Generally Accepted Accounting Principles

One of the major objectives of accounting is to provide business information to users. The information shall be useful to the users if it is consistent and comparable. To bring in consistency in the preparation of accounting information and also that it conveys the same meaning to all the users, a number of rules or guidelines variously called Concepts, Conventions, Postulates, Assumptions and Principles have been developed in Accounting over the years from experience, reason, usage and necessity. The set of assumptions, concepts and principles thus developed are called ‘ Generally Accepted Accounting Principles (GAAPs). These are well-accepted accounting practices at a particular time and form the theoretical base. These represent a consensus view by the accounting profession of good accounting practices and procedures to serve as a guide to action. GAAPs also help us to answer new questions that may arise from time to time. Some of the important concepts and principles are discussed below

i. Business Entity Concept

Business entity concept means that a business enterprise will be viewed as a unit independent from its owners for accounting purposes. All the records and transactions of the business and those of the owners should be kept separately. If there is no separation of these accounts, the affairs of the business will all be mixed up with the private financial affairs of the proprietor. In such circumstances the exact position of the business cannot be worked out.

ii.The Continuity or Going Concern Assumption

It postulates that the business will continue in operation for an indefinite period in the future. This assumption provides guidance with respect to the application of concept of cost in accounting for assets, capital and revenue expenditures. Investors’ decision to contribute capital to enterprise is based on this assumption. Depreciation on fixed assets is charged on the basis of useful expected life and not at the market price. Tangible long lived assets such as buildings are shown at their original cost less a provision for the benefits used up (i.e original cost minus depreciation). Prepayment for insurance and leasing are also based on this assumption. When circumstances indicate that the continuity assumption is no longer valid for a particular firm, the resources could be reported at their current values or liquidated values rather than at their cost price.

iii.Cost Concept

This concept states that assets acquired through exchange are generally measured at their acquisition cost or price paid for it. The initial acquisition cost would not be changed in spite of the fact that current market value of similar type has been changed. Thus assets are recorded at their original purchase price. These assets appear on subsequent balance sheets at historical cost less a provision for the benefits used up. The cost of an asset that has a long but limited life is systematically reduced during its life by the amount of ‘depreciation’ charged for the asset each year.

iv.Accrual Concept

The accrual basis of accounting is essential for the preparation of reasonably accurate statements of income and the financial position. According to this concept revenue is recognized when earned whether or not received in cash and the expenses are recognized when incurred whether or not paid in cash. Revenue is the amount a business earns by selling its products or services to the customers.Revenue is deemed to have been earned in the period in which sale was done or services rendered. For example suppose a dairy plant sells milk products worth Rs. 10 lakhs in the month of Jan., 2005 through its dealers. The dealers make cash payment in the month of Feb. 2005. Though payment was received in the month of Feb, 2005 the right to receive payment was created in Jan. 2005 when products were sold. According to this Accrual Concept, revenue earned is in the month of Jan. 2005. Similarly when any product or service is received the obligation of making payment becomes due and should be recorded as expense though payment might have made in advance or is made in subsequent periods later on.

v.Matching Principle

According to this principle the expenses for a period of time should be matched with the revenue for the same period. It means that the revenue recognized as being earned during a particular period should have deducted the expenses incurred in earning that revenue. First of all, income of a certain accounting period is determined and then expenses incurred in earning this income are determined so that the exact profit or loss for that accounting period can be ascertained. Trading and Profit and Loss Account of a business is prepared according to this concept.

vi.The Dual Aspect Concept

This concept recognize that every transaction affects at least two accounts and there is two fold effect. The dual-aspect concept is commonly expressed in the form of a fundamental accounting equality which is given below:

Assets = Equities (Claims)

Assets = Liabilities + Capital

According to this concept and fundamental accounting equation, for every entry in a ledger account, an entry of equal amount must be made on the opposite side of another ledger account(s) so that the sum of the entries on both sides of the ledger accounts (Debit and Credit) must always be equal. How the entries are made in the two accounts that are affected is highlighted in subsequent section.

vii.The Accounting Period Concept

The Continuity or Going Concern Assumption stipulates that business will continue in operation for an indefinite period in the future. The activities of business occur in a fairly continuous steam throughout its life. But for making decisions and show the results of the operations of the enterprise should the stakeholders be kept waiting till the end of the life of the business ? The accounting period concept stresses that it is necessary to calculate business income for time periods less than the life of a business enterprise. The stake holders want information on various aspects of the enterprise periodically. Accounting period is defined as interval of time at the end of which the income statement and balance sheet are prepared. The year is the most common accounting period. The management may prepare reports even for shorter periods such as one month or a quarter for its own use.

viii.Money Measurement Concept

There are many events that affect business entity. But according to the Money Measurement Concept only those facts which can be expressed in terms of money are recorded in accounting. Business possesses different assets and widely different type of equities. It becomes, therefore, necessary to adopt a common measurement yardstick to record diverse items in the books. Money serves that purpose. In accounts money is expressed in terms of its value at the time an event is recorded. Qualitative transactions which can not be expressed in money cannot be recorded in financial books.

ix.Conservatism

This concept advises us to take a cautious approach to valuation. The essence of this principle is “Anticipate no profit and provide for all possible losses”. It guides us to take into consideration all prospective losses but expected gains should be recorded only when they are actually earned. Similarly the stocks be valued at cost or market price whichever is lower . Wherever required,provision for doubtful debt be kept. It is better to play safe rather than show the rosy picture to the stake holders as it will harm the interests of business.

x.Materiality Concept

It states that financial accounting is only concerned with significant amounts. Amount considered insignificant may be handled in the most expedient manner rather than giving them strict theoretical correct treatment. Amounts are considered significant if they would affect decisions of financial statement users. There is no hard and fast rule to draw a border line between material and immaterial events. Management can best assess a given item and determine its significance. Suppose an electric sharpener is purchased for Rs. 100 and it is expected to last 4 years. Though theoretically Rs. 25 each year should be allocated as expense (Rs100 divided by the expected life of the sharpener i.e.4 years), but the amount of Rs. 100 is so insignificant that it can be treated as immaterial and the entire amount of Rs. 100 may be shown as expense in accounts.

xi.Consistency Assumption

There are several ways to record a transaction in the books of account. The consistency assumption stresses that a given company will consistently apply the same measurement techniques so that valid comparisons from year to year can be made. However, when management feels that there is some good reason for changing measurement technique, it must be disclosed in the financial statements. If there is inconsistency in the application of accounting methods, it might affect the reported profit and the financial position. This could thus mislead the uninformed statement reader.

xii.Objectivity Assumption

The financial statements must be as reliable as possible so that users have confidence in them. The measurements need to be objective and verifiable. The term objective in this context means free from bias and is subject to verification. Many measurements shown in the financial statements contain elements of judgment. Measurement which involve judgment should be systematized so that the others using the some rational process or method would achieve the some measurement results.

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