Financial Accounting: GAAP | Management Optional Notes for UPSC PDF Download

Introduction

• Generally Accepted Accounting Principles (GAAP) is commonly referred to by management theorists as the established framework of fundamental principles guiding financial accounting within a specific jurisdiction. These principles are often termed as accounting standards and encompass the standards, conventions, and regulations that accountants adhere to when recording, summarizing accounting transactions, and preparing financial statements. 
• The concept of Generally Accepted Accounting Principles (GAAP) is rooted in rules of action or conduct derived from experience and practice. When these principles prove beneficial, they are acknowledged and accepted as guiding principles in accounting. GAAP serves as a standardization of how both CPA firms and companies structure and present financial information, including business income and expenditures, assets, and liabilities in their financial statements. It is not viewed as a singular accounting law but rather a compilation of rules dictating the accounting treatment for various transactions.

GAAP in U.S.

In the United States, accounting standards are not explicitly legislated by the government. Nevertheless, publicly traded companies are required by the U.S. Securities and Exchange Commission (SEC) to adhere to US GAAP in their financial reporting. Currently, the Financial Accounting Standards Board (FASB) is responsible for establishing generally accepted accounting principles applicable to public and private companies, along with non-profit organizations.

Historical framework of Generally Accepted Accounting Principles

• Historically, the establishment of accounting standards in the United States has been overseen by the American Institute of Certified Public Accountants (AICPA) in accordance with Securities and Exchange Commission (SEC) regulations. The Committee on Accounting Procedure was initially formed by the AICPA in 1939, later replaced by the Accounting Principles Board in 1951. In 1973, the Financial Accounting Standards Board (FASB) took over from the Accounting Principles Board, operating under the Financial Accounting Foundation's supervision. 
• The Financial Accounting Standards Advisory Council was established to provide recommendations and input on accounting standards. Around 2008, the FASB introduced the FASB Accounting Standards Codification, consolidating thousands of US GAAP statements into approximately 90 accounting topics.
• In 2008, the SEC proposed a plan suggesting a potential shift away from GAAP and a move towards the International Financial Reporting Standards (IFRS), already adopted by over 100 countries. The convergence project between the FASB and the International Accounting Standards Board (IASB) was ongoing as of 2010, with the SEC expressing its intention to fully adopt IFRS in the U.S. by 2014. GAAP serves as a regulatory framework, providing comprehensive information on an organization's financial returns, current balance, and any outstanding debt.
• Accounting literature emphasizes that most companies are required to publish annual audited financial statements. Registered public companies and various private investment firms are mandated to release audited statements that adhere to the rules set forth by the FASB (McCrary, 2009).

There are various factors in GAAP:

1. Accounting concepts: 

• Separate Entity Concept:
  • Accounting views the business as a distinct economic entity.
  • Only the actions and transactions of the business are recorded, while personal activities of owners and other entities are accounted for separately, unless they directly impact the business.
• Money Measurement Concept:
  • Only transactions expressible in monetary terms are recorded.
  • Important events not quantifiable in money are excluded, enhancing the understanding of the business's financial status.
• Dual Aspect Concept:
  • Fundamental to accounting, every debit has a corresponding credit.
  • Referred to as the 'Double Entry Principle,' ensuring balance in transactions.
• Continuing Concern Concept:
  • Assumes the business will operate in the foreseeable future.
  • Fixed asset valuation doesn't consider market value; depreciation is based on expected asset lives.
  • Outstanding and prepaid expenses are accounted for, assuming the business's continuity.
• Time Period Concept:
  • Emphasizes timely financial reporting at regular intervals (monthly, quarterly, or annually).
  • Annual accounting period for preparing Profit and Loss Account and Balance Sheet.
  • Consistency in accounting periods for effective comparison.
• Consistency Principle:
  • Once an accounting procedure is chosen, it must be consistently applied across periods for meaningful comparisons.
• Principle of Conservatism:
  • Advocates choosing accounting alternatives resulting in the least favorable outcome for the business in the current period.
  • Aims to minimize overstatement of assets, income, and understatement of liabilities.
• Objectivity Principle:
  • Requires all transactions to be supported by objective evidence.
  • When independent evidence is lacking, estimates must be made to document business transactions.
• Materiality Principle:
  • Stipulates that significant principles must be accounted for following established rules.
• Monetary Unit Concept:
  • Mandates recording and reporting business transactions in terms of money.
• Cost Principle:
  • Assets and liabilities recorded at their transaction cost.
  • Provides an objective and verifiable basis for initial asset and liability recording.
• Revenue Recognition:
  • Revenue is recorded only when a sale is completed.
• Matching Principle:
  • Requires operational efforts to be matched with operational accomplishments.
  • Advocates proper adjustment for deferred expenditure, which is amortized based on the matching concept.

2. Accounting Conventions: Accounting Conventions states usages and customs of accounting which guide to prepare accounting statements.
There are different types of Accounting Conventions:

• Conservatism:
  • Stresses the importance of cautious operation for accountants.
  • When faced with two equally acceptable methods, the convention advises opting for the more conservative approach to ensure safer financial reporting.
• Consistency:
  • Assumes a foundational principle in accounting, expecting practices to remain consistent annually.
  • Any changes in accounting practices should be disclosed, with their impact quantified, promoting stability and reliability.
• Materiality:
  • Highlights the relative significance of items or events in accounting.
  • Advocates the recording of all material facts, prioritizing their importance over irrelevant details.
  • Emphasizes revealing the precise amount receivable from debtors in statements of account.
• Full Disclosure Principle:
  • Mandates comprehensive financial statements, offering adequate economic information for a thorough understanding.
  • Encourages transparency by disclosing all material facts, encompassing supplementary attachments in financial statements.

Major GAAP

Conclusion

In essence, Generally Accepted Accounting Principles (GAAP) constitute a set of rules, procedures, and conventions defining the accepted practices in accounting at a given time. The fundamental aim, as established by accounting theoretical studies, is to ensure that accounting statements are both reliable and informative. Achieving this objective relies on a shared agreement and adherence to the established accounting principles.