Lecture Notes: Generally Accepted Accounting Principles (GAAP)

Key Takeaways

• GAAP is a standardized set of rules for financial reporting aimed at ensuring accuracy and transparency.
• Required for publicly traded companies and government agencies, GAAP adapts to changes in the economy.
• Focuses on consistency, honesty, and transparency to protect investors and ensure accurate reporting.
• Enforced by government institutions; developed by private organizations like FAF and FASB.

What is GAAP?

• A standardized system for accounting in the U.S. for companies making public financial disclosures.
• Facilitates:
  • Consistency in financial disclosures
  • Accurate analysis of financial standing
  • Direct comparisons between businesses
• Widely used in both public and governmental accounting, and voluntarily adopted by some private businesses.

Basic Principles of Accounting

• Separates business transactions from owners' transactions.
• Standardizes currency and discloses time periods in reports.
• Key GAAP principles include:
  • Principle of Regularity: Adherence to rules
  • Principle of Consistency: Consistent application of standards
  • Principle of Conservatism: Cautious data verification
  • Principle of Matching: Aligning revenues with associated costs
  • Principle of Non-Compensation: Full performance reporting
  • Principle of Prudence: No speculation in reporting
  • Principle of Continuity: Assumption of ongoing operations
  • Principle of Periodicity: Standard accounting periods
  • Principle of Materiality: Full disclosure
  • Principle of Utmost Good Faith: Honesty in actions

History of GAAP

• Created post-1929 Great Depression to address manipulative financial reporting.
• First termed in 1936; endorsed federally through the Securities Acts of 1933 and 1934.
• Monitored by the Financial Accounting Standards Board (FASB).

Developing GAAP

• Enforced by government bodies but designed by private organizations.
• Financial Accounting Foundation (FAF): Oversees FASB and GASB.
• Financial Accounting Standards Board (FASB): Develops standards for public/private/non-profit organizations.
  • Recent projects include tax disclosures, cryptocurrency accounting, measurement frameworks, and debt conversion standards.
• Governmental Accounting Standards Board (GASB): Manages state/local government standards.
  • Recent projects include risk disclosures, reporting model updates, asset classification, and fair value review.

Non-GAAP Reporting

• Non-GAAP or "pro forma" methods offer customized projections and forecasts.
• Pro forma accounting is less transparent and consistent than GAAP.

Limitations of GAAP

• Requires expertise, which can be costly.
• Smaller companies may struggle with GAAP's complexity.
• Time-consuming updates can lead to inconsistencies.
• GAAP is U.S.-centric, differing from international standards like IFRS.

IFRS vs. GAAP

• IFRS: Globally adopted, principles-based, flexible.
• GAAP: U.S.-centric, rules-based, rigid.
• Differences in financial statement preparation, disclosures, and components.

FAQs about GAAP

• GAAP ensures clear standards for financial evaluations.
• May be complex to learn but can be mastered with effort.
• Mandatory for U.S. publicly traded companies and certain other organizations.

Additional Resources

• Explore more about GAAP in bachelor's accounting programs and learn about online opportunities for further study.