GAAP (Generally Accepted Accounting Principles) are a set of commonly accepted accounting rules and standards used by companies and organizations alike to prepare and present financial statements. They provide a framework which defines how businesses should record and report their financial information, setting out clear guidelines for the recording, measuring, and reporting of financial data.
The Principles are rules based and have been established and endorsed by the Financial Accounting Standards Board (FASB), a private sector organization which sets the standards for accounting, and the Securities and Exchange Commission (SEC). This set of principles is used in the preparation of publicly traded companies’ financial statements to ensure accuracy and transparency in the reporting of financial information.
Background
GAAP has evolved over time, with its roots dating back to the 19th century. In the United States, the American Institute of Accountants (AIA) was founded in 1887 and the first volume of GAAP was published in 1937. The AIA has since been disbanded and in 1973 the Financial Accounting Standards Board (FASB) was formed.
Today GAAP is widely accepted in not just the United States, but also many other countries around the world, and is seen as the gold standard for the accounting and financial management industry. It has proven to be invaluable for businesses, investors and other stakeholders by providing a uniform framework for the reporting of financial information and safeguarding the accuracy and integrity of financial statement presentation.
Structure and Process
GAAP is based on a set of principles classified around the areas of measurement, revenue recognition, disclosure and presentation. Each principle is broken down further into concepts, rules and/or practices which businesses must apply when preparing financial statements.
The measurement and presentational principles are the most important and require financial managers and accountants to ensure financial statements present a true and fair view of the company’s financial position. This is generally achieved through careful selection of the most appropriate accounting technique and only reporting items which comply with GAAP, or with any rules existing under the given jurisdiction.
In addition, GAAP also applies the Money Measurement Principle which requires businesses to report transactions and assets in terms of money. This includes all past, present, and future liabilities, assets and events with economic implications that need to be shown as an amount of money.
Benefits
The primary benefit of GAAP is the improved quality of financial statement and reporting as well as offering a level playing field for businesses of all sizes. Companies and organizations have been able to improve the accuracy of their financial reporting and gain access to a single set of accounting specific standards.
By providing a structure for financial statements and reporting, GAAP helps improve the validity and credibility of the finance department. This has made life easier for stakeholders, investors, shareholders and other interested parties by providing one comprehensive set of principles and regulations that must be followed.
Key Features and Considerations
When applying GAAP, financial managers should keep the following in mind:
* GAAP is broad and comprehensive, and provides a single set of standardized accounting principles and regulations to be followed.
* It includes measurement, recognition, disclosure and presentation principles to ensure financial statements accurately reflect the true and fair view of financial position.
* GAAP applies the Money Measurement principle which requires all assets, liabilities and events to be recorded in terms of money.
* It provides consistency and accuracy for reporting purposes and improved quality of financial statements.
Real World Example
An example of GAAP in real-world application is the Coca-Cola Company. In 2019, the company released its annual report which stated that its ‘financial statements are prepared in accordance with U.S. generally accepted accounting principles (GAAP)’. The report included the company’s financial position, profit & loss statements and other information, all prepared in accordance with the GAAP standards.
Conclusion
Overall, GAAP is a set of accounting principles that have been set by the Financial Accounting Standards Board (FASB) and are used in the preparation of financial statements. This set of standards provides a framework for the recording, measuring and reporting of financial data which reduces the risk of inaccuracies and improves the validity of financial statements. GAAP offers businesses the benefit of reducing costs related to financial reporting while providing improved accuracy in their financial statements. GAAP has been deployed in a wide variety of industries and is used by companies and organizations of all sizes.
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