Introduction to Financial Accounting & GAAP Principles
Accounting involves the art of recording, classifying, summarizing and reporting of transactions with the objective of presenting the financial health of the company or any individual or a firm. Financial Accounting deals with the preparation of various financial statements which include Income Statement or Profit and Loss Account, Balance Sheets, Statement of Retained Earnings and Statement of Cash flows. These recording of transactions must be according to Generally Accepted Accounting Principles (GAAP).
Generally Accepted Accounting Principles(GAAP):
Some of the generally accepted principles are:
1. Matching principle: For example, if the sales occur during one period but a part of cost of goods sold is paid only during the following month or previous month, GAAP says to recognize respective costs and revenue in the same month.
2. Revenue recognition principle: For example, if $5,000 is received from a customer for a service to be performed the following month, it should not be recognized as revenue till the said service is completed.
3. Cost principle: Assets to be shown at cost price in the balance sheet, i.e., the price paid at the time of acquisition.
4. Economic entity assumption: For each economic entity financial records should be separately maintained.
Examples of different entities:
a) Trading Businesses
b) Schools and other educational institutions
c) Manufacturing & Retailing
d) Social institutions
e) Hospitals and the like.
The assets and liabilities of the owner’s should not be included in the Company’s financial statements.
5. Other GAAP include Monetary unit assumption, Full disclosure principle, Time period assumption, Accrual basis of accounting, Going concern principle etc.
Objectives of Financial Accounting:
1. To record all the transactions according to the double entry system in a systematic way.
2. To find out the performance of the company.
3. To estimate future earnings and prospects of the company.
4. To calculate the gross & net earnings.
5. To list out and know the different assets and liabilities.
6. To serve as a report of financial health to internal management and outsiders who require it.
7. To comply with the lawful requirement of disclosing the income, assets and liabilities of the company.
8. To compare the records with past data or a competitor’s record to evaluate the performance.
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