Generally Accepted Accounting Principles Stephanie R. Stewart HCS/571 September 24, 2012 Anne Harney Finlon Generally Accepted Accounting Principles Generally Accepted Accounting Principles (GAAP) are important ideas to understand when discussing finances of any kind. It is important for all nurses, especially those in management roles, to understand financial concepts and be involved in the budgetary process. This paper will help to create an understanding of GAAP, the purpose of the principles, and how they relate to the health care industry today. Every profession tends to have a language specific to the profession or occupation.
The financial world is not immune to this language subset. The term Generally Accepted Accounting Principles (GAAP) provides a dictionary for the language used in the finance world. GAAP also allows for consistency and encourages integrity with financial reporting. According to Finkler, Kovner, and Jones (2007), this set of principles involves eight key rules “established by the Financial Accounting Standards Board” (p. 104). Additionally, accountants are compelled to denote if the financial records being examined are in accordance with GAAP (Finkler, Kovner, & Jones, 2007).
Therefore, it is important for health care entities to follow the GAAP concept and ensure adherence to these eight key tenets. While some sources and authors will only list five or six principles, Finkler, Kovner, and Jones discuss eight rules as part of GAAP explanation. These principles “include the following: * Entity concept * Going-concern concept * Matching principle and cash vs accrual accounting * Cost principle * Objective evidence * Materiality * Consistency [and] * Full disclosure (Finkler, Kovner, & Jones, 2007, p. 104). Each of these principles has a general intent and is important for consistency in financial reporting.
The entity concept defines what group or person is being discussed within the financial records. An example of such an entity is Shady Acres Nursing Home. The second rule is known as going concern. This specific concept examines the likelihood of whether the entity will still be operating tomorrow, next month, or next year. The reason for examining this information is due to the value of organizational assets (Finkler, Kovner, & Jones, 2007). Assets of a company that is not expected to be in business next month will have a different value than the assets of a company expected to be in business for many years to come.
For example, the value of the building where Shady Acres Nursing Home operates may be worth far less if it is known the facility will be ceasing operation in a few weeks. The next tenet of GAAP is the matching principle and cash vs. accrual accounting. As discussed by Finkler, Kovner, and Jones (2007), payment for services rendered is not always received in the same year. Additionally, the cost of providing those services may also not be noted as paid in that same year. Inconsistencies can occur as a result of the timing of income and expenses towards the end of a financial year.
This GAAP rule helps to create consistency by requiring income and expenses to be reported in the same year. An instance of this rule is when Shady Acres provides skilled nursing care to Mrs. Smith for the month of December 2012. Though it is unlikely that Mrs. Smith’s insurance will pay Shady Acres any sooner than January 2013, the accountants at the nursing home must show that the income was received in 2012. Additionally, the providers of care likely will not be paid for all hours worked until 2013, but that expense also must be shown in 2012. The rules of cost principle and objective evidence are very closely related.
The cost principle can be difficult to determine without taking into consideration the objective evidence available to the accountants. Cost principle is essentially the amount paid by an entity to purchase the item. Yet, with many items accountants must take into consideration the depreciation or which will occur over time. This is especially true with buildings and other very expensive items expected to be used for many years. Shady Acres may have paid three million dollars for the land and building five years ago, but because of the real estate crisis the cost principle is now only two million dollars.
Due to objective evidence the cost principle will never rise higher than the cost reported on the accounting report even if there is appreciation present. Since cost over time can fluctuate based upon the market and the assessor, it is important to include the rule of objective evidence within this set of accounting principles. To decrease forecasting of cost, accountants list “the value of most assets at their cost” (Finkler, Kovner, ; Jones, 2007, p. 106). In the previous example, Shady Acres was acquired for three million dollars.
If the real estate market rebounds next year and the building appreciates in value, accountants will still use the rule of objective evidence and not set the cost above that which was paid to purchase the building. The sixth component of GAAP is materiality. As pointed out by Finkler, Kovner, and Jones (2007), the expectation for accounting records to be error free is unreasonable. Therefore, accountants take into consideration the degree of the errors made in the financial records. If the degree of error causes decisions to be made differently than if no errors were made, then this is unacceptable and must be corrected.
For instance, if Shady Acres was interested in selling the facility to a wealthy investor, accountants would need to determine the value of organization by calculating assets and outstanding expenses. If accountants made an error and valued the organization at a total worth of four million dollars while the organization is only worth three million dollars, then the investor would be making a purchase decision based on faulty information. Accountants would be required to correct this information under GAAP as soon as it is discovered.
Consistency is one of simplest rules in GAAP, yet has quite profound effects if not followed. Financial methods of accounting chosen by organizations should be consistent from year to year. If accountants at Shady Acres chose to use a different accounting method for 2012 than had been used for the preceding years then comparisons of Shady Acres’ financial health would be difficult to make. Finally, the rule of full disclosure within GAAP requires that organizations divulge all information related to the financial picture of the organization.
It is important to exhibit details of the broader statements generally submitted so that a clear financial status can be ascertained. For example, Shady Acres would be required to submit statements detailing cash flow, appreciation or depreciation of assets, and justifications of all statements presented in addition to the standard “balance sheet and an operating statement” (Finkler, Kovner, & Jones, 2007, p. 106). The concepts of GAAP explained in this paper should be followed by all organizations, including health care organizations.
Accountants expect to find adherence to these standards when auditing organizational finance records. Nurses are familiar with standards and policies in health care; GAAP is yet another set of standards to follow. As leaders in health care organizations, nurses should be aware of these concepts and assist the organization’s accountants with the implementation and use of all eight principles. Reference Finkler, S. A. , Kovner, C. T. , ; Jones, C. B. (2007). Financial management for nurse managers and executives (3rd ed. ). St. Louis, MO: Saunders Elsevier.