Assumptions
U.S. Generally Accepted Accounting Principles (GAAP) have been established as a way to standardize the presentation of financial information.
The Financial Accounting Standards Board (FASB) attempts to base U.S. GAAP on a number of key theoretical assumptions, principles, and constraints (Exhibit 2.1). They are introduced in this chapter, and frequently highlighted in the Basic Principles Revisited sidebar throughout the book.
| ASSUMPTIONS | |
| Accounting Entity | A corporation is considered a “living, fictional” being. |
| Going Concern | A corporation is assumed to remain in existence indefinitely. |
| Measurement & Units of Measure | Financial statements show only measurable activities of a company. Financial statements must be reported in the national monetary unit (i.e., U.S. dollars for U.S. companies). |
| Periodicity | A company’s continuous life can be divided into measured periods of time for which financial statements are prepared. U.S. companies are required to file quarterly and annual reports. |
| PRINCIPLES | |
| Historical Cost | Financial statements report companies’ resources and obligations at an initial historical cost. This conservative measure precludes constant appraisal and revaluation. |
| Revenue Recognition | Revenues must be recorded when earned and measurable. |
| Matching Principle | Costs of a product must be recorded during the same period as revenue from selling it. |
| Disclosure | Companies must reveal all relevant economic information determined to make a difference to their users. |
| CONSTRAINTS | |
| Estimates & Judgments | Certain measurements cannot be performed completely accurately, and so must utilize conservative estimates and judgments. |
| Materiality | Inclusion of certain financial transactions in financial statements hinges on their size and that of the company performing them. |
| Consistency | For each company, preparation of financial statements must utilize measurement techniques and assumptions that are consistent from one reporting period to another. |
| Conservatism | A downward measurement bias is used in the preparation of financial statements. Assets and revenues should not be overstated while liabilities and expenses should not be understated. |
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