GAAP (Generally Accepted Accounting Principles)

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 rules determine what is reported in these financial statements. The US Congress, through the SEC, has the ultimate authority to create GAAP.

While the 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 and honest. This task has been delegated to the Financial Accounting Standards Board (FASB). More specifically, company financial statements filed with the SEC follow the GAAP guidelines set by FASB. Therefore, they give a consistent view of how companies have performed financially at least in terms of GAAP accounting rules.

The FASB 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 US 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.

Source: Michael Dennis, author of "Credit and Collection Handbook" available at the NACM Bookstore.