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Home > Accountancy Checklists > Understanding the Key Components of GAAP: The Continuing Concern Concept

Accountancy Checklists

Understanding the Key Components of GAAP: The Continuing Concern Concept


Checklist Description

This checklist outlines the key components of Generally Accepted Accounting Principles (GAAP).

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Definition

Generally Accepted Accounting Principles (GAAP) are not a fixed set of rules. They are guidelines or a group of objectives and concepts that have evolved on the best way to govern how financial statements are prepared and presented.

The guidelines are as follows:

  • The business entity concept provides that the balance sheet of the business must reflect the financial position of the business alone.

  • The continuing concern concept assumes that a business will continue to operate, unless it is known otherwise.

  • The principle of conservatism provides that accounting for a business should be fair and that evaluations and estimates should be reasonable.

  • The objectivity principle states that accounting will be recorded on the basis of objective evidence—that accounting entries will be based on fact and not on personal opinion or feelings.

  • The time period concept provides that accounting takes place over specific fiscal periods of equal length.

  • The revenue recognition convention provides that revenues are recognized at the time the transaction is completed.

  • The matching principle states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn.

  • The cost principle states that accounting for purchases must be at their cost price.

  • The consistency principle requires accountants to apply the same methods and procedures from period to period, because the readers of financial statements have the right to assume that consistency has been applied if there is no statement to the contrary.

  • The materiality principle requires accountants to use GAAP except when to do so would be expensive or difficult, and where it makes no real difference if the rules are ignored.

  • The full disclosure principle states that any and all information that affects the full understanding of a company’s financial statements must be included with the financial statements.

GAAP compliance is vital. It helps businesses to maintain their creditability with creditors and shareholders because the principles reassure the public that a company’s financial reports accurately portray its financial position.

Note that Generally Accepted Accounting Principles are known in the United Kingdom as Generally Accepted Accounting Practice.

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Advantages

  • These are general rules and concepts that direct the field of accounting and form the foundation on which more detailed, complicated, and legalistic accounting rules are based.

  • The Financial Accounting Standards Board (FASB) uses the basic GAAP accounting principles and guidelines as the starting place for its own, more detailed and comprehensive set of accounting rules and standards.

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Disadvantages

  • GAAP compliance poses challenges to small businesses with limited resources.

  • GAAP are not strict rules. They are only guidelines or a group of objectives and concepts that have evolved on the best way to govern how financial statements are prepared and presented.

  • Measuring and reporting give management considerable discretion and the opportunity to influence results. Those results sometimes depend on the accounting methods used.

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Action Checklist

  • When reviewing audits based on GAAP, be prepared to be involved in a long and detailed analysis. Some areas will need clarification by experts.

  • Check which GAAP are used in the internal audit of the business in which you are interested.

  • GAAP is not infallible. If you are unsure about specific areas or numbers, ask for clarification.

  • Don’t be frightened to ask what may seem naïve or uncomfortable questions.

  • Use the GAAP concepts and guidelines as a basis to help you understand the more complex accounting practices that are used in the specific enterprise, business area, or country in which you are interested.

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Dos and Don’ts

Do

  • Make sure that you take the time and make the effort to analyze the accounts. If in doubt, consult an independent expert.

Don’t

  • Don’t skip the boring bits; accounting is not always simple or interesting, and often it is easier to skip parts. However, sometimes the truth lies in the detail.

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Further reading

Books:

  • Bragg, Steven M. Wiley GAAP 2012: Interpretation and Application of Generally Accepted Accounting Principles. Hoboken, NJ: Wiley, 2011.
  • Epstein, Barry J., and Nadira M. Saafir. Wiley GAAP: Practical Implementation Guide and Workbook. Hoboken, NJ: Wiley, 2011.
  • PricewaterhouseCoopers. Manual of Accounting: UK GAAP 2012. Haywards Heath, UK: Bloomsbury Professional, 2011.

Websites:

  • Federal Accounting Standards Advisory Board (FASAB) Generally Accepted Accounting Principles: tinyurl.com/45xo9n6
  • International Accounting Standards Board (IASB): www.iasb.org

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