GENERALLY ACCEPTED ACCOUNTING PRINCIPLES (GAAP) | Meaning and Need

Accounting is the language of the Business. It is used to express the financial results and the state of financial affairs of a business.

Each language has a basic framework and some principles so that people can understand the message communicated via that language.

Accounting as a language also has some principles which helps it to obtain its objectives i.e. communication of business performance and state of affairs to interested parties.

What Are Accounting Principles?

Concepts and Conventions which guide the process of Accounting are called Accounting Principles.

Accounting Concepts include:

  • Entity Concept
  • Going Concern Concept
  • Periodicity Concept
  • Money Measurement Concept
  • Matching Concept
  • Accrual Concept

Accounting Conventions include:

  • Materiality
  • Disclosure
  • Consistency
  • Conservatism

What is Generally Accepted Accounting Principles (GAAP)?

As the name suggests, GAAP refers to Accounting Principles (rules and guidelines) which have been generally accepted by the Accounting Bodies and Institutes of different bodies around the Globe.

Why Do We Need GAAP?

  • Economies all over the world have opened their doors and now the world has become one economy after globalisation and liberalisation;
  • People and Organisations are investing cross border;
  • Businesses are not restricted to geographical boundaries;
  • Investment Decisions are driven by Accounting Information.

Example Case Study

Suppose Mr Thomas, a resident of USA wishes to invest in an Indian Company by buying its shares. In such a case he will want to get a deep insight of the financial results and the position of the assets and liabilities of the Indian Company.

So now consider that the Accounting Principles in USA and those in India which the Indian Company follows are different.

Will Mr Thomas in that case be able to analyse the financial statements of the Indian Company?

The answer would be a big NO and this lack of uniformity will lead to a decision of non-investment of Mr. Thomas in the shares of the Indian company.

On the other hand, suppose that businesses in USA and India follow the same (or more or less similar) Accounting Principles. In that case it will be possible for Mr Thomas to extract meaningful information from the financial statements of the Indian co. Thus Mr Thomas can take an informed decision regarding his investment in the Indian Company.

I hope you can get the idea that to achieve a true globalisation of all economies in the world, a common set of accounting principles are required to be followed. This will ensure understandability and comparability of global accounting information.

Movement Towards GAAP with IFRS

IFRS (International Financial Reporting Standards) are the set of Accounting and Reporting Standards issued by IASB (International Accounting Standards Board). These standards are being widely adopted by all countries in the world either fully (Full convergence) or partially (Partial convergence). India has partially converged with IFRS by issuing its own IndAS (Indian Accounting Standards). Most of Provisions of IFRS are adopted in these IndAS.

Tutorial Video on GAAP

I hope you got an idea about GAAP and its need by watching the video and reading the post. However, if you have not watched the video then I would request you to watch it once to get an in-depth understanding.

Please provide your feedback in the comments below.

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