Accounting principles are generally accepted standards and rules that are used in the preparation of financial journals, ledgers and statements. Their use permits business owners, investors and other stakeholders to come to a clear and consistent understanding of an enterprise’s financial status based on reading its audited financial statements. Having generally accepted accounting principles is very much like having accepted rules for language, such as definitions for words and standards for grammar. Without generally accepted standards in language, meaning is lost; without generally accepted accounting principles, statements presented to illustrate an enterprise’s financial condition will be interpreted in various ways, leading to confusion and misunderstanding.
Certain accounting principles, such as double-entry bookkeeping and the segregation of company funds from those of its owner, are generally accepted worldwide, while others are more specific to different regions or nations. Others are a matter of choice, and when an enterprise’s statement is prepared, that choice must be noted on the statement. For example, in determining the value of an inventory of purchased goods, a company might use the inventory’s current market value, or it might use the actual amount it paid for the inventory. Another choice a company must make is whether to use the cash or accrual basis for its accounting. The cash basis, favored by individuals and small companies, involves recording expenses and revenue as they occur; larger organizations almost universally use the accrual basis, recording these items as they’re incurred.
The different choices available to accountants, and the complexity of adhering to generally accepted accounting principles (GAAP), actually make it important to codify them so they can be easily consulted. In the United States, the government doesn’t mandate accounting standards, leaving that task to the free market. GAAP are developed by professional bodies composed primarily of accountants. Only one organization, the Financial Accounting Standards Board (FASB), actually issues statements of these principles for non-governmental organizations. Another organization, the Government Accounting Standards Board (GASB), addresses accounting by governments. While the government doesn’t make the rules, the Securities and Exchange Commission (SEC) mandates their use by all publicly-held companies.
The FASB has issued more than 150 statements of financial accounting principles covering such diverse topics as how to account for different types of revenue, how to report salaries paid, and how to report the purchase of another company. FASB statements are exceptionally detailed because they attempt to address every possible combination of factors that accountants might encounter. Despite this, some accountants manage to evade their purpose of presenting an honest and straightforward picture of an organization’s financial status, twisting and manipulating the data to present a distorted and deceptive financial statement. This is why it’s critical that enterprises routinely have their books audited by a disinterested third party — a certified public accountant (CPA) — whose purpose is to certify that their books and records are being kept in accordance with GAAP.