2GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Contents of the LectureContents of the Lecture

Meaning of GAAPMeaning of GAAP GAAPGAAP Accounting StandardsAccounting Standards

Generally Accepted Accounting Generally Accepted Accounting PrinciplesPrinciples

GAAP are the body of doctrines GAAP are the body of doctrines commonly associated with the theory commonly associated with the theory and procedure of accounting serving and procedure of accounting serving as an explanation of current as an explanation of current practices and as guide for selection practices and as guide for selection of conventions and procedures where of conventions and procedures where alternatives exist.alternatives exist.

GAAPGAAP

According to According to American Institute of American Institute of Certified Public Accountants (AICPA), Certified Public Accountants (AICPA), the principles which have substantial the principles which have substantial authoritative support become a part authoritative support become a part of Generally Accepted Accounting of Generally Accepted Accounting PrinciplesPrinciples

AS-1 Disclosure of Accounting AS-1 Disclosure of Accounting PoliciesPolicies

According to AS-1 issued by ICAI, the According to AS-1 issued by ICAI, the ‘‘Fundamental Accounting Fundamental Accounting Assumptions’Assumptions’ while drafting accounts while drafting accounts of a business enterprise are:of a business enterprise are:

Going Concern,Going Concern, Matching (or Accrual) Matching (or Accrual) Consistency. Consistency.

AS-1 Disclosure of Accounting AS-1 Disclosure of Accounting PoliciesPolicies

Considerations in selection of Considerations in selection of Accounting Policies are:Accounting Policies are:

PrudencePrudence Substance over Form Substance over Form Materiality Materiality

GAAPGAAP

The GAAP includes the following concepts:The GAAP includes the following concepts:1.1. Accounting Entity Accounting Entity 2.2. Money MeasurementMoney Measurement3.3. Going ConcernGoing Concern4.4. Accounting Period Accounting Period 5.5. CostCost6.6. Revenue Recognition (or Realization)Revenue Recognition (or Realization)7.7. Matching (or Accrual)Matching (or Accrual)8.8. Dual AspectDual Aspect

GAAP contd…….GAAP contd…….

9.9. Full, Fair and Adequate DisclosureFull, Fair and Adequate Disclosure10.10. Verifiable Objectivity Verifiable Objectivity 11.11. MaterialityMateriality12.12. ConsistencyConsistency13.13. Conservatism (or Prudence)Conservatism (or Prudence)14.14. TimelinessTimeliness15.15. Industry PracticesIndustry Practices16.16. Substance over FormSubstance over Form

Accounting Entity Accounting Entity

A business is treated as a separate entity A business is treated as a separate entity that is distinct from its owner(s), and all that is distinct from its owner(s), and all other economic proprietors. other economic proprietors.

For example, if the household expenses For example, if the household expenses (Rs.12,000/-) of proprietor are shown as (Rs.12,000/-) of proprietor are shown as business expense, the profits of a business expense, the profits of a business will be understated to the business will be understated to the extent of Rs.12,000/-.extent of Rs.12,000/-.

Money MeasurementMoney Measurement

Only those transactions which are Only those transactions which are capable of being expressed in term capable of being expressed in term of money are included in the of money are included in the accounting records. accounting records.

For e.g., entrance of a new For e.g., entrance of a new competitor in the market, rift competitor in the market, rift between production and marketing between production and marketing department, ill health of the department, ill health of the managing director etc. managing director etc.

Going ConcernGoing Concern

The business activities will continue The business activities will continue for a fairly long period of time unless for a fairly long period of time unless and until the business has entered and until the business has entered into a process of liquidation. into a process of liquidation.

It does not imply permanent It does not imply permanent existence but simply stability and existence but simply stability and continuity for a period sufficient to continuity for a period sufficient to carry business plans. carry business plans.

Accounting Period Accounting Period

The economic life of an enterprise is The economic life of an enterprise is artificially split into periodic intervals artificially split into periodic intervals which are accounting periods, at the end which are accounting periods, at the end of which an income statement and position of which an income statement and position statement are prepared to show the statement are prepared to show the performance and financial position.performance and financial position.

The use of this assumption further The use of this assumption further requires the allocation of expenses requires the allocation of expenses between capital and revenue. between capital and revenue.

Cost PrincipleCost Principle

An asset is ordinarily recorded in the An asset is ordinarily recorded in the accounting records at the price paid accounting records at the price paid to acquire it at the time of its to acquire it at the time of its acquisition and the cost becomes the acquisition and the cost becomes the basis for the accounts during the basis for the accounts during the period of acquisition and subsequent period of acquisition and subsequent accounting periods. accounting periods.

Revenue Recognition (or Revenue Recognition (or Realization)Realization)

Revenue is considered as realized or Revenue is considered as realized or earned on the date when the sale earned on the date when the sale process is complete and transfer of process is complete and transfer of title or ownership takes placetitle or ownership takes place

Revenue results in increase in Revenue results in increase in owner’s equity. It has nothing to do owner’s equity. It has nothing to do with inflow of cash. Goods can be with inflow of cash. Goods can be sold for cash or on credit. sold for cash or on credit.

Matching (or Accrual)Matching (or Accrual)

The expenses incurred in an The expenses incurred in an accounting period should be accounting period should be matched with the revenues matched with the revenues recognized in that period, that is, if recognized in that period, that is, if revenue is recognized on all goods revenue is recognized on all goods sold during a period, cost of those sold during a period, cost of those goods sold should also be charged to goods sold should also be charged to that period. that period.

Dual AspectDual Aspect The entry made for each transaction is The entry made for each transaction is

composed of two parts – one for debit and composed of two parts – one for debit and another for credit. Every debit has equal another for credit. Every debit has equal amount of credit. So, the total of all debits must amount of credit. So, the total of all debits must be equal to the total of all credits be equal to the total of all credits

Sum of assets on one hand and sum of Sum of assets on one hand and sum of obligations on other hand must agree. Identity obligations on other hand must agree. Identity of assets and obligations (capital and liabilities) of assets and obligations (capital and liabilities) is expressed in the form of a basic is expressed in the form of a basic Accounting Accounting Equation Equation as given below:as given below:

Assets = Capital + LiabilitiesAssets = Capital + Liabilities

Full, Fair and Adequate Full, Fair and Adequate DisclosureDisclosure

Full disclosureFull disclosure essentially means that essentially means that nothing is omitted. nothing is omitted.

Fair DisclosureFair Disclosure means that the accounting means that the accounting principles have been applied in a fair principles have been applied in a fair manner so as to report the true and fair manner so as to report the true and fair view of the results of the business.view of the results of the business.

AdequacyAdequacy is a qualification which ensures is a qualification which ensures that anything which influences the that anything which influences the decision of the user must always be decision of the user must always be reported. reported.

Verifiable ObjectivityVerifiable Objectivity

Accounting records are based on Accounting records are based on documentary evidence which can be documentary evidence which can be verified objectively and substantiates verified objectively and substantiates the recorded event the recorded event

Source documents such as sales bill, Source documents such as sales bill, purchase bill, pay in slip, cash memo purchase bill, pay in slip, cash memo etc. ensure objective recording of etc. ensure objective recording of business transactions. business transactions.

MaterialityMateriality

Materiality requires that accounting Materiality requires that accounting should focus on material facts and should focus on material facts and resources should not be wasted in resources should not be wasted in recording and analyzing immaterial recording and analyzing immaterial and insignificant fact. and insignificant fact.

ConsistencyConsistency

Whatever accounting practices are Whatever accounting practices are selected for a given category of selected for a given category of transactions, they should be followed on a transactions, they should be followed on a horizontal basis from one accounting horizontal basis from one accounting period to another to achieve compatibility period to another to achieve compatibility

However, it does not mean lack of However, it does not mean lack of flexibility. It does not prelude desirable flexibility. It does not prelude desirable changes in accounting procedures. changes in accounting procedures.

Conservatism (or Prudence)Conservatism (or Prudence)

‘‘anticipate no profit but provide for anticipate no profit but provide for all probable losses’ all probable losses’

In the situation of uncertainty and In the situation of uncertainty and doubt, the business transactions doubt, the business transactions should be recorded in such a should be recorded in such a manner that the profits and assets manner that the profits and assets are not overstated and the losses are not overstated and the losses and liabilities are not understated. and liabilities are not understated.

TimelinessTimeliness

Financial reports must be timely to Financial reports must be timely to have any usefulness for decision have any usefulness for decision makers.makers.

If the quarterly reports are made If the quarterly reports are made available on half-yearly basis, the available on half-yearly basis, the information contained in the information contained in the quarterly report would not be very quarterly report would not be very useful to the decision makers useful to the decision makers

Industry PracticesIndustry Practices

Sometimes, practice prevailing in a Sometimes, practice prevailing in a particular industry is given particular industry is given precedence over generally accepted precedence over generally accepted accounting principles accounting principles

Example is valuation of gold on the Example is valuation of gold on the basis of market price basis of market price

Substance over FormSubstance over Form

Transactions and other events should Transactions and other events should be accounted for and presented in be accounted for and presented in accordance with their substance and accordance with their substance and financial reality and not merely with financial reality and not merely with their legal form their legal form

ACCOUNTING STANDARDSACCOUNTING STANDARDS

An Accounting Standard is a selected An Accounting Standard is a selected set of accounting policies or broad set of accounting policies or broad guidelines regarding the principles guidelines regarding the principles and methods to be chosen out of and methods to be chosen out of several alternatives several alternatives

Accounting Standards are formulated Accounting Standards are formulated with a view to harmonise different with a view to harmonise different accounting policies and practices in a accounting policies and practices in a country. country.

Objective of ASObjective of AS

The objective of Accounting Standard is to The objective of Accounting Standard is to reduce the accounting alternatives in the reduce the accounting alternatives in the preparation of financial statements within preparation of financial statements within the bounds of rationality, thereby ensuring the bounds of rationality, thereby ensuring comparability of financial statements of comparability of financial statements of different enterprises with a view to provide different enterprises with a view to provide meaningful information to various users of meaningful information to various users of financial statements to enable them to financial statements to enable them to make informed economic decisions. make informed economic decisions.

International Harmonization of International Harmonization of Accounting StandardsAccounting Standards

International Accounting Standards International Accounting Standards Committee (IASC) was set up in 1973Committee (IASC) was set up in 1973

IASC is renamed as International IASC is renamed as International Accounting Standards Board (IASB)Accounting Standards Board (IASB)

ICAI being a member body of IASC, ICAI being a member body of IASC, constituted the constituted the AccountingAccounting Standards Standards Board (ASB) on 21st April, 1977Board (ASB) on 21st April, 1977

The ASB gives due consideration to The ASB gives due consideration to International Financial Reporting International Financial Reporting Standards (IFRSs) / International Standards (IFRSs) / International Accounting Standards (IASs) issued Accounting Standards (IASs) issued by IASB and tries to integrate them, by IASB and tries to integrate them, to the extent possible, in the light of to the extent possible, in the light of conditions and practices prevailing conditions and practices prevailing in the country. in the country.