Generally Accepted Accounting Principles (GAAP), Essay Example

GAAP stands for Generally Accepted Accounting Principles (GAAP). GAAP is a set of uniform minimum standards and guidelines that help us with the preparation of financial statements (Office of Financial Management). We need GAAP because without it there would be no clear guideline for companies to prepare their financial reports and as a result, everyone would follow different format and principles(Paul). This will more or less render the financial reports useless since most of the stakeholders are unable to understand and analyze the information.

GAAP helps us achieve several purposes. First of all, it ensures consistency which makes it possible to not only compare different companies regarding their financial performance but also the performance of a particular company over a given period of time. GAAP ensures that everyone speaks the same accounting language which makes it easier for different stakeholders to examine the financial statements.

Despite its several benefits, GAAP is not perfect. First of all, companies have choices regarding accounting principles and this flexibility may be exploited by some to present a distorted picture of the financial performance (Investopedia). Thus, it is no wonder that Corporate America has been rocked by several high profile accounting scandals since the beginning of last decade. Another problem with GAAP is that comparison between companies is not always possible if they may have used different accounting principles. For example, LIFO method of inventory valuation results in lower income and lower remaining inventory value usually as compared to FIFO method of inventory valuation. Another problem with GAAP is that it has its fair share of limitations when it comes to giving a realistic economic picture of a company. For example, a highly profitable company may look good on income statement but could be faced with bankruptcy due to lack of liquidity.Moreover, GAAP requires costs such as preparation and compliance costs which may impose undue burden on smaller companies.

References

Investopedia. (n.d.). Generally Accepted Accounting Principles – GAAP. Retrieved August 14, 2014. Web.

Office of Financial Management. (n.d.). Generally Accepted Accounting Principles. Retrieved August 15, 2014. Web.

Paul, S. (n.d.). General Accepted Accounting Principles or GAAP: What does it mean? Retrieved August 15, 2014. Web.