Whether you’re an E&P operator, part of a private equity firm, or a midstream company, you’re probably expected to be GAAP compliant. But fully understanding GAAP procedures can be a tall task— albeit an important one— especially if you don’t handle your own business’s accounting. Not complying with GAAP can lead to severe consequences for your business, so we’ve explained the 10 GAAP principles and what they mean, how these standards apply to your business, and what the requirements are to be GAAP-compliant.
The 10 GAAP Principles
Before we get into what each principle is, we have to recognize what GAAP means. GAAP, or Generally Accepted Accounting Principles, is a generally accepted set of standards, rules, and procedures established to regulate corporate accounting and prevent fraud. With GAAP, the financial reporting process is transparent and universal across all public companies. This makes it much simpler for an investor, lender, or competitor to compare and analyze a company’s financial records. The following are the 10 core principles that make up GAAP accounting.
1. The Principle of Regularity:
The first GAAP principle simply states that accountants must adhere to GAAP rules and regulations, meaning that they must recognize the other nine principles as a standard.
2. The Principle of Consistency:
The second principle is also fairly simple: accountants must apply consistent standards throughout the entire financial reporting process. This both allows financial statements for different reporting periods to be easily comparable and prevents accountants from creating misleading reports. These standards can be changed, though they must be fully disclosed and explained.
3. The Principle of Sincerity:
The third principle calls for accountants to create accurate and impartial financial reports, no matter the company’s financial standing.
4. The Principle of Permanence of Methods:
Similar to the Principle of Consistency, the fourth principle also dictates that financial reporting must use consistent procedures. But unlike the second principle, this principle requires the specific methods used to create financial reports to be consistent, rather than simply applying consistent standards to the entire reporting process.
5. The Principle of Non-Compensation:
The fifth principle states that all of a company’s financial information must be fully reported— whether positive or negative— without the expectation of debt compensation. An organization cannot avoid reporting negative performance by compensating a debt with an asset.
6. The Principle of Prudence:
The sixth principle means that accountants cannot present any data based on or influenced by speculation; all financial information must be presented factually as is.
7. The Principle of Continuity:
With the seventh principle, accountants must assume that the business will continue its regular operations when valuing its assets. Companies cannot value assets based on any future plans.
8. The Principle of Periodicity:
The eighth principle dictates that financial reports must be divided into a standard period of time, such as a fiscal quarter or year. Revenue and losses must be reported within their appropriate accounting period, and companies cannot decline revealing poor financial performance by skipping an established accounting period.
9. The Principle of Materiality:
Similar to the Principle of Non-Compensation, the ninth principle requires accountants to fully disclose all of a company’s monetary data in financial reports. An accountant cannot withhold information to make the business look more profitable than it is.
10. The Principle of Utmost Good Faith:
Lastly, the tenth principle works under the assumption that all parties involved are acting honestly and in good faith when negotiating deals and releasing financial reports.
Does my business have to abide by GAAP?
All U.S. publicly-traded companies must ensure their financial statements are GAAP-compliant. The Securities and Exchange Commission (SEC) makes this a legal requirement. This, however, does not include small, non-publicly traded companies.
However, it’s still in a small business’s best interest to comply. Lenders and creditors may not want to invest or loan if your company does not release GAAP-compliant financial statements. Also, not following GAAP rules makes it more likely for someone in your company to commit fraud, accidental or intentional. In addition, most financial institutions that issue loans will most likely require you to submit GAAP-compliant financial statements.
If your business uses International Financial Reporting Standards (IFRS) instead of GAAP, it still may not be reviewed favorably by U.S. lenders and creditors. The majority of the world uses IFRS, but the SEC has yet to switch to this international standard. Thus, most financial institutions abide by the system the SEC recognizes. If your small business practices IFRS, you should consider switching to GAAP if you wish to take out loans or seek an investor.
How do I stay GAAP compliant?
Organizations that are GAAP-compliant are required to provide several reports:
- An income statement, which is a report of a company’s revenues, expenses, and overall net income over a certain period of time.
- A balance sheet, which is a record of a company’s assets, liabilities, and equity at one point in time.
- A cash flow statement, which is a report of all the cash that was spent and generated over a certain period of time.
If you’re unsure of how these statements function, read our Basics of Accounting blog to obtain a better understanding of these terms and their specificities.
Each of these three statements must be fully GAAP-compliant. For publicly-traded companies, any violations of the 10 principles could result in costly fines from the SEC. Even if you aren’t part of a non-publicly traded company, violations can be a deal-breaker for lenders, creditors, and investors.
While abiding by these principles may sound simple on paper, there is an unfortunate reality of GAAP compliance. Without an accountant thoroughly trained in GAAP accounting, it’s incredibly easy to overlook violations. If you’d like to learn about some of the most common GAAP violations, Michigan-based firm Clayton & McKervey has a helpful article detailing where many companies go wrong in their accounting.
How can we help?
It can be incredibly challenging to maintain GAAP compliance in-house— that’s why PetroLedger has a team of over 100 professionals who have spent decades learning the ins and outs of GAAP accounting and are prepared to keep your financial statements consistently GAAP-compliant and ready for auditing.
Interested in switching to outsourced accounting? Contact our Sales Team for more information on how PetroLedger can amplify your bookkeeping and help your company fall into the GAAP.