Financial reporting is the language we use to communicate information about the financial condition and operational results of an entity, be that a public or private company, a not-for-profit organization, or government. This typically includes information about an entity's financial position, results of operation, and disclosures. But reports have to follow certain prescribed standards. This is where GAAP enters the chat.
A little definition 🔎
GAAP is the abbreviated form of Generally Accepted Accounting Principles - a set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). GAAP incorporates three components that eliminate misleading accounting and financial reporting practices:
10 accounting principles
FASB rules and standards
Generally accepted industry practices
The 10 principles separate an organization's transactions from its owners'personal transactions, standardize the currency units used in reports, and explicitly disclose the time periods covered by certain reports. They also draw on established best practices in terms of cost, disclosure, matching, revenue recognition, conservatism, and professional judgement.
GAAP is the abbreviated form of Generally Accepted Accounting Principles
Who has to adhere to GAAP?
Public companies in the US. If a corporation's stock is publicly traded, its financial statements must adhere to rules established by the US Securities and Exchange Commission (SEC), which requires that publicly traded companies regularly file GAAP-compliant financial statements in order to remain publicly listed on the stock exchange. However, GAAP are also commonly followed in the private sector.
How is GAAP compliance ensured?
Through an appropriate auditor's opinion coming from an external audit conducted by a certified public accounting (CPA) firm.
When must you adhere to GAAP?
When your organization's accountants put together your financial statements.
What's the ultimate goal of GAAP?
To ensure a company's financial statements are complete, comparable, transparent, and consistent.
Why is GAAP Important?
It helps maintain trust in financial markets
It inspires trust in investors who would otherwise be more sceptical of the information presented to them by companies
Without that trust, we would likely see fewer transactions, which could lead to higher transaction costs and a less robust economy
GAAP helps investors analyze companies by making it easier to compare similar companies to each other
What are the 10 principles of GAAP
GAAP include principles around things such as recognition, measurement, presentation, and disclosure. Read on for the full list of principles.
Principle of Regularity: the accountant adheres to GAAP rules and regulations as a standard
Principle of Consistency: the accountant commits to applying the same standards throughout the reporting process to ensure financial comparability between periods
Pro tip 💡: An accountant is expected to fully disclose and explain the reasons behind any changed or updated standards in the footnotes to financial statements.
3. Principle of Sincerity: accountants strive to provide an accurate and unbiased representation of an entity's financial situation
4. Principle of Permanence of Methods: the procedures used in financial reporting should be consistent, allowing for comparison of the company's financial information
5. Principle of Non-Compensation: both negatives and positives should be reported with full transparency and without the expectation of debt compensation
6. Principle of Prudence: you must not overestimate the amount of revenues recognized or underestimate the amount of expenses. Moreover, you should be conservative in recording the amount of assets, and you should not underestimate liabilities
7. Principle of Continuity: when valuing assets, it should be assumed the business will continue to operate
8. Principle of Periodicity: entries should be distributed across the appropriate periods of time
9. Principle of Materiality: the accountant must strive to fully disclose all financial data and accounting information in financial reports
10. Principle of Utmost Good Faith: this presupposes that parties remain honest in all transactions
How does GAAP differ from IFRS?
Perhaps you've heard of IFRS and now you're a bit confused. GAAP focuses on the accounting and financial reporting of US companies, whereas IFRS are the International Reporting Standards, a set of standards set by the International Accounting Standards Board (IASB).
The IASB and FASB have been working towards a convergence of GAAP and IFRS for some time. As a result, non-US companies registered in the US are no longer required to reconcile their financial reports with GAAP if their accounts already comply with IFRS.
Some differences between GAAP and IFRS that remain include:
LIFO Inventory: GAAP allows companies to use the Last in First Out (LIFO) as an inventory cost method, but it's prohibited under IFRS
Research and Development Costs: under GAAP, these costs are charged to expenses, while under IFRS, they can be capitalized and amortized over multiple periods if certain conditions are met
Reversing Write-Downs: GAAP specifies that the amount of write-down of an inventory of fixed asset cannot be reversed if the market value of the asset subsequently increases. However, under IFRS, the write-down can be reversed
Financial reporting enables us to communicate how our company is doing financially with clarity. It enables a level of transparency which induces trust, especially when you use industry accepted guidelines. GAAP help us build and maintain trust with investors, which is crucial to maintaining a robust economy.
Create seamless and customizable financial reports
Syft's financial statements include a table functionality which empowers you to add more detailed notes to different components of your financial statements across the balance sheet, profit and loss statement, and cash flow direct and indirect. This means that you can make sure that your financial statements are GAAP compliant while Syft speeds up the rest of the reporting process. For more information about adding tables to financial statements, read our guide here. For any queries, feel free to book a call with one of our friendly team members.