What is GAAP?
GAAP, short for Generally Accepted Accounting Principles, is the common set of accounting principles, procedures, and standards used by companies to compile their financial statements. GAAP are, therefore, a combination of authoritative standards and the generally accepted ways of recording and reporting accounting info.
As stated by Investopedia, GAAP are imposed on companies so as to provide the investors with a minimum level of consistency in their financial statements used while analyzing companies for investment rationales. Moreover, GAAP covers things like balance sheet item classification, revenue recognition, and outstanding share. Also, companies are expected to follow GAAP standards while presenting their financial data through the way of financial statements.
Basic objectives of GAAP Accounting Standards
As per the accounting standards presented by GAAP, the financial reports should provide info which is:
- useful in being presented to potential creditors and investors in addition to other users in making cogent investment, credit, and similar financial decisions
- helpful for the potential creditors and investors in addition to other users in evaluating the timing, amounts, and uncertainty of probable cash receipts
- related to economic resources, the claims to these resources, and the changes occurring in them
- helpful in taking financial decisions
- helpful in taking long-term decisions
- helpful in improving the business’ performance
- useful in maintaining records
Basic concepts of GAAP Accounting Standards
In order to achieve the aforesaid objectives of GAAP and implement fundamental qualities, the set accounting standards feature four basic assumptions as listed below:
- Going concern
This assumption of GAAP accounting standards presumes that the business stays in operation indefinitely thus validating the techniques of asset capitalization, amortization, and depreciation. This assumption is, however, not applicable in case of liquidation. The business is believed to continue in the unforeseeable future.
- Monetary Unit Principle
This assumption presumes a stable currency going to be the unit of record.
- Accounting Entity
This assumption presumes the business to individually exist from its owners or other business entities. Also, revenue and expense need to be kept separate from personal expenses.
- Time-period principle
This assumption states that an entity’s economic activities can be divided into simulated time-periods.