Many business owners have heard the accounting term “GAAP” but don’t really understand what it means to their business. But GAAP is the basis for which some companies are required to report their financial information.
GAAP, which stands for “generally accepted accounting principles,” is a collection of principles, standards, and conventions used by the U.S. accounting community for reporting financial information. The American Institute of CPAs decides on the standards that make up GAAP rules.
All publicly held companies are required by federal and state securities regulations to report their financial statements in accordance with GAAP standards. And lenders and other stakeholders may also require privately held companies to report their financial statements in accordance with GAAP. Stakeholders can include customers who rely heavily on your business for supplies or services, governmental agencies that may award your company contracts, and other parties that have an interest in doing business with you. If you plan to sell your business eventually, maintaining GAAP-prepared financials, even if you are not required to, will boost your company’s value.
The easiest way to ensure your financial statements comply with GAAP, or “U.S. GAAP,” as it is sometimes called, is to hire a certified public accountant. A CPA can help you set up your accounting system to properly classify assets, liabilities, income, and expenses. In general, printing an income statement or balance sheet from your accounting software package is not enough to comply with GAAP. However, if you provide a good set of internally prepared books to your accountant, he or she can make the necessary modifications to make them GAAP-compliant.
In general, lenders and other stakeholders require GAAP-formatted financial statements at the end of your fiscal or calendar year, but it is usually not necessary to pay for audited financial statements. There are three kinds of financial statements recognized by the AICPA, each with a higher degree of assurance from your CPA. When prepared by a CPA or a GAAP-knowledgeable accountant, compilations and reviewed financial statements are most often formatted using GAAP but they don’t have the same assurances that audited financial statements carry.
Audited financial statements carry the highest assurance of the accuracy of data and compliance with GAAP. These statements are often required by lenders and governmental agencies that your company may do business with when it reaches a certain size. They can be quite expensive because the CPA firm conducting the audit must take many measures to reach the conclusion that all information is accurate and in GAAP compliance. While audited financial statements are expensive, they do assure a potential buyer of your business that there are no accounting surprises. If your company intends to become public in the future, three years of audited financial statements are required. If your company is large, your borrowing rate can potentially be lower if you provide audited financial statements to prospective lenders.
During the next few years, the United States will migrate from GAAP to the International Financial Reporting Standards, used by more than 150 other countries. Large public and multinational companies will be the first to change. Small and midsize private companies will still use GAAP for a number of years, so there will be plenty of time to make the migration. For the near and midterm, GAAP will continue to be the standard for accounting in the United States.
Sam Thacker is a partner in Austin, Texasbased Business Finance Solutions.