Accounting standards help businesses keep a standardized perspective on their finances. This guide will help you understand accounting standards.
With how diverse business is and continues to become, it is helpful for professionals to have some form of consistency in their business processes. Accounting, financial management and financial statements are unavoidable parts of business operations, and while they can seem baffling to navigate, there are organizational bodies whose sole job is to make accounting easier on all sides of a business.
Accounting standards are the way businesses maintain an overview of their finances. They boil down to a simple principle: a standardization of accounting practices across the U.S. and other countries. These standards, which are updated frequently by their governing bodies, help accountants, investors, and other key stakeholders regulate accounting processes and maintain financial documents.
The importance of accounting standards
While accounting itself has a long history, accounting standards' origins can be traced back to the aftermath of the Great Depression. They were initially proposed by the American Institute of Certified Public Accountants and the New York Stock Exchange in the 1930s, followed by the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission (SEC). From there, the different accounting standards categories and ruling bodies formed over time to appropriately cover the diversity of accounting professionals in the U.S.
The responsibility to understand accounting standards by category largely falls on accountants themselves. However, the differences between accounting standards categories are also necessary for banks, investors and government agencies to make informed decisions about where their money goes. If accounting information is irrelevant, outdated or inaccurate, then these entities cannot properly do their jobs, potentially throwing the whole financial subset of the business world off balance.
Categories of accounting standards
Accounting standards are not a one-size-fits-all set of rules. Financial needs and processes can vary from business to business, but accountants are bound by standards specific to the type of work they do and where this work is located. These are the three accounting standards professional categories relevant to U.S. businesses:
Private and publicly traded companies: In these companies, accountants use GAAP standards (Generally Accepted Accounting Principles), which are created and upheld by the Financial Accounting Standards Board (FASB). Only publicly traded and regulated companies are required by the SEC to follow GAAP, but private companies also follow these for internal management convenience. These principles include revenue recognition, balance sheet item classification and outstanding share measurements.
Global companies: With how connected our world is today, it is possible to have a business that has a global reach and is based in multiple countries. Accountants for these businesses use the International Financial Reporting Standards (IFRS). Developed by the International Accounting Standards Board, IRFS is designed to bring fairness to financial reporting documents for any business that operates globally.
- Government: Anyone working for state and local government bodies will use the government standards developed by the Governmental Accounting Standards Board (GASB).
While divergent in some areas of their financial and accounting guidance, FASB, IFRS and GASB have a common goal: to develop updated principles and standards that cover a wide spectrum of accounting tasks, such as assets, equity, revenue, expenses and liability. GAAP, for example, standardizes accounting related to the measurement of financial activity, disclosure of financial information, summarizing of financial information and recording of financial measurements.
This generous scope means standardization bodies frequently update, revise and add accounting standards to mirror the climate of the business world and its needs. However, given the rapid-fire pace at which these standards can be updated and revised, compliance relies on high-quality, ethical accountants, as the standards will be open to some level of interpretation. Again, it is the accountant's responsibility to be well versed in these standards and their updates.
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National accounting standards vs. global accounting standards
Now that it has become easier for businesses of all kinds to operate on a global scale, important questions arise about how to regulate, if at all, the financial side of international business. Accounting standards fall into these debates as professionals muse over whether or not global accounting standards are truly possible.
In the U.S., accounting professionals turn to the FASB, the organization that "establishes financial accounting and reporting standards for public and private companies and not-for-profit organizations that follow [GAAP]." Recognized by the SEC as the "designated accounting standard-setter for public companies," these bodies claim a national authority in the U.S. over the creation and updates of comprehensive accounting standards.
Especially in recent years, as businesses have gone global, there have been calls to shift from national standards to international accounting standards. This is where the IFRS, a U.K.-based organization of international accounting standards, comes back in. According to the IFRS website, "More than a third of all financial transactions occur across borders, and that number is expected to grow." IFRS proposes to address the complexity of transactions on an international scale by enhancing transparency, accountability, and efficiency in how accounting principles are created and distributed to a wider international business world.
IFRS acknowledges this is a difficult task: "Changing to IFRS Standards does not come without cost and effort. The companies reporting will generally need to change at least some of their systems and practices; investors and others using financial statements need to analyze how the information they are receiving has changed; and securities regulators and accounting professionals need to change their procedures."
It is true that any worthwhile change in the business world takes time and money. Some won't be ready to make that change, with a host of justifications for why not. Eleven countries, including the U.S., still have their own accounting standards. However, many countries, including all EU countries, have adopted IFRS standards.
What does this mean for financial accounting professionals in the U.S? According to Horngren's Financial & Managerial Accounting, the impact of converging the U.S. GAAP and the IFRS will be "limited." Managers and accountants still need to be aware of major changes, as they will impact how "internal managerial decisions are reported to shareholders and other external constituencies."
The differences of financial statements prepared under GAAP versus the IFRS are not substantially different. Though there are differences, they are "technical in nature," according to Financial & Managerial Accounting, and all mentioned accounting standards' managing boards and organizations have dedicated resources online and offline for navigating these technicalities.
The ever-evolving educational sector of the accounting profession relies on bodies like the FASB, IFRS, and GASB to employ diverse and educated individuals to determine accounting standards with accuracy and thoroughness. As time goes on, the accounting world might see a further convergence of the FASB's GAAP and IFRS. While the potential changes and costs that come with this shift might complicate the accounting and managerial professions for a time, in the end, the seamless integration of accounting standards should prove useful as businesses continue to operate internationally. In the meantime, the FASB of the U.S. and independent accounting standards boards of other nations are working to provide accessible accounting resources to businesses of all shapes and sizes in their domestic business spheres.
Additional reporting and writing for this article were conducted by Chad Brooks. Some source interviews were conducted for a previous version of this article.