Who created accounting
principles? Who sets and revises accounting standards? What if you don't
follow all the rules, do you go to jail? Is there an accounting police
force that investigates and arrests violators? It would seem that there
must be some regulatory force to make sure that providers of financial
statements conform to the rules. There is, up to a point, and here is
how it works:
Mainly, it's all
voluntary and it works pretty well. First, double-entry accounting originated
in Italy in the 1400's, so its been around awhile. Accounting principles
have evolved over the years just as have accounting standards. The reason
why the system works is that the business community could not function
if there was not commonality and consistency in financial statement
reporting. It would be chaos, much like if there were no driving rules
of the road.
Therefore, in the
United States, a body of experts known as the Financial Accounting Standards
Board (FASB pronounced Fasbee) was established in 1973, which superseded
another board called the Accounting Principles Board (APB). The FASB
members go through a lengthy process of analyzing and reviewing problems
in the accounting field that are brought to them. After much thought,
they will make a pronouncement as to what they think the new or revised
way of approaching the treatment of an accounting issue should be.
They are a non-governmental
organization that has private financing. A big supporter of FASB is
the American Institute of Certified Public Accountants (AICPA). Many
Certified Public Accountants (CPAs) belong to this prestigious organization
and are obligated to abide by its guidelines and principles of behavior.
Other countries no doubt have similar organizations that require high
levels of accounting professional conduct.
FASB established
an accounting code called "Generally Accepted Accounting Principles"
or (GAAP). The assumption is that if a business financial statement
is prepared according to GAAP, then the user of that financial statement
could rely on or trust the information more readily than if not prepared
according to GAAP. Those businesses that deviate from GAAP, and many
smaller businesses do, cannot say that their statements are prepared
under GAAP; in fact, they should inform the reader that they are not.
However, let the buyer beware.
One governmental
body that has a policing function is the Securities Exchange Commission
(SEC). It is primarily concerned with public companies because their
job is to protect investors from unscrupulous acts. Recently, the SEC
has gotten into the act of establishing accounting standards. It has
its hands full today.
Since most businesses
use their financial statements to prepare their required income tax
returns, the Internal Revenue Service (IRS) may audit those tax returns
and review the financial statements upon which the tax returns are based.
Not following the rules can get you in trouble with this governmental
body.
You can see that
in many ways compliance to the principles and standards is a mixture
of voluntary and regulatory behavior. Currently, there is an effort
underway to set international accounting standards due to the inexorable
globalization process. This is a massive undertaking that will take
years, but it is obviously necessary and inevitable.
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