GAAP (Generally Accepted Accounting Principles)

Generally Accepted Accounting Principles (GAAP) are a set of conventions, rules, standards, and procedures used record, classify and report financial information.  Financial accounting is the branch of accounting concerned with providing useful information to external users. This information takes the form of financial statements, footnotes and periodic news releases.

Financial statements are prepared in accordance with Generally Accepted Accounting Principles (GAAP).  GAAP is the common set of accounting principles, standards and procedures that companies use to compile their financial statements.  GAAP rules determine what is reported in these financial statements.  Requiring conformity with GAAP rules gives creditors [and others] some assurance that the financial statements they receive are accurate, fair and reliable.

While the Securities and Exchange Commission (SEC) has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934, it has chosen to rely on the private sector to create a body of accounting rules to keep financial reporting accurate.  This task has been delegated to the Financial Accounting Standards Advisory Board (FASAB). More specifically, company financial statements filed with the SEC follow the GAAP guidelines set by FASAB. Therefore, they give a consistent view of how companies have performed financially at least in terms of GAAP accounting rules.

The FASAB acts to:

• Improve the usefulness of financial reporting by focusing on the primary characteristics of relevance and reliability, and on the qualities of comparability and consistency; 
• Keep standards current to reflect changes in methods of doing business and changes in economic conditions; 
• Consider any significant areas of deficiency in financial reporting that might be improved through clearer standard-setting processes. 

Note: Publicly traded firms must use GAAP when reporting to the SEC in order to comply with U.S. securities laws and remain listed on the various stock exchanges.

One note of caution: GAAP is quite flexible in some reporting areas, often allowing a choice from among several different accounting methods that can produce quite different financial results. This is the area that credit professionals must be aware of and cautious about.

© 2010.  Michael C. Dennis.  All Rights Reserved.    Mr. Dennis is the author of four books including "Credit and Collection Handbook."