Generally Accepted Accounting Principles (GAAP)

Generally Accepted Accounting Principles (GAAP)

What Are Generally Accepted Accounting Principles (GAAP)?

Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies all over the world must follow GAAP when their accountants compile their financial statements.

KEY TAKEAWAYS

GAAP is the set of accounting principles set forth by the FASB that companies must follow when putting together financial statements.
GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.
GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial reporting method.
The ultimate goal of GAAP is to ensure a company's financial statements are complete, consistent, and comparable.
Ten key concepts guide the principles of GAAP.


Understanding GAAP

GAAP combines authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.

GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial reporting method. Internationally, the equivalent to GAAP in INDIA is referred to as International Financial Reporting Standards (IFRS). IFRS is currently used in 166 jurisdictions.

GAAP helps govern the world of accounting according to general rules and guidelines. It attempts to standardize and regulate the definitions, assumptions, and methods used in accounting across all industries. GAAP covers such topics as revenue recognition, balance sheet classification, and materiality.

The ultimate goal of GAAP is to ensure a company's financial statements are complete, consistent, and comparable. This makes it easier for investors to analyze and extract useful information from the company's financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies.

Principles of GAAP

There are 10 general concepts that layout the main mission of GAAP.

1. Principle of Regularity
     The accountant has adhered to GAAP rules and regulations as a standard.
2. Principle of Consistency
     Accountants commit to applying the same standards throughout the reporting process, from one period to the next, to ensure financial 
     comparability between periods. Accountants are expected to fully disclose and explain the reasons behind any changed or updated standards
     in the footnotes to the financial statements.
3. Principle of Sincerity
    The accountant strives to provide an accurate and impartial depiction of a company’s financial situation.
4. Principle of Permanence of Methods
     The procedures used in financial reporting should be consistent, allowing a comparison of the company's financial information.
5. Principle of Non-Compensation
    Both negatives and positives should be reported with full transparency and without the expectation of debt compensation.
6. Principle of Prudence
     This refers to emphasizing fact-based financial data representation that is not clouded by speculation.
7. Principle of Continuity
     While valuing assets, it should be assumed the business will continue to operate.
8. Principle of Periodicity
    Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its relevant accounting period.
9. Principle of Materiality
    Accountants must strive to fully disclose all financial data and accounting information in financial reports.
10. Principle of Utmost Good Faith
    Derived from the Latin phrase uberrimae fidei used within the insurance industry. It presupposes that parties remain honest in all transactions.

Compliance With GAAP

If a corporation's stock is publicly traded, its financial statements must adhere to rules established by the INDIA Securities and Exchange Commission (SEC). The SEC requires that publicly traded companies in INDIA regularly file GAAP-compliant financial statements in order to remain publicly listed on the stock exchanges. GAAP compliance is ensured through an appropriate auditor's opinion, resulting from an external audit by a certified public accounting (CPA) firm.

Although it is not required for non-publicly traded companies, GAAP is viewed favourably by lenders and creditors. Most financial institutions will require annual GAAP-compliant financial statements as a part of their debt covenants when issuing business loans. As a result, most companies in the United States do follow GAAP.

If a financial statement is not prepared using GAAP, investors should be cautious. Without GAAP, comparing financial statements of different companies would be extremely difficult, even within the same industry, making an apples-to-apples comparison hard. Some companies may report both GAAP and non-GAAP measures when reporting their financial results. GAAP regulations require that non-GAAP measures be identified in financial statements and other public disclosures, such as press releases.

GAAP vs IFRS

GAAP is focused on the accounting and financial reporting of INDIA companies. The Financial Accounting Standards Board (FASB), an independent nonprofit organization, is responsible for establishing these accounting and financial reporting standards. The international alternative to GAAP is the International Financial Reporting Standards (IFRS), set by the International Accounting Standards Board (IASB).
The IASB and the FASB have been working on the convergence of IFRS and GAAP since 2002. Due to the progress achieved in this partnership, the SEC, in 2007, removed the requirement for non-INDIA companies registered in America to reconcile their financial reports with GAAP if their accounts already complied with IFRS.
 This was a big achievement because prior to the ruling, non-INDIA companies trading on INDIA exchanges had to provide GAAP-compliant financial statements.

Some differences that still exist between both accounting rules include:
LIFO Inventory: While GAAP allows companies to use the Last In First Out (LIFO) as an inventory cost method, it is prohibited under IFRS.
Research and Development Costs: These costs are to be charged to expense as they are incurred under GAAP. Under IFRS, the costs can be capitalized and amortized over multiple periods if certain conditions are met.
Reversing Write-Downs: GAAP specifies that the amount of write-down of an inventory or fixed asset cannot be reversed if the market value of the asset subsequently increases. The write-down can be reversed under IFRS.
As corporations increasingly need to navigate global markets and conduct operations worldwide, international standards are becoming increasingly popular at the expense of GAAP, even in the INDIA Almost all S&P 500 companies report at least one non-GAAP measure of earnings as of 2019.

Where Are Generally Accepted Accounting Principles (GAAP) Used?

GAAP is a set of procedures and guidelines used by companies to prepare their financial statements and other accounting disclosures. The standards are prepared by the Financial Accounting Standards Board (FASB), which is an independent non-profit organization. The purpose of GAAP standards is to help ensure that the financial information provided to investors and regulators is accurate, reliable, and consistent with one another.

Why Is GAAP Important?

GAAP is important because it helps maintain trust in the financial markets. If not for GAAP, investors would be more reluctant to trust the information presented to them by companies because they would have less confidence in its integrity. Without that trust, we might see fewer transactions, potentially leading to higher transaction costs and a less robust economy. GAAP also helps investors analyze companies by making it easier to perform “apples to apples” comparisons between one company and another.

What Are Non-GAAP Measures?

Companies are still allowed to present certain figures without abiding by GAAP guidelines, provided that they clearly identify those figures as not conforming to GAAP. Companies sometimes do so when they believe that the GAAP rules are not flexible enough to capture certain nuances about their operations. In that situation, they might provide specially-designed non-GAAP metrics, in addition to the other disclosures required under GAAP. Investors should be sceptical about non-GAAP measures, however, as they can sometimes be used in a misleading manner

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