Generally Accepted Accounting Principles are a common set of accounting rules and standards that dictates how all of our financial statements are prepared. Public companies, nonprofit organizations, and government entities are all required to prepare financial statements in accordance with GAAP. These guidelines were developed over time by the Financial Accounting Standards Board (FASB), and the American Institute of Certified Public Accountants (AICPA).
Principles covered by GAAP
GAAP covers a wide range of accounting practices and philosophies. Some of these include:
- Recognition: How assets, liabilities, revenues, and expenses are recognized on financial statements
- Measurement: How profits and losses are measured and reported on financial statements
- Presentation: How information needs to be presented on financial statements
- Disclosure: What information needs to be shared on financial statements
Purpose of GAAP
The General Accepted Accounting Principles is supposed to create a uniform standard for financial reporting. When financial information is released to the public, it should help investors make informed decisions as to where they would invest. Similarly, it should enable lenders to properly assess the financial condition of companies looking to borrow money.
When GAAP is applied to non-profits and government organizations, its goal is to ensure complete transparency on the part of the reporting entities. The information provided under GAAP needs to not only be clear, comprehensive, and easily understood, but verifiable by auditors and other outside parties.
Importance of GAAP
If GAAP didn’t exist, companies wouldn’t be held to s strict set of standards, which means they’d have a lot more leeway in deciding what information they choose to share or keep hidden. GAAP therefore, serves the very-important function of making sure companies and organizations can’t “cheat” on their financial reporting.
It allows investors to easily evaluate companies simply by reviewing their financial statements. If an investor can’t chose between two companies in the same industry, that investor can compare their respective statements to determine which is doing a better job at generating revenue and managing cash flow.
However, this wouldn’t be possible if companies were allowed to choose what financial information they would represent. When this is applied to government organizations, these principles help taxpayers understand how their tax dollars are being spent.
It also helps companies gain key insights into their own practices and performance. Furthermore, the General Accepted Accounting Prniciples minimizes the risk of erroneous financial reporting by having numerous checks and safeguards in place. The information provided in GAAP-compliant financial statements can therefor generally be regarded as reliable and accurate.