GAAP Basics

While many businesses assume that generally accepted accounting practices bind accountants and that these are inviolate, nothing could be further from the truth. Everything is subject to interpretation, and GAAP is no different. For one thing, GAAP 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 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 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 goods sold expense method to use and which depreciation expense method to use.

For other expenses and sales revenue, once a general accounting method has been established; there are no alternative methods. However, a business has a fair amount of latitude in implementing the methods. One business conservatively applies the accounting methods, while another applies the methods more liberally. The result is more diversity between businesses in their profit measure and financial statements than expected, considering that GAAP has evolved 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 publicly owned businesses’ financial reporting and accounting methods – the Securities and Exchange Commission (SEC).