Accounting Standards: Comparing Apples to Apples

Accounting rules have been in the news a lot lately. One in particular, the mark to market rule, has become something of a scapegoat for the current economic crisis. I thought we’d take a step back today and look at the purpose of accounting standards and their role in our free market economy.

Why Do We Need Accounting Standards and Where Do They Come From?

To ensure uniformity in financial statements, publicly traded companies must follow a set of rules known as the generally accepted accounting principles (GAAP). Basically, GAAP is designed to help investors (including bankers) compare financial apples to financial apples. Without accounting standards, you’d be on your own to determine the profitability or soundness of a given company.

Accounting standards are the rules everyone agrees to play by.

In the US, the Financial Accounting Standards Board (FASB) develops and issues rules on accounting practices. They work with academia and corporate America to create accounting rules that result in financial statements that are economically correct and useful to investors, without being cost prohibitive to implement. 

SEC and Sarbanes-Oxley

In 1934 the Securities and Exchange Act of 1934 granted SEC broad authority to to set, execute and oversee the accounting practices of public companies. However, until recently CPAs who audit the companies were almost entirely self-regulated. Accounting scandals like Enron prompted the SEC and Congress to get more directly involved in the oversight of the standards setting process and in monitoring corporate governance.

The Sarbanes-Oxley Act of 2002 created the Public Company Accounting Oversight Board (PCAOB). They make sure companies are following the accounting rules by conducting inspections of registered public accounting firms and enforcing compliance related to the preparation and issuance of audit reports. They also establish auditing, quality control, ethics, independence, and other standards relating to the preparation of audit reports for issuers.

International Standards

As the world moves to a single economy, the need for international accounting standards is pressing. Investors must be able to compare information about companies with confidence that revenue in Italy will be reported according to the same rules as revenue in the US. The International Accounting Standard Board (IASB) was formed to develop a set of international accounting rules.

Aside from the current kerfuffle over fair value, or mark to market, accounting for distressed assets (like sub-prime mortgages) the move to international accounting standards is the hottest topic in accounting today.

Accounting standards must evolve over time to meet the ever-changing needs of businesses and the the investing public.

Image Credit: SSu, Flickr