Generally Accepted Accounting Principles (GAAP) are a collection of commonly – followed accounting rules and standards for financial reporting.
The purpose of GAAP is to ensure that financial reporting is transparent and consistent from one organization to another.
The use of GAAP is not mandatory for all businesses, but SEC requires publicly traded and regulated companies to follow GAAP for the purpose of financial reporting.
While the overall GAAP is specified by the Financial Accounting Standards Board, the Governmental Accounting Standards Board (GASB) specifies GAAP for state and local government.
IMPORTANCE OF GAAP :-
GAAP is important because it helps maintain trust in the financial markets. The investors may not be willing to trust the information provided in a company’s financial statements if it is not in accordance with GAAP.
In addition to this, it also facilitates the comparison of financial information across different companies.
BASIC PRINCIPLES OF GAAP :-
GAAP is set forth in 10 primary principle, as below :-
- Principle of Consistency :- Consistent standards are applied throughout the financial reporting process.
- Principle of Sincerity :- As per this principle, the accountant should provide the correct depiction of the financial situation of a business.
- Principle of Regularity :- This principle means that all accountants are to consistently abide by the GAAP.
- Principle of Permanence of method :- This principle states that the procedures used in financial reporting should be followed consistently.
- Principle of Non Compensation :- This principle states that all aspects of an organization’s performance , whether positive or negative , are to be reported.
- Principle of Continuity :- The principle assumes that the business will continue its operations in the future & is not going to end its operations any soon.
- Principle of Periodicity :- This principle states that the accounting entries are distributed across the suitable time periods.
- Principle of Full Disclosure :- As per this principle, accountants must disclose all the necessary information in their financial statements.
- Principle of Utmost good faith :- This principle states that anyone involved in financial reporting is expected to be acting honestly and in good faith.
- Principle of Prudence :- Prudence” means wisdom, good judgement, common sense. Thus, this principle states that the financial information should be presented accurately and not be speculative.
Thus, in simple words the Generally Accepted Accounting Principles (GAAP) are a set of rules, guidelines and principles designed to ensure a consistent presentation of financial statements , making it easier for people to read and understand the information contained in them.