Basic Accounting Principles (GAAP) – Explanation

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The Rules which every business has to follow while preparing their financial statements are known as accounting Principles.

What are the Basic Account Principles(GAAP):

Every company must follow some principles, rules, and guidelines to prepare the books of accounts or financial statement which is pre-defined by the country’s law, these are called Accounting principles. Preparation of books and financial statement without adopting these pre-defined principles of accounting would be irrelevant, unacceptable by law, and unreliable.

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Accounting principles differ from country to country. some of the Generally Accepted Accounting Principles (GAAP) are showed below:

Entity Accounting Principle:

The entity concept means that for accounting we have to treat the business as a separate entity from its owner(s). It means that an accountant of the business enterprises will record the business-related transactions only.

The Accounting principle of Entity enables the accountant to record the transactions done between the business and the owner(s). This principle ensures that the accounting records reflect only the all activities of the business, not of the owner(s) personal activities.

For Example

When the owner(s) introduced cash or any other assets into the business, then the accountant of the business enterprise will record it in the owner’s capital account, which means the amount payable to the owner(s) by the business.

and

When the owner(s) withdrawal cash or any other assets from the business, then the accountant of the business enterprise will record it in the owner(s) Drawing account, which means the amount payable by the owner(s) to the business.

Money Measurement:

To recording, classification, and summarization of the business transactions are expressed in the common unit of measurement. In accounting, Money is the best way of measuring the value of all business transactions.

It means that we have to record only that transaction which can be measured in money Because money is an excellent indicator of the value.

For Example: –

If we write the following all item with different measurement: –

  • Building  =  500 sq. yard
  • Furniture consisting of 4 numbers of tables, 16 number of chairs, and 4 number of Almira.
  • The stock of goods is 100 units left
  • Machinery consisting 4 number of the press machine, 2 number of welding machine, 1 number of printing machine
  • Cash balance of Rs/$ 5,000

From the above given it is impossible to prepare a financial statement of the business to know the financial health of the business.

So, From the point of view of the user of accounting information, we should measure these all things in the monetary value.

Going concern Accounting Principle:

Going concern means an entity will operate for an indefinitely long period in the future. The financial statements are prepared on the basis that the company will continue its business activities for at least one year more. That’s why at the end of the financial year we have carried down the balance of all assets and liabilities accounts and the brought down in the next financial year.

If the entity/business/company did not have enough funds to operate their business continues then they have to mention all these things in their financial statements.

Accrual Accounting Principle:

Accrual concept means recording the business transaction when they actually occur. Expenses recorded in books when they are incurred not when they are paid. Incomes recorded when they are earned not when they are received.

For Example: –

Ex. 1. Salary not paid to employees for the M/o March 2019 of 150,000/-.

In the above transaction, we will add the unpaid salary amount in the total salary paid in the F/Y 2018-19 in the Profit/Loss Account and show this unpaid amount as a current liability in the balance sheet.

Ex. 2. Rent for the Building is paid up to the M/o June -2019.

In the books of F/Y 2018-19, The amount of Rent will be treated as expenses will be up to 31 March 2019. The rent which paid extra(in advance) for three months will be treated as a current asset, it will be shown in the balance sheet.

 Cost Accounting Principle:

Cost principle means we should record the value of all types of assets in the books of accounts at the purchase price or expenses incurred on its acquisition and installation, not on the market value of the assets at the time of purchase or acquisition. This value of assets will never change due to the change in the market value of these assets. The market value of assets always changing with the passage of time, it may be increase or decrease.

For Example: –

An old Machine purchase for $ 100,000/- but it’s market value is $ 120,000/-.

So, In the above transaction, we will be recording the value of the assets(Machine) for the $ 100,000 in the accounts. It means that we have recorded the transaction of purchase of machine on the cost value of the machine which has paid by the business to purchase it, not on the market value of $ 120,000.

Accounting period:

The accounting period refers to that time span of the life of business at the end of which financial statements are prepared. It means that dividing the life of a business into a time period of one year to get to know the actual profit/loss of the business. The time period may vary but usually, it has a 12 month period.

The accounting period also helps the management to take the necessary decision to make the business to make it more profitable.

According to Going Concern, the business continues for an indefinite time period. So to know the actual health of the business we should prepare the financial statement of the business.

For Example: –

Mainly the 01/April/20___ to 31/March/20__ is the accounting period.

Full disclosure Accounting Principle:

The main aim of accounting is to communicate the financial information of the business enterprises to its user i.e. management, shareholder, other related parties. Therefore, Full disclosure refers to that we have to disclose all material information about all business transactions done within the financial year in the financial statements either on the face of the financial statements or in the notes to the financial statements.

Matching Accounting Principle:

Matching is one of the pervasive principles of accounting. The whole revenue earned by the business is not the actual income of the business. To earn this revenue many types of resources are consumed, So to obtain the actual income of the particular period we have to subtract the total cost of resources consumed from the total revenue earned within the same period.

For Example: –

The total sale of the business in the financial year 2018-19 is 10,00,000

So we didn’t say that the total income of the business is 10,00,000 Because to achieve this value of sale we had paid many types of expenses in this period. So Total expenses incurred on it is 8,37,500/-

So, our actual income will be 1,62,500/- i.e. (1000000-837500).

Consistency Concept:

Consistency means that we have to use the same accounting methods and techniques in the future which were used in the first year. It means that we have to use the same method of depreciation but if the business wants to change this method, then the business has to prepare the impact sheet of the new method and show all previous years’ effects in the current year’s financial statement.

Reliability Accounting principle:

Reliability means the information provided in financial statements is should be accurate, true, and fair.

Understandability Concept:

Understandability means the information provided in financial statements are should be well presented and easily understandable to each party.

Comparability Accounting Principle:

Comparability Accounting Principle means that Accounting information should be comparable. the accounting standards and policies should be used in the same manner from one period to another and from one region to another., because if standards and policies not used in the same manner then it will be difficult to compare. The characteristics of comparability of financial statements are important because it allows us to compare financial statements with those of prior periods and those of other companies

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