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What is GAAP?


What does GAAP stand for? GAAP means Generally Accepted Accounting Principles, and is a set of widely followed accounting rules and standards for financial reporting.

Where is GAAP used? 

Public companies in the US follow GAAP principles when preparing their financial reporting. The government does not regulate GAAP, and all businesses don't need to follow it. However, the Securities and Exchange Commission (SEC) requires publicly traded and regulated companies to follow GAAP principles.

US firms with external investors are required by the SEC to follow GAAP, while those without external investors do not have to abide by the standards.

Yet the SEC is not responsible for GAAP standards. Instead, the Financial Accounting Standards Board (FASB) decides any changes in corporate financial reporting rules.

FASB is an independent, non-profit organisation that sets standard accounting rules and financial reporting for companies and non-profit organisations in the US. In addition, the FASB Advisory Council (FASAC) advises the FASB on all issues affecting GAAP rules.

For investors and traders, GAAP is a common term they may see in companies’ earnings reports. GAAP earnings per share (EPS), for example, is the EPS calculated according to GAAP standards. 

List of GAAP standards 

  • Principle of regularity

Accountants must adhere to GAAP rules and regulations. 

  • Principle of consistency

Accountants must apply consistent standards throughout the financial reporting process. They are expected to disclose and explain fully the reasons for changes and updated standards to the financial statements.  

  • Principle of sincerity

Accountants should commit to accuracy and impartiality on a company’s financial situation. 

  • Principle of permanence of methods

Accountants should apply consistent procedures in financial reporting to allow the comparison of a company’s financial information.

  • Principle of non-compensation

Positive and negative aspects of a company’s financial situation must be reported with complete transparency and without the prospect of debt compensation.

  • Principle of prudence

The financial report should be based on factual data and not influenced by speculation.

  • Principle of continuity

Asset valuations must assume that the business will continue. 

  • Principle of periodicity

Entries should be spread out over the appropriate periods. For instance, revenue should be reported in the standard accounting period, such as the fiscal year.

  • Principle of materiality

Accountants must make efforts to disclose the company’s or organisation’s financial situation fully.

  • Principle of utmost good faith

All parties are assumed to be honest in all transactions. 

Why is GAAP important?

GAAP creates a consistent, comparable and clear accounting method. By applying GAAP, it ensures companies will have uniform and complete financial records. It is essential for executives because it provides a comprehensive picture of their financial health. 

Since GAAP guarantees consistency, business leaders or investors can compare the company’s performance over specific periods or with other companies in the same industry.

Consistency in reporting is also essential when a company carries out external activities, such as raising capital, launching an initial public offering (IPO) and other activities.

It also helps to build trust in the financial markets. Companies are more likely to earn investors’ confidence when presenting their financial report and showing that this has followed GAAP principles. 

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