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About Generally Accepted Accounting Principles

Generally Accepted Accounting Principles (GAAP) is the standard used in the accounting profession and is designed to provide accurate data regarding economic resources and obligations to record, what changes to record, when to record, how to measure, what information to report, how it should be disclosed, and what financial statements to prepare. Sources of GAAP come from several different authoritative bodies including:

  • Financial Accounting Standards Board
  • Accounting Principles Board
  • American Institute of Certified Public Accountants
  • Securities and Exchange Commission (SEC)
  • Government Accounting Office

All publicly traded companies are required to file GAAP financial statements with the SEC. To ensure that the financial statements are in accordance with GAAP, each publicly traded company is required to have annual financial audits by an independent CPA firm.

Privately held companies are generally required to file GAAP financial statements by creditors or other third party stakeholders. As in publicly traded companies, privately held companies may be required to have annual independent audits or reviews.

Non-profits are required to have audits demonstrating compliance with GAAP principles to retain their non-profit status with the IRS.

Internal vs. External Users of Accounting Information

The decision makers, or users, of accounting information, can be divided into two major categories: external users and internal users. These user groups have somewhat dissimilar information needs because of their different relationships to the business enterprise providing the economic information.

External Users of Accounting Information

External users include actual or potential investors, creditors such as suppliers and lending institutions, and other users. Investors use accounting information primarily to help them make decisions about buying, selling, or holding a security. Creditors use accounting information primarily to evaluate a company's credit worthiness, which drives the amount of money a creditor will lend, as well as the interest rate to charge, depending on the perceived risk of default. This includes notes payable as well as suppliers extending payment terms on goods and services sold to the company. Other external users include financial analysts, advisors, brokers, underwriters, stock exchanges, taxing and regulatory authorities, labor unions, and the general public.

Standard External Financial Reports

There are a number of standard financial reports that a company provides for external users of accounting information. Examples of these reports and their uses are as follows:

Balance Sheet

The Balance Sheet summarizes a company's economic resources, economic obligations, and equity and their relationships on a particular date. The balance sheet is a snapshot of a company's financial position at a single point in time and is used to evaluate a company's liquidity, financial flexibility, and operating capability.

Income Statement

The income statement summarizes the results of a company's operations for the accounting period. This statement reflects a company's growth and how well it manages its costs to produce revenues compared to its competitors. Unlike the Balance Sheet, which is a snapshot of a company's financial position at a point in time, the income statement reflects activity that took place during an accounting period. For comparison purposes, two or more periods of income are generally reported on the income statement.

Internal Users of Accounting Information

Internal users are usually business enterprise managers who are responsible for planning and control of operations on a day-by-day and long-term basis. In contrast to external users, who primarily use financial statement information in their decision process, internal users may request any type of information that they need and that the accounting system is capable of providing to make decisions on internal operations.
Internal users make use of account information for many different purposes, including:

  • Evaluating managers and departments with respect to their cost control.
  • Budgeting for future periods.
  • Employee compensation analysis.
  • Making "Make" or "Buy" decisions for product inventory.
  • Benchmarking.

Standard Internal Financial Reports

Decision makers use management reports internally to review the operations of the organizations. Examples of management reports and their uses are as follows:

Accounts Receivable Aging

The primary use for this report is as support for the Accounts Receivable balance on the balance sheet. The Aging report is a primary source of the Accounts Receivable sub ledger detail and is used to support Cash Collection activities. In general, the weighted average age of receivables can provide insight into the quality of the Accounts Receivable asset and can provide insight into the prediction of future cash flows.

Inventory Balances

The Inventory Balances report provides management with a listing of the various types of -on-hand inventory. The most used inventory reports are for finished goods or for product inventory.

Product Sales

Sales reports are typically used by management on a daily basis, to review month-to-date and year-to-date sales. Sales reports allow managers to develop appropriate pricing and marketing strategies.

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