Generally accepted accounting principles (GAAP) are rules for the preparation of financial statements. Every publicly traded company must release their financial statements each year. These statements are used by investors, banks and creditors to determine the financial health of the company and its suitability for investment or extension of credit. In order to properly compare and evaluate companies and their results, the financial statement must provide similar information in a similar format. Every country has its own generally accepted accounting principles, and all publicly released financial statements must comply with these rules.
GAAP is vitally important in financial accounting because it provides the standards and definition in preparing financial statements. The key assumptions in GAAP are: business entity, going concern, monetary unit and time period principle. The business entity assumption is the idea that the business functions as a legal and financial entity separate from its owners or any other business. This assumption means that all the amounts shown as revenue or expense in the financial statements are for the business alone and do not include any personal expenses. "Going concern" is the assumption that the business will operate for the foreseeable future. This is important when calculating the values for assets, depreciation and amortization. The monetary unit assumption is that all the amounts listed use one stable currency, and that any amounts in another currency are clearly listed. "Time period" assumes that all the transactions reported did in fact occur within the time period as listed.
The four basic principles in GAAP are: cost, revenue, matching and disclosure. The cost principle refers to the notion that all values listed and reported are the costs to obtain or acquire the asset and not the fair market value. The revenue principle states that all revenue must be reported when it is realized and earned,...