Accounting Principles

Accounting principles are the rules and guidelines that companies must follow when reporting financial data. The common set of U.S. accounting principles is the generally accepted accounting principles (GAAP). To remain listed on many major stock exchanges in the U.S., companies must regularly file financial statements reported according to GAAP.

Accounting principles help govern the world of accounting according to general rules and concepts. They form the groundwork for the more complicated, detailed and legalistic rules of accounting. There are a number of principles, but some of the most notable include the revenue recognition principle, going concern principle, accrual principle and matching principle. 

Accounting principles differ from country to country. Since accounting principles differ across the world, investors should take caution when comparing companies from different countries. The issue of differing accounting principles is less of a concern in more mature markets. Still, caution should be used as there is still leeway for number distortion under many sets of accounting principles. U.S. GAAP is based on three important sets of rules: the basic accounting principles and guidelines, the generally accepted industry practices, and the detailed rules and standards that have been issued by the Financial Accounting Standards Board (FASB) and the Accounting Principles Board (APB).

The FASB is a private sector group based in the U.S. The group has based its own detailed and comprehensive accounting rules and standards on basic accounting principles and guidelines. The international counterpart of the FASB is the International Accounting Standards Board (IASB). Driven by the increase in global trade and finance, both organizations are working together in establishing a single harmonious set of international financial reporting standards (IFRS).

GAAP attempts to standardize and regulate the definitions, assumptions and methods used in accounting. This helps companies prepare consistent financial statements from year to year.

U.S. companies are required to follow GAAP when releasing financial statements to the public. If a company's stock is publicly traded, federal law requires that its financial statements are audited by independent public accountants. The company's management and the independent accountants must certify that the financial statements and related notes were prepared in accordance with GAAP.

Accounting data are not absolute or concrete, and standards such as GAAP are developed to minimize the negative effects of inconsistent data. Without GAAP, comparing financial statements of companies would be extremely difficult even within the same industry, making an apples-to-apples comparison hard. Inconsistencies and errors would also be hard to spot.