GAAP

Generally accepted accounting principles (GAAP) are ‘Ground rules’ i.e. principles for preparing financial statements. These are constantly evolving. Accounting was first practiced and then theorized. Certain ground rules were initially set for financial accounting, these rules arose out of conventions. Therefore, these are called accounting conventions or concepts.  We shall discuss here only the basic accounting concepts or conventions that are very vital to understand the process of accounting.

Practice GAAP MCQs

Business Entity Concept

Business Entity Concept states that specific business entity separate from personal affairs of the owner(s). A business is an artificial entity distinct from its proprietor(s). A business entity is an economic unit which owns its assets and has its own obligations. The owner(s) may have personal bank accounts, real estate, and other assets, but these will not be considered as assets of the business.

Cost Concept

Cost Concept describes valuation and recording of assets and liability at historical cost. This is also called historical cost concept. Assets such as land, buildings, plant and machinery etc. and obligations, such as loans, public deposits, should be recorded at historical cost (i.e., cost as on acquisition). For example, the land purchased by a business entity two years back at a cost of Rs.1,00,000 should be shown, as per the cost concept, at the same amount even today when the current price of the land may have increased five-fold.

Going Concern Concept

Going Concern Concept is connected with cost principle, assets acquired for use and not for resale. One common argument put forward that cost concept is that the assets are shown at its original cost (net of depreciation) because these are meant for use for a long period of time and not for immediate resale. An entity is said to be a going concern if it has `neither the intention nor the necessity of the liquidation’. This concept is considered as one of the fundamental accounting assumptions.  The valuation principle of assets and liabilities depend on this concept. If an entity is not a going concern, its assets and liabilities are to be valued in an altogether different manner.

Money Measurement Concept

Money Measurement Concept discuss that each transaction and event must be expressible in monetary terms. If an event cannot be expressed in monetary terms, it cannot be considered for accounting purposes. For example, if you successfully pass a Distance Learning Program of a university, it will give you a great deal of satisfaction. But that satisfaction cannot be expressed in monetary terms. Hence such an event is not fit for accounting. This concept implies that the legal currency of a country should be used for such measurement.

Materiality Concept

Materiality Concept requires all relatively relevant information should be disclosed in the financial statements. Unimportant and immaterial information are either left out or merged with other items.

Objectivity Concept

Objectivity Concept requires that each recorded business transactions in the books of accounts should have an enough evidence to support it. The documentary evidence of transactions should be free from any bias. As accounting records are based on documentary evidence which is capable of verification, it is universally acceptable.

Full Disclosure Concept

Full Disclosure Concept requires facts necessary for proper interpretation of statements; “subsequent events”, lawsuits against the business, assets pledged as securities/collateral, contingent liabilities etc. reflected in Notes.

Periodicity Concept

Periodicity Concept describes that the activities of a going concern are continuous flows.  In order to judge the performance of a business entity, the best way to judge a business is to have a periodic performance appraisal. Such a period to measure business performance is called an accounting period.  The results of operations of an entity are measured periodically, i.e. in each accounting period. Different business units may follow different accounting periods depending on convenience.  For example, one entity may follow calendar year as the accounting period, while the other one may follow the fiscal year (April to March) as the accounting period.

Dual Aspect Concept

Dual Aspect Concept is the basic of accounting; modern accounting system is based on dual concept. Dual concept stated that “for every debit, there is credit”

Accrual Concept

Accrual Concept suggests that incomes and expenses should be recognized as and when they are earned and incurred, irrespective of whether the money is received or paid in connection thereof. This concept is used by all businesses that disclose their financial statements to various interested parties. The alternative to the accrual basis of accounting is called cash basis of accounting.

Matching Principle

The aim of every business is to earn profit. In order to ascertain the profit, expenses and revenues are matched is called Matching Principle. The difference between revenue from sales and cost of producing the goods will be the profit / loss. Revenue earned in an accounting year is offset (matched) with all the expenses incurred during the same period to generate that revenue, thus providing a measure of the overall profitability of the economic activity. Thus, matching concept is very vital to measure the financial results of a business.  The timing of incurring expenses and earning revenues does not always match.

Realization Concept

The realization concept tells that to recognize revenue it has to be ‘realized’. Realization principle does not demand that the revenue has to be received in cash. Revenue from sales transactions should be recognized when the seller of goods has transferred to the buyer the property in the goods for a price and no uncertainty exists regarding the consideration that will be derived from the sale of goods.

Prudence Concept

Prudence Concept is the ‘inclusion of a degree of caution in the exercise of the judgments needed in making the estimates required under conditions of uncertainty, such that assets or income are not, overstated and liabilities or expenses are not understated’.  Expected losses should be accounted for but not anticipated gains.

Accounting Standards

International Accounting Standards Committee was founded in June 1973 in London by professional accountancy bodies from Australia, Canada, France, Germany, Japan, Mexico, the Netherlands, the United Kingdom and Ireland, and the United States of America and replaced by the International Accounting Standards Board on April 1, 2001. It was responsible for developing the International Accounting Standards (IAS) and promoting the use and application of these standards. The purpose of this board is to formulate and publish in public interest, standards to be observed in the presentation of audited financial statements and to promote their world-wide acceptance and observance.

List of Accounting Standards

Following is a list of accounting standards.

International Financial Reporting Standards (IFRS)

IFRS is internationally known by the older name of International Accounting Standards (IAS). IAS was issued between 1973 and 2001 by the Board of the International Accounting Standards Committee (IASC). On April 1, 2001, the new IASB took over from the IASC the responsibility for setting International Accounting Standards. During its first meeting the new Board adopted existing IAS and Standing Interpretations Committee standards (SICs). The IASB has continued to develop standards calling the new standards International Financial Reporting Standards (IFRS).

List of International Financial Accounting Standards

Following is a list of accounting standards.

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