MEANING OF GAAP
GAAP is the short form of Generally Accepted Accounting Principles. It is a set of rules specified by the Financial Accounting Standards Board used for helping publicly-traded companies create their financial statements .
It covers a wide range of topics such as financial statement presentation, equity, assets, liabilities, broad transactions, revenue and expenses.
The principles have been developed and modified through common usage by accountants all over the world and facilitate a reasonable basis for comparison since same and uniform set of rules are used by all the companies using GAAP for creating their financial statements.
PRINCIPLES OF ACCOUNTING
The current set of principles that accountants use rests upon some underlying assumptions. The basic assumptions and principles are listed below –
- BUSINESS ENTITY PRINCIPLE – According to this principle, an organisation’s transactions should be kept separate from the transactions of the business owner. A company must report the assets and liabilities of different subsidiaries separately and not mix with the books of another company.
- GOING CONCERN PRINCIPLE – This principle states that a business is going to continue its operations for an unforeseeable period and is not going to liquidate its assets or shut down its operations in near future. If an organization does not apply the going concern principle, it would have to recognize all of its expenses immediately without deferring.
- FULL DISCLOSURE PRINCIPLE – As per this principle, an entity must disclose all the relevant information in its financial statements which may effect the decision making if the users. It is because of this principle that numerous pages of “footnotes” are often attached to financial statements.
- MATCHING PRINCIPLE – This principle requires the revenue for a particular period to be matched with its corresponding expenditure so as to show the true profit for the period.
- TIME PERIOD PRINCIPLE – This principle states that a company’s accounting process will be completed within a certain period that is typically a financial year or a calendar year. Thus, every transaction that relates to a particular period of accounting must form part of the financial statements prepared for that time.
- COST PRINCIPLE – The cost principle is an accounting principle that requires assets, liabilities, and equity investments to be recorded on financial records at their original cost. It is also referred as Historical cost principle.
- PRINCIPLE OF CONSERVATISM – This principle states that a business should record the expenses and losses as soon as possible but only recognize revenues when they are actually earned.
- PRINCIPLE OF CONSISTENCY – This principle states that the accounting procedure once adopted should be followed for two subsequent accounting periods in order to facilitate comparison of the results between two periods.
- REVENUE RECOGNITION PRINCIPLE – Under the accrual basis of accounting, the revenues must be reported on the income statement in the period in which it is earned. This means that as soon as a product is sold, or the service has been performed, the revenues are recognized.
- MATERIALITY PRINCIPLE – According to this principle, an entity can disregard an accounting information if it does not affect the decision making of the users and only materialistic information must be recorded in the financial statements.
Thus, the GAAP Principles form the core of all of the company’s accounting transactions, irrespective of the size of company and is used by businesses to organize and summarize the financial information into accounting records.