Accounting Under US GAAP: Key Principles and Examples of Change

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Sticking to accountancy guidelines can be quite difficult. However, they’re there to ensure businesses follow the same rules and get, broadly, the same treatment. For a lot of business owners and even beginner accountants, however, GAAP may seem strange. Moreover, they don’t know too much about it. This is especially the case when you look at its relationship with more complex accounting such as operating leases and the like.

So let’s explore US GAAP by looking at its key principles and intricacies, along with tips for sticking to it.

What Is GAAP?

GAAP stands for generally accepted accounting practice (or generally accepted financial practices). The Securities and Exchange Commission (SEC) has adopted GAAP as the standard governing accountancy. These guidelines include accounting principles and definitions of concepts. It also includes industry-specific rules.

What Is the Main Purpose of These Guidelines?

The main purpose of GAAP is to ensure that financial reporting is transparent and consistent. Imagine if every business used different accounting practices. It wouldn’t be fair for a start, would it? But it would also be incredibly difficult for accountants and other professionals to digest company accounts. These guidelines pull everything together.

What Are Their Key Principles?

You can find multiple lists regarding the GAAP principles. Some list ten or more principles, others fewer. However, there are both principles and constraints. The key principles are:

Cost

The concept of cost in US GAAP focuses on listed values. It strives to ensure they represent actual cost, not market value.

Revenue

Essentially, you must report revenue when you recognize it. This method varies, depending on whether you use cash or accrual methodology, but essentially it demands that you recognize revenue in a timely manner.

Matching

The concept of matching has to do with matching revenue and expenses. Basically, GAAP guidelines presume that expenses involved with revenue-producing activity are reported as the item is sold, instead of later on when the business is actually paid.

Disclosure

The disclosure principle is fairly straightforward. It basically asks for the right information to be included. Additionally, facts should be clearly stated so that anyone assessing the financial standing of the business should have all the information they need.

US GAAP Asserts Four Constraints

The constraints are:

Objectivity
Materiality
Consistency
Prudence

These are all pretty clear. They cover verifiable information, completeness of information, using the same accounting method year after year, and in not overstating assets or income.

Learn How to Account for Operating Leases Under US GAAP

It’s worth touching on operating leases under GAAP because it’s a great example of how US GAAP governs certain elements of accounting. It also is a good example of how rules under US GAAP change over time.

The accounting for operating leases under US GAAP changes significantly under the new lease standard, ASC 842. This new standard requires the vast majority of leases to go on the balance sheet.

Previously, businesses could expense operating leases. This change is intended to improve transparency in company financials. It also is an attempt to reduce off-balance-sheet financing, a type of accounting meant to hide significant liabilities.

You can see how US GAAP isn’t static, with new standards such as ASC 842 being brought in to improve elements of accounting.

US GAAP Ensures Transparency

As you can see, US GAAP has its purpose in keeping everything aligned and ensuring transparency. But changes do occur to standards when there are potential improvements to be made. It’s always worth keeping tabs on the changes to ensure you’re still compliant. For example, if you didn’t keep up with the ASC 842 change you might still be keeping leases off the balance sheet. This isn’t currently correct and might lead to problems down the line.