GAAP: The “Rules” of Financial Reporting

The standard format for recording and reporting financial transactions is outlined in guidelines, or rules, called Generally Accepted Accounting Principles(GAAP). These guidelines are published by the accounting profession (with some gentle help from the U.S. government). They are intended to be the foundation upon which report readers can gauge a company’s progress, compare one company or one accounting period with another, and generally judge the financial effectiveness of its management efforts. As we’ve seen, it doesn’t always work out that way, but that’s not necessarily because the rules are flawed. The job of creating comparable accounting and reporting standards for businesses as widely varied as those operating today can be a daunting task for the folks who set the standards. The objective of each accounting rule is to record a transaction so that it makes economic sense for the company and for readers of the company’s reports. Yet to achieve that objective, accountants in two dissimilar companies might need to record the same trans-action differently.

We will devote a fair amount of time in this book to helping you understand how to read and use these primary financial statements, prepared in accordance with GAAP. We will also discuss other, special-purpose reports that company management may find more useful for internal purposes. Our comments will in all cases assume the use of GAAP, except where we specifically note exceptions.