What is GAAP (Generally Accepted Accounting Principles)?

Unlike physical science, where laws are internally and universally true, accounting principles tend to change to meet the demands of changing financial situations.

Adequate financial information that was presented in a report several years ago may not be adequate today.

Over the years, the accounting profession realized that it needs to develop a set of permanent ground rules.

There had to be a set of universal ground rules for all companies, institutions and organizations to follow strictly in the course of preparing financial data and when presenting the financial statements.

That’s where (GAAP) came in!

Over the years, accountants realized the urging need for a consistent, reliable system of financial reporting.

They realized that in order to deal with the sweeping changes of today’s business environment, a consistent financial reporting system must be developed.

Generally accepted accounting principles (GAAP) don’t only consist of principles; they also encompass various procedures for applying these principles.

For illustration, a specific accounting principle that a machine’s price must be divided and spread over a specific period of time, which is the machine’s expected life.

It is a single principle, but there are a few accepted procedures for applying it.

The cost can be divided over the machine life in equal amounts.

It also can be spread over the machine’s life based on the number of produced units every year.

As well, the cost can be divided based on the yearly number of work hours the machine was used.

As stated earlier, accounting is not a pure science; what may sound a theoretically good solution for a particular accounting issue may have practical limitations.

Therefore, generally accepted accounting principles (GAAP) were developed with this practicality issue in mind.

They are a combination of straightforward theoretical principles and practical considerations.

GAAP consist of several fundamental accounting concepts, some of which are: the, the objectivity principle, the business entity concept, the matching principle, and the going concern concept.

 

 

The Objectivity Principle

The objectivity principle states that the historical cost of an item should be confirmed by an independent party, which can be done by simple checking the information in the sale invoice.

This principle establishes the reason of recording assets at their cost, as any other values could not be agreed upon by independent parties, even if they have a long experience in determining values.

 

The Business Entity Concept

This basic accounting principle states that a business entity is separate and distinct from its owners.

 

The Matching Principle

This principle states that expenses incurred in generating revenues must be deducted from revenues they generated during the same accounting period.

 

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The Going Concern Concept

This concept states that a business firm must be established with the assumption of continued existence.

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