How to understand GAAP (Accounting Standards or principles) – Business Finance 101

Business Finance 101 – Key business financial ratios to give you insight to the financial health of the business?

When we do accounting (which is recording the monetary values of financial transactions) we need to understand GAAP which are the Accounting Standards or Principles as part of business finance. These are general guidelines or rules and concepts that have been developed over many decades that apply. These are the groundwork on which more detailed, complicated, and legalistic accounting rules are based.

In Australia. The Australian Accounting Standards Board (AASB) uses the basic accounting principles and guidelines as a basis for their own detailed and comprehensive set of accounting rules and standards.


Definition of GAAP

The phrase “generally accepted accounting principles” (or “GAAP“) consist of three important sets of rules:

  1. basic accounting principles and guidelines,
  2. detailed rules and standards issued by AASB, and
  3. the generally accepted industry practices.

Each year, when a company distributes its financial statements to the owners or the public, it is required to follow generally accepted accounting principles in the preparation of those statements. Further, if a company’s shares are publicly traded, federal law requires the company’s financial statements be audited by independent public accountants. Both the company’s management and the independent accountants must certify that the financial statements and the related notes to the financial statements have been prepared in accordance with GAAP.

Usefulness of GAAP

GAAP is useful because it attempts to standardise and regulate accounting definitions, assumptions, and methods. Because of generally accepted accounting principles we are able to assume that there is consistency from year to year in the methods used to prepare a company’s financial statements. And although variations may exist, we can make reasonably confident conclusions when comparing one company to another, or comparing one company’s financial statistics to the statistics for its industry. Over the years the generally accepted accounting principles have become more complex because financial transactions have become more complex.

The Accounting Standards (GAAP) are spilt into various categories eg “Statement of Cashflows”, “Construction Contracts” etc and a list with most recent updates/ pronouncements for Australia can be found HERE.

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