GAAP is a set of accounting principles, methods, procedures that are used by accountants to record and report the financial statement or information. GAAP refers to Generally Accepted Accounting Principles. Financial Accounting Standards Board (FASB) uses these methods and procedures. All these accounting principles are set by the accounting professionals and the SEC peoples.
In the US it’s mandatory for public companies to follow the GAAP standards and according to these standards, the financial statements are to be prepared by the accountants. If the companies use GAAP standards then their financial statement will be more clear, consistent, and comparable with future use.
It is used by organizations to:
- Records should be properly organized and analyzed
- Summary of the financial statement
- Discloser of the certain information
Principles of GAAP
- Recognition—what should be included in the financial statements Like assets, liabilities, revenues, and expenses
- Measurement—in what ratio the reported should be done for each element which is included in the financial statements,
- Presentation—How many items, subtotals, and totals should be displayed in the financial statements, and how aggregation will be done in the financial statements
- Disclosure—what type of information should be displayed to the users in the financial statements.
Methods of Generally Accepted Accounting Principles(GAAP)
- Business Entity Assumption: Every business entity will be treated as a different entity from the owner’s entity. All financial transactions should also be disclosed in such a manner that all the personal assets and liabilities are separately disclosed and the business assets and liabilities as another entity.
- Monetary Unit Assumption: All the financial transactions should be clearly disclosed so that they capable to expressed in a monetary unit of the business.
- Accounting Period: This principle says that the accounting process of a business should be completed with a particular time period and after that new financial year should be started. Every year from a certain time to a particular time period the financial statements should be prepared
- Historical Cost Concept: FASB says that when you acquire certain economic resources or assets then they are recorded as per the cash which is spent on to acquire that resource. Whether that transaction happened the previous day or ten years ago. The market value of the asset is not taken into account unless the accounting standard.
- Going Assumption: The financial statements are prepared under the going concern assumption that the company will remain in business whether they have assets or not. The assets do not require to be sold at sale values, and all the debt does not need to be paid before maturity. This principle results in the classification of assets and liabilities as short‐term and long‐term.
- Full Disclosure Principle: An accountant need not disclose all the accounting entries and they not suppose to provide all the information relating to the transaction. The full disclosure principle says only those entities should be disclosed to the investor/user which are relevant to them and which assist them to make a decision.
- Matching Concept: This concept says that the revenue for a particular period should be matched with the corresponding expenditure so as to show the true profit for the period.
- Accrual Basis of Accounting: This principle says all revenue and expenditure to be recorded in the incurred time period and not when the process of cash has been taken place.
- Consistency: An accountant needs to follow a particular procedure and method for the series of transactions and the relationship between each and every entity. Such accounting procedures need to be followed between all the accounting statements of the different years so that we can compare the result between two financial statements of the different year. There should be consistency while making the statements.
Materiality principle. this materiality principle states that sometimes the accounting principle may be ignored and there will be no effect on the users of financial information. Tracking individual data will be difficult and put burdensome for any company’s accounting department.