Generally accepted accounting principles (GAAP) are the common set of standards, rules and conventions that businesses and nonprofit organizations in the United States follow when preparing their financial statements. US GAAP covers how transactions are recognized, how assets and liabilities are measured, how items are presented and what must be disclosed. The aim is to make financial reports consistent, comparable and reliable, so that investors, lenders and other readers can trust them and compare one company with another.
Since 1973, US GAAP for public and private companies and nonprofits has been set by the Financial Accounting Standards Board (FASB), whose authority for listed companies is recognized by the Securities and Exchange Commission. State and local governments follow a separate GAAP issued by the Governmental Accounting Standards Board, and federal agencies follow standards from the Federal Accounting Standards Advisory Board. Other countries have their own national GAAP, such as UK GAAP, though most now use or base theirs on International Financial Reporting Standards.
History
US GAAP grew out of the stock market crash of 1929 and the securities laws of 1933 and 1934, which gave the SEC power to set accounting rules for listed companies. The SEC chose to rely on the private sector. The American Institute of Certified Public Accountants (then the American Institute of Accountants) set up the Committee on Accounting Procedure, which issued Accounting Research Bulletins from 1939. It was replaced in 1959 by the Accounting Principles Board, which was in turn replaced by the FASB. In 2009, the FASB brought all authoritative nongovernmental GAAP together in a single, searchable Accounting Standards Codification, organized by topic.
Core principles and assumptions
US GAAP rests on a conceptual framework and a group of long-standing assumptions and principles. Among the most commonly taught are:
- The economic entity assumption, which keeps a business's records separate from those of its owners.
- The going concern assumption, which presumes the business will continue operating for the foreseeable future.
- The monetary unit and time period assumptions, which record items in a stable currency and divide the life of the business into reporting periods.
- The historical cost or cost principle, under which many assets are recorded at their original cost, alongside growing use of fair value.
- The revenue recognition and matching principles, which underpin accrual accounting.
- Full disclosure, consistency and conservatism, which shape how information is presented, all subject to materiality.
The general idea of accounting principles across frameworks is discussed in the entry on accounting principles.
Who must use GAAP
US public companies must prepare their financial statements in accordance with GAAP, and their annual statements must be audited by an independent auditor registered with the Public Company Accounting Oversight Board. Private companies are not required by federal law to use GAAP, but banks, investors and acquirers often insist on it. Smaller private businesses sometimes use other bases instead, such as cash or tax-basis accounting, or the AICPA's framework for small and medium-sized entities. Private companies may also elect certain simplifying alternatives developed by the Private Company Council, such as amortizing goodwill.
GAAP compared with IFRS
US GAAP is often described as more rules-based, with detailed guidance and industry-specific rules, while IFRS is described as more principles-based. The two have converged in many areas, such as revenue, but important differences remain. US GAAP permits the LIFO inventory method, which IFRS prohibits. IFRS allows some reversals of impairment losses that US GAAP does not, and it permits revaluation of property, plant and equipment. Lease accounting and the presentation of some cash flows also differ. Since 2007 the SEC has allowed foreign private issuers to file IFRS statements without reconciling to US GAAP, but domestic companies must still use GAAP.
Criticism
Critics argue that US GAAP has become long and complex, increasing costs especially for smaller companies, and that detailed rules can encourage transactions designed to meet the letter rather than the spirit of the standards. Others point to the growing use of non-GAAP measures by companies as a sign that GAAP figures do not always capture performance as managers see it.