What is GAAP?
GAAP, or Generally Accepted Accounting Principles, refers to rules and parameters set by the Accounting Practices Board of the American Institute of Certified Public Accountants. GAAP also includes certain established ways of accounting, which may or may not have been set by any authority.
Aim of GAAP:
GAAP aims toward making the accounting procedure transparent and make it easier for investors and creditors to get information. Here are some of the goals of GAAP.
1) To make information available to investors and lenders so they can make sound decisions regarding loans and investments.
2) To make information available about resources, funds, and finances.
3) To help investors and lenders assess the viability of an investment or a loan.
Principles behind GAAP:
This section discusses some of the principles behind GAAP.
1) Historical Cost Principle: Companies should make financial statements based on costs related to acquisition of assets and not fair market value. This removes any confusion regarding value of liabilities.
2) Revenue Recognition Principle: The financial statement must state whether revenue is realized or earned.
3) Full Disclosure Principle: The extent of information disclosure is based on analysis of tradeoff.
4) Matching Principle: Expenses have to be proportionate to revenues.
In order to make GAAP implementation effective, here are a few basic assumptions regarding the rules.
1) Going Concern Assumption: The business is long term.
2) Economic Entity Assumption: Business is an independent entity and has an identity different from its owner.
3) Monetary Unit Assumption: The monetary currency that is going to be used for recording financial statements will be the stable currency.
4) Periodic Reporting Assumption: Business operations are to be regularly reported, and there will be a regular gap between reports.
GAAP puts some limits on financial reporting.
1) The advantages of financial reporting need to be considered along with cost of giving the information.
2) The procedures need to scrupulously follow GAAP practices.
3) Given two financial reports, the most accurate one should be selected.
In addition to the above principles and conventions, the financial statement needs to be relevant and reliable, since investors and lenders will make decisions based on it. The report should follow prescribed norms so that reports of different businesses can be compared. Reporting should be consistent, and the accounting method should not vary too much over time. GAAP helps financial reports achieve all of the above and prevents financial misrepresentation. If you need to know more about how to implement GAAP in your financial statements, you can consult small business professionals, who will help you draw up a financial report that implements the major GAAP norms.