GAAP, entity and money measurement

Everything you do in accounting has a rule behind it. Why does rent come straight off the owner's capital, while a machine is kept as an asset? Why do we record a credit sale before the money arrives? This chapter gives the reasons.

Imagine two firms keeping their books in two different ways. Comparing them would be like a race where one runs and the other rides a horse. So accountants everywhere follow the same rules, called GAAP (Generally Accepted Accounting Principles). They bring uniformity: everyone's statements are made the same way. GAAP are not fixed for ever; they change as laws, society and the economy change. People call them principles, concepts, conventions, postulates or assumptions. Your book calls them basic accounting concepts.

Business entity concept: the business and its owner are two separate people in the books. In real life the corner shop and its owner seem the same, but the accountant keeps the shop's books from the shop's point of view.

That one idea explains a lot. The capital the owner brings in is money the business owes him, so it is a liability for the business. When he takes money out for himself (drawings), his capital goes down. And his private spending, like his son's school fee paid from his own pocket, is not recorded at all.

Money measurement concept: only what can be put in money is recorded. A loyal, hard-working employee is valuable, but loyalty has no rupee value. His salary does, so the salary is recorded.

There is a deeper point too: records are kept in money units, not physical units. "We bought 200 TV sets" cannot go in the books; "we bought TV sets worth ₹X" can. A firm with 2 crore of land, 1 crore of buildings, some machinery, stock and ₹5 lakh in the bank cannot add acres to machines; only the rupee values add up, to ₹3 crore 59 lakh.

A weakness: the value of the rupee changes as prices rise, so ₹1 lakh of ten years ago and ₹1 lakh today are not really the same, yet the books treat them alike.