Definition: Abbreviation for Generally Accepted Accounting Principles, the comprehensive set of principles and rules for how publicly-held corporations should account for their business activities and prepare their financial statements. It is maintained by the independent Financial Accounting Standards Board (FASB).
Example: An important GAAP principle is revenue recognition. A business is permitted to record a sale as having taken place when it has delivered the product or completed the service called for in the agreement with the customer. This is true whether or not the customer has paid yet! On the flip side, if a customer pays the company before it provides the agreed-upon product or service, the company cannot record the sale as having taken place.
Another interesting notion about revenue recognition is that if a company offers the customer the ability to return the product it purchased, it’s not really a sale. It becomes a sale when the return period passes and the customer agrees to keep the product!
Investeach explains: There are several principles which guide the FASB as it maintains GAAP, including:
- Relevance: Is the information available in a timely manner? Does it allow investors to confirm whether prior predictions they made about the company came true, or to make predictions about what the company may achieve in the future?
- Reliability: Does it accurately represent what it says it does? Was it prepared with no bias in that the preparers didn’t have any motivation to have the numbers come out a certain way?
- Comparability: Can the information presented by a company be compared to that of its competitors?
- Consistency: Is the manner in which the financial information is compiled and presented the same period after period?
The FASB took over maintenance of GAAP in 1973 from the American Institute of Certified Public Accountants (AICPA), which itself had responsibility for it from 1936 until 1973. Interestingly, the Securities and Exchange Act of 1934 established the Securities & Exchange Commission (SEC) and gave statutory authority (ie: power granted in the law itself) for setting financial reporting requirements. The SEC has turned to the private sector to set and maintain those standards. It is likely to continue to do so as long as it is satisfied with how the standards are maintained.
Riddle me this:
1. What organization maintains GAAP?
2. What principle is concerned with counting a sale only when a company actually delivers the product or service to the customer?
3. What are four principles that guide the maintenance GAAP?
4. What government agency actually has statutory authority for maintaining financial reporting requirements?
5. For how long will the FASB maintain GAAP?