GENERALLY ACCEPTED

ACCOUNTING PRINCIPLES (GAAP)

THE NEED FOR RECOGNIZED ACCOUNTING STANDARDS/PRINCIPLES
The basic purpose of financial statements is to provide information about a
business entity –information that will be useful in making economic decisions.
Investors, managers, creditors, financial analysts, economist and government
policy makers all rely upon financial statements and other accounting reports in
making the decisions which shape our economy. Therefore, it is of vital
importance that the information contained in financial statements possess
certain characteristics. The information should be:-

i) Relevant to the information needs of the decision makers.

ii) As reliable as possible.
iii) Comparable to the financial statements of prior accounting periods and
also to the statements of other companies.
iv) Understandable to the users of the financial statements.

• Therefore FASB (Financial Accounting Standard Board) and APB (Accounting

Principles Boards) form some Rules/Standards /Principles which are known
as GAAP (Generally Accepted Accounting Principles and (IAS) International
Accounting Standards and IFRS (International Financial and Reporting
Standards).
• The Principles which constitute the ground rules for financial reporting are
called Generally Accepted Accounting Principles. They may also be known as
Standards, Assumptions, Conventions or Concepts.

Accounting Concepts/Principles-(GAAP)
Generally Accepted Accounting Principles (GAAP):-
 The accounting profession has developed standards and concepts that are
used for financial reporting purposes. These common set of standards and
concepts is called Generally Accepted Accounting Principles
(GAAP).These standards may also be called standards, assumptions,
convention, or concepts. These standards are the building blocks of
accounting.
These Concepts & Standards are the following:-
1. The Accounting Entity Principle
2. The Going- Concern Assumption.
3. The Time Period Principle.
4. Monetary unit principle
5. The Objectivity Principle.
6. The Historical Cost Principle
7. The Revenue recognition Principle (Realization principle).
8. Expense recognition principle (Matching Principle).
9. The Consistency Principle
10. The Materiality Principle.

1. The Accounting Entity Principle

It means that the activities of the business entity be kept separate and
distinct from:
(i) The activities of its own
(ii) All other economic entities
The reason for this principle is that separate information about each
business is necessary for good decision. A business entity can take one
of the three legal forms: proprietorship, partnership, or corporation.
2. The Going- Concern Assumption.

It means, a basic principle in accounting is assumed that a company will

continue to operate for indefinite time period.
3. The Time Period Principle

It means that for financial reporting purpose, the life of a business must
be divided into series of relatively short accounting periods of equal
length, such as, month, quarter, and year. You must include in the header
of any Financial Statement the time period covered by the statement. For
example, an Income Statement may cover the "six Months ended
December 31, 2017

4. Monetary Unit Principle

It states that select only those transactions to record in books of accounts

that can be expressed in terms of currency. Thus, you cannot record such
non-quantifiable items as employee skill levels or the quality of customer
service.

5. The Objectivity Principle

It means that accounting information is supported by independent,

unbiased evidence. It demands more than a person’s opinion. Information
is not reliable if it is based only on what a preparer thinks might be true.

6. The Historical Cost Principle

It means that accounting information is recorded on actual cost price. Cost
is measured on a cash or equal to cash basis. This means if cash is given
for a service, its cost is measured as the amount of cash paid. If something
instead of cash is exchanged (such as a truck is traded for a car), cost is
measured as the cash value of what is given up or received.

7. The Revenue Recognition Principle (Realization Principle)

Under the accrual basis of accounting (as opposed to the Cash Basis of
Accounting), revenues are recognized as soon as a product has been sold
or a service has been performed, regardless of when the money is actually
received. Under this basic accounting principle, a company could earn and
report Rs.20000 of revenue in its first month of operation but receive Rs.
0 in actual cash in that month.

8. Expense Recognition Principle/(Matching Principle).

According to this principle, the expenses are matched with revenues. For
example, sales commission’s expense should be reported in the period in
which its related sales have been made.

9. The Consistency Principle.

It means that when a particular accounting method, once adopted, it will
not be changed from period to period. This assumption is important
because it assists users of financial statements in interpreting changes in
financial position and changes in net income from the preceding year.

10. The Materiality Principle.

According to this principle, an accountant might be allowed to violate
another accounting principle if an amount is insignificant. Professional
judgment is needed to decide whether an amount is insignificant or
immaterial.

EXAMPLE:-
An example of an obviously immaterial item is the purchase of a Printer
of Rs.5000/= by a Highly Profitable Multi-Million Company. Because
the printer will be used for five years, the “Matching Principle” directs
the accountant to expense the cost over the five-year period. The
Materiality Guideline/Principle allows this company to violate the
matching principle and to expense the entire cost of Rs.5000 in the year
it is purchased. The justification is that no one would consider it
misleading if Rs5000 is expensed in the first year instead of Rs.1000
being expensed in each of the five years that it is used.
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