GAAP Concepts

Question 1

Business Entity Rule

Answer 1

The finances of the company are kept separate from that of the shareholders

Question 2

Going Concern

Answer 2

Financial statements are prepared with the understanding that the company will continue operating in the future

Question 3

Historical Cost

Answer 3

All assets are recorded at their original cost price e.g. Land and Buildings are recorded at the price that you paid for them

Question 4

Matching

Answer 4

Income and expenses must be recorded in the correct financial year e.g. sales and cost of sales

Question 5

Materiality

Answer 5

All important items must be shown separately in the financial statements (e.g. directors’ fees) or when decisions must be made (e.g. is it worth having separate accounts for wages and salaries if you have only two employees?)

Question 6

Prudence

Answer 6

Figures used in financial statements should be realistic (conservative – always record the worst scenario). The aim of this principle is to show the reality “as it is” and not make things prettier than what they are. E.g. you will show ‘net debtors’ in the balance sheet (trade debtors minus provision for bad debts)