Companies all over the world are required to present financial information to investors and other stakeholders at certain intervals. This presentation is usually required by regulatory authorities such as the Securities and Exchange Commission (SEC) in the United States. For purposes of comparability, the financial information presented must conform to certain standards. This minimizes the risk of a company deliberately manipulating its financial information to appear more favorable to stakeholders. The standards or the accounting framework that financial information has to comply with are known as Generally Accepted Accounting Principles (GAAP).
Financial information is presented in the form of a set of financial statements that consists of various components. These components are usually a statement of financial position, a profit and loss statement, a statement of cash flows, a statement of changes in shareholder’s equity and related notes. These components include various balances and transactions representing the company’s assets, liabilities, income and expenses. GAAP provide requirements for the recognition, measurement and disclosure of these balances and transactions. For example, to minimize the risk of overstatement of income by premature recognition, GAAP provide revenue recognition requirements that require companies to all record revenue at the same time. Further, to ensure that companies don’t formulate their own asset management policies, GAAP have prescribed certain policies detailing recognition, depreciation and measurement of assets.
To ensure that companies comply with the requirements of GAAP, companies are also required by regulatory authorities to have financial information audited by accounting firms. These firms essentially review financial information in light of the requirements prescribed by GAAP. Once financial information is audited and no discrepancies are noted, it can be analyzed by shareholders as a basis for their investment decisions.
GAAP in the Global Marketplace
Since the development of this framework, it has been tailored to the requirements of various countries. This has resulted in various different versions of GAAP prevalent in different countries around the globe. For example, China and the US follow tailored versions of GAAP which has resulted in experts sometimes concluding that a single company’s financial statements would present significantly different results if prepared under both frameworks. As a solution, the International Accounting Standards Board (IASB) has developed International Financial Reporting Standards (IFRS) that have been adopted by majority of the countries of the world. In recent years, the shift has been significant with only the US being the last major country to use GAAP as an accounting framework