Small Business Questions & Answers


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Ask Toolkit About GAAP

by Numbers Numbskull | May 20, 2012

Subject :Accounting and Finances

Dear Toolkit,

My accountant told me that he follows GAAP (Generally Accepted Accounting Principles) when preparing my firm's financial statements. I suppose that should reassure me, but in light of the recent accounting scandals I'm wondering who decides on these principles and who enforces them.


Numbers Numbskull

Dear Numbers Numbskull,

GAAP (actually it's US GAAP) is an interesting conglomeration of standards for reporting the financial condition of a business in a manner that is, in theory at least, consistent and understandable. In short, US GAAP is nothing more than a rulebook for reporting on public companies in the US. The use of US GAAP is supposed to ensure that the stakeholders of a business and the regulatory authorities responsible for monitoring that business can rely on the accountant/auditor of the business to express its true condition according to the rulebook.

Keep in mind that the rest of the world doesn't always play by US GAAP rules. There are others such as UK GAAP and SWISS GAAP, etc. The global community also deals with the IAS/IFRS (International Accounting Standards/International Financial Reporting Standards) protocols and there can be considerable differences from GAAP in certain areas. IAS/IFRS became mandatory for all EU (European Union) companies starting in 2005. IAS/IRFS standards are broadly based on principles and encourage an auditor to focus on the spirit/intention of the law as well as its literal letters. US GAAP is more of a laundry list that seems to give an auditor a place to hide to avoid any independent thinking that might uncover a problem—a la the Andersen/Enron debacle ("But Judge, we followed the GAAP rules.").

US GAAP is run under the auspices of the FASB (Financial Accounting Standards Board) which is an independent body recognized as the authority in such matters by both the SEC (Securities and Exchange Commission, the enforcer for the public sector) and the AICPA (American Institute of Certified Public Accountants for the private sector). The FASB didn't just pop up last year in response to the Enron era accounting dilemmas. It came into being in the early 1970s and has evolved to its present state. Its US GAAP rulebook also has evolved, but not quite enough to keep up with the constantly emerging issues it has to deal with these days.

The US GAAP rulebook has become ponderous and complex over the years in response to the litigious nature of the business environment it was created to serve. . .an unintended consequence of good initial intentions. And it includes conflicting and foggy sections that have permitted some flagrant accounting abuses recently. Congress is currently eying dipping its collective toe into this sea of confusion to correct such gaping loopholes as those created by mixed-attribute accounting and asset re-characterization. The private sector is understandably wary of politicians mixing into the rulebook. Time will tell who wins this battle of who-gets-to-revise-the-rules.

But let's face it, the majority of the US GAAP rulebook isn't really relevant to a small business. However, give the FASB credit for forming a Small Business Advisory Committee in May 2004 in an effort to include this community in the development of relevant standards going forward. Today's entrepreneur needs an accountant who is a conscientious auditor, a good communicator and a pragmatic person savvy to the realities of running a small business rather than a technician who slavishly follows the GAAP rulebook.

Hopefully the FASB and IASB will successfully merge GAAP and IAS standards to form a unified system for the future. In the meantime, the bottom line is. . .don't be overly concerned with the letter of the law. Think globally and concern yourself with striving to conform to the spirit of the law and hope that the rule makers and rule revisers do likewise. Integrity and common sense should trump cookbook-style rules any day!