Generally Accepted Accounting Principles (GAAP)
Written by Eddy Hood
What are the GAAP principles? The acronym GAAP stands for "Generally Accepted Accounting Principles." They are the principles of financial accounting that are established by the American Institute of Certified Public Accountants (AICPA). Certified public accountants (CPAs) must adhere to these principles of accounting when preparing financial statements. The GAAP favor the accrual method of accounting, wherein future credits (deposits) and debits (payments) are accounted for, over the cash method, wherein credits and debits are recorded only when they actually occur.
Cash vs. Accrual
Many municipalities and businesses are steering away from the basic accounting principles of the cash method in favor of the accrual method. From a bookkeeping standpoint, the accrual method is much more complicated, in that the accountant must recognize both transactions that have already occurred and transactions that are anticipated to occur to give a better idea of a company's overall worth, as opposed to just its actual cash value. In other words, if your small business is currently in the red because you've overdrawn your business accounts, but you are expecting a significant payment in the near future, the accrual method would take into account that payment, as well, and might reflect your business's standing as in the black. The main difference between these general accounting principles is that one reflects your actual cash balance, while the other reflects your company's overall financial condition. Both can work well for any business, but which one is right for you?
Why Some Businesses Use the Cash Method Anyway
While the generally accepted accounting principles favor the accrual method, the cash method might work better for you if you run a small business. You likely conduct your business on a cash basis with your vendors and employees and have no need to present a financial picture to any investors. You simply check your business's bank account information daily and keep your records neat and tidy. This method of accounting can save you both time and money. Using this method, a company might be able to report smaller revenue at tax time, saving money on taxes. It can save time, as well, simply because it's less complicated than the accrual method. Financial statements using the cash method of accounting are still valid, but if they are prepared by a CPA, the CPA cannot claim the statements are consistent with the GAAP.
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