Accounting Standards

What are Accounting Standards?

Definition: Accounting standards are rules and guidelines set up by governing bodies, like FASB and IASB, to keep accounting practices consistent and understandable across all companies and industries.

An accounting standard is a common set of principles, standards and procedures that define the basis of financial accounting policies and practices. Accounting standards improve the transparency of financial reporting in all countries. In the United States, the Generally Accepted Accounting Principles form the set of accounting standards widely accepted for preparing financial statements. International companies follow the International Financial Reporting Standards, which are set by the International Accounting Standards Board and serve as the guideline for non-U.S. GAAP companies reporting financial statements.

What Does Accounting Standards Mean?

Accounting standards relate to all aspects of an entity’s finances, including assets, liabilities, revenue, expenses and shareholders’ equity. Specific examples of an accounting standard include revenue recognition, asset classification, allowable methods for depreciation, what is considered depreciable, lease classifications and outstanding share measurement.

Financial statements prepared and presented by a company typically follow an external standard that specifically guides their preparation. These standards vary across the globe and are typically overseen by some combination of the private accounting profession in that specific nation and the various government regulators. Variations across countries may be considerable, making cross-country evaluation of financial data challenging.

Publicly traded companies typically are subject to the most rigorous standards. Small and midsized businesses often follow more simplified standards, plus any specific disclosures required by their specific lenders and shareholders. Some firms operate on the cash method of accounting which can often be simple and straight forward. Larger firms most often operate on an accrual basis. Accounting standards prescribe in considerable detail what accruals must be made, how the financial statements are to be presented, and what additional disclosures are required.

Some important elements that accounting standards cover include: identifying the exact entity which is reporting, discussing any “going concern” questions, specifying monetary units, and reporting time frames.

History of Accounting Standards and Purpose

Accounting standards were largely written in the early 21st century. Massive accounting irregularities at large firms such as Worldcom and Enron illustrate that, despite all these efforts, widespread fraud can still occur, and even be missed by the outside auditors.

The American Institute of Accountants, which is now known as the American Institute of Certified Public Accountants, and the New York Stock Exchange attempted to launch the first accounting standards in the 1930s. Following this attempt came the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission. Accounting standards have also been established by the Governmental Accounting Standards Board for accounting principles for all state and local governments.

Accounting standards specify when and how economic events are to be recognized, measured and displayed. External entities, such as banks, investors and regulatory agencies, rely on accounting standards to ensure relevant and accurate information is provided about the entity. These technical pronouncements have ensured transparency in reporting and set the boundaries for financial reporting measures.

Benefits of Accounting Standards

The lack of transparent accounting standards in some nations has been cited as increasing the difficulty of doing business in them. In particular, the Asian financial meltdown in the late 1990s has been partially attributed to the lack of detailed accounting standards. Giant firms in some Asian countries were able to take advantage of their poorly devised accounting standards to cover up immense debts and losses, which yielded a collective effect that eventually led the whole region into financial crisis.

The standardization of the accounting procedures helps businesses to record and monitor their business activity and achieve comparability of accounting information between companies that operate in the same industry. By applying the same accounting principles and methods, businesses ensure homogeneous, reliable and accurate data and information about their assets, liabilities, financial position, and overall activity.

Common Accounting Standards Sround the Globe

International Financial Reporting Standards

International Financial Reporting Standards, usually called IFRS, are accounting standards issued by the IFRS Foundation and the International Accounting Standards Board (IASB) to provide a common global language for business affairs so that company accounts are understandable and comparable across international boundaries. They are a consequence of growing international shareholding and trade and are particularly relevant for companies with shares or securities listed on a public stock exchange. They are progressively replacing the many different national accounting standards.

This standard is adopted in whole, or in large part, by many countries. It is acceptable in the U.S. (for a firm located outside of the U.S.) to report in this widely accepted format.

Generally Accepted Accounting Principles are heavily used among public and private entities in the United States. The rest of the world primarily uses IFRS. Multinational entities are required to use these standards. The IASB establishes and interprets the international communities’ accounting standards when preparing financial statements.

Accounting Standards by Nation

  • Canada – Generally Accepted Accounting Principles
  • China – Chinese Accounting Standards (Zhōngguó qǐyè kuàijì zhǔnzé 中国企业会计准则)
  • France – Generally Accepted Accounting Practice (Plan Comptable Général)
  • Germany – Generally Accepted Accounting Practice (Grundsätze ordnungsmäßiger Buchführung)
  • India – Indian Accounting Standards
  • Luxembourg – Luxembourg Generally Accepted Accounting Principles (Lux GAAP)
  • Nepal – Nepal Financial Reporting Standards
  • Russia – Russian GAAP
  • Switzerland – Swiss GAAP FER (Fachempfehlungen zur Rechnungslegung)
  • United Kingdom – Generally Accepted Accounting Practice (UK)
  • United States – Generally Accepted Accounting Principles (United States) Domestic firms typically report in this format. Foreign firms that trade in the U.S. typically report in IFRS format (above).

U.S. GAAP Accounting Standards

The American Institute of Certified Public Accountants developed, managed and enacted the first set of accounting standards. In 1973, these responsibilities were given to the newly created Financial Accounting Standards Board. The Securities and Exchange Commission requires all listed companies to adhere to U.S. GAAP accounting standards in the preparation of their financial statements to be listed on a U.S. securities exchange. Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities follow the same rules, accounting standards make the financial statements credible and allow for more economic decisions based on accurate and consistent information.

Financial Accounting Standards Board (FASB)

An independent nonprofit organization, the Financial Accounting Standards Board (FASB) has the authority to establish and interpret generally accepted accounting principles (GAAP) in the United States for public and private companies and nonprofit organizations. GAAP refers to a set of standards for how companies, nonprofits, and governments should prepare and present their financial statements.