Three Levels in the Accounting Framework
The discipline of accounting can be broken down into a framework with four general levels. First is the conceptual framework which outlines the theory behind accounting rules. Second is a set of basic generally accepted accounting principles (Basic GAAP) that helps guide decision making when applying GAAP. Thirdly, is the FASB Accounting Standards Codification - the complete source of authoritative GAAP, including specific rules set out by FASB and the SEC. Fourthly, and lastly, there exists a level of pre-existing industry practices that are typically followed. Standard industry practices increase the consistency of financial statements for the same firm between periods, and between different firms in the same industry.
Basic generally accepted accounting principles, also known as basic accounting principles and guidelines, form the groundwork from which the more detailed and complicated FASB accounting standards (also known as US GAAP) are based. These guidelines flow from the conceptual framework of accounting, which is the theory that outlines the goals of accounting information and accounting standards. Because US GAAP gives accountants significant leeway in applying accounting rules in different circumstances, understanding this higher-level framework is important to guide decision-making about how specific standards should be applied.
As well, the SEC allows accountants to depart from US GAAP in the situation where applying these standards might lead to misleading information. As a result, accountants cannot just blindly apply the rules of GAAP without understanding the intent behind the rules. This basic GAAP helps clarify how these types of decisions should be made.
Three Levels in the Accounting Framework
There are two principle methods of accounting that can be used to keep track of a business's income and expenses in the United States: cash-basis and accrual basis. These methods differ in timing for when transactions (such as sales and purchases) are recognized.
Relevance and reliability are considered to be the two fundamental characteristics of accounting information according to the conceptual framework of accounting. That is, in order for accounting information to be useful to the primary users of the financial statements, we say that it must have both of these attributes, relevance and reliability.
Recognition is the process of formally incorporating an item into the financial statements of an entity.
The materiality principle recognizes that in some trivial items, following GAAP would be exceedingly expensive or difficult. In these cases, if the item that needs to be reported is non-material then an accountant can depart from GAAP.
The matching principle is a guiding principle, not a rule, that suggests that expenses should be recognized in the same period as the revenues that they helped earned are recognized.
The cost principle requires that assets on the financial statements of an entity be recorded at historical cost.
The objectivity principle in accounting suggests that the information that is reported in the financial statements should be supported by objective evidence. This means that the amounts of recorded transaction are verifiable.
The going concern principle states that the financial statements of an entity should be prepared as if the firm will continue its operations for the foreseeable future.
The stable-monetary unit assumption has two parts. The first part requires that transactions must be able to be expressed in form of a currency. The second part assumes that the value of the currency in which transactions have been originally reported remains constant over time.
The entity assumptions requires that all of the transactions of the business and the items reported on the business's financial statement are kept separate from the finances of the business's owners.
The time period concept requires that financial reporting take place over specified periods of time known as fiscal periods.
The full disclosure principle states that any information that is material, but is not reported in the financial statements, must be disclosed in the notes to the financial statements.
The principle of conservatism requires that accountants be allowed to recognize anticipated or potential losses, but should not be allowed the same action to be taken when considering anticipated or potential gains.
Consistency requires that once an accounting method is chosen by a firm, the same method should be used from period to period. It also suggests that accountants should strive to use similar accounting methods as other firm’s in the same industry.
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