Generally Accepted Accounting Principles (GAAP) are the standard framework of guidelines for financial accounting used in the United States. These accounting standards, developed and maintained by the Financial Accounting Standards Board (FASB), provide the foundation for financial reporting that ensures consistency, transparency, and accuracy of financial information.
Following GAAP allows business owners, investors, creditors, and other users of financial information to compare and interpret financial results between different companies and enables them to make informed decisions.
What Does GAAP Cover?
GAAP is not simply one collection of policies but rather a combination of principles set by governing bodies and generally accepted practices for recording and communicating accounting data. GAAP covers topics such as:
- Revenue recording: How and when a firm accounts for income from sales of goods or services provided.
- Asset and liability categorization on financial statements: How a business divides its assets, liabilities, and equity on its financial reports.
- Relevance of information: What financial information is meaningful enough to impact the decisions of users of the company’s financial statements.
- Expense recording: When and how a company accounts for costs connected with generating revenue.
- Asset valuation: How assets are measured and reported on the balance sheet.
Who Establishes GAAP?
GAAP is established by groups like the Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC). FASB is an independent body that creates accounting guidelines for public, private firms and charities within the United States.
While FASB establishes the standards, the SEC enforces them, ensuring companies follow the same rules for reporting finances transparently. This provides dependable information for investors to compare the financial health and performance of different businesses.
Why Is GAAP Important?
Complying with GAAP accounting standards produces reliable and consistent financial statements. Business owners, investors, banks, and other stakeholders rely on these reports to evaluate a company’s financial position and performance.
This ensures transparency and builds confidence. By adhering to GAAP, businesses provide financial information organized in a clear, uniform way that gives insight into the company’s finances and results.
TL;DR
GAAP is a collection of widely accepted rules, conventions, standards, and procedures that govern the accounting of income, expenses, assets, and liabilities in the U.S. By following GAAP, companies provide accurate, consistent, and transparent financial statements that are useful for decision-making.
