Rooted in a framework pinpointing the objectives, characteristics, elements, and implementation of financial statements, Generally Accepted Accounting Principles (GAAP) are the bedrock of financial accounting for business entities. GAAP is the combination of accounting principles, standards, and procedures that governs the preparation of financial statements. The Financial Accounting Standards Board (FASB) is the organization that develops, establishes, and communicates standards of financial accounting and reporting, such as GAAP, in the United States. It works to ensure that the financial information provided is faithfully represented and relevant for users.
To ensure financial information is faithfully represented, defining accounting principles and concepts developed in GAAP provides a basis for financial reporting:
- The business entity concept, or the economic entity assumption, is one such concept. This concept requires the transactions of the business to be distinct and separate from those of the business owner.
- The cost principle mandates any business transaction—an economic event that affects the financial condition of an entity—be recorded at cost, or purchase price.
- The objectivity concept necessitates that all accounting records are free of bias.
- The monetary unit concept requires that all transactions are recorded in the U.S. dollar.
- The revenue recognition principle determines when revenue is recorded, that is, only when goods or services have been provided; cash does not have to exchange hands. Revenue includes the value received or to be received from customers, resulting from providing services or delivering goods.
- The accounting period concept denotes transactions should be recorded in the period in which they occurred.
- The matching principle is the concept that expenses incurred during a period match revenues earned during the same period. An expense is the consumption of a business's resources used to generate revenue or in the course of doing business.
While the FASB develops principles and communicates standards for reporting finances, the Securities and Exchange Commission (SEC) regulates financial disclosures and financial markets in the United States. All publicly traded entities are required to submit their audited financial statements to the SEC quarterly and annually. The SEC also monitors accounting standard–setting bodies such as the Public Company Accounting Oversight Board (PCAOB), the entity created by Congress as a component of the Sarbanes-Oxley Act of 2002. The PCAOB was created to oversee the audits of public companies to protect the interests of investors.