What is GAAP?
GAAP stands for generally accepted accounting principles and represents a set of standards, best practices, and professional guidelines for accounting activities.
The goal of GAAP is to standardize corporate reporting and accounting to increase transparency, clarity, comparability, and communication of finances.
Additionally, this universal standard helps prevent less-than-scrupulous companies from skirting the law by using “creative” accounting methods to disguise the worth of their business or to lie to investors and regulatory agencies.
The GAAP Mission
GAAP rules and regulations are put forth by the Financial Accounting Standards Board (FASB) and, through the implementation of 168 individual standards, establish the rubric by which corporate accounting and reporting are measured. For publicly owned corporations, adherence to GAAP standards and principles is mandated by law.
In lieu of detailing each individual standard put forth by the FASB, this article will instead present the GAAP guiding principles. While not direct mandates of the GAAP framework, these ten principles are nevertheless the heart and soul—so to speak—of the guidelines.
Principle of Regularity
GAAP-compliant accountants strictly adhere to established rules and regulations. In short, the rules only work if everyone is on board.
Principle of Consistency
Consistent standards are applied throughout the financial reporting process. This is particularly important because the reports of large corporations are handled by many people. Any inconsistencies in that process can be exaggerated and result in over- or underreported results.
Principle of Sincerity
GAAP-compliant accountants are committed to accuracy and impartiality. One of the reasons the GAAP framework exists at all is to encourage and mandate strong ethics and professionalism on the part of participants.
Principle of Permanence of Methods
Consistent procedures are used in the preparation of all financial reports. Failure to conform to this principle opens the door to reporting inconsistencies over time—changes in accounting methods from year to year can distort historical reporting.
Principle of Non-Compensation
All aspects of an organization’s performance, whether positive or negative, are fully reported with no prospect of debt compensation. Debt compensation is a financial incentive that is tied to minimizing the debt a company carries. If an accountant were compensated in this way, it would strongly encourage accountants to make the unethical decision to conceal debt using creative accounting practices.
Principle of Prudence
Speculation does not influence the reporting of financial data. Financial data should be reported as accurately and faithfully as possible. If investors or the general public choose to speculate based on the provided reporting, they do so at their own discretion. Under the GAAP framework, accountants have a duty to report finances as they are without the influence of speculation.
Principle of Continuity
Asset valuations assume the organization’s operations will continue. Failing to do this could understate the value of assets, which would distort financial reporting.
Principle of Periodicity
Reporting of revenues is divided by standard accounting time periods, such as fiscal quarters or fiscal years. This ensures “apples-to-apples” comparisons of historical reporting as well as standardized comparisons between different organizations.
Principle of Materiality
Financial reports fully disclose the organization’s monetary situation. Investors and, in the case of publicly owned corporations, the general public make their investment decisions based on the information included in financial reporting. The principle of materiality is a way to protect investors and retain confidence in reporting.
Principle of Utmost Good Faith
All involved parties are assumed to be acting honestly. This applies not merely to accountants but to anyone involved in financial reporting.