generally accepted accounting principles (gaap)

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1. Introduction • Generally Accepted Accounting Principles are the basic foundation of accounting structure. • These broad guidelines are the accounting standards in the form of rules, procedures, doctrines, tenets, assumptions, postulates, concepts and conventions which bring about uniformity in recording, classifying, summarizing, interpreting and reporting and the presentation of the accounting information.

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Page 1: Generally Accepted Accounting Principles (GAAP)

1. Introduction

• Generally Accepted Accounting Principles are the basic foundation of accounting structure.

• These broad guidelines are the accounting standards in the form of rules, procedures, doctrines, tenets, assumptions, postulates, concepts and conventions which bring about uniformity in recording, classifying, summarizing, interpreting and reporting and the presentation of the accounting information.

Page 2: Generally Accepted Accounting Principles (GAAP)

1. Introduction

• There is no specific definition of what constitute GAAPs.

– “Financial Accounting for Management” by Gupta Ambrish (Pg. No.170)

Page 3: Generally Accepted Accounting Principles (GAAP)

What is meant by Principle?

Page 4: Generally Accepted Accounting Principles (GAAP)

2. What is Principle?

• The term ‘Principle’ refer to the fundamental belief or a general truth which ones establish does not change. It also means the rule of action or conduct and can be applied to the rules of accounting.

Page 5: Generally Accepted Accounting Principles (GAAP)

2. What are Accounting Principles?

“Accounting principles are a body of doctrines commonly associated with the theory and procedures of accounting, serving as an explanation of current

practices and as a guide for selection of conventions or procedures where alternatives exist.”

Page 6: Generally Accepted Accounting Principles (GAAP)

2. Note on Kinds of Accounting Principles

Accounting principles, rules of conduct and action are described various terms such as concepts, conventions, doctrines, tenets, assumptions, axioms, postulates. For our purposes, we shall use all these terms synonymously. A little difference however, has been made between the terms concepts and conventions.

- “Principles & Practice of Accountancy” – by R.L Gupta & V.K

Gupta, Sultan Chand & Sons, pg.no.-A-9.

Page 7: Generally Accepted Accounting Principles (GAAP)

2. Note on Kinds of Accounting Principles

• “The terms concepts, convention and doctrine are sometimes used interchangeably.”• – “Advance Accounts” by Grewal, Shukla & Gupta)

Page 8: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 9: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 10: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/Postulates

“Accounting concepts includes those basic assumptions or conditions upon which the science of accounting is based. These concepts are self-evident statements or

truths and are fundamental to the accounting practice.”

Page 11: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 12: Generally Accepted Accounting Principles (GAAP)

B.1 Accounting Conventions

“Accounting conventions include those customs or traditions which guide the accountant while preparing the accounting statements. These are the rules which

are referred to for the solution of certain given problem of accounting.”

Page 13: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 14: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.1 Business Entity Concept

• From the accounting point of view every business enterprise is an entity separate and distinct from its proprietor(s)/owner(s).

• The accounting system gives information only about the business and not its owners. In other words we record those transactions in the books of account which relate only to the business.

• The owner's personal affairs (his expenditure on housing, food, clothing, etc.) will not appear in the books of account of his business.

Page 15: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.1 Business Entity Concept

• However, when personal expenditure of the owner is met from business funds it shall also be recorded in the business books. It will be recorded as drawings by the proprietor and not as business expenditure.

• Another implication of business entity concept is that the owner of business is to be treated as a creditor who also has a claim over the assets of the business. As such, the amount invested by him (capital) is regarded as a liability for the business.

Page 16: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 17: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.2 Going Concern Concept

• According to this concept it is assumed that every business would continue for a long period. Keeping this in view, the investors lend money and the creditors supply goods and services to the concern. For all practical purpose the business is normally treated as a going concern unless there is a strong evidence to the contrary.

Page 18: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.2 Going Concern Concept

• Recording of transactions in accounting is judged whether the benefits from expenses are immediate (short period, say less than one year) or a long term. If the benefits from expenses are immediate it is treated as a revenue or if the benefits are for long term, it is to be treated as capital depending upon the nature of expenses.

Page 19: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 20: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.3 Accounting Period Concept

• You know that the going concern concept assumes that life of the business is indefinite and the preparation of income and positional statements after a long period would not be helpful in taking appropriate steps at the right time.

• Therefore, it is necessary to prepare the financial statements periodically to find out the profit or loss and financial position of the business.

Page 21: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.3 Accounting Period Concept

• It also helps the interested parties to make periodical assessment of its performance. Therefore, accountants choose some shorter period to measure the results and one year has been generally accepted as the accounting period.

Page 22: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 23: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.4 Money Measurement Concept

• Usually business deals in a variety of items having different physical units such as kilograms, quintals, tons, metres, liters, etc. If the sales and purchase of different items are recorded in the physical terms, it will pose problems. But if these are recorded in common denomination their total become homogeneous and meaningful.

• Therefore, we need a common unit of measurement. Money does this function.

Page 24: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 25: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.5 Cost Concept

• The price paid (or agreed to be paid in case of a credit transaction) at the time of purchase is called cost. Under this concept fixed assets are recorded in the books of account at the price at which they are acquired. This cost is the basis for all subsequent accounting for the asset.

Page 26: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 27: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.6 Matching Concept

• The term ‘matching’ means appropriate association of related revenues and expenses. For this purpose, first we have to recognize the revenues during an accounting period and the costs incurred in securing those revenues. Then the sum of costs should be deducted from the sum of revenues to get the net result of that period.

• The question when the payment was received or made is irrelevant. In other words, all revenues earned during an accounting period, whether received or not and all costs incurred, whether paid or not have to be taken into account while preparing the final accounts.

Page 28: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 29: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.7 Realization Concept

• According to this concept revenue is recognized when a sale is made. Sale is considered to be made at the point when the property in goods passes to the buyer and he becomes legally liable to pay.

Page 30: Generally Accepted Accounting Principles (GAAP)

A.1 Accounting Concepts/PostulatesA.1.8 Accrual Concept

• The Accounting Standard – 1 (AS-1) issued by the Accounting Standard Board, the Institute of Chartered Accountants of India mentions about “accrual” as under:

• “Revenues and costs are accrued, that is, recognized as they are earned or incurred (and not as money is received or paid) and recognized in the financial statement of the periods to which they relate”

Page 31: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 32: Generally Accepted Accounting Principles (GAAP)

B.1 Accounting Conventions B.1.1 Conservatism

• Conservatism refers to the policy of choosing the procedure that leads to understatement of assets or revenues, and over statement of liabilities or costs.

• The consequence of an error of understatement is likely to be less serious than that of an error of over statement. On account of this reason, accountants generally follow the rule ‘anticipate no profit but provide for all possible losses.

• Closing stock valuation

• Provision for doubtful debts

Page 33: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 34: Generally Accepted Accounting Principles (GAAP)

B.1 Accounting Conventions B.1.2 Full Disclosure

• This concept states that the financial statements are to be prepared honestly and all significant information should be incorporated there in because these statements are the basic means of communicating financial information to all interested parties.

• The Joint Stock Companies Act, 1956 requires that Profit and Loss Account and Balance Sheet of a company must give a true and fair view of the state of affairs of the company and also provided prescribed form in which these statements are to be prepared so that significant information may not be left out.

Page 35: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 36: Generally Accepted Accounting Principles (GAAP)

B.1 Accounting Conventions B.1.3 Consistency

• The principle of consistency means that the same accounting principles should be used for preparing financial statement for different periods. It means that there should not be a change in accounting methods from year to year.

• Consistency eliminates personal bias and helps in achieving comparable results.

• However, consistency does not prohibit change. When a change is desirable, the change and its affect should be clearly stated in financial accounts.

Page 37: Generally Accepted Accounting Principles (GAAP)

3. Accounting Principles (Classified)

Accounting Principles

Accounting Concepts

Business Entity Concept

Going Concern Concept

Accounting Period Concept

Money Measurement Concept

Cost Concept

Matching Concept

Realization Concept

Consistency

Materiality

Conservatism

Full Disclosure

Accounting Conventions

Page 38: Generally Accepted Accounting Principles (GAAP)

B.1 Accounting Conventions B.1.4 Materiality

• American Accounting Association defines the term materiality as “An item should be regarded as material if there is reason to believe that knowledge of it would influence the decisions of informed investor”.

• All material information should be disclosed through the financial statements accompanied by necessary notes.

Page 39: Generally Accepted Accounting Principles (GAAP)

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