GAAP refers to the generally accepted accounting principles, which are imposed on companies by the federal government so that investors have a basic level of financial statement consistency and accuracy. They can then use this information when making investment decisions.
Who Created the GAAPs?
The generally accepted accounting principles have been continuously developed since the Great Depression. However, it wasn’t until the 1970’s, when the Financial Accounting Standards Board (FASB) was formed by the SEC, that regular accounting procedures truly became standardized and systematized. Today, FASB oversees and modernizes the generally accepted accounting principles.
The Financial Accounting Standards Board
As previously mentioned, the FASB is the governing body that continually improves the GAAP principles, which are contained in the FASB Accounting Standards Codification. Every year, the FASB releases updates to the codification standards. For example, they adjusted standards regarding interest imputation and revenue from contracts with customers in 2015. The goal of these technical corrections and improvements is to provide accountants with the best methods for providing investors and the public with financial information.
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What are the Fundamental Principles?
The guidelines are made up of 10 basic accounting principles. For example, the time period assumption refers to the fact that financial statements must identify the distinct time periods used. Next, the going concern principle means that businesses should intend on continuing their operations and not liquidating their business. Additionally, the conservatism principle means that potential liabilities and expenses must be immediately identified. On the other hand, the cost principle means that financial statements should only contain historical costs of purchased items, not the adjusted cost that accounts for inflation.
What are the Benefits?
The generally accepted accounting principles offer excellent benefits to companies. For example, the guidelines help companies consistently provide standard financial information to shareholders and government regulatory bodies. Thus, they safeguard the shareholders invested money and rights. They also reduce the likelihood of financial fraud or misrepresentation. As a result, they increase the level of trust between companies and all interested parties and shareholders. In addition to this, they help companies create and maintain proper accounting controls that will help financial professionals increase the quality and consistency of accounting information. As a result of consistency, company executives can better review and compare financial statements, which will help them identify improvement areas and strategically plan for the future. They will also be able to realistically understand the company’s performance and use this information to make better decisions.
Are there any Gray Areas?
Despite continuous updates, there are still gray areas in the generally accepted accounting principles. For example, it is entirely possible that two competitors can use the same accounting measure, but each may claim that the other is non-GAAP. To illustrate, the accounting measure referred to as consolidated segment operating income (CSOI) means that business operational results are calculated through an internal performance measurement of direct segment operating expenses. However, this excludes things such as stock-based compensations or other operating expenses. Therefore, certain companies can choose their preferred interpretation of how to report segment operating information, such as basing it on a single division or department. Because certain FASB financial reporting requirements are vague, some companies can actually select how they present their operational incomes.
In the end, the generally accepted accounting principles are designed to create consistency and accuracy with financial reporting. These guidelines help publicly-traded companies generate standardized financial statements. This in turns helps people make informed decisions and consequently protects their interests. The GAAP is an important collection of accounting standards that ensures the highest levels of accounting ethics and reporting.