Introduction

The common set of accounting principles, standards and procedures that companies use to
compile their financial statements. GAAP are a combination of authoritative standards (set by
policy boards) and simply the commonly accepted ways of recording and reporting accounting
information.

Generally Accepted Accounting Principles - GAAP

GAAP are imposed on companies so that investors have a minimum level of consistency in the
financial statements they use when analyzing companies for investment purposes. GAAP cover
such things as revenue recognition, balance sheet item classification and outstanding share
measurements. Companies are expected to follow GAAP rules when reporting their financial
data via financial statements. If a financial statement is not prepared using GAAP principles, be
very wary!

Generally Accepted Accounting Principles (GAAP) is a term used to refer to the standard
framework of guidelines for financial accounting used in any given jurisdiction which are
generally known as Accounting Standards. GAAP includes the standards, conventions, and
rules accountants follow in recording and summarizing transactions, and in the preparation
of financial statements.

The term "GAAP" is an abbreviation for Generally Accepted Accounting Principles (GAAP).
GAAP is a codification of how CPA firms and corporations prepare and present their business
income and expense, assets and liabilities on their financial statements. GAAP is not a single
accounting rule, but rather the aggregate of many rules on how to account for various
transactions. The basic principles underlying GAAP accounting are set forth below.

When preparing financial statements prepared using GAAP, most American corporations and
other business entities use the many rules of how to report business transactions based upon the
various GAAP rules. This provides for consistency in the reporting of companies and businesses
so that financial analysis, Banks, Shareholders and the SEC can have all reporting companies
preparing their financial statements using the same rules and reporting procedures. This allows
for an "Apple to Apple" comparison of any corporation or business entity with another. Thus, if
Company A reports $1,000,000 of net income, using GAAP, than the public and other users of
financial statements can compare that net income to another company that is reporting $500,000
of net income, using GAAP.

The rules and procedures for reporting under GAAP are complex and have developed over a
long period of time. Currently there are more than 150 "pronouncements" as to how to account
for different types of transactions, ranging from how to report regular income from the sale of
goods, and its related inventory values, to accounting for incentive stock option distributions. By
using consistent principles, all companies reporting under GAAP report these transactions on
their financial statements in a consistent manner.

The various rules and pronouncements come from the Financial Accounting Standards Board
(FASB) which is a non-profit organization that the accounting profession has created to
promulgate the rules of GAAP reporting and to amend the rules of GAAP reporting as occasion
requires. The more recent pronouncements come as Statements of the Financial Accounting
Board (SFAS). Changes in the GAAP rules can carry tremendous impact upon American
business. For example, when FASB stopped requiring banks to mark their assets (loans) to the
lower of cost or market (i.e. value of a foreclosed home loan). the effect on a bank's "net worth"
as defined by GAAP can change dramatically. While generally neutral, there is some pressure on
the FASB to yield to industry or political pressure when it makes its rules.

Nonetheless, since all companies report using the same set of rules, know the rules of GAAP
reporting can tell the user of financial statements a great deal. The study of accounting, in large
part, entails learning the many rules and promulgations set forth by FASB and how to apply
those rules to actual business events.

GAAP is slowly being phased out in favor of the International Accounting Standards as the
global business becomes more pervasive. GAAP applies only to United States financial reporting
and thus an American company reporting under GAAP might show different results if it was
compared to a British company that uses the International Standards. While there is tremendous
similarity in between GAAP and the International Rules. The differences can lead a financial
statement user to incorrectly believe that company A made more money than company B simply
because they report using different rules. The move towards International Standards seeks to
eliminate this kind of disparity.

Financial Accounting is information that must be assembled and reported objectively. Third-
parties who must rely on such information have a right to be assured that the data are free from
bias and inconsistency, whether deliberate or not. For this reason, financial accounting relies on
certain standards or guides that are called "Generally Accepted Accounting Principles" (GAAP).

Principles derive from tradition, such as the concept of matching. In any report of financial
statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader
whether or not the information contained within the statements complies with GAAP.
PRINCIPLES OF GAAP:

 Principle of regularity: Regularity can be defined as conformity to enforced rules and

laws.

 Principle of consistency: This principle states that when a business has once fixed a
method for the accounting treatment of an item, it will enter all similar items that follow in
exactly the same way.

 Principle of sincerity: According to this principle, the accounting unit should reflect in
good faith the reality of the company's financial status.

 Principle of the permanence of methods: This principle aims at allowing the coherence
and comparison of the financial information published by the company.

 Principle of non-compensation: One should show the full details of the financial
information and not seek to compensate a debt with an asset, revenue with an expense, etc.

 Principle of prudence: This principle aims at showing the reality "as is": one should not
try to make things look prettier than they are. Typically, revenue should be recorded only
when it is certain and a provision should be entered for an expense which is probable.

 Principle of continuity: When stating financial information, one should assume that the
business will not be interrupted. This principle mitigates the principle of prudence: assets do
not have to be accounted at their disposable value, but it is accepted that they are at their
historical value.

 Principle of periodicity: Each accounting entry should be allocated to a given period,

and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease,
etc.), the given revenue should be split to the entire time-span and not counted for entirely on
the date of the transaction.

 Principle of Full Disclosure/Materiality: All information and values pertaining to the

financial position of a business must be disclosed in the records.

 Principle of Utmost Good Faith: All the information regarding to the firm should be
disclosed to the insurer before the insurance policy is taken.
Significance
Most companies in the United States adhere to Generally Accepted Accounting Principles to
maintain consistency in reporting of financial information and to reduce the risk of fraud and
error. The principles have been derived from traditional accounting systems and can be adapted
to an organization's management style and industry. If GAAP did not exist, companies would not
be able to provide accurate and consistent financial information to investors, creditors and
stakeholders of a company.

Function
GAAP is not required by law, but almost all companies that adhere to GAAP guidelines can
maintain consistent reporting processes and prepare accurate financial statements. Any
accountants or financial analysts involved with the financial reporting of a company will need to
understand and enforce the principles of GAAP; this helps set the standard for the organization
and reduces the risk of tax problems and erroneous reporting of transactions across all
departments.

Features
The principles of GAAP have been derived from traditional accounting methods, but many
companies use adaptations of the basic principles to suit their particular business operations. Key
principles of GAAP include: regularity or conformity to all rules and guidelines set forth by the
company; sincerity, which ensures that all accounting representatives work in good faith and
report items "as is"; permanence, which means a company should use the same reporting
methods and protocol at all times so there is no disparity in future transactions; and continuity,
which assumes that business operations will not be interrupted at any time in the future.

Benefits
Adhering to GAAP can help companies achieve their financial objectives by using accurate
financial data, access important financial records and reports throughout a period, and maintain
consistency when complying with tax rules and regulations. GAAP concepts can be interpreted
and applied in different ways, but the core principles serve as a foundation for reporting,
analyzing and drafting financial documents.