What is GAAP Accounting?
GAAP is an accounting term that stands for Generally Accepted Accounting Principles. This is a combination of accounting standards and common principles within the accounting industry and its governing bodies.
Many industries and organizations utilize GAAP to properly integrate their financial information with their accounting records. They need GAAP to create financial statements and also for disclosing any supporting financial information.
GAAP allows uniformity, ease of identifying financial statements, and the creation of a basis for comparison. Because all businesses using GAAP have utilized similar rules, financial reports are easier to understand and collate.
GAAP covers a wide array of accounting principles and topics, including assets, equity, liabilities, revenue, derivatives, and hedging, fair value, and expenses, to name a few. It is useful for creating financial statement presentations, identifying nonmonetary transactions, and covers specific accounting topics relevant to certain industries such as software.
Industry-specific allowances in GAAP vary accordingly from basic standards to accounting transactions. GAAP was formulated from a series of accounting groups with the Financial Accounting Standards Board, or FASB. In addition, the Securities and Exchange Commission also offers accounting declarations through the FASB Accounting Staff Bulletins and through other mediums applicable to publicly–held businesses. These are a part of GAAP, which are included in the Accounting Standards Codification or ASC.
GAAP is utilized by companies to report financial results in the US. The International Financial Reporting Standards or IFRS, is the framework that is also used in other countries. But compared to GAAP, IFRS is less rules-based. The IFRS focuses on general principles than GAAP, and this makes the IFRS work smaller, more comfortable, and more efficient than GAAP. But since the IFRS is still being formulated, the GAAP remains the more comprehensive framework for accounting.
In years past, some groups were creating ways to reduce the comparison between GAAP and IFRS frameworks. The groups aim to overcome differences in reporting if a business switches from GAAP to IFRS and vice versa.
There is also a planned merger of GAAP to IFRS, but this remains unresolved.
Basic Principles of GAAP
The most important objective that GAAP pursues is to make sure that financial statements are consistent, complete, and may be compared with reports from different companies. There are ten (10) principles of GAAP:
REGULARITY – Ensures that the accountant follows GAAP rules as well as standards.
CONSISTENCY – Ensures that accountants use similar standards throughout financial reporting to reduce errors and prevent discrepancies. Accountants should disclose and provide reasons for changes. This includes updated rules indicated in the footnotes of the financial reports.
SINCERETY – This principle states that the accountant should strive to create an impartial and accurate depiction of the financial situation of any business.
PERMANENCE OF METHODS – Ensures that accountants provide consistent financial reporting.
NON-COMPENSATION – This principle states that the negatives and positives must be reported in complete transparency with no debt compensation.
PRUDENCE – This means fact-based information is emphasized and should not be affected by any speculation.
CONTINUITY – As a company’s assets are evaluated, the company’s operations should continue.
PERIODICITY – Companies should report in the appropriate accounting period, and reports should be done regularly.
MATERIALITY OR GOOD FAITH – Ensures that accountants should provide full disclosure when creating financial reports.
UTMOST GOOD FAITH – This statement presumes that the parties involved are honest in creating reports and transactions.
Advantages of GAAP
GAAP promotes the best interest of creditors, investors, and shareholders in the following ways:
Information matches performance
When companies follow GAAP procedures, accounting information becomes consistent with the overall performance of entities determined.
Find areas that need modification
GAAP allows accountants to identify the areas that should be improved or needs modification for improved performance of the business.
Maintain trust and interests
Financial reports made using GAAP maintain the trust and the interest of investors. Companies that follow GAAP provide certain guarantees to anyone who wants to invest in their business.
Readily understood info
Because of reports made using GAAP, accountants can readily understand financial reports and may easily compare these with other financial statements. It is easier to identify profits, expenses, loss, investments, income, and revenues. And with GAAP, companies reduce risks and prevent fraud cases.
What’s the difference between GAAP and Non-GAAP?
GAAP Accounting reports are seamless, easy to understand, and may be used across all kinds of accounting practices. Different accounting professionals may assess companies and businesses, but the information is still comparable and understandable.
Meanwhile, companies who are non-GAAP may follow varying systems or principles. Thus, accountants lose “apples to apples” comparisons and may find it hard to create financial reports, evaluate the current financial status, and establish uniform plans. IFRS is an example of non-GAAP.
The following are examples of how GAAP is applied:
GAAP Accounting for Leases
When preparing for a lease, a lessee uses GAAP-prepared documentations. New standards on lessor accounting are consistent with GAAP.
The new standard will improve transparency and makes it easier to make comparisons among different organizations that lease structures, buildings, equipment, and other types of assets as well as liabilities from rental transactions.
Leasing activities should be reflected in documents so investors and other users can readily and efficiently understand the obligations and rights associated with these. The previous FASB accounting model will retain two kinds of leases and is consistent with the current accounting model that uses GAAP.
A type of financial lease will be considered in the same way as capital leases are grouped under the current GAAP model. Operating leases will be included for income statement and in the statement of cash flows. This is in a way that is consistent with operating leases in the GAAP model.
Meanwhile, as the operating leases identify with the balance sheet, the lessee should recognize these leases responsibilities according to the present values of remaining lease payments and lease assets.
GAAP Accounting for Stock Options
A person has the right to buy shares in a company for a particular price at a specific time. This may be done on a particular date or a range of dates. Options are basic fixtures of an executive compensation package because this can enhance corporate managers to direct their attention on long-term value and less on quick profits.
When it comes to accounting, timing is essential. Stock options are available only after a specific time of service. GAAP reports on stock options indicate what options are and if these are not considered part of compensation.
Stock options are not expenses as long as these plans meet the following requirements.
All employees will share the plan (but this does not apply to those who have their own shares).
The program should not discriminate against the income level and job level, from ordinary employees to managers. The plan should be offered to all employees. The company is allowed to provide a limit to the number of shares each shareholder gets under the policy. There must also be an exercise time for the offer at a reasonable time. And if the stock is offered at a discounted rate from the market price, the discounts should be similar to the discount given to other shareholders.
Meanwhile, all other stock options are considered compensation and thus need recognition of an expense considering US GAAP. The price of the cost is regarded as the fair value of the options. However, this value is not considered from the exercise price as well as the market price.
The expense is considered equally in the vesting period, and this is the time from the date the company gives the options and the time when the employee is allowed to provide the option. US GAAP classifies the options as an earned compensation by the employee in the vesting period.
GAAP Accounting Capitalize vs. Expense
GAAP accounting principles consider capitalization vs. expense. Capitalization eligibility identifies whether the company capitalizes cost or not. A company should get an economic benefit from assets before the current year and use these assets in its normal operations.
Meanwhile, current expenses are described as the company’s inability to show the link between cost and future revenues. These costs should be expensed soon. The cost and development of research and development are current expensing due to a high-risk profile plus uncertainty of foreseen benefits from the charges.
If a company expects to consume an item for a more extended period, then the cost is included in its balance sheet. But rather than expensed, the item cost is capitalized or depreciated throughout its life.
Convert Cash Financials to GAAP
A beneficial objective to a business is to convert Cash Financials to GAAP. This is achieved by making adjustments to the cash basis accounting statements such that appropriate accruals and reserves are posted to reflect accrued revenue (accounts receivable, prepaid expenses, etc.) and accrued expenses (payroll, accounts payable and others as appropriate).
Accordingly, to appropriately classify the income statement accounts into the proper period, revisions may be needed to balance sheet accounts to reflect the GAAP basis balance. The resultant changes produce an income statement also reflecting the application of GAAP.