Generally accepted accounting principles (GAAP) – an overview

The Wall St. crash of 1929, as well as its aftermath, made very obvious the amount of manipulation and fraud taking place when it came to financial reporting. One of the main lessons learned from this infamous event was that there was a great need for effective and far-reaching forms of standardised accounting. Since then, there have been ongoing attempts made to just that and bring about a more uniform way of bookkeeping. This has led to the emergence of the GAAP – generally accepted accounting principles. Simply put, these are the authoritative standards and rules that govern financial accounting and reporting by businesses.

What is the aim of the GAAPs?

The overall goal is to provide an overview of the company’s financial performance over a certain time period, as well as its current financial position. Businesses across the globe follow general standards and guidelines when it comes to preparing financial statements. These standards vary from country to country, with each respective nation generally having both a private accounting sector and some state-led regulators. This then means that each country will have standards, methods, and regulations specific to them. In general, GAAPs can be seen as more of an umbrella term to cover essentially universal principles. This article provides an overview of the GAAPs particularly relevant to the United Kingdom. Anyone looking to do more in-depth and detailed reading on them can find them on the Financial Reporting Council website.

Implementing GAAPs – how and why?

Globally there is  a push to bring about greater uniformity when it comes to financial statements. Growing globalisation means there is a need for a common language to allow company accounts to be interpreted and understood all around the world, regardless of one’s business or accounting background. It is for this reason that the International Financial Reporting Standards (IFRS) have emerged. These were established by the International Accounting Standards Board (IASB) and continue to be maintained by this organisation. 

Small and medium-sized enterprises will sometimes lean towards following more simplified standards, in addition to any specific requirements advocated by their respective lenders and/or shareholders. Some countries have local, country-specific accounting principles that are then applied to regular companies, while larger and/or listed companies are expected to conform to IFRS. The idea behind this is that these financial statements are able to be understood internationally. Since 2005, all listed and grouped companies within the EU have been required to use the IFRS; something which then extends to all listed companies in the UK. Although their overall purpose is to improve the transparency of financial statements, they do not actually guarantee that the aforementioned statements are error-free, or indeed that they are not purposely missing certain information.

Are the GAAPs legally binding?

It can’t be stressed enough that they are still only ‘generally accepted’ accounting principles, standards, and methods. While there is no doubt that they help to bring about more transparency and understanding when it comes to financial statements, this does not necessarily guarantee that they will ensure that the respective financial statements will be free of mistakes or miscalculations. Such errors or omissions could be purely accidental or else have the intention of misleading the likes of potential investors.

GAAPs in the UK

In the UK it is the Companies Act 2006 that is the primary legislation when it comes to financial reporting. This act has integrated European law, which since 2005 has required that all listed European companies adopt the IFRSs. Another aspect of the Companies Act is that it requires limited companies to file their accounts and financial statements with Registrar of Companies, who in turn make them publicly available.

GAAPs in the UK have seen a greater movement towards the principles of the IFRS, and this standardisation has meant the differences between the two have been greatly reduced. Unlisted companies in the UK have the choice of whether they wish to report under IFRSs or under UK GAAPs. However the recent implementation of then new FRSs (see below) means that there are now even more similarities shared with IFRSs.

Old GAAPS vs. New GAAPs

Since 1 January 2015, there has been a change in the GAAPs in the UK. These developments have not affected companies previously subject to EU-IFRS laws and regulations. These companies continue to do so. On the other hand, companies who do not wish to follow the EU-IFRS standards can choose from FRS 100, 101, FRS 102, FRS 103, FRS 104, and FRS 105. The table below outlines the details of these various standards:

FRS 100 The financial reporting guidelines for any business entities preparing financial statements that fit with the legislation and accounting standards of the United Kingdom and the Republic of Ireland.  
FRS 101 Reduced Disclosure Framework – allows most subsidiaries and parent companies to use the recognition and measurement guidelines of the IFRSs in their respective financial statements, while not having to disclose everything that is required.  
FRS 102 As of 1 January 2016, this replaced the FRSSE (Financial Reporting Standard for Smaller Entities) and is mostly relevant for SMEs. It differs from its UK GAAP predecessor in that it includes requirements for the likes of goodwill, intangible assets, group benefit schemes, and deferred tax. Companies adopting these standards can take advantage of exemptions relating to the preparation of cash flow statements and related notes.  
FRS 103 These are accounting requirements specifically for entities with insurance contracts.  
FRS 104 Interim Financial Reporting - based on IAS 34 Interim Financial Reporting, this is intended for use entities applying both FRS 102 and 101.  
FRS 105 Micro-entities standard – very similar to the FRS 102 outlined above, however the accounting requirements are slightly altered to suit the legal requirements of very small companies (also known as micro-entities), who usually have more basic financial statements.  

A look at the evolution of the generally accepted accounting principles down through the years show that they have become more and more complex. This can be attributed to the fact that, in general, financial transactions have also become more complex. However, this has certainly not changed the fundamental purpose of the GAAPs. In fact, if anything these developments have made it increasingly important and it is very likely that they will remain an integral part of accounting and bookkeeping for the near future.

With Brexit and Britain’s departure from the European Union looming, questions have of course been raised about what effect this will have on GAAPs in the UK. There is a consensus that it is in the best interests of Britain and British companies to maintain use of the IFRSs. Firstly, the IFRSs are more than just European wide; they are seen as being the worldwide standard for the reporting of financial statements are now a requirement for public companies in 120 jurisdictions around the globe. It is for this reason that the UK should strongly consider continuing implement IFRSs as this would maintain its appeal as a place to do business to foreign companies and investors. In a post-Brexit Britain, remaining within the IFRS jurisdiction would allow the UK government to not only influence IFRS development, but also to decide whether some sort of endorsement process (like that enjoyed by the EU) is to be required in the UK.

Please note the legal disclaimer relating to this article.

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