GAAP vs Non-GAAPDifferences You Need to Know Between the Two!

Written By:
Adiste Mae

The Generally Accepted Accounting Principles (GAAP) is a set of accounting standards and rules followed by public companies in the United States.

When creditors and investors analyze the financial statements of companies, they must carefully study the non-GAAP exceptions applied because they might result in misleading figures due to the divergence from the accounting standards. 

GAAP

All over the world, there are accounting standards and practices that companies and accountants adhere to.

In the United States, companies – especially public companies – are required to follow the standards set forth within GAAP when preparing financial statements.

It was the Financial Accounting Standards Board (FASB), a non-profit, private standard-setting body in the United States that established GAAP.  

The aim of GAAP is to provide consistency, comparability, and clarity in the financial information provided to investors and creditors.

Through these, there is uniformity in accounting and this improves the credibility of financial reports.

This, in turn, will be able to help stakeholders make sound financial decisions and protect them from misleading reporting. 

When companies across different industries use GAAP, it allows for comparability.

It also allows auditors to verify the financial results thereby reducing the effects of window dressing by some companies to attract more investors. 

Non-GAAP

There are some instances where GAAP results are not sufficient to reflect the true standing of a company.

Even when GAAP is required by the SEC for public companies and some private companies adhere to it, they are still allowed to present their own accounting figures provided that the non-GAAP figures are disclosed.

A reconciliation between GAAP and non-GAAP figures must also be provided. 

Irregular and non-cash expenses are typically removed when non-GAAP reporting is used.

These expenses relate to activities such as restructuring, acquisitions, and one-time adjustments in the Balance Sheet.

By doing this, high-earnings volatility resulting from temporary conditions is smoothed out, thereby giving stakeholders a clearer picture of the financial standing of the business. 

One of the most common non-GAAP measurements is the use of EBITDA (Earnings Before Interest, Taxes, Depreciation, and Amortization).

By computing the EBITDA, companies are able to make reasonable comparisons between companies coming from different industries. 

While FASB has established GAAP, companies with adjusted financials (non-GAAP) are still governed by the SEC. 

Prevalence of Non-GAAP Use

Non-GAAP use is common across industries because there are instances when non-GAAP use is legitimate.

For such companies, they really may have one-time expenses, or the nature of their business is not supported by GAAP reporting. 

When presented with financial reports that are non-GAAP, investors and creditors should exercise caution when interpreting the results in the same way that they recognize GAAP figures to be more appropriate. 

The proper interpretation of non-GAAP figures by stakeholders is essential especially since they do not adhere to the standards set forth under GAAP. 

Conclusion

Even when companies use GAAP and non-GAAP figures, the results, in either case, are still important for investors.

However, when companies diverge from GAAP, the adjusted figures need to be carefully interpreted. 

An example of companies diverging from GAAP is those that consistently acquire smaller firms often exclude acquisition-related expenses.

However, this should not be overlooked as this is an ongoing expense and is considered to be material. 

Financial statements that are presented using GAAP tells an important story but sometimes, it does not tell the whole story.

This is why companies provide a supplemental report that is Non-GAAP to support important financial information of the company.