Generally Accepted Accounting Principles

generally accepted accounting principles (GAAP)

how to report economic events.

The primary accounting standard-setting body in the United States is the

. These standards indicateFinancial Accounting Standards Board (FASB)

Commission (SEC)

financial markets and accounting standard-setting bodies.The SEC relies on

the FASB to develop accounting standards, which public companies must

follow. Many countries outside of the United States have adopted the accounting

standards issued by the

Board (IASB)

try to minimize the differences in their standards and principles.

One important accounting principle is the cost principle. The

principle

at their cost.This is true not only at the time the asset is purchased, but

also over the time the asset is held. For example, if

land for $30,000, the company initially reports it in its accounting records

at $30,000. But what does Best Buy do if, by the end of the next year, the land has

increased in value to $40,000? Under the cost principle it continues to report the

land at $30,000.

Critics contend the cost principle is misleading. They argue that market value

(the value determined by the market at any particular time) is more useful to financial

decision makers than is cost. Those who favor the cost principle counter

that cost is the best measure.The reason: Cost can be easily verified, whereas market

value is often subjective (it depends on who you ask). Recently, the FASB has

changed some accounting rules and now requires that certain investment securities

be recorded at their market value. In choosing between cost and market value, the

FASB used two qualities that make accounting information useful for decision

making—reliability and relevance: In this case, it weighed the

figures versus the

is the agency of the U.S. government that oversees U.S.International Accounting Standards. In recent years the FASB and IASB have worked closely tocost(or historical cost principle) dictates that companies record assetsBest Buy purchasesreliability of costrelevance of market value.

Assumptions

Assumptions provide a foundation for the accounting process. Two main

assumptions are the

assumption

monetary unit assumption and the economic entity.

MONETARY UNIT ASSUMPTION

The

records only transaction data that can be expressed in money terms. This

assumption enables accounting to quantify (measure) economic events.The monetary

unit assumption is vital to applying the cost principle.

This assumption prevents the inclusion of some relevant information in the

accounting records. For example, the health of a company’s owner, the quality of

service, and the morale of employees are not included. The reason: Companies

cannot quantify this information in money terms. Though this information is

important, companies record only events that can be measured in money.

monetary unit assumption requires that companies include in the accounting

ECONOMIC ENTITY ASSUMPTION

An economic entity can be any organization or unit in society.

company (such as

municipality (Seattle), a school district (St. Louis District 48), or a church

(Southern Baptist).The

of the entity be kept separate and distinct from the activities of its

owner and all other economic entities. To illustrate, Sally Rider, owner of

Sally’s Boutique, must keep her personal living costs separate from the expenses

of the Boutique. Similarly,

Schweppes

purposes.A business owned by one person is generally a proprietorship.Usually only a relatively small amount of money (capital) is necessary

There is no legal distinction between the business as an economic unit and the

owner, but the accounting records of the business activities are kept separate

from the personal records and activities of the owner.

Partnership.

is a

that more than one owner is involved. Typically a partnership agreement (written

or oral) sets forth such terms as initial investment, duties of each partner, division

of net income (or net loss), and settlement to be made upon death or

withdrawal of a partner. Each partner generally has unlimited personal liability

for the debts of the partnership.

the partnership transactions must be kept separate from the personal activities

of the partners.

businesses, including professional practices (lawyers, doctors, architects, and certified

public accountants).

A business owned by two or more persons associated as partnerspartnership. In most respects a partnership is like a proprietorship exceptLike a proprietorship, for accounting purposesPartnerships are often used to organize retail and service-type

Corporation.

law and having ownership divided into transferable shares of stock is a

A business organized as a separate legal entity under state corporation

corporation

they are not personally liable for the debts of the corporate entity. Stockholders

.The holders of the shares (stockholders) enjoy limited liability; that is,

may transfer all or part of their ownership shares to other investors at any time

(i.e., sell their shares). The ease with which ownership can change adds to the attractiveness

of investing in a corporation. Because ownership can be transferred

without dissolving the corporation, the corporation

Although the combined number of proprietorships and partnerships in the

United States is more than five times the number of corporations, the revenue produced

by corporations is eight times greater. Most of the largest enterprises in the

United States—for example,

and

Indicate whether each of the five statements presented below is true or false.

enjoys an unlimited life.ExxonMobil, General Motors, Wal-Mart, Citigroup,Microsoft—are corporations.

1.

communication.

The three steps in the accounting process are identification, recording, and

2.

officers.

The two most common types of external users are investors and company

3.

behavior and decrease the likelihood of future corporate scandals.

Congress passed the Sarbanes-Oxley Act of 2002 to reduce unethical

4.

Financial Accounting Standards Board (FASB).

The primary accounting standard-setting body in the United States is the

5.

periods, however, the market value of the asset must be used if market value

is higher than its cost.

The cost principle dictates that companies record assets at their cost. In later

Proprietorship.

The owner is often the manager/operator of the business. Small service-type businesses

(plumbing companies, beauty salons, and auto repair shops), farms, and

small retail stores (antique shops, clothing stores, and used-book stores) are often

proprietorships.

to start in business as a proprietorship. The owner (proprietor) receives

any profits, suffers any losses, and is personally liable for all debts of the business.

It may be aCrocs, Inc.), a governmental unit (the state of Ohio), aeconomic entity assumption requires that the activitiesMcDonald’s, Coca-Cola, and Cadbury-are segregated into separate economic entities for accounting. The Securities and Exchange