When it comes to running a business, there are few thigs more daunting and complex than bookkeeping and accounting. This is even more so the case when dealing with multi-national companies that have interests and investors around the globe. For that reason there are generally accepted accounting principles (GAAPs) which act as guidelines for writing and maintaining financial statements. But what...
Every small business owner is obliged to keep accounts and should be familiar with the Generally Accepted Accounting Principles. These rules ensure that a company’s accounting system meets all legal requirements. The Generally Accepted Accounting Principles are an important part of this. A major aspect of business accounting is preparing the commercial balance sheet, which – for example, at the end of a financial year – presents the financial position of the company correctly and clearly. Here, you can find out what this means in concrete terms, what principles exist, and what else needs to be observed.
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- Generally Accepted Accounting Principles: creating a proper balance sheet
- Guidelines for a complete balance sheet, at a glance
- What is the purpose of following a guide for your balance sheet?
- Who is affected by these guidelines?
Generally Accepted Accounting Principles: creating a proper balance sheet
Accounting best practice in the US stipulates that the annual financial statements for a business must be prepared after each financial year for a specific date. While there is no legal standard for accounting in the US, all of your bookkeeping must be able to satisfy the requirements of the Internal Revenue Service and your local authorities when it comes time to pay your federal and state taxes. This aside, it is also worth adhering to clear, transparent, and consistently structured accounting methods so that you can access information accurately and easily when necessary.
The four principles of GAAP are as follows:
Historical cost principle: Companies must account for and report the acquisition costs of assets and liabilities rather than their fair market value
- Revenue recognition principle: Companies should record revenue when earned but not when received
- Matching principle: Expenses have to be matched with revenues as long as it is reasonable to do so.
- Full disclosure principle: Information disclosed should be enough to make a judgment while keeping costs reasonable
These terms and more can be found in our guide to the principles of proper accounting.
Guidelines for a complete balance sheet, at a glance
Here are some guideline rules to keep in mind when preparing a balance sheet:
- A clear balance sheet: A balance sheet needs to be both clear and concise. The balance sheet should have a clear designation of the different items on the balance sheet. This means that different types of assets and liabilities should not be combined or offset against one another, and balance sheet items that are subject to disclosure should be included. Additional items may be included if it is important for the balance sheet’s clarity. Detailed explanations of the values need to be collected in notes so that the balance sheet can be read clearly.
- Balance sheet accuracy: The balance sheet needs to be complete and correct – you must not omit values or add figures that do not correspond with the truth. Values given in the balance sheet must be correct.
- Balance sheet continuity: A company’s different annual financial statement should be able to be compared quickly. For this reason, the rules stating how to prepare annual accounts are the same every year. For example, annual financial statements are always prepared for the same day. The sequence of different items and their names should not change constantly either. This is the only way to ensure that there is continuity.
- Example: Let’s say for the sake of clarify that you combined several items on your balance sheet last year. This summary should not be dissolved when the next annual financial statement is being made. That would result in the balance sheets being incomparable.
- Identity of balance sheet: This principle prescribes a seamless change from one fiscal year to the next. The opening balance sheet must correspond to the closing balance sheet from the previous year. This means that all items, quantities and values must be the same in both balance sheets.
Other Generally Accepted Accounting Principles concerning balance sheets
Materiality: The materiality principle is an accounting rule that dictates any transactions or items that significantly impact the financial statements and should be accounted for using GAAP exclusively.
Going concern principle: The going concern concept or the going concern assumption states that businesses should be treated as if they will continue to operate indefinitely or at least long enough to accomplish their objectives.
As previously mentioned, there is no legal requirement to adhere to these principles. They are simply considered an aspect of best practice and can help you create accurate, consistent records.
What is the purpose of following a guide for your balance sheet?
The aim of these guidelines is to make a balance sheet comprehensible and meaningful, so that it provides a clear picture of a company’s economic situation. For example, these principles help prevent balance sheet concealment. This offence can lead to serious legal consequences.
Who is affected by these guidelines?
All business owners and sole proprietors must issue financial statements that include a balance sheet annually. This means that anyone involved in a business should be familiar with these guidelines. There are certain circumstances whereby a small business may be able to claim small company exemptions on their balance sheet statement. There are also some circumstances where a business owner may not be required to keep separate accounting records:
Sole proprietors: Sole proprietors are exempt from preparing balance sheets, since their revenue streams and expenses tend to be low, allowing them to use a pared-back bookkeeping system based on cash flows. The most common system is usually a cash basis accounting system, which is a single-entry system.
If your business is classed as a public company, you are required to publish quarterly financial statements that are available to the public. If your business is classed as a private company, then you are not obliged to make your financial statements public, you just have to file your tax returns with the secretary of state that your business is incorporated in.
If your business is a public company, then shares in your company are available for purchase. It also means that you owe transparency to your shareholders, i.e. the public. Large retirement funds and nonprofits may also be legally required to have audited financial statements. There can be advantages and disadvantages to running a public or private company. If your company is private, then you have the benefits of confidentiality, greater financial freedom, and an element of flexibility. On the other hand, if at any time you find yourself looking for outside help, either from a financial institution, angel investor or venture capitalist, you may run into difficulties securing their assistance without providing a complete financial picture of the company
Additionally, companies that issue financial statements often choose, or are obligated, to be audited by an independent auditor. This means that an independent examiner investigates your company’s financial information to prevent fraud. By law, public entities are required to have their financial reports audited, thanks to the US Securities and Exchange Commission. Other companies may choose to have their reports audited to lend credibility to their financial position.
- The guidelines for preparing a proper balance sheet are an important part of the Generally Accepted Accounting Principles
- These guidelines will ensure that your financial statements are sound by including a balance sheet clarity and being accurate and consistent
- The aim is to make balance sheets comprehensible and meaningful, and to prevent fraud
- Anyone required to keep business records should be aware of the principles of proper accounting