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DEFINITION of 'Generally Accepted Accounting Principles

- GAAP'
The common set of accounting principles, standards and procedures that companies use to
compile their financial statements. GAAP are a combination of authoritative standards (set by
policy boards) and simply the commonly accepted ways of recording and reporting accounting
information.
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BREAKING DOWN 'Generally Accepted Accounting

Principles - GAAP'
GAAP are imposed on companies so that investors have a minimum level of consistency in the
financial statements they use when analyzing companies for investment purposes. GAAP cover
such things as revenue recognition, balance sheet item classification and outstanding share
measurements. Companies are expected to follow GAAP rules when reporting their financial
data via financial statements. If a financial statement is not prepared using GAAP principles, be
very wary!
That said, keep in mind that GAAP is only a set of standards. There is plenty of room within
GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP,
you still need to scrutinize its financial statements.
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Financial reporting is the language that communicates information about the financial condition
and operational results of a company (public or private), not-for-profit organization, or state or
local government.
Specifically, financial reporting includes the following information:

Financial position (balance sheet, statement of net position)

Results of operations (statement of revenues, expenses and changes in net position,

statement of comprehensive income, etc.), and

Disclosures

The accounting standards developed and established by the Financial Accounting Foundations
(FAF) standard-setting Boardsthe Financial Accounting Standards Board (FASB) and the
Governmental Accounting Standards Board (GASB)determine how those financial statements
are prepared.
The standards are known collectively as Generally Accepted Accounting Principlesor GAAP.
GAAP is based on established concepts, objectives, standards and conventions that have evolved
over time to guide how financial statements are prepared and presented.
GAAP is set with the objective of providing information that is useful to investors, lenders, or
others that provide or may potentially provide resources to a company or not-for-profit
organization.
A similar objective applies to financial reporting for state and local governments. An additional
objective for governmental reporting is to provide information that enables taxpayers and others
who use governmental financial statements to hold governments accountable.
GAAP includes principles on:

Recognitionwhat items should be recognized in the financial statements (for example

as assets, liabilities, revenues, and expenses)

Measurementwhat amounts should be reported for each of the elements included in

financial statements,

Presentation what line items, subtotals and totals should be displayed in the financial
statements and how might items be aggregated within the financial statements

Disclosurewhat specific information is most important to the users of the financial

statements. Disclosures both supplement and explain amounts in the statements.

The FASB and the GASB are responsible for ensuring that GAAP remains the high-quality
benchmark of financial reporting so that investors, lenders, capital providers, and other users
have access to the information they need to make sound decisions.
The FASB is the independent, not-for-profit organization that sets GAAP accounting and
financial reporting standards for businesses and not-for-profit organizations. The FASBs
standards are recognized as authoritative by the SEC. The FASBs standards also are recognized
by the AICPA as authoritative and the basis for auditors opinions concerning financial
statements; and by the State Boards of Accountancy for private companies and not-for-profit
organizations.
The FASB sets GAAP that applies to public companies, private companies, and not-for-profit
organizations.
Investors, lenders, and other users of financial information rely on financial reporting based on
GAAP to make decisions about how to allocate their capital and to help financial markets operate
as efficiently as possible. The FASB sets GAAP that applies to public companies, private
companies, and not-for-profit organizations. More information on the FASB can be found here.
The GASB is the independent, not-for-profit organization that is recognized by governments and
the accounting industry as the official source of GAAP for U.S. state and local governments. The
GASB establishes standards for financial reporting that provide useful information to assist
individuals in assessing a governments financial condition and performance. The GASBs
standards are recognized by the AICPA as authoritative and the basis for auditors opinions
concerning financial statements; and by the State Boards of Accountancy for state and local
governments.
The GASB establishes standards for financial reporting that provide useful information to assist
individuals in assessing a governments financial condition and performance.
Today, taxpayers, holders of municipal bonds, members of citizen groups, legislators, and
oversight bodies rely on this financial information to shape public policy and make investments.
These standards also help government officials demonstrate to their stakeholders their
accountability and stewardship over public resources. For state and local governments, it is
important to note that GAAP is applicable to external financial reporting, and not to budgeting.
More information on the GASB can be found here.
Both organizations missions are accomplished through a comprehensive and independent due
process that encourages broad participation, objectively considers all stakeholder views, and is
subject to oversight by the FAFs Board of Trustees.

The FASB and the GASB use the following due process procedures to set accounting and
financial reporting standards:

First, the Board identifies a financial reporting issue that needs to be addressed based on
recommendations from stakeholders, staff research, Board members concerns, or other
means. The Board then votes on whether to add a project to the technical agenda, and
discusses the issue and the technical staffs work at public meetings.

The Board drafts and issues a proposal (in the form of an Exposure Draft) for public
comment. Depending on the complexity of the issue, the Board may issue a preliminary
Discussion Paper, Invitation to Comment, or Preliminary Views document before the
Exposure Draft to seek initial stakeholder input on various solutions and approaches to
improve financial reporting.

The Board seeks stakeholder input on the proposal via comment letters, roundtables,
meetings, public hearings, etc. The Board subsequently redeliberates based on the
stakeholder input received.

The Board issues a final standard and provides implementation guidance to preparers,
auditors, and users of financial statements on the new standard.

If the standard is significant in nature and has been in place for two years (three years for
GASB standards), it may be selected by the FAFs Post-Implementation Review team to
evaluate its effectiveness.

The Qualities of GAAP

Companies, not-for-profits, and governments use accounting standards as the foundation upon
which to provide users of financial statements with the information they need to invest capital,
lend or donate money, or determine how public officials are spending tax dollars.
Investors and citizens trust financial statements that follow GAAP and use this information to
assess the financial condition and determine how well an organization or government manages
its resources.
When financial statements are prepared under GAAP, they are based on standards developed by
a robust, open due process that results in information that is:

Relevant, representationally faithful, and reflective of economics

Comparable with other organizations or governments

Verifiable and auditable by a third party

Understood by lenders, investors, donors, taxpayers, and others.

The high-quality financial reporting standards within GAAP are essential to the efficient
functioning of our capital markets.
The high-quality financial reporting standards within GAAP are essential to the efficient
functioning of our capital markets. For example, GAAP leads to better financial information and
is helpful an organization or government in the following ways:

To attract the capital they need to hire workers, build plants, and invest in research and
development, companies and others organizations must report financial information in a
way that investors, lenders, donors, and others find credible and useful.

Greater comparability in accounting and financial reporting also results in better capital
allocation decisionsinvestors, lenders, and donors make wiser decisions about where to
put their money.

It will also help governments better demonstrate to their citizens and bond holders their
stewardship over their governments resources.

Better investing decisions inspire greater confidence in the markets, which ultimately strengthens
our economy. Better relevant information also inspires more confidence in investment decisions,
which ultimately strengthens the efficiency of the market and the economy. In the end, using
GAAP helps form a virtuous cycle.

The Importance of Generally Accepted Accounting

Principles (GAAP)

About GAAP

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