What is an accounting standard?
An accounting standard is a set of rules and guidance that tells companies when and how to record, measure, classify, and present economic events in their financial reports. Standards make financial statements more transparent and comparable across companies and time by imposing a common structure and terminology.
Core definitions
– Accounting standard: rules governing recognition, measurement, classification, and presentation of financial transactions.
– GAAP (Generally Accepted Accounting Principles): the body of accounting standards and common practice used in the United States. Public companies listed on U.S. exchanges must follow GAAP.
– IFRS (International Financial Reporting Standards): a global set of accounting standards issued by the International Accounting Standards Board (IASB); widely used outside the U.S.
– FASB (Financial Accounting Standards Board): an independent nonprofit that develops and interprets GAAP for U.S. companies.
– Recognition: the act of recording an economic event in the financial statements.
– Measurement: the process of determining the monetary amount at which an item is reported (for example, historical cost vs. fair value).
Why standards matter (short)
– Comparability: investors and lenders can compare companies because similar transactions are reported using the same rules.
– Transparency and credibility: consistent rules reduce ambiguity about what numbers represent.
– Decision usefulness: banks, regulators, and market participants rely on standardised reports for credit and investment decisions.
– Boundaries: standards limit how companies can shape reported results, reducing misuse of accounting choices.
Who sets the main standards?
– U.S.: FASB issues GAAP for public and private companies and many nonprofits. The U.S. Securities and Exchange Commission (SEC) enforces requirements for public companies to use GAAP in filings.
– International: IASB issues IFRS for many countries and multinational companies; jurisdictions decide whether to require IFRS.
Typical areas governed by standards
– Revenue recognition (when and how to record sales)
– Asset classification and valuation (what to capitalise and at what amount)
– Depreciation and amortisation methods and useful lives
– Lease accounting (classification and measurement)
– Share count and dilution (how to report outstanding shares)
– Presentation and disclosure in notes to the financial statements
Brief history (high level)
Early U.S. standard-setting began with professional bodies such as the American Institute of Accountants (now AICPA) and exchanges. Federal securities laws in the 1930s and the SEC increased demand for uniform reporting. In 1973 standard-setting responsibilities for GAAP were assigned to the newly formed FASB. Government accounting standards in the U.S. are handled by the Governmental Accounting Standards Board (GASB).
Checklist: what to confirm when you read a company’s financials
– Which accounting framework was used (GAAP or IFRS)? Check the front of the financial statements or note 1 (significant accounting policies).
– Have there been changes in accounting policy this period? If yes, read the disclosure for the reason and effect.
– Revenue recognition policy: when is revenue booked (point in time vs over time)?
– Depreciation and amortisation: method (straight-line vs accelerated), useful lives, salvage value.
– Lease treatment: operating vs finance/capital; impact on assets and liabilities.
– Valuation bases: historical cost, fair value, or recoverable amount for assets and liabilities.
– Share count: basic vs diluted shares outstanding and how dilutive instruments are treated.
– Footnotes and accounting estimates: key judgments (impairments, provisions, contingencies).
– Auditor’s opinion and any emphasis-of-matter or going-concern notes.
Step-by-step: find which standard a company uses (quick)
1. Open the company’s annual report or Form 10-K (for U.S. public companies).
2. Read the first note to the financial statements—usually titled “Summary of Significant Accounting Policies.”
3. Check the auditor’s report and management’s discussion for references to GAAP, IFRS, or other frameworks.
4. If still unsure, check the filing’s header or the investor relations “Financials” page online.
Small worked example: how depreciation method affects reported profit and assets
Assumptions:
– Asset cost = $100,000
– Useful life = 5 years
– Salvage value = $0
Compare two common methods:
1) Straight-line (even expense each year)
– Annual depreciation = (100,000 − 0) / 5 = $20,000
– End of year 1: depreciation expense = $20,000 → profit reduced by $20,000; net book value = 100,000 − 20,000 = $80,000.
2) Double-declining-balance (accelerated)
– Rate = 2 × (1/5) = 40%
– Year 1 depreciation = 100,000 × 40% = $40,000
– End of year 1: depreciation expense = $40,000 → profit reduced by $40,000; net book value = 60,000.
Impact summary:
– In year 1, accelerated depreciation produces lower net income ($20,000 more expense) and a lower asset carrying amount than straight-line.
– Over the full 5-year life, total depreciation equals the same amount ($100,000) assuming no salvage, but timing differences affect interim comparability. Accounting standards require disclosure of the method so readers can interpret results.
Notes on assumptions and limits
– Standards evolve: tax rules, new standards on leases, revenue, and financial instruments have changed reporting in recent decades.
– GAAP and IFRS differ in some applications (examples: certain revenue or lease rules, measurement choices). Always confirm which framework applies for a particular company.
– Accounting choices can affect ratios and trend analysis; use footnote disclosures to adjust or interpret figures.
Further reading (reputable sources)
– Financial Accounting Standards Board (About the FASB) — https://www.fasb.org/about
– IFRS Foundation / IASB (Why global accounting standards?) — https://www.ifrs.org/about-us/why-global-accounting-standards/
– IFRS Foundation (Who uses IFRS accounting standards?) — https://www.ifrs.org/use-around-the-world/
– U.S. Securities and Exchange Commission, Investor.gov (The laws that govern the securities industry) — https://www.investor.gov/introduction-investing/investing-basics/how-markets-work/laws-govern-securities-industry
Educational disclaimer
This explainer is for educational purposes only. It does not constitute investment, tax, or accounting advice tailored to your situation. For decisions that depend on financial reporting or tax outcomes, consult a qualified professional.