To facilitate comparisons, the financial information must follow generally accepted accounting principles. However, about one third of private companies choose to comply with these standards to provide transparency. Even though the U.S. federal government requires public companies to abide by GAAP, the government takes no part in developing these principles. Instead, independent boards assume the responsibility of creating, maintaining, and updating accounting principles. GAAP is used by accountants and other financial professionals to compile financial statements for companies.

The U.S. Securities and Exchange Commission (SEC) requires all publicly traded companies to adhere to GAAP standards. When each company reports and maintains its financial records the same way, it’s easier for investors to compare companies to make investment decisions. The federal government began working with professional accounting groups to establish standards and practices for consistent and accurate financial reporting. GAAP rules are maintained by the Financial Accounting Standards Board (FASB) and in place to help protect business owners, consumers, and investors from fraud.

Finish Your Free Account Setup

GAAP was later established under the Securities Act of 1933 and the Securities Exchange Act of 1934. GAAP principles are required for all publicly traded companies in the United States, but many private companies also follow these standards. GAAP standards apply to all corporate, nonprofit, and government accounting practices.

Financial statements must be prepared in a way that follows and meets GAAP standards. Although exact GAAP requirements may vary depending on the industry, it is necessary to adhere to the principles at all times. Any person or party involved in, or responsible for, the financial side of a business must be honest in all reports and transactions. Along with several other principles, this serves to maintain an ethical standard and responsibility in all financial dealings. Accountants must, to the best of their abilities, fully and clearly disclose all the available financial data of the company.

Applying GAAP in the workplace

These rules are designed to keep your accountants from attempting to inflate your business’s financial records to mislead investors. However, IFRS would give your company more room for interpretation in your financial reporting. The Principle of Consistency dictates that accountants must apply consistent standards throughout the financial reporting process.

Constraints of GAAP

GAAP is the set of standards and practices that are followed in the United States, but what about other countries? Outside the US, the alternative in most countries is the International Financial Reporting Standards (IFRS), which is regulated by the International Accounting Standards Board (IASB). While the two systems have different principles, rules, and guidelines, IFRS and GAAP have been working towards merging the two systems.

Basic Accounting Principles and Guidelines

While each financial reporting framework aims to provide uniform procedures and principles to accountants, there are notable differences between them. The Generally Accepted Accounting Principles are a set of accounting standards and procedures companies use to compile their financial statements. GAAP standards assume an accountant is in place to ensure accurate financial reporting.

Required departures from GAAP

Most small businesses are on a cash basis for tax purposes, meaning revenue is reported when cash is received and expenses are reported when cash is spent (or your business’s credit card is charged). But certain businesses are required to report all financial information on an accrual basis, largely due to the matching principle. Essentially, this principle requires accountants to report financial information only in the relevant accounting period.

Although privately held companies are not required to abide by GAAP, publicly traded companies must file GAAP-compliant financial statements to be listed on a stock exchange. Chief officers of publicly traded companies and their independent auditors must certify that the financial statements and related notes were prepared in accordance with GAAP. When accounting principles allow a choice among multiple methods, a company should apply the same accounting method over time or disclose its change in accounting method in the footnotes to the financial statements. Comparability is the ability for financial statement users to review multiple companies’ financials side by side with the guarantee that accounting principles have been followed to the same set of standards.

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