7 Common GAAP Mistakes Every Company Should Avoid

Generally Accepted Accounting Principles (GAAP) provide a critical and common framework for preparing financial statements, to assist stakeholders understand a company’s financial results.

At the same time, following GAAP standards to a tee can be easier said than done, even for experienced accounting teams. When standards aren't properly followed, this can open the way for potential compliance issues, poor financial outcomes, inaccurate financial reporting, poor decisions, and reputational damage with lenders, stakeholders and others.

By being aware of the most common GAAP mistakes and how to avoid them, accounting teams can better adhere to these standards and avoid issues down the road.

Common GAAP Mistakes to Watch For

So, what are some of the most common mistakes accounting teams make when it comes to following the GAAP framework? From missing disclosures to revenue recognition errors, there's a lot that could go wrong.

1. Mistakes in Reporting Cash Flow

Cash flow reporting can be complicated, and when cash flow is misclassified, this can distort how stakeholders view the liquidity and performance of a company.

This might occur when activities are misclassified (operating, investing or financing) or when non-cash transactions (acquisition of assets by assuming debt, recognizing right-of-use assets and liabilities at commencement, and stock-based compensation) aren't taken into account or disclosed, so it's important to review your cash flow reporting carefully.

2. Revenue Recognition Errors

When contracts with customers take place over multiple stages, contain variable consideration (discounts or rebates), or change over time (price modifications), this can lead to confusion among accounting teams when it comes to when and how to record revenue.

Unfortunately, when this happens, you could end up with revenue recognition errors on your financial statements that may misrepresent your company's real financial situation.

3. Missing or Inadequate Disclosures

GAAP standards require accounting professionals to include detailed, thorough disclosures in the financial statements and the related footnotes, and there are strict guidelines regarding how these should be handled.

Unfortunately, missing or inadequate disclosures are extremely common, which could lead to challenges for stakeholders when it comes to understanding the financial statements.

4. Improper Expense Recognition

Expenses should be carefully documented and categorized following GAAP standards in financial statements. When expenses are not recorded, misclassified or otherwise treated improperly, this can skew a company's profits and mislead stakeholders.

Common errors include (a) capitalization of direct costs and overhead costs to inventory can be easily miscalculated or overlooked and not calculating or allocating costs correctly can cause major errors in inventory values and cost of goods sold, (b) capitalizing repairs and maintenance costs, and (c) failing to record accounts payable and other liabilities.

With this in mind, accounting professionals should take care to ensure that expenses are properly calculated, categorized and recorded in the correct period each time.

5. Income Tax Accounting Mistakes

Income tax can be another confusing area of GAAP compliance, even for experienced accounting professionals. When companies incorrectly compute current and deferred taxes or fail to disclose uncertain tax positions properly, this can create major problems down the road.

Fortunately, these kinds of mistakes can be easily avoided by maintaining a detailed tax calendar and performing a thorough tax provision analysis on a regular basis.

6. Issues with Compensation and Benefits

When accounting professionals fail to record bonuses, accrued vacation, paid-time-off, pensions or other employee compensation/benefits, this can result in valuation problems down the road.

These issues most often arise when dealing with deferred compensation plans, though they can be avoided when professionals take the time to carefully review compensation agreements and update their procedures annually to keep them up-to-date.

7. Depreciation

A company may incorrectly default to (a) using accelerated depreciation methods used for income tax purposes (such as section 179, which allows expensing of certain assets and bonus depreciation); and (b) using the tax life of 39 years to calculated depreciation for leasehold improvements.

However, GAAP stipulates that (a) these acerated methods do not comply with GAAP, and (b) leasehold improvements should be depreciated over the shorter of their useful life or the lease term.

How to Avoid These Mistakes

GAAP accounting errors are more than just a nuisance; they can skew how stakeholders value the company, which can lead to major reputational damage and loss of trust with the public. At the same time, because all publicly traded companies are required to follow GAAP standards, and most non-public entities choose to follow GAAP standards, these mistakes could even lead to restatements of financial statements, loan covenant violations, compliance issues and penalties.

However, many of the most common GAAP mistakes can be avoided with strict and clear internal policies in place. Many companies find success in using checklists to ensure that financial statements and disclosures meet all GAAP standards.

And because these standards can change from time to time, accounting professionals are encouraged to stay on top of the latest news from the Financial Accounting Standards Board (FASB) and update their processes and procedures as needed.

The Bottom Line: Meet GAAP Standards

When it comes to financial statements, GAAP is the gold standard, although it can be a difficult standard to maintain. Still, with proper training, consulting with an experienced accounting firm, utilizing GAAP guidance and research materials, or robust internal controls and regular audits, it is possible to avoid many of these common errors.

From there, with more accurate financial reporting, stakeholders and business leaders may be in a better position to make informed decisions. At the same time, companies can continue to build trust, provide transparency, and maintain accountability with stakeholders.

If you're looking for further guidance on complying with GAAP standards within your company, consult with an experienced accountant at LGT.

To learn more about LGT and how we can serve you, contact us here.