Generally Accepted Accounting Principles (GAAP)

What is GAAP?

Generally Accepted Accounting Principles (GAAP) are the standard framework of accounting rules, standards, and procedures used in the United States for preparing, presenting, and reporting financial statements. GAAP is intended to ensure financial statements are complete, consistent, and comparable so investors, lenders, and other users can make informed decisions.

Who establishes GAAP?

• The Financial Accounting Standards Board (FASB) issues most of the authoritative GAAP guidance for private and public companies.
• The Governmental Accounting Standards Board (GASB) issues standards used by state and local governments.
• The U.S. Securities and Exchange Commission (SEC) requires publicly traded companies to file financial statements prepared in accordance with GAAP.

What GAAP covers

GAAP encompasses a wide range of accounting topics, including:
* Revenue recognition
* Balance sheet classification and presentation
* Measurement and disclosure of assets, liabilities, equity, revenues, and expenses
* Materiality and consistency in reporting

Compliance and assurance

• Public companies must follow GAAP and file GAAP-compliant statements with the SEC.
• GAAP compliance is typically verified by an independent audit resulting in an auditor’s opinion issued by a CPA firm.
• Non-public companies are not legally required to use GAAP but often do because lenders and investors commonly require GAAP financials as part of loan covenants or due diligence.
• Even with GAAP, financial statements can contain errors or be presented in ways that obscure economic reality; auditors and users should remain vigilant.

GAAP vs. IFRS

• International Financial Reporting Standards (IFRS), issued by the IASB, are used widely outside the U.S. (in over 160 jurisdictions).
• Key differences: GAAP permits the last-in, first-out (LIFO) inventory method; IFRS prohibits LIFO. Both accept first-in, first-out (FIFO) and weighted-average methods.
• Since the early 2000s, FASB and IASB have worked toward convergence. In 2007 the SEC allowed certain foreign private issuers to use IFRS without reconciling to U.S. GAAP.
• Many U.S. companies report non-GAAP measures alongside GAAP results; for example, a substantial majority of S&P 500 firms report adjusted earnings metrics and adjusted EPS, and a notable share report EBITDA-type measures.

Non-GAAP measures

Companies may disclose non-GAAP metrics to highlight aspects of performance they believe GAAP does not capture. These measures must be clearly labeled as non-GAAP and reconciled to GAAP figures when required. Investors should treat non-GAAP metrics cautiously because they can be used to present results in a more favorable light.

Why GAAP matters

GAAP builds investor confidence by standardizing reporting and enabling comparability across companies and time periods. This reduces information asymmetry, lowers transaction costs, and supports efficient capital markets. However, adherence to GAAP does not eliminate all risk of misstatement or misleading presentation.

Bottom line

GAAP provides a consistent, transparent framework for U.S. financial reporting, supporting comparability and trust in financial markets. It is enforced for public companies and widely used by governments and lenders. Users of financial statements should understand GAAP’s role and limitations and scrutinize both GAAP and non-GAAP disclosures when evaluating financial performance.