GAAP Basics

While many businesses assume that generally accepted accounting practices and inviolate bind accountants, nothing could be further from the truth. Everything is subject to interpretation, and GAAP is no different. For one thing, GAAP themselves permits alternative accounting methods to be used for certain expenses and revenue in certain specialized types of businesses. For another, GAAP methods require that decisions be made about the timing for recording revenue and expenses, or they require that key factors be quantified. Deciding on the timing of revenue and expenses and putting definite values on these factors require judgments, estimates, and interpretations.

The mission of GAAP over the years has been to standardize accounting methods to bring about uniformity across all businesses. But alternative methods are still permitted for certain basic business expenses. No tests are required to determine whether one method is preferable to another. A business is free to select whichever method it wants. But it must choose which cost of suitable sold expense method to use and which depreciation expense method to use.

One general accounting method has been established; there are no alternative methods. However, a business has a fair latitude in actually implementing the methods. One business conservatively applies the accounting methods, and another applies the methods more liberally. The result is more diversity between businesses in their profit measure and financial statements than one might expect, considering that GAAP has been evolving since 1930.

The pronouncement on GAAP prepared by the Financial Accounting Standards Board (FASB) is now more than 1000 pages long. And that doesn’t even include the rules and regulations issued by the federal regulatory agency that has jurisdiction over the financial reporting and accounting methods of publicly owned businesses – the Securities and Exchange Commission (SEC).