10 Generally accepted accounting principles (GAAP)

GAAP, or Generally Accepted Accounting Principles, is a crucial aspect of financial reporting in the United States. It is a set of rules and procedures that govern accounting and financial reporting practices, ensuring consistency and transparency in financial statements. In this article by Viindoo Enterprise Management Software​, let’s take a closer look at what GAAP is, why it is important, and its history.

What Are Generally Accepted Accounting Principles?

Generally Accepted Accounting Principles or GAAP is a general accounting principle that has been developed by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). These principles are widely recognized and used in the United States to govern financial reporting for all types of organizations, including for-profit businesses, non-profit organizations, and governmental entities. The use of GAAP is mandated by US securities law for all publicly-traded companies, as well as any company that publicly releases financial statements.

What are generally accepted accounting principles

The History of GAAP

GAAP has its roots in the Stock Market Crash of 1929 and the subsequent Great Depression. At the time, there were no standardized accounting principles or regulations to govern financial reporting, and companies often used different methods to account for the same transactions. This made it difficult for investors to compare financial statements and assess the financial health of companies. 

In response to these issues, the Securities Act of 1933 and the Securities Exchange Act of 1934 were passed, which required companies to provide financial statements that followed certain standardized accounting principles. Over time, these principles known as the Generally Accepted Accounting Principles (GAAP) have gradually evolved, based on established concepts and standards, as well as on best practices that have come to be commonly accepted across different industries.

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10 key of generally accepted accounting principles

There are ten principles of GAAP that every company must follow when preparing their financial statements.

1. Principle of Consistency: This principle requires companies to use the same accounting methods and procedures consistently from one accounting period to another. Consistency ensures that financial statements can be compared and analyzed over time.
2. Principle of Permanent Methods: Similar to the principle of consistency, this principle requires companies to use consistent procedures and practices in their accounting and financial reporting, which enables comparability of financial information over time.
3. Principle of Non-Compensation: This principle states that companies should not offset debt with an asset, and all aspects of an organization’s performance, whether positive or negative, should be reported. This ensures that financial statements provide a true and fair view of the financial position of the company.
4. Principle of Prudence: This principle requires companies to report financial data that is factual, reasonable, and not speculative. It emphasizes the importance of accuracy and reliability in financial reporting.
5. Principle of Regularity: This principle means that all accountants must consistently abide by the GAAP. It ensures that accounting practices and procedures are standardized across all companies.
6. Principle of Sincerity: This principle requires accountants to perform and report with basic honesty and accuracy. It emphasizes the importance of honesty and ethical behavior in financial reporting.
7. Principle of Good Faith: Similar to the principle of sincerity, this principle asserts that anyone involved in financial reporting is expected to act honestly and in good faith. It ensures that financial information is reported in a trustworthy manner.
8. Principle of Materiality: This principle requires companies to disclose all financial information that is relevant to the understanding of the company’s financial position. It emphasizes the importance of transparency in financial reporting.
9. Principle of Continuity: This principle states that all asset valuations in financial reporting are based on the assumption that the business or other entity will continue to operate going forward. It ensures that financial statements provide a true and fair view of the company’s financial position.
10. Principle of Periodicity: This principle refers to entities abiding by commonly accepted financial reporting periods, such as quarterly or annually. It ensures that financial information is reported regularly, allowing stakeholders to track the company’s financial performance over time.

10 general accounting principles of GAAP

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Why should use GAAP?

There are several reasons why companies choose to use GAAP as their accounting framework:

• Consistency

By using GAAP, companies can ensure that their financial statements are consistent and comparable over time. This makes it easier for investors and stakeholders to understand and analyze the company's financial performance.

• Compliance

In the U.S., publicly traded companies are required by law to use GAAP when preparing their financial statements. By using GAAP, companies can ensure that they are in compliance with accounting regulations and laws.

• Credibility

GAAP provides a well-established and widely recognized set of accounting principles that are trusted by investors, analysts, and other stakeholders. By following GAAP, companies can increase their credibility and improve their reputation in the financial community.

• Transparency

GAAP requires companies to disclose relevant information in their financial statements, including notes and disclosures. This provides transparency and helps investors and stakeholders make informed decisions about the company.

• Comparison

GAAP is used by many companies and organizations, which allows for easy comparison of financial statements between companies. This can be helpful for investors who are looking to compare companies within the same industry or sector.

GAAP is widely used in the States

Alternative to GAAP

While GAAP is the general accounting principle in the United States, it is not the only system used around the world. Many other countries have their own sets of accounting principles that are different from GAAP, and some have adopted the International Financial Reporting Standards (IFRS) instead.

GAAP vs IFRS

IFRS is a set of accounting standards developed and maintained by the International Accounting Standards Board (IASB). It was created to promote transparency and consistency in financial reporting across the globe, and it is now used in over 140 countries.

One of the main differences between IFRS and GAAP is that IFRS is more principles-based, meaning it provides guidelines and principles for accounting practices, but leaves more room for interpretation. GAAP, on the other hand, is more rules-based, meaning it has specific rules and guidelines that must be followed. Another difference is that IFRS tends to be more focused on the needs of investors, while GAAP has a broader focus that includes the needs of creditors and other stakeholders as well.

In recent years, there have been efforts to converge the two systems, as many companies operate across borders and need to report their financial results in different jurisdictions. The IASB and the FASB have been working on projects to align their standards and reduce differences between them.

While the use of IFRS is growing, it is not likely to completely replace GAAP in the United States anytime soon. The Securities and Exchange Commission (SEC) still requires U.S. companies to use GAAP when filing financial statements, and some industries, such as banking and insurance, have specific GAAP requirements that are not covered by IFRS.

There are specific GAAP requirements that are not covered by IFRS

In conclusion, understanding Generally Accepted Accounting Principles (GAAP) can be essential for people involved in financial reporting or analysis. Hopefully, by reading this article by Viindoo, readers can gain a better understanding of GAAP and the importance of adhering to these principles in financial reporting.

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