Basic Accounting: What is GAAP?

Definition, Principles, and Concept

GAAP, not the jeans, is the Generally Accepted Accounting Principles used to guide the accounting system we use today. Although not laws, the GAAP are as close as you can get, and the accounting industry follows a code of ethics that incorporates the use of the GAAP for all subsequent transactions. Now, on paper and in theory this sounds really good, doesn’t it? Does it actually work that way? No, and you have evidence to support this fact in the corporate scandals that we witness on a continual basis.

But let’s take a more in-depth look at the GAAP, why it originated, how it is supposed to be used, and how it relates to our world today.

The GAAP was not formally founded at all. During the course of history, since the Franciscan monk, Luca Pacioli wrote his math book that turned out to be the foundation for all accounting procedure, certain procedures and principles became widely used and were accepted by all businesses and accountants as the “norm”. From there, the generally accepted accounting principles just became a formal set of procedures everyone used.

Then came the Great Depression. Many companies and businesses went bankrupt. Upon closer examination and further scrutiny, it was discovered that these companies were not healthy, profitable companies. The reported profits and healthy operations were bookkeeping tricks, and that basically, their financial statements were lies. This was one of the lowest points in history for accountants.

What did we realize at this point? Many of the accountants involved in these fraudulent activities, testified to the courts, that these procedures were “generally accepted accounting principles”. At this juncture, the courts and many professionals realized something must change; there must be a better way to govern and regulate accounting activity.

During this time of transition and accountability, the formal accounting system became self-regulated and formed the American Institute of Certified Public Accountants. Although this governing body was not the ultimate solution, it was a beginning. Next came the Accounting Principles Board, then the Financial Accounting Standards Board (FASB) in 1973 and this is the governing body still in place today.

Is the system perfect? No, we still have much to correct and regulate; this is evidenced by the corporate scandals of today, such as HEALTHSOUTH and Enron. But you must look at the bigger picture: as accountability and financial systems grow and evolve, the accounting principles we use grow and evolve also. The personal accounting practices in use are extremely regulated and the principles in use are extremely regulated and work effectively. There is no widespread misuse of accounting procedures in our lower level accounting systems; the abuse is more prevalent in our corporate accounting departments under the direction of the corporate officers, such as the CEO, CIO, and COO.

The FASB works diligently to correct system abuses, incorporate ethical regulations across the board, and keep a watchful eye on all aspects of the accounting process. What can we, as citizens do? Very little in the broad sense; but educating ourselves about accounting principles, conducting our personal business within these guidelines and upholding moral and ethical financial practices will go a long way in ensuring that our corporate counterparts are held accountable as well.

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