Financial Principles: Generally Accepted Accounting Principles

Q) Elaborate the GAAP principle in detail.

Introduction:

GAAP stands for generally accepted accounting principles. These are some basic set of accounting rules which are used in the preparation of financial statements which includes statement of comprehensive income, statement of financial position, statement of changes in equity, cash flow statement and notes to account. These principles are useful in many ways some of the advantages of GAAP are as follow:

Function of GAAP:

The GAAP standards make sure that every company follows the same set of rules while preparing financial statements. Different method of preparing financial statement can lead to misrepresentation of statements and because of it comparability can become difficult. For example,

Entity principle: This principle states that the business and the owner of the business are two separate entities and the transactions of the two individuals should be kept separate. For example if the owner of the business has a car which used as his personal vehicle then it should not be recorded in the books of the business. Similarly if there is a loss in the business then owner’s personals assets should not be used in recovering those losses.

2. Cost principle: This principle of GAAP states that all the assets of the company should be recorded at the purchase price i.e historical cost. The amount of cash or cash equivalents given to acquire the asset should be used to charge depreciation and no other amounts such as market value or replacement value of asset should be used to evaluate the worth of an asset. For example a machine was purchase for $ 20,000 and will be used for 5 years with no salvage value. Then the depreciation expense will be $4000 per year and the balance sheet will show the net book value of the asset.

3. Going Concern

Moreover, the company has no intention of liquidating or ceasing its business.

4. Objectivity Principle: This principle states that the company should record its information based on facts and proper evidence and not only rely on the opinion of the accountants preparing financial statements. The personal interest and benefits of the accountants should be kept aside while making financial statements. The aim of this principle is to give a true and fair representation of financial statement to stakeholders.

5. Stable Dollar Assumption: This rule assumes that the unit to measure any transaction’s monetary value either present or future should remain same and the value of that unit should remain constant. Moreover, inflation rate is assumed to be zero so that it has no effect on financial statement and comparison can be made easy in future.

6. Concept of adequate disclosure: This principle of GAAP tells the businesses that each company should disclose enough amount of information needed by investors in decision making. No information which is material to the business should be kept