Accounting principles are the rules and guidelines that companies must follow when reporting financial data. The common set of U.S. principles is the generally accepted accounting principles (GAAP). To remain listed on many major stock exchanges in the United States, companies must regularly file financial statements reported according to GAAP.
Explaining Accounting Principles
Accounting principles differ from country to country.
Some principles differ across the world. The problem of differences in these principles are less of an issue in mature markets.
The professional world of accounting is governed by general rules and concepts referred to as basic accounting principles and guidelines. Together, they form the groundwork for the more complicated, detailed and legalistic rules of accounting.
GAAP is base on three important sets of rules: the basic accounting principles and guidelines, the generally accepted industry practices, and the detailed rules issued by the Financial Accounting Standards Board (FASB) and the Accounting Principles Board (APB).
The FASB and the IASB
The FASB is a private sector group based in the United States. It based its own detailed and comprehensive accounting rules on basic accounting principles and guidelines. The international counterpart of the FASB is the International Accounting Standards Board (IASB). Driven by die increase in global trade and finance, both organizations are working together in establishing in single harmonious set of international financial reporting standards (IFRS).
Generally Accepted Accounting Principles
GAAP attempts to standardize and regulate the definitions, assumptions and methods used in accounting. This helps companies prepare consistent financial statements from year to year.
U.S. companies are required to follow GAAP when releasing financial statements to the public. If a company’s stock is publicly traded, federal law requires that its financial statements are audited by independent public accountants. The company’s management and the independent accountant must certify that the financial statements and related notes were prepared in accordance with GAAP.
Accounting data are not absolute or concrete, and standards such as GAAP are developed to minimize the negative effects of inconsistent data. Without GAAP, comparing financial statements of companies would be extremely difficult even within the same industry, making an apples-to-apples comparison hard. Inconsistencies and errors would also be hard to spot.