Accounting is a complicated subject, and involves elements of both academic theory and actual business practice. Furthermore, standard accounting practices vary by industry and even national standards are often different. Keeping that in mind, both private industry and governmental entities have taken significant steps toward harmonization of accounting standards over the last few decades. A major results of that effort here in the U.S. is the development of a set of accounting standards called the Generally Accepted Accounting Principles (GAAP), to which listed U.S. companies must adhere.
GAAP
GAAP represents a general set of accounting principles and procedures that companies use to determine profits, losses, and earnings, and to compile their financial reports. GAAP is in some sense a practical compromise, and it was developed from both academic research in accounting and the usual methods that businesses have used to record revenues, expenses etc. for many years.
In specific, GAAP consists of three broad sets of accounting standards: (1) basic academic accounting principles and guidelines, (2) the rules and standards promulgated by the Financial Accounting Standards Board (FASB), and (3) commonly accepted industry practices.
The Importance of GAAP
GAAP is important for several reasons but mainly because it provides a standard, reasonably consistent set of expectations for reporting company financial data. The net result is that both government regulators and tax authorities, as well as average investors, can more easily understand financial data because it is standardized. But remember that GAAP does not guarantee accurate accounting. GAAP is no more than a broad set of accounting standards, and unethical accountants are still able to falsify financial data if they so choose.
The History of GAAP
According to Christina Errico, Accounting Director and Instructor at STFB, Inc., early efforts at standardizing accounting practices go all the way back to the 1950s, and the American FASB established the first official version of GAAP in 1973. Furthermore, U.S. companies that are listed on public stock exchanges have in most cases been legally required to use GAAP since then.
GAAP vs IFRS
However, there is also an international accounting standard that is similar to but not the exact same as GAAP. And since its inception in 2001, most of the rest of the world has started to use the International Financial Reporting Standards (IFRS). IFRS is considered by most experts to to be somewhat less rigid in its accounting standards, giving companies a little more flexibility in structuring and writing their financial statements. A number of corporations in the United States have already started to adopt methods from IFRS and steps are already being taken to insure that this global standard will eventually be the accounting standard in the United States as well.
For more information on accounting, business, investing or personal finance see below:
Income Tax Returns - the IRS and Tax Questions
Financial Statement Analysis – How to Read a Financial Statement
Financial Statements – Non-Profit Financial Statement Analysis
Actuarial Science - Statistical Methods in Insurance
Stock Trading Tips - How to Make Money in the Stock Market
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Clayton Browne - Clayton Browne has a BA and an MS in Anthropology, and has been writing professionally since 1994. He worked for many years in both ...
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