accounting principles

Factual Questions
1

I don’t know much about accounting, but I have the impression that there are two main sets of standards, one known as Generally Accepted Accounting Principles (GAAP) and another one whose name I can’t remember.

A few years ago, when I was practicing regulatory law, one of my supervisors cautioned me that our clients would never want to promise a regulatory agency that they would comply with U.S. GAAP because its requirements are too onerous and business would grind to a halt.

Given the attention that accounting practices have been getting in light of recent events, I was wondering whether someone might be able to enlighten me here.

What is GAAP, exactly, and what is the other one whose name I can’t remember?

Why would one or the other cause business to grind to a halt?

Why is this stuff so difficult? It would seem to a non-businessman that it shouldn’t be too difficult to tick off one’s income, expenses, and assets without “accidentally” lying all the time.

2

FASB is the other one (“Fazz-Bee”).

I can contribute very little else to the end in view, except to note that some of this stuff really is hard, and much of the rest of it is arbitrary enough that it’s easy to get “wrong.” (Like driving on the correct side of the road – there’s no reason at all to pick one side over the other except that everybody else does it this way – but in complex business transactions where there are very few “everybody elses,” you have to gamble on which position will become the standard.)

–Cliffy

3

Not quite, Cliffy.

FASB is the Financial Accounting Standards Board. They promulgate Financial Accounting Statements (FAS’s). FAS’s define U.S. GAAP – Generally Accepted Accounting Principles.

You may be thinking of the rules for governmental accounting, which are set by the Governmental Accounting Standards Board (GASB). Accounting for governmental and non-profit entities (so-called “fund accounting”) is significantly different from ordinary financial standards.

Of course, accounting standards can also vary from country to country.

4

And another point: it’s not really an “accounting standard,” but sometimes the reporting requirements imposed by the tax code are different from what GAAP requires (different depreciation rates are one example that springs to mind). Thus, many companies keep two sets of books: one for the taxman, and one for their financial statements.

As to the rest of the OP:

Usually when my clients (I am a corporate lawyer, doing mostly merger and acquisition work) don’t want to provide GAAP financials, what they really are trying to avoid is providing audited financial statements. An audit is an intrusive and time-consuming process. It is very expensive, and it means that key personnel are going to have big chunks of their time taken away from actually running the business.

In other words, it isn’t that GAAP in and of itself is onerous – most companies would, I suspect, generate financials in accordance with GAAP anyway; non-GAAP financials wouldn’t be terribly useful since it would minimize how well the financials could be compared to othe companies in the same industry. Your supervisor may be using “GAAP financials” as shorthand for “audited GAAP financial statements.”

Having said that, this stuff can get terribly complicated. The big question is classification: should a given outflow be characterized as a capital expense (and thus written off over time) or as an expense (written off in the current period)? How likely is a given potential liability such as pending litigation to occur – should it be reflected in the financials themselves, in the footnotes, or passed on altogether? Is a lease an operating lease or a capital lease? Do holdings in other entities need to be consolidated into the financial statements? Etc, etc, etc. Accounting, at least from an audit point of view, is less about mathematics (which is what most people think) and more about classification.

Oh, and one last thing (sorry for the stream-of-conciousness thing), and given you were practicing regulatory law this may apply: some industries, most notably insurance, have to provide statutory financials, with accounting standards prescribed by the state insurance commission (or whatever other regulatory body applies) of their state of operation. Those standards also differ from GAAP. Insurance companies usually produce both GAAP and statutory finanicals, though it is conceivable that they only produce the statutories; perhaps your boss wanted to avoid generating a second set of financials.

5

I believe the complications only arise when the statements are intended to obfuscate conditions. While it is true that GAAP provides for the exercise of a lot of ‘professional judgment’, it isn’t that complex if you want to tell the straight dope.

6

Sorry, keno, but that does a disservice to public accountants. Accounting is not unlike engineering in the amount of major-specific courses one has to take for an accounting degree. The hours my wife and I spent (my wife is a Big 5/4 auditor) getting our undergraduate degrees weren’t spent learning simple concepts. And the CPA exam is a nasty bear of a test (I actually think it may be tougher than the bar exam in some respects).

You wouldn’t say what a mechanical engineer does is uncomplicated. Financial accounting, particularly for large enterprises, is no different.

7

Considering that many of our clients were start-up telecommunications companies who were reluctant to even provide simple income and balance statements, and have since gone belly-up, I have a strong suspicion that they were trying to avoid telling the whole truth to the PUCs and PSCs.

8

Recent scandals notwithstanding, US GAAP is very strict and does not allow as much latitude to management to manipulate earnings as other GAAPs.

There is something of a debate in Canada right now about bank earnings - which the banks prefer to report on a “cash basis” rather than a GAAP basis, since the numbers look better. Unfortunately, I can’t find a cite on that.

Many Canadian issuers with a US following will provide a reconciliation between Canadian GAAP and US GAAP as part of their annual financial statements.

9

Lots of good info above.

Just wanted to point out, GAAP is occasionally confused with GAAS, which is Generally Accepted Auditing Standards. GAAS is not a type of financial reporting, but standards that auditors must follow when conducting audits of GAAP financial statements (among other types of engagements).

US GAAP is about as good as it gets from a reporting standpoint. IMHO, inherent weaknesses in the standards are far outweighed by greed, lack of auditor independence, fraud, shady accouting tricks that appear to follow GAAP but don’t, etc. The issues you see arise are more people problems than issues with the GAAP standards themselves.

Makes me cringe when the politicians scream at the FASB and talk about re-writing GAAP - the FASB does a good job with making the rules, its lack of enforcement of the standards that causes the problems.

As financial markets become more complex, GAAP must address new issues. While it can get complex in some areas, its not too hard for many corporations to follow - most of the non-GAAP violations are specifically designed to try to bend the rules rather than innocent mistakes that fail to follow them.

At any rate, there is precedent for just about any transaction that a company may incur in the normal course of business, and your typical CPA should be somewhat versed in the general GAAP rules, even not an expert in an accouting area outside his/her focus. By passing the CPA exam, they have demonstrated an understanding of accounting theory and the ability to learn new principles, anyway.

Anyway, the general purpose of GAAP is to get financial reporting standardized so that all publicly traded companies follow the same reasonable and fair accounting rules. It can get complex, simply because transactions are often designed to expoit loopholes in GAAP, which the FASB must then specifically address. After a while, the whole damn thing starts to look like the federal tax code.

10

Found it! The European counterpart to FASB is the International Accounting Standards Board, at http://www.iasc.org.uk. The EU is introducing a rule enforcing compliance with the International Accounting Standards for listed companies in the EU

The SEC is considering allowing companies to list in the US with non-US-GAAP financials, as long as they have IAS statements.