Generally Accepted Accounting Principles (GAAP) is a set of accounting rules created to govern financial reporting for corporations in the United States. Publicly traded companies, and some others, are required by law to use GAAP for their reporting. Here's the history of how GAAP became the standard financial reporting measure for the U.S.
Understanding GAAP
Following the Stock Market Crash of 1929 and the ensuing Great Depression, the U.S. government sought ways to regulate the practices of publicly traded companies and other major market participants. The government believed that at least some of the causes for the crash were due to less than above board practices by publicly traded companies.
Authority to set standards on accounting practices was granted to the Securities and Exchange Commission (SEC). The SEC decided to delegate this responsibility to the private sector auditing community, and in 1939, the American Institute of Accountants (precursor to the American Institute of Certified Public Accountants) created the Committee on Accounting Procedure (CAP).
CAP was replaced by the Accounting Principles Board (APB) 20 years later. The APB began issuing opinions about major accounting topics to be adopted by business accountants, which could then be imposed on publicly traded companies by the SEC. In 1973, the APB gave way to the Financial Accounting Standards Board (FASB).
The FASB has been the major policymaking body on acceptable accounting practices ever since. Other governmental and non-governmental organizations influence FASB decisions, but the FASB is responsible for issuing opinions and rendering judgments. The collective decisions passed down from the APB and FASB form GAAP.
The American Institute of Certified Public Accountants (AICPA), the SEC, and the Governmental Accounting Standards Board (GASB), are the core organizations that influence GAAP in addition to the FASB. In 1984 the FASB created the Emerging Issues Task Force (EITF) to deal with new and unique accounting that will most likely become standard in the future, such as accounting for the technology sector.
GAAP Objectives and Core Principles
GAAP represent objectives and guidelines for financial statements and reporting calculations. There are three major sets of rules covered in GAAP: basic accounting principles and guidelines, detailed standards of the FASB, and generally accepted industry practices.
The 10 core principles of GAAP are:
- Consistency
- Permanent Methods
- Compensation
- Prudence
- Regularity
- Sincerity
- Good Faith
- Materiality
- Periodicity
- Continuity
Within the confines established by GAAP, auditors attempt to establish uniformity among the financial reports of publicly traded companies, although private companies often use GAAP as well. Through GAAP, investors can more easily compare and understand the financial health of different businesses. This uniformity also has ancillary benefits for regulators, lenders, corporate managers, and the accounting community.
Other Accounting Rules
Accounting standards in the European Union and some countries in Asia are governed by the International Financial Reporting Standards (IFRS), which is governed by the International Accounting Standards Board (IASB), created in 2001. There has been collaboration between the IASB and FASB to align the practices of GAAP and IFRS. In 2002, both bodies signed the Norwalk Agreement, with the intent to make best efforts to make their respective accounting reporting fully compatible.
