Generally Accepted Accounting Principles (“GAAP”s)

Generally Accepted Accounting Principles “GAAP”s

INTRODUCTION

• To avoid confusion and achieve uniformity in Financial Statements, the “Generally Accepted
Accounting Principles” (GAAP’s) are required to be followed.
• These GAAP’s are used to describe rules developed fo the preparation of financial statements.
• These GAAP’s can also called as Concepts, Conventions and principles.
• The GAAP is the backbone of the accounting.
• GAAP and Accounting Standards are considered as the theory base of accounting.

Accounting Concepts:

• The term 'Concepts' refers to a statement of fundamental truth which is widely used and
universally accepted.
• It includes accounting conventions, procedures and rules adopted by the business in preparation
and presentation of financial data.

Accounting Concepts Required for

Assets Valuation Income Measurement Accounting Procedure

1) Going Concern 1) Periodicity 1) Separate Entity

2) Cost Concept 2) Matching 2) Dual Aspect
3) Realisation 3) Accrual 3) Money measurement
4) Conservatism (Conservatism also 4) Full Disclosure
(For Current Assets) affects income) 5) Materiality
6) Consistency

Accounting Concepts Required for Asset's Valuation:

Going • It is assumed that enterprise has neither the intention nor the necessity of
Concern liquidation or winding up of business.
• Means in other words, it is assumed that business will continue for unlimited
period.
• Joint Venture is an exception. Going concern concept is not followed in the context
of Joint Venture.
• If an enterprise is not going concern, valuation of its assets and liabilities will be
made on realisable vauue basis because the historical cost concept becomes
unsuitable..
• As per going concern concept, Assets must be shown at their historical cost

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 Generally Accepted Accounting Principles (“GAAP”s)

(Purchase Price).
• This concept indicates that asset are kept for generating future benefits and not for
immediate sale therefore current change in value of asset is not realisable and so it
should be ignored.

Cost Concept • Asset shall recorded in the books of accounts at it's acquisition
cost/purchase price.
• This acquisition cost shall be the base for all subsequent accounting treatments of
assets like providing of depreciation.
• This cost concept is objective in nature and free from all biases.
• However, cost concept suffers from following Limitations:

a) If inflationary situations exists then preparation of financial statements on

the basis of historical costs becomes irrelevant for judging the financial
position of the business.
b) Many assets do not have acquisition costs. e.g. Goodwill may not have
acquisition cost if it is generated as well as dedicated labour force, efficient
management teams don’t have acquisition cost even they are very important.
c) Comparison of financial Statements of two entity started on different point
of time is not possible.

Realisation • Realisation concept closely follows cost concept.

Concept • But under realisation concept, any change in value of an asset is to be recorded
only when the business realises it.
• Such change is not counted unless there is certainty that such change will
materialised.
• e.g. If asset was purchased at 8,00,000 Rs. and Market price is Rs. 80,00,000
Then such change shall not be recorded unless there is certainty that such value
will be surely realised.
• Thus, this concept shall be followed only if when their values undergo a
permanent change. Thus, surplus on revaluation of fixed asset is taken to Capital
Reserve.
Conservatism • This concept has impact on valuing Current Assets and Measurement of
concept Income.
• Conservatism concept lays golden rule of Current Assets valuation 'Cost or Net
Realisable value whichever is lower.'
• This is the policy of 'Playing safe'.
• This concepts specifies two important guidelines

1. Account/record for all expected losses and expenses but ignore

anticipated Income, gains and profits". E.g. Provision for doubtful debtors.
2. Whenever there are two alternatives, the alternative which shows lower
profit shall be selected and followed. E.g. Valuing Stock at market price or
cost price whichever is less.
• However, conservatism may lead to understatement of income and wealth (or
overstatement of loss.)
• The conservatism puts break on realization concepts.
• Following are the qualitative characteristics required for this concepts:
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 Generally Accepted Accounting Principles (“GAAP”s)

1. Prudence: E.g. judgement about possible future losses which are to be

guarded as well as gains which are uncertain.
2. Nuetrality: Unbiased outlook is required to identify and record all such
possible losses as well as exclude uncertain gain.
3. Faithful representation of alternative values.
Accounting Concepts Governing Income Measurement

Periodicity • Life of business is assumed to be indefinite/unlimited due to going concern

Concept concept.
• But it is not appropriate to measure performance of business at the end of life of
the business because it will be useless because it will be too late to take
corrective steps at that time since such analysis is like 'postmortem of dead
body'.
• It is, therefore, absolutely necessary that after certain time interval, the
businessman must evaluate the business operations.
• Such time interval at which businessmen stops for evaluation is called
'accounting period'.
• Such time interval shall be small but workable therefore It is normally of a
year (but it may be 15 days, 3 months, 6 months etc.
• At the end of each accounting year, an Income Statement (i.e. Profit and Loss
Account) and a Balance Sheet is prepared.
• Income statement reflects operating results of the business for that accounting
period and Balance Sheet reflects financial position of the business as at the end
of the accounting period.

Matching • In order to ascertain the Profit made by the business during a particular year, it
Concept is necessary that 'revenues' of the period should be matched with the costs
(expenses) of that period.
• This concept gives rise to classification of expenses into 'Capital' and
Revenue'.
• This concept gives rise to treatment for Prepaid Expenses, Outstanding
Expenses, Accrued income, Advance Income.

Accrual • According to this concept Revenue/Income shall be recorded when they

Concept are earned and costs shall be recognised and recorded when they are
incurred.
• According to this concept, mere receipt & payment of cash shall not be taken as
base for recognizing and recording of expenses and income.
• Thus, all revenues and costs for the period are to be recorded even if cash is not
actually received or paid.
• In other word, it is called as Mercantile system of accounting.
• It is mandatory for all companies as per Sec-209 of Indian Companies Act,
1956 to keep accounts under accrual basis.

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 Generally Accepted Accounting Principles (“GAAP”s)

Accounting Concepts Governing Accounting Procedure

Separate • As per this concept every organization is considered to be separate entity

Entity from the owner/ proprietor(s).
Concept • Thus, brings capital into the business, it will be deemed that business has
borrowed Rs.10,000/- from the proprietors and it is shown as the liability side
of balance sheet.
• The concept of separate entity is applicable to all forms of business organisation.
• Due to this concept, it is possible to find out exact performance of the business.
Dual Aspect • According to this concept, every business transaction has a dual effect-debit and
credit.
• The total amount debited always equals the total amount credited.
• The dual aspect can be expressed by way of a following equation: Capital +
Liabilities = Assets.
• Every transaction and event has two effects as follows:
1. Increase in one asset may leads to decrease in other assets.
2. Increase in one asset may leads to Increase in other Liabilities.
3. Decrease in one asset may leads to increase in other assets.
4. Decrease in one asset may leads to decrease in other liabilities.

Money • This concepts implies that Accounting recognises & records only those,
measurement transactions and events which can be expressed in terms of money only.
• In other words, transactions /events which cannot be expressed in terms of
money are not recorded in books of accounts, e.g. Talent, Hard work of Owner
etc.
Full • According to this concept, each & every fact of the business shall be fully
disclosure disclosed in the books of accounts.
• Even the Companies Act, 1956 has made provisions for the full disclosure of
essential information in Company Accounts.
Materiality • Any item should be regarded as material if it has impact on the decision
making of the user of accounting information.
• Therefore accountant should attach importance to material details and ignore
immaterial things.
• On the basis of this concept, Indian Companies Act 1956, has provided that all
expenses, less than Rs.5000/- or 1% of total turnover whichever is higher
need not be disclosed separately and can be grouped under the head
Miscellaneous Expenses.
Consistency • One of the qualitative characteristics of accounting data is comparability,
whether data of the same enterprise over the periods or data of different
enterprises of the same period or both.
• Whatever may be the accounting policies, these are to be followed
consistently. e.g. Method of charging depreciation (whether W.D.V. or S.L.M. ) is
to be followed consistently year after year.

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 Generally Accepted Accounting Principles (“GAAP”s)

Fundamental Accounting Assumptions

Note: AS-1 'Disclosure of Accounting Policies' issued by the Institute of Chartered Accountants of
India (ACAI) states that following are the fundamental Accounting Assumptions:
(a) Going Concern
(b) Accrual
(c) Consistency.
These three concepts are so fundamental that their acceptance and use are assumed in the preparation
of financial statements.
If above fundamental accounting assumptions are not followed, the fact should be disclosed
clearly in the financial statements together with reasons.

Qualitative Characteristics Of Financial Statement

• Financial statements are to be prepared to convey meaningful information to the users.

• These statements should present a true and fair views of Position of the business.
• Qualitative characteristics which make financial statement meaningful are explained below :

1. Understandability : An essential quality of the information provided in the financial statements is

that it must be readily understandable by the users. But, this doesn't mean, information which
relatively complex and not easily understandable should not included even if it is relevant
information.

2. Relevance : Financial statement must contain relevant information. Information becomes

relevant and material if its omission or mis-statement could influence the decisions of users of
accounting Information.

3. Reliability: Information is useful only if it is reliable. Information is said to be reliable when it is

reliable from material error and bias. The reliable information means the information on which the
person can depend/rely.
Relevance and Reliability are treated as two primary qualitative characteristics.

4. Comparability : Financial Statement must be comparable with the statement of last year of the
company and with finacial satatement of same year with other competitive organisation.
By comparison, it is possible to find out trends of past performance as well as decision about the
future can be taken.
A S-1 makes it mandatory to disclose accounting policies followed so as to facilitate inter firm
comparison.

5. Matriality: Information disclosed in statement shall be material.

6. Faithful presentation of transactions and events.

7. Substance over Form: The transaction should be recorded according to Economic reality and not
merely on the basis of their mere legal form.
E.g.X transferred land to Y but documentation is pending then according to law land is not
transferred but according to Economic reality land is transferred therefore reality shall be
considered and land is to be recorded as an sold.
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 Generally Accepted Accounting Principles (“GAAP”s)

8. Nuetrality: Financial statements should be free from bias.The preparers of financial statements
come cross uncertainties.

9. Prudence: It is degree of caution to be taken to be taken for taking judgement about the future
uncertainties and estimates.
• In other word prudence is estimmate required under conditions of uncertainties.
• It takes precaution that assets and incomes are not overstated and liabilities and expenses are
not understated but it does not allows creation of secret reserve.
• E.g. Estimate about Bad Debts, Useful life of Assets & Provisions etc.
• If the prudence is not followed properly then Financial statement will loose reliability.

10. Full Fair and adequate Disclosure:

11. Completeness:

Limitations Of Financial Accounting / Statements:

Different • If two organization follows different accounting policies, then it is not possible
Accounting to compare Financial statements of the two entities.
Policies • If the same organization follows different accounting policies over two years
then the financial statement is not comparable as different accounting policies
produce different results.

Records only • Financial Statement ignores intangible/non monetary strengths and

Monetary weaknesses as it records only monetary transaction.
Transaction • Non-monetary Strength: Loyalty and effieciency of labour, hard work of owner
etc.
• Non Monetary weaknesses: Poor Management, internal dispute, strikes and lock
out.
Asset • Due to historical cost, comparison between financial statement of two entity
recorded on started on different point of time is not possible. (due to price fluctuation in
historical Cost value of asset)
• If the another option of realisable value is used then it is costly as well as
estimation of exact amount is not possible.

Perpetual • Firms are treated as Going Concern but statements are prepared periodically.
Continuity & • Due to above problem it is difficult to classify between Capital and revenue
periodical Expenditure.
statement • It leads to difficulty in making accurate books of Accounts.

Management • Management Policies are not recorded in books of accounts.

Policies • Sometime management may decide that profit should not be beyond the
specified limit to avoid taxes. In this case, due to management policy accurate
financial statement can not be prepared.
• Or in other case, management may decide that profit should be dislosed highre
than actual profit to apply for loan or other benefit & due to such management
policy accurate financial statement can not be prepared.

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 Journal Entry
Journal Entry
Problem No. 1

2005
Mar 1 Bought cash as a capital for starting business ₹ 20000
2 Deposited into the bank ₹ 10000
4 Purchased machinery on cash ₹ 3500
6 Purchased furniture for office use from M/s Naik & Co. ₹ 5000
9 Withdraw from the bank ₹ 5000
11 Paid to M/s Naik & Co. ₹ 5000
13 Purchased goods on cash ₹ 2000
16 Sold goods for cash ₹ 2500
18 Paid rent of ₹ 500
20 Bought stationery for ₹ 100
22 Placed an order to buy goods from M/s Kulkarni & sons. ₹ 10,000.
24 Withdrew from bank ₹ 2,000 for office use.
27 Withdrew cash ₹ 2,000 for personal use from office
28 Sold old personal car & amount invested into business ₹ 60,000.
29 Purchased office equipments ₹ 12,000
31 Invested in shares of M/s Kamana Trading Co. Ltd. ₹ 10,000
31 M/s Kulkarni & Sons executed our order

Problem No. 2

2005
April 1 Invested ₹ 40000 into business & borrowed ₹ 50000 from the bank for business
purpose
3 Bought goods for cash ₹ 11500 from Vinayak off 10% C.D.
5 Sold goods worth ₹ 8000 to Ms. Saroj & received 50% cash immediately.
6 Bought machinery ₹ 12850 on credit from M/s Kirloskar Bros.
8 Taken loan from Mrs. Bhaya ₹ 40000
11 Loan taken from Mrs. Bhaya is deposited into Bank.
13 ₹ 12750 paid in full settlement to M/s Kirloskar Bros. by issuing a cheque.
15 Received a dividend ₹ 875 on our share investment
18 Paid office rent ₹ 1500 & house rent ₹ 1800 from business fund.
20 Purchased pens, pencils, ink, etc. for office use ₹ 1000
22 Sold goods to Mr. Singh on account ₹ 10000
25 Paid traveling exp. ₹ 500
27 Paid conveyance ₹ 100
28 Paid refreshment bill ₹ 100 & given tips to waiter ₹ 5
29 Given diwali advance to the office staff ₹ 5000
30 Paid for advertisement ₹ 4800 by cheque
31 Goods of ₹ 1150 distributed as a free samples.

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 Journal Entry
Problem No. 3

2003
July 1 Miss Maya started business with cash ₹ 35000; goods ₹ 45000 & furniture ₹ 10000
2 Borrowed loan of ₹ 40000 from Miss Kishori for business.
4 Paid office rent ₹ 1500 & house rent ₹ 1500
5 Bought goods on credit from Miss. Chhaya ₹ 15000 less 10% T.D.
7 Paid carriage ₹ 1000 on purchases
9 Paid conveyance ₹ 150,
13 Withdrawn goods for personal use ₹ 750 & cash ₹ 500 from office.
14 Cash sales ₹ 15000 off 5% T.D. & 2% C.D
18 Cash sales ₹ 18000 & 50% amount deposited into the bank
21 Cash purchases ₹ 20000 & earned 5% C.D. on cash purchases.
24 Paid carriage on purchases ₹ 200

Final Account

Problem No. 1

Following is the Trial Balance of Royal Traders. Prepare a Trading & Profit & Loss Account for the year
ended 31st Dec. 2005 & a Balance Sheet as on that date.

Particulars Dr. Cr. Particulars Dr. Cr.

Opening stock 46,000 Office electricity Exp. 9,400
Purchases & sales 4,72,000 8,22,000 Telephone Charges 4,400
Sales return 8,000 Cash at Bank 18,000
Purchases return 12,000 Printing & Stationery 11,200
Discount received 2,200 Postage & Stamp 1,090
Wages 43,500 Furniture 2,00,000
Salaries 66,000 Petty cash 1910
Carriage inwards 39,000 Insurance premium 4,200
Advertisement 10,100 Carriage outwards 12,000
Bills receivable 9,000 Bad debts 800
Bills Payable 10,000 Int. paid on Bank loan 1,500
12% Bank Loan 1,50,000 Capital Account 4,75,000
Office Equipment 1,00,000 Sundry Creditors 40,000
Land & Building 3,39,000 Rates & Taxes 5,300
Prov. for doubtful debts 3,200 Drawings 70,000
Sundry Debtors 42,000
15,14,400 15,14,400 15,14,400 15,14,400

Adjustments:

1. Closing stock was valued at ₹ 38,000 on 31st Dec. 2004.

2. Depreciate Furniture by 5 % p.a. & office equipment by 10%.
3. Rates & Taxes of ₹ 800 was paid in advance for 2006.
4. Goods distributed as free sample ₹ 5,000.
5. Further bad debts ₹ 2,000
6. Maintain RDD @ 5% of debtors.