GAAP accounting occurs when a business records financial transactions and issues financial statements that are in accordance with GAAP rules. GAAP is an acronym for generally accepted accounting principles; it is the most widely used accounting framework within the United States. This means that GAAP accounting is widely practiced within the United States. Outside of that geographic area, the predominant accounting framework is IFRS (international financial reporting standards), so IFRS accounting is found outside of the United States.
GAAP accounting covers many topics, including the following:
- Presentation of the financial statements
- Earnings per share
- Cash, receivables, investments, inventory, and fixed assets
- Liabilities, deferred revenue, contingencies, and debt
- Revenue recognition
- The cost of sales, compensation expenses, and income taxes
- Business combinations, consolidations, derivatives, fair value, foreign currency, related party transactions, and other topics
With its broad coverage of topics, GAAP accounting allows for the consistent reporting of financial transactions both within and across industries. This means that someone reviewing the financial statements of two or more competitors within an industry can be reasonably sure that these entities are reporting their results in approximately the same way.
The process of generating new GAAP standards is managed by the Financial Accounting Standards Board (FASB). Many of the core concepts used in GAAP were actually developed by earlier standard-setting bodies or through common practice.
An auditor will not certify the financial statements of a business unless they have been prepared using GAAP accounting, IFRS accounting, or some other accepted accounting framework. Thus, there is considerable pressure to use GAAP accounting if an organization needs to release its financial statements to outsiders, such as investors, lenders, and creditors.