The Generally Accepted Accounting Principles (GAAP) are official guidelines that accountants use to record, measure and communicate financial information. Most people are unaware that GAPP may actually refer to basic accounting principles, industry best practices or rules issued by the FASB.
When people talk about GAAP, they usually refer to the standardized principles and procedures related to financial accounting and reporting.
When reporting their financial data via public reports, organizations are expected to closely follow GAAP rules. The SEC requires that any company that has listed securities on the stock exchange, or that issues new securities, must follow GAAP regulations. Failure to follow GAAP standards may result in SEC investigations, suspensions of business practices and loss of consumer confidence. The Financial Accounting Standards Board (FASB) sets the current standards and changes them based on economic trends and industry circumstances.
The Basis of the GAAP
GAPP is based on 10 fundamental accounting principles. Economic entity assumptions refer to how businesses are classified and monetary unit assumptions refer to how economic activities are monetarily measured. Time period assumptions means that certain financial activities can be reported within definable time intervals. Cost principles are the product’s original purchase price. The full disclosure principle means that vital information must be openly shared, while the going concern principle assumes that companies will exist long enough to meet their financial obligations. The matching principle requires companies to match expenses with revenues. The revenue recognition principle requires income to be recognized immediately after sale. Materiality and conservatism refer to alternative accounting solutions.
The Advantages of GAAP
There are well-recognized advantages of GAAP. They provide structure and guidelines for legalistic and complicated accounting rules. The 10 basic principles establish minimal accounting guidelines, which small businesses often used to set their own accounting rules and standards. One reason that small business owners issue GAAP-based financial statements is ensure that their financials are comparable to other companies. As a result, potential investors can easily make sound judgments on the company’s viability and financial health. As an internal benefit, management can compare their company’s financial data with competitors in order to benchmark performance. GAAP regulations help prevent fraud and financial mismanagement. On the other hand, some of the GAAP standards have become so complex and industry specific that small companies may struggle to maintain compliance.
Advice for New or Small Businesses
For companies that prepare financial statements, they may want to or be required to follow GAAP policies. First, any publicly-traded company must use GAAP. Privately-held companies are not required to prepare financial statements, but it is an excellent idea if external professionals review company records. Companies that want to implement GAAP procedures should establish policies for accountants or those who prepare financial statements. Finally, managers and business owners should become familiar with basic accounting principles. While many people dislike financial math, understanding the basics of accountancy will help business leaders make better decisions.
The Generally Accepted Accounting Principles are very important guidelines that maintain financial transparency and procedural standardization.