Explain Generally Accepted Accounting Principles (GAAP) and cost principle

Q. Explain Generally Accepted Accounting Principles (GAAP) and cost principle (June’13).

Generally Accepted Accounting Principles (GAAP): Financial accounting practice is governed by concepts and rules known as generally accepted accounting principles (GAAP). To use and interpret financial statements effectively, we need to understand these principles, which can change over time in response to the demands of users GAAP aims to make information in financial statements relevant, reliable, and comparable. Relevant information affects the decisions of its users Reliable information is trusted by users Comparable information is helpful in contrasting organizations.

Cost Principle: The measurement principle, also called the cost principle, usually means that accounting information is based on actual cost (with a potential for subsequent adjustments to market). Cost is measured on a cash or equal-to-cash basis. This means if cash is given for a service, its cost is measured as the amount of cash paid. If something besides cash is exchanged (such as a car traded for a truck), cost is measured as the cash value of what is given up or received. The cost principle emphasizes reliability and verifiability, and information based on cost is considered objective. Objectivity means that information is supported by independent, unbiased evidence; it demands more than a person’s opinion. To illustrate, suppose a company pays Tk. 5000 for equipment. The cost principle requires that this purchase be recorded at a cost of Tk. 5000. It makes no difference if the owner thinks this equipment is worth Tk.7000. Later in the book we introduce fair value measures. Revenue (sales) is the amount received from selling products and services.