Accounting Principles

Accounting PrinciplesIf everyone involved in the process of accountingfollowed their own system, or no system at all,there's be no way to truly tell whether a companywas profitable or not. Most companies follow whatare called generally accepted accountingprinciples, or GAAP, and there are huge tomes inlibraries and bookstores devoted to just this onetopic. Unless a company states otherwise, anyonereading a financial statement can make theassumption that company has used GAAP.

If GAAP are not the principles used for preparingfinancial statements, then a business needs tomake clear which other form of accounting they'reused and are bound to avoid using titles in itsfinancial statements that could mislead theperson examining it.GAAP are the gold standard for preparingfinancial statement. Not disclosing that it hasused principles other than GAAP makes a companylegally liable for any misleading ormisunderstood data. These principles have beenfine-tuned over decades and have effectivelygoverned accounting methods and the financialreporting systems of businesses. Differentprinciples have been established for differenttypes of business entities, such for-profit andnot-for-profit companies, governments and otherenterprises.

GAAP are not cut and dried, however. They'reguidelines and as such are often open tointerpretation. Estimates have to be made attimes, and they require good faith effortstowards accuracy. You've surely heard the phrase\"creative accounting\" and this is when a companypushes the envelope a little (or a lot) to maketheir business look more profitable than it mightactually be. This is also called massaging thenumbers. This can get out of control and quicklyturn into accounting fraud, which is also calledcooking the books. The results of these practicescan be devastating and ruin hundreds andthousands of lives, as in the cases of Enron, RiteAid and others.