For most assets, this value is easy to determine as it is the price agreed to when buying the asset from the vendor. The cost principle, also known as the historical cost principle, states that virtually everything the company owns or controls ( assets) must be recorded at its value at the date of acquisition. The employee worked for Lynn in April, helping her earn revenue in April, so Lynn must match the expense with the revenue by showing both on the April income statement. There would be no reliability in statements if expenses were recorded separately from the revenues generated.įor example, if Lynn earned printing revenue in April, then any associated expenses to the revenue generation (such as paying an employee) should be recorded on the same income statement. A mismatch in expenses and revenues could be an understated net income in one period with an overstated net income in another period. The expense recognition principle (also referred to as the matching principle) states that we must match expenses with associated revenues in the period in which the revenues were earned. She provided the service to the customer, and there is a reasonable expectation that the customer will pay at the later date. When should Lynn recognize the revenue, on August 10 or at the later payment date? Lynn should record revenue as earned on August 10. The customer did not pay cash for the service at that time and was billed for the service, paying at a later date. She completed a print job for a customer on August 10. Since the company has provided the service, it would recognize the revenue as earned, even though cash has yet to be collected.įor example, Lynn Sanders owns a small printing company, Printing Plus. Even though the customer has not yet paid cash, there is a reasonable expectation that the customer will pay in the future. A customer may not pay for the service on the day it was provided. There also does not have to be a correlation between when cash is collected and when revenue is recognized. This means the period of time in which you performed the service or gave the customer the product is the period in which revenue is recognized. The revenue recognition principle directs a company to recognize revenue in the period in which it is earned revenue is not considered earned until a product or service has been provided. Here are a few of the principles, assumptions, and concepts that provide guidance in developing GAAP. The conceptual framework sets the basis for accounting standards set by rule-making bodies that govern how the financial statements are prepared. Guidance may be given on how to report transactions, measurement requirements, and application on financial statements, among other things. These concepts can help ensure information is comparable and reliable to stakeholders. The FASB uses a conceptual framework, which is a set of concepts that guide financial reporting. The basics of accounting discussed in this chapter are the same under either set of guidelines. The SEC regulates the financial reporting of companies selling their shares in the United States, whether US GAAP or IFRS are used. Some companies that operate on a global scale may be able to report their financial statements using IFRS. The SEC not only enforces the accounting rules but also delegates the process of setting standards for US GAAP to the FASB. As a result, financial statement users are more informed when making decisions. By having proper accounting standards such as US GAAP or IFRS, information presented publicly is considered comparable and reliable. The SEC is an independent federal agency that is charged with protecting the interests of investors, regulating stock markets, and ensuring companies adhere to GAAP requirements. Publicly traded companies (those that offer their shares for sale on exchanges in the United States) have the reporting of their financial operations regulated by the Securities and Exchange Commission (S.E.C.). International accounting rules are called International Financial Reporting Standards (I.F.R.S.). If US accounting rules are followed, the accounting rules are called US GAAP. GAAP are the concepts, standards, and rules that guide the preparation and presentation of financial statements. The Financial Accounting Standards Board (F.A.S.B.) is an independent, nonprofit organization that sets the standards for financial accounting and reporting, including generally accepted accounting principles (G.A.A.P.), for both public- and private-sector businesses in the United States. 1.7 Accounting Principles, Concepts and Assumptions
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