Definition of GAAP
GAAP is the acronym for generally accepted accounting principles. GAAP consists of the following:
- Basic underlying accounting principles, assumptions, and concepts such as the cost principle, matching principle, full disclosure principle, and more.
- Detailed reporting standards and other rules established and organized by the Financial Accounting Standards Board (FASB) in its Accounting Standards Codification (FASB ASC)
- Generally accepted industry practices
Examples of the Basic Underlying Accounting Principles
The basic underlying accounting principles are:
- 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
In addition to the basic underlying accounting principles, there are various characteristics that also guide accountants. Some of the characteristics include objectivity, conservatism, materiality, cost/benefit, comparability, relevance, and timeliness.
Why GAAP is Important
In order for investors, bankers, financial analysts, portfolio managers, etc. to make informed decisions, it is necessary to have financial statements that are consistent and which can be compared to the financial statements of other corporations. This is more likely to occur when there are common rules for financial reporting. When financial statements are distributed by a business or other organization, the common rules that must be followed are known as generally accepted accounting principles or GAAP.