What is GAAP?
GAAP — Generally Accepted Accounting Principles — is the common set of accounting rules, standards and procedures that U.S. companies must follow when they prepare and report financial statements. It exists so that investors, lenders and regulators can compare one company's financials to another's with confidence. The Financial Accounting Standards Board (FASB) issues and maintains GAAP in the U.S.
GAAP is the standardized framework of accounting rules and conventions — including principles like consistency, materiality and going concern — that publicly traded U.S. companies must use to prepare financial statements.
- •Rules-based, very detailed guidance
- •Set by FASB
- •LIFO inventory method allowed
- •Development costs mostly expensed
- •Principles-based, more judgment
- •Set by IASB
- •LIFO inventory method prohibited
- •Some development costs can be capitalized
Step-by-step worked examples
A company changes its depreciation method from straight-line to declining balance. Under GAAP, what must it do?
Identify the change as a change in accounting estimate (or principle) Disclose the nature of and reason for the change in the notes Apply the new method prospectively (going forward), not retroactively Ensure comparability is preserved through disclosure, per the consistency principle
A retailer's revenue is $50 million and it just received a $2,000 vendor rebate. Should it be highlighted as a separate line item?
Compare the rebate ($2,000) to total revenue ($50,000,000) = 0.004% Because it is far below common materiality thresholds (often 0.5%–5%) GAAP's materiality principle says it can be grouped with other income No separate disclosure is required
A manufacturer buys a $120,000 machine with a 10-year useful life and no salvage value. How does GAAP require the cost to be recognized?
Apply the matching principle: match the expense to the revenue it helps generate Spread the cost over the useful life instead of expensing it all at purchase Annual depreciation = $120,000 / 10 = $12,000 per year Record $12,000 depreciation expense each year for 10 years
Flashcards
Quick quiz
Q1.GAAP is primarily used by companies in which country/region?
Q2.Which organization sets GAAP?
Q3.GAAP is best described as:
Q4.Compared to IFRS, GAAP is generally:
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Common mistakes
GAAP and IFRS are the same set of rules. — Correct: They are different frameworks — GAAP is used in the U.S., IFRS is used in most other countries, and they differ on rules like LIFO and R&D capitalization.
GAAP is only relevant to accountants, not investors. — Correct: Investors rely on GAAP-compliant statements to compare companies and make decisions.
GAAP is a single fixed law that never changes. — Correct: FASB continually issues new standards and updates (ASUs) that evolve GAAP over time.
Private companies never need to follow GAAP. — Correct: Many private companies choose or are required (by lenders/investors) to follow GAAP too.
FAQ
What is GAAP in simple terms?
GAAP is the set of standardized accounting rules U.S. companies follow so their financial statements are consistent and comparable.
What is the GAAP formula or framework?
GAAP isn't a single formula — it's a framework built on principles like consistency, materiality, matching and going concern.
What are examples of GAAP principles?
Examples include the matching principle, revenue recognition, materiality, consistency and the going concern assumption.
How is GAAP different from IFRS?
GAAP is rules-based and used mainly in the U.S.; IFRS is principles-based and used internationally.