How Does GAAP as Accounting Standards Affect Financial Reporting?
What is GAAP?
To start, you are probably wondering, what even is GAAP? GAAP is an acronym for generally accepted accounting principles. It is a set of rules, guidelines, and principles set out by the Financial Accounting Standards Board and the Governmental Accounting Standards Board.
These accounting standards pave the way for “standard” financial reporting.
10 Key Principles
Principle of Regularity
This principle states that all organizations should maintain accounting systems that adhere to these standards.
Principle of Consistency
Consistency is important to ensure that accounting practices remain the same across every reporting period. If they are not the same, you will need to explain why the changes are being made.
Principle of Sincerity
When you’re creating the organization’s financials, you ensure they are accurate.
Principle of Permanence of Methods
Permanence of methods means keeping the same method over accounting periods. This does not mean that you’re necessarily stuck with the same method forever, though; it just means that if you are going to change accounting methods, you will need to give some formal explanation as to why.
Principle of Non-Compensation
The principle of non-compensation, to me, feels a little bit misleading in the title. It is the idea that an accountant will not accept bribes or compensation to make a business or organization’s accounting statements look more favorable.
Principle of Prudence
This is a very simple principle. It reflects the idea of ensuring that books are completed in a timely and realistic manner.
Principle of Continuity
The definition of continuity is the consistent existence over a period of time. This principle holds that the financial classification of any short- or long-term information should be based on the assumption that the business will continue in the future.
Principle of Periodicity
Previously, we mentioned keeping the same method over accounting periods. This principle dictates that the accounting periods are also consistent and remain the same year over year. Again, if you do need to change this, you are not stuck in the same accounting time frame, but you will need to take extra steps to ensure it is changed correctly.
Principle of Materiality
This refers to asset purchases and ensuring they are recorded accurately and at cost, with truthful information.
Principle of Utmost Good Faith
Finally, last but definitely not least important is the principle of utmost good faith. This means that every person working in accounting should act honestly and with integrity.
GAAP v. IFRS
Another question that we see come up a lot when we’re referring to GAAP is what the difference between GAAP and IFRS is.
Now we already know that GAAP stands for generally accepted accounting principles. The IFRS stands for International Financial Reporting Standards. Moving forward, we will use the acronyms because both are quite wordy.
Overview Differences
There are key differences between these two, even though they share the same goal. The first difference is that IFRS is an international standard, while GAAP is a US standard. This leads to another difference: the IFRS is a standard across many countries; it provides a more general guideline, whereas the GAAP is very detailed in what it accepts.
A major difference in the actual accounting rules centers on inventory. There are multiple ways to track inventory: FIFO (first in – first out), LIFO (last in – first out), Weighted Average Cost, and Specific Identification methods are the most commonly accepted by GAAP. However, IFRS has banned the LIFO (last–in, first–out) method.
Quick Detail Differences
For asset evaluation, GAAP requires valuing assets at historical cost, meaning what was originally paid. IFRS, on the other hand, allows companies to re-evaluate and adjust the value of long-term assets to reflect their current fair value.
Development Costs are expensed under GAAP, but under IFRS many of those costs can be capitalized on the balance sheet.
The final difference we will touch on today is the Balance Sheet layout. The IFRS has an increasing liquidity presentation style compared to the reverse employed by the GAAP.
Why is GAAP Necessary?
GAAP and financial statements go hand in hand. GAAP was created to ensure that financial reporting adheres to the standards we discussed above.
The benefits of GAAP for financial statements are:
- Transparency and Accuracy
- Compliance and Fraud
- Consistency and Comparability
One word to describe how GAAP affects financial reporting is integrity. GAAP upholds all the values above and establishes more detailed standards to ensure financials are as uniform as possible, thereby setting clear financial reporting expectations.
If you need help with your accounting to ensure it is GAAP standard, please feel free to reach out to Waterford Business Solutions at 864-351-0852 or info@waterfordbusiness.com
