Accurate bookkeeping and accounting play an essential role in business growth. The Generally Accepted Accounting Principles (GAAP) are a collection of rules, procedures, and standards that harmonize the recording and presentation of financial information. The essential aim of GAAP is to create consistency, clarity, and convenience for all organizations that utilize accounting services.
Why is GAAP Important?
By standardizing and regulating various accounting definitions and methods, GAAP facilitates the flow of commerce between businesses, states, and countries. It has ten general principles:
- Regularity: This concept expects your business to adhere to the standard GAAP accounting requirements.
- Consistency: You’re supposed to use the same accounting methods from one financial period to the next. You must fully disclose any deviation and provide ample reasons for the change.
- Sincerity: Your accounting methods should present an unbiased and precise depiction of your company’s financial standing.
- The permanence of methods: The procedures you use should be consistent to allow comparisons between different accounting periods.
- Non-compensation: Report all financial information transparently, including the positives and negatives. Do so without expecting an asset to compensate for a debt or revenue to cover expenses.
- Prudence: This principle emphasizes recording financial facts over speculative data.
- Continuity: During asset valuation, this principle assumes your business will keep operating for the foreseeable future.
- Periodicity: Distribute accounting entries across the relevant financial periods.
- Materiality: This principle expects you to make an effort to reveal all accounting information in your statements.
- Utmost good faith: The concept borrows from Uberrimae Fidei, a Latin phrase common in the insurance industry. It expects interested parties to remain honest in every accounting aspect of the business.
If followed diligently, these ten principles facilitate a smooth relationship with investors, suppliers, regulators, and other stakeholders.
All public US companies must implement GAAP requirements when compiling accounting records. It’s not a must for small and private businesses because many of these principles won’t apply to small-scale or cash-based transactions. However, you should follow these principles if you’re looking for outside funding or if investors might not trust your financial data. GAAP is also suitable for businesses that use the accrual accounting method.
GAAP vs. IFRS
GAAP requirements are used mainly by American companies. The Financial Accounting Standards Board is the governing body responsible for ensuring compliance. On the other hand, IFRS is an acronym for the International Financial Reporting Standards. At least 120 countries around the world follow these principles. The International Accounting Standards Board is responsible for dictating IFRS guidelines.
Some companies report non-GAAP earnings for huge one-off costs. Their justification is that these are unusual transactions that would distort the organization’s financial health if reported using prevailing standards. Common non-GAAP reports include:
- Free cash flow and funds from operations (FFO)
- Earnings before interest and taxes (EBIT)
- Earnings before interest, taxes, depreciation, and amortization (EBITDA)
- Core earnings
- Adjusted revenues
Applying GAAP to Your Business
Your business will reap many benefits by implementing GAAP accounting standards. If it sounds complicated, you can always hire a qualified accountant to perform this task. Other than ensuring accuracy and regulatory compliance, they’ll also help you with tax planning. Please contact a reputable CPA or financial advisor for more information.