The term GAAP, or “generally accepted accounting principles,” refers to a set of accounting policies and procedures used in the formal compilation of financial statements. Some part of GAAP come from formal accounting standards from various boards and agencies, and some come from industry standards.
I don’t deal with GAAP much in my practice, though I do have 2 not-for-profit clients that use GAAP. None of my small business clients use it; they all use tax-basis accounting. Here are a few differences between GAAP and tax-basis accounting:
- GAAP requires the use of accrual-basis accounting. With tax-basis accounting, a business can use cash or accrual.*
- GAAP uses different depreciation methods from tax-basis accounting. In GAAP, the business can use any rational method, typically the straight-line method based on the estimated useful life of the asset. In tax-basis accounting, the business will use MACRS, where the depreciation method and useful life are determined by IRS charts.
A further discussion is beyond the scope of this article and is also beyond the scope of my area of expertise, since I don’t have much experience with GAAP beyond the 2 not-for-profits that use GAAP.
*-NOTE: One mistake people make in talking about tax-basis accounting is assuming that this automatically also means “cash basis.” Many tax-basis businesses do indeed use the cash basis of accounting, but it’s possible to be on the tax basis and use accrual accounting.