 Hello, and welcome to this session. This is Professor Farhad. In this session, we would look at GAP and the setting standard bodies for accounting. This topic is covered in financial accounting, so this topic is designed as an introductory course and also could be used for the CPA FAR section, but here we are talking about basic stuff. If you want to learn more about this topic, visit my intermediate accounting course where you will have the material covered. Now, as always, I would like to remind everyone that's listening to me to connect with me on LinkedIn. If you haven't done so, YouTube is where you would need to subscribe. I have 1600 plus accounting, auditing, finance, and tax lecture. This is a list of all my resources, including if you're studying for your CPA exam, hundreds and hundreds of hours of CPA lectures. On my website, you'll have access to additional materials, such as PowerPoint slides, true, false, multiple choice. If you're studying for your CPA exam, 2000 plus CPA question, this is a list of the resources that I cover. So we're going to start to talk about generally accepted accounting principle, and specifically we're going to be talking about the US generally accepted accounting principle. So what is GAP? So when we say the word GAP, what does GAP represent? Well, the GAPs are concepts, basically rules and regulations that we follow, the regulation rules to follow when we are preparing financial statements. So basically GAP is the reference for the accounting. So simply put, financial is counting is governed by concepts and rules known as GAP, generally accepted accounting principle. It's pronounced like the store GAP, but it's a G-A-A-P. And notice it's generally accepted. It's not set in stone. It's generally accepted. GAP aims to make the information relevant, reliable, and comparable. It has other characteristics other than relevant, reliable, and comparable. But today, since this is an introductory course, we're only going to talk about three characteristics of GAP and just discuss them briefly. But if you want more of this, go to my intermediate accounting. What does relevant mean? It means when the information is provided, it has to be relevant. What does relevant mean? Relevant means it affect the decision of users. It means it helps the user make a decision. It's not, it's not irrelevant to what they are doing. For example, if you want to invest in the company, you want to know about the company's profit, about the company's debt, about the company's ability to sustain its current operation. Well, that's relevant information. So the accounting information that you provide has to be relevant, has to help them make a decision. Well, that's good. But also the information has to be reliable. What is reliable? It means I can't trust it. It's not biased. It's not favoring one group over the other. It's complete. It's giving me everything I need to know. This is when the information is reliable. Of course, think about it. If the information is not reliable, how good is it? It's not good. Even it's relevant. But if it's not true, how good is it? Also, the information has to be comparable. What does it mean comparable? Comparable means is when I am looking at this information, I can take the information that you gave me about company A and I can look at company B and be able to compare the performance of company A versus company B. Why? Because we are all using GAP. We are all using the same rules. Therefore, the information has to be reliable. So the information has to be relevant, reliable, and comparable. Are these the only three characteristics? Absolutely not. But for a financial accounting course, that's all what we have to know about. Now, the question should be, who sets GAP? So who are the standard-setting bodies? Here we go. FASB, the Financial Accounting Standard Board, and this is a private organization. Private means it's not governmental. It's not public. In the U.S., FASB sets GAP, the Financial Accounting Standard Board. Now, bear in mind that we do have government oversight, and the government oversight comes from the SEC, Securities and Exchange Commission. The SEC oversees the financial market and by-product also oversees the accounting standard. So if the SEC doesn't like something, they can object. And if the SEC object to something FASB created, and what FASB created is GAP, then it has to be changed, because the SEC is a public or a government, or a federal government, or a federal government organization that you have to comply with. And the SEC came about after the Great Depression to monitor the financial market. Therefore, we have to follow the SEC. So technically, the SEC has the first priority in setting the rules, but they don't. They give this to the private sector. Actually, to be more technical, Congress can set the accounting rules if they want to, but they don't. So think about it. Accounting rules are self-governed. It means the private sector sets their own rules for their accounting record. Now, this is in the US. What about globally? Globally, you have to remember, in today's world, companies operate across the globe. Therefore, they have to assure reports across the globe as well. So what do they follow? Well, everybody else, other than the US, other than the US, they follow different sets of rules. They follow different sets of rules. What rules do they follow? Well, they follow something called the International Financial Reporting Standard. So this is the equivalent of GAP. So in the US, we use GAP. Everybody else uses the International Financial Reporting Standard. Now, in this course, we would learn about GAP. I do have a course about IFRS under my YouTube channel. Teachers about the IFRS are very similar. They're 80 to 90, if not more similar, the way we do accounting for both. But there are still some differences. Now, the IASB is the equivalent of FASB. It's the organization that sets the rules internationally called IASB. They issue the IFRS, which for us, they are called GAP. And that's all what you need to know about international standards. The organization that sets the rules in IFRS. And over the years, there has been a lot of conversion, a lot of conversion between the two. And recently, there was a conversion about the conceptual framework. And what's the conceptual framework? Both the FASB, the US organization and the IASB, the international organization, they're attempted to converge, to bring the rules to be very similar, to enhance the conceptual framework that guys standard setting. What is the conceptual framework? It's basically the background that we need, the background that we need to issue new accounting rules. So they're trying to basically agree on certain principles. For example, one of them is the objective. For example, they both agree that the main users of accounting information, and we talked about this in the prior sessions, are investors and creditors. So those are the main users. Now, we do have other users, but the main users are investors and creditors. They both agree to that. They both agree that the characteristic, the qualitative characteristic of accounting information has to be relevant, reliable and comparable. They both agree to that. Also, we're very close to defining the items on the financial statements. What are the items on the financial statements? We'll talk about those later, like how to define revenues, expenses, assets, liabilities, so on and so forth. They're coming close to this. Also, recognition and measurement set the criteria that an item must meet for it to be recognized as an element and how to measure the element. Simply put, when to record the transaction and how to record the transaction, they're trying to agree on this. So basically, this is major stuff that they are working on, which is trying to have the same conceptual framework. And the conceptual framework doesn't mean the same rules. It means create the rules within the same spirit. This is basically the conceptual framework. And anyhow, these are beyond the scope of this course. So if you want to learn more about the conceptual framework, go to my intermediate accounting course. That's all what you need to know for now as an introductory financial accounting students. Now, we talked a little bit more about principles of accounting assumptions and constraints that you're going to see throughout the course. So what are the general principles? We're going to have general principles. There are the assumptions, concepts and guidelines for preparing financial statements. And we're going to talk about those general principles today. Not all of them, but the majority of them. There are also specific principles that are detailed rules used in reporting business transaction and event. So they were going to talk about generally general principles, like the revenue recognition, expense principle, full disclosure principle, measurement. And we have certain assumptions, going concern assumption, monetary unit assumption, time period. We'll talk about this later, business entity as well as constraint, which are called cost and benefit. So we're going to look at each one of those very briefly today. And that's going to do for a financial accounting course. But again, those topics are covered a little bit more in intermediate accounting. And I keep saying this is because if you are listening to this and you want more, go to my intermediate accounting. The first principle that we need to be aware of, and it's an important principle called the cost principle. And what does it's very simple, but it's very powerful or very important principle. Simply put, accounting information is based on actual cost. Actual cost is considered objective. What is actual cost? Actual cost means when you buy something for $500, you would record it. If you paid $500, you would record the item at $500. Now you bought for $500, but it's worth $500. It's worth $600. It's worth $700. It does not matter. It's what you paid for it. You paid $500, you recorded at $500 because this number is considered objective. The second principle, very important, very important principle. This is the revenue recognition principle. What does it mean revenue recognition? And we're going to see this in future chapter. Recognition means when do you record? That's basically what we're saying. When do you record revenue? Well, here we go. Recognize revenue when goods or services are provided to customers and an amount expected to be received from the customer. They don't have to pay you now. As long as they're going to pay you in the future, it's revenue. So what does that mean? It means when you provide a service, let's assume I hire you to paint my home. So I hire you, you painted my home and you build me. Again, we're going to go with $500. You build me $500. Well, as soon as you build me, because you did finish the work, you have revenue. As a painter, you have revenue of $500. Why? Because you did the work. So revenue recognize when goods or services are provided, you provided the service to me. Now I'm not going to pay you until 60 days later. That's irrelevant. As far as you are concerned, you have revenue of $500. It's not in cash. Nevertheless, it's revenue. And we'll talk about this later on, but this is an important principle in accounting. Expense recognition principle, very similar to the revenue recognition principle. When you have an expense, you have to recognize the expense. So a company records its expense incurred to generate the revenue reported. Let's go back to my painting example. Let's assume you hired an employee and that employee cost you $100. So that employee worked for you. Now, you're not going to pay this employee until 30 days later for whatever reason. Now, although you did not pay the employee now, you have an expense. Why? Because you hired that employee, the expense was incurred to generate revenue. So because the expense was incurred, it means the expense did happen. As long as the expense happened, as long as the expense happened, you have an expense. You may not pay this employee until 30 or 60 days later, or that contractor, you have an expense regardless. So basically, similar to the similar in concept to the revenue recognition, it means record the expense before you pay them in cash. Full disclosure principle basically, a company reported the details behind the financial statement that would impact users' decision in the notes of the financial statements. What does the full disclosure means? It means when you have additional information other than the numbers that you need to make the users aware of. I'll give you an example just to illustrate the point. Let's assume the company is being sued. There's a lawsuit against that company. Maybe that's relevant to the users of the financial information. In addition to the numbers, they want to know about this lawsuit. So anything that's relevant and there's a lot about the full disclosure, which accounting method you are using because you would learn later that you have many accounting methods you can use. You have to tell the users which one you are using and any relevant information, any information that you think it's important, you'll have to disclose it. But this is, again, just know the principle, but in the real word, this is much more complicated than just tell them everything that's required. Other things that we need to talk about, let's go back here to this picture. We talked about the principles, a few principles. Now we need to talk about certain assumptions. This is all under gap, certain assumptions. When we do accounting, we have to make certain assumptions. What are those certain assumptions? The first assumption is something called the going concern assumption. And what does that mean? So what is the going concern assumption? In its simplest form, it means we are going to stay in business forever. So once you start the business, we're going to stay in business forever. So business is presumed to continue operating instead of being closed or sold. Why is this relevant? This is relevant because when we prepare financial statements, we have to prepare financial statements under the assumption that we're staying in business. Why? Because if we make the opposite assumption, if we are making the assumption that we're going to be closed or sold, it means we're not going to be in business anymore. Then we have to report the numbers in a certain way. Do you remember we talked about the cost principle? Let me show you here. This cost principle right here, cost principle means everything should be reported at cost. Well, if you're going out of business, the information about your cost is irrelevant. Now you have to use what's called market value. Well, we don't because we're going to assume we're going to stay in business forever. Now, if we happen to go out of business, we have to change the accounting method, but that's way beyond the scope of the scores. So the first assumption is we're going to be in business forever. That's the going concern assumption. Assumption number two, transaction or event are expressed in monetary or money unit. What does that mean? It means when you prepare financial statements, you have to tell me whether it's US dollar, euro, yen, so on and so forth. So the monetary unit you are using has to be expressed. I have to know which one because a thousand US dollar is different than a thousand yen. So you have to tell me which currency you are using and you will state this in the financial statement. Another assumption that we make is the business entity assumption. And what does that mean? It means a business is accounted for separately from other entities, including its owners. So the first thing is we have an owner and we have a business. Those are two separate entities. The owners and the business are separate. Now we might have an owner, a business and many other businesses, okay? Maybe three separate businesses. They are independent. They are owned by this individual or this business, own this business and own this business or this business, own this business and this business owns this business. The point is each one of them, we account for each one of them separately, okay? Including the, we don't include the owner as well. So each business is an entity for accounting purposes, okay? Time period assumption. Well, what does that mean? And we're going to be seeing this much, much more in details and action later on. It means the life of any company is broken down by period. For example, the life of the company could be broken down by quarters. Q1, Q2, Q3 and Q4. Or there's no Q4. It's the fourth quarter. Or the life of the company could be broken down into periods every six months. Or the life of the company could be broken down by monthly. All what we're saying is when we prepare financial statements, we have to determine a period. We have to stop at some point and prepare the financial statement based on that particular period. And this is going to become, this is a very powerful, this is very powerful assumption and very important assumption that we're going to see later on when we prepare adjustments. For example, doctors, medical doctors, they're interested in knowing on a monthly basis what's going on in their clinic. Why? Because they don't have time to keep up with their finances, but they may ask someone to prepare financial statement on a monthly basis. And I used to do this all the time when I was in practice. Our CPA firm had many clients that are medical doctors, dentists or MDs. And we prepared financial statements on a monthly basis. For example, if you are a publicly traded company, it means like Microsoft, Apple, Walmart, company that have their stock traded, they have to report, they have to report on a quarterly basis. They don't have an option. Now for small companies, for example, medium-sized companies, they may want to know what's going on halfway throughout the year. So if you're an investor, you want the company to report on a quarterly basis, on a mid-year basis. And if you want to, you can ask them to report quarterly. So simply put, the life of the company, you can take it and break it down into semi-pieces. Now, all companies, they have to report on at least a yearly basis because they have to prepare their taxes. So at least even small store, you know, mom and pop store, they have to report on a yearly basis because they have to report their financial statements. Last but not least, we have two accounting constraints and that's cost benefit and materiality. Cost benefit means only information with benefit of disclosure greater than the cost must be disclosed. It means you don't have to disclose every single thing if the cost of something overweights benefit, not benefit to you, benefit to the users, not benefit to you. Well, obviously, you know, everything it's going to, as far as benefit you prepare, you will take the benefit over the cost. But what I'm, what we're trying to say is the benefit to the users. If you think it's relevant to the users, then you have to provide it to the users. Okay. But if you think the cost generated is, it doesn't add value to the user, then you have to take this cost benefit into consideration. Also, materiality, only information that would influence the decision of a reasonable person need to be disclosed. You don't have to disclose every single thing. You have only to disclose only the information that's considered material. Now, materiality is a very subjective concept because it depends on the company, the size of the company, the nature of the business, the nature of the event. So all we need to know for now is materiality is whatever influence a reasonable person. Now, what is a reasonable person? We don't have to worry about this year because, you know, you could have a reasonable person that's a regular investor or you could have a reasonable person that's a multimillion dollar hedge fund that's using, that's looking at the same information. What's reasonable to one may not be reasonable to the other, but the point is we don't have to discuss this in here because, again, beyond the scope of the course, just know that materiality is one of those constraints. So don't report everything, only the information that's considered reasonable to be disclosed for a reasonable person. Now, this is all what I'm going to cover in this session. In the next session, I might look at the various form of businesses, especially that we talked about business entity assumption because the business entity assumption, when you run a business, you can have the business as a sole proprietary ship, which is one individual, you could run a business as a corporation, you could run a business as a partnership, you're in many type of business organization. So we talk about this just to kind of illustrate this business entity concept a little bit further. As always, I would like to remind you if you are an accounting student or a CPA candidate, I strongly suggest you visit my website, consider subscribing, invest it in your career. If you have any questions, please email me, StudyHeart, accounting is a rewarding career. StudyHeart, it will pay off down the road. Good luck.