2. Concept & Definition
The common set of accounting principles,
standards and procedures that companies use to
compile their 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.
GAAP are imposed on companies so that
investors have a minimum level of consistency in
the financial statements they use when analyzing
companies for investment purposes.
Companies are expected to follow GAAP rules
when reporting their financial data via financial
statements to avoid the variation of financial
3. Major Components of the GAAP.
GAAP
Basic
principles
Assumptions
or
Conventions
Doctrines or
Standards
5. 1) ENTITY PRINCIPLE
Owners are treated as two separately identifiable
parties.
Business stands apart from other organizations as a
separate economic unit.
It is necessary to record the business's transactions
separately, to distinguish them from the owners'
personal transactions. This helps to give a correct
determination of the true financial condition of the
business..
Personal transactions of owners are treated
separately from those of the business. As such, each
can be treated as a separate accounting entity, that
is, the account of the owner must be kept separately
from the account of the company he or she owns.
6. 2) DOUBLE ENTRY PRINCIPLE
Every transaction has two effects.
Accounting attempts to record both effects of a
transaction or event on the entity's financial
statements.
Without applying double entry concept,
accounting records would only reflect a partial
view of the company's affairs.
The two effects of an accounting entry are known
as Debit (Dr) and Credit (Cr). Accounting system
is based on the principal that for every Debit
entry, there will always be an equal Credit entry.
This is known as the Duality Principal. -
7. 3) COST PRINCIPLE / HISTORICAL
COST
Accounting requires the accounting transactions
to be recorded at their historical costs – the
original value, that is the value exchanged at the
time of their acquisition. This is called historical
cost principles.
Historical cost is the value of a resource given up
or a liability incurred to acquire an asset/service
at the time when the resource was given up or
the liability incurred.
In subsequent periods when there is appreciation
is value, the value is not recognized as an
increase in assets value except where allowed or
required by accounting standards.
8. 4) ACCOUNTING EQUATION
It was also called as the balance sheet equation,
represents the relationship between the assets,
liabilities, and owner's equity of a business.
It is the foundation for the double-entry bookkeeping
system. For each transaction, the total debits equal
the total credits.
It can be expressed as:
Assets = Liabilities + Owners Equity
In a corporation, capital represents the stockholders'
equity. Since every business transaction affects at
least two of a company’s accounts, the accounting
equation will always be “in balance,” meaning the left
side should always equal the right side.
Thus, the accounting formula essentially shows that
what the firm owns (its assets) is purchased by either
what it owes (its liabilities) or by what its owners
invest (its shareholders equity or capital).
9. 5) MATCHING PRINCIPLE
The matching principle states that expenses
should be recorded during the period in which
they are incurred, regardless of when the transfer
of cash occurs.
The principle that requires a company to match
expenses with related revenues in order to report
a company's profitability during a specified time
interval.
As a result, prepaid expenses are not recognized
as expenses, but as assets until one of the
qualifying conditions is met resulting in a
recognition as expenses.
10. Assumptions or Conventions
1) GOING CONCERN
2) FIXED TIME PERIOD ASSUMPTION -
ACCOUNTING PERIOD
3) STABLE DOLLAR OR MONETARY VALUE
11. 1) GOING CONCERN
Financial statements are prepared assuming that
a business entity will continue to operate in the
foreseeable future without the need or intention
on the part of management to liquidate the entity
or to significantly curtail its operational activities.
In other words, unless otherwise noted, financial
statements are prepared under the assumption
that the company will remain in business
indefinitely.
Therefore, assets do not need to be sold at
fire‐sale values, and debt does not need to be
paid off before maturity. This principle results in
the classification of assets and liabilities as
short‐term (current) and long‐term.
12. 2) FIXED TIME PERIOD ASSUMPTION -
ACCOUNTING PERIOD
Going Concern Concept signifies that the
business entity will remain existence for an
unknown future or it's perennial existence.
However it's not possible to ensure continued
existence of a business entity with out
ascertaining the performance result & Assets-
Liabilities status periodically.
All entities need to report their results in the form
of either profit or operating surplus, determined in
particular periods of time, such as a months or a
year, in order to get comparability of results. This
divisions of the life of the entity into equal time
intervals is knows at period assumption
13. 3) STABLE DOLLAR OR
MONETARY VALUE
An economic entity's accounting records include
only quantifiable transactions and all accounting
transactions are recorded in terms of monetary
value.
The use of a monetary value makes it easy to
compare financial data, and it is the common
factor of all business transactions.
14. Doctrines or Standards
1) OBJECTIVITY
2) CONSITENCY
3) FULL DISCLOSURE
4) MATERIALITY
5) CONSERVATISM
15. 1) OBJECTIVITY
In accounting a company's financial information
must be based on verifiable data.
Accounting will be recorded on the basis of
objective evidence. Objective evidence means
that different people looking at the evidence will
arrive at the same values for the transaction.
Accounting entries will be based on fact and not
on personal opinion or feelings.
The source document for a transaction is almost
always the best objective evidence available.
16. 2) CONSISTENCY
The convention of consistency means that same
accounting principles should be used for
preparing financial statements year after year.
A meaningful conclusion can be drawn from
financial statements of the same enterprise when
there is comparison between them over a period
of time.
But this can be possible only when accounting
policies and practices followed by the enterprise
are uniform and consistent over a period of time.
17. 3) FULL DISCLOSURE
Financial statements normally provide information
about a company's past performance. However,
pending lawsuits, incomplete transactions, or other
conditions may have imminent and significant effects
on the company's financial status.
The full disclosure principle requires that financial
statements include disclosure of such information.
Footnotes supplement financial statements to convey
this information and to describe the policies the
company uses to record and report business
transactions.
In other words, full disclosure requires that all material
and relevant facts concerning financial statements
should be fully disclosed. Full disclosure means that
there should be full, fair and adequate disclosure of
accounting information.
18. 4) MATERIALITY
The convention of materiality states that, to make financial
statements meaningful, only material fact i.e. important
and relevant information should be supplied to the users of
accounting information.
The materiality of a fact depends on its nature and the
amount involved. Material fact means the information of
which will influence the decision of its user
Accountants follow the materiality principle, which states
that the requirements of any accounting principle may be
ignored when there is no effect on the users of financial
information.
Certainly, tracking individual paper clips or pieces of paper
is immaterial and excessively burdensome to any
company's accounting department.
Although there is no definitive measure of materiality, the
accountant's judgment on such matters must be sound.
Several thousand dollars may not be material to an entity
such as General Motors, but that same figure is quite
material to a small, family‐owned business.
19. 5) CONSERVATISM
This convention is based on the principle that
“Anticipate no profit, but provide for all possible
losses”. It provides guidance for recording
transactions in the books of accounts. It is based
on the policy of playing safe in regard to showing
profit.
The main objective of this convention is to show
minimum profit. Profit should not be overstated.
As such, in reporting financial data, accountants
follow the principle of conservatism, by
adopting the less optimistic estimate be chosen
when two estimates are judged to be equally
likely.
