GAAP

Generally Accepted
Accounting Principles

Conceptual Framework for

Financial Reporting

LO 2

Qualitative Characteristics
Char s-
“Fundamental”

1. Relevance:
x Information significant to decisions
2. Faithful representation:
x Information is complete, neutral, free from
error
 Qualitative Characteristics
Ch s-
“Enhancing”
1. Comparability:
x Information is more useful if it can be compared
2. Verifiability:
x Different people would come to the same
conclusion
3. Timeliness:
x Having information available in time to influence
decisions.
4. Understandability:
x Information should be classified, characterized, and
presented clearly and concisely

Assumptions
1. Economic Entity: Company’s finances are reported
separately from the owners’ finances.
2. Going Concern Assumption: We assume that the
company is a continuing business. Value of assets would
be reported differently if company is about to be
liquidated.
3. Monetary Unit (Stable Dollar): We assume the U.S.
dollar is a stable common denominator of economic
activity.
4. Periodicity (Yearly Reporting): Normal practice is to
prepare annual financial statements with less detailed
information on an interim basis (monthly, quarterly)

Principles
1. Measurement Principle: Assets are measured in various
ways
x Historical Cost: Assets are reported at their cost as of
the date of acquisition, no adjustments are made to
market value. Example – Long lived assets such as
buildings, equipment, land.
x Fair Value: FV is the price asset would be sold for or
amount paid to transfer a liability. Example – some
investment securities.
x Net Realizable Value: The amount expected to be
realized/received in the future. Example – Accounts
receivable.
x Lower of cost or market: Assets reported at cost
unless the market value is lower. Example – Inventory.
 Principles
2. & 3. Revenue & Expense Recognition (Accrual Basis)
x Revenue & expenses are recorded when the
transaction that causes them occurs
x Record the amount the company expects to receive
or pay
x Timing of cash received or paid does not affect when revenues
or expenses are reported
4. Full Disclosure Principle:
x Firms should provide all information that is of
sufficient importance to influence the judgment and
decisions of an informed user.
x Completeness vs. Understandability tradeoff

Constraints
Materiality & Cost Benefit Analysis: Accounting
principles need not be applied if failure to follow
would not have a material effect on the financial
statements.
- Ask would it affect decision making?
- Illegal/Fraud always material!
Conservatism: When there is uncertainty about
how to record a transaction the uncertainty will
be resolved with a “bias” in favor of understating
assets or income. (i.e. report inventory at
market when it is lower than cost)