Generally Accepted Accounting Principles (GAAP) Definition

Tally Solutions | Updated on: August 10, 2022

Business documentation and reports are essential for business communication and evaluation. For businesses and accountants to understand each other, it is imperative that they follow similar processes to create their reports. A set of commonly accepted and followed standards and practices ensures that all the business documents are understood unambiguously by all the stakeholders. The Generally Accepted Accounting Principles (GAAP) is a standard that sets out principles, rules, and standards that are accepted and followed by public companies in the United States.

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What is Generally Accepted Accounting Principles (GAAP)?

GAAP, or  Generally Accepted Accounting Principles are a standard set of procedures and rules that govern the recording of accounting information to draw up financial statements. Standard principles are necessary for the totality, clarity, and consistency in the financial statements of all organizations. The GAAP is issued by the Financial Accounting Standards Board (FASB) and is followed by public companies in the United States. The GAAP standards are rules-based and also have ten tenets that underpin the standards. Internationally, most countries follow the International Financial Reporting Standards (IFRS) which is more principle-based than the GAAP. In recent years there has been an effort to evolve GAAP towards the IFRC.

Understanding GAAP

GAAP combines the commonly followed methods of accounting management and the standards set by the board to make all financial reports that follow the standards comparable and consistent. The IFRS is a separate set of accounting principles that is followed in 166 jurisdictions while the GAAP is the US equivalent. GAAP attempts to make the general definitions, rules, assumptions and methods used in accounting similar and standardized. The aim of GAAP is financial statements across companies and industries that are whole, consistent and comparable. This is essential for stakeholders and businesses to understand each other's financial statements and documents. Comparable and consistent reports make it easy to analyze and understand financial statements and reports.

10 Principles of GAAP

The ten principles that govern Generally Accepted Accounting Principles are:

  1. Principle of regularity: The accountant must follow GAAP rules and regulations as a benchmark.
  2. Principle of consistency: There must be consistent and uniform use of the GAAP principles across all the books of accounts and in all the accounting periods. Any difference should be explained in the financial statement footnotes.
  3. Principle of sincerity: The financial statements should be prepared in an unbiased and impartial manner.
  4. Principle of permanence of methods: Consistent usage of methods is a must for comparable statements.
  5. Principle of non-compensation: There should be no debt compensation in the reports and all the positives and negatives should be balanced.
  6. Principle of prudence: The accountant should only report fact-based items without resorting to speculation in the financial statements.
  7. Principle of continuity: All financial statements should be prepared with the intention that the organization will continue its operations.
  8. Principle of periodicity: The financial entries should be accounted for in the appropriate periods.
  9. Principle of materiality: There should be full disclosure of the financial information in the financial reports.
  10. Principle of utmost good faith: There should be complete honesty in the transactions.

Compliance With GAAP

A publicly-traded company in the United States must follow the rules imposed by the US Securities and Exchange Commission (SEC), which mandates following Generally Accepted Accounting Principles for financial statements. This is imposed through an auditors' opinion issued by a certified public accounting (CPA) firm that has performed an external audit. Though it is mandatory for publicly traded companies, GAAP is followed widely by most financial institutions in the US. While issuing loans, most financial institutions would require that the borrower submits GAAP -compliant statements. Investors are suspicious of non-GAAP compliant reports issued by companies as it makes a comparison or evaluation uncertain and difficult. If a financial report is non-GAAP compliant it should be mentioned on the report.

Where is Generally Accepted Accounting Principles (GAAP) used?

GAAP is mandatory for US public companies in the preparation of their financial statements so that they are comparable and consistent. It is also generally used and required by financial institutions and companies that submit documents to these institutions for loans etc. GAAP is issued by the Financial Accounting Standards Board (FASB).

Why is GAAP important?

Investors make vital decisions based on the financial statement released by companies. When these reports are prepared with consistency and to ensure standardization they are comparable. So, adherence to the GAAP standards builds investor trust that the reports are prepared with honesty and integrity. It is challenging to evaluate a company based on non-standardized reports.

What are non-GAAP measures?

Sometimes companies prepare statements that are not as per GAAP and this happens when the company is of the opinion that its unique situation cannot be expressed as per GAAP. They should disclose the special procedures and metrics and non-GAAP measures that were used instead of Generally Accepted Accounting Principles.

Easy and complete GAAP compliance

TallyPrime is designed to be GAAP compliant and ensures that your organization can prepare and present financial statements that are complete, cohesive, accurate and GAAP compliant.

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