History of GAAPs
Without laid down rules and regulations, companies would present their financial information in their own ways. And with such freedom, they can present a company's financial information in their favor and mislead investors.
In 1929, The Great Depression caused financial hardships to many American Citizens resulting from inaccurate financial reporting in businesses. As a response, professional accounting groups and the federal government created ethical standards to guide businesses on financial reporting. Today, however, the FASB monitors and updates the GAAPs accurate and ethical. This board comprises seven members that are not involved in any other organization.
Importance of GAAPs
The following are the importance of GAAPs to investors, companies and other stakeholders:
GAAPs standardize all financial statements. They create the rules, assumptions, and regulations that businesses must follow when reporting information and statements. Additionally, they specify the time and mode in which the businesses should follow these guidelines.
2. Company Performance
GAAPs guidelines cover all scenarios possible. By doing that, they ensure that businesses report their true financial position in all transactions they undertake. Additionally, the consistency in these standards ensures that businesses report the actual performance over the years. And the fact that accounting policies do not keep on changing makes it easy to compare performance over a long period.
3. Language of Business
GAAPs are the official language of business. This means that they help businesses to communicate properly to all stakeholders. Since GAAPs standardize all financial statements, it is easy to compare different companies in the same industry. Moreover, shareholders and other stakeholders can analyse the progress of their business from one period to another.
All financial statements that conform to the GAAPs standards are reliable, especially for audits. Reliable audited statements help the management make decisions per the company's objectives.
GAAPs standards ensure that all businesses report useful transactions that help stake holders make informed decisions. Therefore, we can conclude that GAAPs minimizes the information that businesses should disclose without compromising transparency and accuracy.
6. Accountability on Spending
All businesses and government entities must follow GAAPs standards to ensure that stakeholders obtain details on money spent.
What are the Principles of GAAPs?
There are ten principles of GAAPs that demystify the mission of GAAPs rules and regulations.
1. Principle of Regularity
This principle states that all businesses and accounting personnel should apply GAAPs rules and regulations as a standard practice.
2. Principle of Consistency
All accounting personnel should make accounting entries exactly as stipulated. By applying these similar standards, they avoid discrepancies. If there are any changes in the entries, they are expected to explain the change.
3. Principle of Sincerity
According to this principle, all accountants should provide the entity's correct and accurate financial situation.
4. Principle of Permanence of Method
This principle ensures consistency in the procedures used in reporting financial information.
5. Principle of Non-Compensation
All businesses should disclose their full financial information, whether positive or negative. In other words, the accountant should get paid whether the report is positive or negative.
6. Principle of Prudence
The financial statements should show the business's financial position 'as it is' and not as speculations.
7. Principle of Continuity
Asset valuations and financial data collection should not interrupt the business’ operations. This principle assumes that the institution will continue to operate under the current practices even in the future.
8. Principle of Periodicity
All financial data should be organized and reported across the relevant periods. For instance, accountants should report income and expenses in their respective reporting periods.
9. Principle of Full Disclosure
While making financial reports, all accountants should fully disclose the financial and accounting facts.
10. Principle of Utmost Good Faith
This principle states that all parties should be honest when disclosing financial data collecting and reporting.
Adopting a single set of standards in the U.S simplifies the accounting procedures and gives stakeholders and auditors a cohesive view of finances. Outside the U.S, other countries follow similar rules and regulations known as International Financial Reporting Standards (IFRS).