Table of Content
- What are Generally Accepted Accounting Principles (GAAP)
- Key Principles of GAAP
- The Evolution of Generally Accepted Accounting Principles (GAAP)
- GAAP vs. Non-GAAP Accounting
- Examples of GAAP Application
- Conclusion
In a recent growing financial economy, precision and consistency are important. The Generally Accepted Accounting Principles (GAAP) are implemented in Accounting to maintain these two principles. They are standardised accounting principles that guide companies on preparing and presenting their financial statements. GAAP principles ensure that financial reports are transparent, comparable, and genuine for internal and external users. Companies use these principles to offer investors, creditors, and stakeholders a clear view of their financial statements.
This article will define GAAP principles and explain why they are important in modern accounting practices.
What are Generally Accepted Accounting Principles (GAAP)
Generally Accepted Accounting Principles (GAAP) are standardised rules, guidelines, and procedures that control financial accounting and reporting. They serve as a foundation for financial reporting as they regulate how financial statements are prepared in many countries.
The full form of GAAP in accounting reflects its core objective: promoting transparency, investor confidence, and ethical financial practices.
Key Principles of GAAP
To define GAAP principles, it is useful to interpret the base concepts that guide financial reporting. These principles make sure that there is consistency, precision, and objectivity across all financial statements. Below are the fundamental principles that form the core of these principles:
1. Principle of Regularity
The accountants must strictly follow established rules and regulations.
2. Principle of Consistency
Consistent standards must be applied over time. If changes occur, they must be disclosed in the financial reports.
3. Principle of Conservatism
Advices accountants to use high alertness and diligence while preparing entries and documents, and checking data. This principle should be followed especially in cases involving uncertainty.
4. Principle of Matching
The reported revenues should match those expenses incurred in the same period to link the cost of an asset to its benefits.
5. Principle of Non-Compensation
All aspects of financial reporting should be presented without offsetting debts against assets or expenses against revenues, ensuring full disclosure.
6. Principle of Prudence
Accountants should avoid speculation, recording revenues and assets only when certain, while recognising liabilities as soon as anticipated.
7. Principle of Continuity
The asset's value is recorded assuming that the organisation’s operation will continue in the foreseeable future.
8. Principle of Periodicity
Financial records are maintained in specific, consistent periods, e.g., quarterly or annually.
9. Principle of Materiality
The financial statements must disclose all significant material information to avoid misleading users.
10. Principle of Utmost Good Faith
All parties involved in financial reporting must act honestly and disclose all relevant information truthfully.
The Evolution of Generally Accepted Accounting Principles (GAAP)
The Generally Accepted Accounting Principles we follow today have been formed over the years to meet the needs of the leading financial economy.
Without standards regulating financial position, companies would be open to presenting information in a manner that might mislead information users. The Great Depression of 1929 is one such example of faulty reporting of financial position.
The Great Depression of 1929 led to the formation of the Securities and Exchange Commission (SEC) in 1934, which was tasked with overseeing corporate financial reporting. In response, the American Institute of Accountants formed formal accounting standards. Over time, responsibility shifted to independent boards such as:
- Committee on Accounting Procedure (CAP) (1939–1959)
- Accounting Principles Board (APB) (1959–1973)
- Financial Accounting Standards Board (FASB) (since 1973)
Currently, FASB maintains and updates GAAP in the United States.
GAAP vs. Non-GAAP Accounting
Many countries follow GAAP, but some follow non-GAAP financial reporting and accounting standards. Here are the differences between these two approaches:
Examples of GAAP Application
Conclusion
Applying Generally Accepted Accounting Principles (GAAP) remains fundamental for ensuring financial reporting accuracy, consistency, and comparability. These principles provide a comprehensive financial transaction recognition, measurement, presentation, and disclosure framework—a thorough understanding of the meaning of GAAP and the ability to define GAAP.
Adherence to these principles allows organisations to present financial information reliably and transparently, thereby facilitating informed economic decisions by all stakeholders.
FAQs
- What is the concept of GAAP?
Generally Accepted Accounting Principles (GAAP) are standardised rules, guidelines, and procedures that control financial accounting and reporting. They serve as a foundation for financial reporting as they regulate how financial statements are prepared in many countries.
2. What are the key principles of GAAP?
These GAAP principles make sure that there is consistency, precision, and objectivity across all financial statements. They include the Principle of Regularity, the Principle of Materiality, the Principle of Consistency, etc.
3. Who creates GAAP?
Currently, FASB maintains and updates GAAP in the United States. Established in 1973, the Financial Accounting Standards Board (FASB) is the independent, private-sector, not-for-profit organization based in Norwalk, Connecticut, that creates GAAP standards followed by various profit and non-profit organizations.
4. What are GAAP and IFRS?
GAAP and IFRS are sets of accounting standards used for financial reporting. GAAP provides a set of accounting rules and procedures that govern how financial statements are prepared and presented in the United States. IFRS is a common accounting language that facilitates international comparability of financial statements.
5. What are the limitations of GAAP?
GAAP standards aim for consistency and allow standardisation. However, they have limitations, including not being recognised globally, being complex to understand and costly, and emphasizing historical cost in asset valuation, which may not reflect the current market value of assets.
