Generally Accepted Accounting Principles (GAAP) are a combination of authoritative standards (set by policy boards) and are simply the commonly accepted ways of recording and reporting accounting information.

GAAP define the accounting procedures, and understanding them is essential for producing accurate and meaningful records.

GAAP provide objective standards for judging and comparing financial data and its presentation, and limit the directors' freedom in showing an unrealistic picture through creative accounting. An auditor must certify that the provisions of GAAP have been followed in reporting an organization's financial data in order it to be accepted by investors, lenders, and tax authorities. Most countries (Canada, India, Japan, UK, US, etc.) have their own GAAP which may differ from those of others in minor or major details.

Who Defines GAAP?

The Financial Accounting Standards Board (FASB) is the authoritative body having the primary responsibility for developing accounting principles. The FASB publishes Statements of Financial Accounting Standards as well as Interpretations of these Standards.

Apart from “Financial Accounting Standards Board” (FASB), the American Institute of Certified Public Accountants (AICPA), and the Securities and Exchange Commission (SEC) along with the statutory authoritative bodies of various countries (Example – Institute of Chartered Accountants of India, for India), have played an influential role in developing generally accepted accounting principles which span across boundaries of nation and have global acceptability.

Efforts are still going on to emerge globally accepted principles, as variations are still found in principles from countries to countries as well as from businesses to businesses that warrants a need to have different accounting methods.

The “Why” of Accounting:-

By applying generally accepted accounting principles in accounting practices, accountants make sure that their work is consistent and meaningful to others.

GAAP1: The Business Entity Principle:

Under the business entity concept, the activities of a business are recorded separately from the activities of the stakeholders. The Business Entity Principle states that a business must be considered a separate entity, and only the transactions carried out by the business may be recorded in the accounting books. This ensures that the financial picture of the business represents the activities and events of the business; this reflects the economic impact and value of the business not of its stakeholders.

GAAP2: The Cost Principle:

The Cost Principle states that anything a business purchases is recorded as the amount paid, regardless of its real or perceived value. This accounting principle requires the amounts in the accounts to be the actual cost rather than the current or future value. Accountants can show an amount less than cost due to conservatism in certain circumstances, but accountants are generally prohibited from showing amounts greater than cost. This eliminates guesswork or the possibility of recording inaccurate information.

For example- A business has acquired a building for $100,000 by paying the seller in cash after taking a loan from the bank. The Ask Price by seller was $150,000 and the business was only willing to pay $90,000. As far as the valuation of the property by the corporation is concerned it was valued at $120,000 for property tax purposes. Business applied for a loan from bank and the approved property assessor estimated the market value of the property to be $125,000. Bank only financed $75,000 against that valuation. After the business bought the property it received an offer of $135,000 next day by a neighbouring store for the same building. What should be the amount that should be entered into the business’s accounting records?

As per the cost principle, the cost of the building for the business here is $100,000 and the other amounts have no effect on the accounting records because they did not result in an exchange of the building from the seller to the buyer. The cost concept is the basis for entering the exchange price, or cost, into the accounting records for the business.

GAAP3: The Objectivity Principle:

Using the cost concept involves two other important accounting concepts—objectivity and the unit of measure. The Objectivity Principle states that accounting operates on objective evidence. All transactions must have proof that they were carried out.

In the earlier real estate example, while negotiating the deal, both buyer and seller, try to get the best price. Only the final agreed-upon amount, on the basis of which the transfer of title was initiated, is objective enough for accounting purposes.

GAAP4: The Unit of Measure Principle:

The unit of measure concept requires that economic data be recorded in monetary terms that are dollars or rupees or any other applicable currency. Money is a common unit of measurement for reporting uniform financial data and reports. This principle also involves another linked principle of “Stable Monetary Unit of Measure “that states that the value of the monetary measure (rupee) does not change. This ensures that the unit of measure (rupee) is kept as a stable unit of measure for accounting purposes. It also makes it easier to compare financial statements over time.

GAAP5: The Going-Concern Principle:

The 'going concern' concept directs accountants to prepare financial statements on the assumption that the business is not about to go broke or be liquidated. So, unless there is significant evidence to the contrary, accountants will base their valuations and their reporting of financial data on the assumption that the business will remain in existence for an indefinite period. An indefinite period means the foreseeable future or long enough for the business to meet its objectives and to fulfil its commitments.

NEED FOR INDIAN COMPANIES TO CONFIRM TO US GAAP:-

With advent of foreign institutional investors (FII) and mutual funds, shareholders’ and investors’ need for data about the company has changed drastically. As they compete for their institution’s attention corporaters have no choice but to provide undistorted data. Simultaneously India Inc.’s rush into global markets for debt and equity has necessitated the disclosure of sufficient information to compete with global contenders for same capital.