To achieve basic objectives and implement fundamental qualities GAAP has four basic assumptions, four basic principles, and four basic constraints.
Business Entity: assumes that the business is separate from its owners or other businesses. Revenue and expense should be kept separate from personal expenses.
Going Concern: assumes that the business will be in operation indefinitely. This validates the methods of asset capitalization, depreciation, and amortization. Only when liquidation is certain is this assumption is inapplicable. The business will continue to exist in the unforeseeable future.
Monetary Unit principle: assumes a stable currency is going to be the unit of record. The FASB accepts the nominal value of the US Dollar as the monetary unit of record unadjusted for inflation.
The Time-period principle implies that the economic activities of an enterprise can be divided into artificial time periods.
Historical cost principle requires companies to account and report assets & liabilities acquisition costs rather than fair market value . This principle provides information that is reliable (removing opportunity to provide subjective and potentially biased market values), but not very relevant. Thus there is a trend to use fair values. Most debts and securities are now reported at market values.
Recognition principle holds that companies should record revenue when earned but not when received. The flow of cash does not have any bearing on the recognition of revenue. This is the essence of accrual basis accounting. Conversely, however, losses must be recognized when their occurrence becomes probable, whether or not it has actually occurred. This comports with the constraint of conservatism, yet brings it into conflict with the constraint of consistency, in that reflecting revenues/gains is inconsistent with the way in which losses are reflected.
Matching principle. Expenses have to be matched with revenues as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or the product actually makes its contribution to revenue. Only if no connection with revenue can be established, cost may be charged as expenses to the current period (e.g. office salaries and other administrative expenses). This principle allows greater evaluation of actual profitability and performance (shows how much was spent to earn revenue). Depreciation and Cost of Goods Sold are good examples of application of this principle.
Full disclosure principle. Amount and kinds of information disclosed should be decided based on trade-off analysis as a larger amount of information costs more to prepare and use. Information disclosed should be enough to make a judgment while keeping costs reasonable. Information is presented in the main body of financial statements, in the notes or as supplementary information
Objectivity principle: the company financial statements provided by the accountants should be based on objective evidence.
Materiality principle: the significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.
Consistency principle: It means that the company uses the same accounting principles and methods from period to period.
Conservatism principle: when choosing between two solutions, the one which has the less favorable outcome is the solution which should be chosen (see convention of conservatism)
Cost Constraint- The benefits of reporting financial information should justify and be greater than the costs imposed on supplying it.