Final answer:
GAAP requires that a transaction must possess commercial substance, meaning it should have an economic impact on the company's financial statements.
Step-by-step explanation:
GAAP stands for Generally Accepted Accounting Principles, which are a set of standard accounting rules and guidelines followed in the United States. According to GAAP, a transaction must possess commercial substance. This means that the transaction should have an economic impact on the financial statements of the company. In other words, it should change the company's resources, liabilities, or equity.
For example, if a company sells its old office furniture and buys new furniture of the same value, the transaction may not possess commercial substance because it does not cause any change in the company's financial position. However, if the company sells its old office furniture and invests the proceeds in a new technology that improves productivity, the transaction possesses commercial substance as it affects the company's operating efficiency and potential future cash flows. In conclusion, the principle of commercial substance ensures that transactions recorded in the financial statements are significant and impact the company's financial position and performance.