What are Generally Accepted Accounting Principles?
Generally accepted accounting principles (GAAP) refer to a common set of accounting
principles, standards, and procedures issued by the Financial Accounting Standards Board
(FASB). Public companies in the United States must follow GAAP when their accountants
compile their financial statements. GAAP is a combination of authoritative standards (set by
policy boards) and the commonly accepted ways of recording and reporting accounting
information. GAAP aims to improve the clarity, consistency, and comparability of the
communication of financial information.
GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial
reporting method. Internationally, the equivalent to GAAP in the United States is referred to
as international financial reporting standards (IFRS). IFRS is followed in over 120 countries,
including those in the European Union (EU).
Part 1 accounting principles
Accounting Principles are the rules and guidelines followed by the different entities to record,
to prepare and to present the financial statements of the company for presenting true and fair
picture of those financial statements.
Accounting principles are uniform practices which entities follow to record, prepare and
present financial statements. An entity must prepare its financial statements as per
acceptable accounting principles in order to present true and fair view of state of affairs of
entity.
Accounting principles will matter to you differently if you want to invest in a company or if
you own a company.
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Accounting standards
The term standard denotes a discipline, which provides both guidelines and yardsticks for
evaluation. As guidelines, accounting standard provides uniform practices and common
techniques of accounting. As a general rule, accounting standards are applicable to all
corporate enterprises. They are made operative from a date specified in the standard. The
Institute of Chartered Accountant of India (ICAI) constituted the Accounting Standards
Board (ASB) in April, 1977 for developing accounting standards. However, the International
Accounting Standards Committee (IASC) was set up in1973, with its headquarter in London
(U.K.). The Accounting Standards Board is entrusted with the responsibility of formulating
standards on significant accounting matters keeping in view the international developments,
and legal requirements in India.
What is GAAP?
Understanding GAAP will help you adhere to the most common set of accounting principles.
Let’s understand GAAP briefly –
GAAP is a set of rules and guidelines that the companies need to follow while
reporting its financial statements.
GAAP is created to ensure that the financial reporting remains transparent and
coherent throughout the process. And it also ensures that the financial reporting done
in one organization remains consistent with the financial reporting done in another
company.
The fascinating thing about GAAP is it is not similar in all geographic locations. As
per the region and the industries, GAAP is implemented and followed upon. In the
United States, the Securities and Exchange Commission (SEC) ensures that the
financial reporting done by the company is followed as per the generally accepted
accounting principles (GAAP).
The publicly traded companies in the United States must comply with both the SEC
and the GAAP. Otherwise, it wouldn’t be possible for them to remain publicly traded.
What is IFRS?
GAAP is not being followed in many countries. That’s why we also need to talk about
International Financial Reporting Standards (IFRS). Let’s talk about IFRS briefly as well.
In the US, GAAP is being followed. In many countries other than the US, IFRS is
being followed in the case of financial reporting.
IFRS helps public companies prepare and report financial statements in all over the
world.
Since similar IFRS are set for the entire world, it becomes easy to implement. And for
investors also, the comparison between companies becomes significantly easier.
The auditors also get a global standard to adhere to whenever they verify the financial
statements of companies prepared by following IFRS.
IFRS is not like GAAP. IFRS doesn’t change as per the region. Rather IFRS has a
general guideline for preparing financial statements but IFRS doesn’t have any
industry-specific financial reporting.
Part 2 accounting concept and convention
Accounting principles can be divided into two parts:
Accounting Concepts
Basic concepts of accounting governs the various aspects and procedures of accounting and helps to
maintain and prepare accounting records and financial statements in a better, understandable,
comparative and a uniform manner. The concepts of accounting are as follows:
1. Business entity concept: A business and its owner should be treated separately as far
as their financial transactions are concerned.
2. Money measurement concept: Only business transactions that can be expressed in
terms of money are recorded in accounting, though records of other types of
transactions may be kept separately.
3. Dual aspect concept: For every credit, a corresponding debit is made. The recording
of a transaction is complete only with this dual aspect.
4. Going concern concept: In accounting, a business is expected to continue for a fairly
long time and carry out its commitments and obligations. This assumes that the
business will not be forced to stop functioning and liquidate its assets at “fire-sale”
prices.
5. Cost concept: The fixed assets of a business are recorded on the basis of their
original cost in the first year of accounting. Subsequently, these assets are recorded
minus depreciation. No rise or fall in market price is taken into account. The concept
applies only to fixed assets.
6. Accounting year concept: Each business chooses a specific time period to complete
a cycle of the accounting process—for example, monthly, quarterly, or annually—as
per a fiscal or a calendar year.
7. Matching concept: This principle dictates that for every entry of revenue recorded in
a given accounting period, an equal expense entry has to be recorded for correctly
calculating profit or loss in a given period.
8. Realisation concept: According to this concept, profit is recognised only when it is
earned. An advance or fee paid is not considered a profit until the goods or services
have been delivered to the buyer.
Accounting Conventions
Accounting Conventions helps out in accounting when specific guidelines are present. It is a common
practise which gives guidelines in those situations where accounting standard fails to govern a
specific situation. The four main accounting conventions followed in day to day accounting
practises are as follows:
Conservatism is the convention by which, when two values of a transaction are available, the
lower-value transaction is recorded. By this convention, profit should never be overestimated,
and there should always be a provision for losses.
Consistency prescribes the use of the same accounting principles from one period of an
accounting cycle to the next, so that the same standards are applied to calculate profit and
loss.
Materiality means that all material facts should be recorded in accounting. Accountants
should record important data and leave out insignificant information.
Full disclosure entails the revelation of all information, both favourable and detrimental to a
business enterprise, and which are of material value to creditors and debtors.
