The GAAP or Generally Accepted Accounting Principles comprises a set of commonly followed accounting standards, procedures, and principles for financial reporting. GAAP is the basis of accounting procedures, as approved and used by the FASB or Financial Accounting Standards Board.
10 Principles of GAAP
There are 10 general notions that line up the main mission of GAAP.
- Principle of Regularity - All accountants should follow the practices set forth by GAAP.
- Principle of Consistency - Accountants are committed to using the same accounting standards from one period to the next. This will ascertain comparability within periods.
- Principle of Sincerity - Accountants will make great efforts to produce an accurate, fair, and just depiction of the company's financial performance.
- Principle of Permanence of Methods - Uniform practices should be used in financial accounting and reporting for comparability.
- Principle of Non-Compensation - All the financial aspects should be reported, regardless of whether it is positive or negative, without compensating for a liability.
- Principle of Prudence - All aspects of financial reporting should not be based on speculation but fact-based, reasonable and prudent.
- Principle of Continuity - All company assets should be valued on the supposition that the organization will continue operating and moving forward.
- Principle of Periodicity - Entries should be distributed for financial reporting across appropriate periods of time, like monthly, quarterly, and annually.
- Principle of Materiality - Financial reports should provide complete disclosure and present the true financial position of the organisation.
- Principle of Utmost Good Faith - Financial reporting of all companies should be honest and thorough.
Basic Principles of Accounting
Accounting principles are the standardised set of rules and guidelines that companies should follow when reporting their financial information.
There are several accounting principles, and here are the most basic and notable:
- Revenue Recognition - Demand as necessary that revenues are recognised on the income statement, not when cash is received, but on the period it is realised and earned.
- Matching Principle - Requires the recognition of revenue and related expenses in the same reporting period.
- Materiality Principle - Items that can influence investors' decision-making should be reported in detail in the business' Financial Statement using GAAP standards.
- Consistency Principle - Once an Accounting principle has been adopted, it should be used all throughout the process.
- Cost Principle - You need to record your company's assets when you purchase a product or service, keeping your business expenses neatly and methodically arranged.
- Objectivity Principle - Your accounting data should be consistently accurate and do not have any personal opinions. Data should be supported by evidence, such as receipts, invoices, and vouchers.
Importance of Generally Accepted Accounting Principles (GAAP)
GAAP exists to create a constant, clear, and comparable accounting method. The following are the reasons why GAAP is important:
- GAAP ensures that a company's financial records are complete and comparable.
- Business leaders can completely picture a company's financial health.
- GAAP allows the company's performance to be compared month over month.
- GAAP is important in pursuing external activities, such as public trading, raising capital, preparing for a business transaction, and competitive comparisons.
- GAAP is especially important to companies that are required to release their financial statements publicly or those companies that are publicly traded.
Where are the Generally Accepted Accounting Principles Used?
Primarily, GAAP is used in reporting financial status by businesses, allowing them to make useful and reliable accounting statements.
GAAP is also used as a basis for comparison for anyone reviewing the Financial Statements of several companies.
GAAP is also used in reporting to external users, such as profit-oriented companies and those not for profit.
Investors and creditors also use GAAP in comparing the financial data among businesses.
GAAP Vs. IFRS
GAAP stands for Generally Accepted Accounting Principles, while IFRS stands for International Financial Reporting Standards.
These are two primary sets of accounting standards and principles of financial reporting followed by countries worldwide. The IFRS encourages consistency in preparing a company's Financial Statements.
On the other hand, the GAAP companies are guided by the Financial Accounting Standards Board (FASB) in compiling their yearly Financial Statements. The GAAP is based in the US.
The IFRS, unlike the GAAP, does not authoritatively lay down how the Financial Statements should be prepared. It provides coordinating guidelines that make the accounting process unchanging in form and function.
The following are some other ways the GAAP and IFRS are distinct.
IFRS = 110+ countries, including the EU, South America, Asia, and Africa
GAAP = US only
Treatment of Inventory
IFRS = LIFO (Last In First Out) inventory is prohibited
GAAP = Both LIFO and FIFO (First In, First Out) are allowed
IFRS = Costs in the research phase are expensed as incurred or recorded as they occur, while prices in the development phase may be capitalised depending on some factors.
GAAP = Immediate expensing of the research and development costs is required, although there may be some exceptions.
Understanding these differences between GAAP and IFRS is extremely important for businesses of any size, especially those operating internationally. Stakeholders and investors need to be concerned and well informed about these differences so they can make easy financial interpretations of either standard.
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