Without a common set of accounting rules, comparing two companies' financial statements would be meaningless — one could report revenue conservatively while another aggressively, and there'd be no way to tell the difference. GAAP solves this problem. Piper's Chapter 7 explains what it is, who created it, and who must follow it.
| Entity | Required? | Note |
|---|---|---|
| All U.S. public companies | YES — Required | SEC-registered — GAAP required by law |
| Companies seeking to go public (IPO) | YES — Required | Must present 2–3 years of GAAP financials in S-1 |
| Private companies (large) | No — Optional | Can use GAAP or modified basis; lenders often require it |
| Private companies (small) | No — Optional | Often use cash-basis or tax-basis accounting |
| Non-profits | No — Optional | Follow FASB ASC 958 (non-profit GAAP), not exactly the same |
| Foreign private issuers on U.S. exchanges | No — Optional | Can use IFRS instead of GAAP — SEC allows this |
| Dimension | GAAP (U.S.) | IFRS (International) |
|---|---|---|
| Used in | United States | 140+ countries (EU, UK, Australia, Canada) |
| Set by | FASB | IASB (International Accounting Standards Board) |
| Rules-based vs. principles-based | More rules-based — detailed bright lines | More principles-based — management judgment |
| Inventory (LIFO) | LIFO allowed | LIFO prohibited |
| Lease classification | Finance/Operating (ASC 842) | Single model, most leases on balance sheet (IFRS 16) |
| Revaluation of assets | Not permitted (historical cost) | Permitted for PP&E and intangibles |
Imagine two companies in the same industry. Company A counts a sale as revenue when the order is placed. Company B counts a sale as revenue when the product is delivered and the customer pays. At year-end, Company A might report $50 million in revenue while Company B reports $30 million — not because Company A is actually bigger or more profitable, but because it uses a different accounting rule. Without standardization, comparing financial statements would be a useless exercise.
This is exactly the problem GAAP is designed to solve. Piper explains the purpose clearly: 'The goal of GAAP is to make it so that potential investors can compare financial statements of various companies in order to determine which one(s) they want to invest in, without having to worry that one company appears more profitable on paper simply because it is using a different set of accounting rules.'
GAAP stands for Generally Accepted Accounting Principles. It is the framework of rules used to prepare financial statements in the United States. It covers everything from how to recognize revenue, to how to value inventory, to how to account for long-term debt. When you see a set of audited financial statements with the phrase 'in accordance with generally accepted accounting principles,' you know the company followed the same rulebook as every other U.S. public company.
GAAP is created by the Financial Accounting Standards Board, known as FASB (pronounced 'faz-bee'). FASB is a private, nonprofit organization established in 1973, funded primarily by accounting fees and recognized by the SEC as the authoritative body for setting U.S. accounting standards. When FASB issues a new standard — say, a new rule for how companies recognize revenue from contracts — all public companies must adopt it.
| Entity Type | Required? | Notes |
|---|---|---|
| Publicly traded U.S. companies | Yes — SEC mandate | All companies listed on U.S. exchanges (NYSE, NASDAQ, etc.) must file GAAP-compliant financial statements with the SEC |
| Private companies | Not legally required | But many follow GAAP anyway because lenders, investors, and acquirers expect it. Banks often require GAAP financials as a loan condition. |
| Government entities | Yes — but different GAAP | Federal, state, and local governments follow GAAP created by the Governmental Accounting Standards Board (GASB), a separate body with different rules |
| Non-U.S. public companies | May use IFRS instead | International Financial Reporting Standards — used in most of the world outside the U.S. Similar in principle, different in some important details |
The United States uses GAAP. Most of the rest of the world uses IFRS (International Financial Reporting Standards), maintained by the IASB (International Accounting Standards Board). The two systems agree on most fundamentals but differ on some significant rules — particularly around inventory accounting (LIFO is permitted under GAAP but prohibited under IFRS) and the treatment of certain financial instruments. When analyzing a foreign company, always check whether it reports under GAAP or IFRS.
GAAP doesn't just tell companies which numbers to report — it prescribes the rules for generating those numbers. It covers the major accounting decisions that would otherwise allow companies to manipulate their reported results:
GAAP sets the rules, but many rules involve significant management judgment. How long will this asset last? What percentage of receivables will go uncollected? Is this restructuring charge 'one-time' or recurring? Companies that push the boundaries of these judgments can report dramatically different financial results than identical companies that apply the rules conservatively. Understanding GAAP doesn't just help you read financial statements — it helps you identify when the rules are being applied aggressively.
Every lesson in this curriculum, from the balance sheet to the cash flow statement to depreciation and inventory accounting, rests on specific GAAP rules. When you understand why a rule exists — what problem it solves — you can apply it analytically, not just mechanically.
For example: GAAP requires historical cost for asset valuation (not current market value) because historical cost is objective and verifiable — it's the actual price paid, provable by a receipt or contract. Current market value is subjective and could be manipulated. Once you understand why historical cost was chosen, you also understand its limitation: a piece of land purchased 30 years ago may be worth 10× its recorded value, and the balance sheet will never show that appreciation. This is not a flaw in GAAP — it's a deliberate trade-off of objectivity over relevance.
Piper makes an important point: GAAP creates the framework, but it doesn't eliminate judgment. Accountants and managers make dozens of decisions within GAAP's rules every reporting period. An investor's job is to read behind the numbers to understand whether the choices were made conservatively or aggressively — because two companies with identical economic realities can report very different numbers depending on how they exercise GAAP's judgment latitude.
Key Takeaways
What does GAAP stand for, and which organization is responsible for creating it?