If financial accounting is going to be useful, a company's reports
need to be credible, easy to understand, and comparable to those of
other companies. To this end, financial accounting follows a set of
common rules known as accounting standards or generally accepted accounting principles (GAAP, pronounced "gap").
GAAP is based on some basic underlying principles and concepts such
as the cost principle, matching principle, full disclosure, going
concern, economic entity, conservatism, relevance, and reliability. (You
can learn more about the basic principles in Explanation of Accounting Principles.)
GAAP, however, is not static. It includes some very complex standards
that were issued in response to some very complicated business
transactions. GAAP also addresses accounting practices that may be
unique to particular industries, such as utility, banking, and
insurance. Often these practices are a response to changes in government
regulations of the industry.
GAAP includes many specific pronouncements as issued by the Financial
Accounting Standards Board (FASB, pronounced "fas-bee"). The FASB is a
non-government group that researches current needs and develops
accounting rules to meet those needs.
In addition to following the provisions of GAAP, any corporation
whose stock is publicly traded is also subject to the reporting
requirements of the Securities and Exchange Commission (SEC), an agency
of the U.S. government. These requirements mandate an annual report to
stockholders as well as an annual report to the SEC. The annual report
to the SEC requires that independent certified public accountants audit a
company's financial statements, thus giving assurance that the company
has followed GAAP.