Accounting Standards Every Accountant Should Know

Without a common set of accounting standards, businesses would struggle to accurately report revenue, costs and losses to investors or shareholders. These standards, known as generally accepted accounting principles (GAAP), provide guidelines that accountants must follow to ensure transparency and compliance, helping businesses avoid audits or penalties from regulatory agencies.

Keep reading for an overview of some of the most important accounting standards that professionals in the field should know.

What Is GAAP?

Another important assumption is the going concern principle, which presumes that a business will continue operating in the foreseeable future. This principle affects financial reporting by ensuring that assets are assessed at cost rather than liquidation value. If there is substantial doubt about a company's ability to continue operations, reporting standards must be adjusted accordingly. GAAP is not mandatory for all businesses, but accountants working for publicly traded companies must adhere to GAAP accounting standards when preparing financial statements. Although GAAP itself is not a government entity, it is regulated by the U.S. Securities and Exchange Commission (SEC).

There are 12 fundamental GAAP principles categorized into three main groups:

• Assumptions
• Principles
• Constraints

These guidelines are set by the Financial Accounting Standards Board (FASB), which has issued over 100 pronouncements since GAAP’s establishment in 1973. While U.S. businesses must comply with GAAP, companies operating internationally must also follow additional regulations, such as the International Financial Reporting Standards (IFRS). 

Assumptions

GAAP includes several assumptions that accountants use when preparing financial statements. One key assumption is the business entity principle, which asserts that a business is separate from its owner or any other business.

Under this principle, accountants classify businesses as one of the following:

• Corporation 
• Partnership
• Sole proprietorship

Another important assumption is the going concern principle, which presumes that a business will continue operating in the foreseeable future. This principle affects financial reporting by ensuring that assets are assessed at cost rather than liquidation value. If there is substantial doubt about a company's ability to continue operations, reporting standards must be adjusted accordingly. 

Principles

GAAP principles dictate how businesses should report financial data, particularly revenue and expenses. Two crucial principles are:

• Revenue recognition principle: This principle requires businesses to report revenue when it is earned, not necessarily when payment is received. This approach ensures that financial statements accurately reflect a company’s financial position.
• Matching principle: This principle states that expenses should be recorded in the same period as the revenue they generate. For example, if a company incurs advertising costs in January that directly contribute to revenue in February, the expense should be reported in February. This practice aligns with accrual accounting and helps maintain accurate financial records.

Constraints

GAAP also includes constraints that limit how companies report financial information. One key constraint is the materiality principle, which allows businesses to bypass certain accounting standards for immaterial items. For example, instead of depreciating an inexpensive office chair over several years, a company may choose to expense the full cost immediately. However, the SEC advises against frequent misuse of this principle, as misstatements can impact financial reports.

Another important constraint is the conservatism principle, which requires accountants to choose the reporting method that has the least favorable immediate impact when multiple options exist. This principle ensures that businesses do not overstate income or undervalue liabilities, providing a more accurate financial picture.

 

Exceptions to GAAP

While GAAP governs financial reporting for most businesses, certain entities operate under different guidelines. For example:

• Governmental entities follow the Governmental Accounting Standards Board (GASB) instead of GAAP.
• International companies adhere to International Financial Reporting Standards (IFRS), which are regulated by the International Accounting Standards Board.

Aspiring accountants should familiarize themselves with these alternative reporting frameworks, particularly if they plan to work in specialized industries or global markets.

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