Introduction to Accounting Principles
Did you know? To make the topic of Accounting Principles even easier to understand, we created a collection of premium
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There are general rules and concepts that govern the field of accounting. These general rules–referred to as
basic accounting principles and guidelines–form the groundwork on which more detailed, complicated, and
legalistic accounting rules are based. For example, the Financial Accounting Standards Board (FASB) uses the
basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of
accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules: (1)
the basic accounting principles and guidelines, (2) the detailed rules and standards issued by FASB and its
predecessor the Accounting Principles Board (APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow generally accepted
accounting principles in the preparation of those statements. Further, if a company's stock is 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 exceedingly useful because it attempts to standardize 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.
Basic Accounting Principles and Guidelines
Since GAAP is founded on the basic accounting principles and guidelines, we can better understand GAAP if
we understand those accounting principles. The following is a list of the ten main accounting principles and
guidelines together with a highly condensed explanation of each.
1. Economic Entity Assumption
The accountant keeps all of the business transactions of a sole proprietorship separate from the business
owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one
entity, but for accounting purposes they are considered to be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be expressed in U.S. dollars are
recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing power has not changed
over time. As a result accountants ignore the effect of inflation on recorded amounts. For example, dollars from
a 1960 transaction are combined (or shown) with dollars from a 2019 transaction.
Did you know? To make the topic of Accounting Principles even easier to understand, we created a collection of premium
materials called Accounting Coach PRO. Our PRO users get lifetime access to our accounting principles cheat sheet,
flashcards, quick test, and more.
There are general rules and concepts that govern the field of accounting. These general rules–referred to as
basic accounting principles and guidelines–form the groundwork on which more detailed, complicated, and
legalistic accounting rules are based. For example, the Financial Accounting Standards Board (FASB) uses the
basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of
accounting rules and standards.
The phrase "generally accepted accounting principles" (or "GAAP") consists of three important sets of rules: (1)
the basic accounting principles and guidelines, (2) the detailed rules and standards issued by FASB and its
predecessor the Accounting Principles Board (APB), and (3) the generally accepted industry practices.
If a company distributes its financial statements to the public, it is required to follow generally accepted
accounting principles in the preparation of those statements. Further, if a company's stock is 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 exceedingly useful because it attempts to standardize 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.
Basic Accounting Principles and Guidelines
Since GAAP is founded on the basic accounting principles and guidelines, we can better understand GAAP if
we understand those accounting principles. The following is a list of the ten main accounting principles and
guidelines together with a highly condensed explanation of each.
1. Economic Entity Assumption
The accountant keeps all of the business transactions of a sole proprietorship separate from the business
owner's personal transactions. For legal purposes, a sole proprietorship and its owner are considered to be one
entity, but for accounting purposes they are considered to be two separate entities.
2. Monetary Unit Assumption
Economic activity is measured in U.S. dollars, and only transactions that can be expressed in U.S. dollars are
recorded.
Because of this basic accounting principle, it is assumed that the dollar's purchasing power has not changed
over time. As a result accountants ignore the effect of inflation on recorded amounts. For example, dollars from
a 1960 transaction are combined (or shown) with dollars from a 2019 transaction.
