Accounting Principles, GAAP and IFRS

Accounting principles are the rules and guidelines that businesses and other organizations must adhere to when reporting financial data. The terms and methods that accountants must employ are standardized by these guidelines, making it simpler to analyze financial data. With adoption in 167 jurisdictions, the International Financial Reporting Standards (IFRS) are the most commonly utilized set of accounting principles. The generally accepted accounting principles (GAAP) are a unique collection of accounting standards used in the US.

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Accounting Principles' Objectives

To ensuring that a company's financial statements are comprehensive, consistent, and comparable is the ultimate purpose of any set of accounting standards.

As a result, it is simpler for investors to look at and extract valuable information from the company's financial statements, such as historical trend data. Additionally, it makes it easier to compare financial data between several businesses. Accounting principles also reduce accounting fraud by enhancing transparency and making it easier to identify indications of fraud.

 

What Are the Fundamental Accounting Principles?

The following are some of the most fundamental accounting principles:

• Monetary unit principle
• Reliability principle
• Cost principle
• Revenue recognition principle
• Time period principle
• Economic entity principle
• Full disclosure principle
• Going concern principle
• Accrual principle
• Conservatism principle
• Consistency principle
• Matching principle
• Materiality principle

The income recognition principle, matching principle, materiality principle, and consistency principle are among the more significant ones. The materiality principle ensures completeness because all significant transactions must be disclosed in the financial statements. A company's use of accounting standards over time is referred to as consistency.

 

Generally Accepted Accounting Principles (GAAP)

In the United States, private businesses and NGOs must adhere to the same accounting standards known as generally accepted accounting principles (GAAP). The Financial Accounting Foundation selects the members of the Financial Accounting Standards Board (FASB), an impartial nonprofit body that sets many of these guidelines. The Governmental Accounting Standards Board (GASB), a comparable entity, is in charge of establishing the GAAP requirements for local and state governments. The Federal Accounting Standards Advisory Board (FASAB), a third organization, also provides the accounting guidelines for federal entities.

While privately held businesses are exempt from GAAP compliance requirements, publicly traded businesses are obliged to submit GAAP-compliant financial statements in order to be listed on a stock market. The independent auditors of publicly traded corporations and their chief executives must attest that GAAP was followed in the preparation of the financial statements and accompanying notes.

Lenders or investors may also demand that nonprofit organizations and privately held businesses submit financial statements that comply with GAAP. For instance, most banking institutions need annual audited GAAP financial statements as a typical loan covenant. Therefore, even though GAAP is not mandated by law, the majority of American businesses and organizations follow them.

 

International Financial Reporting Standards (IFRS)

International Financial Reporting Standards (IFRS) are published by the International Accounting Standards Board (IASB). More than 120 nations, including those in the European Union (EU), utilize these standards.

The U.S. government agency Securities and Exchange Commission (SEC), which is in charge of safeguarding investors and maintaining order in the securities markets, has indicated an interest in implementing IFRS. However, the U.S. is unlikely to switch in the near future due to the discrepancies between the two standards. However, as accounting issues grow, the FASB and the IASB continue to collaborate to produce equivalent laws on specific subjects.

For instance, in 2014, the FASB and the IASB jointly unveiled new guidelines for revenue recognition.

Investors should exercise caution when comparing the financial statements of companies from various nations since international accounting standards vary. In more developed markets, the issue of varying accounting principles is less of a concern. However, due to the fact that many sets of accounting rules still allow for the possibility of number distortion, vigilance should be exercised.

 

Who establish accounting principles and standards?

Setting accounting standards is the responsibility of several organizations. The Financial Accounting Standards Board (FASB) oversees generally accepted accounting principles (GAAP) in the US. International Accounting Standards Board (IASB) created International Financial Reporting Standards (IFRS) for use in Europe and other regions.

When were the first accounting principles established?

Double-entry bookkeeping, which introduced a T-ledger with matched entries for assets and liabilities in the 15th and 16th centuries, is where standardized accounting concepts first appeared. Some academics contend that the introduction of double-entry accounting procedures at that time served as a catalyst for the development of capitalism and trade. The New York Stock Exchange (NYSE) and the American Institute of Certified Public Accountants (AICPA) tried to introduce the first accounting standards that American businesses would employ in the 1930s.

Which accounting principles have been criticized?

Principles-based accounting systems are criticized for allegedly allowing businesses too much latitude and failing to mandate openness. They contend that corporations' reporting may give a misleading image of their financial health since they are not required to adhere to certain regulations that have been established. Complex rules in the case of rule-based methodologies like GAAP might obstruct the creation of financial statements through unneeded complexity. According to these critics, having rigorous regulations forces businesses to use an unfair amount of resources to adhere to industry norms.

What distinguishes IFRS from GAAP?

While GAAP is primarily employed in the United States, IFRS is a standards-based methodology that is applied globally. In contrast to GAAP, which is more static, IFRS is viewed as a more dynamic framework that is continuously updated to reflect an ever-changing financial landscape.

There are several methodological variations between the two methods. In terms of inventory costing, for instance, GAAP permits businesses to utilize either first in, first out (FIFO) or last in, first out (LIFO). However, LIFO is prohibited under IFRS.

Conclusion

Accounting principles are a set of rules and regulations that businesses must follow when disclosing financial information. The main objective of these principles, whether they are known as GAAP in the United States or IFRS elsewhere, is to increase transparency and essentially make it simpler for investors to compare the financial statements of various companies.

Without these guidelines, publicly traded corporations would probably report their financial data in an exaggerated manner, making their trading performance appear better than it actually was. Investors would have a nightmare if firms had the freedom to decide what information to reveal and how to share it.