CHAPTER 3
GAAP and BASIC ACCOUNTING CONCEPTS
Generally Accepted Accounting Principles (GAAP)
A set of rules and guidelines which were formed, developed and gradually
changed from time to time in order to:
bring uniformity and consistency in the process of accounting.
enhance utility of accounting information to users of accounting
information.
set a universal guidelines to record the transactions and events.
Basic Accounting Concepts and Conventions
These concepts are used for recording business transactions, preparing
financial statements and presenting accounting information in the best
possible manner. These concepts comprise of basic accounting assumptions.
Various Accounting Concepts and Conventions are as follows:
Business Entity Concept
This concept treats business as a separate identity from its owner. All
business transactions are recorded in the books of business from the
business’s point of view not from the owner’s point of view.
For example: Started business with cash Rs 1,00,000. According to the
Business Entity Concept, business being a separate entity needs to pay back
this amount at the time of closure. Thus Rs 1,00,000 is a liability for the
business.
Money Measurement Concept
According to this concept, only those events are recorded in the books of
account, to which money value is attached or which can be expressed in
monetary terms.
Going Concern Concept
This concept holds that the business will continue its operation for indefinite
period, irrespective of its owners. The purpose of this concept is to
differentiate between capital expenditure and revenue expenditure.
Accounting Period Concept
According to this concept, the life of an enterprise is divided into different
accounting period (say years, half-yearly, quarterly, days), so that the
performance of the business in each period and at regular intervals can be
measured and assessed.
Cost Concept
According to this concept, all assets of a business are recorded at their
acquisition price (i.e. the price paid to acquire them) and not at their current
market price. The acquisition price forms the basis for charging depreciation
and maintaining other accounting records of the asset in the subsequent
periods.
Dual Aspect Concept
According to this concept, all the transactions that are recorded in the books
of account have dual aspects. In other words, every transaction effects two
accounts simultaneously, i.e. debit and credit.
Revenue Recognition Concept
According to this concept, revenue is recognised when the right of receiving
of the revenue is established and not when the revenue is actually received.
For Example: Goods sold on credit Rs 5,000 on January 01 and the payment
is received on February 11. In this case, revenue is recognised in the month of
January and not in February, as the right of receiving the amount is
established in January.
Matching Concept
This concept suggests that in order to ascertain actual profit or loss made
during a period, expenses incurred (during the period) for earning revenues
should be matched with their related revenues earned during that particular
period. In other words, both the expenses and revenues should belong to the
same accounting period.
Consistency Concept
This concept suggests that the accounting policies and practices once adopted
should be followed from year to year. In other words, accounting practices
should not be frequently changed. Adherence to Consistency Concept infuses
higher degree of consistency and thereby enabling meaningful comparison and
better assessment of the performance of the business over the years.
Full Disclosure Concept
According to Full Disclosure Concept, besides disclosing statutory required
information, vital information that is significant and relevant to the different
users of accounting information must also be disclosed.
Conservatism Concept
This concept holds that in order to ascertain profit or loss made during an
accounting period, all anticipated losses should be deducted from the
revenues but all anticipated profits should not be taken into consideration
until and unless they are realised.
Materiality Concept
This concept implies that only those items which may affect the decisions of
the informed investors are considered as material. Materiality of an item
depends on the nature and the amount of the item.
Objectivity Concept
According to this concept, transactions recorded in the books of accounts
should be free from personal bias. In other words, transactions recorded
should be objective, i.e. should be supported by verifiable evidences.
