Generally Accepted Accounting Principles (GAAP) refers to the widely accepted set of rules, conventions, standards, principles, policies and practices that provide broad guidelines and detailed procedures for recording the financial and accounting information of an organization. It combines authoritative rules and standards set by Financial Accounting Standard Boards (FASB) with basic accounting principles and generally accepted industry practices to make the financial information standard, uniform, consistent and transparent (Investopedia).
Some of the key principles of GAAP are:
Economic Entity Assumption: According to this principle, the business and its owner are two different entities and their transactions are to be recorded separately. Business is a separate legal and economic entity and exist distinctly from the owner. For example: If Mr. A is the owner of a sole proprietorship company and he has started the company by taking a loan of certain amount. The loan is to be recorded as the liability of business not as liability of Mr. A though he is responsible to pay back the loan amount.
Going Concern Concept: This principle assumes that the business will continue to exist and carry its operations for indefinite time in future. Thus the financial and accounting policies are followed to maintain the continuity of business unit (Diploma in Insurance Services). The calculation of depreciation based on the expected economic life of fixed assets is an example that the company believes it will not liquidate or forced to close down in the future.
Time Period Assumption: Though the business is assumed to continue till indefinite time period, the financial reports are prepared taking into accounts the transactions of certain time period to reduce complexity. It also allows to measure the performance and take corrective actions on time. Generally the financial statements are prepared on annual basis at the end of every fiscal year (in Ashadh) in Nepal. However, the companies prepare may also prepare weekly, monthly, quarterly or semi-annually reports as per their requirement.
Monetary Unit Assumption: This principle deals with the ability to measure transactions in monetary terms without drastic fluctuations in currency values in short term. All the transactions are expressed in dependable and stable monetary units to make the recording consistent as well as comparable. If we look at the financial statements of the government organizations in Nepal, all the values are expresses in NPR that is the adaptation of this concept.
Cost Principle: All the transactions are recorded on the basis of cost or purchase price. Thus the amounts expressed on financial statements are referred to as historical costs (Accounting Coach). For example: Besides shares and bonds, other assets are recorded on the basis of cost price and are not adjusted to represent the value. For example, the calculation of depreciation on a five year old machine is calculated on the basis of its purchase price not on the value of the machine in current time.
In addition to these, the matching principle, revenue realization principle, full disclosure principle, materiality and conservatism are also applied in recording the financial transactions based on GAAP. It tries to facilitate financial decision making process by providing comparable, credible and neutral financial information.
Investopedia. (n.d.). What are ‘Generally Accepted Accounting Principles - GAAP’. Retrieved from Generally Accepted Accounting Principles - GAAP: investopedia.com/terms/g/gaap.asp
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Generally Accepted Accounting Principles (GAAP) refers to the widely accepted set of rules, conventions, standards, principles, policies and practices that provide broad guidelines and detailed procedures for recording the financial and accounting information of an organization. It combines authoritative rules and standards set by Financial Accounting Standard Boards (FASB) with basic accounting principles and generally accepted industry practices to make the financial information standard, uniform, consistent and transparent (Investopedia).
Some of the key principles of GAAP are:
Economic Entity Assumption: According to this principle, the business and its owner are two different entities and their transactions are to be recorded separately. Business is a separate legal and economic entity and exist distinctly from the owner. For example: If Mr. A is the owner of a sole proprietorship company and he has started the company by taking a loan of certain amount. The loan is to be recorded as the liability of business not as liability of Mr. A though he is responsible to pay back the loan amount.
Going Concern Concept: This principle assumes that the business will continue to exist and carry its operations for indefinite time in future. Thus the financial and accounting policies are followed to maintain the continuity of business unit (Diploma in Insurance Services). The calculation of depreciation based on the expected economic life of fixed assets is an example that the company believes it will not liquidate or forced to close down in the future.
Time Period Assumption: Though the business is assumed to continue till indefinite time period, the financial reports are prepared taking into accounts the transactions of certain time period to reduce complexity. It also allows to measure the performance and take corrective actions on time. Generally the financial statements are prepared on annual basis at the end of every fiscal year (in Ashadh) in Nepal. However, the companies prepare may also prepare weekly, monthly, quarterly or semi-annually reports as per their requirement.
Monetary Unit Assumption: This principle deals with the ability to measure transactions in monetary terms without drastic fluctuations in currency values in short term. All the transactions are expressed in dependable and stable monetary units to make the recording consistent as well as comparable. If we look at the financial statements of the government organizations in Nepal, all the values are expresses in NPR that is the adaptation of this concept.
Cost Principle: All the transactions are recorded on the basis of cost or purchase price. Thus the amounts expressed on financial statements are referred to as historical costs (Accounting Coach). For example: Besides shares and bonds, other assets are recorded on the basis of cost price and are not adjusted to represent the value. For example, the calculation of depreciation on a five year old machine is calculated on the basis of its purchase price not on the value of the machine in current time.
In addition to these, the matching principle, revenue realization principle, full disclosure principle, materiality and conservatism are also applied in recording the financial transactions based on GAAP. It tries to facilitate financial decision making process by providing comparable, credible and neutral financial information.
References
Accounting Coach. (n.d.). Introduction to Accounting Principles. Retrieved from Accounting Principles: accountingcoach.com/accounting-pri...
Diploma in Insurance Services. (n.d.). Basic Accounting Principles. Retrieved from nios.ac.in/media/documents/VocInsS...
Investopedia. (n.d.). What are ‘Generally Accepted Accounting Principles - GAAP’. Retrieved from Generally Accepted Accounting Principles - GAAP: investopedia.com/terms/g/gaap.asp