• cost
• revenue recognition
• matching
• full disclosure

The cost principle requires that assets appear on the books at the acquiring cash value. Even though a building or land may have substantially increased in value, it is still recorded at the historical cost. This condition explains how the reported “book” value of a company can often be lower than its actual value. Conversely, inflated purchase prices can hide problems in a shaky balance sheet.

The next principle is revenue recognition. Under GAAP, the company recognizes revenue only when it is earned upon product delivery or service completion. It seems straightforward that a furniture store recognizes revenue when it sells a table to a customer in July. When does the wholesaler recognize the revenue? In April, when it receives the order? In May, when it delivers the table? In June, when the furniture store pays the bill? The answer is May, when it delivers the product.

Consider the more complicated case of a construction company over the long course of erecting a building. The company needs cash from its customer to pay the ongoing costs of construction. GAAP has industry specific guidelines on activities like progress payments to accommodate special needs of unique business activities.

The matching principle measures the performance of the gozinta and gozouta for each time period. The costs of doing business, the expenses, in the period are matched to the revenues generated. Revenues earned less expenses incurred equals income. Income is the measure of performance for the period.

The time period assumption often makes measuring and matching revenues and expenses a chore. At the end of the chosen period, many transactions can be at various stages of ompletion. Income or loss can be hard to measure. The preparer must make assumptions as to the eventual outcome of these transactions. For example, all accounts receivable may be uncollected at the end of the period. The preparer must estimate how much of the receivables can be collected. Inventory is another area subject to estimate and error. How much yearend inventory will be sold in future periods? In addition, estimates must be made as to wages owed, taxes owed, etc. Matching these estimates to the facts of the case often requires sound judgment.

The full disclosure principle states that financial information should be complete and accurate for past transactions. There may also be external events, such as a pending lawsuit, or internal events, such as a union action, that would affect the firm’s financial health. Even if there’s no verifiable economic impact at present, these events should be noted in footnotes to the financial reports. Also, financial transactions between company officers and managers, such as loans, must be noted

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