What is GAAP?

Generally accepted accounting principles, or GAAP, are the accounting standards used in the United States, set primarily by the Financial Accounting Standards Board. They govern how transactions are recognized, measured and presented in financial statements.

Key principles

• Accrual basis: revenue is recognized when earned and expenses when incurred; see accrual accounting
• Matching: costs are recorded in the same period as the related revenue
• Consistency: methods are applied the same way from period to period
• Disclosure: significant matters and uncertainties are disclosed

Do small businesses need GAAP?

Not necessarily. Private small businesses are not generally required to follow GAAP unless a lender, investor, bonding company or other party requires it, often through reviewed or audited statements. Many use the cash or tax basis of accounting, sometimes with management adjustments.

Tax basis vs GAAP

Tax rules and GAAP differ. For example, tax depreciation methods, the treatment of meals and prepaid expenses and the timing of some income often differ. The IRS describes tax accounting methods in Publication 538. Businesses reporting under GAAP reconcile book income to taxable income on their returns.

Special purpose frameworks

Alternatives include the cash basis, tax basis and other frameworks designed for smaller entities. They can be simpler and still useful for owners and lenders.

When it matters

If you plan to raise investment, borrow significant amounts, bid on bonded contracts or sell the business, ask early which framework will be expected. Converting years of cash-basis books to GAAP later is expensive.

Our accounting services can prepare accrual or tax-basis statements. See EBITDA for a common non-GAAP measure.

Related terms

• Accrual Accounting: Accrual accounting records income when it is earned and expenses when they are incurred, regardless of when cash moves.
• EBITDA: EBITDA is earnings before interest, taxes, depreciation and amortization, a measure of operating performance.
• Prepaid Expenses: Prepaid expenses are payments made in advance for goods or services the business will receive in future periods.
• Tax Basis: Tax basis is the amount the tax law treats as your investment in property, used to figure depreciation and gain or loss.

Browse more definitions in the small business glossary.