GAAP

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Generally Accepted Accounting Principles (GAAP) is the term used to refer to the standard framework of guidelines for financial accounting used in any given jurisdiction. GAAP includes the standards, conventions, and rules accountants follow in recording and summarizing transactions, and in the preparation of financial statements.

Contents

Overview

Financial accounting is information that must be assembled and reported objectively. Third-parties who must rely on such information have a right to be assured that the data are free from bias and inconsistency, whether deliberate or not. For this reason, financial accounting relies on certain standards or guides that are called "Generally Accepted Accounting Principles" (GAAP).

Principles derive from tradition, such as the concept of matching. In any report of financial statements (audit, compilation, review, etc.), the preparer/auditor must indicate to the reader whether or not the information contained within the statements complies with GAAP.

  • Principle of regularity: Regularity can be defined as conformity to enforced rules and laws.
  • Principle of consistency: The consistency principle requires accountants to apply the same methods and procedures from period to period.
  • Principle of sincerity: According to this principle, the accounting unit should reflect in good faith the reality of the company's financial status.
  • Principle of the permanence of methods: This principle aims at allowing the coherence and comparison of the financial information published by the company.
  • Principle of non-compensation: One should show the full details of the financial information and not seek to compensate a debt with an asset, a revenue with an expense, etc.
  • Principle of prudence: This principle aims at showing the reality "as is" : one should not try to make things look prettier than they are. Typically, a revenue should be recorded only when it is certain and a provision should be entered for an expense which is probable.
  • Principle of continuity: When stating financial information, one should assume that the business will not be interrupted. This principle mitigates the principle of prudence: assets do not have to be accounted at their disposable value, but it is accepted that they are at their historical value.
  • Principle of periodicity: Each accounting entry should be allocated to a given period, and split accordingly if it covers several periods. If a client pre-pays a subscription (or lease, etc.), the given revenue should be split to the entire time-span and not counted for entirely on the date of the transaction.
  • Principle of Full Disclosure/Materiality: All information and values pertaining to the financial position of a business must be disclosed in the records.

The "outsourcing" of standards setting

The Fox and the Ostrich: Is GAAP a Game of Winks and Nods?, by Arthur Acevedo, The John Marshall Law School, was recently posted on SSRN. Here is the abstract:

The fox is frequently described as sly, cunning and calculating in world literature. It is often associated with behavior that seeks advantage through trickery and pretext. The ostrich on the other hand, has been portrayed as cowardly and irrational. Its character defect is epitomized when it sticks its head in the sand at the first sign of trouble.

The Financial Accounting Standards Board (FASB) can be described as the fox; the Securities and Exchange Commission (SEC), the ostrich. This article examines the creation of accounting principles by the fox and the failure to govern by the ostrich.

History demonstrates that the SEC adopted a policy of relying heavily on FASB in establishing accounting standards commonly known as generally accepted accounting principles (GAAP). However, neither FASB nor any of its predecessor organizations bear a responsibility of a public trust, nor any liability in the event of a breach of that trust.

The SEC’s failure to establish accounting principles and constant reliance on private standard setters has contributed to the manipulation and exploitation of GAAP by corporations and their auditors.

This article challenges the SEC’s policy of relying on third party standard setters such as FASB and calls upon the SEC to stop relying on private standard setters and start taking an active role in creating accounting standards. Only then, can it be said that the SEC is no longer sticking its head in the sand.

International Accounting Standards and Rules

Many countries use or are converging on the International Financial Reporting Standards (IFRS), established and maintained by the International Accounting Standards Board.

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