Many sometimes refer to accountancy as an art — the artwork of documenting, categorising, and summarising financial data. Like any other type of art, accounting requires using an individual's creative ability to keep track of financial operations. Nevertheless, if the accounting method is left to its own devices, there'll be no limits for manipulating the accounts. In providing income reports to outside parties like investors, bankers, stock markets, income authorities, governments, etc., each company requires an accounting framework to record monetary activities and make the resultant accounting information consistent. This requirement has paved the way for GAAP.
Did you know?
The four basic characteristics associated with GAAP include objectivity, materiality, consistency and prudence.
What is GAAP?
GAAP is an acronym that stands for Generally Accepted Accounting Principles. Generally Accepted Accounting Principles is a collection of accounting rules and regular industry use that have evolved through time. Companies employ it to correctly arrange the financial data into accounting proceedings, summarise the monetary report into the income statement, and reveal specific supportive evidence.
One of the main purposes for utilising Generally Accepted Accounting Principles is to provide a realistic foundation of comparability for anybody viewing the income reports of the firms since all firms employing GAAP have generated their financial information using a similar set of principles.
Below are the principles of GAAP:
- Business entity assumption: One must recognise each company unit as distinct from its proprietors. As a result, it identifies all money transfers in the same way. This principle is particularly significant for documenting a lone proprietor's economic activities. Whenever the owner owns the whole firm, including all assets and debts and cash transactions, they must separate links between personal and professional relations.
- Monetary unit assumption: One must express every company's money transfer in the unit of currency like Indian rupees. Do not enter that transaction in the accounting books if you cannot do so.
- Accounting period: As per the principle, the company has to finish all the accounting procedures within a specific timeframe, commonly a fiscal term or a chronological year. Therefore, each transaction under a specific accounting timeframe will form a part of the monetary records that the company prepares for that period.
- Historical cost concept: Usually, whenever a business acquires specific financial capital and resources, they document it in accordance with the money or cash correspondent genuinely spent to buy that item or property upon the date of acquisition - irrespective of when the transaction happens. Consequently, the valuation of the leftover property would stay unchanged regardless of the accounting cycle.
- Going concern assumption: There is an assumption that each business unit is a going concern, which means it will keep functioning indefinitely. This assertion is significant because, in the situation of a takeover, the firm must reaffirm its assets and debts in line with the appropriate figure to receive or release, even as the case might well be, in reflecting the institution's true financial condition.
- Full disclosure principle: A bookkeeping record might not have been able to convey all of the necessary data about the activity on its own. As a result, the FDP concept compels the company to reveal all economic data relating to the shareholder in order to aid them in making decisions. It accomplishes at each transaction level via documenting an acceptable narrative with each trade and then at the income statement stage by giving comments on the balances.
- Matching Concept: This notion demands that the income for a given time must match with its equivalent spending in order to calculate the genuine profits for that period.
- Accrual basis of accounting: According to this concept, it is mandatory to record all income and spending in the time they are incurred, instead of receiving or spending the money or current assets. Generating revenue and experiencing spending is significant, regardless of the matching financial flow.
- Consistency: Concerning a sequence of operations, an organisation may choose to adopt a specific accounting technique. One must continuously follow these accounting processes across the succeeding accounting periods to compare outcomes across periods. For instance, a company may select to depreciate its physical capital assets using the straight-line technique. So they have to follow this strategy regularly also in the subsequent years.
- Materiality: This principle permits a company to overlook some other principles if the outcome has no impact on the decision-making of the income statement consumer. One may overlook some mistakes or exclusions if their impact on the financial accounts is insignificant. For instance, the matching principle enables the firm to acknowledge the spending over the item's service life whenever the company acquires a permanent asset. Suppose an organisation buys a keypad for ₹3,000 and its sales are in millions of rupees. It makes little difference to the user of financial statements whether a certain item classifies as property or expenditure. As a result, even when one documents the keypad as expenditure during the year of acquisition, it does not violate fundamental accounting standards because the cost incurred and the consequences of the same are insignificant.
- Conservatism: In bookkeeping, one may come into circumstances in which there are 2 equally acceptable approaches to reporting for a specific transaction. It may even be necessary to select between documenting a transaction and not documenting it. In that case, the company must use a cautious approach. This indicates that while reporting for a specific transaction, the company must document all projected costs or losses, but one should not document possible income or profits till received. This is why arrangements are in place for costs such as toxic debt, but still, no comparable record is kept for a rise in the obtainable price of an item.
Sources of GAAP
Formation of Generally Accepted Accounting Principles after the declarations of several government support accountings institutions, the most recent is the IFRS. The Securities and Exchange Commission also issues accountancy declarations via accounting professional newscasts and other releases that are solely relevant to publicly traded firms and are regarded to be parts of Generally Accepted Accounting Principles. GAAP is clear in the Accounting Standards codification, accessible electronically and (for better legibility) on paper.
GAAP includes a wide range of issues; below is the list:
- Presentation of financial statements
- Combinations of businesses
- Hedging and derivatives
- Reasonable price
- Currency exchange
- Non-monetary exchanges
- Following events
- Accounting for certain industries like aviation, fossil fuel industries, and medical services
The manufacturing relating reports permitted or needed by GAAP may differ significantly from the more general requirements for particular accounting operations.
Also Read: What is the List of Accounting Standard
Users of GAAP
GAAP is largely utilised by companies reporting revenue figures in India, and the accounting system used throughout the majority of other nations is International Financial Reporting Standards. Unlike IFRS, Generally Accepted Accounting Principles are substantially more rule-based. Because IFRS concentrates on basic concepts rather than specific rules, the IFRS oeuvre is significantly smaller, clearer, and simpler to grasp than Generally Accepted Accounting Principles. Because IFRS is now being developed, GAAP is regarded as the more complete accounting standard.
Managing the financial operations of a company is a tedious task. A professional who has adept accounting knowledge acts as an important asset to the company. This is where GAAP comes into the picture. GAAP stands for Generally Accepted Accounting Principles. Creating GAAP is to protect shareholders' rights from dishonest and deceptive reporting practices that firms used to engage in a generation back. GAAP focuses on reliable, constant, accurate, and truthful information such that shareholders may make educated judgments. GAAP also encourages a full transparency report, which entails including relevant content of financial report annotations such that shareholders aren't caught unawares by these developments.
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