Accounting isn’t a free for all, as you are probably aware. You must abide by certain rules, like recordkeeping and tax reporting. Many businesses are also governed by a set of accounting guidelines known as GAAP.
Find out what GAAP is and whether your business needs to follow these guidelines.
What is GAAP?
GAAP stands for generally accepted accounting principles. Think of these principles as a rulebook that companies follow when creating financial statements (e.g., income statement, balance sheet, and cash flow statement). Generally accepted accounting principles ensure businesses use a standard method to report financial information.
Under GAAP, you need to structure your financial statements the same way from year to year. And, financial statement outlines should be the same as other businesses following GAAP.
These accounting principles determine how to create financial statements. The standard format makes it easy for investors, lenders, and auditors to gather information about your business.
GAAP accounting standards
So, what are GAAP rules? These guidelines influence which items you include on your financial statements, how to measure finances at your business, which time frames to use for recording and reporting, and how to format statements.
Information must be reliable and truthful. Business owners cannot pull different information from different time periods to make their finances look good—they need to show the truth about the financial health of their businesses.
Who issues GAAP?
GAAP rules for business are issued by the Financial Accounting Standards Board (FASB). The FASB is an independent, private-sector, not-for-profit organization that was established in 1973.
The Governmental Accounting Standards Board (GASB) also establishes GAAP accounting standards, but these are for state and local governments.
Both the FASB and the GASB are overseen by the Financial Accounting Foundation (FAF).
Although the FASB and GASB both establish GAAP accounting principles, businesses follow the set of guidelines created by the FASB.
Are you required to follow GAAP guidelines?
Not all businesses are required to follow GAAP. You must follow the established accounting standards if your stock is publicly traded or you provide financial statements to people outside of your business, like investors.
The U.S. Securities and Exchange Commission (SEC) requires publicly traded companies to follow GAAP in addition to other SEC rules.
If you are preparing financial statements to secure outside funding, you must follow generally accepted accounting principles. Otherwise, investors might not trust your financial statements.
Small, private companies are generally not required to use GAAP because many of the rules do not apply. And, GAAP requires that you use accrual accounting. Businesses that use cash-basis accounting will find that the GAAP accrual accounting rules are not relevant. But if you need to use GAAP down the line, you will need to switch to accrual.
Reasons to follow GAAP
Even if you are not required to follow GAAP, you can choose to do so. Following established standards have many benefits.
Some businesses decide to follow GAAP because it is the common language used by other business owners, accountants, investors, and lenders. Using GAAP can help you better communicate with the people you work with.
Following the same principles as other companies also makes it easier to compare financial statements. If you want to monitor the financial health of your business, you might want to compare it to a similar company. Doing this is easier if you follow uniform guidelines.
Switching your financial statements from non-GAAP to GAAP can be tricky and time consuming. If you think you will be required to use GAAP in the future, you might benefit from following them from the start.
With Patriot’s online accounting software, you can keep your financial information consistent and clear. Track expenses and income, record payments, and more in our easy-to-use software. Try it for free today!
This article has been updated from its original publication date of 10/27/2015.