This is a system
of accounting principle
s which are widely used in a given industry
. While legal mandate
s vary, observing a balance sheet that does not use these principles is good cause for inverstor
s to inquire why not.
GAAP provides a long lists of the way things should be done. Outside the United States, many prefer International Accounting Standards. These rules are not always as detail oriented, and specifically require auditors to respect the spirit as well as the letter of the rules.
Accounting standards are supposed to be as conservative as possible, providing rules more likely to understate than overstate profits. For instance, companies are required to value real estate they own at the purchase price rather than at the price they think it might be worth, to prevent artificial inflation of net worth. This can be a problem if real estate prices go down, and a much bigger problem if two corporations sell parcels of land to each other for inflated prices to improve their balance sheets. If each inflates the sale by the same amount neither is being cheated on the transaction.