GAAP
By: Sidra gazali
GAAP
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What is GAAP?
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Generally Accepted Accounting Principles are a specific
set of directions that aid publicly traded companies
prepare their financial statements
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These guidelines, long standing assumptions and
methodologies are an aftermath of years of thought and
experience
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GAAP
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The Financial Accounting Standards Board (FASB) has
been the primary U.S. accounting rule maker since
the early 1970s.
The standards of the IASB are also known as IFRS
(International Financial Reporting Standards).
The objective of FASB and IASB is to bring about a single
set of norms and procedures to facilitate comparison and
consistency
Securities and Exchange Commission(SEC)came into
force to regulate and stabilize the capital markets of USA.
GAAP can be broadly classified into
Accounting Assumptions, Principles
and Constraints
Assumptions
principles
Constraints
Entity
Historical cost
Conservatism
Going concern
Revenue recognition Materiality
Periodicity
Matching principles
Monetary unit
Full disclosure
consistency
Assumptions
Entity
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The economic entity assumption requires that the
activities of the entity be kept separate and distinct from
the activities of its owner and all other economic entities.
It also promotes ownership in business as the liability of
the members is limited. Precisely insolvency of the
company is not the insolvency of its members.
Going-Concern
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Going-Concern is primarily an assumption that the
business/organisation will continue to operate for a
substantial period. Therefor the fixed assets are recorded
at their cost price and their market price is of less
importance.
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If there is serious doubt about the above assumption and
the management has no concrete plans to address
such issues than a disclosure is mandatory and
the financial statements will be presented at estimated
liquidation values
The Fiscal Period/Periodicity
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All reporting is done for fixed periods of time; months,
quarters or annual periods.
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These fiscal periods usually coincide with calendar
periods and not necessarily calendar year.
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A few companies define their fiscal month as 28 days and
their calendar year as 12 of those months. Other
companies adopt a fiscal year of, say, July 1 to June 30.
Monetary Unit
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The monetary unit assumption means that accounting
measures transactions and events in units of money only. The
monetary unit assumption requires that companies
include in the accounting records only transaction data that
can be expressed in money terms. This assumption.
This assumption prevents the inclusion of some relevant
information in the accounting records. For example, the health
of a company’s owner, the quality of service, and the morale of
employees are not included. The reason: Companies cannot
quantify this information in money terms. Though this
information is important, companies record only events that
can be measured in money.
Principles
Historical Cost
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The transactions and events are recorded at cost of
acquisition.
Under GAAP, original purchase price or the book value
will continue even though the market value changes. This
eliminates the need for continuous revaluation
For example if Best Buy purchases land for $300,000, the company initially
reports it in its accounting records at $300,000. But what does Best Buy do
if, by the end of the next year, the fair value of the land has increased to
$400,000? Under the cost principle, it continues to report the land at
$300,000.
Revenue Recognition
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Accrual basis of accounting dictates that revenues
must be recorded when earned and measurable.
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It determines the specific conditions under which revenue
is recognized or accounted for
Matching Principle
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Under the matching principle, costs associated with
making a product must be matched to the revenue
generated from that product during the same period.
It directs a company to report an expense on its income
statement in the same period as the related revenues
Disclosure
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Companies must reveal all relevant economic information
that can be useful to the users, owners, government etc.
Such disclosure should be made through
Financial statements
Notes to financial statements
Supplementary information
Annual Reports
Constraints
Conservatism
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Financial statements should be prepared in precautious
manner which means assets and revenues should not be
overstated, while liabilities and expenses should not be
understated. In other words less optimistic approach to
be selected if chances of both are same.
For Inventory Valuation and like wise market value
or book value whichever is lower is considered
This approach is followed because in any case profits of
the company should never be misreported.
Materiality
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Any event that might be significant, is one that may affect
the judgment, analysis, or perception of the user of
financial.
This is a relative concept. Something that is significant in a
company with annual revenues of $20 million might be
largely irrelevant in a multibillion-dollar enterprise.
E.g. Tracking individual paper clips is immaterial and
excessively burdensome to any firms accounting
department.
Consistency
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The preparation of financial statements must utilize
measurement techniques and assumptions that are
consistent from one period to another
companies can choose among several different accounting
methods to measure their inventories, depreciation, etc.
But what is paramount is to use the same methods
throughout the fiscal years
Any change in such reporting should be backed by
concrete reasons and should result in giving true and fair
view to the users of financial statements.
Thank you