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In every organization, from the government, to non-profit companies to small businesses to corporations, accounting is being used for recording daily transactions and financial report. As it is also a major part of their corporate decision making or investment decisions. Difficulties might be faced when comparing financial statements between companies, because there are different methods being used for each. That is why accounting policies were made. Accounting being the link between organizations, rules, regulation and policies were established to standardize financial information for the company's benefit and the public.
Generally Accepted Accounting Principles
The common set of accounting principles, standards and regulations that organizations use to assemble their financial statements. GAAP are a combination of authoritative and reliable standards which is used in reporting financial statements.
The Standard Setting Process: Parties Involved
American Institute of Certified Public Accountants (AICPA)
Financial Accounting Standards Board (FASB)
Securities and Exchange Commission (SEC)
Governmental Accounting Standards Board (GASB)
Objective of Accounting Standards
The objective of Accounting Standards is to standardize the various accounting objectives and policies. The aim is to synchronize the different accounting policies which are used to prepare financial statements, which would result in easy comparison between companies. When companies produce their financial statements, many users benefit from it, Owners as investors, employees, Analysts/advisors, trade unions, journalists, stockbrokers, Suppliers, the government and the public. Information must be useful for investment and credit decisions and reviewing cash flow prediction for future decisions.
The Accounting Standard Board believes there should be a need for a globally standard which is accepted around the world and has common policies which should be applied in order to avoid any difficulties. That is because it is only through using the standard accounting rules and regulation which is created by shared principles that a reliable approach can be used to resolve any accounting problems and differences.
Standards are used to create stability, because the lack of rules and orders would lead to chaos between organizations.
The more organizations can manage their financial statements with other organization and use the same accounting standards, the more efficient business can increase and rise. The main advantage of the organization having the same format is it makes it easier for different companies to compare their financial statements if one is considering doing business with the other.
This is why standard software, standard bookkeeping practices and standard documentation are established. Another advantage is sharing a common standard with your clients, customers, competitors, suppliers, and partners would make it easier to connect to each other. And it would allow people to see various organizations from different parts of world.
The disadvantages are limited and can be defeated by competent employees. If a company is fixed on a specific standard, then any new staff hired by the company should enrol through a training to introduce them to the company's standard. It might lead to some extent a cut back in creativity and productivity for some time.
Financial reports are presented depending on the organization's timeframe, providing full information that must be high quality and assembled objectively. Third-parties who are interested on such information have the right to be guaranteed that the information which is delivered to them is accurate. For this reason, financial accounting relies on certain standards.
There are characteristics which are meant to be served as a framework to start the process of building a standard financial statement.
Understandability: The information should be presented in a way that is understandable by the various users who have the knowledge of business and accounting.
Relevance: The information in financial statements is relevant when it is able of influencing economic decisions of users and by providing the relevant information from either past, present or future events. It should make a difference in their decisions, like correcting past decisions. Materiality is one of the factors in which it determines whether information is relevant or not. Timeliness is another element of relevance. To make the information more useful to the users, the information must be given to users within the time period in which it is will be most likely accepted.
Reliability: The information in the financial statements is reliable and dependable if it is free from material error and favouritism. It should also be faithful. The information should represent what it really represents in the organization; information that is biased can be misleading. The data should be Complete - the reported information should not have a missing material fact. Neutrality - information should be free from bias, it should not favour one side to the other.
Comparability & Consistent: Users should be capable of comparing the financial statements of various organizations over time so that they can discover its financial situation, performance and competing interests. This would lead to the need of some consistency and stability, wherever comparisons are to be expected to be done by the users. Releasing of relevant information of accounting policies is vital for comparability.
Accounting is a standard language which is used to evaluate financial performance by a variety of organizations. Common accounting standard has made it easier for companies locally and internationally to compare and to refer to other financial statements. Acquiring the set of principles made it clear for people with business and accounting knowledge a better understanding to the reports. The standards were set by known accounting bodies, to avoid any correction made by the companies on their financial statements just to benefit them. Therefore, this has smoothed the way for accounting standards to come into existence.