Generally Accepted Accounting Principles
GAAP is a word we probably hear quite often in the business world. To know and understand it will be beneficial in your business conversations and to help you progress in your career.
What is GAAP? It's an acronym for the generally accepted accounting principles. It's a common set of accounting principles, standards, and procedures that are set by a governing board called FASB, which is the Financial Accounting Standards Boards. Think of it as the rules and standards for financial reporting, primarily in the United States.
Why do we need it? Well, we need to have a set of common rules, so that we have consistency — period-to-period and company-to-company — across different industries. If you're looking at two sets of financials from two different companies that are GAAP compliant, you know they're playing by, and reporting by, the same set of rules. These principles across the accounting standard give integrity to financial reporting.
Now, are there other standards out there? Yes! One of the biggest ones in the world is called IFRS, which is International Financial Reporting Standards.
The biggest question I get, or confusion that comes around these standards, is companies will often report GAAP as reported financials, and then you'll hear them say, “and our adjusted revenue”, or “our adjusted operating profit”, or “our non-GAAP measure was this.” Why do they do both? We need GAAP reporting to provide that standard set of reports that we know are consistent across all reporting, consistent over time, and consistent against other companies.
But sometimes what you have to report from a GAAP perspective may not be very indicative of the underlying performance of the company.
For example, let's say a company just lost a lawsuit. They have a $50 million bill they have to pay because they lost this big lawsuit. Well, if you looked at the profitability and it went down by $50 million, you might think that the company's really struggling. Management might say, “look, our GAAP standard is this number, but we're going to provide an adjusted number.” An adjusted number means “we don't think that that legal fee is indicative of the underlying performance of the company.” Our adjusted number is going to be a number that we provide that gives insight into what we believe is a more reflective number of performance.
So, it's not meant to create confusion. It's not meant to be sneaky. It's really meant to say, “look, here's the GAAP number — we're compliant — and you can compare it across different companies and in different places. And here's a number that we adjusted that we think is more reflective of the underlying performance.” The two of them combined together really provide clarity and understanding.
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