Generally Accepted Accounting Principles (GAAP) are originally a set of rules and procedures to be followed when you frame your financial statements.
Along with this, certain guidelines have to be followed. These guidelines include financial statement presentation, assets, revenue, liabilities, expenses, leases, fair values, collaborations, and a few other official accounting statements.
All these forms the principles for the accounting system in general
History of GAAP
The American Institute of Accounts gives a specialized Committee on Accounting Procedure (CAP) further responsibility.
Later this position was moved to Accounting Principles Board (APB). APB was established by the American Institute of Certified Public Accountants, where a few rules were outlined further.
Around the 1970s, the role was taken over by FASB from APB. Until now, all the rules and guidelines are under FASB.
Now some of these are frequently referred to as IFRS, which is considered it is equivalent.
Technically, GAAP was under the islemen of the Financial Accounting Standards Board (FASB). The United States Securities and Exchange Committee adopted it later.
How does GAAP work?
- All public sector companies have to follow the General Accepted Accounting Principles under the U.S. Securities and Exchange Commission.
- If the refined companies have to attain a public stock exchange listed status, it has to be secured by an auditor’s statement. This is achieved after the CPA conducts an external audit.
- After this process, certain companies must file financial accounting statements to get their publicly listed stock exchange status.
- As for private organizations, GAAP is optional. But in both sectors, it ensures the financial reports are precise.
- GAAP also provides services to non-profitable or government-based companies. The only thing that is expected is to submit accurate financial statements.
What is the purpose of GAAP?
- GAAP ensures that the given financial reports don’t collide within the organizations. It also makes sure that the statements are liable and consistent.
- With GAAP, the companies will know their finances' history and current stock market position. This will help in the company's investments for the future.
- GAAP secures the information carefully such that the companies can see through it when required.
Principles of GAAP:
Under this section, ten prominent standardized principles are formed for the better structure of the organization.
The following are the principles included and propagated for this process.
- Principle of Consistency
This principle ensures that the submitted financial statements should be consistent standards and accurate from time to time.
- Principle of Regularity
This is about following the regulations held by GAAP.
- Principle of Sincerity
This is about abiding by the rules and standards of the GAAP with utmost honesty.
- Principle of Permanence
The statements and reports provided should be processed and are to be original and true to form.
- Principle of Non-Compensation
The company profile of both negatives and positives is to be stated. This helps in creating a balanced report of the organization.
- Principle of Prudence
Every formal and true, and non-speculative information of financial reporting is done.
- Principle of Materiality
All the material items are to be subjectively reported in the financial statement.
- Principle of Continuity
With the asset valuation, the business is continued through further process.
- Principle of Periodicity
Under this, data is recorded quarterly or annually.
- Principle of Utmost Good Faith
This principle ensures that the act of any financial reports under GAAP is presented with good faith and an honest approach.
Terms of GAAP
- Precise accounting methods
One of the important regulated primary processes of GAAP is to provide accurate financial statements. This helps in tracking the revenue of the goods sold and bought. The indirect expenses are recorded, while the direct expenses are paid.
- Report of loss and profit expenditures
The financial report of the entire expenditures is to be submitted. The loss and profits frame the financial arc, which helps in the speculations.
- Statement of complete finances
From the initial step to the most recent record of the financial propagation. Anu form of finance is to be recorded. Property, assets, and types of equipment are used under original prices other than market values.
- Statement of loans and debts
Under this, the lost finances through loans and bad debts will come under bad revenue losses.
Additional guidelines under GAAP:
The report should include all the financial assets, revenues, liabilities, and properties, along with expenses.
Accurate measurement of the regulated guidelines should be followed.
The statement should include the income statement, balance sheets, cash flow statements, and shareholder equity. These are the four important elements of the report.
Statements should include the final prepositions that complete the report presented.
Applications of GAAP
So who uses these generally accepted accounting principles in practicality? The following is where GAAP is used.
- Public sector companies
Under the United States Securities and Exchange Commission, all public sector companies must comply with GAAP. This is to achieve a stock exchange-listed status for the company.
- Private sector companies
When it comes to private sector companies, it is optional to them. Few companies avail and follow the guidelines of GAAP.
- Non-profitable services
GAAP also provides services to non-profitable and government organizations. All the companies have to do is submit precise statements under the propagated set of guidelines.
- Financial Analysts
A financial analyst evaluated the given data to abide by the guidelines and prepare a financial report.
Accountants also recourse the GAAP principles to frame a standard financial report periodically from time to time.
Relation with IFRS
IFRS also serves the same purpose as GAAP. Out of 160 nations, 144 nations opted for IFRS.
It is also about disclosing financial statements under a few guidelines. But there are a few differences between these two financial systems.
- LIFO inventory
LIFO, as in Last In First Out, is an inventory cost method that is provided under GAAP. While IFRS doesn't allow this.
- Changing write-ups
Under the write-down of a specific asset, the fixed asset value can not be changed in GAAP. IFRS allows reversing this.
- Handling of development costs
Under GAAP, the costs of development are handled as expenses. While in IFRS, the development expenses are prioritized as investments.
- Fixed assets analysis
GAAP records the assets, financial properties, and equipment under the historical cost. IFRS records it under the fair market value.
Importance of GAAP
- It implements structured and transparent data of the company's financial statements.
- It helps to attain the stock exchange status of the reports.
- A comparison of financial statements can be made with the available data.
- An official propaganda formed by following the regulated guidelines.
- Also helpful to non-profit organizations as well
- To know the information regarding an organization with easy access.
- consistent information leading to the development of revenue.
- With financial statements, it is easy to read and understand the company's profile.
- It maintains trust in the investment process, which leads to profitable transactions.
- Also contributes to economic development with its services.
Generally Accepted Accounting Principles contribute a specified profit to every organization and country.
It is a well-planned formation of rules and regulations which leads to profitable results—providing services to the public, private sectors, and non-profitable organizations as well.
GAAP includes a professional approach to organizations that has many benefits. When adopted, it leads to useful intentions for the organizations.
Unlike many other systematic functionings of other services, GAAP provides entrusted and transparent approach to information.
Well, it has yet to be discovered in most countries. But in the countries where this is followed, it is highly functioning. The quality and approach of GAAP are entirely different and high.
Frequently Asked Questions (FAQS)
1. Why should I prefer GAAP?
GAAP is the most entrusted service that has a strict set of rules to attain. The principles of GAAP ensure the creation of a particular and proper piece of work. In the market, it is stable and sturdy, which is safe and secure.
2. Does GAAP have any drawbacks?
Well, primarily, GAAP is not global. It is not very much known among the millennials. It also doesn't have any diversifying standards. It takes a long time to create new standards as well.
3. How good is GAAP?
Even though GAAP is used in a minimal number of countries, it is very well functioning in the countries following it. It has a piece of standard information that is honest and trustworthy. It makes the companies understand the comparison of financial statements and the changing revenue. This helps in gaining knowledge and an idea of the organizations in the market race.
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