- What is GAAP?
- The 10 generally accepted accounting principles
- Who sets GAAP standards?
- Key GAAP concepts and methods
- Why GAAP matters for financial reporting
- GAAP compliance requirements
- GAAP vs. IFRS: Understanding the differences
- What are non-GAAP measures?
- Limitations of GAAP
Generally accepted accounting principles (GAAP) are the standardized rules US companies use to prepare consistent, transparent financial statements. Public companies must follow GAAP, and many private companies adopt it to build credibility with lenders and investors.
If you manage your company’s finances, understanding GAAP helps you reduce reporting errors, prepare for audits, and make decisions based on reliable data. Strong GAAP compliance builds trust and supports long-term growth.
What is GAAP?
Generally accepted accounting principles (GAAP) are the authoritative accounting standards and reporting rules used in the United States. The SEC requires publicly traded companies to follow GAAP, making it the foundation of US financial reporting.
GAAP ensures consistency, transparency, and comparability in how you report financial information. While public companies must apply GAAP when preparing financial statements, many private companies adopt it voluntarily to strengthen credibility with lenders, investors, and potential acquirers.
GAAP governs three core areas of financial reporting:
- Financial statement preparation: How you record and present assets, liabilities, revenue, and expenses
- Disclosure requirements: What information you must share with investors and other stakeholders
- Consistency standards: How you apply accounting methods from one reporting period to the next
The 10 generally accepted accounting principles
GAAP is supported by 10 foundational principles that shape how financial information is recorded and presented. While these principles aren’t standalone rules in the FASB Accounting Standards Codification, they form the conceptual backbone of US financial reporting.
Regularity
You follow established GAAP rules and regulations consistently. A retailer, for example, can’t create its own revenue recognition method—it must apply the standards issued by FASB.
Consistency
You apply the same accounting methods from one reporting period to the next. If you use FIFO to value inventory this year, you shouldn’t switch to last-in, first-out (LIFO) without proper disclosure and justification.
Sincerity
Financial reporting reflects an accurate and impartial view of your company’s financial position. That means reporting both strong performance and setbacks without bias.
Permanence of methods
You maintain consistent procedures over time so stakeholders can compare results meaningfully. If you establish depreciation schedules for equipment, you follow those schedules throughout the assets’ useful lives unless a justified change is required.
Non-compensation
You report assets and liabilities separately rather than offsetting them to show only a net amount. Financial statements must present complete information, including both positive and negative figures.
Prudence
You rely on verifiable data rather than speculation or overly optimistic assumptions. For example, inventory is recorded at cost, not at an anticipated selling price.
Continuity
Financial reporting assumes your business will continue operating for the foreseeable future unless evidence suggests otherwise. This assumption allows you to spread certain costs, such as equipment purchases, over multiple reporting periods.
Periodicity
You record revenues and expenses in the appropriate reporting period. If you complete work in December but receive payment in January, you still recognize the revenue in December under accrual accounting.
Materiality
You disclose all information that could influence a reasonable stakeholder’s decisions. This often includes footnotes explaining accounting policies, contingent liabilities, or significant post-period events.
Utmost good faith
All parties involved in financial reporting are expected to act honestly. Management provides accurate records, and auditors perform independent, objective reviews.
Who sets GAAP standards?
The Financial Accounting Standards Board (FASB) establishes and updates GAAP in the United States. The Securities and Exchange Commission (SEC) recognizes FASB as the designated accounting standard-setter for public companies.
Financial Accounting Standards Board
The Financial Accounting Standards Board (FASB) is the independent organization responsible for issuing and revising GAAP. Since 1973, FASB has released Accounting Standards Updates (ASUs) covering areas such as revenue recognition, lease accounting, and financial instruments.
Public companies must comply with new standards issued by FASB. Because the SEC oversees the US capital markets, its recognition of FASB gives GAAP its regulatory authority.
Financial Accounting Foundation
The Financial Accounting Foundation (FAF) oversees FASB and appoints its board members. It also secures funding and ensures the standard-setting process remains independent and transparent.
By separating governance from rulemaking, the FAF protects the credibility of US accounting standards. This structure helps ensure GAAP reflects public interest rather than political or commercial pressure.
Key GAAP concepts and methods
GAAP relies on accrual accounting and standardized financial statements to present a consistent view of performance. These core concepts ensure your reporting reflects economic reality, not just cash movement.
Accrual accounting under GAAP
GAAP requires accrual accounting, which records revenue when earned and expenses when incurred. This approach reflects economic activity more accurately than cash-based reporting.
Under accrual accounting, you recognize revenue when you deliver goods or services, even if payment arrives later. For example, if you complete a consulting project in March and receive payment in April, you record the revenue in March.
The matching principle applies to expenses as well. If you purchase inventory, you record the expense when you sell the goods, not when you pay the supplier. This alignment gives stakeholders a clearer picture of profitability.
By contrast, cash basis accounting records transactions only when money changes hands, which can distort performance from one period to the next.
Accrual vs. cash-basis accounting examples
Assume a graphic design agency completes a $5,000 project in March with net 30 payment terms. Under accrual accounting, the agency records the $5,000 revenue in March when the work is delivered.
Under cash-basis accounting, the agency records the revenue in April when the payment arrives. The timing of cash receipt determines when income appears on the books.
This difference can materially change how profitable a month or quarter appears.
Financial statements required by GAAP
GAAP requires four primary financial statements that together provide a comprehensive view of your company’s financial position:
- Balance sheet: Reports assets, liabilities, and equity at a specific point in time. GAAP dictates how you value inventory, depreciate fixed assets, recognize intangible assets, and classify short- and long-term obligations
- Income statement: Reports revenue and expenses over a period to determine net income. GAAP governs revenue recognition, expense classification, and earnings per share presentation
- Statement of cash flows: Reports cash inflows and outflows from operating, investing, and financing activities and reconciles net income to cash from operations
- Statement of shareholders’ equity: Shows changes in equity, including stock issuances, dividend payments, and retained earnings activity
Together, these statements give lenders, investors, and internal stakeholders a standardized and comparable view of performance.
Why GAAP matters for financial reporting
GAAP strengthens the credibility, consistency, and reliability of your financial reporting. When you follow standardized rules, stakeholders can trust that your numbers reflect economic reality rather than accounting discretion.
GAAP compliance provides several practical advantages:
- Investor confidence: GAAP-compliant financial statements signal disciplined reporting and internal controls. Lenders and investors rely on GAAP to evaluate risk, which can improve your access to capital and financing terms.
- Comparability: Standardized rules allow stakeholders to compare your results with peers. Two companies applying the same revenue recognition and expense standards can be evaluated on equal footing.
- Legal and regulatory protection: Clear accounting standards reduce the risk of misstatements and enforcement actions. Consistent reporting also makes audits smoother and less disruptive.
- Access to capital: Venture capital firms, private equity investors, and banks often expect GAAP financials during due diligence. Clean, compliant books accelerate funding conversations
GAAP’s disclosure requirements also ensure stakeholders receive complete information about your accounting policies, significant risks, and contingent liabilities.
GAAP compliance requirements
Not every organization is legally required to follow GAAP, but understanding your obligations helps you make informed reporting decisions. In many cases, even voluntary adoption improves credibility and access to capital.
Public companies
Publicly traded companies in the US must follow GAAP when preparing financial statements. The SEC requires GAAP-compliant reporting for companies listed on US exchanges and for those filing registration statements, including initial public offerings.
Private companies
Private companies have more flexibility in choosing accounting methods. However, many adopt GAAP because lenders often require GAAP-compliant financial statements before approving loans.
Private equity investors and potential acquirers also prefer GAAP reporting because it allows them to compare performance across companies. FASB provides certain private company alternatives, including simplified guidance and extended adoption timelines for new standards.
Nonprofit organizations
Nonprofits follow a specialized version of GAAP tailored to fund accounting and donor restrictions. These standards govern how organizations report contributions, grants, endowments, and restricted funds.
Certain industries face additional reporting requirements beyond general GAAP:
- Banks and financial institutions: Apply specialized guidance for loan loss reserves, credit impairments, and investment securities
- Insurance companies: Follow industry-specific standards for policy liabilities and premium recognition
Whether required or voluntary, GAAP adoption signals disciplined financial reporting and strengthens stakeholder confidence.
GAAP vs. IFRS: Understanding the differences
GAAP and International Financial Reporting Standards (IFRS) are the two dominant accounting frameworks globally. GAAP governs US financial reporting, while IFRS standardizes reporting across many international markets.
International Financial Reporting Standards (IFRS) is used in more than 140 jurisdictions, including the European Union, Canada, and Australia. While both frameworks aim to ensure transparency and comparability, they differ in structure and application.
| Factor | GAAP | IFRS |
|---|---|---|
| Overall approach | Rules-based system with detailed, prescriptive guidance | Principles-based system with broader guidelines and greater reliance on professional judgment |
| Geographic use | Required for US public companies and widely adopted by private US companies | Used in 140+ jurisdictions, including the EU, Canada, and Australia |
| Inventory valuation methods | Allows FIFO, LIFO, weighted average, and specific identification | Allows FIFO, weighted average, and specific identification but prohibits LIFO |
| Development costs treatment | Requires most research and development costs to be expensed as incurred | Allows capitalization of development costs once technical feasibility is demonstrated |
| Revaluation of assets | Generally requires historical cost less depreciation | Permits revaluation of certain assets, such as property, plant, and equipment, to fair value |
| Component depreciation | Permitted but not required | Required when significant asset components have different useful lives |
| Governing body | Financial Accounting Standards Board (FASB) | International Accounting Standards Board (IASB) |
These differences affect how you value inventory, recognize development costs, and measure assets. If you operate internationally, you may need to reconcile GAAP financials to IFRS or maintain dual reporting systems.
What are non-GAAP measures?
Non-GAAP measures are financial metrics that adjust standard GAAP results to highlight specific aspects of performance. Companies use them to provide additional context, but they don’t replace official GAAP financial statements.
Because non-GAAP metrics aren’t standardized, companies must clearly define their adjustments. The SEC requires public companies to reconcile any non-GAAP figures to the most directly comparable GAAP measure.
Common non-GAAP measures include:
- EBITDA: Earnings before interest, taxes, depreciation, and amortization
- Adjusted earnings: Net income adjusted for items such as restructuring charges, acquisition costs, or stock-based compensation
- Free cash flow: Operating cash flow minus capital expenditures
| Aspect | GAAP | Non-GAAP |
|---|---|---|
| Definition | Standardized accounting principles required for public reporting | Supplemental metrics that adjust GAAP results by excluding or adding specific items |
| Regulation | Governed by FASB and enforced by the SEC | Not standardized; companies define adjustments but must reconcile to GAAP |
| Where presented | Required in audited financial statements and SEC filings | Common in earnings releases, investor presentations, and calls |
| Adjustments | Includes all revenues, expenses, gains, and losses under accounting standards | Often excludes stock-based compensation, restructuring charges, acquisition costs, or other non-recurring items |
| Strength | Promotes consistency and comparability | Highlights operating trends and management’s view of performance |
| Risk | May include non-cash or one-time items that affect comparability | Can mislead if adjustments are aggressive or inconsistently applied |
Public companies must prioritize GAAP results in official filings. Non-GAAP reporting can provide helpful context, but only when presented transparently and reconciled clearly.
Limitations of GAAP
GAAP provides a strong foundation for US financial reporting, but it has structural limitations. Understanding these gaps helps you interpret financial statements more critically and supplement reporting where needed.
Industry-specific challenges
GAAP applies broadly across industries, which can make it less precise in specialized sectors. Technology companies, for example, may find that expensing most research and development costs doesn’t fully reflect long-term value creation.
Real estate, financial services, and other capital-intensive industries can face similar tensions between standardized rules and economic substance.
Slow adaptation to change
Accounting standards often lag behind evolving business models. Digital assets, subscription revenue models, and complex financial instruments have required updated guidance over time. During these transition periods, you may need to apply judgment within existing standards while awaiting formal updates from FASB.
Limited global application
US GAAP isn’t widely accepted outside the United States. If you operate internationally, you may need to reconcile GAAP financials to IFRS or maintain dual reporting systems. That added complexity can increase compliance costs and extend your close process.
FAQs
GAAP stands for generally accepted accounting principles. It’s the standardized framework of accounting rules US companies use to prepare financial statements.
The four basic assumptions are:
- Economic entity assumption: Business transactions are separate from the owner’s personal transactions
- Monetary unit assumption: Only transactions measurable in currency are recorded
- Time period assumption: Financial activity can be reported over consistent periods, such as months or quarters
- Going concern assumption: The business will continue operating for the foreseeable future
Public companies that fail to follow GAAP can face SEC penalties, restatements, delisting, and legal consequences. Private companies may lose investor trust, struggle to secure financing, or encounter audit issues.
GAAP isn’t legally required for most small businesses. However, following GAAP can improve credibility with lenders and investors and make future audits, funding rounds, or acquisitions smoother.
GAAP governs financial reporting for investors and lenders, while tax accounting follows IRS rules to calculate taxable income. The two often produce different results because revenue recognition and depreciation rules can differ between financial statements and tax returns.
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