Generally Accepted Accounting Principles (GAAP) Definition
Generally accepted accounting principles (GAAP) are a set of standards, guidelines, and regulations for financial accounting. Companies should follow GAAP rules when preparing financial statements.
GAAP rules were established to provide consistency in financial reporting and accounting practices. The rules evolve over time and are meant to reflect the most relevant and applicable accounting practices.
Generally Accepted Accounting Principles (GAAP), in short, means the rules which provide the basis of all accounting decisions for financial institutions, businesses, and organizations. In the U.S., several organizations influence what GAAP rules, including the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), the Securities and Exchange Commission (SEC), and the Internal Revenue Service (IRS). U.S. GAAP differs from other international accounting standards, but organizations like FASB and the International Accounting Standards Board (IASB) are working to establish acceptable international accounting standards.
Overall, accountants calculate in two ways: for a financially stable or financially instable company. This is referred to as the Going Concern; unstable companies calculate assets by estimated value of the item when it is liquidated.
GAAP uses many standards and protective measures to ensure reliable and useful accounting statements. For example, accounting is done in fiscal periods which may not coincide with actual calendar periods. They instead coincide with the relevant events that happen to the company with respect to accounting standards.
Many GAAP standards account for the worst-case scenario. Past events are recorded in their value at the given time, called the historical monetary unit. Additionally, subtractions from company cash are made when possible whereas additions are made only when the product is sent and cash is received.
Under GAAP, intangible values such as workforce knowledge or brand goodwill are not considered an asset. These are not recorded in the balance sheet. Furthermore, an effort towards consistency is always made. Expectations like depreciation or inventory are accounted for in the same way across all periods which they occur. Any changes to one period, under this concept, must be made to all periods past. These changes are also made completely clear to the reader of the statement, providing the necessary background to understand the true meaning of the document.
Lastly, the scope of the company comes into play. An example of this would be a laptop computer: the accidental destruction of a single laptop means much more to a small business than a multinational one. The company scope is essential to relevant and readable financials.
Nataile is the CFO at a large, multinational corporation. Her work, hard and crucial, effects the decisions of the entire company. She must use GAAP to reflect company accounts very carefully to ensure the success of her employer.
Natalie begins her process of creating GAAP compliant statements. First, she looks at past records. These provide the crucial understanding of where her company has been. From here she can expand her accounting to meet the current and future needs of the company.
Nataile makes sure to to keep statements consistent. With the recent change in company policy from LIFO to FIFO, she has a lot of work ahead to correct past balances as well as make the change clear in the body text of the document.
When Natalie creates financials she ignores the value of the company name and brand, despite the fact that they sell a product which is in many ways a commodity. Her concern is tangible rather than intangible assets.
Finally, the executive salesperson enters her office with the bad news that he has been in a car accident with the company car. The vehicle has been totally destroyed beyond repair. Though Nataile is concerned for the health of her co-worker she is not concerned with the value of the vehicle: with a vehicle fleet valued at over $25 million a single car is not the concern of Natalie.
Natalie finally completes her assignment. She has faith in her work due to her training and expertise in her field. She has confidence that she has prepared sound GAAP complaint statements.