Accounting standards are the boundaries a company must work within when recording financial transactions from normal business operations. Generally accepted accounting principles (GAAP) are the standards for companies in the United States and most companies doing business in the United States. GAAP measures represent the accounting procedures a company specifically uses for certain items, such as the computation of net income or valuation of inventory. Publicly held companies tend to disclose the GAAP measures they use for their accounting documents and statements. A reconciliation between non-GAAP measures may also be on the disclosures for a company’s accounting books.
GAAP measures are typically among the most common accounting practices a company implements in its accounting system. GAAP covers many different types of business transactions and other technical financial situations a company may be in. Companies must be very particular about the measures they use to account for specific financial transactions. Disclosures are then necessary to inform outside stakeholders how the measures apply and why the company used them in the way they did. GAAP is not a list of rules; they are standards that require the use of sound judgment for recording and completing accounting activities.
Net income is one of the most common examples of a GAAP measure. Companies typically follow it as standard format to arrive at the bottom line, such as net operating profit. A standard format may be revenues less cost of goods sold, which results in gross operating profit; this figure less expenses represents net operating profit. This accounting measure can have many different pieces or parts to it depending on the company’s information. The standard measure exists so a company can use it as a starting point and build an income statement that closely resembles the standard accounting document for operating profit.
Inventory valuation represents another GAAP measure that applies to many types of companies, particularly those in manufacturing or retail. Here, a company needs to implement procedures and accounting policies that dictate what the value of items for sales are on the accounting books. Different inventory valuation methods exist, such as first in, first out or last in, first out. A company can select whichever methods it believes best represents its information on the accounting ledger and financial statements. The GAAP measure again is a baseline companies can follow in order to value inventory and create accounting documents; deviations from non-GAAP measures most likely require reconciliation to standard GAAP measures.