Businesses experience a variety of financial transactions as they work to meet customer demands. These include paying bills, receiving payments or borrowing money. Accountants record these transactions in the financial records. The Financial Accounting Standards Board, or FASB, creates generally accepted accounting principles, also known as GAAP, that outline the proper method for recording various transactions, such as revenues or pension liability. These recognized accounting standards provide important advantages, but also carry some disadvantages. As a small business owner, it is critical to know these standards and comply with them always.
Advantage: They Foster Transparency
One advantage of using GAAP involves the ease of understanding the financial statements. The accounting standards published by the FASB represent the required processes for businesses to follow. Financial statement users expect companies to follow the published accounting standards when creating financial statements. These users rely on the assumptions set forth in the accounting standards when interpreting the results reported. The users interpret the financial statements of different companies using the same assumptions. Once the users understand these assumptions, they use this knowledge when reading any financial statement.
Advantage: They Provide Guidance
Another advantage of using GAAP concerns the guidance provided to accountants. When financial reporting issues arise, the accountant may refer to GAAP to determine how to record the event. These issues include new accounting transactions arising from technology, such as internet sales, or new actions incorporated by the company, such as changes in pension plans. The FASB incorporates the needs of financial statement users as well as company feedback when creating accounting standards. This process allows the accountant to trust that the guidance provided through the accounting standard passed the rigorous process of ensuring that it meets everyone’s needs.
Advantage: They Provide a Benchmark
When businesses and industries use GAAP for bookkeeping, it is easier to see upward or downward trends and understand the bigger picture of how well or poorly a business is doing. Investors and small businesses can measure the performance of one company against another or against industry benchmarks and projections. This can help determine whether a business or industry is a solid investment, as well as when changes are needed to alter the trajectory of a business or industry to get things moving in a more positive direction.
Disadvantage: They Can be Inflexible
A disadvantage of using accounting standards involves the inflexible framework the accountant must comply with. GAAP is incredibly clear and specific about how things must be done in order to maintain accuracy and consistency. Each company faces different experiences with working to consistently meet GAAP standards. The accountant must make the company’s unique business and practices fit into the guidelines of the published accounting standards. This is more easily done with a hired accountant than in a business where the business owner is trying to meet GAAP without formal education.
Disadvantage: Compliance Can be Costly
Another disadvantage of GAAP has to do with the costs for the company to comply with the standards. New accounting standards require the company to consider the requirements of the standard, what actions the company must take to implement the standard and what the cost will be. In many cases, the company must design new procedures, which requires a large financial investment that includes employee labor costs, system upgrades and employee training.