In GAAP, What Are the Principles?

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Investors need to start with a GAAP company, but still verify information.
Investors need to start with a GAAP company, but still verify information. (Image: BananaStock/BananaStock/Getty Images)

Generally accepted accounting principles (GAAP) are a set of accounting principles, standards and procedures that companies use to prepare their financial statements. The American Institute of Certified Public Accountants and the Financial Accounting Standards Board establish and administer GAAP. Businesses that do not follow these universal principles run the risk of misrepresenting their company to potential investors. GAAP is an accounting measuring stick -- the definitive source of accounting guidelines.

Accuracy

Your company needs accurate and to-the-penny accounting of all monies that it takes in and pays out. When the company records financial transactions for the purchase of a piece of equipment or the sale of a good, the company must record the exact dollar amount and change in order for your company to be in compliance with GAAP's accuracy in recording requirement. Any discrepancy found later in a company touting that it adheres to GAAP will be suspect, as it could indicate fraudulent activity.

Comparability

Under GAAP, a company that makes only one product, such as tennis shoes, must be able to look at the financial records of another single tennis shoe GAAP manufacturer and know that the information is accurate, comparable, objective and verifiable. With this comparability principle, potential buyers and investors can compare companies within an industry and benchmark their performance.

Objectivity

Investors do not want to weed through investment portfolios that contain biased financial statements. They want to look at your financial statement and see only factual information that an independent company, such as your bank, can verify is accurate. Financial statements that claim a company made a million dollars last year, but can't prove it is not objective enough for those who utilize GAAP for their financial and business transactions.

Verifiability

Businesses and investors who use GAAP to guide their decisions are not going to take your word, or even your bank's word, completely when evaluating the wisdom of investing money or purchasing your company. They want to verify everything you say in the financial records you give them. But they do have a better feeling that your organization is legitimate when they learn you use GAAP instead of your own accounting principle system.

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