GAAP Guidelines and Financial Reporting Standards

The financial statements are management’s communication to external users. Since management has knowledge of the company’s day-to-day transactions and external users do not, there's an inherent risk that management’s communication may be inaccurate, misleading, or presented in a way that makes it difficult for external users to compare the company’s financial condition to that of other companies. For this reason, standard-setting organizations provide standards and guidelines for management to follow in their accounting system and financial statement presentation. In the United States, the primary authority for accounting standards is the Securities and Exchange Commission (SEC), a government body. The SEC has the power to ensure that accounting standards are upheld and financial statement users’ interests are protected. However, the SEC delegates responsibility for setting specific accounting standards to the Financial Accounting Standards Board (FASB), made up of accounting and finance experts with backgrounds in industry, auditing, education, and investing.

Remember that GAAP stands for Generally Accepted Accounting Principles, and some of these accounting principles have been in use for centuries. The FASB has created formal written descriptions of already-existing GAAP and has organized the guidance by topic into a framework called Codification. New guidance and revisions to old guidance are added to the Codification after a period of public comment and deliberations.

The FASB has also created a conceptual framework describing (1) the characteristics of useful accounting information, (2) the elements comprising the financial statements, and (3) assumptions and principles used throughout the accounting system. Here, we’ll consider the important characteristics of accounting information, as defined in the conceptual framework:

• Relevance: The information should help financial statement users confirm their assessment of the company’s financial condition, as well as predict the company’s financial future. Also, the information reported should be material—large enough or important enough to influence the decisions of a financial statement user.
• Faithful representation: The information should be complete, error-free, and neutral (unbiased).
• Enhancing characteristics: The information should be consistent (to allow for comparisons), verifiable, timely, and understandable.

In the following sections, we will look at the four financial statements, highlighting their elements and structure. Throughout the rest of the course, some of the assumptions and principles in the conceptual framework will be covered.