If every accountant made up their own rules, no one could compare two businesses' financial statements, and no one could trust that the numbers meant what they said. Generally Accepted Accounting Principles, or GAAP, are the shared set of rules, assumptions, and guidelines that accountants in Canada (and most of the world) follow so that financial statements are prepared consistently. Accounting standards are the principles, rules, and guidelines followed when preparing and presenting accounting information — GAAP is the umbrella term for the most important of those principles.
The Core Principles
- Business entity principle — requires that each business be considered a separate entity and that the financial data for each business be kept separate from the owner's personal data. The owner's personal car loan never appears on the business's balance sheet.
- Cost principle — assets are shown on the balance sheet at the cost of their acquisition or construction, not at what they might be worth today. A building bought for $200,000 stays on the books at $200,000, even if the market price rises.
- Fair value principle — uses the current fair market value of certain assets (like investments held for trading) for financial reports, instead of original cost, when a reliable market value exists.
- Objectivity principle — requires that accounting data be free from any bias and be verifiable to support the values used to record transactions; an invoice, not a guess, backs up every entry.
- Time period principle — requires the definition and use of the same length of period (month, quarter, year) for each accounting period, so results can be compared period to period.
- Matching principle — says that expenses should be recorded and matched with the revenue they help to generate during the same accounting period.
- Revenue recognition principle — states that revenue is recognized at the time it is definitely earned, not necessarily when the cash is received.
- Materiality principle — requires that information that could affect the decisions of the users of financial statements be included when the statements are prepared, even if strict accuracy would suggest otherwise for tiny amounts.
- Conservatism principle — requires that, where there are acceptable alternative accounting treatments for an item, accountants must choose the one that results in lower net income and net assets, so a business is never made to look better off than it really is.
- Going concern principle — assumes a business will continue operating into the foreseeable future, which is why assets are recorded at cost rather than at a quick "liquidation" price.
IFRS vs. ASPE
In Canada, GAAP is applied through one of two rulebooks, depending on the type of company. Publicly traded companies (those on a stock exchange) must use IFRS — International Financial Reporting Standards — a detailed, internationally shared standard designed so investors around the world can compare companies fairly. Most private companies instead use ASPE — Accounting Standards for Private Enterprises — a simpler made-in-Canada standard, since private companies don't need to satisfy a global pool of investors. The underlying principles (entity, cost, matching, and so on) are the same idea under both; IFRS just applies them with more detailed, uniform rules.
| IFRS | ASPE | |
|---|---|---|
| Used by | Public companies | Most private companies |
| Detail level | Very detailed, internationally uniform | Simpler, Canada-specific |
| Why | Global investors need comparability | Lower cost/complexity for smaller businesses |