GAAP: what are they?

GAAP

Last modified on March 26th, 2024

In 2019, Pinterest reported a loss of $1.36 billion. But when they used non-GAAP conversions, their losses suddenly turned into profits of $17 million. Almost one-fifth of firms in the 2010s could turn their losses into profits by using non-GAAP methodology. Without GAAP, the accounting world could be compared to the wild west. With teams able to pick and choose their reference points or cover certain losses with depreciation values, it’s hard to determine how accurate the numbers are.

In this piece, we’ll explain the key principles of GAAP, and how our fraud prevention software Trustpair helps firms to work better and more efficiently. Request a demo to learn more! 

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What is GAAP?

GAAP stands for Generally Accepted Accounting Principles. They represent the ten key guidelines that financial professionals must abide by while working for a US-based business. The purpose of such standards is to hold financiers accountable for their documentation, ensuring both accuracy and integrity in reports on paper and online. This, in turn, should keep stability in the markets at work.

GAAP rules were introduced after the 1929 financial crisis, in a time known as the Great Depression. It is thought that shady accounting practices contributed to the downfall, with accounts payable fraud, for example. So GAAP reporting requires companies regulated under the regime (like Government entities) to file public reports based on key metrics. The principles are regulated by the Financial Accounting Standards Board.

These standardized reporting requirements enable potential investors and customers to accurately compare various competitors and generally support them in evaluating an organization’s performance.

Who must comply with GAAP?

GAAP guidelines apply to three types of companies:

  • Publicly-traded companies
  • Non-profit organizations
  • Government entities of the United States

Meeting the requirements of GAAP means that any time an organization is required to report to the public, the standards must be followed. Moreover, it means that any non-GAAP measurements must be identified, and declared.

Finally, while a private company is not required to follow GAAP, it may choose to comply. This is because the GAAP measures are preferred by the likes of banks and an investor board.

It’s also why there are standard practices for other financial processes, such as the accounts payable workflow. Where accountants follow the standard accepted principles, they are more likely to be trusted and deemed credible, even while operating in a small business.

Non-compliance means that companies will risk huge fines. Not only that, but they also risk huge reputational damage, since this is the industry standard by definition.

The generally accepted accounting principles are constantly being evaluated and assessed. As such, they are considered a living agreement, rather than an outdated regulation. For example, the SEC is currently looking to match GAAP to the IFRS as globalization increases, and more American companies operate in foreign markets.

 

GAAP vs IFRS: what are the differences?

While GAAP represents the accounting standards of the United States, there is another set of rules and practices for more than 140 other global jurisdictions. This is known as the IFRS- the International Financial Reporting Standards.

While GAAP and international standards are comparable, US-based companies do have to put measures in place if they want to operate outside of the States by converting their GAAP reports. As such, the IFRS is generally considered to be more stringent.

IFRS also has more principles than GAAP. It could be argued that some modules, such as customer contracts or lease modules, are considered more prudent than GAAP’s focus on corporate accounting.

 

The 10 GAAP principles

The ten guiding principles of GAAP include:

  • Regularity
  • Consistency
  • Sincerity
  • Method Permanence
  • Non-compensation
  • Prudence
  • Continuity
  • Periodicity
  • Materiality
  • Good faith

Find a detail of each principle below:

Regularity

Entities must follow the accounting principles in full, and cannot be modified or ignored.

Consistency

Accountants must use the same methodology for all of the accounting periods, no matter which accountant is performing their duties. This means that any change in methodology must be back-dated, justified, and documented.

Sincerity

Financial professionals must provide unbiased and accurate financial reporting, even if it could compromise the future stability or existence of their company. Putting in detective controls is a good way to ensure that employees are warned away from insincere actions.

Method Permanence

Accountants must use the generally accepted methods that they have been trained in, such as cost-benefit analysis. This helps external parties to compare a business’s performance with competitors.

Non-compensation

By fiddling with just a few numbers like revenue, income, and expenses, accountants can hide certain debts, or cover up debts, for example. But the non-compensation rule requires accountants to act in honesty, without attempting to compensate for issues or perform other cover-ups.

Prudence

Financial reporters should act with fact-based decisions that can be traced. Where digital software is used to transform the process from manual to automated, firms must be able to prove how these calculations were made. While companies are within their rights to forecast and make predictions, they cannot be included in formal statements.

Continuity

Accountants must assume that the companies they report over will continue to operate, no matter the actual status of the organization.

Periodicity

If companies are required to report profits every quarter, for example, then they must only include the numbers from that relevant period. There can be no carry-across or date changes to hide outcomes.

Materiality

The full range of financial data must be disclosed to give investors, customers, and potential mergers the full picture.

Good faith

Accountants must agree to be honest in all of their financial reports, maintaining ethical standards and their responsibility towards market integrity.

 

What’s an example of a GAAP violation?

As previously mentioned, GAAP violations are not only possible, but they can cause significant damage to a company’s credibility. One of the most common violations is the wrong depreciation value of leased building improvements.

Depreciation of leased building improvements

When accounting for office expenses, some accountants choose the accelerated tax method of depreciation (where the value is reduced faster than traditional accounting methods). However, this is not compliant with GAAP.

One common violation is that the old accepted depreciation length for structural improvements to a leased building was 39 years. But this isn’t the best method – the actual length of depreciation should be dependent on the shorter of either:

  • The lease term
  • The length of its useful life

GAAP compliance requires the right employee training, alongside the right hires. However automated tools can help companies to remain on the right side of the regulators. For example, Trustpair’s account validation software secures the accounts payable process by constantly monitoring vendor data, improving efficiency across the accounting department.

Here’s a recap on GAAP:

The Generally Accepted Accounting Principles are a set of standards that all financial professionals – working in publicly traded companies – must follow. They instill honesty, transparency, and accuracy in financial reporting. Each principle helps accounting teams work with peace of mind and transparency. Work more efficiently in accounting by partnering with Trustpair to monitor vendor data on an ongoing basis. Our software helps businesses and accounting teams wipe out fraud and streamline their daily work.

FAQ

Alongside the ten principles, GAAP guidance involves four key rules that must be followed when accountants prepare financial statements. The first is recognition – the idea that statements must accurately reflect the true picture, without omissions. The second is measurement; statements must be prepared under the accepted methods.

Presentation is the third rule and requires reports to specifically include income and cash flow statements, balance sheets, and equity statements. Finally, disclosure is the fourth rule and mandates the inclusion of extra, relevant information in reports.

In simple terms, GAAP is a set of accounting standards that ensure reports are clear and accurate. Each principle is important as it helps businesses be compliant and transparent. By mandating GAAP across industries, regulators ensure that companies can be effectively compared, and are all measuring their success in the same ways. This can better inform both customers and investors on the better – or worse – opportunities.

Our fraud prevention software helps accounting and finance teams handle fraud risks better and monitor their vendor data automatically. Our services include online automated account validation, detailed risk analytics, live warnings in case of risky situations, customized workflows, etc. Customer support shares daily best practices and helps with deployment and usage. Overall, we will help your teams work with peace of mind.

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