Why Is GAAP Important to Financial Statements?

by Sabah Karimi; Updated September 26, 2017

Generally Accepted Accounting Principles (GAAP) are the set of rules, methods, processes and procedures used by companies across all industries in order to prepare standardized financial statements. Both publicly traded and privately-held companies in the United State can use GAAP as part of their organization's accounting system to measure economic activities and disclose information about transactions and reports in an objective and unbiased manner.

Significance

Most companies in the United States adhere to Generally Accepted Accounting Principles to maintain consistency in reporting of financial information and to reduce the risk of fraud and error. The principles have been derived from traditional accounting systems and can be adapted to an organization's management style and industry. If GAAP did not exist, companies would not be able to provide accurate and consistent financial information to investors, creditors and stakeholders of a company.

Function

GAAP is not required by law, but almost all companies that adhere to GAAP guidelines can maintain consistent reporting processes and prepare accurate financial statements. Any accountants or financial analysts involved with the financial reporting of a company will need to understand and enforce the principles of GAAP; this helps set the standard for the organization and reduces the risk of tax problems and erroneous reporting of transactions across all departments.

Features

The principles of GAAP have been derived from traditional accounting methods, but many companies use adaptations of the basic principles to suit their particular business operations. Key principles of GAAP include: regularity or conformity to all rules and guidelines set forth by the company; sincerity, which ensures that all accounting representatives work in good faith and report items "as is"; permanence, which means a company should use the same reporting methods and protocol at all times so there is no disparity in future transactions; and continuity, which assumes that business operations will not be interrupted at any time in the future.

Benefits

Adhering to GAAP can help companies achieve their financial objectives by using accurate financial data, access important financial records and reports throughout a period, and maintain consistency when complying with tax rules and regulations. GAAP concepts can be interpreted and applied in different ways, but the core principles serve as a foundation for reporting, analyzing and drafting financial documents.

Identification

Companies that adhere to GAAP standards can offer unbiased and consistent information to third parties and reduce their risk of problems with the IRS. These companies typically report their financial information by disclosing all of the details about each transaction; use the same reporting methods, procedures and protocol each period; and enforce company-wide rules and regulations in order to maintain their own standards throughout each period.

About the Author

Sabah Karimi is a professional Web and print copywriter. She specializes in several niches including travel, fashion, beauty, health, fitness, lifestyle and small business. Karimi has an educational background in business administration and marketing from the University of Wisconsin-Platteville.