What is GAAP

GAAP is an acronym for Generally Accepted Accounting Principles. Every financial transaction is recorded by accountants as it acts as a statement of the debts and credits of a company. There are different basic accounting concepts and principles of keeping records of assets and liabilities. As businesses have become multinational there is a need to have a common set of standards so that there is no confusion or ambiguity. In this scenario, generally accepted accounting principles act as standard for maintaining records around the world. It is defined as the standard set of accounting principles and procedures that companies use to prepare their financial statements.

Before we go ahead and look into the use of GAAP in US, let us take a quick look at the history of accounting. The GAAP was not formally founded by any one accountant or economist. However, most of the modern-day accountants consider Luca Pacioli to be the father of bookkeeping. He was the first to use the double-entry system and advised men to not to go to sleep in the night until their debits equaled the credits! In US, the first committee on accounting principles was set in 1939, and in 1951 was replaced by Accounting Principles Board. Since then, Government Accounting Standards Board (GASB) decides the rules for companies in the US. Other countries of the world adhere to the rules set by the International Financial Reporting Standards Board (IFRS). This was some information on the history of GAAP and what is US GAAP accounting, let us now know about the importance of writing your statements in accordance with GAAP.

Compliance with GAAP helps advance creditability with creditors and stockholders because it reassures outsiders that a company's banking letters accurately portray its banking position. Plus, anyone who reads your banking statements like stockholders, creditors, analysts etc. will accept that the statements are in accordance with the rules of GAAP. More importantly, if the financial position is recorded according to GAAP, investors are more likely be to be less apprehensive.

GAAP Principles

1. Principle of Regularity
2. Principle of Consistency
3. Principle of Sincerity
4. Principle of Permanence
5. Principle of Non-Compensation
6. Principle of Prudence
7. Principle of Continuity
8. Principle of Periodicity
9. Principle of Disclosure
10. Principle of Utmost Good Faith

These were some of the principles which are the basis of GAAP. But as we mentioned before that it is not a rigid set of rules, it works on several assumptions. Let us take a look at some of the assumptions of GAAP.

GAAP Assumptions

• Going Concern Assumption: According to going concern assumption, the business is a long-term venture and it will be there for foreseeable time.
• Monetary Unit Assumption: This assumption means that the currency used for recording the financial transactions will be the stable currency.
• Economic Entity Assumption: This principle distinguishes business as being separate from its owners or their other businesses.
• Periodic Reporting Assumption: This assumption means that the business transactions can be divided into different time-frames or periods so that a difference between the present transactions and the past transactions can be ascertained.

GAAP Depreciation

Depreciation is the undesirable phenomenon due to which value of a substance is decreased. The depreciation can be because of wear and tear or several other factors. Depreciation is an important part of financial transactions as these are a loss to the business. GAAP uses several methods to include depreciation in its income statements. Some of the methods are

• Straight-Line: This is one of the most common methods to calculate depreciation. In this method, the salvage value of the asset is subtracted from the cost at which you brought the asset initially and the amount is then divided by the 'useful years' of the product. For example, if you bought a car for $50,000 and you think it will be useful for five years and you sell it off at $10,000 then according to the straight-line method, the depreciation would be (50,000 -10,000) ÷ 5 = $8000. So, your car depreciates at the rate of $8000 annually.
• Declining Balance: This method of GAAP depreciation states that the depreciation is higher in the first years and keeps decreasing over a period of time. So, as per decline balance depreciation, if an asset worth $100 depreciates at 10% per year, then the depreciation is $10 in the first year, $9 in the second year, $ 8 in the third year and so on.
• Units of Production: This is the third method of GAAP depreciation. It focuses on the activity of the asset rather than the time period for which the asset is used. If an asset like a machine is used to produce higher number of products, then the depreciation will be higher and vice-versa.