Understanding Accounting Standards: Principles & Importance

An accounting standard is a standardized guiding principle that determines the policies and practices of financial accounting. Accounting standards not only improve the transparency of financial reporting but also facilitates financial accountability.

An accounting standard is relevant to a company’s financial reporting. Some common examples of accounting standards are segment reporting, goodwill accounting, an allowable method for depreciation, business combination, lease classification, a measure of outstanding share, and revenue recognition.

The Generally Accepted Accounting Principles (GAAP) is the primary accounting standard adopted by the U.S. Securities and Exchange Commission (SEC)Securities and Exchange Commission (SEC)The US Securities and Exchange Commission, or SEC, is an independent agency of the US federal government that is responsible for implementing federal securities laws and proposing securities rules. It is also in charge of maintaining the securities industry and stock and options exchanges. GAAPs were designated in the United States and form the basis of accepted accounting standards for preparing and reporting financial statements across the world.

The International Accounting Standards Board (IASB) provides rule-based and principle-based accounting guidelines for international companies that are based outside the U.S. The International Accounting Standards (IAS) are intended to achieve the uniformity of approach and identity of meaning. Accounting standards of a specific country are strongly influenced by its governance arrangement and tax policy.

Summary

• An accounting standard is a policythat defines the treatment of an accounting transaction in financial statements.
• Accounting standards provide guidance for companies to prepare and report useful financial statements in an accurate fashion.
• The U.S. Generally Accepted Accounting Principles (GAAP) is the bedrock of accounting standards, which now differ by country.

History of Accounting Standards

Before the development of accounting standards, each company developed and used their own approach to prepare and report financial information. In the 1930s, following the stock market crash, the American Institute of Accountants, in partnership with the New York Stock Exchange (NYSE)New York Stock Exchange (NYSE)The New York Stock Exchange (NYSE) is the largest securities exchange in the world, hosting 82% of the S&P 500, as well as 70 of the biggest, formed the Committee on Accounting Procedure (CAP), which recommended five broad principles of accounting.

To improve accounting practices, the Institute’s membership introduced an additional principle, making six in total. Progressively, the institute enacted the Securities Act of 1933The 1933 Securities ActThe 1933 Securities Act was the first major federal securities law passed following the stock market crash of 1929. The law is also referred to as the Truth in Securities Act, the Federal Securities Act, or the 1933 Act. It was enacted on May 27, 1933 during the Great Depression. ...the law was aimed at correcting some of the wrongdoings and the Securities Exchange Act of 1934, which saw the creation of the Securities and Exchange Commission (SEC). The SEC was charged with reviewing periodic filings of companies to ensure they adhered to its requirements, especially for full disclosure, adherence to proper accounting, and comparability.

Accounting standards exist to define the manner in which economic events are recorded and reported. They are also valuable to external stakeholders – such as shareholders, banks, and regulatory institutions – to ensure that relevant information is reported accurately. The technical conventions provide the boundaries between measures of financial reporting, as well as facilitate transparency and accountability.

IFRS vs. U.S. GAAP Accounting Standards

The International Financial Reporting Standards (IFRS) specifies how international companies should manage and report their financial statements and define different types of transactions with financial implications. It is a principle-based accounting standard whose foundations set the ground for investors and businesses to analyze financial records and make a decision.

The IFRS aims to ensure that the international markets across the globe follow a common set of standards for transparency, efficiency, and accountability. The element of openness that IFRS advocates for is important for businesses, as it enables investors to invest in companies with transparent business practices.

The standard IFRS requirements cover a wide range of financial statements, including the statement of cash flows, the statement of comprehensive incomeStatement of Comprehensive IncomeThe Statement of Comprehensive Income provides a summary of a company’s net assets over a given period of time. In other words, the statement, the statement of financial position, and the statement of changes in equity.

The U.S. GAAP Accounting Standards allow foreign public companies to be listed on the U.S. stock exchange without reconciling with the IFRS and the U.S. Generally Accepted Accounting Principles. The application and use of the initial set of accounting standards were credited to the American Institute of Certified Public Accountants (AICPA)’s Accounting Principles Board.

However, in 1973, the role was taken over by the Financial Accounting Standards Board (FASB). The SEC requires companies to meet all the provisions of the U.S. GAAP Accounting Standards to qualify for listing on the U.S stock exchange.

The SEC’s standard requirement facilitates the comparability of financial statements from different companies. Accounting standards also ensure credibility and robust economic policies based on credible and consistent information.

Financial Accounting Standards Board (FASB)

The Financial Accounting Standards Board (FASB) is a private non-profit organization that is responsible for creating and interpreting financial accounting standards in the United States. Its role extends to public and private companies. The organization is recognized as the principal party that sets accounting standards for public companies.

The FASB is headquartered in Norwalk, Connecticut, and it is run by a team of seven full-time board members. The chairman to the board is appointed by the Financial Accounting Foundation, which also performs an oversight function on the FASB.

The organization’s mission is to create and improve financial accounting practices for credible and accurate information to investors and other users. Also, it is mandated to educate stakeholders on how to comprehend and implement accounting standards effectively.

Related Readings

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To keep learning and developing your knowledge of financial analysis, we highly recommend the additional resources below:

• Analysis of Financial StatementsAnalysis of Financial StatementsHow to perform Analysis of Financial Statements. This guide will teach you to perform financial statement analysis of the income statement,
• Dodd-Frank ActDodd-Frank ActThe Dodd-Frank Act, or the Wall Street Reform and Consumer Protection Act of 2010, was enacted into law during the Obama administration as a response to the financial crisis of 2008. It sought to introduce significant changes to financial regulation and create new government agencies tasked with implementing the various clauses in the law.
• Assertions in AuditingAssertions in AuditingAssertions are claims that establish whether or not financial statements are true and fairly represented in the process of auditing.
• Types of SEC FilingsTypes of SEC FilingsThe US SEC makes it mandatory for publicly traded companies to submit different types of SEC filings, forms include 10-K, 10-Q, S-1, S-4, see examples. If you are a serious investor or finance professional, knowing and being able to interpret the various types of SEC filings will help you in making informed investment decisions.