There are four basic accounting principles that, along with four basic accounting assumptions and four basic accounting constraints, make up the generally accepted accounting principles, or GAAP, in the U.S. The GAAP are the accounting rules under which businesses record and report their financial earnings and losses for the accounting period. These rules are issued by the Financial Accounting Standards Board, usually in conjunction with other government entities. Accountants are not necessarily required to follow the rules, but the rules should be followed as closely as possible as they set standards that should be met to ensure appropriate accounting activity, understandability and comparability of the accounting data for different businesses. Below is a list of the four basic accounting principles and a brief explanation of each one.
1. The Cost Principle
Businesses are required to record and report assets based on the actual cost incurred to acquire them rather then the free-market value of the acquired assets themselves. The idea behind this principle is that this method of recording and reporting is reliable and lessens the opportunity for factors such as biased market values to interfere with the accounting. However, this method may be viewed as irrelevant as it relates to the actual value of assets.
2. The Accrual Principle
Businesses are required to record and report revenue at the time it is earned and realized by the business, not when the cash for the revenue is received by the business. This method is known as accrual basis accounting. The purpose of this principle is to actually show what work has been completed and not what is to be done in the future.
3. The Matching Principle
This principle allows for real time analysis of the expenses and revenues. Using this principle will show just how well the business has done financially and how effective it was. Somewhat like the Accrual Principle, expenses in this case can only be recorded and reported when revenue is to which such expenses are related was earned.
4. The Disclosure Principle
The accounting records of a business must be disclosed so that judgment about the financial status of a business can be easily made. However, the disclosure of accounting and financial information should not cause the business to accrue unreasonable expenses or cause erroneous opinions.