GAAP, or generally accepted accounting principles, form the basis for financial reporting in the United States. Accountants follow these principles when measuring the financial impact of certain transactions, recording transactions and creating financial statements. Investors, regulators and others rely on these principles to understand the information reported in the financial statements of companies and other organizations.
Stakeholders trust in the financial statements to communicate information accurately and consistently with GAAP. When financial statements are prepared in accordance with GAAP, the stakeholders know how the accountant interprets and reports financial transactions. The stakeholders include the Securities and Exchange Commission (SEC), stockholders and financial analysts. The SEC oversees the financial reporting of all publicly traded companies. Stockholders use the financial statements to evaluate the performance of their investment. Financial analysts review the financial statements in order to advise their clients.
GAAP includes general principles and specific principles. The general principles include objectivity, cost, going-concern, monetary unit, revenue recognition and business entity. The objectivity principle refers to the independence of the accountant preparing the financial statements. The cost principle refers to the concept of reporting every transaction at the actual cost. The going-concern principle assumes the company will continue existing indefinitely. The monetary unit applies to the concept of communicating all transactions in financial terms. The revenue recognition principle means the company records its revenue as it earns it. The business entity principle signifies that the company operates as an independent entity.
The specific principles of GAAP refer to a set of principles created to meet unique reporting needs. More than 100 principles exist to guide companies in their financial reporting for various situations. These include accounting for pensions, construction contracts or installment sales. As circumstances in the accounting world change, new principles are created to address those changes and provide direction to companies.
The Financial Accounting Standards Board, or FASB, creates the accounting principles used to guide accountants in the United States. FASB consists of seven full-time members who review accounting issues, consider alternative methods of recording for those issues, seek public feedback and determine the final standard for reporting on those issues.