Final answer:
Firms keep two sets of accounting books, one following the GAAP for financial statements and another for the IRS. GAAP ensures consistent and comparable financial reporting, which is vital for informing stakeholders and raising financial capital.
Step-by-step explanation:
Firms generally maintain two sets of books, one for the IRS and the other for the purposes of generating financial statements according to the GAAP (Generally Accepted Accounting Principles). The GAAP guidelines are used to ensure that financial statements are consistent, transparent, and comparable across different entities. This is in contrast to the reporting requirements for tax purposes, which can differ and sometimes require different treatment of revenue and expenses.
Understanding the difference between these two sets of books is important for various stakeholders, including investors, regulators, and lenders. For example, when a firm has a record of at least earning significant revenues, or even better, of earning profits, it can make a credible promise to pay interest, making it possible for the firm to borrow money. The firm has to choose between different sources of financial capital, like borrowing from a bank, issuing bonds, or issuing stock.