants are required to follow GAAP.
What is GAAP in Accounting
There are 10 key tenets that guide GAAP, along with a set of standards that is rule-based. The overarching goal of the generally accepted accounting principles is to provide consistency, clarity, and comparability when communicating financial information. Unless you are operating a company that is publicly traded, though, you generally won’t need to worry about adhering to these principles. It’s also important to note that these are US-based standards, while the rest of the world generally uses IFRS standards.
In addition to GAAP, there are basic accounting principles that businesses should be following, even if those businesses aren’t publicly traded. These basic rules and regulations for companies make it more likely that every company will be in compliance with state and federal laws when they file financial and accounting documents. Here are the five top accounting tips and principles every company needs to know.
1. The Revenue Recognition Principle
If there is one rule to remember in accounting, it’s the revenue recognition principle, which is also sometimes just called the revenue principle. This principle is based on when a company recognizes revenue. That should ideally be after the earnings process has been mostly completed. It’s a much more professional way of saying “don’t count your chickens before they’ve hatched.”
When a service is completed or a buyer has taken possession of the item they purchased, then it’s time to recognize (and record) the revenue from the sale. That doesn’t necessarily mean that the buyer has paid the invoice or the company has received the money yet, but it does indicate that the business has fulfilled their end of the transaction.
This helps keep track of accounts more easily, because nothing gets recorded as revenue until the task or product that produces that revenue has been fully provided. That avoids discrepancies in when and how revenue-generating activities are recognized, and reduces the chances of confusion in a company’s finances.
2. The Cost Principle
The cost principle addresses the concept that a business should be using the historical cost of an item that’s in the books, instead of the resale or market cost. In other words, if a company owns its own building it should be recording the cost of that building as what was paid for it, not what it’s worth on the current market.
There are other costs that become part of the total cost, though, such as overhead. These should also be included, since it’s important for any business to make sure they’re addressing all the expenses they have for an item they own, not just what they originally paid for it at the time of purchase.
When you follow the cost principle you’re keeping track of what was actually paid for items, as opposed to what they’re currently worth if they’ve gone up in value. Even if you could sell your building or equipment for a lot more than was originally paid, those items still only cost what was paid for them along with any overhead, upgrades, or other actual costs of owning them.
3. The Objectivity Principle
Among the top accounting tips is the objectivity principle. Anything that companies are putting into their books should be completely verifiable. Objective evidence is needed for these items, and subjective or speculative information has no place in accounting. It’s all about facts and figures, and keeping it that way is a vital part of making sure laws and regulations are correctly followed.
Even if subjective data appears to be better than the actual, objective data, it should still never be used as a part of any accounting a business does. Part of the reason for this is that not everyone will see subjective data the same way. Objective data, on the other hand, is factual and can be verified. It is clear and precise, which is exactly what you want to have when it comes to your company’s financial information.
Rather than take the chance on subjective discrepancies, make sure only objective information is provided to accountants or included in any financial forms or other paperwork. Other people may need to verify claims that a business makes in that paperwork, and subjective claims don’t have the ease of verification that comes with more objective types of data.
4. The Expense Recognition Principle
Following accounting rules is important, and the expense recognition principle is no exception. This principle is, essentially, the flip side of the revenue principle. It states that an expense should be logged into the books when your company accepts the good or service that generates that expense. You might not even have an invoice yet, but it needs to be counted as an expense.
If a company has someone come and do repairs on their building, for example, they should count the amount of the repair bill as an expense on the books, even if they haven’t paid the bill or even received an official invoice yet. Recognizing expenses when they occur, as opposed to when they’re invoiced or paid, can help keep books balanced and actual, available finances clear.
Even if a business has plenty of money in the bank, they might not have the ability to spend that money and still pay outstanding bills. If expenses aren’t considered until they’re billed or paid, running out of money could become a real possibility. It’s far better to know how much money has to go out, so that money can be held back in preparation of paying invoices or other bills.
5. The Matching Principle
Basic accounting principles include the matching principle, which says that every revenue item should match an expense item. If you sell something you count it as revenue, but you must also count the expense of the materials to make the item you sold. The same is true for a service, because there will generally be time and supplies required to provide that service to a customer.
Applying the matching, revenue, and expense principles is the accrual method of accounting, and it can help companies have better control of their financial picture in the present and for the future. There is also a cash-based accounting method, which doesn’t require matching. While that may work for smaller businesses, the accrual method is a more complete type of financial tracking.
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