Accounting principles: National and international standards
In the United States, there is a set of standards in place for annual financial accounting called the US GAAP (United States Generally Accepted Accounting Principles). These principles are set in place by the Financial Accounting Standards Board, or FASB, and are a national version of the international accounting standards set by the IFRS. The accounting principles contained in the GAAP are only required for publicly traded companies, though many private businesses choose to follow them as well. Following the principles helps to guarantee consistency and accuracy in finances, which helps companies to secure the trust of their investors, employees, and financial backers. Compliance to the GAAP also depends on the state: Some states require full GAAP compliance, while others require none at all.
- What are accounting standards?
- Accounting standards in Europe
- International accounting standards
- Accounting standards in the US: Comparison of the GAAP and IFRS
Accounting standards exist to ensure that accounting decisions are made in a unified and reasonable way. They should be comparable: so it is easy to compare the financial standing of similar entities. They should be transparent: leaning in the direction of openness when deciding how to provide information to observers. Standards make sure the information in the financial statements is relevant: this makes it more difficult for organizations to misdirect observers.
The aim of the standards is to organize a company in such a way as to provide all of the necessary information to any independent observer. The US GAAP system actually functions under 10 basic tenets, all intended to promote the consistency and transparency of official financial records.
It goes without saying that capital-market-oriented companies are obliged to protect the interests of their investors and shareholders. Compliant annual financial statements aim to provide an objective insight into the economic situation of a company within the scope of the shareholder protection principle so that those shareholders can form their own estimation of possible returns and risks. Commercial books and financial statements also assist in tax planning and optimization.
Creditor protection, shareholder protection, and tax structuring are reflected in two basic functions of the annual financial statements: How easily the business can pay its bills and the profitability of the business.
- The income of the business year serves as a basis for the taxation of a company as well as the determination of performance-related distributions (dividends and profit sharing)
- The balance sheet displays the financial health of a company at a point in time and serves as the basis for financial planning and resource allocation.
Annual consolidated financial statements, when prepared according to uniform accounting standards, are reliable and meaningful sources of information. The other 10 basic tenets of the US GAAP are as follows:
- Permanence of Methods
- Materiality / Good Faith
- Utmost Good Faith
What are accounting standards?
Accounting standards are national or international principles set in various areas of business accounting. The aim is to regulate bookkeeping and accounting in relevant legal areas by means of statutory requirements, thereby standardizing the process of reporting on company finances and making statements relevant and comparable.
For accountants in the US, this means a divide between the national standards of the FASB and the international standards of the IFRS. The standards laid out by the FASB in the US GAAP translate easily to many international markets. US companies that have non-US subsidiaries preparing financial statements using an IFRS framework should keep up-to-date on IFRS developments.
National accounting standards
Accounting standards have a long tradition. As early as 5,000 years ago, merchants in Egypt and Mesopotamia organized their business using an ancient version of financial statements and accounts. In the Roman Empire, bankers were obliged to use systematic accounting. Even double-entry accounting, the most commonly used system of commercial business income and expenditure recording today, found its origins in 17th century northern Italy.
In the States, accounting standards were first introduced by the American Institute of Accountants (AIA) in the 1930s. After the global economic crisis of the 1920s and the stock market crash of 1929, the overly lax accounting practices of many businesses shouldered a lot of the blame. Without strict standards of financial presentation, companies could manipulate their reports to suit whatever needs they had, making their finances appear in better shape than they actually were. The Securities and Exchange Commission (SEC) began enforcing legislation for public companies with the Securities Act of 1933 and the Securities Exchange Act of 1934. Accounting standards in the US are now monitored by the FASB, an independent organization that is responsible for setting accounting standards for public companies in the US.
While the accounting principles contained in the US GAAP only apply to US companies, there are national accounting principles in Canada, France, Germany, the UK, China, India, Nepal, and Russia. Though there is some overlap (for example, Germany has voluntarily signed the US GAAP in addition to their own standards), principles are only really applied to domestic business. Any companies doing business with or from foreign nations typically apply international accounting standards, such as the IFRS format.
The application of the IFRS standards is much less prevalent in the US, however. While public companies are required to uphold US GAAP standards, private companies are allowed to choose their own accounting methods and there are no laws in place requiring the application of IFRS standards. IFRS is also only required for the consolidated accounts of EU listed companies and any companies not included in that population are only subject to national standards.
While operating according to IFRS is generally all that’s required for conducting foreign business, the following table will provide a quick overview of the national accounting standards for the DACH countries (Germany, Austria, and Switzerland) as well as the other major players in Europe: the UK, France, Spain, and Italy.
Accounting standards in Europe
The German Commercial Code (HGB in German) forms the legal basis for the management of business books and creation of annual financial statements in Germany. This requires every merchant to disclose transactions and assets in accordance with proper accounting principles. Details on these can be found in the Commercial Code and aren’t explicitly defined by the legislature. Instead, the principles are formed based on educated recommendations and generally accepted practice.
Deutsche Rechnungslegungsstandards (DRS)
Handelt es sich bei dem bilanzierenden Unternehmen um ein Mutterunternehmen (Konzern), sind darüber hinaus die Deutschen Rechnungslegungsstandards (DRS) zu beachten. Diese werden im Auftrag des Bundesministeriums der Justiz (BMJ) vom Deutschen Rechnungslegungs Standards Committee (DRSC) – einem privatrechtlichen Rechnungslegungsgremium – entwickelt. Die DRS interpretieren Rechnungslegungsvorschriften, füllen Regelungslücken und bieten somit detaillierte Vorgaben zur Konzernrechnungslegung. Alternativ kann der Konzernabschluss freiwillig gemäß internationalem Standard IFRS (International Financial Reporting Standards) erstellt werden. Dieser ersetzt den Konzernabschluss nach HGB und DRS, sofern ergänzende handelsrechtliche Vorschriften beachtet werden.
International Financial Reporting Standards (IFRS)
Kapitalmarktorientierte Mutterunternehmen hingegen bilanzieren nicht nach HGB und DRS. Stattdessen kommen europaweit die von der EU anerkannten internationalen Vorgaben der IFRS zur Anwendung.
The German Corporate Code (UG in German) is used in Austria for drawing up annual financial statements. Austrian law also refers to the principles of proper accounting. Unlike in Germany, these are described directly in the legal text and so are official legislative standards.
Similar to the situation in Germany, parent companies in Austria have the right to choose between IFRS and the national standard. According to EU regulations though, capital-market-based parent companies must account in accordance with IFRS.
The Swiss Code of Obligations (OR in German) contains statutory minimum requirements for accounting in Switzerland. The OR regulations are binding for all commercial transactions of companies and organizations with account obligations. Strict rules apply to companies listed on the largest Swiss stock exchange, SIX Swiss Exchange. In this case, it’s required to either follow the recommendations for accounting (Swiss GAAP FER) or international accounting standards (IFRS).
Swiss GAAP FER
For Swiss companies listed on the SIX Swiss Exchange in the secondary segment, the recommendations for accounting (Swiss GAAP FER) apply as a minimum standard. Companies that aren’t listed can choose to use Swiss GAAP FER for their accounting as well. These recommendations include:
- A framework concept
- Core expert recommendations
- Swiss GAAP FER 30 for consolidated financial statements
- Swiss GAAP FER 31 for listed companies
Small companies only have the option to align themselves with the framework concept and select expert recommendations. Medium-sized organizations must observe all standards for their accounting. The Swiss GAAP FER 30 is also required for companies, coordinated with the consolidated financial statements. Exchange-listed companies also must take the Swiss GAAP FER 31 (“Complementary recommendation for listed companies”) into account. Industry-specific recommendations are offered for insurance companies, pension institutions, non-profit organizations, health insurers, and building insurers.
IFRS or US GAAP
Since 2005, a financial statement prepared according to international standards (IFRS or US GAAP) has been mandatory for Swiss companies listed on the SIX Swiss Exchange in the main segment.
New UK-GAAP Generally Accepted Accounting Practice (New UK-GAAP)
New national accounting standards have been in place in the UK since January 1, 2015, called the New UK GAAP. The accounting framework is aimed at non-capital-oriented companies and covers the six standards FRS 100 to FRS 105.
- FRS 100 - Application of Financial Reporting Requirements: FRS 100 explains the framework for financial statements prepared in accordance with national laws, regulations, and accounting standards.
- FRS 101 - Reduced Disclosure Framework: FRS 102 presents a reduced accounting concept that allows companies to prepare consolidated financial statements in accordance with the international IFRS requirements, without having to comply with all IFRS disclosure requirements.
- FRS 102 - The Financial Reporting Standard Applicable in the UK and Republic of Ireland: FRS 102 is the actual financial reporting standard for the UK and Ireland. This covers 250 pages and replaces all previous Old UK GAAP standards.
- FRS 103 - Insurance Contracts: FRS 103 contains separate accounting standards for companies that issue insurance contracts.
- FRS 104 - Interim Financial Reporting: FRS 104 is based on the international standard for interim reporting, IAS 34, and serves as a basis for the preparation of interim financial statements for companies that use FRS 101 or FRS 102 accounting.
- FRS 105 - The Financial Reporting Standard Applicable to the Micro-entities Regime: FRS 105 is a modified version of FRS 102, directly tailored to the requirements and needs of micro-enterprises.
The FRS is issued by the Accounting Standards Board (ASB), a division of the Financial Reporting Council (FRC).
Listed companies also have to prepare accounts according to the IFRS international accounting standards in the UK.
Plan comptable général (PCG)
The Comptable Général (PCG) is the minimum standard for the accounting of non-listed companies in France. The framework contains the following content:
- Overview of the topics and principles of the accounting
- Definition of core concepts such as the balance sheet, profit and loss account, liabilities, assets, income, as well as profits and losses
- Presentation of accounting and valuation rules
- Account management and naming rules
- Documentation requirements
- Special accounting rules
- Statements by the National Audit Office (Conseil National de la Comptabilité) and the Committee on Urgency (Comité d’Urgence)
Like any other EU member state, France also requires listed parent companies to prepare consolidated financial statements in accordance with the IFRS.
Código de comercio (CCom) und Ley de sociedades anónimas (LSA)
Merchants and trading companies in Spain are also obligated to prepare business books according to commercial principles. Corresponding requirements can be found in the Spanish Commercial Code (Código de comercio, CCom) and the Spanish Stock Corporation Act (Ley de sociedades anónimas, LSA). These are largely based on the European guidelines and differ only slightly.
Plan general de contabilidad
One criticism of the CCom and LSA accounting standards concerns their overall account plan (Plan general de contabilidad, PGC), which was approved by Royal Decree 1514/2007 and is a broad adaptation of the international accounting standard IFRS. A simplified account plan for small and medium-sized companies is available in accordance with Decree 1515/2007.
Spanish capital-oriented parent companies report according to the IFRS, just like all other EU member states.
The legal basis for accounting standards in Italy is contained in Article 2423 of the Italian Civil Code (Codice Civile, CC). The possibility of a condensed financial statement is the subject of Article 2435.
Accounting principles of the OIC
An interpretation and clarification of the Italian Civil Code of accounting principals is available to companies by the accounting principles of the Organismo Italiano di Contabilità (OIC). In the case of regulatory gaps in the national guidelines, resorting to international standards (generally IFRS) is possible.
Listed companies and insurance agencies in Italy are required to create individual and consolidated financial statements according to IFRS. Non-listed companies are allowed to choose between IFRS and the national standards.
International accounting standards
To make annual and consolidated financial statements that are comparable across national borders, international harmonization has been underway for a number of years. The goal is to provide companies with a uniform framework for financial statements. The international accounting standards in use today are the IFRS, created by the IASB, as well as the US GAAP, created by the FASB, which are used primarily in America but are also applied abroad. The following is a brief recap of these standards, which were discussed earlier as well.
The International Financial Reporting Standards (IFRS) were published by the International Accounting Standards Board (IASB) as basic principles for international company accounting. The goal was to achieve a worldwide harmonization of the accounting system.
The framework consists of three parts:
- Framework: The IFRS framework forms the theoretical basis of the standards as a framework concept. It describes the goals and the main premise of the international requirements, as well as qualitative requirements for the IFRS financials statements. It also provides framework definitions of the central terms such as assets, liabilities, income, or expenses.
- Standards (IFRS/IAS): The actual accounting and valuation requirements are in the form of individual standards. These include both the IFRS from the IASB as well as the IAS (International Accounting Standards) from the predecessor organization, the IASC (International Accounting Standards Committee).
- Interpretations: To unify the understandings of the international requirements, the third part of the framework includes official interpretations of the standards published by IFRS Interpretations Committee (IFRS IC).
Application of the IFRS: In the event of a conflict, the IFRS standards and interpretations have a higher liability as special regulations than the overall specifications of the framework. The framework itself doesn’t have a default status.
Since 2005, all capital-oriented parent companies with locations in Europe are required to create financial statements according to the IFRS.
The United States Generally Accepted Accounting Principles (US GAAP) are accounting standards issued by the Financial Accounting Standards Board (FASB) for the US. They obtain legal status with the approval of the US Securities and Exchange Commission (SEC) as well as the largest professional association of American auditors, the AICPA (American Institute of Certified Public Accountants).
US GAAP also enjoys a high international status, since a listing on the US stock exchange requires reporting in accordance with the rules of the SEC. Until 2007, foreign companies wishing to meet their capital requirements on the US capital market were also required to fulfill the US GAAP or a compliant transition to the US standard. But since December 21, 2007, with the acceptance of the IFRS by the SEC, this requirement has been omitted.
Accounting standards in the US: Comparison of the GAAP and IFRS
While the accounting standards of the US GAAP have been around since the 1930s, the IFRS is still yet to be widely accepted in the United States and are still not standards required by the SEC. Companies can choose to conform to IFRS standards, which can be particularly helpful when conducting global business. Public companies, regardless of whether they choose to integrate IFRS, are required to follow the US GAAP for their financial statements.
The FASB, which supplies the US GAAP standards, and the IFRS have been working together to agree on both domestically and internationally applicable standards. The SEC is still deliberating on what recommendations or requirements to put forth regarding global standards.
The following table presents the main differences between the US GAAP and IFRS, as shown in financial statements with regard to itemization and content:
|Balance sheet||Recommends separation of current and non-current asset and liability categories||Requires separation of current and non-current asset and liability categories|
|Intangible assets||Recognizes intangible assets at fair value||Intangible assets only examined if they could display future benefit|
|Documentation||Statement of Comprehensive Income is required||Statement of Comprehensive Income is not required|
|Inventory write-downs||Inventory write-down reversals are not permitted||Inventory write-down reversals are possible under certain circumstances|
|Extraordinary items||Listed separately under new income||Included with other items on income statement|
Zahlungsbemessungsfunktion vs. Informationsfunktion (decision usefulness)
Internationale Rechnungslegungsstandards sind im Wesentlichen durch den angloamerikanischen Wirtschaftsraum beeinflusst. Wie US-GAAP orientieren sich auch die IFRS am Kapitalmarkt. Während deutsche Unternehmen ihren Finanzmittelbedarf in erster Linie durch Fremdkapital in Form von Krediten decken, rückt im internationalen Raum die Beschaffung von Eigenkapital über die Börse in den Mittelpunkt. Adressaten internationaler Abschlüsse sind daher in der Regel Aktionäre. Der IFRS-Abschluss soll Anlegern im Sinne der decision usefulness alle Informationen zur Verfügung stellen, die diese benötigen, um angemessene Entscheidungen zu treffen. Beim Abschluss gemäß HGB tritt diese Informationsfunktion zugunsten der Zahlungsbemessungsfunktion in den Hintergrund.
Vorsichtsprinzip vs. accrual principle
Mit der Ausrichtung auf den Kapitalmarkt ist die investorenorientierte Bilanzierung nach internationalen Standards stets an einer periodengerechten Erfolgsermittlung orientiert. Der Bilanzierung nach IFRS liegt das accrual principle zugrunde – ein Prinzip, nach dem Erträge und Aufwendungen in derjenigen Periode verzeichnet werden, in der sie erwirtschaftet werden, und nicht in derjenigen, in der die Zahlungseingänge oder -ausgänge erfolgen. Beim HGB-Abschluss hingegen erfährt das accrual principle starke Einschränkungen durch das Vorsichtsprinzip (prudence principle). In der deutschen Rechnungslegung dominiert der Gläubigerschutz. Das Vorsichtsprinzip soll Fremdkapitalgeber vor einer allzu optimistischen Darstellung der Geschäftslage schützen. Die konkrete Umsetzung des Vorsichtsprinzips erfolgt in Form zweier Folgeprinzipien: Realisationsprinzip und Imparitätsprinzip.
- Realisationsprinzip: Das Realisationsprinzip dient vordergründig dem Gläubigerschutz und besagt, dass Gewinne und Verluste nur dann zu berücksichtigen sind, wenn sie am Abschlusstag realisiert wurden. Nicht realisierte Gewinne bleiben somit unberücksichtigt.
- Imparitätsprinzip: Das Imparitätsprinzip besagt, dass alle vorhersehbare Verluste und Risiken bereits vor Realisation berücksichtigt werden müssen – beispielsweise durch die Bildung von Rückstellungen oder Abwertungen.
Durch die ungleiche Behandlung realisierter Gewinne und Verluste führt das in Deutschland dominierende Vorsichtsprinzip zu vergleichsweise pessimistischen Jahresberichten.
Prudence principle vs. accrual principle
The focus on the capital market means that investment-oriented finance reports based on international standards are aimed at meeting needs within a given period. IFRS statements are based on the accrual principle - income and expenses are recorded in the period in which they’re generated and not in the period in which the payment receipts or payments actually appear. By contrast, the US GAAP places a larger emphasis on the prudence principle that strives to remove speculation from the reporting of fact-based financial data. The prudence principle is intended to protect lenders from the overly optimistic presentation of financials. For example, revenue is not recognized unless it is certain.
The concrete implementation of the principle of prudence works with the two other principles: non-compensation and materiality/good faith.
- Principle of non-compensation: The non-compensation principle requires full transparency of both negative and positive values in the financial statement, without the inclusion of any expected debt compensation.
- Principle of materiality: This principle means trivial matters are to be disregarded and all important matters are to be disclosed.
- Principle of utmost good faith: All involved parties are assumed to be acting honestly with every necessary disclosure documented.