Generally Accepted Accounting Principles

Those of you who are either studying financial accounting or are pursuing a career in it must be quite familiar with Generally Accepted Accounting Principles (GAAP). For those who are not that familiar with the warps and wefts of financial accounting, the term Generally Accepted Accounting Principles (GAAP) refers to the standardized guidelines that govern the various financial accounting activities including the way transactions are recorded, the format of drafting the accounting statements, etc. These GAAPs are mostly founded along the lines of the concepts and conventions of accounting, also known as the basic accounting concepts and principles, that are more or less similarly followed all over the world, wherever the double entry accounting system prevails. The subsequent paragraphs discuss and elaborate upon each principle of the GAAP so that you gain a clear understanding of them.

What are Generally Accepted Accounting Principles?

As mentioned above, these principles are the globally standardized guidelines for performing financial accounting activities that conform to the double entry system of accounting. However, this is not a stringent framework and different countries have various modified versions that are suited to their accounting conventions. The framework of the GAAP is based upon the method followed by CPA firms to prepare, record and present statements of their incomes, expenses, assets and liabilities and the regulations that govern the calculation of the profit/ loss figure for a given period of time which is usually one year (whether the year followed is the financial year or the calendar year depends upon individual firm's accounting policies). Given below is a simplified elaboration of each of these principles as they are followed as a standard set of regulatory procedures.

Principle of Regularity: According to this principle, the accounts must be prepared and presented in conformity with the prevalent rules and legal provisions that apply to the jurisdiction within which the firm/ organization falls.

Principle of Consistency: According to this principle, a firm should stick to a single, consistent method of preparing, recoding and presenting its accounts.

Principle of Sincerity: This principle emphasizes the importance of truthfulness, good faith and integrity in preparing the accounts and reflecting the incomes, expenses, assets and liabilities in their true light.

Principle of Permanence: This is an extension of the principle of consistency and it states that in order to compare the financial statements of different accounting periods to interpret and comprehend financial trends, it is necessary that the accounts are maintained in a consistent way.

Principle of Non-Compensation: This principle establishes that the entire details of assets, debts, revenues and expenses should be reflected in the financial statements and no attempt should be made to write off any debt against an asset of similar value and an expense against an equal amount of revenue.

Principle of Prudence: This principle emphasizes the importance of presenting the "true and actual financial picture as it is" . This includes the recording of incomes and revenue only when they are actually realized and provision should be made for expected expenses. The logic of this principle follows along the lines the accounting convention of conservatism.

Principle of Continuity: This principle follows along the lines of the going concern concept of accounting and according to it, all financial statements should be drafted assuming the perpetual existence and uninterrupted functioning of the business entity.

Principle of Periodicity: This principle is completely based upon the accounting period concept and the accrual concept. It states that all accounting transactions must be recorded for a given accounting period. For instance, any prepayment or pre-receipts for subsequent accounting periods must be allocated accordingly to those accounting periods rather than recording the entire amount as the expense or revenue for the current accounting period.

Principle of Disclosure: According to this principle, the true and fair financial position of an organization must be reflected in its financial records and statements. This principle is based upon the materiality concept of accounting.

Principle of Utmost Good Faith: This is an extension of the principle of disclosure and it is stringently applicable to insurance companies. As per this principle, an organization must reveal to its client or customer such financial information the communication or omission thereof may have a significant bearing upon the client's decision to do business with the firm. In insurance parlance, it is known as the principle of Uberrima fides.

The U. S. GAAP is a modified version of the standard Generally Accepted Accounting Principles that are customized to suit the accounting requirements of companies and organizations that fall under the legal jurisdiction of the United States. I hope this brief, simplified tutorial on GAAP would help those who are new to the accounting domain understand the basic without getting confused by subject specific terminologies and jargon.