GNDU B.Com (Bachelor of Commerce)

Chapter 2: Accounting Principles (GAAP) and Capital versus Revenue Items

Summary

Generally Accepted Accounting Principles (GAAP) are the common rules, concepts and conventions that give accounting information uniformity, comparability and reliability. They are usually grouped into accounting concepts (basic assumptions) and accounting conventions (customs followed in practice). Key concepts include the business-entity concept (the firm is separate from its owner), going-concern (the business will continue indefinitely), money-measurement (only money-measurable facts are recorded), cost concept (assets recorded at historical cost), dual-aspect, accounting-period, matching, realisation and accrual concepts. The chief conventions are consistency, full disclosure, materiality and conservatism (prudence). These principles are not legal rules but agreed standards that make statements meaningful, though they involve estimation and historical-cost bias, which limits them. A practical application of these principles is the distinction between capital and revenue items. Capital expenditure benefits the business for more than one accounting period and is shown in the Balance Sheet (for example, purchase of machinery), whereas revenue expenditure is consumed within the period and is charged to the Profit & Loss Account (for example, wages and rent). Similarly, capital receipts (such as sale of a fixed asset or capital introduced) differ from revenue receipts (such as sales and commission earned). Correct classification is vital because misclassification distorts both the profit figure and the financial position.

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Practice quiz