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
The following three major financial statements are required under GAAP: The income statement. The balance sheet. The cash flow statement.
Which type of accounting reports must be prepared according to GAAP? ›
For companies that issue GAAP financial statements, financial reporting, often facilitated by efficient financial reporting software, includes the following: External financial statements (balance sheet, income statement, statement of cash flows, and statement of shareholders' equity)
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?
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 is the role of GAAP in financial reporting? ›
GAAP sets out to standardize the classifications, assumptions and procedures used in accounting in industries across the US. The purpose is to provide clear, consistent and comparable information on organizations financials.
What are the financial reporting requirements? ›
Here are common financial reports businesses need to put together to be in compliance, regardless of whether they are large or small.
- Income Statements.
- Cash Flow Statements.
- Balance Sheets.
- A balance sheet shows the assets, liabilities and equity of the business for a set period, usually for one quarter.
Generally accepted accounting principles, or GAAP, are standards that encompass the details, complexities, and legalities of business and corporate accounting. The Financial Accounting Standards Board (FASB) uses GAAP as the foundation for its comprehensive set of approved accounting methods and practices.
What is the most important GAAP principle? ›
The objectivity principle is one of the most important constraints under generally accepted accounting principles. According to the objectivity principle, GAAP-compliant financial statements provided by your accountant must be based on objective evidence.
What is the 2 main sources of GAAP? ›
2.10 There are two primary authoritative sources of generally accepted accounting principles (GAAP) for local governments:
- GASB – Governmental Accounting Standards Board.
- AICPA – American Institute of Certified Public Accountants.
GAAP has three main sections: the ten GAAP principles, standards set by the Financial Accounting Standards Board (FASB), and guidelines for individual industries.
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.
What is an example of GAAP? ›
For example, if a business owes $30,000 on a startup loan and holds $50,000 of working capital in reserve, GAAP rules require that the business report both of those numbers rather than subtracting the liability from the asset and reporting the net balance alone.
Which method is required by GAAP rule? ›
GAAP prefers the accrual accounting method because it records sales at the time they occur, which provides a clearer insight into a company's performance and actual sales trends as opposed to just when payment is received.
How to demonstrate knowledge of GAAP? ›
You should probably structure your answer around how you used GAAP to report various transactions on various aspects of the accounting cycle. Sample Answer - I have reported general transactions using ABC accounting software with emphasis to follow GAAP revenue recognition principles.
What are the 12 GAAP principles with examples? ›
12 basic principles of accounting
- Accrual principle. ...
- Conservatism principle. ...
- Consistency principle. ...
- Cost principle. ...
- Economic entity principle. ...
- Full disclosure principle. ...
- Going concern principle. ...
- Matching principle.
GAAP is required for all publicly traded companies in the U.S.; it is also routinely implemented by non-publicly traded companies as well. Internationally, the International Accounting Standards Board (IASB) issues International Financial Reporting Standards (IFRS).
Why must accounting reports be prepared in according to specific procedures such as GAAP? ›
Accounting reports must be prepared in accordance with specific procedures such as GAAP (Generally Accepted Accounting Principles) in order to ensure that the information presented is accurate, consistent, and reliable.
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.
Which of the following are required to follow GAAP? ›
Explanation: Generally Accepted Accounting Principles (GAAP) are a set of accounting standards used in the United States for preparing financial statements. These principles are required to be followed by all state governments and all local governments.
