If you run a small business, you may not know much about the Generally Accepted Accounting Principles (GAAP). After all, GAAP standards apply to publicly traded companies, so these rules don’t always feel relevant to your small business.
However, it’s a good idea to have a basic understanding of GAAP standards. This information will help you improve your accounting skills, understand accounting principles and pinpoint how your business should track and measure its financial information.
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GAAP refers to the rules and standards used for financial reporting in the United States. GAAP standards were developed by the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB). These standards apply to corporate, government and nonprofit accounting.
The U.S. Securities and Exchange Commission (SEC) requires all publicly traded companies to adhere to GAAP standards. When each company reports and maintains its financial records the same way, it’s easier for investors to compare companies to make investment decisions.
GAAP requires publicly traded companies to adhere to these four standards:
Even if you employ an accountant or bookkeeper, understanding GAAP standards helps business owners ensure accurate and transparent financial reporting.
These 10 principles can help you understand the purpose of GAAP:
To hire the right accountant for your business, seek out someone with appropriate experience who can explain accounting concepts clearly.
If you run a publicly traded company, the SEC requires that your business follows GAAP standards. You must complete GAAP-compliant financial statements to remain listed on the stock exchanges.
GAAP compliance is not required for private companies but most lenders prefer it. If you plan to apply for a small business loan, you may be required to file GAAP-compliant financial statements.
Additionally, investors are often wary of businesses that don’t follow GAAP standards. That’s because the consistency of GAAP principles makes it easier to compare financial statements. In case your company ever goes public, you should begin adopting GAAP standards now.
GAAP standards are based on principles like accrual accounting, revenue recognition and expense matching. However, some believe financial statements prepared according to GAAP standards don’t always reflect a company’s performance accurately.
For that reason, some companies supplement their financial reports with non-GAAP statements, often referred to as pro forma statements. The goal is to present a more accurate and complete view of the company’s underlying operations.
Non-GAAP statements can include the following:
Proponents of non-GAAP reporting argue that including this information presents a more nuanced view of the company to investors. Critics argue that using non-GAAP financial statements could result in fraudulent reporting. In particular, the SEC has issued a statement advising caution when it comes to pro forma statements.
Most companies operate on either a cash or accrual accounting basis. Cash-basis accounting records revenue after the business receives the cash. In contrast, accrual accounting records revenue after a buyer receives the goods or services ― whether or not the company has received payment.
The best accounting software solutions are designed in accordance with GAAP principles and can help simplify your financial accounting. Many accounting platforms are affordable, easy to use and integrate with your other business software.
We’re highlighting the following options to help you choose the right accounting software and ensure GAAP compliance:
GAAP standardizes the financial reporting process and creates a common accounting language that all U.S.-based businesses can follow. It ensures that all companies follow the same reporting procedures, making it easier for investors to understand and compare financial statements.
GAAP requires all companies to report their financial data fairly and accurately. Maintaining GAAP standards makes it easier to trust the financial market and invest in companies.
GAAP is required for all publicly traded companies in the United States. However, many private companies also follow these standards. GAAP standards apply to all corporate, nonprofit and government accounting practices.
The FASB and the GASB created GAAP standards in response to the 1929 stock market crash and the Great Depression. At the time, many publicly traded companies were not always accurate in reporting their financial data, which likely contributed to the stock market crash. GAAP was later established under the Securities Act of 1933 and the Securities Exchange Act of 1934.
If you aren’t a publicly traded company, following GAAP standards may not be necessary. However, all businesses should be familiar with these five basic accounting principles:
International Financial Reporting Standards (IFRS) is a set of accounting principles for publicly traded companies. IFRS is issued by the International Accounting Standards Board (IASB) and has been adopted by 120 countries ― including those in the European Union.
These rules are designed to increase consistency and transparency for publicly traded companies worldwide. Like GAAP, IFRS outlines how companies should maintain their financial records and report income and expenses. It creates a global accounting language that investors, auditors and government regulators can understand.
Public companies in the U.S. must follow GAAP standards. While the SEC has expressed interest in switching to IFRS, there’s been no real movement.
Here’s a breakdown of the primary differences between IFRS and GAAP:
IFRS | GAAP |
---|---|
Issued by the IASB | Issued by the FASB |
Doesn’t allow last-in, first-out (LIFO) method to estimate inventory | Uses LIFO or first-in, first-out (FIFO) to estimate inventory |
Intangible assets are assessed for their future economic benefit | Intangible assets are measured for their fair market value |
Allows companies more room for interpretation on financial statements | Follows a specific set of rules and procedures on financial statements |
Revenue can be reported once value is delivered | Revenue can be reported once goods or services are received |
Groups all liabilities together | Groups liabilities as either current or noncurrent |
Here is additional information about the primary differences between GAAP and IFRS: