Who Enforces GAAP?

Responsibility for enforcement and shaping of generally accepted accounting principles (GAAP) falls to two organizations: The Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC).

The SEC has the authority under securities law to both set and enforce accounting standards, while the FASB, an independent non-governmental body tasked by the SEC, can only set standards. It does so via the Accounting Standards Codification.

Understanding GAAP Enforcement

GAAP is not law, though violating GAAP can have costly ramifications. Errors and omissions can impact a company’s credibility with lenders, investors, and other parties who rely on financial statements for an accurate picture of a company’s finances. The SEC does not take a kind view of companies that fail to conform to GAAP. In 2019, it fined Hertz (HTZ) $16 million for reporting items that were not consistent with GAAP.

In 2016, the SEC hit Monsanto with an $80 million penalty for failing to accurately reflect the cost of rebates according to GAAP rules. It has also punished companies who put a shine on their earnings statements by highlighting non-GAAP financial measures “without giving equal or greater prominence” to comparable GAAP financial measures.

The FASB was given the task of establishing financial and reporting standards with its establishment in 1973. Between 1959 and 1973, the job belonged to the Accounting Principles Board under the American Institute of Certified Public Accountants (AICPA), but that role was relinquished as the SEC took a more active part in setting accounting standards, particularly on controversial issues where it disagreed with the board. The Committee on Accounting Procedure, which was also established under AICPA, set accounting standards from 1939 to 1959.

GAAP and Private Companies

Although they are not required to follow GAAP, private companies may choose to do so, especially if they wish to obtain loans or other financing, and if they have long-term plans to seek funding from private equity firms and institutionalize the company to be ready for public listing. The belief is that GAAP financial statements are widely understood by lenders and investors.

Private firms have alternatives to GAAP. AICPA has designed an accounting framework for small and medium-sized businesses. In addition, the FASB has established the Private Company Council as an alternative framework within GAAP.