What is Generally Accepted Accounting Principles (GAAP)?
Generally Accepted Accounting Principles (GAAP) are a set of accounting standards, conventions, and rules used to prepare, present, and report financial statements of an organization. GAAP provides a framework for companies to follow when preparing financial statements so that the information is reliable, comparable, and relevant to users of financial statements.
Table of Content
- 1 What is Generally Accepted Accounting Principles (GAAP)?
- 2 Definition of Generally Accepted Accounting Principles (GAAP)
- 3 Objectives of Generally Accepted Accounting Principles (GAAP)
- 4 Characteristics of Generally Accepted Accounting Principles (GAAP)
- 5 Difference Between GAAP & International Accounting Standards
There is a set of ground rules in financial accounting to present the financial information. These rules are recognised as GAAP. We have already discussed that in order to be useful, financial information need to be collected, classified, summarised and reported objectively.
The stakeholders who access this information have a right to ensure that the information is reliable and free from biases and inconsistencies. For this reason, accounting practices should be bound by certain rules and guidelines. Financial accounting information can be useful only when it follows these standards and guidelines.
It should be noted that GAAP are simple guidelines and principles for accounting. Therefore, it is subject to amendments. At times, certain specific principles need to be altered and some new principles added to adapt to the changing economic circumstances and changing business practices.
Moreover, various accounting principles originate from changes in law, tax regulations, new business organisational arrangements, or new financing or ownership techniques.
Definition of Generally Accepted Accounting Principles (GAAP)
According to the Walgenbach, et al. Because no basic natural accounting law exists, accounting principles have developed on the basis of their usefulness. Consequently, the growth of accounting is more closely related to experience and practice than to the foundation provided by an ultimate law.
As such accounting principles tend to evolve rather than to be discovered, to be flexible rather than precise and to be subject to regular evaluation rather than be ultimate or final. Generally Accepted Accounting Principles (GAAP) are accounting rules for standardising the preparation and reporting of financial statements including balance sheets, income statements and cash flow statements by organisations in a country.
GAAP is required to ensure that the information provided in the financial statements of an organisation is useful for assessing the financial viability of the organisation. For instance, investors and creditors often assess the financial statements of an organisation to make economic decisions.
According to the American Institute of Certified Public Accountants (AICPA) Generally Accepted Accounting Principles incorporate the consensus at any time as to which economic resources and obligations should be recorded as assets and liabilities, which changes in them should be recorded, how the recorded assets and liabilities and changes in them should be measured, what information should be disclosed and which financial statements should be prepared.
Objectives of Generally Accepted Accounting Principles (GAAP)
Every organisation issuing financial statements to the public follows an accounting system. This is important for maintaining consistency in recording financial data over the years and across different organisations.
For example, an investor can compare the Balance Sheet of one organisation to those of another organisation to take his/her investing decisions. Similarly, there are several important objectives of the commonly used accounting system, GAAP.
These are as follows:
- It provides an accounting framework to the various companies that follow these principles.
- It brings uniformity to the various financial statements made by different companies.
- It helps various stakeholders in interpreting the financial statements in the same manner.
- It provides various stakeholders from different jurisdiction in understanding the accounts prepared in other jurisdictions.
- It clarifies issues and confusions regarding various accounting issues.
Characteristics of Generally Accepted Accounting Principles (GAAP)
GAAP includes principles as well as the procedures to apply these principles.
This implies that the accounting principles are simple and man-made guidelines, derived from past experiences.
This implies that the accounting principles are set for ensuring uniformity and meaningful presentation of the accounting information, which can be understood by the users.
It depicts that the accounting principles are relevant to the extent that the accounting information presented after following these principles is meaningful and useful to the users.
This implies that the accounting principles are not influenced by the personal bias or judgment of those who have formulated them. This ensures the reliability of the presented accounting information.
It refers to the extent to which the accounting principles can be implemented without the complexity and incurring any cost.
Difference Between GAAP & International Accounting Standards
International Accounting Standards (IAS) is a set of standard guidelines set by the International Accounting Standard Committee (IASC), located in London. The International Accounting Standard Board (IASB) is the standard-setting body of the IASC. GAAP on the other hand, are accounting standards followed in any country.
GAAP dictates the rules or standards, as well as the conventions to be followed when organisations in a country, records, summarises, transact and prepare their financial statements. Although IASC is a powerful committee, it has no direct control for setting the rules for GAAP.
However, GAAP are influenced by IAS e.g. the set of rules principles, conventions and the Accounting Standards followed in India would be known as “Indian GAAP” .
Therefore, when IASC sets accounting standards, various countries tend to adopt these standards or at least interpret these standards to fit the accounting standards of various jurisdictions. These become the GAAP of the respective jurisdictions.
For example, in the USA, the Financial Accounting Standard Board (FASB) makes the rules and regulations of accounting, which becomes US GAAP. Therefore, GAAP of different countries varies.