Project 2

Project 2: Generally Accepted Accounting Principles (GAAP)

 

Project Introduction

 

In this project, you are introduced to the Generally Accepted Accounting Principles used by businesses to run their operations and keep their financial records.

 

FIN1015 Learn EveryWare © 2009 Alberta Education

Project 2: Generally Accepted Accounting Principles (GAAP)

 

What I Need to Know

 

Accountants follow principles and prescribed guidelines to assist them in their work. These are called Generally Accepted Accounting Principles, or GAAP for short. You may have noticed that some of the positions you found in the newspaper or on the Internet in Project 1 required the applicant to have a knowledge of GAAP.

 

Why Is This Important?

 

You are already familiar with the need for rules or guidelines when you are playing a sport or game. These rules help you know what you are able to do, how you are doing, and who is winning. Similarly, GAAP principles were developed as a result of the increased use of accounting by corporations and the need for all corporations to follow the same basic guidelines. This consistency allows the financial records of a business to be compared from year to year or from company to company, since all companies must play by the same rules or guidelines.

In Canada, the Canada Business Corporation Act and the corresponding statutes of the various provinces demand the use of the term Generally Accepted Accounting Principles in the reports presented at the annual meetings of shareholders. The term is incorporated in the auditor’s statement. An auditor is a professional accountant who deals with analysis of books and records. The auditor’s wording may be similar to the following:

In our opinion, the accompanying balance sheet and income statement present fairly the financial position of Anchors Fisheries as at the December 31, 20xx, and the results of its operations for the year then ended, in conformity with Generally Accepted Accounting Principles applied on a basis consistent with that of the preceding year.

What Do I Need to Do?

 

To help you decide where and when to record various financial information for a company, it is necessary for you to become familiar with the main GAAP principles. Explore these principles in the Time to Work below.

 

Time to Work

 

The following project will introduce you to the main principles of GAAP through case studies. Understanding these principles is fundamental to your success in this course. Complete the questions at the end of each case study and save them in your FIN1015 Course Folder for your teacher to mark. Please check with your teacher for instructions regarding where to save assignments for assessment.

 

FIN1015 Learn EveryWare © 2009 Alberta Education

Project 2: Generally Accepted Accounting Principles (GAAP)

 

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Case Studies

 

1. The Business Entity Concept

 

The Business Entity Concept provides that the accounting for a business or organization is kept separate from the personal affairs of its owner or from any other business or organization. This means that the owner of a business should not place any personal assets on the business balance sheet. The balance sheet of the business must reflect the financial position of the business alone.

 

Nadia operates a tow-truck business from her home. She has renovated her garage to allow for the additional truck and has installed an extra phone line in her home for business purposes. Nadia would like to renovate her family room, and she has purchased materials and supplies to do these renovations. Her friend, Harley, has suggested that she include the expenses for the family room in her business expenses. “No one will notice,” suggested Harley.

1. Nadia has her accounting done by a local accountant. What would the accountant say about this?

2. The Principle of Consistency

 

The Principle of Consistency states that in the preparation of financial statements, the same accounting principles are applied the same way in each accounting period.

 

Stephen has a word processing business. He prepares documents, such as résumés and reports, for his customers. In his first month of operation, he recorded the purchase of his printer as office supplies. Two months later he decided he needed a second printer and this time recorded the purchase as office equipment.

2. Why was his accountant questioning this on the year-end report? What difference would it make to Stephen’s business?

3. The Going-Concern Concept

 

The Going-Concern Concept assumes that a business will continue to operate and have a long life. This means that the business will not cease to operate immediately after commencing business. The assets belonging to a business that is alive and well are relatively easy to value.

 

The owners of FitKings Recreation Centre have applied to their bank for a loan to renovate their building. The owners asked for $100 000 and plan to upgrade the carpeting and furnishings in the building. The bank advanced the money to the company and, three weeks later, the company ceased operations, leaving unpaid bills.

3. Would the bank have loaned the funds if they had known that FitKings was going out of business?

4. The Principle of Conservatism

 

The Principle of Conservatism provides that accounting for a business should be fair and reasonable. Accountants are required in their work to make evaluations and estimates, to deliver opinions, and to select procedures. They should do so in a way that neither overstates nor understates the affairs of the business or the results of operation.

 

Fielding Software has an inventory of 2000 software packages with an inventory price of $149 each. Since the development of this software, a competitor has launched a similar product with a retail price of $129.

4. What value should Fielding Software list their software when recording it in their books: $149 or $129?

5. The Principle of Objectivity

 

The Principle of Objectivity states that accounting will be recorded on the basis of objective evidence. Objective evidence means that different people looking at the evidence will arrive at the same values for the transaction. Simply put, this means that accounting entries will be based on fact and not on personal opinions or feelings.

 

Hans does consulting for medical offices. He reviews the office computer system and staffing and recommends changes to the system. Hans normally charges $200 an hour. A competitor who charges $150 an hour for similar services has arrived on the scene. Hans normally bills approximately 200 hours a month, but he has noticed that for the past few months, his hours have dropped to 185. The bank that finances the business has asked for an updated financial statement.

5. What should Hans state as his average anticipated income in hours: 185 or 200?

6. The Time Period Concept

 

The Time Period Concept says that accounting takes place over specific time periods known as fiscal periods. These fiscal periods are of equal length and are used when measuring the financial progress of a business.

 

Mira began her teahouse business on April 1 of 2010. After four months of operation, her accountant prepared financial statements, which reflected the status of the company as of July 31, 2010. Five months later, at the end of December, Mira has financial statements prepared again and compares the revenue and expenses from the first period to the second.

6. What is wrong with Mira’s analysis?

7. The Matching Principle

 

The Matching Principle states that each expense item related to revenue earned must be recorded in the same accounting period as the revenue it helped to earn. If this is not done, the financial statements will not measure the results of operations fairly.

 

Sarah is a sign painter. On April 26, she purchased enough paint and other supplies to make several signs. She earned $3600 from the sale of two signs she painted in May. In April, she recorded the cost of the paint and other supplies as an expense. However, she earned no income using these supplies during that month.

7. What is wrong with Sarah’s accounting?

8. The Cost Principle

 

The Cost Principle states that the accounting for purchases must be at their cost price. This is the figure that appears on the source document for the transaction in almost all cases. There is no place for guesswork or wishful thinking when accounting for purchases. The value recorded in the accounts for an asset is not changed later if the market value of the asset changes. It would take an entirely new transaction based on new objective evidence to change the original value of an asset.

 

Azmina has opened a tanning studio. As a gift, her family bought lovely white wicker furniture for the waiting area of the business. At the end of the year, when doing her financial statement, the accountant asked Azmina to value the assets. Azmina stated that the furniture was a gift and therefore should not be included.

8. What is wrong with Azmina’s logic?

9. The Full Disclosure Principle

 

The Full Disclosure Principle states that any and all information that affects the full understanding of a company’s financial statements must be included with the financial statements. Some items may not affect the ledger accounts directly. These would be included in the form of accompanying notes. Examples of such items are outstanding lawsuits, tax disputes, and company takeovers.

 

Ron and Peggy Thompson operate a furniture refinishing business, ReNue Finishers. They share equally in the profits of the business, although Ron is the skilled craftsman and Peggy handles the management of the business. Ron and Peggy have been having marital problems, and they have decided to separate and go their own ways in the new year. They have two bank loans, and their financial statements are to be audited and provided to the bank at the end of the year. The Thompsons have decided not to let the bank know what is happening in their personal lives.

9. Is this correct?

Portfolio Submission

 

Complete a summary of the GAAP principles described in this project and their meanings, and save it in your Course Portfolio folder. Be sure to include the purpose of GAAP and what it means, since a prospective employer may ask you this question in an interview.

 

FIN1015 Learn EveryWare © 2009 Alberta Education

Project 2: Generally Accepted Accounting Principles (GAAP)

 

Project Summary

 

You examined some of the Generally Accepted Accounting Principles, known as GAAP, in this project. A summary of these principles can be found in the Toolkit. This project gives only a brief overview of the basic principles—there are many more detailed principles involved in the accounting profession. For a complete list of updated accounting principles, check out the Canadian Institute of Chartered Accountants website. You can do an Internet search to find this website.

 

As you work on your projects, you will recognize some of these principles being put into practice. When you see this icon beside some of your lessons, you are able to access a drop-down menu to identify the GAAP principle involved. See if you can identify the principle before you check your answer. You can return to this lesson to review the GAAP case studies if you need to refresh your understanding.

 

Continue to Project 3, where you will be introduced to financial statements.

 

FIN1015 Learn EveryWare © 2009 Alberta Education