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These are the general rules and standards which are being set up for the purpose of preparation of financial statements of an organization. These are the mandatory guidelines which are required to be followed by the organizations at the time of doing accounting and preparation of financial statements. The usage of GAAP is being made in financial statements such as income statement, cash flows, and balance sheet. The financial statements are being prepared by usage of GAAP and the investors are in the position to find out whether the financial statements are prepared appropriately for making certain categories of decisions regarding the economy and investment decisions.
There are mainly two principles which are being used for the purpose of implementation of GAAP. The principles include Disclosure Principles and Measurement Principles. Disclosure principles are guidelines and policies which provide information regarding value and amounts along with necessary facts required to be entered in the balance sheet. The measurement principles define basis towards recording of financial statements in the organization. Generally Accepted accounting principles are mainly concerned with the following:
- The measurement of economic activities of the organization at a particular point of time.
- Timely measurement and recording of the transactions of the organization.
- Preparation of financial statements which consist of financial information being required by the stakeholders.
If GAAP is not being followed by the organizations then, it will not be considered to be preparing the financial statements in a proper and appropriate way. The organizations would be concealing the information and would not provide the information in a proper and appropriate way so that, best results are being generated. This is going to make it difficult for the investors as the financial reports of the organization are being required to be prepared on the basis of correct principles and if correct principles are not followed then, investors would not be in the position to make proper decisions regarding the investments to be made by them.
- Business Entity Concept: The business entity concept states that the company and its members are different from one another and not one. For accounting purpose, business is to be treated entirely different from its owners. The capital being brought by the owners should be treated as a liability of the organization. This liability is to be paid back to the owners of the company. If owners are making drawings from the business then, it is going to be considered as the reduction in capital and this will reduce the liability of the organization.
- Going Concern: Based on this concept, it is being identified that the business of the organization carries on forever and this does not result in a liquidation of foreseeable future. This is a crucial concept as it provides information regarding base of assets of the organization. The business is not put to an end even in the case, there are certain legal issues or there is a case of death of partner or owner of the organization.
- Monetary Unit: On the basis of this concept, it is being identified that a stable currency is the unit of record. The transactions are required to be carried out by the organization on the basis of that monetary unit.
- Accounting Period: It is necessary for the organization to prepare financial reports as they are the means for identification of financial conditions of the enterprise and value of its assets at a particular point.
These reports are required to be prepared at regular periods of time. The interval between preparations of one financial report to another financial report is being considered as accounting period.
- Cost Concept: This concept provides that the assets of the organization are required to be shown at their purchase price including installation, transportation and acquisition and not at the fair market value. If the cost including all the above is at the level of $500 then, it is going to be a scenario that, price shown in the balance sheet would be at the level of $500 and not at the fair market value of the asset.
- Revenue Recognition: The organizations are required to ensure that revenues are being recorded at the time when these are being earned not at the time when revenues are being received. If a business is making credit sales then, revenue is to be recognized at the time when the sale is being made. The receipt of money in the course of the sale is not going to be taken into account in respect of revenue recognition.
- Matching Concept: The expenses of the organization are shown not when these are being incurred by the organization. Instead, the expenses are being recognized at the time when these are being used for generation of revenue.
The expenses such as salary, rent, and insurance are certain examples of concepts which are being recognized at the time when these are being incurred not at the time when these are being paid by the organization.
- Full Disclosure Concept: The information about financial statements is being used by the organizational investors. If there is the high level of information then, it would be useless for the investors. The information without any concealment should be provided to ensure that the investors see the information and make necessary decisions accordingly.
- Consistency Concept: The information in financial statements is going to be used only at the time when comparisons over a period of time are being allowed. It is essential for the organization to make sure that both categories of comparisons i.e. intra firm and inter-firm comparisons are being made for making proper and appropriate decisions.
- Conservatism Concept: According to this concept, it is being identified that profits should not be recorded until the time these are being recognized. On the other hand, losses should be recorded even if there is a slight chance of occurrence. The applications of conservatism include recognition of stock at cost or market price whichever is lower, discounts to debtors, and writing off of intangible assets such as patents, goodwill and trademark should be taken into consideration.
- Materiality Concept: This concept states that only material facts should be taken into account and irrelevant facts should not be considered. These are the facts which are being known by the user and these factors are going to make an influence on the decisions to be made by the users. The change in method of depreciation is a material fact and it should be taken into consideration and shown in financial reports of the organization.
- Objectivity Concept: The concept states that recording of transactions should be made in an objective manner and there should be no bias in terms of the transactions. This would be possible at the time when, the transaction is being supported by way of verification of documents, invoice or vouchers etc.
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