GAAP is the acronym for Generally Accepted Accounting Principles. Specifically, GAAP is a set of the accounting rules and procedures companies use to compile and report financial statements. The rules and procedures are determined by the American Institute of Certified Public Accountants and circulated by the Financial Accounting Standards Board. Although many small-business owners are aware of GAAP, they may not know how GAAP can directly affect their businesses.
Congress passed the Sarbanes-Oxley Act in 2002. Sarbanes-Oxley, or SOX, requires publicly held companies to prepare and report financial information contained in their financial statements according to GAAP guidelines. Moreover, SOX stipulated that publicly held companies and its officers were subject to sanctions by the Securities and Exchange Commission for the reporting of non-GAAP compliant financial statements for public consumption under Regulation G of the Community Reinvestment Act.
The SEC made its first Regulation G complaint under SOX in SEC vs. Safenet, Inc. in 2009. Without admitting or denying the SEC complaint that Safenet, a publicly held company, misclassified certain ordinary operating expenses as nonrecurring expenses in order to increase its earnings, the company agreed to pay a civil penalty of $1 million.
Privately-owned companies are exempt from SOX. However, private companies have stakeholders that may require GAAP-compliant financial statements. For instance, failure to provide GAAP financials could hinder your ability to get bank financing, because lenders frequently require GAAP financials. Other stakeholders requiring GAAP financials could include key account customers, government agencies and trade creditors whom you rely on for raw materials, supplies and services. Consequently, although you may be exempt from GAAP requirements as the owner of a private business, your stakeholders can make it difficult for you to conduct business without GAAP-compliant financials.
There are lesser degrees of GAAP reporting that may satisfy some of your more demanding stakeholders. However, your accounting software-generated financials probably won't make the cut without tweaking. A GAAP-experienced accountant can likely modify your computer-generated financials to become GAAP-compliant. As a practical matter, having a relationship with a CPA could be beneficial without having to pay for audited statements. There are three kinds of GAAP-compliant financial statements having increasing levels of assurance that are prepared by CPAs and acknowledged by the AICPA: compiled statements, reviewed statements and audited statements. CPA compiled financials are the least costly and may be appropriate for your business.
Becoming GAAP-compliant with your financial statements can't hurt your business and could likely be quite helpful. However, GAAP compliance is not the end of the saga. The wheels have been in motion to fold GAAP into the International Financial Reporting Standards since 2002. IFRS are the accounting standards used by the rest of the world for financial reporting -- 150 countries and counting. As the global economy becomes more integrated, businesses participating in the global economy will be expected to conform to IFRS guidelines. Hence, becoming GAAP-compliant is just the first step.