What is GAAP in Accounting?
Generally accepted accounting principles (GAAP) are the minimum standard and uniform guidelines for the accounting and reporting which establishes proper classification and measurement criteria of financial reporting and provides a better picture when the financial reports of different companies are compared by the investors.
In simple words, it is defined as the collection of commonly used and followed accounting rules and procedures for the Financial reporting of a company. GAAP describes us about the accounting concepts and the principles to be followed while preparing a financial statement of a company or a Firm.
- GAAP standards change from place to place. For example, in the United States, they follow the Securities and Exchange Commission ( SEC), which mandates the financial reports stick to the requirements.
- Many countries in the world follow International Financial Reporting Standards (IFRS). IFRS is followed in more than 110 countries. IFRS specifies to prepare and disclose the financial statement of the companies globally.
- Indian Accounting Standard (Referred to as Ind-AS) is the accounting standard adopted by the Indian companies under the supervision of the Accounting Standards Board (ASB ).
Why GAAP?
- To make transparent and fair of the Accounting and the financial reporting of the company and
easily understandable to ordinary people. - The Generally Accepted Accounting Principles is necessary for the accounting rules and the standardizing the reporting of financial
statements like balance sheets, income statement and the cash flow statement for all the
companies. - The financial statements prepared under GAAP are intended to show the economic reality.
What Happens if GAAP is Not Available?
- Without these principles, there are chances of fraudulent cases in Accounting and financial reporting. Thus affecting the interest of the Investors and the creditors in the market.
- Without Generally Accepted Accounting Principles, companies would be free to decide themselves what financial information to report and how to report it, which will be very difficult for the investors and creditors who have stake or shares in that company.
- For example, if we see the Punjab National Bank scam happened due to fraudulent financial reporting by the employees, auditors, and the customer without practicing any of the accounting rules and standards, because of which the ultimate losers are the Investors who invested in that company.
Advantages of Generally Accepted Accounting Principles
- It promotes the interest of the Investors, Shareholders, and Creditors in the market.
- By following Generally Accepted Accounting Principles, procedures, consistency can be maintained and the overall performance can
be determined. - Identifying the areas that need improvement and required modifications for the better
performance of the company. - The financial reports which are made using the GAAP help to maintain investor’s trust and interest in investments of that company;
- Complying with GAAP gives the guarantee to anyone who wants to invest in that company.
- With the help of the GAAP report, one can easily understand the financial statements and can also compare easily with another.
- Generally Accepted Accounting Principle, reports it is easy to find out the profit, loss, expenses, investment, income, and revenues of the company.
- Generally Accepted Accounting Principles reduce risks and avoids fraud cases by monitoring them properly.
The Basic Principles of Generally Accepted Accounting Principles
The following are the top 10 basic principles of GAAP (Generally Accepted Accounting Principles).
#1 – The Business as a single Entity Principle
A business is a separate entity in terms of the law. All its activities are treated separately from that of its owners. In terms of accounting, the business is independent, and the owners are different.
#2 – The Specific Currency Principle
A currency is specified for the reporting of financial statements. In India, we deal with Indian Rupee. Hence it should be treated as INR for the money specific. In the United States, they economically deal with the US dollar, and their financial reporting will be mentioned in USD.
#3 – Time period Specific Principle
Financial statements pertain to a specific period i.e., end time and start time. Balance sheets are also reported on a particular date, like monthly, quarterly, half-yearly, and annually.
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#4 – The Cost Principle
In accounting, “Cost” refers to the amount spent on obtaining the goods or services. Hence for this, the amounts shown in the financial statements also referred to as the Historical cost amounts.
#5 – The full disclosure Principle
The Full disclosure principle states that a company should disclose all the financial statements fully. It is vital for an investor or the lender to know about the significant account policies. A company generally lists its accounting policies as the first note to its financial statements.
#6 – The Recognition Principle
This revenue recognition principle states that the companies should reveal the income and expenses of the company in that period where they have occurred.
#7 – The Non-death Principle of Business
It is also called as Principe of continuity as for accounting. There should not be an end as its continuing to operate until and unless any winding up of the company.
#8 – Matching Principle
This Matching Principle requires companies to use the accrual basis of accounting. The matching principle requires that expenses should be matched with the revenues.
#9 – The Principle of materiality
This Principle generally states about the adjustment of the very minute errors, that is, while maintaining accounting reports, there could be some small errors like $5 error which is not matching, here this can be used and adjusted accordingly.
#10 – The Principle of Conservative Accounting
Conservative Accounting Principle should be adopted by all companies wherein when expenses occur that are to be recorded immediately, but the income to be recorded when actual cash flow is there. In addition to all these, the Principle of Honesty to be maintained.
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