Generally accepted accounting principals (GAAP) are rules that govern the way a business must report earnings, losses and activity surrounding their property. The GAAP allows for depreciation of equipment over the estimated life of the product. A minimum value, or threshold amount, is established for each piece of office or industrial equipment to allow a business to show that inherent value on its assets sheet. A company establishes its total worth by including the value of its property and fixed assets.
In simpler days, accounting was done in ledgers by hand. One side of the ledger listed assets and income and the other side held the liabilities or debt. When a business bought a piece of equipment it was entered in the assets column. As it depreciated in value, its worth was adjusted. At some point, after completely run down to zero, the value of the machinery had to have some way of being listed in the company’s ledger. Accountants came up with a threshold that was considered to be the fair market value of the equipment.
As public companies flourished and governments required more accountability, unscrupulous bookkeepers found ways to manipulate the numbers to make it look as if a company had more assets, and more profitability, than it actually did. The Great Depression of the early 20th century proved this form of corruption to be harmful to the society and to the credibility of business and financial accounting methods.
Generally accepted accounting principals have been governing the way United States businesses record earnings and losses well into the 21st century. Basically, GAAP says that if everyone is doing it, then it should be all right. The Securities and Exchange Commission (SEC) was created in the 1930s to stem the tide of shady accounting methods. Early federal accounting standards were initiated in the 1970s and revoked. The Sarbanes-Oxley legislation of 2002 attempted to create additional levels of reporting requirements for public companies. The GAAP capitalization threshold has undergone changes throughout the years as generally acceptable accounting rules continue to change.
New rules of accounting, following the International Financial Reporting Standards (IFRS) eventually will prevail over GAAP. Mandates with minimum standards of reporting asset value will become more effective in leveling the field among businesses worldwide. Investors, valuators and acquisition specialists will appreciate any rules that will force a fair and equitable form of accounting that judges apples to apples. Assets will be given fair treatment rather than being valued on shifting sands.
While government auditors continue to standardize capitalization thresholds for public companies, private concerns must rely on their accountants to find and record the fair market value of their assets to come up with the most reliable figures. Until the world is working under consistent rules and standard capitalization sheets, accountants must rely on GAAP and find out what others in the same industry are doing.