Generally Accepted Accounting Principles: An Introduction
One feature of every human activity is the peculiar set of rules that, if followed diligently, guarantee that the activity will produce desired outcomes. As human civilization evolved, many of man’s activities developed into trades and professions that have had their respective guidelines. Today, professions and less formal human pursuits are still evolving; so are the respective guidelines. In the case of the accounting profession in the United States of America, generally accepted accounting principles (GAAP) have been formal occupational guidelines for many decades.
The extensive range of accounting conventions that constitute GAAP is the result of pioneering work by America’s accounting profession and its Securities and Exchange Commission (SEC). America’s Securities Act of 1933 and its Securities Exchange Act of 1934 first authorized the SEC to institute stipulations for reporting and disclosing business information. In 1959, the American Institute of Certified Public Accountants established its Accounting Principles Board (APB) to settle accounting controversies and document GAAP. Thus, differences between existing accounting practices were to be minimized or eliminated. Until 1973, when the APB ceased operating and was succeeded by the Financial Accounting Standards Board (FASB), the Opinions of the APB constituted the supreme sources of GAAP. Nowadays, Opinions of the FASB are the authoritative bases of GAAP.
GAAP are a combination of authoritative standards, established accounting principles and routine accounting methods. The FASB establishes the authoritative standards, whereas accounting methods and principles evolve with accounting practice. GAAP govern the preparation of financial statements for organizations and individuals. Accountants, as they record and report financial data for their clients, resort to GAAP for assurance concerning the integrity of their output. When independent auditors attest that clients’ financial statements conform to GAAP, they confirm that such statements benefitted from the application of FASB standards, established general accounting guidelines and acceptable accounting procedures. With this confirmation, users of the statements have a basis for attributing credibility and consistency to the statements. These attributes are essential for these users’ analysis of the performance documented by the financial statements.
The reliance on GAAP is consistent with the perspective that investors and creditors entrust resources to managers and accounting facilitates reporting on the managers’ stewardship of these resources. Financial statements have enhanced credibility if they are based on GAAP, since GAAP are independent of managers’ and other persons’ preferences for particular financial results.
On account of GAAP, users of accounting information may safely presume that accounting methods for an entity are consistent from period to period and, consequently, facilitate the comparison of the entity’s periodic financial results. Additionally, consistent use of GAAP facilitates comparisons of the entity’s financial results with those of other entities and the particular industry. GAAP facilitate standardization of accounting assumptions, definitions and procedures.
With the advent of International Financial Reporting Standards (IFRS) early this century, the SEC has been contemplating substituting IFRS for GAAP. Work still needs to be done in this regard.