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The accounting profession has developed standards that are generally accepted
and universally practiced. This common set of standards is called generally
accepted accounting principles (GAAP). These standards indicate how to report
economic events.
Two organizations are primarily responsible for establishing generally accepted
accounting principles.The first is the Financial Accounting Standards Board
(FASB). This private organization establishes broad reporting standards of general
applicability as well as specific accounting rules.The second standards-setting
group is the Securities and Exchange Commission (SEC). The SEC is a governmental
agency that requires companies to file financial reports following generally accepted accounting principles. In situations where no principles exist, the SEC
often mandates that certain guidelines be used. In general, the FASB and the SEC
work hand in hand to ensure that timely and useful accounting principles are developed.
One important principle is the cost principle, which states that assets should
be recorded at their cost. Cost is the value exchanged at the time something is
acquired. If you buy a house today, the cost is the amount you pay for it, say,
$200,000. If you sell the house in two years for $230,000, the sales price is its market
value—the value determined by the market for homes at that time. At the time
of acquisition, cost and fair market value are the same. In subsequent periods, cost
and fair market value may vary, but the cost amount continues to be used in the
accounting records.
To see the importance of the cost principle, consider the following example.
At one time Greyhound Corporation had 128 bus stations nationwide that cost
approximately $200 million. The current market value of the stations is now close
to $1 billion. But, until the bus stations are actually sold, estimates of their market
values are subjective—they are informed estimates. So, under the cost principle,
the bus stations are recorded and reported at $200 million, not $1 billion.
As the Greyhound example indicates, cost has an important advantage over
other valuations: Cost is reliable. The values exchanged at the time something is
acquired generally can be objectively measured and can be verified. Critics argue
that cost is often not relevant and that market values provide more useful information.
Despite this shortcoming, cost continues to be used in the financial statements
because of its reliability.
and universally practiced. This common set of standards is called generally
accepted accounting principles (GAAP). These standards indicate how to report
economic events.
Two organizations are primarily responsible for establishing generally accepted
accounting principles.The first is the Financial Accounting Standards Board
(FASB). This private organization establishes broad reporting standards of general
applicability as well as specific accounting rules.The second standards-setting
group is the Securities and Exchange Commission (SEC). The SEC is a governmental
agency that requires companies to file financial reports following generally accepted accounting principles. In situations where no principles exist, the SEC
often mandates that certain guidelines be used. In general, the FASB and the SEC
work hand in hand to ensure that timely and useful accounting principles are developed.
One important principle is the cost principle, which states that assets should
be recorded at their cost. Cost is the value exchanged at the time something is
acquired. If you buy a house today, the cost is the amount you pay for it, say,
$200,000. If you sell the house in two years for $230,000, the sales price is its market
value—the value determined by the market for homes at that time. At the time
of acquisition, cost and fair market value are the same. In subsequent periods, cost
and fair market value may vary, but the cost amount continues to be used in the
accounting records.
To see the importance of the cost principle, consider the following example.
At one time Greyhound Corporation had 128 bus stations nationwide that cost
approximately $200 million. The current market value of the stations is now close
to $1 billion. But, until the bus stations are actually sold, estimates of their market
values are subjective—they are informed estimates. So, under the cost principle,
the bus stations are recorded and reported at $200 million, not $1 billion.
As the Greyhound example indicates, cost has an important advantage over
other valuations: Cost is reliable. The values exchanged at the time something is
acquired generally can be objectively measured and can be verified. Critics argue
that cost is often not relevant and that market values provide more useful information.
Despite this shortcoming, cost continues to be used in the financial statements
because of its reliability.
