If you own a small business, now is the time to adapt to the top accounting practices of 2023, which means complying with the Generally Accepted Accounting Principles (GAAP).
What is GAAP?
GAAP is the gold standard for accounting in the United States. It’s a collection of ten fundamental accounting principles created to ensure financials are accurately reported and managed.² The Financial Accounting Standards Board (FASB) is a private body that sets the GAAP standards, and the complete handbook is around 2,700 pages.¹
Here are the ten principles businesses should follow:
- Permanence of Methods
- Utmost Good Faith
In the U.S., public companies must comply with GAAP standards to be listed on any U.S. stock exchange. Private businesses are not required to follow GAAP. The question is, should you and why? It depends on whether to follow the top accounting practices of 2023.
GAAP is a competitive advantage
Here’s what’s essential: Following GAAP standards shows clients, partners, and investors that your business’s financial statements can be trusted.
GAAP practices benefit your business by
- ensuring consistent and transparent accounting records;
- making it easy to compare records with other companies; and
- building reliable standards and practices for accurate financial forecasting.
Most large companies and organizations in the U.S. follow GAAP standards as a matter of best practice. If you want your small business to look big and show proof of credibility, it’s a must.
Know the GAAP “big four”
Small businesses can get along without GAAP-compliant accounting. I said, “Get along.” But are we talking about subsisting or thriving?
Here are the big four principles I want you to look at first.
Principle of Consistency
This principle states that when you have a fixed method for the accounting treatment of an item, you’ll continue to enter all similar items in the same manner into the future.
The principle of consistency applies to line items on all your financial statements, including
- balance sheets;
- cash flow statements; and
- AP/AR reports.
Following this principle is as simple as saying “yes” to extra credit. Going the extra mile. Following the rules.
Principle of Periodicity
Your accounting periods should be regular and consistent; each financial entry in your ledger should be recorded in the appropriate period of time.
Whether it’s week-by-week, month-to-month, or quarter-to-quarter, choose a period and stick to it. Consistent periods give internal and external shareholders the ability to share financial statements efficiently and plan accordingly.
If an entry spans multiple periods, then revenue should be split and recorded across the appropriate periods.
Principle of Prudence
Accounting entries should be timely and realistic. So, growing your business is not about tweaking your books. For example, you should never overestimate revenues recognized or underestimate your expenses.
Instead, proactively identify potential liabilities and adopt a conservative outlook on potential income.
If you account for cash assets that are actually available to you at the time of reporting, then you’re following the principle of prudence.
The principle of prudence will help keep you out of trouble, prevent cash flow issues, and keep forecasts realistic.
Principle of Materiality
Reports must fully disclose your monetary situation, even if it paints your business negatively. You must record all items that will materially impact decision-making.
How you determine material versus immaterial is where things get tricky.
What’s material for one business will be immaterial for another. It depends on your size and priorities. The issue of materiality is another GAAP standard that produces financial statements with information relevant to your company’s profitability and performance.⁴
Can your internal team support GAAP practices?
The goal of GAAP is to ensure your financial statements are complete, consistent, and comparable.
So, let’s look at the challenges:
- Consistency: Do you have a fail-safe system to review your bookkeeper’s work? Otherwise, inconsistencies will slip through.
- Periodicity: Choosing the best period (week-to-week, month-to-month) and adjusting for revenue-spanning periods are two different tasks. What if a different accounting period comes with tax benefits? Would anyone on your team know those benefits existed, and could your team adapt to new practices without disruption?
- Prudence: Do you trust your accounting team? What incentives are there to follow the rules? For a CPA firm, the incentive is not to get sued or have licensure revoked.
- Materiality: This is highly subjective and requires experience. Materiality is not for recent graduates or accounting associates. It’s for organized CPA firms.
Whether you build up an internal team or contact a CPA firm, GAAP (when executed appropriately) is a scalable accounting system that comes with big business benefits.
I want to get you on the right track with GAAP standards. Schedule a discovery call to chat with me today, and we’ll bring your business in line with the top accounting practices of 2023.
Jeremy A. Johnson, CPA
- FASAB Handbook of Federal Accounting Standards and Other Pronouncements, as Amended. June 30, 2022. The Federal Accounting Standards Advisory Board. Available from: https://files.fasab.gov/pdffiles/2022_%20FASAB_%20Handbook.pdf
- Generally Accepted Accounting Principles (GAAP) Guide Sheet. 2023. Ojp.gov. Available from: https://www.ojp.gov/sites/g/files/xyckuh241/files/media/document/GAAP_Guide_Sheet_508.pdf
- How we set IFRS Standards. Ifrs.org. 2023. Available from: https://www.ifrs.org/about-us/how-we-set-ifrs-standards/
- What is materiality in accounting, and why is it important? Business Insights Blog. Harvard Business School. 2021. Available from: https://online.hbs.edu/blog/post/what-is-materiality