What Is GAAP? Generally Accepted Accounting Principles Explained
By Markets & Investing DeskUpdated Nov 10, 2026
Definition
GAAP, or generally accepted accounting principles, is the set of rules and standards U.S. organizations use to prepare and report financial statements, set by the FASB and the GASB.
Key takeaways
- GAAP is the standard framework for financial reporting in the United States, often written as "US GAAP" to separate it from other national frameworks.
- The FASB issues and revises GAAP for businesses. The GASB covers state and local governments.
- The SEC requires U.S. publicly traded companies to file GAAP-compliant financial statements, and an external CPA firm audits that compliance.
- Private companies are not legally required to use GAAP, but lenders often require it in loan agreements.
- Most other countries use International Financial Reporting Standards (IFRS). The two frameworks differ on points such as LIFO inventory.
- Non-GAAP measures are allowed if they are clearly labeled and reconciled to GAAP figures.
GAAP stands for generally accepted accounting principles, the body of rules, standards and procedures that U.S. organizations use to prepare, present and report financial statements. In the United States, the Financial Accounting Standards Board (FASB) sets GAAP for companies and nonprofits, and the Governmental Accounting Standards Board (GASB) sets the parallel standards for state and local governments. When a U.S. public company reports revenue, profit or total assets, those figures are measured under GAAP unless the company explicitly labels them otherwise.
How GAAP Works
GAAP combines two things: authoritative standards written by policy boards, and widely accepted methods for recording and reporting transactions. Together they govern questions such as when revenue counts as earned, how items are classified on the balance sheet, and how large an item must be before it is material enough to disclose.
The FASB was established in 1973. Since 2009 its standards have been organized into a single source, the FASB Accounting Standards Codification, which it amends by issuing Accounting Standards Updates. The SEC holds legal authority over the reporting of public companies under the Securities Exchange Act of 1934 and recognizes the FASB as the standard setter.
Interpreting GAAP: the core principles
Accounting textbooks summarize GAAP’s foundations as a set of principles. Common formulations include:
- Consistency: the same methods are applied from period to period, and any change is disclosed.
- Accrual basis: revenue and expenses are recorded when earned or incurred, not when cash moves.
- Matching: expenses are recognized in the same period as the revenue they helped produce.
- Historical cost: many assets are recorded at what was paid for them, with specific exceptions for fair-value items.
- Materiality: information that could change a reader’s decision must be reported.
- Full disclosure: relevant facts appear in the statements or their notes.
- Going concern: statements assume the business will keep operating unless evidence suggests otherwise.
- Conservatism (prudence): when outcomes are uncertain, losses are not understated and gains are not anticipated.
These principles shape the three primary statements: the income statement, the balance sheet and the cash flow statement.
Who Must Follow GAAP
A company whose stock trades publicly in the U.S. must file regular GAAP-compliant statements with the SEC to keep its exchange listing. Compliance is confirmed through an auditor’s opinion issued by an independent CPA firm after an external audit.
Privately held companies have no legal obligation to use GAAP. Banks and other creditors, however, frequently require annual GAAP-compliant statements as a condition of a business loan, written into the debt covenants. That requirement leads many private U.S. companies to adopt GAAP anyway.
In the public sector, all 50 states follow GAAP as set by the GASB, and many counties, cities, towns and school districts must as well.
Why GAAP Is Important
The main purpose of GAAP is comparability. Picture two teams keeping score with different rules: one ignores penalties, the other counts only some kinds of points. The scoreboard would not tell you who is winning. GAAP puts every reporting company on the same scoring system, so an investor can compare one company’s margins or debt load with a competitor’s on an apples-to-apples basis.
That shared rulebook also supports trust in markets. If investors could not rely on reported figures, they would demand more compensation for risk or avoid investing, which raises the cost of capital and reduces activity. Statements prepared without GAAP are harder to compare even within the same industry.
Example of GAAP: Inventory Under LIFO and FIFO
Hypothetical example. A retailer buys 100 units at $10 each, then another 100 units at $14 each. It sells 100 units for $20 each, so revenue is $2,000.
| Method | Cost of goods sold | Gross profit | Ending inventory |
|---|---|---|---|
| FIFO (first in, first out) | $1,000 | $1,000 | $1,400 |
| LIFO (last in, first out) | $1,400 | $600 | $1,000 |
GAAP permits both methods, as well as weighted average cost. With rising purchase prices, LIFO assigns the newer, higher costs to cost of goods sold, which lowers reported profit and leaves older, cheaper costs on the balance sheet. Two companies with identical sales could therefore report different gross profit. GAAP’s consistency and disclosure principles require each company to state its method and keep using it, so readers can adjust their comparison.
GAAP vs. IFRS
IFRS are issued by the International Accounting Standards Board (IASB) and used in about 169 jurisdictions. GAAP is primarily a U.S. framework.
The inventory example shows one concrete difference: IFRS prohibits LIFO, while GAAP allows it. Both accept FIFO and weighted average cost. GAAP is also often described as more rules-based, with detailed guidance for specific situations, while IFRS is more principles-based and leaves more room for judgment.
The FASB and IASB began working to align the two frameworks in 2002. In 2007 the SEC allowed foreign companies registered in the U.S. to file IFRS statements without reconciling them to GAAP, removing a costly duplicate reporting step. U.S. domestic companies still report under GAAP.
Non-GAAP Measures
Companies may present figures that do not follow GAAP, provided they label them as non-GAAP and, under SEC rules, reconcile them to the most directly comparable GAAP measure. Common examples include adjusted earnings, EBITDA and free cash flow. A large majority of S&P 500 companies report at least one such measure alongside their GAAP results.
Hypothetical example. A company reports GAAP net income of $50 million. Its earnings release also shows “adjusted net income” of $85 million, adding back $20 million of stock-based compensation and $15 million of restructuring charges. The reconciliation shows exactly which expenses were excluded, and the reader can judge whether those costs are truly one-time or recur every year.
Management may argue that GAAP figures miss operational details. The same flexibility can make performance look stronger than GAAP results support.
Limitations of GAAP
GAAP improves transparency but does not guarantee accurate statements. Errors, aggressive estimates and deliberate manipulation can still occur within the framework, and an audit opinion provides reasonable assurance, not certainty. GAAP also allows choices, such as the inventory method or depreciation schedule, that affect reported profit. Historical cost can leave asset values well below current market worth, and differences from IFRS complicate comparisons between U.S. and foreign companies.
FAQs
Is GAAP the same as tax accounting?
No. GAAP governs financial statements for investors and lenders, while federal taxable income follows the Internal Revenue Code and IRS rules. A company's book income and taxable income often differ, for example because depreciation schedules allowed for tax purposes can differ from those used for financial reporting.
How often does GAAP change?
GAAP changes whenever the FASB issues an Accounting Standards Update. There is no fixed schedule. New standards typically carry an effective date and transition rules, so a company may apply a change in a later reporting period than the one in which it was issued.
The Bottom Line
GAAP matters most to investors comparing U.S. companies, to public companies that must file compliant statements with the SEC, and to private firms whose lenders require it. Its shared rules make figures comparable, but method choices such as LIFO or FIFO still affect reported profit. Readers should check each company's disclosed methods and treat non-GAAP figures with care, using the required reconciliation to see which expenses were excluded.
