A:

Generally accepted accounting principles (GAAP) are controlled by the Financial Accounting Standards Board (FASB), a nongovernmental entity. The FASB creates specific guidelines that company accountants should follow when compiling and reporting information for financial statements or auditing purposes. GAAP is not law, and there is nothing illegal about violations of its rules unless those violations happen to coincide with other laws.

Nevertheless, most companies follow GAAP as though they were law. This is one of the chief examples of private businesses regulating themselves to help promote credibility within an industry. Even though the Securities and Exchange Commission (SEC) is responsible for setting accounting and reporting standards for companies whose securities are publicly traded, the SEC has chosen to delegate the responsibility of establishing standards to the private sector. The first body to assume this task was the Committee on Accounting Procedure, which was replaced in 1959 by the Accounting Principles Board. In 1973, the Accounting Principles Board was replaced after much criticism by the FASB.

Partially due to the influence of the SEC, IRS, the AICPA and other agencies, GAAP has become the universally accepted standard for accounting practices. Certified Public Accountants (CPAs) must be hired to audit accounting records and financial statements for publicly traded companies to ensure their conformity with GAAP. Failure to do so could violate lenders' agreements, cause stock prices to drop or ruin business deals. These auditing requirement create useful leverage for the FASB and GAAP.

There is less pressure on smaller, non-publicly traded companies to comply with GAAP. Nevertheless, many lenders or business partners still require that books be audited according to GAAP. Other businesses believe that the framework created by GAAP requirements make it easier to measure business performance.

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