Whether you’re doing your own business accounting or a college student studying for an accounting course, you’ve likely come across the term “GAAP.” The GAAP meaning in accounting is that it’s an abbreviation for Generally Accepted Accounting Principles. These accounting standards guide organizations and companies in the United States on how to:
- Organize and manage financial information and accounting records
- Translate accounting data into financial statements
- Present supporting financial information
Companies and investors use GAAP to organize their accounting records, create financial statements, and compare the financial records of one company with another.
Generally Accepted Accounting Principles (GAAP): Included Topics
GAAP covers the following accounting topics:
- Hedging and derivatives
- Industry-specific accounting concepts
- Business combinations
- Fair value
- Foreign currency
- Non-monetary transactions
Where did GAAP come from?
The General Accepted Accounting Principles Standards are established, maintained, and updated by a group of government-sponsored policy organizations, including:
- Financial Accounting Standards Board (FASB)
- Securities and Exchange Commission
- American Institute of Certified Public Accountant (AICPA)
Financial Accounting Standards Board (FASB)
Created in 1973, the Financial Accounting Standards Board is responsible for establishing the standards for accounting and financial reporting activities. The accounting standards finalized by the FASB apply to private companies, public companies, and nonprofit organizations within the United States.
Securities and Exchange Commission (SEC)
This independent agency of the U.S. government is responsible for ensuring that the securities market operates well, protecting investors, and encouraging capital formation. The SEC regulates reporting standards and regulations for public companies within the United States.
American Institute of Certified Public Accountants (AICPA)
The AICPA is a nonprofit organization, founded in 1887, to represent certified public accountants and develop external auditing standards for private U.S. companies.
What’s the history of GAAP?
Following the Stock Market Crash in 1929, the U.S. government endeavored to improve regulation on public trading activities by companies and other market participants. The federal government authorized the Securities and Exchange Commission (SEC) to establish standards on accounting practices.
The SEC delegated this authority to the auditing community in the private sector, establishing the American Institute of Accountants. This entity was the precursor to the American Institute of Certified Public Accountants. In 1939, the American Institute of Accountants established the Committee on Accounting Procedure (CAP).
Nearly two decades later, the CAP was replaced by the Accounting Principles Board (APB), which continued to issue opinions on major accounting topics. In 1973, the CAP became the Accounting Principles Board (APB), which later became the Financial Accounting Standards Board (FASB).
Since being established in 1973, the Financial Accounting Standards Board has acted as the major policymaker on acceptable accounting standards and practices. Though other government organizations and non-governmental entities influence FASB decisions, the FASB is responsible for issuing opinions and final judgments.
The Generally Accepted Accounting Principles (GAAP) consist of the sum of all decisions and opinions made by CAP, APB, and FASB over the years.
The 10 Generally Accepted Accounting Principles
When referring to the GAAP accounting standards, there are 10 principles that guide companies in preparing financial statements:
The principle of regularity requires companies who follow GAAP standards to comply with GAAP regulations.
The principle of consistency means that businesses must constantly apply GAAP standards throughout their accounting and financial reporting activities. If there are deviations from GAAP standards, a clear explanation must be provided.
Companies and accountants who are following GAAP standards must be impartial and honest as they prepare financial records.
#4: Permanence of records
This accounting principle stipulates that companies must use the same methods and procedures to prepare its financial reports.
The principle of non-compensation states that both negative and positive aspects of a company must be reported, with no expectation of debt compensation.
The prudence principle requires financial data to be based on verifiable facts, not assumptions or guesses.
This accounting principle assumes that a business or entity will continue to operate in the future.
This accounting principle requires accounting entries to be reported within its corresponding or relevant accounting period.
This principle requires accountants to fully disclose all of a company’s financial information and accounting data in financial statements and reports.
#10: Utmost good faith
This principle is also applied within the insurance industry, and assumes that parties will act honestly while engaging in accounting transactions.
Who must comply with Generally Accepted Accounting Principles?
Companies with publicly traded stock must comply with SEC regulations (like GAAP) to remain listed on the stock exchanges. An organization’s compliance with GAAP accounting standards is verified through an auditor’s opinion, provided by a certified public accountant.
While private companies are not required to comply with GAAP, those that do are viewed much more favorably by creditors.
Limitations of GAAP
The intention of GAAP is to provide a consistent framework that guides companies in financial reporting activities and their management of corporate financial data. However, companies who use GAAP often run into the following limitations:
GAAP isn’t globally recognized
International companies or those in the process of globalizing encounter many challenges when attempting to use GAAP since GAAP isn’t intended for international use.
Comparing GAAP and the International Financial Reporting Standards (IFRS)
Where GAAP regulates financial reporting activities of publicly traded U.S. companies the International Financial Reporting Standards (IFRS) guide international and globalized companies.
However, the International Accounting Standards Body (IASB) and FASB have been endeavoring to converge the IFRS frameworks and GAAP standards since 2002.
Prior to 2007, non-U.S. companies were required to provide GAAP-compliant financial statements to engage in trading on U.S. exchanges. But, as of 2007, non-US companies are no longer required to comply with GAAP if their financial reporting is aligned with IFRS frameworks.
Though much work has been done to merge GAAP and IFRS, a few key differences that remain include:
- LIFO inventory: Inventory is allowed by GAAP, but prohibited by IFRS.
- Research and development costs: Under GAAP, R&D costs are listed as expenses at the time they occur. In contrast, IFRS allows R&D costs to be capitalized and amortized over time.
- Reversing Write-downs: Under GAAP, write-down amounts for inventory or fixed assets cannot be reversed if the asset’s market value has increased. But, under IFRS, a write-down can be reversed.
As more business is conducted globally, more companies are adhering to IFRS frameworks than to GAAP standards. Veritas Investment Research shows that most S&P 500 companies adhere to at least one non-GAAP earnings measure in 2019.
Other resources to learn about GAAP
If you want to learn more about GAAP, we’ve put together some resources below: