It seems all cultures have their favorite, sometimes idiosyncratic ways to describe rules and practices. Governments, Militaries, Religions… and Business is no different. Humans can’t help themselves. Acronyms seem to be in our DNA. And here’s one that no one outside of certain business sectors will know.
GAAP. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES.
What The Heck Are Generally Accepted Accounting Principles?
Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP standards when their accountants compile their financial statements. GAAP principles are a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information. And the GAAP definition, or standards, is accepted worldwide by more than 100 countries.
U.S. law requires businesses that release financial statements to the public, and companies that are publicly traded on stock exchanges to follow GAAP guidelines.
- Principle of regularity: GAAP-compliant accountants strictly adhere to established rules and regulations.
- Principle of consistency: Consistent standards are applied throughout the financial reporting process.
- Principle of sincerity: GAAP-compliant accountants are committed to accuracy and impartiality.
- Principle of permanence of methods: Consistent procedures are used in the preparation of all financial reports.
- Principle of non-compensation: All aspects of an organization’s performance, whether positive or negative, are fully reported with no prospect of debt compensation.
- Principle of prudence: Speculation does not influence the reporting of financial data.
- Principle of continuity: Asset valuations assume the organization’s operations will continue.
- Principle of periodicity: Reporting of revenues is divided by standard accounting time periods, such as fiscal quarters or fiscal years.
- Principle of materiality: Financial reports fully disclose the organization’s monetary situation.
- Principle of utmost good faith: All involved parties are assumed to be acting honestly.
And What Are the Basic Principles of Accounting?
The Business as a Single Entity Concept- A business is a separate entity in the eyes of the law. All its activities are treated separately from that of its owners. In legal terms a business can exist long after the existence of its promoters or owners.
The Specific Currency Principle- A currency is specified for reporting the financial statements. In the United States all the numbers have to be expressed in US dollars. Companies who conduct parts of their businesses in foreign currencies have to convert the amounts in US dollars using the prevalent exchange rate while reporting their financial statements.
The Specific Time Period Principle- Financial statements always pertain to a specific time. Income statements have a start date and an end date. Balance sheets are reported as on a certain date. This way the readers know during which period the business transactions were conducted in.
The Historical Cost Principle- Historical costs are used for valuing items. The prices at which items were brought and sold are used for the valuations. Real values do change during the course of time due to inflation and recession, but these are not considered for reporting purposes.
The Full Disclosure Principle- With all the accounting scandals in the news, the full disclosure principle is important. It is required that companies reveal every aspect of the functioning in their financial statements.
The Recognition Principle- States that companies reveal their income and expenses in the same time period in which they were accrued.
The Non-Death Principle of Businesses- The accounting principles assume that businesses will continue to function eternally and have no end date as such.
The Matching Principle- The accrual system of accounting is to be used and for every debit there should be a credit and vice versa.
The Principle of Materiality- Then there are principles which require the bookkeepers to use their judgment. There are inaccuracies in all accounting records. A five dollar error can be ignored, but not a $10,000 error. This is where accountants have must use their own judgment.
The Principle of Conservative Accounting- When expenses occur they are to be recorded immediately, but income is to be recorded only when the actual cash has been received.
The History of GAAP
And where did come from GAAP anyway?
As with many practices, GAAP was born of crisis. The stock market crash of 1929 and the Great Depression that followed, shattered the public’s faith in the economy and it’s governance. In desperation, the United States created the Securities and Exchange Commission, and the SEC asked the American Institute of Accountants to formulate new standards for accounting. The thought was that the abuses discovered after the crash in the world’s financial centers might be avoided in the future if there was some standards and regulations to keep fraud at bay.
Generally accepted accounting principles are a set of rules that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.
U.S. law requires businesses that release financial statements to the public and companies that are publicly traded on stock exchanges to follow GAAP guidelines, which incorporate 10 key concepts
Those general accounting principles continue to evolve today, but the basic principles remain and are still enforced by the SEC.
The Financial Accounting Standards Board (FASB)
FASB is a private, non-profit organization standard-setting body whose primary purpose is to establish and improve Generally Accepted Accounting Principles (GAAP) within the United States in the public’s interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the US. The FASB replaced the American Institute of Certified Public Accountants’ (AICPA) Accounting Principles Board (APB) on July 1, 1973.
FASB accounting standards are accepted as authoritative by many organizations, including state Boards of Accountancy and the American Institute of CPAs (AICPA).