What is the Significance of Generally Accepted Principles of Accounting?

Generally accepted principles of accounting are a standard framework of financial accounting guidelines used in a specific jurisdiction. These accounting principles are also known as standard accounting practices or accounting standards, which include standards, rules and conventions that accountants should follow when they record, summarise, prepare and present financial statements. However, the generally accepted accounting principles have been varying significantly from one country to another in the world. This has led to serious issues of understanding the financial statements of business entities from different countries with diverging presentations due to the recent high level of globalisation of businesses. Hence, experts on generally accepted accounting principle decided to evolve a universal system of accounting.

Emergence of Common Generally Accepted Principles of Accounting

The result of such a combined effort by accounting experts has been the creation of International Financial Reporting Standards (IFRS), which has been designed as a common global accounting language for all business affairs. This has enabled the stakeholders of business entities to understand, interpret and compare company accounts cutting across international borders or boundaries.  The emergence of IFRS is the direct consequence of increasing international financial market trading and shareholding. Further, the IFRS, which has become the generally accepted accounting principle, is especially useful for companies that are going global in their operations and have operations in several countries on earth. This standard is progressively but slowly replacing the various accounting standards of individual countries, making the business entities to adapt to a single common standard.

The International Accounting Standards Board has established and maintains the International Financial Reporting Standards. Many countries allow smaller companies to adapt to local accounting principles but have made it mandatory for larger or listed companies to conform to IFRS, so that the reporting of such companies becomes comparable across jurisdictions on an international basis. All the listed companies in the European Union have been mandated to adapt to IFRS since 2005. Canada has adapted IFRS in 2009, the Republic of Korea embraced it in 2011 and Taiwan has followed it in 2013. Even though the Securities and Exchanges Commission (SEC) of the United States has clearly supported a single set of globally accepted, high quality accounting standards and has explicitly expressed that IFRS is the best generally accepted accounting principle to serve this purpose, the progress of adapting to this accounting standard has been somewhat slow in the United States.

Objectives of Generally Accepted Principles of Accounting

All financial statements should reflect fair and true view of the business affairs of any organization. All these financial statements are useful for various stakeholders of the company including constituents of the regulators and the society. Hence, they should reflect the exact financial position of the company, so that the stakeholders are able to assess the financial position for specific periods and compare them with other periods and decide whether the company is on a path of growth or is having financial or business difficulties. Only a generally accepted accounting principle can provide the right solution for this issue and it has emerged as the International Financial Reporting Standards.

The International Financial Reporting Standards basically acknowledges and authorises three accounting models. They are

1) Current Cost Accounting

Current cost accounting is done under actual physical capital maintenance at every level of inflation or deflation calculated under the historical cost paradigm, along with the maintenance of capital in constant purchasing power units paradigm.

2) Maintenance of Financial Capital in Nominal Monetary Units

Maintenance of historical cost accounting on a global implementation basis in times of inflation and deflation, especially under the traditional or standard historical cost paradigm is the second major stipulation of IFRS.

3) Maintenance of Financial Capital measured in Units of Constant Purchasing Power

This type of accounting is termed as CMUCPP (Capital Maintenance in Units of Constant Purchasing Power) and it is computed in terms of daily consumer price index or calculated at every level of inflation and deflation on a daily rate.

The IFRS assumes three basic underlying facts or situations for implementing generally accepted accounting principle in business entities. They are

1) Going Concern

IFRS assumes that the business entity will continue under both the historical cost paradigm and the CMUCPP in the near foreseeable future without any chances of failure, even if the success rate is moderate.

2) Assumption of Stable Measuring Unit

The companies should maintain their financial capital only in traditional historical cost accounting or in nominal monetary units within the historical cost paradigm. An example is the consideration by accountants of changes in the purchasing power of the currency that they use as the base but exclusion of around 26% annually for a continuous period of three years as immaterial or insignificant. This is important in terms of CMUCPP based on everyday consumer price index (CPI) at every level of inflation or deflation or in terms of purchasing power accounting of constant items for inflation and deflation according to the authorised framework of IFRS.

3) Constant Power Purchasing Units

CMUCPP at every level of inflation and deflation including situations of hyperinflation as defined by IAS 29 is this process of generally accepted accounting principle, with total rejection of all stable measuring unit assumptions at each level of inflation and deflation.

However, the companies adhering to generally accepted accounting principle should also take into consideration all non-monetary items with real value over different periods, though they may not be determined on a daily basis. These non-monetary items include borrowing costs, paid interests, received interests, comprehensive income, bank charges, fees, royalties, salaries, wages, short-term employee benefits, pensions, retained earnings or losses, capital reserves, share premium and discount accounts, all profits and losses accounted, payable and receivable dividends, trade debtors, and creditors, all payable and receivable taxes, deferred tax assets and liabilities, provisions, revaluation surpluses, and other non-monetary payables and receivables.

If business entities achieve all the above objectives of generally accepted principles of accounting properly, they will be able to provide a true and clear picture of their financial positions to their stakeholders. There are several other stipulations and characteristics of IFRS, the internationally accepted accounting principles, which have to be studied in detail to comply with its strict norms.