Definition of GAAP and Examples of GAAP
What is GAAP?
Generally Accepted Accounting Principles, or GAAP, are the accounting standards used by public companies and other organizations in the United States to present their financial results. Investors rely on them to make sound investment decisions.
How does GAAP work?
All public companies are required to issue regular reports on their financial matters, which typically include details about ongoing and one-time revenues and expenses, taxes, earnings, and more. This is done not only for the benefit of lenders, donors, and taxpayers but also for investors.
History of GAAP
Since money exchange began, there has been some form of accounting. The practices familiar to us today emerged in the fifteenth century with the organization of double-entry bookkeeping, where credits and debits were recorded in separate columns.
GAAP Alternatives
Even companies that generally comply with GAAP may also present other financial statements that are not GAAP-compliant. This data is known as “pro forma” statements.
Audit analytics, an independent research provider, indicates that the presentation of non-GAAP-compliant data has been on the rise. It found that in 2017, 97% of companies in the S&P 500 had a non-GAAP measure in their reports. However, only 76% of companies used non-GAAP measures in 2006, and only 59% in 1996.
Proponents of non-GAAP argue that pro forma statements allow for a more detailed presentation of financial data and provide a clearer picture for investors. However, the U.S. Securities and Exchange Commission has expressed concerns that such data can obscure results and mislead investors.
Additionally, companies outside the U.S. often do not follow GAAP standards. Companies in over 100 countries (and over two-thirds of the G20 countries) follow standards set by the International Financial Reporting Standards (IFRS) Foundation, which closely resemble GAAP.
Other companies present financial data using a mix of GAAP and non-GAAP methods, although non-GAAP financial data is more likely to appear in press releases or investor presentations rather than in the audited documents submitted to the SEC.
Some argue that a blend of both frameworks is more beneficial than either alone. For example, members of the FASB noted that using non-GAAP information to complement official GAAP-compliant financial statements can be helpful, and some argue that non-GAAP information provides insight into how management views the company’s performance.
McKinsey & Company, a global business consulting firm, published a report supporting that income statements from companies that use GAAP reporting are difficult to interpret. In fact, McKinsey noted that many companies have already presented some earnings in different ways in an attempt to provide more clarity to investors.
Key Takeaways
GAAP is a set of accounting standards established by the FASB and GASB and used by public companies as well as other organizations. GAAP aims to produce financial information that is relevant, comparable, verifiable, and interpretable. Investors can use financial statements prepared according to GAAP to assess the financial conditions of various companies. The presentation of non-GAAP financial data is on the rise, although the combination of GAAP and non-GAAP reporting is considered by some experts to provide the greatest value.
Source: https://www.thebalancemoney.com/what-is-gaap-4778101
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