Definition of Generally Accepted Accounting Principles
Generally accepted accounting principles (commonly referred to as GAAP or US GAAP) are the common accounting rules that must be followed when a U.S. company prepares financial statements that will be distributed to people outside of the company.
These common rules range from basic underlying principles and assumptions to the detailed rules established by the Financial Accounting Standards Board (FASB) for complex financial transactions. The FASB has organized the generally accepted accounting principles in its Accounting Standards Codification (ASC).
Why Generally Accepted Accounting Principles are Required?
Generally accepted accounting principles are required so a knowledgeable reader of financial statements is able to do the following:
- Compare a company's current financial statements to the earlier financial statements of the same company
- Compare a company's financial statements to those of other companies (especially within the same industry)
- Understand how a company recognizes/reports revenues, expenses, assets, liabilities, etc.
Examples of the Basic Underlying Accounting Principles
The basic underlying accounting principles consist of the following:
- Economic entity assumption
- Going concern assumption
- Time period assumption
- Monetary unit assumption
- Cost principle or measurement principle
- Matching principle or expense recognition principle
- Revenue recognition principle
- Full disclosure principle
- Industry practices
Related to these underlying accounting principles are the following: objectivity, conservatism, materiality, cost/benefit, comparability, consistency, relevance, and timeliness.