Paying taxes is one thing, but calculating how much you owe the government can quickly become cumbersome if things aren't clear. The more standardized and streamlined the documentation and processing, the easier it is for entities to pay the right amount of taxes.
That's why certain governmental bodies and institutions emphasize the importance of GAAP rules and provide best practices to follow. In this article, we discuss these GAAP accounting rules. Furthermore, it also helps them know what they entail and some essential principles in these rules.
What are Generally Accepted Accounting Rules or GAAP Rules?
GAAP are the rules that the Financial Accounting Standards Board (FASB) issues to streamline procedures, principles, and methods to help companies succeed. GAAP rules are more common in the US, while internationally, they use the International Financial Reporting Standards (IFRS).
Most companies are expected to follow these rules to make it easier for entities to apply them. It can also help the IRS to audit them correctly. This allows these companies to keep consistency in their financial statements, making them easily comparable as they are complete.
You can, however, also use Pro Forma Accounting rules even if many governmental entities are following GAAP practices. The prime reason behind these practices is that they have been refined over a very long duration. You can use them to recognize revenue, enhance and classify your balance sheet, etc.
Ultimately, it is helpful because you can extract crucial information from these reports. You can then compare it with others to see the differences.
Why are GAAP Principles So Important?
Even if you don't follow these principles, they do help your reporting become more consistent and standardized. Even if it takes time for new and flourishing businesses, they should learn and implement these principles as much as they can for the long game. Furthermore, the more in line you are with these practices, the easier it is for the IRS to approve and for a tax professional to understand how you can improve them.
Who Must Follow GAAP Rules?
The US Securities and Exchange Commission (SEC) ensures that publicly traded companies abide by these rules if they want to remain so. One of the best methods to ensure this is being done is through a CPA firm.
On the other hand, companies that are not publicly traded are allowed to forego these rules or some of them as necessary. Nonetheless, many companies still require them from clients or contractors as it makes financial transactions more transparent.
GAAP vs. IFRS
Other than the US, where GAAP rules are prevalent, most international countries will use the IFRS that the International Accounting Standards Board (IASB) sets.
Following are some of the main differences between them.
- IFRS bans LIFO while GAAP allows it. LIFO is the Last-in, First-out inventory accounting method.
- Despite LIFO, both allow FIFO or first-in, first-out methods.
- They have converged more and more in recent years, allowing international companies working in the US to follow IFRS instead of GAAP accounting rules.
Are There Some Non-GAAP Measures that Companies Can Use?
There are still provisions within major GAAP rules that companies can not use if they deem it fit. The primary reason companies give in these cases is that GAAP rules arent as flexible and might deter their business practices.
In these cases, these entities have to disclose what methodologies they used and what metrics they followed, allowing the IRS to assess the overall report. Still, these measures can sometimes be a bit misleading and should be used with caution.
The 4 Primary GAAP Principles
As GAAP is a collection of essential and fundamental rules, this section will discuss four main ones.
The Cost Principle
The principle entails that you include the actual cost of items and services instead of mentioning their market value, as that may change. This approach will help you write the actual costs in most cases, no matter how small or inconsequential it may seem. This will also leave little to no room for error in your reporting.
The Revenue Principle
GAAP capitalization rules or revenue rules, asks you to report revenues as soon as you as an entity recognize them. Though this principle will cater for the way your company handles different revenue streams, it is still better to follow the best practices as much as you can.
The Matching Principle
In this principle, you match your expenses against generating revenue, making it easier to report them in their separate categories. In most cases, companies usually report against the invoice generated for a product or service. Still, it is intuitive to mention revenue against expenses to make it easier for companies to gain credits if done this way.
The Disclosure Principle
This is an important principle, requiring you to present all information clearly to someone assessing your financial status. The main draw behind this principle is to provide clear and concise, honest communication. This principle helps navigate different processes and makes it easier for companies or entities to benefit from the many levies the government allows.
Bottom Line
One significant aspect of following GAAP rules in the US and IFRS methodologies worldwide is to make reporting as transparent as possible. However, this doesn't mean your reporting will be devoid of mistakes or discrepancies. Certain unsavory accountants can always twist different figures to pay fewer taxes.
So, no matter which company uses how many portions of the GAAP rules, your assessment should be made carefully, especially if you are an audit or assessing 3rd party.
