The concepts of accounting which inspired the blueprints of accounting standards used globally today dates back to 7000 years ago when the early human civilizations began in Mesopotamia (Brown, 2014). During the Mesopotamian era, people used accounting to record crop harvest and herd growth; this could enable them to establish if there was growth or decline in their investments. In the Roman Empire; Emperor Augustus used accounting to list his financial dealings, these dealings involved; money allocated to the military, number of temples built, land allocation among other activities. This practice aided in decision-making processes within the kingdom (Brown, 2014). Luca Pacioli contributed to the accounting field further by establishing the technique of bookkeeping and writing a book on the same. His works inspired teaching and accounting practices for a hundred years (Brown, 2014) before accounting evolved further. During the middle ages, when Europe transitioned from barter trade to monetary trade; bookkeeping techniques took a center-stage in accounting during this period. Merchants used information gathered from their bookkeeping activities to make resourceful decisions to bolster the growth of their businesses (Brown, 2014). Continuous evolution and growth of the accounting field in addition to advancements in civilizations and industrial revolutions led to a deeper definition of accounting. This contributed to the formation of accounting regulations, auditing regulations, and ethical standards to enhance integrity, accuracy, and transparency in financial reporting.
History and Evolution of Accounting Standards
Accounting standards are a set of shared principles, procedures, and ethics that informs and guides financial accounting policies and activities. These standards foster the credibility and integrity of all financial reporting from different companies globally. The history of accounting standards dates back to the 1930s when the American Institute of Certified Public Accountants (AICPA) and New York Stock Exchange launched the first accounting guidelines which were inspired by the great depression (Botzem & Quack, 2009). Many investors felt that incompetent accounting techniques led to an economic downturn, this compelled the American Institute of Public Accountants and New York Stock Exchange to revise existing financial reporting procedures at the time. Subsequently, after the revision of accounting standards; the Securities Act of 1934 was launched (Botzem & Quack, 2009). The act was meant to govern the transactions of securities; its aim was to enhanced transparency, integrity, accuracy, and block fraud and manipulation. This further led to the creation of the Security Exchange Commission (SEC), which was given authority to monitor accounting and auditing activities of securities across the U.S.
Delegate your assignment to our experts and they will do the rest.
Accounting standards evolved by the 1970s when market players felt the need to have an independent standard-setting organization separate from the accounting profession (Botzem & Quack, 2009). This inspired the creation of the Financial Accounting Foundation (FAF) to serve as the accounting standard-setting authority for the nation. The FAF and the formation of Financial Accounting Standards Board (FASB) were completed in 1973 and designated with governing standard-setting activities for the private sector and aimed at managing financial reporting of private companies and non-profit organizations (Botzem & Quack, 2009). The FASB was granted the mandate to establish and interpret the Generally Accepted Accounting Principles (GAAP), which is widely accepted for use across America.
Continuous evolution was witnessed in the accounting field with both the management of Securities Exchange Commission (SEC) and Financial Accounting Foundation (FAF) in 1984 when they launched the Government Accounting Standards Board (GASB). GASB was meant to guide the financial reporting of governmental organizations to ensure better decision-making processes and the creation of competent public policies (Botzem & Quack, 2009). GAAP is used by both public and private companies across America but for the case of multinational companies or the global companies; they are required to use International Financial Reporting Standards (IFRS). International Accounting Standards Board (IASB) is tasked with interpreting accounting standards used by international entities.
Types of Accounting
Three major types of accounting help in the financial reporting of any organization across the globe. These are; financial accounting, managerial accounting, and tax accounting. Financial accounting keeps a financial track record of a company using standardized guidelines. The financial report is presented as; financial statement, income statement, or balance sheet. These statements are issued on a routine schedule to the public. For publicly traded companies, they widely circulate their financial statements, these reports likely get to their competitors, shareholders, investors, customers, and employees (Kimmel, Weygandt, & Kieso, 2018). The main purpose of financial accounting is to help external players assess the value of the company to help them make credible investment decisions. Due to the importance of this form of financial reporting; financial accounting is required to conform to accounting standards and specifically the GAAP or IFRS standards to be useful, accurate, reliable, and comparable to financial statements of other companies (Kimmel, Weygandt, & Kieso, 2018). Additionally, every publicly traded company’s financial accounting is subjected to the rules and principles of the Stock Exchange Commission (SEC).
Tax accounting on the contrary is prepared towards tax compliance and in adherence to the set rules and principles which govern companies across the United States. Internal Revenue Service (IRS) regulates tax accounting across America and sets specific legislation companies and individuals ought to follow when filing returns (Balakrishnan, Blouin, & Guay, 2019). The accounting procedure used for tax is significantly different from that of preparing a financial statement. For instance, a company might use First in First Out (FIFO) to record their inventory for financial accounting purposes but implement LIFO (Last In Last Out) approach in taxation, this helps them reduce payable tax annually (Balakrishnan, Blouin, & Guay, 2019). Tax accounting, therefore, focuses on the company’s financial activities that are taxable and its subjection to IRS legislation makes the process transparent and fraud-free.
Managerial accounting involves analysis and interpretation of financial reports to managers; this helps them make competitive decisions towards the achievement of the company’s vision (Jiambalvo, 2019). Managerial accounting reports touch on the following areas; accounts receivables reports break down balances owed by the clients, this allows managers to identify debtors and the extend of debt and enable them to tighten credit policies in case the amount of debt is huge. Performance is also an issue captured in managerial accounting reports; managers can identify underperforming departments and make relevant decisions to inspire better performance. Cost managerial accounting report involves the analysis of the cost of production against the selling price of the products and services of the company (Jiambalvo, 2019). This report is used in determining the right profit margin for the company’s products.
General Accepted Accounting Principles (GAAP)
The great depression of 1929 was attributed mostly to inaccurate criteria used for reporting financial positions of companies. This led to the establishment of Generally Accepted Accounting Principles (GAAP) by the federal government in collaboration with the American Institute of Certified Public Accounts, Financial Accounting Foundation, and Stock Exchange Commission. Today the federal government requires that all companies should comply with GAAP when presenting their financial statements. GAAP has a set of principles that makes it competitive to guide the financial reporting of companies in the United States (Flood, 2015). Business as a single entity is the first principle; according to GAAP standards, accounting activities of a business are separate from those of its owners and there is an underlying assumption that the business existed long after the existence of the owners.
Specific currency principle demands that companies across the United States should express their financial statement using US dollars. In the case of a company reporting revenue of other branches of their companies that exist in foreign countries; the company is required to convert the revenue into US dollars before reporting. This enhances consistency and conformity to the provisions of GAAP (Pries & Baker, 2010). Financial statements are required to adhere to the specific period principle, balance sheet or income statements or any other financial reports should have a start and end date; most companies normally report quarterly, half-yearly, or annual financial statements. This indication helps customers and investors understand the concepts of the report from a time-frame standpoint. Recognition principle requires accountants responsible for compiling the company’s financial statements to record revenue once earned (Pries & Baker, 2010). Therefore, in case there a doubt of a supplier paying their debts, this should be excluded from the income statement under the accrued income and expenses category but should record under the allowance doubtful accounts to enhance accurate reporting of income statements.
The GAAP standard considers a going concern assumption, which is also a principle under the GAAP standard. The accountant takes the assumption in preparing the company’s financial statements that the organization will continuously operate, even in the future. Unless otherwise, the financial reporting assumes this scenario but in the case, an accountant is aware of any liquidation, he/she should capture the same in financial reporting (Pries & Baker, 2010). According to the GAAP principles, the company should make full disclosure, withholding nothing. In the case a company fails to exercise full disclosure principle, it not only violates the GAAP accounting standard but also manipulates the decision of investors which might result in loss of money (Flood, 2015). This principle prevents the companies from engaging in any unethical procedure which might aid them in manipulating the information provided in their financial reports.
Accounting reports should also incorporate the matching principle, which requires a company to report an expense at the time of a corresponding revenue earned. It is also prudent for accountants to determine important material to report and leave out the unimportant ones, under the principle of materiality, it states that errors in accounting are inevitable and it is within the accountant’s authority to determine if the error can be ignored or reevaluated (Pries & Baker, 2010). Accountants are also required to record the purchases of goods, services, and assets with the prices they paid for even when there are market fluctuations. In addition to the ten principles of GAAP, this accounting standard is still subjected to other general accounting legislations like generally accepted industry practices and regulations laid by the Financial Accounting Standard Board (FASB) and the Accounting Principles Board (APB). Despite strict adherence to GAAP, companies are still prone to make mistakes in reporting their financial health. It is necessary for investors to exhaustively scrutinize the company’s financial statements before making any investment decision.
International Financial Reporting Standards (IFRS)
Adoption of IFRS in most European countries came into effect in 2005 when the EU gave the green light for the usage of these accounting standards for EU listed companies. However, before that; the International Accounting Standards Committee (IASC) formed in 1973 to deliberate on global accounting standards contributed to the creation of International Accounting Standards (IAS) responsible for managing the international accounting issues. In 2001 International Accounting Standards Board (IASB) replaced IASC, but continued the use of some of the principles embedded in IAS accounting standards, the new body adopted International Financial Reporting Standards (IFRS) to govern accounting globally (Balsmeier & vanhaverbeke, 2016). The IFRS, therefore, is a common set of accounting regulations used for transparency, consistency, and comparability by companies around the world. Just like GAAP, IFRS helps investors and banks in determining the financial health of a company before making any investment decisions (Balsmeier & vanhaverbeke, 2016). This accounting standard is currently used in more than 100 countries globally including EU countries; the U.S has not implemented the use of IFRS as they are yet to find a convergence point between IFRS and their GAAP.
A company making a shift from GAAP to IFRS is required to adhere to the principle of first-time adoption of IFRS, this alters ways in which an organization presents its financial statements and enhance compliance to IFRS protocols. Presentation of financial statements is an important activity in IFRS and its why one of its component IAS1 is fully dedicated to the effective comparison of the company’s financial statements with past reports and those of the competitors (Latridis, 2010). However, in general, IFRS standards are mainly geared towards the following objectives; statement of the financial position, this provides information regarding the company’s financial positioning at a specific period in time. IFRS uses the balance sheet to determine the financial health of a company (Latridis, 2010). The following elements are considered in the balance sheet; assets, equity, assets, and liabilities held for sale (Latridis, 2010). However, current and non-current assets and liabilities are presented separately unless a different presentation based on liquidity deems them more relevant.
A statement of comprehensive income is as well a component that IFRS provides detailed procedures on how it should be presented. This document is presented either as a single statement or as a profit and loss statement (Latridis, 2010). Comprehensive income statement comprises of the following elements; revenue, gains and losses, financial costs, the share of the profit and loss, tax expense among others (Latridis, 2010). The IFRS accounting standards also reports the statement of retained earnings which details activities in reserves that sums up to shareholder’s equity. The statement is obtained through a process of subtracting the value of liabilities from the value of assets to obtain the company’s equity (Kimmel, Weygandt, & Kieso, 2018). Statement of equity reports on the following; profit and loss associated with shareholders, decline or increase in share capital reserves, amount of payments made to shareholders, and also additional information on changes in accounting policy. The last element considered is the statement of cash flows. This statement provides details on the amount of cash acquired and spent by the company over a given duration (Pries & Baker, 2010). The main items found in cash flow statements are; financing, investing, and operating activities. The total amount of cash provided or used in the three categories sums up to the total change in cash for the given period. The main reason for the preparation of this statement is to make comparisons between cash used for operations and net income. Managers and financial analysts use the information obtained from cash flows to determine how well the company executes and manages its operations.
Differences Between GAAP and IFRS Accounting Standards
Despite both standards driving at accuracy, transparency, and reliable financial reporting; there exist enormous differences between the two standards. IFRS is an international accounting standard and it is in use in more than 100 countries including the EU countries while GAAP, on the other hand, is only used in the U.S (Murphy, 2012). GAAP uses a rules-based approach since most U.S companies have specific industry rules and procedures to follow; however, IFRS uses a principle-based approach, which employs principles in the analysis and interpretation of financial reports to determine its application in any given situation (Murphy, 2012). In inventory recording methods; both IFRS and GAAP allow the use of FIFO in recording their inventories but GAAP also uses the LIFO approach which IFRS does not allow for its use. Last in the Last Out (LIFO) approach is bound to result in low net income and its reflection on the actual flow of inventory is flawed (Murphy, 2012). In case of a change in market value prices of inventory, IFRS allows for a write-down reversal but GAAP prohibits such action.
The IFRS consideration of future economic benefits qualify internal costs used in the creation of intangible assets to be capitalized; on the contrary, under GAAP internal costs are always recorded as an expense unless it is an internally developed software and also for a software geared towards external used, they are recorded under capital once its viability has been established (Barth, Landsman, Lang, & Williams, 2012). IFRS has a unique entry for investment property, that records and measures property held for rental income. The property is measured initially at cost and later revalued to market value, GAAP lacks such a unique category in its financial reports (Barth, Landsman, Lang, & Williams, 2012). Earnings-per-share under IFRS is not obtained through averages of individual interim period calculations, for GAAP however, makes an average of individual interim period calculations to establish their earnings-per-share.
The Convergence of IFRS with GAAP
The ongoing development in the field of accounting standards has to be the push to create one universal standard for accounting practices, leading to the elimination of U.S-based accounting standard or harmonizing of the differences between the two standards. Convergence is a project that has been taking place for several decades and most countries today have adopted the use of IFRS entirely or converged their accounting standards towards IFRS requirements, to eradicate the differences (Pillhofer, 2013). The Financial Accounting Standards Board (FASB) and International Accounting Standards Board (IASB) have been working collaboratively since 2002 for convergence between GAAP and IFRS. However, SEC has been adamant to adopt IFRS with so many criticisms arising for such a convergence in the past. Many critics have always had worries on the many infrastructures that GAAP and SEC have both laid out, which might be a daunting task in making a shift, as a result, this might take longer than expected for IFRS accounting standards to come to fruition in America (McEnroe & Sullivan, 2014). However, despite the efforts of convergence taking years, executives from both IASB and FASB have a binding agreement (Norwalk agreement) (McEnroe & Sullivan, 2014) aimed at ensuring the U.S adoption of IFRS or convergence of GAAP towards IFRS accounting standards is achieved.
There are enormous benefits of convergence; these include, consistent reporting of financial reports which also allows comparability of companies across multiple countries. Improvement of financial transparency is a possibility with IFRS adoption, which also fosters global competition and economic growth (Joos & Leung, 2013). The convergence will simplify the stock market's works on the conversion of foreign exchange and interpretations of financial reports, this will also allow companies to compete for global capital to foster their growth (Joos & Leung, 2013). However, the cost of adopting IFRS or convergence is extremely high since this process requires infrastructure and rigorous training of accountants on the IFRS module, this requires a significant investment before the company realizes the benefits that come with adopting IFRS accounting standards.
References
Balakrishnan, K., Blouin, J. L., & Guay, W. R. (2019). Tax Aggressiveness and Corporate Transparency. The Accounting Review, 94 (1), 45-69.
Balsmeier, B., & vanhaverbeke, S. (2016). International Financial Reporting Standards and Private Firms’ Access to Bank Loans. European Accounting Review, 27 (1), 75-104.
Barth, M. E., Landsman, W. R., Lang, M., & Williams, C. (2012). Are IFRS-based and US GAAP-based accounting amounts comparable? Journal of Accounting Economics, 54 (1), 68-93.
Botzem, S., & Quack, S. (2009). (No) Limits to Anglo-American accounting? Reconstructing the history of the International Accounting Standards Committee: A review article. Accounting, Organizations and Society, 34 (8), 988-998.
Brown, R. (Ed.). (2014). History of Accounting and Accountants. New York: Routledge.
Flood, J. M. (2015). Wiley GAAP 2016: Interpretation and Application of Generally Accepted Accounting Principles. New Jersey: John Wiley & Sons.
Jiambalvo, J. (2019). Managerial Accounting. New Jersey: John Wiley & Sons.
Joos, P., & Leung, E. (2013). Investor Perceptions of Potential IFRS Adoption in the United States. The Accounting Review, 88 (2), 577-609.
Kimmel, P. D., Weygandt, J. J., & Kieso, D. E. (2018). Financial Accounting: Tools for Business Decision Making (9 ed.). New Jersey: John Wiley & Sons.
Latridis, G. (2010). International Financial Reporting Standards and the quality of financial statement information. International Review of Financial Analysis, 19 (3), 193-204.
McEnroe, J. E., & Sullivan, M. (2014). The Rise and Stall the U.S. GAAP and IFRS Convergence Movement. The CPA Journal, 84 (1), 14-19.
Murphy, S. L. (2012). IFRS and U.S. GAAP: Some Key Differences Accountants Should Know. Management Accounting, 14 (1), 19-26.
Pillhofer, J. A. (2013). Potential Adoption of IFRS by the United States: A Critical View. Accounting Horizons, 27 (2), 271-299.
Pries, F., & Baker, R. (2010). A Proposal for Teaching Introductory and Intermediate Accounting in an Environment of International Financial Reporting Standards and Generally Accepted Accounting Principles for Private Enterprises. Accounting Perspectives, 9 (1), 15-27.
