The Fundamentals of GAAP

If you are in the business realm you most likely have heard the term GAAP, also known as Generally Accepted Accounting Principles, but you might still be unsure as to what it really means for you. This is where this blog comes in handy, and we hope that it will clarify your questions and help you get onto the right track. Basically, GAAP is the language of the IRS and accountants, and if you own a small business, you will be dealing with GAAP rules whether you know them or not. 

What is GAAP?

Generally Accepted Accounting Principles (GAAP) are a common set of accounting principles, standards, and procedures that were set by the Financial Accounting Standards Board (FASB). In the United States, when accountants compile a company’s financial statements, public companies must follow GAAP. The goal of GAAP is to improve the clarity, consistency, and comparability of financial information amongst different companies through the fact that GAAP consists of authoritative standards and commonly accepted ways to record and report accounting information. GAAP is an important concept because it helps to maintain trust in financial institutions and also helps investors to analyze companies due to them having some sort of basis for their “playing grounds” so to speak. All in all, the purpose of GAAP is to ensure that the financial information that is provided to investors and regulators is accurate, reliable, and consistent. 

Ten Primary Principles of GAAP

1. Principle of consistency: This alludes to the fact that there are consistent standards that must be followed in terms of financial reporting from period to period.
2. Principle of permanent methods: In order for comparison to be possible there is a need for consistent procedures and practices which are applied in accounting and financial reporting. 
3. Principle of non-compensation: With this principle, it is noted that all aspects of a company’s performance must be reported, regardless of whether they are positive or negative.
4. Principle of prudence: The financial data that is reported needs to be reasonable and factual, not merely speculative.
5. Principle of regularity: All accountants must consistently follow GAAP.
6. Principle of sincerity: Honesty and accuracy should be of foremost importance when accountants perform reports.
7. Principle of good faith: All persons involved in financial reporting must act in good faith and with honesty.
8. Principle of materiality: The company’s true financial position must be disclosed through the financial reports. 
9. Principle of continuity: The basis for all asset valuation in the financial reports is based on the assumption that the company will continue to be in operation in the future.
10. Principle of periodicity: The company needs to follow the generally accepted financial periods whether it be quarterly, annually, and so forth. 

In short, as previously alluded to, GAAP tries to make sure that the financial statements of a company are complete, consistent, and comparable. This is done by attempting to standardize and regulate the definitions, assumptions, and methods that are used in accounting in all companies. 

Sources:

https://www.investopedia.com/terms/g/gaap.asp https://corporatefinanceinstitute.com/resources/knowledge/accounting/gaap/