Accounting is a systematic process, one needs to follow some rules and principles while doing it to avoid confusion between client and accountant. They are formulated by the financial accounting board of the country which is applicable throughout the country in every business. These principles are commonly known as GAAP. Generally accepted accounting principles are the common set of principles of accounting that helps to govern the world of finances and accounting effectively. This is because they provide a framework for classification, summarization, and financial information. This makes it a lot easier because now all companies have a set framework under which they have to work everyone has to follow the same rules.
What is GAAP?
1. Business entity concept: This concept see the business owner and business entity as two different person or units. This helps in distinguishing financial transactions of sole propertier and business firm. This is important to get a proper profit and loss statement.
2. Monetary unit assumptions: According to this assumption only the transactions which are done with the behold of money have to be recorded in the account book. Money has to be the medium of exchange for every transaction.
3. Accounting period: Books should be maintained according to a certain period of time, which can be a financial year (mostly) or calendar year. This makes us clear when and in which financial year the transaction has been made, this also helps in calculating net profit and loss statements.
4. Historical cost method: According to this method transaction of an asset(machinery, goods, furniture, etc) is recorded with its original price, irrespective of in which financial year it is being purchased or what is its market value.
5. Going concern assumption: This sees the business as a long-running firm, all the financial statements are made with this kept in mind, this allows the firm to hold expenses for the future, and also benefits the shareholders of the firm.
6. Full disclosure principle: It is not possible to depict the background of every transaction through entries which may be on credit, in hand cheque, and many other things. So, a little narration about the transaction is written beneath entries.
7. Matching concept: A matching concept in accounting is maintaining an equal balance for expenditures of the firm and revenues and income collected to get financial profit and loss statement.
8. Accrual basis of accounting: This principle requires all the transactions to be penned down on the day they occur, instead of the day payment is initiated or received.
9. Consistency: Every business firm needs to follow the same accounting format throughout with consistency. For example, the entity may follow the straight-line accounting method of depreciation of its tangible fixed assets, then it needs to follow it consistently in the upcoming years too, they can’t switch to any other method.
10. Materiality concept: This concept allows to ignore some small principles of accounting if the transaction doesn’t impact much on the business entity's financial condition.
11. Conservatism: It is a kind of approach which is needed when comes to a situation to choose between 2 financial rules while recording a transaction. It emphasizes recording further losses of business rather than recording gains of business.