When Was GAAP Established and Why Was It Needed?

Generally Accepted Accounting Principles (GAAP) represent a common set of accounting rules, standards, and procedures for financial reporting in the United States. These principles ensure consistency, comparability, and transparency in financial statements. Adherence to GAAP allows investors and other stakeholders to make informed decisions by providing a reliable framework for understanding a company’s financial health and performance.

The Impetus for Standardization

Before formal accounting standards, financial reporting in the U.S. was inconsistent, creating challenges for investors. Diverse and opaque accounting methods made it difficult to compare companies’ financial performance. This lack of uniformity led to investor confusion and distrust in reported financial information.

The period around the 1929 stock market crash and the Great Depression highlighted problems caused by this absence of standardized practices. Questionable accounting by publicly traded companies contributed to economic instability and loss of public confidence. The crisis underscored the urgent need for greater transparency and reliability in financial data to protect investors and restore faith in capital markets.

The Genesis of GAAP: Key Milestones and Organizations

The drive for accounting standardization gained momentum with legislative action in the 1930s. The Securities Exchange Act of 1934 empowered the Securities and Exchange Commission (SEC) to prescribe accounting principles for publicly traded companies. The SEC largely delegated this responsibility to the private sector, overseeing the standard-setting process.

Early efforts were led by professional accounting bodies, particularly the American Institute of Certified Public Accountants (AICPA). In 1939, the AICPA formed the Committee on Accounting Procedure (CAP) to address accounting concerns. The CAP issued Accounting Research Bulletins (ARBs) offering guidance on specific issues like revenue recognition and inventory valuation.

Despite its contributions, the CAP was criticized for its piecemeal approach and failure to develop a comprehensive framework. In response, the AICPA replaced the CAP with the Accounting Principles Board (APB) in 1959. The APB established and improved accounting principles, practices, and procedures, issuing Opinions that shaped GAAP.

The Evolution and Formalization of GAAP

Concerns regarding the APB’s effectiveness and independence led to its replacement. The APB’s part-time members and perceived susceptibility to influence prompted a call for a more autonomous standard-setting body. This led to the establishment of the Financial Accounting Standards Board (FASB) in 1973.

The FASB became the primary private-sector organization responsible for setting accounting standards in the U.S., recognized as authoritative by the SEC. It operates through a comprehensive and independent due process, which includes:
Identifying issues
Conducting research
Issuing exposure drafts for public comment
Holding public hearings
Deliberating stakeholder feedback

This transparent process ensures broad participation and consideration of diverse viewpoints before a new standard is finalized.

To simplify access to accounting guidance, the FASB introduced the FASB Accounting Standards Codification (ASC) in 2009. The ASC serves as the single source of authoritative U.S. GAAP for non-governmental entities, consolidating pronouncements into a topically organized structure. This codification reorganized existing literature, making it easier for financial professionals to research and apply the appropriate standards.