What are ‘Generally Accepted Accounting Principles – GAAP’
Generally accepted accounting principles (GAAP) are a common set of accounting principles, standards and procedures that companies must follow when they compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP improves the clarity of the communication of financial information.
Explaining ‘Generally Accepted Accounting Principles – GAAP’
GAAP is meant to ensure a minimum level of consistency in a company’s financial statements, which makes it easier for investors to analyze and extract useful information. GAAP also facilitates the cross comparison of financial information across different companies.
Compliance
GAAP must be followed when a company distributes its financial statements outside of the company. If a corporation’s stock is publicly traded, the financial statements must also adhere to rules established by the U.S. Securities and Exchange Commission (SEC).
GAAP vs. IFRS
GAAP is focused on the practices of U.S. companies. The Financial Accounting Standards Board (FASB) issues GAAP. The international alternative to GAAP is the International Financial Reporting Standards (IFRS) set by the International Accounting Standards Board (IASB). The IASB and the FASB have been working on the convergence of IFRS and GAAP since 2002. Due to the progress achieved in this partnership, in 2007, the SEC removed the requirement for non-U.S. companies registered in America to reconcile their financial reports with GAAP if their accounts already complied with IFRS. This was a big achievement, because prior to the ruling, non-U.S. companies trading on U.S. exchanges had to provide GAAP-compliant financial statements.
Notes
GAAP is only a set of standards. Although these principles work to improve the transparency in financial statements, they do not provide any guarantee that a company’s financial statements are free from errors or omissions that are intended to mislead investors. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP, you still need to scrutinize its financial statements.
Further Reading
- … States Generally Accepted Accounting Principles (US GAAP) and International Accounting Standards (IAS): implications for the harmonization of accounting standards – www.tandfonline.com [PDF]
- GAAP as a symbol of legitimacy: New York State's decision to adopt generally accepted accounting principles – www.sciencedirect.com [PDF]
- Institutional theory and accounting rule choice: an analysis of four US state governments' decisions to adopt generally accepted accounting principles – www.sciencedirect.com [PDF]
- A comparison of the International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (GAAP) for small and medium-sized entities … – search.proquest.com [PDF]
- Earnings management under German GAAP versus IFRS – www.tandfonline.com [PDF]
- A unifying model of how the tax system and generally accepted accounting principles affect corporate behavior – www.nber.org [PDF]
- Toward an empirical institutional governance theory: Analyses of the decisions by the 50 US state governments to adopt generally accepted accounting principles – papers.ssrn.com [PDF]
