Generally Accepted Accounting Principles

Generally Accepted Accounting Principles
September 2, 2013

Generally accepted accounting principles (GAAP) is the term “used to describe the body of and requirements that shape the preparation of the four primary financial statements (Cleverley & Cameron, 2007).” These statements include the balance sheet, the statement of revenues and expenses, statement of cash flow, and statement in changes of net assets (Cleverley & Cameron, 2007). These statements track financial information and give a clear view of the information needed to assure the organization is financially healthy.

Health care uses both managerial accounting which tracks information for internal users and is less restrictive in preparation, and the principles of accounting which are more stringent methods of handling information. With principles of accounting both financial and managerial information is addressed. Principles of Accounting

Cleverley and Cameron (2007) define six specific accounting principles. 1. Accounting entity
2. Money measurement
3. Duality
4. Cost valuation
5. Accrual accounting
6. Stable monetary unit
These principles are required for the preparation of audited financial statements. Definition of principles
The accounting entity is the organization for which the financial statements are being furnished. In health care these entities typically do not involve individuals who are involved in the organization but rather only the organization’s financial transactions. The focus on the entity primarily involved assures the information is pertinent. If the entity is not clearly defined the information may be incorrect. The intent is to show a true
picture of the entity’s financial situation.

Money measurement involves the measurement of economic resources including money, supplies, buildings, equipment, and ownership in other money producing interests. The intent is that money owned (assets) exceeds money owed (liabilities). Economic resources (scarce means) are usually limited in supply but affect economic activities. Assets are offset by economic responsibilities. Assets, liabilities, and net assets would be shown in a balance sheet. In health care there is normally no residual ownership claim in the event of liquidation, but rather funds left over go to the state.

Duality refers to the fundamental premise of accounting shown in an arithmetic equation: assets + liabilities = net assets. This equation assures that a balance sheet will balance. Daily transactions affect the balance sheet. A change in assets will be matched by a change in liability value. Transactions can produce both positive and negative results to a balance sheet. Acquisitions will increase the assets while payments, loans, and purchases affect liabilities and both will affect net assets.

Cost valuation is often falsely assumed to represent the real worth of assets or liabilities. In truth, asset values equal the amount of money an entity could receive from the liquidation of such assets as opposed to the price paid. Values of many necessary items fall with age/use and can more accurately be valued by amounts still owed. Accrual accounting deals with the actual cost of an item versus the replacement cost. The cost is divided over the life span of the item and the monthly amount is used in preparation of financial statements. Showing the full value of an item on financial statements will show a false picture of actual net incomes. Adjustments must be made to financial sheets to account for cash, accounts receivable and accounts payable, supplies, equipment depreciation, and buildings. An increase in assets should equal increases in net assets.

A stable monetary unit is actually a presumption that the buying power of the dollar today will equal the buying power of the dollar in the future. If this assumption were not made simple arithmetic operations would produce an inaccurate accounting when factoring in unadjusted costs of assets purchased during different time periods. This is the intent for assuming a stable monetary unit. In times of high inflation or depression the stable monetary unit may have to be revised to prevent a cash deficit. Generally accepted accounting principles are intended to show as true a picture of an entity’s financial health as possible. They provide consistency in accounting methods across the span of responsible entities by giving an accurate account of monies accrued along with monies spent. Transactions posted on a routine basis provide a picture of the entity on an ongoing basis and allow the monies to be monitored closely to prevent problems with cash flow. A true accounting of net assets is vital to the organization in terms of credit worthiness and audit readiness.

References

Cleverley, William O., Cameron, Andrew E., (2007) Essentials of Health Care Finance:  Jones and Barlett Publishers
Finkler, Steven A., Kovner, Christine, T., Jones, Cheryl B., (2000). Financial
Management for Nurse Managers and Executives: Saunders Elsevier Publishers