Foundations of Financial Accounting & Reporting (FAR): Generally Accepted Accounting Principles (GAAP)
Welcome to the foundational module on Generally Accepted Accounting Principles (GAAP) for your CPA preparation. Understanding GAAP is crucial as it forms the bedrock of financial reporting in the United States. This module will guide you through the core concepts and importance of GAAP.
What are Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles (GAAP) are a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB) in the United States. Public companies in the U.S. must follow GAAP when compiling their financial statements. GAAP ensures that financial reporting is consistent, comparable, and transparent, allowing investors, creditors, and other stakeholders to make informed decisions.
The Conceptual Framework for Financial Reporting
Underlying GAAP is the FASB's Conceptual Framework for Financial Reporting. This framework outlines the objectives of financial reporting and the qualitative characteristics of useful financial information. It serves as a guide for the FASB in developing new standards and for preparers and users of financial statements in applying existing standards.
| Qualitative Characteristic | Definition | Enhancing Characteristic |
|---|---|---|
| Relevance | Information that can affect a decision. | |
| Faithful Representation | Information that is complete, neutral, and free from error. | |
| Comparability | Allows users to identify similarities and differences between items. | |
| Verifiability | Different knowledgeable and independent observers could reach consensus. | |
| Timeliness | Information is available to decision-makers before it loses its capacity to influence decisions. | |
| Understandability | Information is classified, characterized, and presented clearly and concisely. |
Key Principles of GAAP
Several fundamental principles guide the application of GAAP. These principles ensure that financial statements accurately reflect a company's economic activities.
To ensure financial statements are consistent, comparable, transparent, reliable, relevant, and understandable.
Some of the core principles include:
Economic Entity Assumption: Assumes that the business is a separate entity from its owners. All financial transactions are recorded for the business only.
Going Concern Assumption: Assumes that the business will continue to operate indefinitely into the future. This justifies depreciating assets over their useful lives rather than at liquidation value.
Monetary Unit Assumption: Assumes that only transactions that can be expressed in terms of money are recorded. Inflation is generally ignored.
Periodicity Assumption (Time Period Assumption): Assumes that the economic life of a business can be divided into artificial time periods (e.g., month, quarter, year) for reporting purposes.
Historical Cost Principle: Assets are generally recorded at their original cost. This principle provides objectivity and verifiability.
Revenue Recognition Principle: Revenue is recognized when it is earned and realized or realizable, regardless of when cash is received. The core idea is to recognize revenue when the company has substantially completed its performance obligations.
Matching Principle (Expense Recognition Principle): Expenses are recognized in the same period as the revenues they help generate. This ensures that the financial statements show the profitability of operations for a given period.
Full Disclosure Principle: All information that could affect a user's understanding of the financial statements should be disclosed. This includes footnotes to the financial statements.
The Matching Principle is often referred to as the 'cause and effect' relationship in accounting – matching the effort (expenses) with the reward (revenues).
The FASB Accounting Standards Codification (ASC)
The FASB Accounting Standards Codification (ASC) is the single source of authoritative nongovernmental U.S. GAAP. It organizes and simplifies U.S. GAAP by topic. Understanding how to navigate the ASC is a key skill for any aspiring CPA.
The FASB Accounting Standards Codification (ASC) is structured hierarchically. It begins with broad Areas (e.g., General, Presentation, Assets, Liabilities, Equity, Revenue, Expenses), which are then broken down into Topics (e.g., Inventory, Leases, Revenue from Contracts with Customers). Each Topic is further divided into Subtopics, Sections, and Paragraphs. This structured approach allows for precise referencing and ensures that all relevant guidance for a particular accounting issue is consolidated.
Text-based content
Library pages focus on text content
The FASB Accounting Standards Codification (ASC).
Importance for CPA Candidates
A deep understanding of GAAP is fundamental to passing the CPA exam. The FAR section heavily tests your knowledge of these principles and their application to various accounting scenarios. Mastering GAAP will not only help you pass the exam but also equip you with the essential skills for a successful career in accounting and finance.
Next Steps
Continue to explore the resources provided to deepen your understanding of specific GAAP pronouncements and their practical implications. Practice applying these principles to various case studies and exam-style questions.
Learning Resources
The official source for all authoritative U.S. GAAP. This is the primary reference for understanding accounting standards.
Provides the underlying objectives and qualitative characteristics of useful financial information, guiding GAAP development.
Official information about the CPA exam, including the FAR section, exam content, and study resources.
A comprehensive overview of GAAP, its purpose, and key principles, explained in an accessible manner.
An explanation of the structure and importance of the FASB ASC, with insights from a leading accounting firm.
Insights and updates on accounting standards from KPMG, often including explanations of GAAP implications.
Resources and publications from Deloitte on accounting and financial reporting, including GAAP.
Detailed explanations of various accounting topics, including a clear breakdown of GAAP principles and their application.
A video tutorial explaining the core concepts of GAAP, often helpful for visual learners preparing for the CPA exam.
A broad overview of GAAP, its history, and its international variations, providing context and foundational knowledge.