GAAP- Generally Accepted Accounting Principles

Definition:
GAAP (Generally Accepted Accounting Principles) are standardized guidelines for accounting and
financial reporting. These principles should be followed when preparing a company’s financial
statement. It is mandated by the US Securities and Exchange Commission (SEC) for reporting publicly
traded companies. GAAP establishes a proper classification and measurement criteria for financial
reporting. These principles assist investors in comparing the financial performance of different
businesses. It is a legal procedure that ensures transparency and accuracy. GAAP emerged in the 1970s.

GAAP, is a framework that shows the right way of accounting to the organizations. Although it isn’t
compulsory for every business entity, the Securities and Exchange Commission (SEC) has made it
mandatory for publicly listed companies. The Generally Accepted Accounting Principles are issued by
the Financial Accounting Standards Board (FASB). These principles are to be followed when preparing
a financial statement of a company or a Firm. They set a foundation for preparing income statements,
balance sheets, and cash flow statements. By doing so, they aid the taxation process. Further, these
principles initiate proper classification and measurement criteria for financial reporting. Ultimately,
investors get a better picture of various firms and their financial performances.

Users of GAAP:
Accountants and other financial professionals use GAAP rules and standards to organize and present
the financial reporting periodically required by publicly traded companies within the U.S. Since GAAP is
intended to ensure complete, accurate and consistent financial reporting between businesses, it affects
investment decisions by enabling investors to objectively compare business performance and influences
the stability of the investment market.
There is no universal GAAP standard and the specifics vary from one geographic location or industry to
another. The U.S. Securities and Exchange Commission (SEC) mandates that financial reports adhere to
GAAP requirements. The Financial Accounting Standards Board stipulates GAAP overall and the
Governmental Accounting Standards Board stipulates GAAP for state and local government. Publicly
traded companies must comply with both SEC and GAAP requirements.

GAAP involves four major rules and standards:

Accrual accounting methods: GAAP uses accrual accounting, which records revenue when a service or
good is sold but not when payment is received; direct expenses for goods sold are recorded when a sale
is transacted, and indirect expenses are recorded when expenses are paid.
Depreciation and capital expenditures: Costs of major asset acquisitions are accounted for over the
entire life of the asset. For example, an item with a 10-year life is accounted for at 10% for 10 years.
Reporting of historical costs: Some assets -- such as property, equipment and facilities -- are accounted
for using original purchase costs rather than current market values.
Reporting of bad debts: Companies with significant money owed by customers, or accounts receivable,
must report the possibility that some or all of that money may not be received and becomes lost
revenue.

GAAP Principles in Accounting:

1. Principle of Regularity: This is the foremost principle that assures that the accountant has adhered
to Generally Accepted Accounting Principles norms.
2. Principle of Consistency: The company should adopt a single accounting standard like Generally
Accepted Accounting Principles or IFRS for reporting the financial position. This prevents confusion.
3. Principle of Sincerity: After interpreting all the data, the accountant should represent the company’s
financial position accurately.
4. Principle of Permanence of Methods: The accountant should use the same accounting method every
time. Standardization is crucial as these reports are often used for comparative studies.
5. Principle of Non-Compensation: The only purpose of financial reporting should be transparency in
accounting. Irrespective of positive or negative information, transparency has to be upheld.
6. Principle of Prudence: Financial accounting has no space for speculation and should always be
pillared upon actual data.
7. Principle of Continuity: It relates to concern, which presumes that the business will keep operating
forever.
8. Principle of Periodicity: The financial statements pertain to a specific period, i.e., end time and start
time. Business transactions should be recorded on time. For instance, the balance sheet is to be reported
annually.
9. Principle of Materiality: This Principle makes the adjustment of minute errors possible. That is, while
maintaining accounting reports, there could be some minor errors like a $5 not matching. This principle
can be used to adjust such errors.
10. Principle of Utmost Good Faith: This principle is a belief that all the parties involved in the business
transaction have been honest and trustworthy..

Benefits of GAAP:
1. Helps to Plan Ahead: GAAP provides an accurate picture of business transactions and revenue to
determine and predict regular cash flow trends.
2. Maintains Consistency: GAAP ensures that businesses follow the same accounting principles for all
reporting periods. For instance, changing your inventory accounting method from first-in, first-out to
last-in, first-out can confuse the users of financial statements.
3. Reduces Risks and Frauds: GAAP helps companies lower the risk of data misrepresentation and other
business frauds. GAAP guidelines are what your investors or stakeholders follow to hold you liable for
reporting business finances effectively.
4. Identifies Scope for Improvement & Competitive Analysis: GAAP enables you to compare your
company’s overall performance with other business rivals in the market and highlight areas where you
require to make necessary changes.
5. Gives You Detailed Information on Business Spending: GAAP offers you a detailed view of the costs
you have collected – the way your investors or other people see them
6. Helps in Earning the Trust of Shareholders: Using GAAP to present your business information helps
you establish trust among people interested in what you do.

Conclusion:
GAAP is that it is virtually required for all financial documentation. Even for those who create financial
documentation or do research for privately held corporations, any outside investor or auditor will
expect GAAP compliance in any special project or presentations. Many firms, even in non-compliant
states, have a policy that all staff working for them and every legal or economic form follow GAAP
rules. Any regulator or accountant will find that GAAP-compliant documents follow a similar logic and
structure. Due to the fact that most accountants have attended AICPA-accredited accounting programs,
most companies use the standard. Creditors, donors, and potential acquisition targets are sure to
demand the standard, as well.

Without these principles, there would be fraudulent accounting, which could potentially hinder an
organization’s market credibility. An absence of protocol would make it very difficult for investors and
creditors who have a stake in a firm. In simple words, these principles are all about uniformity. When
followed, auditing is easy, and as a result, a firm’s performance and policies are transparent.

Reference:
1)https://www.wallstreetmojo.com/gaap-generally-accepted-accounting-principles/
2)https://chargezoom.com/top-6-benefits-of-gaap-accounting-for-your-business/
3)https://universityhq.org/resources/accounting/gaap/