Generally Accepted Accounting Principles (GAAP): Assumption and Features
Arjun EP
What is GAAP ?
GAAP (Generally Accepted Accounting Principles) is a collection of commonly followed accounting principles, rules and standards for financial reporting.
The acronym is pronounced “gap”.
The American Institute of Accountants (AIA) first used GAAP terminologies in 1936.
GAAP include definitions, concepts, principles as well as industry-specific rules.
The purpose of GAAP is to ensure that financial reporting is transparent and consistent (similar) from one organization to another.
GAAP represents a set of broad concepts and detailed practices.
It represents best accounting practices as it is accepted at a given time.
FASB (Financial Accounting Standards Board) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.
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Assumption about GAAP
There are four major assumptions about GAAP; while recording financial transaction, bookkeeper and accountant must follow these assumptions:
First assumption
The first assumption of GAAP is that the business entity and business owner is separate and distinct from each other.
Business records all its expenses in income statement as per business expenses.
Business owner record his expenses as drawing in his personal account.
It means all of the figures shown in the organization’s financial reports are specific only to that organization; there is not any expense related to business owner.
Second assumption
The second assumption is that the business is a going concern and it will not die (close).
But time is separated for every 12 months to prepare financial statements.
Third assumption
The third assumption is that amounts shown in the organization’s financial statements are stated in terms of a one currency.
All amounts are recorded in the same currency; it means an international company cannot report in a combination of rupees, dollars, euros, dinars, sterling or any currencies used in the countries in which the company operates.
Fourth assumption
The fourth assumption of GAAP is that the time period stated in financial reporting is accurate.
If the time period is identified as including 1 January to 31 December 31, then GAAP dictates that all transactions included in the report did indeed occur within the identified time period.
Keep in mind
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There is no universal GAAP standard; it is vary from one geographic location or industry to another but most of the countries flow it.
In the United States, the Securities and Exchange Commission (SEC) mandates that financial reports follow to GAAP requirements. The Financial Accounting Standards Board (FASB) instructs GAAP overall. The Governmental Accounting Standards Board (GASB) instructs GAAP for state and local government. Publicly traded companies must comply with both SEC and GAAP requirements. |
Many countries have adopted the International Financial Reporting Standards (IFRS).
IFRS is designed to provide a global framework for how public companies prepare and disclose their financial statements.
Adopting a single set of world-wide standards simplifies accounting procedures for international countries and provides investors and auditors with a cohesive view of finances.
IFRS provides general guidance for the preparation of financial statements, rather than rules for industry-specific reporting.
Features of GAAP
The main features of the GAAP are explained below:
Relevance
All decision making information must be presented on the financial statements.
Nothing should be over or understate that would cause the interpretation of the statements to change.
The information must be prepared in a timely manner.
If users do not understand, financial information, such principles will not acceptable.
Reliability
All the financial information must be error free
It should not be bias otherwise it will decrease its utility.
Information presented in the financial statement must be verifiable.
GAAP is the totally based on facts and figures.
Understandability
Users of the financial statements must be able to understand the financial reports.
Companies will usually provide extensive annexures (supplementary notes) to the financial statements.
If user has any confusion, he can understand from annexures.
Comparability
A company’s financial statements should be comparable from year to year. Joint stock Companies usually prepare their financial statements comparability current year and previous year.
User of financial statement can easily compare their need information.
If there is not comparative financial statement, last year’s financial statement printed alongside this year’s.
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