GAAP and the role of the accountant

Shared rules, so that a stranger can read your books

If every business invented its own way of recording things, no outsider could compare one business to another, or even compare a business to itself last year. Generally Accepted Accounting Practice, usually shortened to GAAP, is the set of shared rules that solves this. It exists for the benefit of the reader, not the writer.

At Grade 10 level these are the ones to hold on to:

Business entity rule. The business is treated as separate from its owner. The owner's house, private car and personal store account are not in the books. Money the owner takes out is drawings, not an expense.

Historical cost. Assets are recorded at what was actually paid for them, because that amount is provable from a document. What the owner believes an item is worth is an opinion, and opinions do not balance.

Going concern. Statements are prepared on the assumption that the business will keep trading in the foreseeable future, which is why assets are not shown at what they would fetch in a fire sale.

Prudence. Do not overstate assets or income, and do not hide a likely loss. When two treatments are defensible, take the more cautious one.

Matching. The expenses of a period are set against the income of the same period, so that the profit reported for a month belongs to that month.

Materiality. Record separately only what is big enough to change a reader's decision. A R12 box of pins does not need its own asset account.

Consistency. Use the same methods from year to year, so that this year's figures can be compared with last year's.

Who does what

The bookkeeper records transactions from source documents, day by day, and keeps the books in order.

The accountant checks and corrects that work, makes the year-end adjustments, prepares the financial statements, and explains what the figures mean for decisions. Interpretation is the part of the job that computers have not taken.

The internal auditor works inside the business and tests whether the internal controls actually operate.

The independent (external) auditor is not an employee. This person examines the statements and expresses an opinion on whether they fairly present the results of the business. The value of that opinion comes entirely from independence, which is why an auditor may not audit their own work.

The owner or manager makes the decisions. Accounting does not make decisions. It puts the person who does make them in possession of the facts.

Worked example. Sipho buys a delivery bakkie for his courier business for R95 000, paid from the business bank account. A dealer tells him it would fetch R120 000 on the road today, and he wonders whether to show R120 000 in the books.

Historical cost answers it: the books show R95 000, because R95 000 is the amount that actually left the bank and is proved by the invoice. Now think about what writing R120 000 would do. Assets would rise by R25 000, but no money came in, nobody paid anything and no liability was created, so the R25 000 could only be balanced by inflating owner's equity. The business would report R25 000 of value that nobody contributed and nothing earned.

The same reasoning is why the entity rule matters. When Sipho pays his son's school fees of R2 000 from the business account, the business has not incurred a R2 000 expense. It has given R2 000 to its owner.

Core checkpoint: GAAP exists so that the reader, not the writer, can trust the statements. Whenever you are unsure how to record something, ask which treatment a careful outsider could verify from documents and would recognise from any other business's books.