Keeping track of income and expenses is essential, even if you don't own a business. And if you do own a business, things get even more complicated. There are paychecks to issue, taxes to track, and subcontractors to pay out. All of these details are a whole lot less challenging when you hire an accountant to oversee them. However, it is still important to know a little bit about accounting yourself. Dig into the articles on this website, and you'll gain a better understanding of accounting principles, what services accountants really offer, and the benefits of hiring these professionals to assist with your finances.
Depending on the type of business you operate, you might find your account encouraging you to adopt what is known as GAAP. The Generally Accepted Account Practices were designed by the Securities and Exchange Commission to make sure all publicly traded companies were present their numbers in the same way.
GAAP has since expanded well beyond the world of stocks, and it's not unusual for a business accountant to work with any client to use its methods. Let's take a look at what using GAAP entails.
All GAAP-based accounting should be guided by four principles: objectivity, materiality, consistency, and prudence. Objectivity requires that all accounting must be conducted by parties without a stake in the numbers, such as accountants and independent auditors. Materiality means the scope of all reports should be constrained to information that's material to making decisions. Consistency means the same methods should always be used, such as always using the same currency denomination.
Prudence is arguably one of the trickier principles. In GAP, prudence means an accountant should always err toward understating successes and projections. Simply put, a prudent accountant doesn't engage in puffery, even if they're highly confident in the company's future.
One big aspect of GAAP is revenue recognition. Unless you're using a cash accounting method, something that's often frowned upon, there will always be gray areas about when revenue should be declared.
To solve this problem, GAAP strongly encourages the recognition of revenue once a particular party has performed whatever contract was attached to an arrangement. Notably, this means the entire cycle should be completed.
If you purchase inventory items, for example, the revenue involved will not be recognized until each item is sold. This means the cost and the sale price don't show up on the books until a sale is made. Doing so discourages questionable practices, such as purchasing massive inventories to drive down reported profits by increasing costs.
When Is GAAP Required?
The federal government does not always require GAAP outside of companies that issue securities. Across the U.S. states, there is a patchwork of regulations. Some states don't require GAAP at all, while others having varying degrees of compliance. Notably, the states that require complete compliance with GAAP are the minority. You and your business accountant should determine which framework is right for your organization based on the applicable state and federal laws and the industry you work in.