Question

How and why might the importance of budget affect GAAP for external (general purpose) reports?

Answer 1

GAAP is a term that refers to a set of rules, standards and practices used throughout the accounting industry to prepare and standardize financial statements that are issued outside the company. These standards help investors and creditors better compare companies. Companies are expected to follow generally accepted accounting principles when they report their financial information.

GAAP affects the following activities:

1.Measuring economic activity

2.Disclosing information about an activity

3.Preparing and summarizing economic information

4.Recording measurements at regular intervals

The GAAP is the accounting rules used to prepare or standardize the reports of financial statements that include balance sheets, cash flow, and income statements from publicly and private companies. GAAP affects the financial reporting by measurement and disclosure principles.

Generally accepted accounting principles, or GAAP, essentially impact every item on a qualifying financial statement. Most companies and organizations follow GAAP when creating financial statements. In fact, publicly traded companies and local, state and federal governmental entities are required to stick to GAAP. However, private companies and other organizations are not necessarily required to produce financial statements that follow GAAP, so some financial statements are produced without adhering to those common standards.

The principles, standards and procedures that comprise GAAP will differ between governmental and nongovernmental entities. However, in all cases, GAAP dictates how financial statements are produced every step of the way, covering hundreds of different components, according to Stanford University's Cardinal Money Management website. GAAP guides accountants in how these components should be measured and in how they should be represented on a financial statement. It prevents an entity from simply choosing a measurement method that puts its finances in the best possible light.

Some of the principal components that GAAP covers on a financial statement are debt, costs, investments, revenue and sales, taxes, time periods, disclosure and profits. For instance, GAAP requires costs to be measured based on when the expense was made and not adjusted based on inflation levels or other factors. In that same vein, GAAP requires that costs be reported during the same time period as any related assets that were created through those costs. GAAP also directs how entities present themselves as a whole. For example, governments must use fund accounting, according to GAAP. Fund accounting requires that the government entity report itself through separate financial statements for each of the units within a government.

Financial reporting standards and requirements vary by country, which creates inconsistencies. This problem becomes more prevalent for investors when they are considering funding capital-seeking companies that follow the accounting standards and financial reporting of the country in which they are doing business.

The main difference between the GAAP and the IFRS is one of approach: The GAAP is rules-based while the IFRS is a principles-based methodology. The GAAP consists of a complex set of guidelines attempting to establish rules and criteria for any contingency, while the IFRS begins with the objectives of good reporting and then provides guidance on how the specific objective relates to a given situation.