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What are Generally Accepted Accounting Principles (GAAP)?

Generally Accepted Accounting Principles (GAAP) are known as the standard instructions for financial accounting – also known as standard accounting practice, or accounting standards.

GAAP is essentially a series of rules on how financial statements should be prepared. When a company uses GAAP, any individual with a basic understanding of accounting should be able to examine its financial conditions – or so the theory goes.

GAAP differs depending on geographical location. Many countries adopt the International Financial Reporting Standards (formed and maintained by the International Accounting Standards Board) as a means of making financial reporting comparable internationally.

GAAPGenerally Accepted Accounting Principles (GAAP) are a set of official procedures, rules and standards that publicly-traded companies must use in preparing their financial statements.

GAAP is important as it allows investors to analyze financial statements for investment purposes without having to deal with consistency issues.

However, it is very important to note that despite GAAP being an enforced set of rules on reporting financial statements, it is still fairly common for accountants to distort the figures. Companies often have discretion to use varying methods for valuing assets and recognizing costs and revenue, i.e. there is still wiggle room for businesses to ‘fudge’ the figures.

Financial statements are created to provide key information about the financial position of a company – to help investors make economic decisions. It also reveals how well management has used firm’s resources.

Financial statements include information about an entity’s: assets, liabilities, equity, income, expenses, gains/losses, and cash flows.

The IFRS (International Financial Reporting Standards) requires faithful representation of the effects of the transaction, presented on a going concern basis, with no offsetting, and a complete set of financial statements to be presented annually.

IFRS financial statements consist of (IAS1.8) of the following:

  • A Statement of Financial Position
  • A Statement of Comprehensive Income
  • An Income Statement
  • A Statement of Comprehensive Income
  • A Statement of Changes in Equity (SOCE)
  • A Cash Flow Statement
  • A summary of the accounting policies

The U.S. Securities and Exchange Commission (SEC) has said that it will gradually switch from US GAAP to the International Financial Reporting Standards (IFRS). All European Union companies have been required to use IFRS since 2005.