Understanding Accounting Principles and Financial Statements
Generally Accepted Accounting Principles (GAAP)
Three Categories of GAAP
- Those that apply to the business or economic entity.
- Those that are applied to the quantification of the entity’s operations.
- Those related to the presentation of the economic entity’s financial information.
Basic Postulates Concerning the Economic Unit
Entity
This principle states that the operations and accounting of a company are independent of its shareholders, creditors, debtors, and any other entity. The objective of this principle is to avoid confusion between the economic operations performed by the company and those of another entity.
Realization
This determines the exact time, for accounting purposes, that the operations and economic events of an entity are considered made. In general, this occurs when conducting transactions with other economic entities.
Accounting Period
This provides that, for accounting purposes, the reflected life of an entity should be divided into periods (quarterly, semi-annually, or annually) to determine the results of operations and financial situation.
Basic Postulates Concerning the Quantification of Results
Original Historical Value
This provides that property and rights are evaluated according to their cost of acquisition. This principle is very clear and specifies that the record should be made according to the cost of acquisition.
Business Started
This postulate assumes that the business will have no limits or end, except in the case of liquidation.
Economic Duality
Every resource available to a company was created by a third party, who possesses rights and interests in the property of the entity.
Postulates Concerning the Presentation of Financial Information
Adequate Disclosure
This concerns the fact that financial statements must contain, in a clear and understandable manner, everything necessary to justify the results of the operation. For this reason, they must be accompanied by explanatory notes.
Relative Importance
This criterion implies that development should balance financial detail and the multiplicity of data with the requirements of the user.
Consistency
This provides that the assumptions and rules through which accounting information was obtained have stability, which facilitates comparability.
Users with Direct Interests
Owners, creditors, suppliers, investors, and administration.
Users with Indirect Interests
Advisors, financial analysts, regulatory entities, and business associations.
Components of Financial Statements
Income Statement
These reports allow users of financial information to perceive the reality of the company and, in general, of any economic organization.
Profit or Loss
In general, the income statement summarizes the company’s operations, referencing accounts of income and expenditure for a certain period.
Balance Sheet
This has been useful for making decisions regarding investment and operations. It shows the amount of assets, liabilities, and equity.
Statement of Cash Flows
This provides accounting information on relevant inputs and outputs for a period and changes from one period to another in the entity’s financial situation.
Reliability
To ensure that information is useful, it must also be reliable. Information must contain reliable quality.
Comparability
Users must be able to compare a company’s financial statements over time to identify trends in financial performance and situation.
Assets
An asset is a resource controlled by the enterprise as a result of past events, from which the company expects to obtain future economic benefits.
Liabilities
A liability is a present obligation of the company resulting from past events, which the company hopes to settle and may incorporate economic benefits.
Equity
Equity is the residual interest in the assets of the company after deducting its liabilities.
Income
Income represents increases in economic benefits produced during the accounting period as an entry or increase in the value of assets.
Expenses
Expenses are decreases in economic benefits produced during the accounting period.