What Are Accounting Standards?

What is an accounting standard?

Accounting standards boil down to a simple principle: standardizing accounting methods and practices across the United States and other countries. These standards ― updated frequently by their governing bodies ― help accountants, investors and other key stakeholders regulate accounting processes and maintain financial documents.

What are the two main types of accounting standards?

Accounting standards vary from country to country. However, most have adopted generally accepted accounting principles (GAAP) or International Financial Reporting Standards (IFRS).   

GAAP

GAAP is a set of accounting principles issued by the Financial Accounting Standards Board (FASB). In the U.S., publicly traded companies must follow GAAP when compiling their financial statements. 

Compliance with GAAP ensures transparency in financial reporting, making it easier for third parties to compare different companies’ accounting reports and financial statements. 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. In 168 countries, IFRS standards are mandated or highly suggested for domestic public companies, foreign companies or both. 

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. 

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 their work type and location. 

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 rules 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 broad spectrum of accounting tasks, such as assets, equity, revenue, business expenses and liabilities. 

For example, GAAP 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 business world’s climate and 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.

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 proposal 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, these entities cannot properly do their jobs, potentially throwing the financial subset of the business world off-balance.

The best accounting software for GAAP compliance

Among our nearly dozen picks for the best accounting software, the following three platforms are especially useful when it comes to GAAP compliance:

• Xero: You can customize your balance sheets and income statements in Xero to appear in GAAP-compliant formats. It’s also easy to compare your budgets to actuals in Xero and customize your profit and loss (P&L) statements. Check out our Xero review to learn more about this accounting platform.
• Oracle NetSuite: This enterprise resource planning (ERP) software includes a rule-driven engine through which your financial reports are always generated in GAAP-compliant formats. You can also create IFRS-compliant reports and reports that adhere to both IFRS and GAAP standards. Learn more via our Oracle NetSuite review.
• Wave Financial: All Wave Financial reports are GAAP-compliant by default, plus all Wave accounting features are entirely free to use. The reports you generate in Wave include balance sheets, P&L statements and sales tax reports. Read our Wave Financial review to learn more about this platform’s exceptionally high-quality features for a free accounting platform.

How should accounting standards be regulated?

Now that it is easier for businesses of all kinds to operate on a global scale, crucial 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 United Kingdom-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 addressing the complexity of international transactions by enhancing transparency, accountability and efficiency in how accounting principles are created and distributed to the international business world.

IFRS acknowledges this is difficult: “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 many justifications for why not. Eleven countries, including the U.S., still have their own accounting standards. However, many others, including all countries in the European Union, have adopted IFRS standards.

The future of accounting practices

What does a potential accounting standards shift 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 must be aware of significant changes affecting 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 Horngren’s 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 accurately and thoroughly. As time passes, 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.

Standardizing your accounting

Although you’re only required to follow GAAP standards if your company is publicly traded, prioritizing compliance is still smart. This way, anyone looking at your company’s reports can easily assess your financial standing. Chances are you’ll eventually need to share your reports externally, for example, when you apply for bank loans for your business. Adhering to accounting standards today makes for an easier understanding of your financials tomorrow ― and long after.

Max Freedman and Rebecka Green contributed to this article.