GAAP or the Generally Accepted Accounting Principles, are accounting principles large businesses have to use in the United States.
GAAP is a set of standards for how to do bookkeeping and accounting, specifically how to prepare the financial statement, which makes up part of a business’ annual report.
GAAP dates all the way back to the 1930s.
Do I have to use GAAP?
Large companies in the US use GAAP, while large companies in the rest of the world tend to use the International Financial Reporting Standards (IFRS). Smaller companies generally have other standards, which will vary depending on what country you’re based in.
Usually, if you earn below a certain income threshold, you don’t have to do bookkeeping for your business at all. Although it’s still recommended—both to keep an overview of your finances and to establish good practices if you cross the threshold later.
If you earn above this threshold, you have to bookkeep all transactions in your company. Whether you have to submit an annual report, and what accounting standard you have to use, depends on your specific situation. If you’re unsure, you should reach out to an accountant or to the tax authorities.
Why is it important?
The GAAP principles are meant to ensure that a business’ accounting is correct and comparable with the accounts of other businesses.
Using a set of standards ensures that investors, banks, tax authorities, and auditors can easily review your bookkeeping and understand the financial history of a business.
They don’t have to master other bookkeeping principles to access the financial information, or convert the reports to another format in order to compare it with reports from another company.
To put it another way: With GAAP, third-parties can compare apples and apples, not apples and oranges.
However, it’s important to note that GAAP isn’t foolproof: Businesses can still make mistakes or —whether deliberately or by accident—make omissions that mislead third-parties.