GAAP

Generally accepted accounting principles

GAAP, or Generally accepted accounting principles, are recognised as the gold standard of financial accounting and reporting. GAAP guarantees the accuracy, consistency, and comparability of business financial accounts. As a result, it is simpler for investors to examine and extract valuable data from the corporation’s financial statements, such as historical trend data. Also, it makes it easier to compare financial data between several businesses.  

What are GAAP? 

GAAP are a set of standards that public companies use to report their financials. The US Securities and Exchange Commission (SEC) requires all public companies to use GAAP when reporting quarterly and annual results. While private companies are not required to use GAAP, many do so voluntarily because it provides investors and other stakeholders with a consistent framework for evaluating a company’s financial health.  

 

Understanding GAAP 

According to general standards and rules, GAAP aids in regulating the accounting world. It tries to harmonise and control accounting terms, assumptions, and techniques throughout all business sectors. Balance sheet classification, revenue recognition, and materiality are all covered by GAAP. 

GAAP is developed and maintained by the Financial Accounting Standards Board (FASB). 

Not every company is required to adhere to GAAP. The SEC mandates that publicly listed corporations adhere to GAAP. Investors, lenders, or regulators may force private businesses, non-profit organisations and state and local governments to utilise GAAP or adhere to its accounting standards. 

History of GAAP 

The history of GAAP can be traced back to the early 20th century. In the wake of the stock market crash of 1929 and the great depression, the US government looked for measures to control the activities of key market participants and publicly listed firms. The authorities thought that publicly traded corporations’ unethical actions were at least partially to blame for the crisis. 

One of the SEC’s key mandates was ensuring publicly traded companies provided investors with accurate and transparent financial information. The American Institute of Accountants (AIA) adopted GAAP terminology for the first time in 1936, as claimed by accounting historian Stephen Zeff in The CPA Journal.  

Government support for GAAP began with regulations like the Securities Exchange Act of 1934 and Securities Act of 1933 which are enforced by the SEC and are directed at public firms. GAAP is continuously monitored and updated by the FASB, an independent entity.   

Key principles of GAAP 

There are 10 basic principles of GAAP:  

  • Principle of regularity 

Financial statements must be prepared consistently from period to period. 

  • Principle of prudence 

Financial statements must be prepared with caution, avoiding optimistic bias.  

  • Principle of continuity  

A company should assume it will continue to operate indefinitely unless there is evidence to the contrary. 

  • Principle of consistency 

A company should use the same accounting methods from one period to the next.  

  • Principle of historical cost 

Assets and liabilities should be recorded at their original historical cost.  

  • Principle of full disclosure 

All material information should be disclosed in the financial statements.  

  • Principle of fair value 

Some items, such as investments, may be recorded at fair value.  

  • Principle of sincerity 

According to this rule, every accounting team or accountant hired by a firm must present the most impartial, truthful financial report. 

  • Principle of objectivity 

Financial statements should be free from bias.  

  • Principle of matching 

Revenue and expenses should be matched in the period they are incurred.  

  • Principle of periodicity 

This principle mandates that accountants only report financial data within the appropriate accounting period. 

  • Principle of materiality 

Only items that are material, or have a significant impact on the financial statements, should be included.  

Compliance with GAAP 

Although it sometimes goes unnoticed by many business owners, GAAP compliance is essential in drawing investors to any firm. To ensure compliance with GAAP, all businesses must keep accurate and up-to-date financial records. These records must be under GAAP. Businesses must also disclose any material information that could impact financial statements. Failure to comply with GAAP can result in civil or criminal penalties. 

If a company’s stock is traded publicly, the SEC regulations must be followed by its financial statements. To continue to be publicly listed on stock exchanges, publicly traded U.S. corporations are required by the SEC to provide GAAP-compliant financial statements regularly. A suitable auditor’s opinion obtained through an external audit by a certified public accounting (CPA) company ensures GAAP conformity. 

Thus, being GAAP compliant implies that your financial records have been kept to enable investors, lending organisations, potential customers, etc., to make an informed choice about your business. 

Frequently Asked Questions

The Governmental Accounting Standards Board (GASB) and FASB created the US GAAP used for governmental and non-profit accounting. 

GAAP is important because it provides investors and stakeholders with a consistent framework for evaluating a company’s financial health. The 10 basic principles of GAAP ensure that financial statements are prepared consistently, with caution, and with all material information disclosed. This allows investors to make informed decisions about whether or not to invest in a company. 

Financial statements are prepared and reported using GAAP. GAAP is the cornerstone of the FASB’s extensive collection of authorised accounting procedures. 

 

Non-GAAP measures are financial measures that are not calculated per GAAP. Companies usually use these measures to give a more accurate picture of their financial performance. 

Non-GAAP measures include adjusted pro forma and core earnings. Non-GAAP measures are not necessarily bad, but investors should know how they are calculated and what they exclude. Companies should also be transparent about their use of non-GAAP measures. 

 

There are a few key differences between IFRS and GAAP.  

  • First, IFRS is a more principles-based approach, while GAAP is more rules-based.  
  • IFRS allows for more flexibility in financial reporting, while GAAP is more rigid. 
  • IFRS is used more internationally, while GAAP is used primarily in the United States.  
  • IFRS is constantly evolving, while GAAP is more static. 

 

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