GAAP is short for Generally Accepted Accounting Principles.

GAAP is a cluster
of accounting standards and common industry usage that have been developed over
many years. It is used by organizations to:

Properly organize their financial information into accounting records;

Summarize the accounting records into financial statements; and

Disclose certain supporting information.

One of the reasons for using GAAP is so that anyone reading the financial statements
of multiple companies has a reasonable basis for comparison, since all companies
using GAAP have created their financial statements using the same set of rules. GAAP
covers a broad array of topics, including:

Financial statement presentation

Assets

Liabilities

Equity

Revenue

Expenses

Business combinations

Derivatives and hedging

Fair value

Foreign currency

Leases

Nonmonetary transactions

Subsequent events

Industry-specific accounting, such as airlines, extractive activities, and health care

The industry-specific accounting that is allowed or required under GAAP may vary
substantially from the more generic standards for certain accounting transactions.

GAAP is derived from the pronouncements of a series of government-sponsored

accounting entities, of which the Financial Accounting Standards Board (FASB) is the
latest. The Securities and Exchange Commission also issues accounting
pronouncements through its Accounting Staff Bulletins and other announcements that
are applicable only to publicly-held companies, and which are considered to be part of
GAAP. GAAP is codified into the Accounting Standards Codification (ASC), which is
available online and (more legibly) in printed form.

GAAP is used primarily by businesses reporting their financial results in the United
States. International Financial Reporting Standards, or IFRS, is the accounting
framework used in most other countries. GAAP is much more rules-based than IFRS.
IFRS focuses more on general principles than GAAP, which makes the IFRS body of
work much smaller, cleaner, and easier to understand than GAAP. Since IFRS is still
being constructed, GAAP is considered to be the more comprehensive accounting
framework.

There are several working groups that are gradually reducing the differences between
the GAAP and IFRS accounting frameworks, so eventually there should be minor
differences in the reported results of a business if it switches between the two
frameworks. There is a stated intent to eventually merge GAAP into IFRS, but this has
not yet occurred. Given recent differences of opinion arising during several joint
projects, it is possible that the frameworks will never be merged.

US GAAP

What is GAAP?

GAAP, or Generally Accepted Accounting Principles, is a commonly recognized set of

rules and procedures designed to govern corporate accounting and financial reporting in
the United States (US). The US GAAP is a comprehensive set of accounting practices
that were developed jointly by the Financial Accounting Standards Board (FASB) and
the Governmental Accounting Standards Board (GASB), so they are applied to
governmental and non-profit accounting as well.

US law requires all publicly-traded companies, as well as any company that publicly
releases financial statements, to follow the GAAP principles and procedures.

In addition, or as an alternative, are the International Financial Reporting Standards

(IFRS) established by the International Accounting Standards Board (IASB). The IFRS
govern accounting standards in the European Union, as well as in a number of
countries in South America and Asia.

The Core GAAP Principles

GAAP is set forth in 10 primary principles, as follows:

Principle of consistency: This principle ensures that consistent standards are followed
in financial reporting.

Principle of permanent methods: Closely related to the previous principle is that of

consistent procedures and practices being applied in accounting and financial reporting.

Principle of non-compensation: This principle states that no entity is to expect any

compensation for providing full and accurate financial reporting.

Principle of prudence: All reporting of financial data is to be factual, reasonable, and

not speculative.

Principle of regularity: This principle means that all accountants are to consistently
abide by the GAAP.

Principle of sincerity: Accountants should perform and report with basic honesty and
accuracy.

Principle of good faith: Similar to the previous principle, this principle asserts that
anyone involved in financial reporting is expected to be acting honestly and in good
faith.

Principle of materiality: All financial reporting should clearly disclose the organization’s
genuine financial position.

Principle of continuity: This principle states that all asset valuations in financial
reporting are based on the assumption that the business or other entity will continue to
be in operation going forward.

Principle of periodicity: This principle refers to entities abiding by commonly accepted

financial reporting periods, such as quarterly or annually.

The Generally Accepted Accounting Principles further set out specific rules and
principles governing such things as standardized currency units, cost and revenue
recognition, financial statement format and presentation, and required disclosures. For
example, it requires precise matching of expenses with revenues for the same
accounting period (the matching principle).

History of GAAP
Generally Accepted Accounting Principles were eventually established primarily as a
response to the Stock Market Crash of 1929 and the subsequent Great Depression,
which were believed to be at least partially caused by less than forthright financial
reporting practices by some publicly-traded companies. The federal government began
working with professional accounting groups to establish standards and practices for
consistent and accurate financial reporting.

Generally Accepted Accounting Principles began to be established with legislation such

as the Securities Act of 1933 and the Securities Exchange Act of 1934.

The GAAP have gradually evolved, based on established concepts and standards, as
well as on best practices that have come to be commonly accepted across different
industries.

Why is GAAP Important?

Generally Accepted Accounting Principles make financial reporting standardized and

transparent, using commonly accepted terms, practices, and procedures. The
consistency of presentation of financial reports that results from the GAAP makes it
easy for investors and other interested parties (such as a board of directors) to more
easily comprehend financial statements and compare the financial statements of one
company with those of another company.

GAAP also seek to make non-profit and governmental entities more accountable by
requiring them to clearly and honestly report their finances.

In short, GAAP is designed to ensure consistent presentation of financial statements,

making it easier for people to read and comprehend the information contained in the
statements.

OVERVIEW

Financial reporting is the language that communicates information about the financial
condition and operational results of a company (public or private), not-for-profit
organization, or state or local government.

Specifically, financial reporting includes the following information:

Financial position (balance sheet, statement of net position)

Results of operations (statement of revenues, expenses and changes in net position,
statement of comprehensive income, etc.), and

Disclosures

The accounting standards developed and established by the Financial Accounting

Foundation’s (FAF) standard-setting Boards—the Financial Accounting Standards
Board (FASB) and the Governmental Accounting Standards Board (GASB)—determine
how those financial statements are prepared. The standards are known collectively as
Generally Accepted Accounting Principles—or GAAP.

For all organizations, GAAP is based on established concepts, objectives, standards

and conventions that have evolved over time to guide how financial statements are
prepared and presented. For companies or not-for-profits, GAAP is set with the
objective of providing information that is useful to investors, lenders, or others that
provide or may potentially provide resources.

An additional objective applies to financial reporting for state and local governments: to
provide information that enables taxpayers and others who use governmental financial
statements to hold governments accountable.

GAAP includes principles on:

Recognition—what items should be recognized in the financial statements (for

example as assets, liabilities, revenues, and expenses)

Measurement—what amounts should be reported for each of the elements included in

financial statements,

Presentation—what line items, subtotals and totals should be displayed in the financial
statements and how might items be aggregated within the financial statements

Disclosure—what specific information is most important to the users of the financial

statements. Disclosures both supplement and explain amounts in the statements.

WHO SETS GAAP?

The Financial Accounting Foundation (FAF) is the independent, private-sector, not-for-

profit organization based in Norwalk, Connecticut responsible for the oversight,
administration, financing, and appointment of the Financial Accounting Standards Board
(FASB) and the Governmental Accounting Standards Board (GASB).
The FASB establishes financial accounting and reporting standards for public and
private companies and not-for-profit organizations.

The GASB establishes accounting and financial reporting standards for U.S. state and
local governments.

The FASB and the GASB are responsible for ensuring that GAAP remains the high-
quality benchmark of financial reporting so that investors, lenders, capital providers, and
other users have access to the information they need to make sound decisions.

The FASB is recognized by the Securities and Exchange Commission as the

designated accounting standard setter for public companies. The FASB’s standards are
recognized as authoritative by many other organizations, including State Boards of
Accountancy and the American Institute of CPAs (Rule 203, Rules of Professional
Conduct, as amended May 1973 and May 1979).

The FASB establishes financial accounting and reporting standards for public and
private companies and not-for-profit organizations.

Investors, lenders, and other users of financial information rely on financial reporting
based on GAAP to make decisions about how and where to provide financing, and to
help financial markets operate as efficiently as possible. More information on the
FASB can be found here.

The GASB’s standards are recognized as authoritative by state and local governments,
state Boards of Accountancy, and the American Institute of CPAs (AICPA).

The GASB establishes accounting and financial reporting standards for U.S. state and
local governments that follow GAAP.

Today, taxpayers, holders of municipal bonds, members of citizen groups, legislators,

and oversight bodies rely on this financial information to shape public policy and make
investments. These standards also help government officials demonstrate to their
stakeholders their accountability and stewardship over public resources. For state and
local governments, it is important to note that GAAP is applicable to external financial
reporting, and not to budgeting. More information on the GASB can be found here.

Both organizations’ missions are accomplished through a comprehensive and

independent due processthat encourages broad participation, objectively considers all
stakeholder views, and is subject to oversight by the FAF’s Board of Trustees.
The FASB and the GASB use the following due process procedures to set accounting
and financial reporting standards:

First, the Board identifies a financial reporting issue that needs to be addressed based
on recommendations from stakeholders, staff research, Board members’ concerns, or
other means. The Board then votes on whether to add a project to the technical agenda,
and discusses the issue and the technical staff’s work at public meetings.

The Board drafts and issues a proposal (in the form of an Exposure Draft) for public
comment. Depending on the complexity of the issue, the Board may issue a preliminary
Discussion Paper, Invitation to Comment, or Preliminary Views document before the
Exposure Draft to seek initial stakeholder input on various solutions and approaches.

The Board seeks stakeholder input on the proposal via comment letters, roundtables,
meetings, public hearings, etc. The Board subsequently redeliberates based on the
stakeholder input received.

The Board issues a final standard and provides implementation guidance to preparers,
auditors, and users of financial statements on the new standard.

If the standard is significant in nature and has been in place for two years (three years
for GASB standards), it may be selected by the FAF’s Post-Implementation Review
team to evaluate its effectiveness.

Companies, not-for-profits, and governments use accounting standards as the

foundation upon which to provide users of financial statements with the information they
need to provide financing, lend or donate money, or determine how public officials are
spending tax dollars.

Investors and citizens trust financial statements that follow GAAP and use this
information to assess the financial condition and determine how well an organization or
government manages its resources.

When financial statements are prepared under GAAP, they are based on standards
developed by a robust, open due process that results in information that is:

Relevant, representationally faithful, and reflective of economics

Comparable with other organizations or governments

Verifiable and auditable by a third party

Understood by lenders, investors, donors, taxpayers, and others.

The high-quality financial reporting standards within GAAP are essential to the efficient
functioning of our capital markets.

The high-quality financial reporting standards within GAAP are essential to the efficient
functioning of our capital markets. For example, GAAP leads to better financial
information and is helpful an organization or government in the following ways:

To attract the financing they need to hire workers, build plants, and invest in research
and development, companies and others organizations must report financial information
in a way that investors, lenders, donors, and others find credible and useful.

Greater comparability in accounting and financial reporting also results in better

financing decisions—investors, lenders, and donors make wiser decisions about where
to put their money.

It will also help governments better demonstrate to their citizens and bond holders their
stewardship over their government’s resources.

High quality financial accounting and reporting standards promote better information in
the marketplace. Better information fosters greater transparency. Transparent, relevant
information helps investors and lenders make better decisions about where to put their
money with confidence. Investors, recognizing the value of high quality financial
information, support an objective and inclusive standard-setting process. This “virtuous
cycle” ultimately helps make our capital markets more efficient and robust.