The Generally Accepted Accounting Principles.
Every business needs to prepare accounts for one or several of many
reasons. One good example of these reasons is statutory obligations where
company law requires that all incorporated businesses must prepare and file
company accounts with Companies House and HM Revenue & Customs
within a specified period. Accounts are also necessary as a first step to
calculating the tax liability and preparing the tax return of a business.
Another reason could be for management information and efficient running
of a business. Senior managers of a business require information about past
performance and results in order to plan for the future.
If everyone involved in the process of accounting services followed their
own system, or no system at all, there will be no way to truly tell whether a
company was profitable or not. Most companies follow what are called
generally accepted accounting principles, or GAAP, and there are tons of
books and thesis in libraries and bookstores devoted to just this one topic.
Unless a company states otherwise, anyone reading a financial statement can
make the assumption that company has used GAAP.
GAAP is like the rule of the game if you like. They dictate how accounts are
presented in general. They also give guidelines to Ltd company accountants
or anyone else responsible for preparing business accounts on how
individual items in the accounts are to be presented. Company accounts are
generally accompanied by notes that are meant to help the user understand
their content better. The way these notes are prepared and their contents are
often dictated by GAAP.
If GAAP are not the principles used for preparing financial statements, then
a business needs to make clear which other form of accounting they have
used and are bound to avoid using titles in its financial statements that could
mislead the person examining it.
GAAP are the gold standard for preparing financial statement. Not
disclosing that it has used principles other than GAAP makes a company
legally liable for any misleading or misunderstood data. These principles
have been fine-tuned over decades and have effectively governed accounting
methods and the financial reporting systems of businesses. Different
principles have been established for different types of business entities, such
as for-profit and not-for-profit companies, governments and other
GAAP are not cut and dried, however. They are guidelines and as such are
often open to interpretation. Often times estimates have to be made due to
one reason or the other, and they require good faith efforts towards accuracy.
The phrase "creative accounting" is a well know terminology and refers to
the situation where a company pushes the envelope a little to make their
business look more profitable than it might actually be. This is also called
massaging the numbers. This can get out of control and quickly turn into
accounting fraud, which is also called cooking the books. The results of
these types of practices can be devastating and has been known to lead to
huge financial losses, as in the cases of Bank of Scotland, Anderson and