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The Importance of Generally Accepted Accounting Principles (GAAP)

Published on: November 12, 2021

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Anyone exploring a degree in accounting or finance is bound to encounter Generally Accepted Accounting Principles (GAAP) somewhere along their educational path. These important principles play a vital role in ensuring that accountants abide by the ethics, regulations, and best practices set forth by the Financial Accounting Standards Board (FASB). Since all public companies are required to abide by these standards when compiling their financial statements, GAAP is something that every accountant needs to be familiar with.

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The Importance of Accounting Standards

Accounting standards are critical for ensuring that investors aren’t led astray by misleading financial statements. Without the right accounting standards, publicly traded companies would be free to present their financial information in whatever format that casts the company's position in the best possible light. In fact, such faulty and deceiving reporting practices are considered to be one of the primary factors that ultimately led to the Great Depression in 1929.

In response to this catastrophe, the U.S. government teamed up with a number of professional accounting groups to create a set of accounting standards that would prevent public companies from releasing misleading financial reports. What they came up with is known today as GAAP. These principles were eventually written into law and enforced by the Securities Act of 1933 and the Securities Exchange Act of 1934 along with a number of other laws issued by the Securities and Exchange Commission (SEC).

Today, GAAP is monitored and updated by the Financial Accounting Standards Board (FASB) and continues to play a crucial role in ensuring that all financial statements are compiled in an accurate, ethical, and honest manner. The FASB is an independent board that was formed in 1973 for the specific purpose of taking over GAAP determinations and updates. It is today comprised of seven full-time members that are independent of any other organization and charged with ensuring that GAAP works in the best interest of the investing public.

The Ten Generally Accepted Accounting Principles

There are ten core principles that make up GAAP, and each one of these principles takes a different approach toward the ultimate goal of ensuring that a company's financial statements are as accurate and nondeceptive as possible. The ten principles that make up GAAP are:

1. The Principle of Regularity

The Principle of Regularity dictates that accountants must abide by all established rules and regulations. It is this principle that establishes the mandate that all other principles and regulations set forth by GAAP must be always followed. 

2. The Principle of Consistency

The Principle of Consistency dictates that accountants must apply consistent standards throughout the financial reporting process. This principle ensures that accountants are unable to adjust reporting standards in order to create misleading reports in addition to helping accountants avoid the errors and discrepancies that arise when consistent reporting standards are not used. If reporting standards are changed or updated, accountants are expected to fully disclose those changes and explain the reason behind them.

3. The Principle of Sincerity

The Principle of Sincerity dictates that accountants must strive to provide a complete and accurate depiction of a company's financial situation. This principle mandates that accountants must be sincere in their charge to create financial reports that will provide potential investors with an accurate and honest account of a company's current financial standing. 

4. The Principle of Permanence of Methods

The Principle of Permanence of Methods dictates that accountants must employ a consistent set of procedures throughout the financial reporting process. This principle is similar to the Principle of Consistency but strives to create consistent methods within the financial reporting process itself as opposed to consistent standards that the financial accounting process must meet. 

5. The Principle of Non-Compensation

The Principle of Non-Compensation dictates that all financial information must be disclosed regardless of whether it is positive or negative for the company in question. This principle mandates that all aspects of a company's financial performance must be disclosed with no expectation of debt compensation.

6.The Principle of Prudence

The Principle of Prudence dictates that accountants must present all financial information "as-is" and avoid presenting any data that is based on speculation. This principle prevents companies from presenting investors with speculative data that does not reflect the company's current financial situation.

7. The Principle of Continuity

The Principle of Continuity dictates that accountants must value assets based on the assumption that the company will continue its normal operations. This principle prevents companies from valuing their assets based on speculative future plans.

8. The Principle of Periodicity

The Principle of Periodicity dictates that financial reports must be released based on a pre-determined schedule such as every fiscal quarter or fiscal year. This principle prevents companies from refusing to share financial information during periods where the company's performance is suffering.

9. The Principle of Materiality

The Principle of Materiality dictates that accountants must strive for full disclosure of a company's monetary situation. This principle prevents companies from omitting any information from their financial reports regardless of whether it casts the company in a positive or negative light.

10. The Principle of Utmost Good Faith

The Principle of Utmost Good Faith dictates that it should be assumed that all parties involved in a transaction are acting honestly. This principle is derived from the Latin phrase uberrimae fidei that is used within the insurance industry and presupposes that any contract or transaction discussed in a financial report will be carried out in the exact manner that it is described.

Where Is GAAP Used?

Any organization that releases financial statements - public companies and government organizations alike - is expected to abide by the principles of GAAP. With this being the case, GAAP is something that is utilized by accountants across a broad range of organizations and industries. Anyone pursuing a career in accounting or finance will need to be deeply familiar with GAAP and abide by its principles throughout their career.

At Husson University Online, teaching students everything they need to know about GAAP and the important standards that it sets forth is just one of the many objectives our acclaimed online accounting degree program. To learn more about applying for this program and embarking on a journey toward a rewarding career in the fields of accounting and finance, be sure to contact us today. A friendly and knowledgeable admissions professional will be happy to take your call and answer any questions you might have about applying for Husson University's online accounting degree program.

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