Gaap Constraints, Concepts, Assumptions, and Principles

GAAP – ACCOUNTING CONSTRAINTS, CONCEPTS,
ASSUMPTIONS, AND PRINCIPLES
www.420taxconsultants.com
Presented by Damon L. Mayer, ChFC, LTC, EA

Introduction to GAAP
• Accountants use generally accepted accounting principles (GAAP) as a
guide to recording and reporting financial information. GAAP is comprised
of a broad set of principles developed by the accounting profession and
the Securities and Exchange Commission (SEC) over many years.
• The Securities Act of 1933 and the Securities Exchange Act of 1934, give the
SEC authority to establish reporting and disclosure requirements.
However, the SEC operates in an oversight capacity, allowing the FASB and
the Governmental Accounting Standards Board (GASB) to establish GAAP
standards.

Introduction to GAAP, continued
• The current set of principles used by accountants are built on specific
underlying assumptions. The basic assumptions and principles reviewed
next are the foundation of GAAP and applicable to most professionally
prepared financial statements.
• In addition to these concepts, accountants may be required to adhere to
additional standards when preparing financial statements depending on
their professional licensure. GAAP is an international convention of good
accounting practices based on the following core principles.

The Underlying GAAP Principles
• The GAAP is founded on principles more than strict rules. Above all, GAAP intends
to promote honest financial reporting adhering to consistent vocabulary and
protocols.
• Generally accepted accounting principles are required so a knowledgeable
financial statement reader can do the following:
o Compare a company's current financial statements to prior financial
statements of the same company,
o Compare a company's financial statements to other companies within the
same industry, and
o Understand how a company recognizes/reports revenues, expenses, assets,
liabilities, and equity related transactions.

GAAP Operating
Guidelines
• FASB classifies GAAP guidelines as
assumptions, principles, and constraints.
oAssumptions provide a foundation for the
accounting process,
oPrinciples are specific rules that indicate
how economic events should be reported
in the accounting process, and
oConstraints on the accounting process
allow for a relaxation of the principles
under certain circumstances.

GAAP ASSUMPTIONS
Economic Entity, Going Concern, Monetary Unit, and
Time Period Assumptions.

GAAP
Assumptions
 Assumptions are agreed upon rules of accounting,
and are basic, understood beliefs and provide a
foundation for the accounting process.
 There are four Assumptions of accounting:
o Economic Entity
o Going Concern
o Monetary Unit
o Time Period

Economic Entity
Assumption
• All of the business transactions should be separate
from the business owner’s personal transactions.
• There should be no commingling of personal assets
with business assets. Both business revenue and
expenses must be kept separate from personal
revenue and expenses.
• If transactions exist consisting of personal
expenditures of an owner, those transactions are
properly charged to the shareholder equity and not
affect the business's operating results.

Going Concern Assumption
• Financial statements are prepared under the assumption that the company will
remain in business indefinitely unless there is sufficient evidence otherwise.
assumes that the business will be in operation indefinitely, validating the
methods of asset capitalization, depreciation, and amortization.
• If there is evidence to the contrary, proper disclosure must made in the financial
statement notes.

Monetary
Unit
Assumption
• An economic entity's accounting records include only
quantifiable transactions.
• Assumes a stable currency is going to be the unit of
record.
• FASB accepts the nominal value of the US Dollar as the
monetary unit of record unadjusted for inflation, also
known as the stable dollar principle.
• Certain economic events that affect a company, such
as hiring anew CEO, cannot be easily quantified in
monetary units and, therefore, would not appear in its
accounting records.

Time Period
Assumption
• The entity’s activities are separated
into periods of time such as months,
quarters or years.
• Transactions must be accounted for
within the time period they occur
regardless of when cash is
exchanged.

GAAP PRINCIPLES
Cost Principle, Full Disclosure Principle, Revenue
Recognition Principle, and Matching Principle.

GAAP Principles
• Principles are accounting rules used to prepare, present, and report
financial information.
• Principles dictate how events should be recorded and reported.
• GAAP Principles include:
o Cost Principle,
o Full Disclosure Principle,
o Revenue Recognition Principle, and
o Matching Principle.

Cost Principle
• Also referred to as the “Historical Cost Principle.”
• The cost principle states that assets and liabilities are recorded at their
acquisition costs rather than than fair market value.
• For instance, a business buys a warehouse for $700,000, it is recorded at
$700,000 and remains on the books at $700,000 until it is disposed of.
• If the warehouse appreciates to $950,000 over the next four years, no
adjustment to value is made to record the appreciation.

Full Disclosure
Principle
• All information pertaining to the operations and
financial position of a business must be reported
within the reporting period in question.
• Circumstances and events that may make a
difference to a financial statement end-user must
be disclosed as material information.
• Information must be presented either in the main
body of a financial statement, in the notes section
or as a supplementary information attachment.

Revenue
Recognition
Principle
• Revenue is earned and recognized upon product
delivery or service completion, without regard to
when a business actually receives the cash.
• Also referred to as “accrual basis accounting.”
• Example: A customer purchases an inventory item
on credit. Even though no cash has yet been
received, the sale must be recorded.

Matching Principle
• The costs of doing business are recorded in the same period as the revenue is
generated, regardless of when the money is received. The matching principle
requires expenses to be matched with revenues in the same period.
• Also called “accrual basis accounting.”
• Example: XYZ, LLC orders inventory items on credit and has 15 days in which to
pay. This inventory purchase is recorded immediately, even though no monies
have been paid.

GAAP CONSTRAINTS
Objectivity, Consistency, Cost-Benefit Constraint,
Conservatism, and Materiality.

GAAP
Constraints
• Constraints (constraints of accounting) refer
to boundaries, limitations, or regulatory guidelines.
• Constraints on the accounting process allow for a
relaxation of the principles under certain circumstances.
• GAAP constraints include:
oObjectivity,
oConsistency,
oCost-Benefit Constraint
oConservatism, and
oMateriality.

Objectivity
Constraint
• The objectivity principle states that accounting is
recorded based on objective evidence.
• Objective accounting entries are based on fact and
not on personal opinion, and that two different
people looking at the evidence will arrive at the
same valuation.
• The best objective in accounting is generally a
transactions source document, which shows an
amount agreed to by a buyer and a seller.

Consistency
Constraint
• The consistency constraint requires an
accountant to apply the same procedures and
methods from one reporting period to another.
• If change is necessary, it must be explained in
the financial statement notes.
• Readers of financial statements have the right
to assume consistency in the information unless
there exists a statement to the contrary.
• The consistency constraint prevents a business
from changing methods for the sole purpose of
financial statement manipulation.

Cost-Benefit
Constraint
• Also referred to as “Cost-Benefit Relationship.”
• A business considers the cost to prepare financial
reports and the value provided an end-user.
• The cost of preparing financial information should
not exceed the value of providing the information.
• Example: When reconciling your checkbook, you
find your register and bank statement differ by
$1.00. Rather than waste the time necessary to
locate the $1.00, you simply record the difference as
a reconciliation discrepancy.

Conservatism
Constraint
• Accountants must use their judgment when
recording transactions requiring estimation.
• The principle of conservatism requires that a less
optimistic estimate is chosen when two estimates
are judged to be equal.
• Example: An appliance company accountant
should account for an upcoming years warranty
work in such a way that neither overstates nor
understates the amount of service calls the
company may expect.

Materiality
Constraint
• The materiality constraint states that an
accounting principle may be ignored
when there is no direct effect on an end-
users decision-making ability.
• For instance, an accountant does not
need to keep track of each individual
paperclip in the company supply closet.

GAAP CONCEPTS
Principle of Regularity, Principle of Consistency, Principle of Sincerity, Principle
of Permanence of Methods, Principle of Non-Compensation, Principle of
Prudence, Principle of Continuity, Principle of Periodicity, Principle of
Materiality/Good Faith, and Principle of Utmost Good Faith.

GAAP Concepts
• The 10 concepts behind the GAAP accounting
principles:
1) Principle of Regularity,
2) Principle of Consistency,
3) Principle of Sincerity,
4) Principle of Permanence of Methods,
5) Principle of Non-Compensation,
6) Principle of Prudence,
7) Principle of Continuity,
8) Principle of Periodicity,
9) Principle of Materiality/Good Faith, and
10) Principle of Utmost Good Faith.

The Principle of Regularity
• An accountant must adhere to GAAP rules
and regulations as standard operating
procedure, on a regular basis.

The Principle of
Consistency
• An accountant must
apply consistent
standards throughout
the financial reporting
process to prevent
unnecessary errors or
discrepancies.

The Principle of
Sincerity
• An accountant strives to provide
an accurate and impartial
depiction of a company’s financial
situation in a sincere fashion
without exception.

THE PRINCIPLE OF
PERMANENCE OF
METHODS
Accountants practice
consistent procedures
in their financial
accounting methods at
all times.

THE PRINCIPLE
OF NON-
COMPENSATION
Both positives and
negatives must be
reported with full
transparency.

THE PRINCIPLE OF
PRUDENCE
An accountant must
focus on fact-based
financial data that is void
of speculation.

THE PRINCIPLE OF
CONTINUITY
An accountant should
assume that a company
will continue operations
while valuing assets.

THE PRINCIPLE OF PERIODICITY
All financial accounting entries should occur in the relevant time period.

THE PRINCIPLE OF
MATERIALITY/GOOD FAITH
Financial statements should disclose a company’s genuine financial
position in a clear and concise manner. The reader of a financial
report should expect absolute transparency without exception.

The Principle of
Utmost Good Faith
• The assertion that the preparer of
financial statements is acting
honorably and in good faith.

Thank you!
• Damon L. Mayer, ChFC, LTC, EA
• Federally Authorized Tax Practitioner
• (541) 218-9037
• Cannabis Accounting and Tax Preparation
• damon@420taxconsultants.com

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