Lecture Notes: Generally Accepted Accounting Principles (GAAP)

Introduction to GAAP

• GAAP Definition: Generally Accepted Accounting Principles
  • Common set of rules, principles, and standards for financial statements
  • Aimed at external users such as the government, investors, and creditors
• Scope: Specifically pertains to financial accounting (not management accounting or tax)
  • Includes items like income statements, balance sheets, etc.

Importance of GAAP

• Ensures consistency in financial statements across companies
  • Helps investors make informed comparisons and investment decisions
  • Prevents companies from using entirely different accounting rules

Example of Appliance Stores

• Scenario:
  • Two stores: Santa Claus Appliance Store and Naughty Elf Appliance Store
  • Both sell a dishwasher on credit for $700 (exact same transaction)
• Recognition of Sale:
  • Expectation: Both companies recognize a $700 sale
  • Must follow a common set of rules for recognizing the sale
  • Accrual Accounting: Required over cash basis accounting
  • Potential complexity with credit sales (e.g., setting up accounts for uncollectible sales)

Flexibility within GAAP

• While some rules are fixed, there is flexibility in methods used
  • Examples: Aging of accounts receivable, percentage of sales
  • All methods must conform to GAAP

Localization of GAAP

• Local GAAP: Country-specific versions of GAAP
  • Example: United States GAAP created by the Financial Accounting Standards Board (FASB)
  • FASB: Private agency creating accounting standards in the U.S.
• International GAAP: International Financial Reporting Standards (IFRS)
  • Adopted by over 100 countries