In today’s business environment, there exists the need for presenting financial information to external users such as the government, banks, stock exchanges and revenue departments.
This leads to the requirement of an accounting framework that is helpful in recording business transactions and also assists in comparing financial statements. GAAP was created with the purpose of fulfilling such requirements.
What is GAAP?
Generally Accepted Accounting Principles or GAAP is a defined set of rules and procedures that needs to be followed in order to create financial statements, which are consistent with the industry standards.
GAAP helps in ensuring that financial reporting is transparent and uniform across industries. As financial information is based on historical data, therefore in order to facilitate comparison between data from various sources, GAAP must be followed.
GAAP is developed by the Financial Accounting Standards Board (FASB)
The following GAAP principles can be discussed:
- Principle of Consistency: This principle ensures that the organizations use consistent standards while recording the transactions.
- Principle of Regularity: This principle states that all the accountants abide by the rules and regulations as per GAAP.
- Principle of Sincerity: This principle states that an accountant should provide an accurate depiction of the financial situation of a business.
- Principle of Permanence of Method: This principle states that consistent practices and procedures should be followed for financial reporting purposes.
- Principle of Prudence: This principle states that financial data should be reasonable, factual and should not be based on any speculation.
- Principle of Continuity: This principle states that the valuation of assets is based on the assumption that the business will be continuing its operations in the future.
- Principle of Materiality: This principle lays emphasis on the full disclosure of the true financial position of the business.
- Principle of Periodicity: This principle states that business entities should abide by the commonly accepted accounting periods for financial reporting such as yearly, half-yearly, etc.
- Principle of Non-compensation: This principle states that no business entities should expect compensation in return for providing accurate information in financial reporting.
- Principle of Good Faith: This principle states that all the parties involved in financial reporting should be honest in reporting the transactions.
This concludes the topic of GAAP, which is an important component of Accountancy for the students of Commerce. For more information, stay tuned to BYJU’S.