Definition
GAAP (Generally Accepted Accounting Principles) is a standard framework of guidelines for financial accounting used in any given jurisdiction. Non-GAAP signifies the methods of financial reporting that, while legitimate, don’t adhere to the GAAP protocol. The differences between GAAP and Non-GAAP basically revolve around how certain financial transactions are recorded and reported, with Non-GAAP measures considered less strict or customary than GAAP.
Key Takeaways
- GAAP (Generally Accepted Accounting Principles) refers to a set of standardized rules and guidelines created by the Financial Accounting Standards Board for financial reporting. It is the authoritative standard of how businesses are to maintain their financial records and reports. This ensures consistency, clarity, and comparability among the financial statements of different businesses.
- Non-GAAP (non-Generally Accepted Accounting Principles), on the other hand, are any accounting practices not standardized by GAAP. These methods may provide valuable insights about a company’s operations and performance from a different perspective. Non-GAAP methods may be used to highlight a company’s earning potential by excluding certain one-time or non-cash expenses, such as restructuring or acquisition costs.
- The main difference between the two lies in their acceptance and use. While GAAP is widely accepted and used by companies for their official financial reporting to the public and regulatory bodies, Non-GAAP measures are often used internally by companies for managerial accounting and decision-making. However, companies that report using non-GAAP measures are required to reconcile these figures with their GAAP equivalents, so investors and stakeholders can make accurate comparisons.
Importance
GAAP (Generally Accepted Accounting Principles) and Non-GAAP are both crucial concepts in finance as they represent different methods of reporting financial information. GAAP is a standard set of accounting principles, procedures, and criteria that companies must follow when compiling their financial statements, promoting consistency and comparability across different entities.
Non-GAAP, on the other hand, allows companies to provide alternative insights into their financial performance by excluding certain items that are included under GAAP, such as restructuring costs or stock-based compensation. While GAAP reporting is considered more stringent and regulated, Non-GAAP can provide a more tailored view of a company’s financial health.
The vital importance of understanding GAAP vs. Non-GAAP lies in the ability to make informed decisions based on comprehensive and context-specific financial information.
Explanation
GAAP, an acronym for Generally Accepted Accounting Principles, is a collection of shared accounting standards and protocols that companies must follow when compiling their financial statements. These principles enhance consistency, comparability, and integrity in the financial reports across different companies, making it easier for investors, creditors, and other stakeholders to make well-informed decisions. One essential purpose of GAAP is to ensure that financial information is transparent and follows specific rules, thereby reducing the potential for deceitful or misleading practices.
However, companies sometimes use non-GAAP measures to supplement the GAAP measures. These are typically used to provide a potentially more accurate depiction of the company’s ongoing performance and financial health. Non-GAAP measures differ from the standard GAAP measures and are primarily used where GAAP metrics may not be fully reflective of the company’s operational reality.
Though less standardized, non-GAAP measures like adjusted earnings, free cash flow, and others are often used by management to help users better understand the business. It is important for stakeholders to understand both GAAP and non-GAAP presentations of financial data to get a comprehensive view of a company’s financial health and performance. However, they should also be cautious as non-GAAP metrics can be subjectively determined and could be used to paint a misleadingly optimistic picture.
Examples of GAAP vs Non-GAAP
Facebook: Facebook employs both GAAP and non-GAAP measures in their financial reporting. For instance, under GAAP accounting, Facebook reported 2020 full-year net income of $15 billion. However, using non-GAAP measures, which exclude certain expenses such as share-based compensation and amortization of intangible assets, the reported net income was higher at $
3 billion.Amazon: Amazon often uses non-GAAP metrics to communicate its financial performance. An example is when in 2016, Amazon reported an “Operating Income” figure that had been adjusted to exclude a variety of one-off costs: primarily related to stock-based compensation. The GAAP version of this figure was significantly lower than the non-GAAP figure because GAAP required those costs to be factored into the calculation.
Salesforce: Salesforce routinely publishes both GAAP and non-GAAP financial results. The difference often comes from expenditures related to stock-based compensation paid to their employees, among other adjustments. For example, for their Q1 2021 results, Salesforce reported a GAAP operating margin of5%, but when excluding stock-based compensations and similar expenditures from the calculation, the company reported a significantly higher non-GAAP operating margin of
2%. This provides a more optimistic view of its operational profitability.
FAQ: GAAP vs Non-GAAP
What is GAAP?
Generally Accepted Accounting Principles (GAAP) is a set of accounting standards that companies must follow when reporting their financial details. These standards promote consistency, reliability, and comparability of financial statements across different companies.
What is Non-GAAP?
Non-GAAP numbers are adjustments made to GAAP earnings, stripping out certain costs or revenue streams that a company believes distort its true operational performance. It’s a set of alternative accounting methods used by companies to provide a clearer picture of their financial performance.
What are the main differences between GAAP and Non-GAAP?
GAAP follows a strict set of rules and guidelines for financial reporting, while Non-GAAP may exclude certain items that a company believes should not be part of their normal business operations. However, what is excluded in Non-GAAP reporting can vary from company to company.
Is Non-GAAP better than GAAP?
Neither Non-GAAP nor GAAP is inherently better or worse than the other. Each has its own uses. GAAP is typically more strict and standard, which allows for easier comparisons between companies. Non-GAAP can provide additional context about a company’s financial health.
Why do companies use Non-GAAP measures?
Companies use Non-GAAP measures to provide a more accurate picture of ongoing operational performance. By excluding certain costs or revenues, these measures can help investors better understand the company’s financial health and growth prospects.
Related Entrepreneurship Terms
- Reconciliation
- Earnings Before Interest, Taxes, Depreciation, and Amortization (EBITDA)
- Pro-forma Financial Statements
- Standard Accounting Principles
- Non-recurring Items
Sources for More Information
- Financial Accounting Standards Board (FASB): This organization sets the Generally Accepted Accounting Principles (GAAP) for public and private companies, as well as nonprofit organizations.
- Investopedia: Investopedia offers a wealth of articles on various finance and investing topics, including the differences between GAAP and non-GAAP.
- U.S. Securities and Exchange Commission (SEC): This government agency regulates the securities industry and enforces the regulatory rules and standards, including those related to GAAP and non-GAAP.
- American Institute of CPAs (AICPA): The AICPA has numerous resources related to both GAAP and non-GAAP, as well as other accounting principles and standards.
