The heart of GAAP revolves around a list of ten principles. Together, these principles are intended to clearly define, standardize and regulate a company’s financial reporting and to prevent data falsification or unethical practices.
1. Principle of regularity
GAAP should always be followed by accountants and businesses when dealing with financial information. At no time can a business or finance team choose to ignore or change any of the regulations.
2. Principle of consistency
Accountants are required to use the same standards and practices for all accounting periods. If a method or practice is changed, or if you hire a new accountant with a different system, the change should be fully documented and justified in the footnotes to the financial statements. This principle guarantees the consistency over time of the internal financial documentation of any company.
3. Principle of sincerity
This principle stipulates that any accountant or accounting team hired by a company is required to provide the most objective and accurate financial report possible. Although a company may be in a bad financial situation, or even jeopardize its future, the accountant can only report on the situation as it is.
4. Principle of permanence of methods
This principle requires accountants to use the same reporting method procedures for all financial statements prepared. Although similar to the second principle, it is limited specifically to financial reports, ensuring that any report prepared by a company can be easily compared to one another.
5. Principle of non-compensation
All negative and positive values in a financial statement, regardless of their impact on the business, should be clearly reported by the accounting team. Accountants cannot try to make things look better by offsetting a debt with an asset or an expense with income.
6. Precautionary principle
Officially reported data should be fact-based and dependent on clear, hard numbers. It’s easy to get into speculation when talking about finance, especially when thinking about the future of the business, and this principle ensures that accountants stay firmly grounded in reality. Companies can still engage in speculation and forecasting, of course, but they cannot add this information to formal financial statements.
7. Principle of Continuity
When compiling reports, accountants must assume that a business will continue to operate. The principle applies regardless of the status of the company.
8. Principle of periodicity
Essentially, this principle requires accountants to report financial information only in the relevant accounting period. For example, if an accounting team is compiling a report on revenue generated during a quarter, the report should focus only on that exact period. This is intended to prevent any possibility of distorting figures or data over time – for example, if a company earns more in one quarter than the next, the accountant should accurately represent this fact instead of changing the dates of the period or modify the data to hide or reduce the difference.
9. Principle of materiality
Accountants should, to the best of their ability, fully and clearly disclose all available company financial data. They are obligated to acquire this information from the business, which is why an accounting team’s inquiries can seem extremely in-depth when requesting financial information.
10. Principle of utmost good faith
Any person or party involved or responsible for the financial side of a business must be honest in all dealings and dealings. Along with several other principles, this serves to maintain an ethical standard and accountability in all financial transactions.