GAAP: Generally Accepted Accounting Principles

1929 Erskine 52 Royal SedanGenerally accepted accounting principles play a critical role in the financial accounting process.  They define the standards for external reporting, which produces greater uniformity in the accounting methods used by the variety of profit seeking entities in the economy.  Defining general reporting practices by a single set of standards facilitates meaningful comparisons of the financial performances of different companies.  In addition, the level of credibility in the financial statements is largely determined by the extent to which their preparation follows, GAAP.  For example, if neither Exxon or Amoco, two major oil companies, followed GAAP in the preparation of their financial statements, not only would it be virtually impossible to compare their levels of performance, because their measures of profit would be computed in different ways, buy neither measure of profit would be very credible.

While the development of financial accounting and the need for reporting standards can be traced back to the beginning of record keeping, perhaps the most important single even occurred in 1929 when the U.S. capital markets collapsed, and the great depression followed.  Many factors contributed to this dramatic economic downturn, and the lack of both credibility and uniformity in the financial accounting information available to investors and creditors did little to help the situation.

The SEC – In response to demands from the investing community for uniform and credible financial accounting information, in 1934 the U.S. Congress created SEC, which stands for Securities and Exchange Commission.  An agency of the federal government, the SEC was commissioned to implement and enforce the Securities Act of 1933 and the securities Exchange Act of 1934.  The Securities Act of 1933 requires that companies issuing securities on the public security markets file a registration statement with the SEC prior to the issuance.  The SEC Act of 1934 states that, among other requirements, companies with securities listed on the public security markets must annually file audited financial reports with the SEC.