When and Why Were GAAP First Established?

What Is GAAP?

Generally Accepted Accounting Principles, often known by the acronym GAAP, is a set of accounting rules created to govern financial reporting for corporations in the United States. Publicly traded companies, as well as many non-profit organizations, are required by law to use GAAP for their reporting.

These standards are established, implemented, and maintained by the Financial Accounting Standards Board (FASB), a body that is independent of any government organization or corporation. The goal of GAAP is to ensure that investors, government agencies, and taxpayers can trust the financial reporting of public and non-profit companies.

Understanding GAAP

Following the Stock Market Crash of 1929 and the ensuing Great Depression, the U.S. government sought ways to regulate the practices of publicly traded companies and other major market participants. The government believed that at least some of the causes of the crash were unethical or deceptive practices by publicly traded companies.

The authority to set standards for accounting practices was granted to the Securities and Exchange Commission (SEC). The SEC decided to delegate this responsibility to the private sector auditing community; in 1939, the American Institute of Accountants (precursor to the American Institute of Certified Public Accountants) created the Committee on Accounting Procedure (CAP).

CAP was replaced by the Accounting Principles Board (APB) 20 years later. The APB began issuing opinions about major accounting topics to be adopted by business accountants, which could then be imposed on publicly traded companies by the SEC. In 1973, the APB gave way to the Financial Accounting Standards Board (FASB).

The FASB has been the major policymaking body on acceptable accounting practices ever since. Other governmental and non-governmental organizations influence FASB decisions, but the FASB is responsible for issuing opinions and rendering judgments. The collective decisions passed down from the APB and FASB form GAAP.

The American Institute of Certified Public Accountants (AICPA), the SEC, and the Governmental Accounting Standards Board (GASB) are the core organizations that influence GAAP in addition to the FASB. In 1984, the FASB created the Emerging Issues Task Force (EITF) to deal with new and unique accounting that will most likely become standard in the future, such as accounting for the technology sector.

GAAP Objectives and Core Principles

GAAP represent objectives and guidelines for financial statements and reporting calculations. There are three major sets of rules covered in GAAP: basic accounting principles and guidelines, detailed standards of the FASB, and generally accepted industry practices.

For companies and non-profit organizations, the broad goals of GAAP are to provide objective, clear information in financial statements and reporting that will be useful to investors, lenders, and others. When it comes to financial reporting by government agencies, there is an additional goal of holding governments accountable.

GAAP objectives cover:

• Recognition: What should appear on financial statements, such as liabilities, assets, expenses, and revenues
• Measurement: What amounts should be reported in each item that is included in financial statements
• Presentation: How line items, subtotals, and totals should be aggregated and displayed in financial statements
• Disclosure: What supplemental or explanatory information should be disclosed as part of a financial statement

Within the confines established by GAAP, auditors attempt to establish uniformity among the financial reports of publicly traded companies, although private companies often use GAAP as well. Through GAAP, investors can more easily compare and understand the financial health of different businesses.

There are 10 core principles that GAAP attempts to achieve:

1. Regularity
2. Consistency
3. Sincerity
4. Permanence of methods
5. Non-compensation
6. Prudence
7. Continuity
8. Periodicity
9. Materiality
10. Utmost good faith

This uniformity, predictability, and reliability in standards benefits investors, regulators, lenders, corporate managers, governments, taxpayers, and the accounting community. By creating a standard that companies must follow, GAAP makes it harder for companies to conceal damaging information, mislead regulators, or take other unethical actions in their financial reporting.

Other Accounting Rules

Accounting standards in the European Union and some countries in Asia are governed by the International Financial Reporting Standards (IFRS), which is governed by the International Accounting Standards Board (IASB), created in 2001. There has been collaboration between the IASB and FASB to align the practices of GAAP and IFRS. In 2002, both bodies signed the Norwalk Agreement, with the intent to work toward making their respective accounting reporting fully compatible.

The Bottom Line

Generally accepted accounting principles, or GAAP, are a uniform accounting system used by publicly traded companies in the United States when creating financial reports. GAAP is also used by many non-profits, private companies, and government entities. GAAP standards are set by the Financial Accounting Standards Board (FASB), which is an independent body of accounting professionals.

The goal of GAAP is to create a uniform system of financial reporting, which minimizes the potential for fraud or misleading financial statements. It is primarily used in the United States. Internationally, more than 160 countries use IFRS (International Financial Reporting Standards) as their accounting method. Companies that do business both in the U.S. and internationally may have to prepare financial statements according to both sets of accounting standards.