Business Owners & Executives Alike Should Understand the Importance of Generally Accepted Accounting Principles aka GAAP
Business executives, particularly business owners, should understand the importance of generally accepted accounting principles (GAAP). While you don’t need to be an accounting expert, it is important to be able to determine whether GAAP is being applied properly and appreciate the role it may play in certain contract provisions.
What Are Generally Accepted Accounting Principles?
In basic terms, GAAP is a collection of widely-followed accounting principles, rules and standards for financial reporting. It is intended to ensure consistency in financial reporting, which makes it easier for investors to analyze the information presented and compare it between companies.
GAAP reflects established concepts, objectives, standards and conventions that have evolved over time to guide how financial statements are prepared and presented. GAAP addresses the following aspects of financial reporting, among others:
Recognition: What items should be recognized in the financial statements, such as assets, liabilities, revenues, and expenses
Measurement: What amounts should be reported for each element of the financial statements
Presentation: What line items, subtotals and totals should be displayed in the financial statements, as well the manner in which items are aggregated within the financial statements
Disclosure: What specific information is most important to the users of the financial statements. Disclosures serve to supplement and explain amounts in the statements.
The Financial Accounting Standards Board (FASB) sets GAAP for public and private companies and not-for-profit organizations. It is recognized by the Securities and Exchange Commission (SEC) as the designated accounting standard setter for public companies.
Similarly, Governmental Accounting Standards Board (GASB) establishes GAAP for state and local government. The international version of GAAP is the International Financial Reporting Standards (IFRS), which is set by the International Accounting Standards Board (IASB).
Last year, GAAP underwent its largest overhaul in several years. The FASB initiated the Accounting Standards Codification (ASC), which supersedes all prior standards. Prior to ASC, GAAP guidance was comprised of thousands of individual pronouncements. While there is now only one authoritative source, it is still a complex system of codification.
Should Your Company Use GAAP-Based Financial Statements?
If your business plans to seek outside credit or investment and/or your ultimate goal is to become a public company, GAAP-based financial statements will ultimately become a necessity. Because it can be expensive and cumbersome to switch accounting systems once a company has been operational for some time, it is wise to adopt a GAAP-based system from the outset.
Most creditors and investors require financial statements to be GAAP-compliant because it allows them to quickly and reliability assess the viability of your company. Internally, GAAP financials also you to readily compare your company’s financial performance with competitors and other similar companies. It also ensures that financials can be consistently compared year after year.
Because the SEC requires public companies to file GAAP-compliant financial disclosures, businesses considering an initial public offering or other means of going public must also move to GAAP-based statements. The switch can be burdensome. That is because GAAP must not only be applied going forward, but its impact on past financials must also be analyzed.
For investors, the lack of GAAP-compliant financial statements should raise concerns. While some companies use both GAAP and non-GAAP compliant measures when reporting financial results, non-GAAP measures should be clearly identified in financial statements and other public disclosures.
Do you have any questions? Would you like to discuss the decisions further? If so, please contact me, Fred Zemel, at 201-806-3364.
Understanding Chattel Paper: A Key Component in Secured Transactions
Using chattel paper to obtain a security interest in personal property is a powerful tool. It can ensure lenders have a legal claim on collateral ranging from inventory to intellectual property. To reduce risk and protect your legal rights, businesses and lenders should understand the legal framework. This framework governs the creation, sale, and enforcement […]
For years, digital assets operated in a legal gray area, a frontier where innovation outpaced the reach of regulators and law enforcement. In this early “Wild West” phase of finance, crypto startups thrived under minimal oversight. That era, however, is coming to an end. The importance of crypto compliance has become paramount as cryptocurrency has […]
Supreme Court and Title VII: Implications for Reverse Discrimination
Earlier this month, the U.S. Supreme Court issued a decision in Ames v. Ohio Department of Youth Services vitiating the so-called “background circumstances” test required by half of federal circuit courts.1 The background circumstances test required majority group plaintiffs pleading discrimination under Title VII of the Civil Rights Act to meet a heightened pleading standard […]
Special purpose acquisition companies (better known as SPACs) appear to be making a comeback. SPAC offerings for 2025 have already nearly surpassed last year’s totals, with additional transactions in the pipeline. SPACs last experienced a boom between 2020–2021, with approximately 600 U.S. companies raising a record $163 billion in 2021. Notable companies that went public […]
Short Form Merger: Streamlining the Process for Businesses
Merging two companies is a complex legal and business transaction. A short form merger, in which an acquiring company merges with a subsidiary corporation, offers a more streamlined process that involves important corporate governance considerations. A short form merger, in which an acquiring company merges with a subsidiary corporation, offers a more streamlined process. However, […]
Tariff Response Options for Small Businesses Facing Financial Distress
The Trump Administration’s new tariffs are having an oversized impact on small businesses, which already tend to operate on razor thin margins. Many businesses have been forced to raise prices, find new suppliers, lay off staff, and delay growth plans. For businesses facing even more dire financial circumstances, there are additional tariff response options, including […]
No Aspect of the advertisement has been approved by the Supreme Court. Results may vary depending on your particular facts and legal circumstances.
Sign up to get the latest from our attorneys!
Explore What Matters Most to You.
Consider subscribing to our Firm Insights mailing list by clicking the button below so you can keep up to date with the firm`s latest articles covering various legal topics.
Stay informed and inspired with the latest updates, insights, and events from Scarinci Hollenbeck. Our resource library provides valuable content across a range of categories to keep you connected and ahead of the curve.
Let`s get in touch!
Sign up to get the latest from the Scarinci Hollenbeck, LLC attorneys!
