The main component of financial statements (and many other statutory reports) is financial accounting information. While much of financial accounting information is determined by GAAP, other determinants are preparers (managers) and the monitoring and enforcement mechanisms that ensure its quality and integrity.
Generally Accepted Accounting Principles (GAAP)
Financial statements are prepared in accordance with GAAP, which are the rules and guidelines of financial accounting. These rules determine measurement and recognition policies such as how assets are measured, when liabilities are incurred, when revenues and gains are recognized, and when expenses and losses are incurred. They also dictate what information must be provided in the notes. Knowledge of these accounting principles is essential for effective financial statement analysis. In this book we will refer to two sets of GAAP: (1) the US GAAP, which refers to rules and practices that are currently in use in the United States; and (2) IFRS, which refers to rules and principles that are laid down by the International Accounting Standards Board and adopted by the most of the countries outside the United States. There is a great deal in common between these two forms of GAAP, but some significant differences do exist. Also, while US GAAP is very detailed with a many specific rules and regulations, IFRS tends to be more principle oriented with less detailed guidance.
US GAAP. Accounting standard setting in the United States is mainly the responsibility of the private sector, with close ties to the accounting profession. The FinancialAccounting Standards Board (FASB) currently serves as the standard-setting body in accounting. The rules and guidelines issued by FASB are called Statements of Financial Accounting Standards (SFAS). These standards, together with standards issued by standard-setting bodies that existed before FASB, are the basis on which US GAAP is determined. In addition to these standards, US GAAP also involves other pronouncements, opinions, interpretations, and practice guidelines. Other bodies such as the American Institute of Certified Public Accountants (AICPA) and the Securities and Exchange Commission (SEC) also help define US GAAP. The FASB has recently codified accounting standards by topic area so that all the latest rules for a particular topic are available at one place. In this book, we will sometimes refer to these codes and rarely to a particular SFAS
The FASB has seven full-time members, who represent various interest groups such as investors, managers, accountants, and analysts. Before issuing a standard, the FASB issues a discussion memorandum for public comment. Written comments are filed with the board, and oral comments can be voiced at public hearings that generally precede the issuance of an Exposure Draft of the proposed standard. After further exposure and comment, the FASB usually issues a final version of an SFAS. It also sometimes issues interpretations of pronouncements. Standard setting by the FASB is a political process, with increasing participation by financial statement users. From an analysis viewpoint, this political process often results in standards that are compromise solutions that fall short of requiring the most relevant information.
While FASB determines the accounting standards, it has no legal authority to enforce these standards. The legal authority to enforce US GAAP resides with the SEC. The SEC is an independent government agency that administers the Securities Acts of 1933 and 1934. These acts pertain to disclosures related to public security offerings. The SEC plays a crucial role both in regulating information disclosure by companies with publicly traded securities and in monitoring and enforcing compliance with accepted practices. The SEC can override, modify, or introduce accounting reporting and disclosure requirements. It can be viewed as the final authority on financial reporting in the United States. However, the SEC respects the accounting profession and understands the difficulties in developing accepted accounting standards. Consequently, it has rarely used its regulatory authority. However, it has become increasingly aggressive in modifyingFASB standards.
International Financial Reporting Standards. International Financial Reporting Standards (IFRS) determine the GAAP in most countries outside the United States. Thesestandards are formulated by the International Accounting Standards Board (IASB). Based in London, UK, the IASB is private sector body representing accountants and other interested parties from different countries. Even though IFRS is not currently mandated in the United States, we need to be aware of the growing influence of the IFRS outside the United States. Financial analysts in the United States must have knowledge of IFRS because of the increased internationalization of capital markets. Unlike the US GAAP, the IFRS tends to be more principles based. This means that IFRS tends to be more conceptual and provides less of a “cookbook” approach to implementing accounting rules. The IFRS rules are not very different from US GAAP, with a few exceptions. Also the FASB is currently involved in a joint project with the IASB that aims to eventually eliminate all differences between the two sets of standards. Even then, it is important for a financial analyst to understand key differences between the two sets of GAAPs.
Like US GAAP, IFRS is also ruled by a set of pronouncements. These pronouncements fall into two categories, those issued earlier by the International Accounting Standards Board (prefixed with IASB) and later standards that are part of the International Financial Reporting Standards (prefixed with IFRS). We will occasionally refer to these pronouncements.
Generally Accepted Accounting Principles (GAAP)
Financial statements are prepared in accordance with GAAP, which are the rules and guidelines of financial accounting. These rules determine measurement and recognition policies such as how assets are measured, when liabilities are incurred, when revenues and gains are recognized, and when expenses and losses are incurred. They also dictate what information must be provided in the notes. Knowledge of these accounting principles is essential for effective financial statement analysis. In this book we will refer to two sets of GAAP: (1) the US GAAP, which refers to rules and practices that are currently in use in the United States; and (2) IFRS, which refers to rules and principles that are laid down by the International Accounting Standards Board and adopted by the most of the countries outside the United States. There is a great deal in common between these two forms of GAAP, but some significant differences do exist. Also, while US GAAP is very detailed with a many specific rules and regulations, IFRS tends to be more principle oriented with less detailed guidance.
US GAAP. Accounting standard setting in the United States is mainly the responsibility of the private sector, with close ties to the accounting profession. The FinancialAccounting Standards Board (FASB) currently serves as the standard-setting body in accounting. The rules and guidelines issued by FASB are called Statements of Financial Accounting Standards (SFAS). These standards, together with standards issued by standard-setting bodies that existed before FASB, are the basis on which US GAAP is determined. In addition to these standards, US GAAP also involves other pronouncements, opinions, interpretations, and practice guidelines. Other bodies such as the American Institute of Certified Public Accountants (AICPA) and the Securities and Exchange Commission (SEC) also help define US GAAP. The FASB has recently codified accounting standards by topic area so that all the latest rules for a particular topic are available at one place. In this book, we will sometimes refer to these codes and rarely to a particular SFAS
The FASB has seven full-time members, who represent various interest groups such as investors, managers, accountants, and analysts. Before issuing a standard, the FASB issues a discussion memorandum for public comment. Written comments are filed with the board, and oral comments can be voiced at public hearings that generally precede the issuance of an Exposure Draft of the proposed standard. After further exposure and comment, the FASB usually issues a final version of an SFAS. It also sometimes issues interpretations of pronouncements. Standard setting by the FASB is a political process, with increasing participation by financial statement users. From an analysis viewpoint, this political process often results in standards that are compromise solutions that fall short of requiring the most relevant information.
While FASB determines the accounting standards, it has no legal authority to enforce these standards. The legal authority to enforce US GAAP resides with the SEC. The SEC is an independent government agency that administers the Securities Acts of 1933 and 1934. These acts pertain to disclosures related to public security offerings. The SEC plays a crucial role both in regulating information disclosure by companies with publicly traded securities and in monitoring and enforcing compliance with accepted practices. The SEC can override, modify, or introduce accounting reporting and disclosure requirements. It can be viewed as the final authority on financial reporting in the United States. However, the SEC respects the accounting profession and understands the difficulties in developing accepted accounting standards. Consequently, it has rarely used its regulatory authority. However, it has become increasingly aggressive in modifyingFASB standards.
International Financial Reporting Standards. International Financial Reporting Standards (IFRS) determine the GAAP in most countries outside the United States. Thesestandards are formulated by the International Accounting Standards Board (IASB). Based in London, UK, the IASB is private sector body representing accountants and other interested parties from different countries. Even though IFRS is not currently mandated in the United States, we need to be aware of the growing influence of the IFRS outside the United States. Financial analysts in the United States must have knowledge of IFRS because of the increased internationalization of capital markets. Unlike the US GAAP, the IFRS tends to be more principles based. This means that IFRS tends to be more conceptual and provides less of a “cookbook” approach to implementing accounting rules. The IFRS rules are not very different from US GAAP, with a few exceptions. Also the FASB is currently involved in a joint project with the IASB that aims to eventually eliminate all differences between the two sets of standards. Even then, it is important for a financial analyst to understand key differences between the two sets of GAAPs.
Like US GAAP, IFRS is also ruled by a set of pronouncements. These pronouncements fall into two categories, those issued earlier by the International Accounting Standards Board (prefixed with IASB) and later standards that are part of the International Financial Reporting Standards (prefixed with IFRS). We will occasionally refer to these pronouncements.
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