GAAP and Accounting Standards
An Explanation of Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) are the basis of financial accounting and reflect federal financial accounting standards. GAAP is important to US firms.
GAAP is a collection of methods used to process, prepare, and present public accounting information. GAAP is overall very general in its methods, as it needs to be somewhat applicable to many different types of industries. GAAP can be principle-based or specific technical requirements. Due to the fact that in many instances it is flexible and general, most industries in the United States are expected to follow GAAP principles.
Although different organizations contribute to GAAP, the Financial Accounting Standards Board (FASB) is the main contributor to GAAP. This is done through one of four categories of methods which differ on method and level of importance.
FASB is an organization that has been granted the authority to establish generally accepted accounting principles (GAAP) by the Securities and Exchange Commission (SEC).
Generally Accepted Accounting Principles (GAAP)
Generally accepted accounting principles (GAAP) are varied but based on a few basic principles that must be upheld by all GAAP rules. These principles include consistency, relevance, reliability, and comparability.
Consistency means that all information should be gathered and presented the same across all periods. For example, a company cannot change the way they account for inventory from one period to another without noting it in the financial statements and having a valid reason for the change.
Relevance means that the information presented in financial statements (and other public statements) should be appropriate and assist a person evaluating the statements to make educated guesses regarding the future financial state of a company.
Reliability means simply that the information presented in financial statements is reliable and verifiable by an independent party. Basically a company must confirm that if an independent auditor were to base their reports off of the same information that they would come up with the same results. Following this generally accepted accounting principle (GAAP) also means that the company is representing a clear picture of what really happened (and is happening) with their company.
Comparability is one of the most important GAAP categories and one of the main reasons having something similar to GAAP is necessary. By ensuring comparability, a company’s financial statements and other documentation can be compared to similar businesses within its industry. The importance of this principle cannot be overstated, as without comparability investors would be unable to discern differences between companies within an industry to benchmark how a company is doing compared to its peers.
Generally accepted accounting principles (GAAP) ensures that all companies are on a level playing field and that the information they present is consistent, relevant, reliable, and comparable. Although U.S. GAAP is only applicable in the U.S., other countries have their own versions that are similar in purpose, although not always in design.
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