Explain GAAP and its Principles

GAAP stands for Generally Accepted Accounting Principles. It is the bunch of accounting standards and usage of the common industry which has managed to develop a lot in past many years. It is helpful in the organization sin the many ways. It helps in proper organization of the financial information in the companies or any business unit. It helps in summarizing the accounting records in the form of the financial statements. It helps in disclosing the certain information that is very useful and supportive. The main reason to use GAAP is one can easily compare the multiples companies on the reasonable basis. It covers a large number of topics and all can be discussed under the GAAP. They include financial statement presentation, assets, liabilities, equity, revenue, expenses, business combinations, derivatives and hedging, fair value, foreign currency, leases, non monetary transaction, subsequent events, industry specific accounting which includes airlines, health care and extractive activities. The industry specific accounting which is allowed or required under the process of GAAP may vary from the more generic standards substantially for certain types of the accounting transactions.

GAAP is basically derived from the pronouncements of a series of the accounting entities that are government sponsored. The Financial Accounting Standard Boards (FASB) is the latest among all these. The Security and exchange commission also gives accounting pronouncements with the help of accounting staff bulletins which are applicable to the companies that are publically held. It is considered as the part of the GAAP. GAAP is also codified into ASC which is Accounting Standard Codification that is in printed form and available online. It is very much useful for the businesses that need to report their financial results to United States. IFRS or International Financial Reporting Standards is the accounting framework which is used worldwide. However GAAP is more rules based as compared to IFRS. In IFRS more focus is laid upon the general principles as or when compared to the GAAP and that makes work body smaller, easier and cleaner to understand than GAAP. GAAP is considered to be more comprehensive accounting framework as IFRS is still under construction and is not completed up to mark yet. There are many several working groups that are working on reducing the difference between the GAAP and IFRS. Hence minor difference is led between these two terms which is almost negligible. It is also proposed to eventually merge both these things in order to get better results. The investors are always likely to review the GAAP financial results of the company as it is reliable method in case one wants to compare financial results of the multiple companies.

The rules of the GAAP are subjected to the different types of the interpretations which the companies often find a way to bend or manipulate them. The SEC needs the companies to reconcile their non GAAP financial measures with the GAAP measure that are closely comparable. The non GAAP calculations do not always provide close comparisons as they can differ widely from firm to firm. The origin of GAAP has been in 1929 and the stock market crash which created the Great Depression. The faith in Economy was very low which made the government to decide about the rebuilding of the faith. The SEC or Security Exchange Commission was formed with the mission to regulate financial practices. The SEC in lieu of it asked the American Institute of accounting to help in order to review the financial statements. The Economic Entity Assumption is the main principle of the GAAP. The accountant keeps separate the business transactions of proprietorship from personal transaction of the business owner. When the purpose is taken as the legal one both the sole proprietorship and its owner are considered as the single entity. When the accounting is taken in consideration both the things are considered as the separate entities. The economic activity is measured in US dollars. Only transactions that expressed in US dollars are recorded for that purpose. The purchasing power of dollar does not change over the time and this assumption is required to be made due to this accounting principle. Due to this very reason the accountants does not count the effect of the inflation on the recorded amount. The Time Period Assumption is the other principle of GAAP. In this accounting period it is assumed that possibility of reporting the complex activities of a business in a short period of time becomes more. It is imperative that time interval is shown in detail in every income statement. The term cost refers to the amount that is spent during the obtaining of the item irrespective of the fact that if the purchase has taken place recently or thirty years ago. Due to this very reason the amounts that are shown in the financial statements are termed as the historical cost amounts. Due to this kind of principle assets, the amounts are not adjusted upward for the purpose of the inflation. As per the general rules the asset amounts are not made to adjust to reflect any type of the increase in the value. He money company is receiving is not affected by the asset amount.

The long term assets report of the company will not be received in the financial statement of the company. The full disclosure principle is another important principle of the GAAP. In this principle if any part of the information is important to the investor in the financial statement then that part of the information should be disclosed within that statement or in the notes of that statement. It is due to the reason hat number of pages of footnotes are often attached to the financial statements. A company normally gives the list of its accounting policies as the first notes to the financial statements. The Going concern principle gives the assumption that a company will exist long enough to carry out its objectives and commitments. It will not liquidate in the coming future. If the financial situation of the company is such that there is doubt in the existence of the company in the mind of the accountant, it is the duty of the accountant to disclose this assessment. The going concern principle lets the company to defer some of its prepaid expenses up till the accounting periods of the future. The matching principle lets the companies to make the usage of the accrual basis of accounting. The matching principle requires that expenses be matched with the expenses. The future economic benefits of the things cannot be measured and we cannot match the ad expenses with the future revenue then the accountant charges to run that ad is required. The revenue recognition principle states that the revenues are recognized as soon as the selling of the products or the concerned service has been performed irrespective of the fact when actually the money has been received. The accounting might be allowed to violate another accounting principle because of insignificant amount due to the presence of the materiality principle of accounting. The professional judgment is needed to determine if the amount is immaterial or insignificant. The conservatism is the another principle of the accounting principle that is very helpful in the process of accounting. Sometimes there is the situation when two alternatives can be accepted to report a single item then in that case the principle of the conservatism guides the accountant to select the option that result in the less net income or less asset amount or both at the same time. This type of the principle helps the accountant to break a tie. It does not guide the accountant to be conservative. Hence the accountants are expected to be objective and unbiased. This basic principle leads accountants to disclose losses or anticipate them however it does not guide in the same way in the case of the gains. In this way all these principles help to follow the rules of accounting in a proper way. The accounting information is expected to be verifiable, reliable and objective. The consistency is must in the information of the accounting. The comparability is also the feature of the accounting information. The principles and guidelines of the financial statements are liable to put great impact on the financial statements. The balance sheet also gets affected by the financial statement. The principles are also liable to put effect on the income statement. The revenues are the fees that are earned during the period of the time that is mentioned in the heading in the financial statement. The recognizing revenues are earned when the cash is received actually. The small business owners should explain the two methods along with the tax advisors. The gains and expenses are the two methods through which one can get detail of everything. The gains are the net amount that relates to the transactions that are not considered part of the main operations of the company. The expenses are costs used up by the company in the performance of the main operations. The primary purpose of the GAAP is to keep people honest and prevent the people from the creative accounting. Its mere purpose is to provide insight to the accountant and other people that are included in the business in the different concepts of the recording and reporting the data. The record keeping is also done with the help of the GAAP principle. The main idea behind the GAAP is to keep the needs same for all types of the business and hence acquire uniformity in the field of the accounting. The process of GAAP needs the proper hierarchy system. In this higher level of GAAP contain the statements from FASB and AICPA. The opinion of staff of FASB and AICP is contained in the lower levels of the GAAP. The accountants are encouraged to consult the higher level of GAAP first then consult the upper level of the GAAP. The lower levels are consulted for the clarification. The basic assumptions which are required for the GAAP include business entity, monetary unit and periodicity. The business is separate from its owners and other types of the businesses. The revenue and expense should be kept separate from the personal expenditures that are made by the business owners. They should keep their professional and personal transaction separate so that there could be clear cut difference made in the both of the things. The stable currency is the unit of the record.

The nominal value of monetary unit of record is the US Dollar which remains unchanged during the process of the inflation. The constraints of GAAP include the objectivity principle, materiality principle, consistency principle, conservatism principle and cost constraint. The Audit and accounting guidelines summarizes the accounting practices of industries that are specific in nature. It provides important guidelines on the topics that are not taken in consideration or discussed by the GASB and FASB. It provides guidance on the financial reporting topics so that GASB as well as FASB set standards on the issue. The practice bulletins indicate AcSEC’s views on narrow financial reporting issues that are not the addressing part of the GASB or FASB. In order to realize the need to perform the APB the leaders in the accounting profession appoints a study. This group helps to determine the dissolving of APB and setting of the new standards that are very helpful in structuring the organization. The four main type of the publication that FASB had includes the Statements of Financial Accounting Standards, statements of Financial Accounting Concepts, interpretations and Technical bulletins or staff position. The EITF or Emerging Issues Task Force was created by the FASB in 1984 that deals with financial transactions that are unusual and new and has potential to become common. It cats more like the problem filter for the FASB. It helps in dealing with the short term, more pervasive, quickly resolvable problems for the FASB. The EITF and FASB do not issue new standards as all the GAAP resides in the Accounting Standards Codification. The concepts statements still exist outside but are not authoritative.