14 Feb
Generally accepted accounting principles (GAAP) are the set of accounting procedures, rules, and standards used to prepare financial statements. It ensures that all financial statements are compiled accurately, reliably, and honestly.
Whether public or government, every company releases its financial statements each year. They must follow GAAP while preparing financial statements because investors, banks, and creditors use these statements to determine their company’s financial health. Therefore, all companies must comply with these rules.
These guidelines are updated and monitored by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA). Along with this, GAAP is used by organizations to:
- Improve the clarity, comparability, and consistency of the communication of financial information.
- Ensures a company’s financial statements are complete, consistent, and comparable.
- Helps in summarizing the accounting record into the financial statement.
Table of Contents
Why GAAP is Important?
GAAP plays a vital role in managing your business. So, how does it take your business to another level? Let’s have a quick look.
- GAAP provides an accurate picture of your business revenue and expenses so that you can determine regular cash flow.
- It helps in promoting the usability and consistency of all financial statements.
- Its relay on accurate financial statement and lower the risk of financial data misrepresentation and other frauds.
- It tells about your company’s performance and improves it positively if needed.
- It offers you a detailed view of your cost. This is a great way to analyze how you are spending your funds, is there any need for improvement, how well decisions are being taken and so on.
- It provides accurate financial performance to the shareholders, investors, and anyone interested in your business. In addition, it leads all interested parties to trust in your business by showing that all your financial statements have been prepared considering GAAP guidelines.
Where are Generally Accepted Accounting Principles(GAAP) used?
Companies use these standard principles to prepare financial statements and other accounting disclosers. It ensures that the financial data provided to investors and regulators are reliable and accurate.
10 Principles of GAAP
Ten principles lay out the primary mission of GAAP.
1. Principle of Regularity
This principle ensures that accountants strictly stick to established rules and regulations.
2. Principle of Consistency
This principle states that accountants ensure financial comparability between each period by applying the same standards throughout the accounting process.
3. Principle of Sincerity
This principle states that accountants should report financial data with accuracy and honesty.
4. Principle of Continuity
This principle states that the assets are valued assuming that the company will continue to operate for indefinite time period.
5. Principle of Prudence
According to this principle, all financial data should be factual and reasonable, not speculative.
6. Principle of Materiality
This principle states that financial statements fully disclose the organization’s monetary situation.
7. Principle of Periodicity
This principle states that accounting entries are distributed by suitable periods, such as quarterly or annually.
8. Principle of Good Faith
This principle is similar to the principle of sincerity. However, this assumes that all involved parties in financial reporting should act faithfully and honestly.
9. Principle of Non-Compensation
According to this principle, all financial data should be disclosed fully including both positive and negative aspects.
10. Principle of Permanence Method
The focus of this principle is that there should be consistency and permanence in the method used in financial reporting.
What are non-GAAP measures?
Non-GAAP is the reverse of GAAP. Sometimes companies believe that GAAP rules are not much flexible to meet the criteria of their operations. In that condition, they provide non-GAAP Measures.
The international financial reporting standard(IFRS) is an accounting standard used in more than 144 countries. It is considered a more principle-based accounting standard than the Generally Accepted Accounting Principle(GAAP).
Some of the differences between the two accounting standards are the following:
- In GAAP, once inventory has been written down cannot be reversed, but Under IFRS, inventory can be changed if criteria are met.
- GAAP allows companies to use Last In First Out (LIFO) as an inventory cost method, but it is forbidden under IFRS.
- An entity using IFRS rules can classify equity method investment as “held for sale,” which is impossible under GAAP.
Limitation of GAAP
There are some limitations in GAAP. Companies suffer from GAAP issues due to their business size, categorization, location, and global presence. The following are the common limitation of GAAP:
GAAP is not used Globally
Generally Accepted Accounting Principles are not globally used to prepare accounting reports. However, some countries outside the US use the International Financial Reporting Standard (IFRS). In addition, the Financial Accounting standard board (FASB) and International Accounting Standard Board (IASB) develop and update globally uniformed standards. These accounting boards are working to reduce the difference between GAAP and IFRS frameworks, but they will never be merged.
One-size-fits-all approach
GAAP offers a one-size-fits-all approach; applying it to smaller companies finds it too complex and struggles to incorporate all the principles into basic financial reports.
Wait for new standards approval
The GAAP policy board has an extensive process to set a new standard for the Generally Accepted Accounting Principles (GAAP). In this situation, companies may face issues; they would have to wait for a standard to be approved before implementing them.
Conclusion
Thus, Generally Accepted Accounting Principles (GAAP) help companies get reliable, accurate, and honest financial statements. In addition, despite some limitation, GAAP help companies in compiling standard financial statement.
Shabana has been a committed content writer and strategist for over a 5 years. With a focus on SaaS products, she excels in crafting compelling and informative content.
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