GAAP stands for Generally Accepted Accounting Principles. Within the United States, it provides a set of rules and standards for accounting practices, including the creation of standard financial statements like the balance sheet and income statement.
The goal of a unified approach to accounting is to allow greater transparency into the health of any business. By reviewing the same standard reports—created using the same methodology—outside parties (i.e. investors, board members) can learn quite a bit about a company.
Where Did GAAP Come From?
Most countries around the world follow their own variation on the same accounting principles followed in the United States, but there are some variations. Within the United States, GAAP rules are set by the Financial Accounting Standards Board (FASB). The FASB is not a government agency, but they are a governing body whose responsibility is setting the standards for accounting practices.
The first accounting principles in the U.S. were developed in 1939, and since then several governing bodies have been responsible for their maintenance. By 2008, there were thousands of unorganized GAAP principles that needed to be followed. So the FASB undertook a major project of organizing and codifying them into 90 categories.
In recent years, there have been questions about whether GAAP will eventually be replaced by a more internationally-focused set of principles.
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IFRS vs. GAAP
International Financial Reporting Standards (IFRS) is similar to GAAP. It is also a guide to accounting principles with a goal of standardizing accounting practices across companies in different countries.
The primary difference between the two is in the overarching philosophy. While GAAP is more rules-based, providing specific instructions for different scenarios, IFRS is more rooted in principles. So while the IFRS is still a very detailed set of instructions, it allows for a little more flexibility in reporting.
IFRS is currently used in over 120 countries around the world, including the European Union. GAAP remains the accounting method of choice in the United States and is adapted in a handful of other countries around the world.
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Does My Business Need to be GAAP Compliant?
Generally speaking, the only businesses that are required to be GAAP-compliant are publicly traded companies. It’s worth noting that there is an important difference between following GAAP and taking the additional steps to prove your financials are GAAP-certified.
All businesses in the U.S. should follow GAAP when handling their accounting. Many investors will even make that a requirement in their contracts. However, certifying your financial reports requires both an internal audit, performed by someone embedded in the company, and an external audit, performed by a third-party CPA firm. In the vast majority of cases, private companies do not need to take these additional steps. However, they should work with an accountant or an accounting solution that follows the Generally Accepted Accounting Principles.
Accrual Vs Cash Accounting
Cash basis accounting is not compliant with GAAP principles. However, as noted above, most businesses do not need to operate with GAAP-certified compliant financials. If you are concerned about GAAP compliance, you should use accrual based accounting.
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