Accounting Principles

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What are '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 United States, companies must regularly file financial statements reported according to GAAP.

BREAKING DOWN 'Accounting Principles'

Accounting principles differ from country to country. Since accounting principles differ across the world, investors should take practice caution when comparing companies from different countries. The problem of differences in accounting principles is less of an issue in mature markets. Still, investors should be careful, since there is still leeway for the distortion of numbers under many sets of accounting principles.

The professional world of accounting is governed by general rules and concepts referred to as basic accounting principles and guidelines. Together, they form the groundwork for the more complicated, detailed and legalistic rules of accounting.

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 and the IASB

The FASB is a private sector group based in the United States. It 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).

Generally Accepted Accounting Principles

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.