Concepts and Principles, Checks and Balances
The double-entry innovation to track the increase and decrease of each part of the accounting equation (assets = liabilities + equity) made recording business transactions more manageable. There were still several complications. How do you present the information you’ve recorded? How does an Amsterdam merchant convince a Venetian banker to back the ships sailing for Java? It’s a bit impractical to drag out your set of double- entry ledgers for each of your 250 accounts. Even the general journal recording each transaction as it took place is too much. How can you structure this mass of financial information order to make a decision?
Over time, the accounting profession in the United States developed a series of standards that add uniformity to financial statements. These standards are called Generally Accepted Accounting Principles (GAAP). GAAP provides a common language. The users of financial statements feel secure that the numbers in statements issued in New York can be compared
with numbers issued in California. This common language of accounting allows investors to make informed choices without having to learn a new set of accounting rules for each investment considered.
While GAAP is a constant within the United States, these principles are not discovered through scientific research. GAAP is not like the laws of physics, transgressed at peril of death. Experience, application, and observation led to general acceptance that these principles helped meet the objectives of financial accounting and reporting. In setting these standards, accountants asked the question, “What are the objectives of financial accounting information in the U.S.?” The answer was that accounting was to provide full disclosure to actual and potential investors and creditors. The United States developed a type of capitalism that brought it many individual investors. The accounting system that developed could feed those users the data needed to make informed decisions.
As GAAP is the product of several committees, it’s not always internally consistent or applied uniformly. Nonetheless, GAAP represents the best collective thinking on the underlying assumptions driving the presentation of financial data. The goal is to publish the quality information needed to make meaningful decisions. These basic GAAP requirements apply to most financial statements. There are other GAAP and accounting requirements that come into play in more technical circumstances. These are appropriate subjects for advanced study.
Table 2-1. GAAP fundamentals
The Four Qualitative Characteristics of Information