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Understanding GAAP
So many contracts contain the phrase “in accordance with generally accepted accounting principles,” but do lawyers really understand what this phrase means or how it may affect a client in any given contract? Generally accepted accounting principles, often referred to simply as GAAP, constitute a body of rules, principles, and practices that is not as well defined as many people think, despite the fact that the fortunes of a company, its managers, and its investors can rise and fall depending on how GAAP is applied to determine the company's financial results. Before placing the above phrase in a contract, a lawyer should have at least a basic understanding of how that phrase may operate within the contractual terms.
U.S. GAAP is the term that describes the rules companies use to prepare financial statements ' the rules that tell companies how to account for transactions and disclose the results. When people refer to GAAP, they generally mean the body of accounting rules developed from a succession of different standard setters. Today, these rules have mostly been rolled into one primary authoritative source known as the Financial Accounting Standards Board (“FASB”) Accounting Standards Codification (“Codification”). However, not all of the rules that companies follow as GAAP are found in the Codification. The Codification excludes some followed guidance and even leaves some of the principles up to industry practice. For example, the very basic definition of an asset is not in the Codification. The term “asset” is defined in a FASB Concepts Statement, but FASB Concepts Statements have been excluded from the Codification and, thus, are non-authoritative literature that, nonetheless, are considered GAAP in the absence of specific guidance in the Codification.
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