GAAP – Accounting is also referred to as the process of recording, classifying, and summarizing financial records. As in every type of craft, accounting often requires the use of one’s artistic talents to keep a database of financial transactions. Whereas if free rein is granted to the accounting scheme to be practiced, the extent of the abuse of the accounts would not be restricted.
The Generally Accepted Accounting Principles (GAAPs) are fundamental accounting principles and frameworks that establish a basis for even more formal and rigorous accounting laws, standards, and other industry-specific accounting methods. For instance, the Financial Accounting Standards Board (FASB) utilizes these guidelines as a framework for drawing up its own accounting rules. thus the GAAP consists of the following:
- Principles/Guidelines for basic accounting
- Accounting requirements are typically provided by the chief accounting body of the nation
- Industry-specific accounting standards to address uncommon situations
In India, financial statements are drawn up on the basis of accounting principles published by the Institution of Chartered Accountants of India (ICAI) and the regulations placed down in the relevant acts (for instance, Schedule III of the Companies Act, 2013 to be observed by all companies). ICAI also provides guidance reports on different subjects from time to time to aid with the accounting process and offer clarification. Although simple accounting principles do not be part of accounting rules and relevant regulations explicitly, they are presumed and required to be uniformly practiced.
Following are the Generally Accepted Accounting Principles (GAAP)
Business entity Assumption
It says that a business organization must be regarded as an entity independent of its shareholders. Consequently, all financial transfers can also be differentiated in this way. This definition is extremely important when tracking the financial activities of a single owner. If the whole company and its properties and obligations belong to the owner, the financial activities must be differentiated from those relating to the business as well as those relevant to the owner himself.
Monetary Unit Assumption.
Both financial transactions of a company must be worthy of being represented in a currency unit (e.g. Indian Rupees) and if this is not practicable, must not be reported in the records of the company accounts.
This theory assumes that the accounting process of a company must be done within a defined amount of time, which would be typically a financial year or a calendar year. Consequently, any transaction relating to a given time period would be part of the financial statements prepared for that time.
Historical Cost Concept.
As a rule of thumb, when such economic resources or assets are purchased via an organization, they are reported as cash and cash equivalents directly expended on the purchase of the resource or commodity on the day of the sale – regardless though the transaction occurs the previous day or ten years earlier. This will contribute to the consistent valuation of the residual asset regardless of the accounting period. The market valuation of the asset shall not be taken into consideration unless expressly allowed by statute or accounting standards.
Going Concern Assumption.
The business entity is considered to be a continuing concern, i.e. it will continue to function for an undefined period of time. This presumption is essential because if the company company were to liquidate in the immediate future, it would have to recover its assets and obligations in line with the appropriate sum that could be calculated or payable, as the situation could be in order to represent the accurate financial condition of the company.
Full disclosure Principle.
An accounting entry could not be sufficient to include all the necessary facts pertaining to the transaction separately. Accordingly, the full disclosure principle allows the company to report any financial details related to the client/user in order to support the investor in the decision-making process. At the transaction level, this is achieved by documenting an appropriate narrative of each transaction and at the level of the financial statements, by making notes to the accounts.
This definition demands that the income for a given period be compared to the corresponding expense in order to display the true benefit for that period.
Accrual Basis of Accounting
This theory demands that both revenue and expenses be reported within the time currently incurred and not when cash or cash equivalents have been received/spent. Earnings from income and incurrence of expenditure are significant, regardless of the resulting cash flow.
An entity may choose to accept a certain accounting protocol for a series of transactions. These accounting procedures must be implemented continuously over the subsequent accounting years in order to allow reconciliation of the outcomes of the two periods. For example, an organization can choose to follow a straight-line depreciation approach for its tangible fixed assets. Even in the coming years, this approach has to be continuously pursued.
This accounting theory requires an individual to neglect another accounting principle provided the outcome doesn’t really impact the judgement process of the recipient of the financial statements. Such mistakes or omissions can also be omitted if they have an immaterial impact on the financial statements. For example, whenever a fixed asset is acquired, the matching principle involves an individual to consider the cost over the functional life of the asset. If an individual buys a keyboard for Rs. 300 and the entity’s revenue is in the crores of ropes, it will be immaterial to the recipient of the financial statements if the asset is regarded as an asset or an expense. Therefore, even though the electronic keyboard is deemed to be an expenditure in the year of procurement, the fundamental accounting rules will not be broken, because the quantity concerned and the effect of such is immaterial.
In the accounting process, separate circumstances can exist in which there are two equally appropriate means of accounting for a specific transaction. One could also choose between recording a transaction or not recording the same thing. A cautious strategy should be adopted in such a scenario. This ensures that when accounting for a single purchase, all anticipated costs or expenses would have to be compensated for, but all future profits or benefits should not be reported until they are eventually earned/received. That is why a provision is made for expenditures such as bad loans, but no equivalent documentation is given for an improvement in the achievable value of the asset.