- Accounting standards help guide CPAs, accountants and bookkeepers when they are managing an organization's financial recordkeeping.
- In the U.S., Generally Accepted Accounting Practices (GAAP) are the standard. Elsewhere, the International Financial Reporting Standards (IFRS) are preferred.
- Different types of organizations will require different treatments and strategies from accountants. Accounting standards help outline expectations.
- This article is for small business owners, accountants, bookkeepers, and anyone who wants to better understand how accounting standards should apply to financial recordkeeping.
When the business world is so diverse, it is helpful for professionals to be consistent in their business processes. Accounting, financial management and financial statements can seem baffling to navigate, but there are organizational bodies whose sole job is to make business accounting easier on all sides by applying standards.
What is an accounting standard?
Accounting standards 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. Accounting standards can vary from country to country, with the majority adopting GAAP or IFRS.
GAAP
GAAP is a set of accounting principles issued by the Financial Accounting Standards Board (FASB). In the U.S., publicly traded companies are required to follow GAAP when compiling their financial statements.
Compliance with GAAP ensures transparency in financial reporting. This makes it easier for third parties to compare financial statements from different companies. However, following GAAP principles does not ensure that financial statements are free of errors or information that could mislead investors.
IFRS
The IFRS is set by the International Accounting Standards Board (IASB). Like GAAP, this set of standards was established to bring transparency and consistency to accounting practices.
IFRS also seeks to establish a common global language for company accounting principles. More than 144 countries have already adopted IFRS.
However, IFRS is not used universally, which can be confusing when reviewing international companies. The U.S. Securities and Exchange Commission (SEC) has stated it won't switch from GAAP to IFRS, but it is reviewing a proposal to allow IFRS to supplement financial filings in the U.S.
Why are accounting standards important?
While accounting itself has a long history, accounting standards originated in the aftermath of the Great Depression. The American Institute of Certified Public Accountants and the New York Stock Exchange originally proposed them in the 1930s.
This was followed by the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the SEC. From there, accounting standards categories and ruling bodies formed over time to appropriately represent the diversity of accounting professionals in the U.S.
In general, accountants are responsible for understanding accounting standards. However, banks, investors and government agencies should also understand the differences between accounting standards categories to make informed decisions about where their money goes.
If their accounting information is irrelevant, outdated or inaccurate, then these entities cannot properly do their jobs, potentially throwing the financial subset of the business world off balance.
What are the categories of accounting standards?
Accounting standards are not a one-size-fits-all set of rules. Financial needs and processes 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 categories relevant to U.S. businesses:
- Private and publicly traded companies: In these companies, accountants use GAAP. The SEC only requires publicly traded and regulated companies to follow GAAP, but private companies also follow these for internal management convenience. GAAP principles include revenue recognition, balance sheet item classification and outstanding share measurements.
- Global companies: Some businesses are based in multiple countries and have a global reach. Accountants for these businesses use IFRS. These standards are designed to bring fairness to financial reporting documents for any business that operates globally.
- Government: Anyone who works for state and local government bodies uses the government standards developed by the Governmental Accounting Standards Board (GASB).
While divergent in some areas of their financial and accounting guidance, the FASB, IASB 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 pace at which these standards are updated and revised, compliance relies on high-quality ethical accountants, as the new 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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How should accounting standards be regulated?
Now that it is easier for businesses of all kinds to operate on a global scale, important questions arise about how to regulate the financial side of international business, if at all. Accounting standards fall into these debates as professionals consider 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 creating and updating comprehensive accounting standards.
Should the U.S. switch to IFRS?
In recent years, as businesses have gone global, there have been calls to shift from national to international accounting standards. This is where the U.K.-based IFRS 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 the 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."
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 others, including all countries in the EU, have adopted IFRS standards.
The future of accounting practices
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 affect how "internal managerial decisions are reported to shareholders and other external constituencies."
The differences between financial statements prepared under GAAP versus the IFRS are not substantial. Most are "technical in nature," according to Financial & Managerial Accounting, and 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, IASB and GASB to determine accounting standards with accuracy and thoroughness. As time goes on, the accounting world might see a further convergence of the GAAP and IFRS principles.
While the potential changes and costs that come with this shift might complicate the accounting and managerial professions for a while, 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 the 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.
Rebecka Green and Chad Brooks contributed to the writing and research in this article.