GAAP, or Generally Accepted Accounting Principles, is a commonly recognized set of rules and procedures designed to govern corporate accounting and financial reporting in the United States (US). The US GAAP is a comprehensive set of accounting practices that were developed jointly by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB), so they are applied to governmental and non-profit accounting as well.
US securities law requires all publicly-traded companies, as well as any company that publicly releases financial statements, to follow the GAAP principles and procedures.
The Generally Accepted Accounting Principles further set out specific rules and principles governing such things as standardized currency units, cost and revenue recognition, financial statement format and presentation, and required disclosures. For example, it requires precise matching of expenses with revenues for the same accounting period (the matching principle).
10 GAAP Principles
1. Principle of Regularity: GAAP-compliant accountants strictly adhere to established rules and regulations.
2. Principle of Consistency: Consistent standards are applied throughout the financial reporting process.
3. Principle of Sincerity: GAAP-compliant accountants are committed to accuracy and impartiality.
4. Principle of Permanence of Methods: Consistent procedures are used in the preparation of all financial reports.
5. Principle of Non-Compensation: All aspects of an organization's performance, whether positive or negative, are fully reported with no prospect of debt compensation.
6. Principle of Prudence: Speculation does not influence the reporting of financial data.
7. Principle of Continuity: Asset valuations assume the organization's operations will continue.
8. Principle of Periodicity: Reporting of revenues is divided by standard accounting periods, such as fiscal quarters or fiscal years.
9. Principle of Materiality: Financial reports fully disclose the organization's monetary situation.
10. Principle of Utmost Good Faith: All involved parties are assumed to be acting honestly.
Who Came Up With Generally Accepted Accounting Principles?
Even though the U.S. federal government requires public companies to abide by GAAP, the government takes no part in developing these principles. Instead, independent boards assume the responsibility of creating, maintaining, and updating accounting principles.
As GAAP issues or questions arise, these boards meet to discuss potential changes and additional standards.To ensure the boards operate responsibly and fulfill their obligations, they fall under the supervision of the Financial Accounting Foundation.
Financial Accounting Foundation (FAF)
FAF formed in 1972 as the administrative corporation that oversees the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB).
The FAF is responsible for appointing board members and ensuring that these boards operate fairly and transparently. Members of the public can attend FAF organization meetings in person or through live webcasts.
Limitations of GAAP
While GAAP accounting strives to alleviate incidents of inaccurate reporting, it is by no means comprehensive. Companies can still suffer from issues beyond the scope of GAAP depending on their size, business categorization, location, and global presence.
Diverse Types of Companies
GAAP may seem to take a "one-size-fits-all" approach to financial reporting that does not adequately address issues faced by distinct industries. For example, state and local governments may struggle with implementing GAAP due to their unique environments. New GAAP hierarchy proposals may better accommodate these government entities.
Timeframe
Due to the thorough standards-setting process of the GAAP policy boards, it can take months or even years to finalize a new standard. These wait times may not work to the advantage of companies complying with GAAP, as pending decisions can affect their reports.
Global vs. Domestic
GAAP is not the international accounting standard, which is a developing challenge as businesses become more globalized. The International Financial Reporting Standards (IFRS) is the most common set of principles outside the United States. IFRS is used in the European Union, Australia, Canada, Japan, India, and Singapore.
GAAP VS IFRS
• LIFO Inventory: While GAAP allows companies to use the Last In First Out (LIFO) as an inventory cost method.
• Research and Development Costs: These costs are to be charged to expense as they are incurred under GAAP.
• Reversing Write-Downs: GAAP specifies that the amount of write-down of an inventory or fixed asset cannot be reversed if the market value of the asset subsequently increases.
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