What is GAAP Accounting and Do I Need it?
GAAP stands for Generally Accepted Accounting Principles.
It is a type of accounting standard that is generally considered more stringent than Pro Forma Accounting and is looked upon favorably by investors and banks. The goal of adhering to GAAP standards is to establish consistent and transparent financial metrics by which companies can be measured.
If your company is preparing for an IPO, GAAP standards are essential as the SEC requires GAAP accounting for any Initial Public Offering. But what about companies who are simply raising capital, looking at an exit, or looking to raise funds to acquire other smaller companies?
For those companies choosing to adhere to the GAAP principles (of which there are 10) may make investors look more favorably on your company.
First let’s review what the GAAP standards are:
10 Principles of GAAP
- Principle of Regularity
The accountant has adhered to GAAP rules and regulations as a standard over time and regularly. - Principle of Consistency
Accountants commit to applying the same standards throughout the reporting process, from one period to the next, to ensure financial comparability between periods. - Principle of Sincerity
The accountant strives to provide an accurate and impartial depiction of a company’s financial situation. - Principle of Permanence of Methods
The procedures used in financial reporting should be consistent, allowing a comparison of the company’s financial information. - Principle of Non-Compensation
Both negatives and positives should be reported with full transparency and without the expectation of debt compensation. - Principle of Prudence
This refers to emphasizing fact-based financial data representation that is not clouded by speculation. - Principle of Continuity
While valuing assets, it should be assumed the business will continue to operate. - Principle of Periodicity
Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its relevant accounting period. - Principle of Materiality
Accountants must strive to fully disclose all financial data and accounting information in financial reports. - Principle of Utmost Good Faith
Derived from the Latin phrase uberrimae fidei used within the insurance industry. It presupposes that parties remain honest in all transactions.
GAAP Compliance
All of these principles make sense from a transparency and honesty perspective. Ensuring that the spirit of the rules being adhered to, however, can be easier than actually being marked as being GAAP compliant. Larger corporations often adhere to GAAP requirements even when they are not required to by the SEC because their lending institutions request it and or simply look favorably upon it.
For investors looking at opportunities to grant funding to middle-market companies, GAAP accounting can make the difference in their interest level, their risk tolerance and their terms. Compliance With GAAP
To ensure GAAP compliance an external audit is conducted by the CPA of the investors. And many Banks require annual GAAP-compliant financial statements when issuing business loans.