Per generally accepted accounting principles (GAAP), companies are responsible for providing reports on their cash flows, profit-making operations, and overall financial conditions. The following three major financial statements are required under GAAP:
- The income statement
- The balance sheet
- The cash flow statement.
The income statement recaps the revenue earned by a company during the reporting period, along with any corresponding expenses. This includes revenue from operating and non-operating activities, allowing auditors, market analysts, investors, lenders, regulators, and any other stakeholders, to evaluate the company's financial cycle and results. It is sometimes referred to as the profit and loss (P&L) statement.
Key Takeaways
- Per generally accepted accounting principles (GAAP), companies are responsible for providing reports on their cash flows, profit-making operations, and overall financial conditions.
- The following three major financial statements are required under GAAP: the income statement, the balance sheet, and the cash flow statement.
- A company's balance sheet summarizes assets and sets them equal to liabilities and shareholder's equity. These three categories highlight what a company owns and how it finances its operations.
Balance Sheet and Cash Flow
A company's balance sheet summarizes assets and sets them equal to liabilities and shareholder's equity. These three categories highlight what a company owns and how it finances its operations. The balance sheet is an open snapshot of a company's assets and liabilities at a specific point in time.
GAAP also requires a cash flow statement, which acts as a record of cash as it enters and leaves the company. The cash flow statement is crucial because the income statement and balance sheet are constructed using the accrual basis of accounting, which largely ignores real cash flow. Investors and lenders can see how effectively a company maintains liquidity, makes investments, and collects its receivables.
The Securities and Exchange Commission
In the United States, publicly traded companies are regulated by the Securities and Exchange Commission (SEC). Since its inception, the SEC has delegated its accounting and financial reporting standards responsibilities to private-sector groups. The Financial Accounting Standards Board (FASB) is responsible for generating rulings under GAAP, and the SEC enforces those standards on the financial community.
Origins of GAAP
GAAP was ultimately created in response to the Stock Market Crash of 1929 and the subsequent Great Depression. Many economists believe that these historical events were at least partially the result of questionable reporting practices by some publicly-traded companies.
After the federal government started consulting with accounting groups to develop standards and practices for accurate and consistent financial reporting mechanisms GAAP began emerging with legislative measures like theSecurities Act of 1933and the Securities Exchange Act of 1934.
FAQs
What is an example of GAAP? The GAAP standards cover financial reporting as a whole. For example, GAAP stipulates how to file income statements, what financial periods to include, and how to report cash flow.
What financial statements does GAAP require? ›
The Four Financial Statements Required for GAAP Compliance
There are four different financial statements that GAAP requires companies to report: income statement (or P&L statement), balance sheet, cash flow statement/statement of cash flows, and the statement of owner's equity.
Which reports are required by GAAP? ›
The following three major financial statements are required under GAAP:
- The income statement.
- The balance sheet.
- The cash flow statement.
Principle of Regularity: An entity's accounting must strictly adhere to the GAAP standards. Principle of Consistency: The accounting practices are both consistent and comparable each reporting period. Principle of Sincerity: The organization's accountants are committed to accuracy and objectivity.
What is GAAP in financial reporting? ›
GAAP (generally accepted accounting principles) is a collection of commonly followed accounting rules and standards for financial reporting. The acronym is pronounced gap. GAAP specifications include definitions of concepts and principles, as well as industry-specific rules.
What 4 things does GAAP ensure? ›
What Are The 4 GAAP Principles?
- The Cost Principle. The first principle of GAAP is 'cost'. ...
- The Revenues Principle. The second principle of GAAP is 'revenues'. ...
- The Matching Principle. The third principle of GAAP is 'matching'. ...
- The Disclosure Principle. ...
- Why are GAAP Principles important?
The International GAAP® checklist: Shows the disclosures required by the standards. Includes the IASB's encouraged and suggested disclosure requirements under IFRS. Summarizes relevant IFRS guidance regarding the scope and interpretation of certain disclosure requirements.
What are financial reporting requirements? ›
Financial statements must follow certain presentation requirements including a classified statement of financial position (balance sheet) and minimum information on both the face of the financial statements and in the notes. A significant number of the world's listed companies report under either IFRS or US GAAP.
What is the US GAAP reporting standard? ›
GAAP is the set of accounting rules set forth by the Financial Accounting Standards Board (FASB) that U.S. companies are expected to follow when putting together their financial statements. The goal of GAAP is to ensure that a company's financial statements are complete, consistent, and comparable.
What type of accounting is required by GAAP? ›
Only the accrual accounting method is allowed by generally accepted accounting principles (GAAP). Accrual accounting recognizes costs and expenses when they occur rather than when actual cash is exchanged.
Principle of Consistency: Consistent standards are applied throughout the financial reporting process. Principle of Sincerity: GAAP-compliant accountants are committed to accuracy and impartiality. Principle of Permanence of Methods: Consistent procedures are used in the preparation of all financial reports.
How to ensure GAAP compliance? ›
Achieving GAAP compliance involves a thorough review and adaptation of your accounting practices. It starts with understanding the specific GAAP standards applicable to your business and conducting an internal audit of your financial reporting processes.
How many standards are there in GAAP? ›
There are 10 main principles (shown in figure 1), which can help you remember the main mission of GAAP.
What are the four financial statements of GAAP? ›
The four main financial statements include: balance sheets, income statements, cash flow statements and statements of shareholders' equity. These four financial statements are considered common accounting principles as outlined by GAAP.
What are the financial reporting standards? ›
The International Financial Reporting Standards (IFRS) are a set of accounting rules for public companies with the goal of making company financial statements consistent, transparent, and easily comparable around the world.
What happens if you don't comply with GAAP? ›
The FASB can set standards, which it does via the Accounting Standards Codification. GAAP is not law, though violating GAAP can have costly ramifications. The SEC has issued many steep fines for GAAP violations, including several famous recent cases, like those of Hertz and Monsanto.
Does GAAP require full disclosure? ›
As one of the principles in GAAP, the full disclosure principle definition requires that all situations, circ*mstances, and events that are relevant to financial statement users have to be disclosed. In other words, all of a company's financial records and transactions have to be available for viewing.
What are the four financial statements a company is required to prepare according to GAAP? ›
The four financial statements a company is required to prepare according to GAAP are: income statement, balance sheet, statement of cash flows, and statement of owner's equity.
Does GAAP apply to personal financial statements? ›
The American Institute of Certified Public Accountants' State of Position 82-1 also provide GAAP for personal financial statements. The processes involved in the preparation of these statements are discussed.
