Generally Accepted Accounting Principles

2

GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Contents of the Lecture   

Meaning of GAAP GAAP Accounting Standards

Generally Accepted Accounting Principles 

GAAP are the body of doctrines commonly associated with the theory and procedure of accounting serving as an explanation of current practices and as guide for selection of conventions and procedures where alternatives exist.

GAAP 

According to American Institute of Certified Public Accountants (AICPA), the principles which have substantial authoritative support become a part of Generally Accepted Accounting Principles

AS-1 Disclosure of Accounting Policies According to AS-1 issued by ICAI, the ‘Fundamental Accounting Assumptions’ while drafting accounts of a business enterprise are:  Going Concern,  Matching (or Accrual)  Consistency.

AS-1 Disclosure of Accounting Policies Considerations in selection of Accounting Policies are:  Prudence  Substance over Form  Materiality

GAAP The GAAP includes the following concepts: 1. Accounting Entity 2. Money Measurement 3. Going Concern 4. Accounting Period 5. Cost 6. Revenue Recognition (or Realization) 7. Matching (or Accrual) 8. Dual Aspect

GAAP contd……. 9. 10. 11. 12. 13. 14. 15. 16.

Full, Fair and Adequate Disclosure Verifiable Objectivity Materiality Consistency Conservatism (or Prudence) Timeliness Industry Practices Substance over Form

Accounting Entity 

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A business is treated as a separate entity that is distinct from its owner(s), and all other economic proprietors. For example, if the household expenses (Rs.12,000/-) of proprietor are shown as business expense, the profits of a business will be understated to the extent of Rs.12,000/-.

Money Measurement 

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Only those transactions which are capable of being expressed in term of money are included in the accounting records. For e.g., entrance of a new competitor in the market, rift between production and marketing department, ill health of the managing director etc.

Going Concern 

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The business activities will continue for a fairly long period of time unless and until the business has entered into a process of liquidation. It does not imply permanent existence but simply stability and continuity for a period sufficient to carry business plans.

Accounting Period 

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The economic life of an enterprise is artificially split into periodic intervals which are accounting periods, at the end of which an income statement and position statement are prepared to show the performance and financial position. The use of this assumption further requires the allocation of expenses between capital and revenue.

Cost Principle 

An asset is ordinarily recorded in the accounting records at the price paid to acquire it at the time of its acquisition and the cost becomes the basis for the accounts during the period of acquisition and subsequent accounting periods.

Revenue Recognition (or Realization) 

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Revenue is considered as realized or earned on the date when the sale process is complete and transfer of title or ownership takes place Revenue results in increase in owner’s equity. It has nothing to do with inflow of cash. Goods can be sold for cash or on credit.

Matching (or Accrual) 

The expenses incurred in an accounting period should be matched with the revenues recognized in that period, that is, if revenue is recognized on all goods sold during a period, cost of those goods sold should also be charged to that period.

Dual Aspect 

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The entry made for each transaction is composed of two parts – one for debit and another for credit. Every debit has equal amount of credit. So, the total of all debits must be equal to the total of all credits Sum of assets on one hand and sum of obligations on other hand must agree. Identity of assets and obligations (capital and liabilities) is expressed in the form of a basic Accounting Equation as given below: Assets = Capital + Liabilities

Full, Fair and Adequate Disclosure 

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Full disclosure essentially means that nothing is omitted. Fair Disclosure means that the accounting principles have been applied in a fair manner so as to report the true and fair view of the results of the business. Adequacy is a qualification which ensures that anything which influences the decision of the user must always be reported.

Verifiable Objectivity 

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Accounting records are based on documentary evidence which can be verified objectively and substantiates the recorded event Source documents such as sales bill, purchase bill, pay in slip, cash memo etc. ensure objective recording of business transactions.

Materiality 

Materiality requires that accounting should focus on material facts and resources should not be wasted in recording and analyzing immaterial and insignificant fact.

Consistency 

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Whatever accounting practices are selected for a given category of transactions, they should be followed on a horizontal basis from one accounting period to another to achieve compatibility However, it does not mean lack of flexibility. It does not prelude desirable changes in accounting procedures.

Conservatism (or Prudence) 

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‘anticipate no profit but provide for all probable losses’ In the situation of uncertainty and doubt, the business transactions should be recorded in such a manner that the profits and assets are not overstated and the losses and liabilities are not understated.

Timeliness 

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Financial reports must be timely to have any usefulness for decision makers. If the quarterly reports are made available on half-yearly basis, the information contained in the quarterly report would not be very useful to the decision makers

Industry Practices 

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Sometimes, practice prevailing in a particular industry is given precedence over generally accepted accounting principles Example is valuation of gold on the basis of market price

Substance over Form 

Transactions and other events should be accounted for and presented in accordance with their substance and financial reality and not merely with their legal form

ACCOUNTING STANDARDS 

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An Accounting Standard is a selected set of accounting policies or broad guidelines regarding the principles and methods to be chosen out of several alternatives Accounting Standards are formulated with a view to harmonise different accounting policies and practices in a country.

Objective of AS 

The objective of Accounting Standard is to reduce the accounting alternatives in the preparation of financial statements within the bounds of rationality, thereby ensuring comparability of financial statements of different enterprises with a view to provide meaningful information to various users of financial statements to enable them to make informed economic decisions.

International Harmonization of Accounting Standards 

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International Accounting Standards Committee (IASC) was set up in 1973 IASC is renamed as International Accounting Standards Board (IASB) ICAI being a member body of IASC, constituted the Accounting Standards Board (ASB) on 21st April, 1977

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The ASB gives due consideration to International Financial Reporting Standards (IFRSs) / International Accounting Standards (IASs) issued by IASB and tries to integrate them, to the extent possible, in the light of conditions and practices prevailing in the country.