10 Things You Need to Know About GAAP
Businesses large and small are built on ideas, but ideas alone can’t sustain them. Instead, systems like GAAP – generally accepted accounting practices – create the architecture on which a business’s dreams can rest.
Businesses large and small are built on dreams. It is not dreams, however, that sustain these inkling ideas. Instead, systems like GAAP – generally accepted accounting practices – create the architecture on which a business’s dreams can rest.
The Financial Accounting Standards Board (FASB) does just that with the help of the GAAP. If you’re at the helm of a business, you’ll need to be familiar with both to successfully remain afloat. With that in mind, try and keep the following GAAP basics in mind.
A Brief Overview of GAAP
The most important thing you need to know as a business owner regarding the GAAP is this: the GAAP requires three primary financial statements to be submitted, in accordance with principles and legalities yet to be discussed:
- An income statement at the end of a fiscal quarter or fiscal year
- A balance sheet
- A cash flow statement
Your accountant will need to competently file these documents in accordance with GAAP guidelines upon request as well as in accordance with your industry’s financial standards.
Origins of GAAP
The generally accepted accounting practices were originally put in place as a response to the Stock Market Crash of 1929. At the time, GAAP was intended to formalize the financial reporting process required of all businesses operating within the United States.
That said, GAAP and FASB don’t dictate the ongoings of all of the public trade companies in the United States. Instead, that regulatory duty falls to the Security and Exchange Commission (SEC). If you want to break the hierarchy down, try and remember: SEC has the authority to enforce the rules that the FASB establishes, and the FASB can only establish those rules courtesy of the legislation originally put in place by the GAAP.
10 Key GAAP Concepts
Feel like a lot of information? It is. It’s a little simpler to understand the concepts GAAP holds at its core and how those concepts will impact your business’s accounting practices.
1. Principle of Regularity
This principle dictates that registered accountants must comply with those rulings established by the GAAP. This means that you can’t just hire someone off the street to handle your books. Instead, they need to be qualified and well-versed in GAAP rulings.
2. Principle of Consistency
This principle dictates that all financial reports submitted through the GAAP financial reporting process need to comply with nationally-understood standards.
3. Principle of Sincerity
This principle dictates that accountants will approach their financial reports with impartiality. Likewise, all reports shall be filed accurately.
4. Principle of Permanence of Methods
This principle dictates that, similar to the principle of consistency, financial reports will all be completed using consistent and well-established procedures.
5. Principle of Non-Compensation
This principle dictates that, whether a business is in debt or in the black, accountants will accurately report the affiliated earnings. When that report comes through, the accountants in question acknowledge that they will not automatically receive debt compensation, nor should they file their reports with the expectation of that reception.
6. Principle of Prudence
This principle dictates that accountants should not speculate as to the future of their affiliated business’s financial standing in their submitted reports.
7. Principle of Continuity
This principle dictates that files submitted through GAAP assume that the business in question will continue to operate into the coming fiscal year.
8. Principle of Periodicity
This principle dictates that financial reports will be issued on a schedule, be that by fiscal quarters or fiscal years.
9. Principle of Materiality
This principle dictates that, similar to the principle of non-compensation, accountants will report the full truth of a business’s financial standing.
10. Principle of Utmost Good Faith
This principle dictates that GAAP, FASB, and the SEC will assume that submitting accountants are filing honesty and with good intentions.
GAAP’s Additional Rulings
The aforementioned ten GAAP principles demand – primarily through faith – honesty, consistency, and formality from business-affiliated accountants. Those principles don’t consist of the GAAP’s only rulings, though. Three of the GAAP’s other rulings include:
- Basic Accounting Principles & Guidelines – a business’s financial transactions are to be considered separate from the personal transactions of the business’s owner and affiliates. Likewise, accountants are meant to legally comply with the best practices established in the aforementioned principles regarding production costs, going concern, revenue, conservatism, and additional financial matters.
- National Compliance – the GAAP dictates that accountants in all fifty states will comply with the rules and standards put forth by the FASB and APB as they are updated.
- Industry-Wide Accepted Practices – while the GAAP speaks in broad terms, it does not present accountants with a universal model to follow. Instead, accountants operating within individual industries will need to comply with the best practices outlined by their fellows, superiors, and the needs of their business.
GAAP Compliance by State
That last note addressing variations on best practices is especially important to consider. While the GAAP does outline universal behavioral principles, different states have different compliances with the GAAP. A full outline of the states’ GAAP varying compliance requirements is detailed below:
- Fully Compliant States – Utah, Colorado, Arizona, New Mexico, Louisiana, Minnesota, Wisconsin, Kentucky, Virginia, North Carolina, Georgia, Maine, Massachusetts, Rhode Island, and Connecticut
- Mostly Compliant States – Nevada, Ohio, Tennessee, Mississippi, Florida
- Somewhat Compliant States – California, Oregon, Montana, Wyoming, South Dakota, Iowa, Texas, Nebraska, Arkansas, Pennsylvania, New Jersey, South Carolina, New Hampshire
- Non-Compliant States – Washington, Idaho, North Dakota, Oklahoma, Kansas, Missouri, Illinois, Indiana, Michigan, Alabama, West Virginia, New York, Vermont
Sound complicated? That’s because it is. The financial well-being of established businesses across the United States is not an easy matter to understand. However, when thinking about your business and your business alone, do what you can to thoroughly understand your industry’s financial expectations. Those expectations, more than anything else (though not discounting your state’s registered compliance) will determine how your relationship with the GAAP plays out.