Theory Base of Accounting

Generally Accepted Accounting Principles- Introduction and Overview

Objectives

After going through this lesson, you shall be able to understand the following concepts.

✶ Introduction to GAAP
✶ Need for Accounting Principles
✶ Characteristics of Accounting Principles
✶ Accounting Concepts & Conventions

Introduction to GAAP

Generally Accepted Accounting Principles (GAAPs) are a set of basic rules and procedures prescribed by the Institute of Chartered Accountants of India (ICAI) which have to be followed while preparing financial statements. These are the accounting principles, concepts and conventions which ensure that financial reporting is transparent and consistent from one organisation to another. The management and the auditors are bound by the Companies Act of 2013 to follow GAAPs.

According to The American Institute of Certified Public Accountants “Principles of Accounting are the general law or rule adopted or proposed as a guide to action, a settled ground or basis of conduct or practice”

Need For Accounting Principles
 
The basic objective of accounting is to communicate information about the financial well-being of an enterprise to the users of the financial statements. As the accounting principles and assumptions followed across various enterprises are different due to biases and difference of opinion between the accountants. This gives rise to the need for a set of universally accepted guidelines and rules which help in making financial results of various enterprises comparable across industries and time period. In today’s dynamic environment the needs and expectations of businesses from accounting keep on changing, hence the accounting principles have to be developed and changed according to the needs of business.   

Characteristics of Accounting Principles

1. Flexible in Nature: As we know businesses operate in a dynamic environment and in order to keep up with the ever changing needs of the business world and economy, the principles of accounting must be flexible in nature.

2. Man-made: These principles have been developed by accountants and academicians over a long period of time through continuous application, while adapting to the ever changing needs of the businesses.

3. Generally Accepted: These principles are universally accepted, free from personal bias. In order to be universal in character three basic criteria should be fulfilled which are as follows :

a. Usefulness

b. Objectivity  and

c. Feasibility

 Accounting Concepts and Conventions

1. Accounting Concepts: These are the basic propositions and fundamental assumptions on which accounting operate. Financial statements are prepared and transactions are recorded on the basis of these generally accepted rules of accountancy. By following accounting concepts we can ensure that the users of such financial statements are better able to understand and compare the financial statements.

2. Accounting Conventions: Accounting conventions are the customs and traditions that guide an accountant while preparing the financial statements. These are those guidelines that have been arrived at after years of practice and will change in case of change in environment. These are not legally binding on an accountant but are just generally accepted practices.

Objectives

After going through this lesson, you shall be able to understand the following Fundamental Accounting Assumptions.

• Going Concern
• Consistency
• Accrual

Let us first understand the meaning and importance of these fundamental accounting assumptions with the below video.



Going Concern

Going concern is the basic underlying assumption of accounting. Financial statements are prepared assuming that the business is a going concern i.e. the company intends to continue the business and will be able to do so. In short, it means business will continue indefinitely.

The business will continue operating and will not close but will realise assets and discharge liabilities in the normal course of operations.

Examples

1. A nationalized company is in cash flow problems but the government of the country provided a guarantee to the company to help it out with all payments, the company is a going concern despite poor financial position.

2. An insurance company is in serious financial troubles and the government is not willing to bail it out. The Board of Directors have passed a resolution to liquidate the business. The insurance company is not a going concern.

3. An oil and gas firm operating in Sudan is stopped by a Sudanese court from carrying out operations in Sudan. The firm is not a going concern in Sudan, because it has to shut down.

4. A manufacturing company has a current ratio below 0.5. A creditor $1,000,000 demanded payment which the company could not make. The creditor requested the court to liquidate the business and recover his debts and the court grants the order. The company is no longer a going concern.

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