If everyone involved in the accounting process followed their system, or no system at all, honestly, there’d be no way to tell whether a company was profitable. Most companies follow generally accepted accounting principles or GAAP; considerable tomes in libraries and bookstores are devoted to this topic. Unless a company states otherwise, anyone reading a financial statement can assume that the company has used GAAP.
Suppose GAAP is not the principle used for preparing financial statements. In that case, a business needs to make clear which other form of accounting they’re using and is bound to avoid using titles in its financial statements that could mislead the person examining it.
GAAP is the gold standard for preparing financial statements. A company that does not disclose its use of principles other than GAAP is legally liable for any misleading or misunderstood data. These principles have been fine-tuned over decades and have effectively governed accounting methods and the financial reporting systems of businesses. Different principles have been established for businesses, such as for-profit and not-for-profit companies, governments, and other enterprises.
GAAP are not cut and dried, however. They’re guidelines and, as such, are often open to interpretation. Estimates sometimes have to be made, requiring reasonable faith efforts toward accuracy. You’ve undoubtedly heard the phrase “creative accounting,” when a company pushes the envelope a little (or a lot) to make their business look more profitable than it might be. This is also called massaging the numbers. This can get out of control and quickly become accounting fraud, also called cooking the books. The results of these practices can be devastating and ruin hundreds and thousands of lives, as in the cases of Enron, Rite Aid, and others.