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The Basics of Generally Accepted Accounting Principles (GAAP)

written by: John Garger•edited by: Michele McDonough•updated: 9/25/2010

Generally Accepted Accounting Principles have been established so financial records and reporting by companies are fair and accurate.

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    Accounting and Finance are complicated subjects. Coupled with the complexity of large organizations, the need for accurate and fair accounting practices is an important consideration for multiple stakeholders. Without uniform recording and reporting schemas, each organization would be on its own to account for its operations.

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    GAAP

    Generally Accepted Accounting Principles (GAAP) refers to rules of accounting used to record and report the financial operations of an organization. GAAP is used by a number of organizational types such as publicly-traded firms, private firms, non-profit organizations, and governments. GAAP brings together a collection of standards including laws, common practices, and frameworks.

    Each country typically has its own GAAP that govern its organizations’ accounting principles. The United States Government does not formally set forth accounting standards, leaving it up to its citizens to determine appropriate accounting procedures. It is important to note that GAAP is not written into U.S. law. However, the Securities and Exchange Commission (SEC) does require that publicly-traded companies follow GAAP. The organization most influential in setting accounting principles according to GAAP is the Financial Accounting Standards Board (FASB). The international nature of business today has led some to believe that international standards, not intra-country standards, should govern accounting practices. However, the complexity of international accounting is likely to keep international GAAP in the planning stages for many years.

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    GAAP Assumptions

    There are four assumptions GAAP makes about the organizations recording and reporting financial information. GAAP assumes that the business is separate from its owners and from other businesses. This is primarily the reason why corporations are considered to be entities like people. They may own property, enter into contracts, and take on debt just like an individual. GAAP also assumes that businesses will be in operation forever. The permanency of the corporation ensures that accounting of amortization, depreciation, etc. is appropriate. A stable monetary unit is assumed to be the unit of record for a corporation. The company’s home-country currency is usually this unit of record. Finally, GAAP assumes that the operations of an entity can be divided into time periods such as months, quarters, years, etc.. This ensures that treatments of interest and dividends are uniform across multiple companies.

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    Conclusion

    GAAP set forth standards that allow investors and other stakeholders to gain an accurate view of a company’s financial status. The U.S. Government does not set into law the standards with which organizations must comply. Instead, commissions and trade organizations set GAAP to ensure appropriate accounting practices.