Generally Accepted Principles of Accounting
Generally accepted principles of accounting means a common set of accounting principles, standards and procedures which is issued by the Financial Accounting Standards Board (FASB). GAAP is required to be followed by the public companies in the U.S. when their accountants compile the financial statements of their business firms. This improves consistency, comparability, clarity, and communication of the financial norms and details of the financial background.
There are 10 principles of GAAP:
Principle of Regularity - The accountants are strictly required to adhere to established rules and regulations according to the GAAP compliance.
Principle of Consistency - The financial reporting process includes all the consistent standards which are applied throughout.
Principles of Sincerity - There is the commitment of accuracy and impartiality according to the GAAP compliant accountants
Principles of Permanence of Methods - There is a consistent set of procedures that are used for the preparation of financial reports.
Principles of Prudence - The reporting of financial data is not influenced by speculation.
Principle of Non-compensation - The reporting with no prospects of debt compensation is conducted from all the aspects of an organization whether it is positive or negative.
Principle of Continuity - The operations of the organization will continue according to the valuation of the assets.
Principle of periodicity - Fiscal quarters or disc years included reporting of revenues which is divided by standard accounting periods.
Principle of Materiality - The organization's full monetary situation is disclosed by financial reports.
Principle of Utmost Good faith - The assumed parties are expected to be acting honestly.
Why are Accounting Principles Important?
Accounting principles are important as they ensure consistency when it comes to keeping financial records worldwide. They describe certain values and principles, which companies are expected to adhere to obtain a more accurate and effective view of the company's statements and reports.
Among the Several Accounting Concepts, the Following are the Most Important:
Money Measurement policy: In accounting, all business transactions are measured financially as a standard unit of measurement. Since money is a standard unit of measurement, as a measure of accounting, you are only allowed to record those transactions or events that can be measured or disclosed in cash.
Business entity concept: This concept of accounting system looks at the business and the business owner differently in terms of their financial transactions. Legally, your business can exist without you and your company can sue or be sued in its name.
Going Concern Concept: This principle applies to the fact that every transaction is recorded assuming that the business will remain viable for a long time and will be able to fulfill its obligations accordingly.
Cost Principle: This accounting policy sets out the rules for accounting for fixed assets. In terms of cost, all fixed assets are calculated at the actual cost i.e. the amount paid to acquire them and thereafter, year after year, the value decreases based on usage, aging, accidents, overtime etc.
Dual-Aspect concept: This calculation principle states that for every deduction, corresponding credit is made. This is the foundation on which the accounting system is implemented. This is important to understand it in detail.
Accounting Year concept: This means that each entity selects a specific period to complete the accounting and reporting cycle. In short, this principle deals with the periodicity of accounting. The time can be monthly, quarterly or yearly.
Matching Concept: The concept emphasized in the accounting principle is that if any revenue is recognized the costs associated with earning that revenue should also be considered. This gives a true picture of the profit earned during the accounting process.
Realization concept: The concept of accounting suggests that revenue is reported when received, regardless of when the payment is received. Anything paid or received is not considered profitable until the goods or services have been delivered to the buyer.
FAQs on Accounting Objectives and Functions Explained
1. What are the primary objectives of accounting for a business?
The main objectives of accounting are to maintain a systematic and complete record of all business transactions, calculate the final profit or loss for an accounting period, determine the financial position of the business on a specific date, and provide useful financial information to various users like owners, managers, and investors for decision-making.
2. What are the key functions that accounting performs?
Accounting serves several essential functions in a business. The most important ones include:
- Measurement: Quantifying past performance and current financial position in monetary terms.
- Forecasting: Providing data to help predict future financial trends and performance.
- Decision-Making: Supplying relevant information to management to make informed choices.
- Comparison & Evaluation: Helping to compare financial results over different periods and with other businesses.
- Control: Identifying weaknesses in operations and helping to implement corrective measures.
3. What is the difference between bookkeeping and accounting?
Bookkeeping is the foundational step that involves the systematic recording of financial transactions in the books of accounts. Accounting is a much broader concept that includes not only recording transactions but also summarising, interpreting, and communicating this financial information to users. In short, bookkeeping is a part of the accounting process.
4. What are the three 'golden rules' of accounting?
The three golden rules of accounting are fundamental principles that guide how transactions are recorded. They are based on the type of account:
- Personal Account: Debit the receiver, Credit the giver.
- Real Account: Debit what comes in, Credit what goes out.
- Nominal Account: Debit all expenses and losses, Credit all incomes and gains.
5. How do the objectives of accounting actually help in making better business decisions?
Accounting information directly impacts business decisions. For example, by showing whether a company is making a profit or loss, it helps managers decide whether to continue or shut down a product line. By presenting the financial position through a Balance Sheet, it helps stakeholders assess the company's health before making investment or lending decisions.
6. Why is providing information to users considered a key objective of accounting?
Providing information is a crucial objective because a business does not operate in isolation. Internal users like management need data for planning and control, while external users like investors need it to assess profitability and banks need it to evaluate creditworthiness. Without clear communication of financial data, these stakeholders cannot make sound economic decisions.
7. Can a business realistically operate without accounting? What are the biggest risks?
While a very small vendor might manage informally, any structured business would face huge risks without accounting. The biggest challenges would be not knowing if it's profitable, being unable to manage cash flow, failing to comply with legal and tax requirements, and finding it nearly impossible to secure loans or investment as there would be no proof of financial performance.
8. What does it mean when people say accounting is the 'language of business'?
This is a common analogy because accounting translates complex business activities into quantitative reports that can be understood by various stakeholders. Just as we use language to communicate ideas, businesses use the principles and reports of accounting to communicate their financial story—their performance, position, and cash flow—to investors, creditors, and managers.
