10 GAAP Guidelines

By Indeed Editorial Team

Updated March 8, 2021 | Published February 4, 2020

Updated March 8, 2021

Published February 4, 2020

Properly formatting and structuring your company's financial documents is a great way to ensure these documents are organized and easy to understand. Following the GAAP, for example, means your statements will follow a structured set of guidelines and principles. This will allow for clarity and streamlined comparison to other company's financial records for you or your accountant. In turn, the financial reporting process will run more smoothly and efficiently. In this article, we will define GAAP, explain its importance and detail its 10 guidelines.

What is GAAP?

GAAP stands for generally accepted accounting principles. These principles are a set of accounting rules, principles and standards that allow organizations to organize their financial information. They also allow for the clarity and comparison of accounting records because GAAP is widely used in the United States. The GAAP encompasses a variety of principles, including the principle of sincerity and the principle of materiality. Businesses that release financial information publicly or companies whose stock is traded publicly are required to follow the GAAP. Your business's financial statements, meaning your income statements, balance sheet and more, must follow the same structure each year.

Why is GAAP important and beneficial?

Following GAAP is helpful for investors or auditors who spend a lot of time gathering your company's financial documents. Because so many businesses use these guidelines, it provides for a more streamlined and efficient process for anyone viewing your company's financial statements. For example, if an investor is interested in your business, an organized and uniform financial statement utilizing GAAP will help them make an informed decision. This could be beneficial for you if they end up deciding to invest in your company.

Using GAAP is also important because it sets the parameters for your financial document preparation. For example, GAAP lets you know what to include or eliminate in your financial documents as well as how to organize and format your statements. It can also eliminate the stress by providing you with clear instructions on how to prepare these important financial documents.

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What are the limitations of GAAP?

Though using this set of guidelines can be greatly beneficial for your company, your accounts and potential investors, there are also limitations that you should take into consideration. Though you might be required to follow GAAP, it's still important to understand the restrictions it places. Here are some GAAP limitations:

  • Global recognition: Though GAAP is used in the U.S., GAAP is not recognized as a global standard. The International Financial Reporting Standards (IFRS), however, is. GAAP and IFRS have separate guidelines and handle various issues differently. For example, revenue accounting issues having to do with revenue recognition will be treated differently by both sets of principles.

  • Company diversity: Various companies face issues with GAAP's generic approach to financial reporting. For example, small businesses might have a hard time utilizing these principles and would benefit from a more tailored structure.

  • New standard timeline: Creating new standards takes a long time. This is because the process of setting these standards by GAAP policy boards is very thorough. Company financial reports might be affected by the process it takes to finalize a new standard.

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Why should you use GAAP?

Though not all companies are required to follow GAAP, using these guidelines can be highly beneficial for your company's financial reports. This is especially the case if you'd like to compare your company's financial documentation with that of another company to determine how well your business is doing financially. Following GAAP is a great way to create a uniform structure for your financial reporting.

10 GAAP guidelines

GAAP encompasses these 10 principles for structuring your financial documents:

1. Principle of regularity

The principle of regularity means accountants have abided by GAAP rules and methods. This ensures that accountants don't follow their own set of rules, but rather those of GAAP.

2. Principle of consistency

This principle means these guidelines were administered consistently throughout the financial statement's documentation process. It also means accountants will prevent any discrepancies in the disclosing of your company's financial statements. Accountants must also be able to explain any changed or updated standards.

3. Principle of sincerity

The principle of sincerity states that accountants will remain impartial when working on your company's financial statements. It also stipulates that they will provide an accurate depiction of how well or poorly your company is doing financially.

4. Principle of permanence of methods

This principle states that consistent procedures are utilized during the financial document preparation. Consistent measures allow for a more efficient comparison process with other financial statements.

5. Principle of non-compensation

The principle of non-compensation means that both positive and negative aspects of a business's performance are reported in full without a debt compensation prospect. For example, accountants must not seek to repay a revenue with an expense.

6. Principle of prudence

This principle states that only facts will be used in the financial reporting process — no speculation will be considered. For example, revenue amounts should not be over or underestimated. This ensures the accuracy of your company's financial statements.

7. Principle of continuity

The principle of continuity stipulates that in the valuation of assets, it's assumed that business operations will continue and not be interrupted.

8. Principle of periodicity

This guideline states that financial documents will be distributed during the standard accounting time periods. For example, your company's financial reports will be distributed during a fiscal quarter or fiscal year. They could also be reported monthly.

9. Principle of materiality/good faith

This guideline makes sure accountants aim for full disclosure in their financial reporting. Being honest and practicing full disclosure ensures accuracy in the preparation of your business's financial documents.

10. Principle of utmost good faith

Lastly, the principle of utmost good faith stipulates that all parties must be truthful and honest. In other words, you must provide all "material" information during the financial reporting process.

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