July 07, 2021

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What is GAAP in Accounting?

What is GAAP in Accounting?

Overview

The main purpose of accounting is to provide interested parties with the information they need to make a decision. Generally Accepted Accounting Principles (GAAP) refers to the general set of standards and procedures that all bookkeepers and other specialists dealing with the finances are expected to follow. These principles provide an overall framework on the financial data that should be kept a record of and how it should be done.

This set of principles tries to establish a standard way the accounting processes are conducted across all types of organizations and make it easier to regulate this sphere. It is compiled to ensure that every company prepares reports on its finances that are consistent and do not omit any important data. This way, every reader of the documents and other financial records will be able to analyze them with ease and confidence and set side by side with the accounting data of other organizations. These standards are considered to be very stringent in respect of investor interests.

What is GAAP in Accounting?

Accounting principles cannot be compared with physical laws. They do not exist in nature, waiting to be discovered, but are created by people. In many ways, they are similar to those established for sports. For example, they:

  • come from a combination of tradition, experience, and law
  • require the support of the authorities and some means of enforcement
  • are sometimes arbitrary
  • can be changed over time, when shortcomings in the existing rules become apparent
  • must be understood and followed by everyone.

Unfortunately, accounting principles differ from country to country. However, these principles are very similar in Canada, Great Britain, and a number of other countries. In addition, foreign companies that closely work with the US usually prepare their reports in accordance with principles accepted in the US.

Since each country has its own accounting principles and rules, this difference is reflected in the appearance of additional letters or a name before the GAAP acronym, indicating belonging to a particular country. Several international organizations are currently trying to unify accounting principles around the world.

Basic Principles

The main list of principles adhered to in the accounting world looks like this:

  1. Dual-aspect conceptThe sum of the company’s funds is always equal to the sum of its liabilities and capital. A well-known accounting equation must always be respected.
  2. Going-concern conceptThe concept of continuity is based on the fact that an enterprise will continue to operate indefinitely unless there is evidence to the contrary. In this regard, the accounting does not contain information about the price at which the enterprise’s funds could be sold if it ceased its activities.
  3. Cost conceptIn accounting, in accordance with the cost principle, bookkeepers work with the cost of items, and not with their market value. Therefore, accounting does not contain information about the real (market) value of the enterprise’s funds at the moment and does not make it possible to determine the total value of the enterprise.
  4. Conservatism conceptIn accordance with the principle of conservatism, income represents an increase in the company’s capital, and the accounting does not record an increase in the capital until the transaction becomes a well-defined event (for example, the shipment or delivery of goods). Similar considerations apply to capital depletion.
  5. Materiality conceptAccording to the principle of materiality, accounting records should not take into account immaterial transactions but reflect only important events that will have a significant effect on the business’s financial position.
  6. Realization conceptFollowing this principle, revenues are recorded by the company when its products are delivered to the consumer (and not when they were produced), and services – at the time they are provided to the client.
  7. Accrual principleThis principle means that to account for the company’s operations:- not only transactions that are related to money are recorded, but also barter, credit sales, exchange of assets and liabilities, etc.;- all transactions that have a potential monetary value are kept account of;- at the same time, the fact of payment of money is not necessary.Thus, based on this principle, the actual exchange of cash is not necessary to record a transaction. Instead, it should be accounted for right when it happens.
  8. Principle of impartialityThis principle implies that the preparers of the statements do not intend to persuade users of financial information to make a certain decision, for example, to purchase securities of an enterprise.
  9. Objectivity principleThe principle of objectivity assumes that accounting data must be obtained from properly executed primary documents.
  10. Periodicity assumptionThis principle assumes that the activities of an enterprise can be broken down into relatively short periods of time (month, quarter, year) and that all types of income and expenses can be attributed to these periods.

Reporting information should not only be prepared keeping in mind these principles, but also submitted in a time frame in which it does not lose its value to users. The information must be available for making a decision before it loses the ability to influence a decision.

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Author: Charles Lutwidge

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