GAAP is the standard implemented by accountants and auditors. The acronym stands for generally accepted accounting principles. It is a compilation of all the principles accountants utilize in preparing financial statements. By having a common standard, it is easier to regulate and understand a company's financial reports.
In 1939, the American Institute for Certified Public Accountants created the Committee on Accounting Procedure. This committee determined generally acceptable accounting principles. This committee evolved over time, eventually becoming the Federal Accounting Standards Board (FASB), which, as of 2011, still governs GAAP.
GAAP exists to maintain a common method for business accounting. Investors and lenders must be able to make informed decisions when reviewing financial statements. Without a standard of reporting, this becomes a guessing game. Without a standard and governing body, the door is open for misrepresentation and outright fraud on a company's financial statements.
GAAP is comprised of three major components: Assumptions, principles and considerations. An assumption is exactly as it sounds. It is an aspect of the financial statement the accountant assumes is true. An example is that the business will continue operating for the foreseeable future (going concern assumption). Principles build from assumptions and are basic truths about the financial statements. For example, assets are reported at original cost (historical cost principle). Considerations are standard modifications to GAAP principles. For example, accepted industry practices can supersede GAAP (industry practices consideration).
GAAP is maintained by FASB, which falls under the jurisdiction of the Securities and Exchange Commission. State and local governments maintain their own accountant standards entities known as Government Accounting Standards Body. On a company level, many business have accounting departments. These departments are subject to both internal and external audits to ensure compliance with GAAP.