GAAP refers to accounting rules and standards used to prepare and standardize financial statements.
- Financial statements are compiled and reported in accordance with generally recognized accounting standards (GAAP).
- The ten GAAP rules are concerned with ethics, openness, and uniformity in accounting.
- GAAP is generally advised for all businesses even if it is only required for publicly listed and regulated organizations.
- This article is intended for accountants and business owners who need to understand generally accepted accounting principles (GAAP), particularly when a firm is getting ready to go public or merge with another company.
Understanding generally accepted accounting standards (GAAP) is essential if your business is to ever issue shares or take part in mergers and acquisitions. Although accountants are ultimately responsible for adhering to GAAP, understanding the rules and advantages and disadvantages of GAAP may help you recruit qualified financial professionals and may eventually have an impact on your company’s long-term sales and stock value potential.
Also Read: Entrepreneur or Small Business Owner: Which One Are You?
What is GAAP?
A company’s financial statements are prepared and standardized according to a set of accounting rules, regulations, and procedures known as GAAP. These guidelines seek to provide uniformity and openness so that creditors and investors may compare businesses more effectively. Companies are expected to disclose their financial data in accordance with widely accepted accounting rules.
The following actions are impacted by GAAP:
- measuring the state of the economy
- revealing details on a certain activity
- gathering and compiling economic data
- taking measurements on a regular basis
The 10 principles of GAAP
You and your accounting staff must follow these 10 conventions if your business must comply with GAAP (for example, if it is a public company):
1.The principle of regularity
According to this idea, GAAP adherence occurs consistently, not just infrequently.
2.The principle of consistency
The same procedures must be followed by accountants in all accounting periods and for all external income statements. The footnotes to your company’s financial statements must explain and justify any adjustments an accountant makes to their accounting procedures.
3.The principle of sincerity
Accountants should maintain objectivity and make 100% correct entries.
4.The principle of permanence of methods
To make it simpler to compare one financial statement to another, accountants must apply the same financial reporting techniques across all financial statements.
5.The principle of non-compensation
This rule states that all positive and negative figures on a financial statement must be stated unambiguously. Accountants must also avoid trying to offset a debt with an asset or an income with an expense.
6.The principle of prudence
Financial statements should only be prepared by GAAP accountants using data and facts. This implies that while you and your accounting staff can create internal budget predictions for this reason, accountants shouldn’t speculatively or forecast financial figures on external financial statements.
7.The principle of continuity
According to GAAP, accountants make the assumption that the company they are tabulating financial data for will continue to operate for the foreseeable future.
8.The principle of periodicity
Instead of extending periods or statistics to better fit a financial report, GAAP compliance mandates that accountants provide all financial data in the accounting period they represent.
9.The principle of materiality and good faith
This common concept states that accountants should, to the best of their abilities, report all available financial data and accounting information.
10.The principle of utmost good faith
This GAAP concept calls for honesty and integrity from accountants, business owners, and all other parties engaged in financial reporting.
How GAAP is regulated
The government approved laws creating the U.S. Securities and Exchange Commission (SEC), which defined accounting procedures for publicly owned corporations, in the wake of the 1929 stock market crash and the Great Depression. Here is further information on what GAAP regulates and who is in charge of developing, implementing, and upholding GAAP rules.
Demands for GAAP use:
The SEC mandates that publicly listed and regulated corporations disclose their financial information in accordance with GAAP. The Securities Act of 1933 and the Securities Exchange Act of 1934, which provide for yearly external audits by independent accountants, hold companies that issue shares to this standard. Companies without outside investors are not required to abide with this requirement.
Regulating bodies for GAAP:
The SEC has given the Financial Accounting Standards Board (FASB), a private organization, the power to establish the financial reporting standards that corporations utilize. The FASB seeks advice from the Financial Accounting Standards Advisory Council (FASAC) on issues that affect GAAP regulations. The FASB standards are acknowledged by the SEC, which also has the authority to enforce them.
Government requirements:
A collection of rules that create GAAP principles for state and local governments have an impact on government enterprises. These standards are overseen by the Government Accounting Standards Board (GASB).
Foreign nation requirements:
Foreign countries have their own GAAPs that are distinct from American GAAPs. These regulations are developed by each nation’s FASB, such as the Canadian Institute of Chartered Accountants (CICA).
Applying GAAP in the workplace
Financial Accounting Standards, or FASB pronouncements, are used by accountants to implement GAAP (FAS). The FASB has published more than 100 FAS declarations since its founding in 1973. Before the FASB was established, other organizations, such as the Accounting Standards Committee of the American Institute of Certified Public Accountants, either established or contributed to GAAP. Proclamations from the Accounting Principles Board (APB) and the Committee on Accounting Procedure (CAP) go all the way back to 1939. The APB and CAP developed several accounting rules that are still in use today.
While the majority of GAAP is governed by the standards established by FASB and its predecessors, other guidelines can be found in reports from the AICPA’s Financial Reporting Executive Committee (FinREC). Additional best practices exist outside of official declarations and are widely acknowledged as a result of their widespread application. For instance, it is typically believed that financial statements are predicated on the expectation that a firm will keep operating.
Hiring GAAP accounting professionals
Accounting experts are knowledgeable in GAAP accounting. However, because GAAP is associated with so many different standards, the rules may be open to different interpretations and manipulation.
The expense of fabricating documents or using subpar accounting services puts a lot of pressure on businesses to engage competent accountants.
If you think your small firm could ultimately need to comply with GAAP, you might want to start doing so right away. Your business can hire an expert financial lawyer to help you screen potential accountant hires during the interview process if the cost is within your budget. This expert can help you formulate questions to find out how knowledgeable your candidate is with GAAP.
GAAP vs. IFRS
The disparities between GAAP and IFRS, or the International Financial Reporting Standards, are something that some nations and international corporations would like to have eradicated. Comparing businesses with various regional bases would be simpler if the two were combined. The combination, according to its proponents, would also streamline management, investing, transparency, and accountant training.
Currently, the primary distinction between these two standards is that GAAP is governed by rules and guidelines, whereas IFRS is based on principles.
Even if management, accounting, and investing are now easier, others contend that integrating the standards will create new problems. It may be impossible to overcome the challenge of incorporating international corporate ethics and procedures into a single defined norm. Significant variations in political and fiscal structures could also be costly. More specifically, the time required to combine the systems and adopt a global standard might cause cost losses greater than the advantages anticipated from streamlined standards.