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Generally accepted accounting principles (GAAP) are standard guidelines for the practice of accounting that are adapted by an entire nation or group of nations. GAAP is also referred to as accounting standards or standard accounting process. Read on to learn more about the generally accepted accounting principles in the United States and how they are applied by business and finance professionals.
GAAP Components
In the United States, there are three critical components that make up GAAP: the rules, regulations, and guidelines by which accounting professionals must abide; the detailed rules and standards behind these guidelines, which are issued and maintained by the Financial Accounting Standards Board (FASB); and additional, generally accepted common industry practice that augments the first two components. GAAP standards are maintained in the FASB Advisory Handbook.
Assumptions and Principles of GAAP
While GAAP standards are extensive, there are ten common assumptions and principles that underpin all the guidelines. These include:
- Economic Entity Assumption: Each separate economic entity is required to keep its own financial records.
- Monetary Unit Assumption: Only quantifiable transactions are included in financial records.
- Full Disclosure Principle: Information about pending lawsuits and other pertinent information is included in financial records.
- Time Period Assumption: Business costs are reported equally across the time period to which they apply.
- Accrual Basis: Economic events are reported in the time period during which they occur.
- Revenue Recognition Principle: Revenue is reported when product or service delivery is complete.
- Matching Principle: Costs of doing business are reported in the same period that revenue from said business is reported.
- Cost Principle: Assets are recorded at actual cost, not at projected appreciated cost.
- Principle of Conservativism: Accountants should be conservative in reports where estimation is required.
- Materiality Principle: Other principles can be ignored if there is no resulting effect on the reader’s understanding of the report; for example, the cost of something small such as individual paperclips need not be recorded.
Importance of GAAP
In addition to providing a framework for honest and ethical accounting, the GAAP standards exist to insure consistency among the reports of publicly traded companies. This means that investors will be able to compare certain aspects of corporations with a standards baseline when deciding where and how to invest their money.
Adoption of the International Financial Reporting Standards (IFRS)
The Securities and Exchange Commission (SEC), which administers the GAAP for the United States, is in the process of shifting from the currently used U.S. standards to the IFRS, which is the worldwide standard for accounting practice. More than 100 countries in the world use the IFRS standards, which were developed in London. Though SEC has proposed a roadmap for this shift, progress has thus far been slow.
What does this mean to you as a student pursuing an accounting degree? Generally accepted accounting principles are a cornerstone of the U.S. financial system as we know it and should be strictly adhered to by all accounting professionals.
