GAAP stands for “generally accepted accounting principles” and is used by businesses to:
- Properly organize their financial information into accounting records
- Summarize the accounting records into financial statements
- Disclose certain supporting information
Why is GAAP Important?
While it is particularly important in publicly traded companies, many investors and lenders require GAAP compliance as part of their decision making process for all businesses.
GAAP is currently defined by the Financial Accounting Standards Board (FASB) and is primarily used by U.S. business. International Financial Reporting Standards, or IFRS, is the accounting framework used outside the U.S. GAAP has more rules than IFRS and, not surprisingly, is more difficult to understand. Still, it is considered to be a more comprehensive accounting structure.
GAAP makes it easier for anyone reading multiple financial statements from different companies to make a reasonable comparison since all of them have created their financial statements using the same rules. Some of the topics included in GAAP are:
- Assets and liabilities
- Financial statement presentations
- Equity and revenue
- Fair value
- Non-monetary transactions
There may also be industry-specific accounting topics which can vary greatly from the more generic standards.
Every company, publicly traded or not, should make sure its financial statements are GAAP complaint by having an external audit performed by a certified professional.