Generally Accepted Accounting Principles

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Generally Accepted Accounting Principles

The standard accounting rules, regulations, and procedures used by companies in maintaining their financial records.

Generally accepted accounting principles (GAAP) provide companies and accountants with a consistent set of guidelines that cover both broad accounting principles and specific practices. For example, accountants use GAAP standards to prepare financial statements.

In response to the Stock Market crash of 1929 and the ensuing Great Depression, Congress passed the Securities Act in 1933 and the Securities Exchange Act in 1934. Among other things, these acts established a methodology for standardizing accounting practices among publicly held companies. The task of creating and maintaining accounting standards was handled by the American Institute of Certified Public Accountants (AICPA) from 1936 until 1973. In 1973, the responsibility was taken over by the Financial Accounting Standards Board (FASB), which was established the same year.

The Financial Accounting Standards Advisory Council (FASAC), which is composed of 33 members from both the public and private sectors, advises the FASB on matters that may affect or influence GAAP rules. These 33 individuals meet quarterly to discuss accounting issues and gather information, which they then present to FASB. Essentially, FASAC serves as FASB's sounding board. FASAC is overseen by the Financial Accounting Foundation, an independent organization whose 16-member board of trustees chooses FASAC's 33 members. The FASB is also monitored by the Corporation Finance division of the Securities and Exchange Commission (SEC). Among the organizations that influence GAAP rules are the AICPA and the Internal Revenue Service (IRS).

Other countries have their own GAAP rules, which are set by their versions of the FASB. For example, the Canadian Institute of Chartered Accountants (CICA) sets GAAP standards in Canada.

Publicly held companies are required to conform to GAAP standards. Specifically, the Securities Act and the Securities Exchange Act established a requirement that publicly held companies must undergo an external audit by an independent accountant once a year. In the 2000s, companies faced increased scrutiny in light of the widely publicized cases involving such major corporations as Enron and World-Com, along with the firm of Arthur Andersen, one of the world's largest accountancy firms. In the case of Enron, for example, the company manipulated its financial information to give the appearance that revenues were much higher than they actually were. After the company declared Bankruptcy in 2001, Arthur Andersen came under attack because its auditors had signed off on Enron's financials despite numerous misgivings. Andersen was found guilty of Obstruction of Justice by a jury in Houston, Texas, in June 2002.

In July 2002, President george w. bush signed the sarbanes-oxley Act, which established new regulations for accounting reform and investor protection. Among the provisions of Sarbanes-Oxley was the creation of the five-member Public Company Accounting Oversight Board, overseen by the SEC. Accounting firms that audit publicly held companies are required to register with the board, which has the authority to inspect audits. Sarbanes-Oxley also requires chief executive officers and chief financial officers of publicly held companies to provide a statement attesting to the veracity of their financial statements.

Further readings

Financial Accounting Standards Board Website. Available online at <www.fasb.org> (accessed August 11, 2003).

Securities and Exchange Commission. Available online at <www.sec.gov> (accessed August 11, 2003).

Schilit, Howard, 2002. Financial Shenanigans: How to Detect Accounting Gimmicks and Fraud on Financial Reports. New York: McGraw-Hill.

Squires, Susan E., et al. 2003. Inside Arthur Andersen: Shifting Values, Unexpected Consequences. Upper Saddle River, N.J.: Prentice-Hall.

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