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Business Financials – GAAP – Understand Accounting Principles and why we have them

images/Business Financials2.jpgWhen we make accounting records (which is recording the monetary values of financial transactions) there are general rules and concepts that have been developed over many decades that apply. These are called basic accounting standards / principles or guidelines and are the groundwork on which more detailed, complicated and legalistic accounting rules are based.

In Australia. The Australian Accounting Standards Board (AASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards.

The standards are known as "generally accepted accounting principles" (or "GAAP") which consist of three important sets of rules:

  1. Basic accounting principles and guidelines;
  2. Detailed rules and standards issued by AASB; and
  3. The generally accepted industry practices.

When a company distributes its financial statements to the owners or the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company's shares are publicly traded, federal law requires the company's financial statements be audited by independent public accountants. Both the company's management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP.

GAAP is useful because it attempts to standardise and regulate accounting definitions, assumptions and methods. Because of generally accepted accounting principles we are able to assume that there is consistency from year to year in the methods used to prepare a company's financial statements. And although variations may exist, we can make reasonably confident conclusions when comparing one company to another or comparing one company's financial statistics to the statistics for its industry. Over the years the generally accepted accounting principles have become more complex because financial transactions have become more complex.

The Accounting Standards (GAAP) are split into various categories eg “Statement of Cashflows”, “Construction Contracts”, etc and a list with most recent updates/ pronouncements for Australia can be found HERE.

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