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Demystifying generally accepted accounting principles

By:
Sreevatsan Thandalam
May 15, 2021
Wooden blocks with letters GAAP, coins and charts representing accounting services.

As a business owner, you don’t need to be an accounting expert. What you need is a fundamental understanding of generally accepted accounting principles or GAAP. The knowledge helps you judge if the principles are properly applied or not. With that in mind, we, one of the leading online accounting services in the US, dive deep into what GAAP is and why it is important.

GAAP or Generally Accepted Accounting Principles were established by the American Institute of Certified Public Accountants and the Financial Accounting Standards Board. You can think of them as guidelines that every company, irrespective of size, has to follow in the USA.

These guidelines form the core of all accounting transactions for every type of organization. They are also utilized to organize all financial data and summarize it in accounting records.

Overall, ten concepts explain the mission of generally accepted accounting principles:

  • Principle of regularity - Every accountant must comply with all GAAP rules and regulations.
  • Principle of consistency - To avoid discrepancies and errors, all items must be entered in the same way. By fixing the standards of reporting, you avoid mistakes. In cases the standards are tweaked or upgraded, the changes must be disclosed along with the reasoning.
  • Principle of sincerity - The accountant must always depict the accurate and impartial financial position of a business.
  • Principle of permanence of method - The financial reporting procedure should remain consistent. Thus, allowing for comparison.
  • Principle of non-compensation - The entire financial information must be reported. It includes positives and negatives. There should be no expectation of debt compensation.
  • Principle of prudence - The financial data must be fact-based and show as-is. It should be speculated.
  • Principle of continuity - During asset evaluation, it is assumed that the business will have continued operations in the coming time.
  • Principle of periodicity - All accounting entries must correspond to their relevant time periods.
  • Principle of full disclosure - An accountant must endeavor to disclose all information in the financial reports fully.
  • Principle of utmost good faith - Based on the phrase “uberrimae fidei,” the principle takes for granted that every party is honest in their transactions.

What Makes Following GAAP Essential For Businesses In The USA?

GAAP builds a clear and consistent method of accounting. When you follow the principles, you get complete financial reports. As a result, you have access to the entire picture of your business’s financial health.

What’s more, because GAAP provides homogenous reports, you can compare performance year-over-year. Beyond internal use, following GAAP helps a business owner prepare for a transaction, raise capital, or trade publicly. Let’s drill down further on why GAAP is important. You can plan ahead!

Running a business means planning ahead. It also means executing those plans at the right moment. With GAAP, you get the tools to put those plans in action as it provides you a full picture of revenue and transaction.

It can also predict cash flow trends, ensuring that you can strike while the iron is hot. Further, it makes sure you don’t skip essential aspects like receiving invoices on time. You maintain consistency.

A major benefit of GAAP is gaining consistency in your financial statements. When your accounting methods remain the same, it makes it simpler for investors and other stakeholders to evaluate your financial data.

On the other hand, when you keep switching accounting principles for different reporting periods, it confuses decision-makers, negatively impacting your business. You can compare performance.

Since GAAP creates standardized financial statements, it is easier to compare them. You can either compare your financial position in different periods like month over month or compare it with other businesses in the same industry. Additionally, based on the comparison, business owners can grasp the performance benchmark and then optimize operations.

The Value GAAP Brings To Your Organization

One of the most significant benefits of following GAAP is reduced data misrepresentation risk. That, in turn, lessens business fraud. For instance, you can analyze the issues in collection and diagnose areas of earning. Another risk GAAP mitigates is pin-pointing your business mistakes, correcting them, and running the business more efficiently.

One more value-addition of GAAP is relevance. Economic events like the ongoing pandemic do impact the financial health of a business. When you fail to record such events, particularly when they materially influence your operations, the usability of your financial reports lessens.

The generally accepted accounting principles clarify which information you need to include in the financial statements. Thus, making them accurate and relevant.

The last advantage of GAAP is reliability. Assume you are a small business owner in the USA seeking a loan. When you offer audited and attested financial statements, the lender can easily assess you. It makes reaching a lending agreement simpler.

Another benefit of reliable and valid financial statements is better decision-making. For instance, if reports show thinning profit margins, business owners or top management can make adjustments and improvements accordingly.

In essence, being GAAP compliant is all but essential for every business. But we know it is not easy to follow the principles. More so, if you rely on manual processes.

At Tickmarks, we maintain your books and automate routine tasks. It makes you GAAP compliant and frees up your precious time. So, you focus on what matters – expanding the business!

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