Basic Accounting Principles (GAAP) – Explanation

Principle of accounting feature image

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.

1. Going concern Accounting Principle:

Going concern means an entity will operate for an indefinitely long period in future. The financial statements are prepared to assume that the company can and will continue its business 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.

2. 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 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.

3. Entity Accounting Principle:

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 the transactions between business and 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 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.

 4. Cost Accounting Principle:

Cost principle means we have to record value of all type 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 an assets(Machine) for the $ 100,000 in the books of accounts. It means that we recorded the transaction of purchase of machine on cost value of the machine which is paid by the business to purchase it, not on the market value of $ 120,000.

5. 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 the 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 number of table, 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 the user of accounting information point of view, we have to measure these all thing in the monetary value.

6. Accounting period:

Accounting period refers to that time span of the life of an entity at the end of which financial statements are prepared. It means dividing the life of an entity into time period says one year to report profit/loss for the entity. The time period may vary but usually a 12 month period.

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

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

For Example: –

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

7. Full disclosure Accounting Principle:

The main aim of accounting is to communicate the financial information of the business enterprises to its of user i.e. management, shareholder, other related parties. Therefore, Full disclosure refers 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.

8. 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 resource 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).

9. Consistency Concept:

Consistency means that we have to use the same accounting methods and techniques in future which is applied. Its means that we have to use same method of depreciation, if you want to change the method you have to prepare the impact sheet and show the all previous year effects in the current year financial statement.

10. Reliability Accounting principle:

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

11. Understandability Concept:

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

12. Comparability Accounting Principle:

Accounting information is comparable when accounting standards and policies are applied consistently from one period to another and from one region to another. The characteristic of comparability of financial statements is important because it allows us to compare a set of financial statements with those of prior periods and those of other companies