Accounting GAAP


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Accounting GAAP

  1. 1. AccountingThe process of recording of business transactions is called accounting.ORThe action or process of keeping financial accounts is called accounting.Recording provides information about different interested parties such as:1 - Shareholders2 - Management3 - Employees4 - Investors5 - Creditors6 - Government7 - Owners8 – Competitors etcSome of them are internal and some of them are external.Internal interested parties:Internal parties of a business mean the management of business. Management prepare the budgetsfor the business, in other words we can say that management recognizes the future transaction andestimates the monitory effect of these transaction, But the management prepares the budgets, onlyfor internal use for this purpose the management adopts a system which is called managementaccounting information system.ORInternal interested parties are parties inside the reporting entity or company who are interested inaccounting information.For example, 1. The-Management helps in planning, decision making and controlling. 2. Employees, who use accounting information to determine a companys profitability and profit sharing.Managerial accounting: provides information that is useful in running a company by internal users.Such reporting is usually accomplished through custom-designed (or managerial) reports.External interested parties:External interested parties are parties outside the reporting entity or company who are interested inthe accounting information.For Example:
  2. 2. Investors (i.e., owners), who use accounting information to make buy, sell or keep decisions related toshares, bonds, etc.Creditors (i.e., suppliers, banks), who utilize accounting information to make lending decisions.Taxing authorities (i.e., Internal Revenue Service), who need accounting information to determine acompanys tax liabilities.Customers, who may need accounting information to decide which products to buy from whichcompanies.Financial accounting: provides information that is designed to satisfy the needs of external users.Such reporting is usually done in the form of financial statements.Accounting Cycle:The name given to the collective process of recording and processing the accounting events of acompany. The series of steps begin when a transaction occurs and end with its inclusion in thefinancial statements. There are some steps in accounting cycle which are given below: 1. Recording: a. Collecting and analyzing data from transactions and events. b. Putting transactions into the general journal (Chronological record of transactions, showing an explanation of each transaction). 2. Classifications: Posting entries to the general ledger. 3. Summarization: a. Preparing an unadjusted trial balance. b. Adjusting entries appropriately. c. Preparing an adjusted trial balance. 4. Financial Reporting: a. Organizing the accounts into the financial statements. i. Income Statement: Prepared from revenue, expenses, and gains and losses. ii. Balance Sheet: Prepared from assets, liabilities, and equity accounts. iii. Statement of retained earnings: Prepared from net income and dividend information. iv. Cash flow statement: Derived from other financial statements using either direct or indirect method. b. Closing the books. (Close temporary accounts such as revenues, expenses, gains and losses and transfer the balances of temporary accounts (e.g revenues and expenses) to owner’s equity) c. Post closing entries to ledger accounts and after closing the trial balance, a final trial balance is calculated after closing entries are made.
  3. 3. The accounting cycle is a methodical set of rules to ensure the accuracy and conformity of financialstatements. Computerized accounting systems have helped to greatly reduce mathematical errors inthe accounting process, but the uniform process of the accounting cycle also helps reduce mistakes.Financial statements:Internal and External management is known as financial statements. Financial statement givesinformation regarding finance.There are few types of financial statements: 1. Balance Sheet 2. Income Statement 3. Income owner equity 4. Statement of cash flowFiscal year of Pakistan: 1st July-30th June.It is a period in which all the business transactions of a year are classified and analyzed. Normal durationis from 3-12 months. Months are known as fiscal months and a year is known as fiscal year.GAAP (Generally Accepted Accounting Principles):The common set of accounting principles, standards and procedures that companies use to compiletheir financial statements. GAAP are a combination of authoritative standards (set by policy boards)and simply the commonly accepted ways of recording and reporting accounting information.ORThe rules that govern accounting are called GAAP (Generally Accepted Accounting Principles).Explanation:GAAP are imposed on companies so that investors have a minimum level of consistency in thefinancial statements they use when analyzing companies for investment purposes. GAAP cover suchthings as revenue recognition, balance sheet item classification and outstanding share measurements.Companies are expected to follow GAAP rules when reporting their financial data via financialstatements. If a financial statement is not prepared using GAAP principles, be very cautious!That said, keep in mind that GAAP is only a set of standards. There is plenty of room within GAAP forunscrupulous accountants to distort figures. So, even when a company uses GAAP, you still need toscrutinize its financial statements.3 Main Categories of GAAP:
  4. 4. 1. Assets: an asset is an item of value owned by a company. Assets may be tangible physical items or intangible items with no physical form. Assets add value to a company, and are important to a companys continued success. As with assets, you may look at the wider world to gain an understanding of whats a liability. No one is particularly pleased when he or she is described as a "liability". This is so because the liability description is a negative one. 2. Liabilities: In accounting, liabilities are obligations of the company to transfer something of value (an asset - see above) to another party. On a company’s balance sheet, a liability may be a legal debt or an accrual, which is an estimate of an obligation. 3. Equity: Equity is the owners value in an asset or group of assets. In accounting, equity is usually defined as the value of the assets contributed by the owners. This is added to the total income earned and retained by the company to give the companys total equity value. This description of equity is correct but very simplistic. A more profound description is really that used by the homeowner, that is, equity is the owners value in an asset or group of assets. As an example, a company with total assets valued at $1,000, may have debt (liabilities) valued at $900, in which case the owners value in the assets is $100, representing the companys equity. The following is the Equity equation: Total Assets minus Total Liabilities (T - A = E). T - A (or Equity) is also referred to as Net Worth, Capital & Shareholders Equity.GAAP Principles:The GAAP principles are divided into two categories: 1. Accounting Concepts: Accounting Concepts are basic assumptions or conditions upon which science of accounting is based. Accounting Concept includes: a) Separate Entity Concept: It is helpful in keeping the business affairs strickly free from the effect of the private affairs of the proprietor(s). Consequently: Amount invested by the proprietor is shows as “ Liability”. Amount paid for the personal expenses of the proprietor are shown as drawings from the capital of the proprietor. b) Money Measurement Concept: Only the transactions which can be recorded in terms of money are recorded. Many significant events like low morale of work force, production manager’s resignation etc. are not capable to be expressed in monetary terms are not recorded. This is being used so as to provide a common yardstick (i.e. money) for measurement. c) Dual Aspect Concept (IMP): Every business transaction has a dual affect i.e. it affects two accounts. This is based on accounting equation:
  5. 5. Liabilities = Assets Owner’s equity + Outsider’s equity = Assets This equation can be explained as “for every debit there is an equivalent credit”. Double entry system of book keeping is based on this concept. d) Matching Concept: It is the basis for recording expenses and includes two steps: 1. Identify all the expenses incurred during the accounting period. 2. Measure the expenses and the match the expenses against the revenues earned. Revenues – Cost = Net income or Profit. e) Going Concern Concept: Business would continue to operate indefinitely in the future. Business will not cease doing business, neither; it will sell its assets to pay off its liabilities. f) Cost Concept: Assets and liabilities should be recorded at the historical cost i.e costs on as acquisition. g) Accounting Period Concept: Accounting period is the span of time, at the end of which financial statements are prepared to throw light on the results of the operations at the end of a relevant period and the financial position at the end of a relevant period. h) Realization Concept: The Revenue principle governs two things: 1. when to record revenue 2. Amount of revenue to record To be recognized, revenue must be: Earned: Goods are delievered or a service is performed. Realised: Cash or claim to cast (credit) is received in exchange for goods and services rendered.2. Accounting Conventions: Accounting Conventions include those customs and traditions which are followed up by an accounting while preparing a financial statement. Accounting Convention Includes: a) Full Disclosure: Financial statements should be honestly prepared and sufficiently, disclose information which is of material interest to proprietors, present and potential creditors and investors. b) Conservatism: c) Materiality: Only material or significant details are to be recorded leaving the insignificant or minute details. This is done to prevent overburdening of accounts. d) Consistency