axnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com JOB BOARD CAREERS, What is GAAP? DEGREES v SCHOLARSHIPS WHAT IS GAAP? IN YOUR STATE v a uirrent professionals are expected to h a strong knowledge of genssalyessepted accounting principles (GAAP). These rules and standards are mandated for the required to follow GAAP, though: many do. Accountants adhere to GAAP for consistency, fairness, honesty and accuracy in measuring and disclosing financial information. A company's fiscal reports have a significant impact on the decisions made by investors, employees and financial institutions; GAAP provides the set of foundational guidelines used to support these analyses. HISTORY OF GAAP Without regulatory standards, companies would be free to present financial information in whichever format best suits their needs. With carte blanche to portray a company's fiscal standing in the most ideal light, investors could be easily misled. The Great Depression in 1929, a financial catastrophe which caused years of hardship for millions of Americans, was primarily attributed to faulty and manipulative reporting practices among businesses. In response, the federal government, along with professional accounting groups, set out to create standards for the ethical and accurate reporting of financial information According to Stephen Zeff in The CPA Journal, GAAP terminology was first used in 1936 by the American Institute of Accountants (AIA). Federal endorsement of GAAP began with legislation like the Securities Act of 1933 and the Securities Exchange Act of 1934, laws enforced by the U.S. Securities and Exchange Commission (SEC) that target public companies. Today, the Financial Accounting Standards Board (FASB), an independent authority, continually monitors and updates GAAP. Today, all 50 state governments prepare their financial reports according to GAAP. While a little less than half of US. states officially require local governments to adhere to GAAP, the Governmental Accounting Standards Board (GASB) estimates that approximately 70% of county and local financial offices do anyway. GAAP REQUIREMENTS BY STATE hhiphwwrw accounting comresourcesigap 19axnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com FULLY GAAP COMPLIANT Local and county governments and school districts are required to prepare financial reports under GAAP. MOSTLY GAAP COMPLIANT Two of three regulated state governing boards and districts must comply to GAAP. SOMEWHAT GAAP COMPLIANT One of three regulated state governing boards and districts must comply to GAAP, NOT GAAP COMPLIANT Local and county governments and schoo! districts are not formally required to comply to GAAP, Source: Government Accounting Standards Board WHO DETERMINES GAAP? While the federal government requires public companies to file financial reports in compliance with GAAP, they are not responsible for its creation or maintenance. Instead, a few independent boards serve as authorities on these principles, continually updating them to accommodate changing business practices and evolving organizations. For example, goodwill and interest rate swap standards are among several recent changes to provide alternatives for private companies. Below, we have created an overview of the boards that oversee GAAP pronouncements. Financial Accounting Foundation (FAF) — This organization was formed in 1972 as the administrative corporation that oversees the Financial Accounting Standards Board (FASB) and the Governmental Accounting Standards Board (GASB) . The FAF is responsible for appointing board members and ensuring that these boards operate in a fair and transparent manner. Members of the public are. invited to attend FAF organization meetings in person or through live webcasts. FINANCIAL ACCOUNTING STANDARDS BOARD On the recommendation of the American Institute of CPAs (AICPA), the FASB was formed as an independent board in 1973 to take over GAAP determinations and updates. The board is comprised hhiphwwrw accounting comresourcesigap7016 “The Comprehensive Gude to Understanding GAAP | Accounting com of seven full-time, impartial members, ensuring it works for the public's best interest. In adcition, the board is monitored by the 30-person Financial Accounting Standards Advisory Council (FASAC). FASB is responsible for the Accounting Standards Codification, a centralized resource where accountants can find all current GAAP. The FASB Standards-Setting Process 1 Identify current investor issues 2 Draft issue agenda and hold public meetings 3 Publish Exposure Draft for investor commentary 4 Propose new standards and invite business feedback 5 Weigh all public responses and revise accordingly 6 Announce final revisions to the ASC MAJOR PROJECTS IN 2015 * Proposed Standards Update: reated Embedded Derivatives isclosures about Hybrid Financial Instruments with Organizations would be required to make the connections between bifurcated embedded derivatives and host contracts known in their financial reporting. * Effects on Historical Earnings Per Unit of Master Limited Partnership Dropdown Transactions Creating a standardized reporting process for historical earnings before general partners transfer assets once a master limited partnership is created GOVERNMENTAL ACCOUNTING STANDARDS BOARD The GASB was established in 1984 as a policy board charged with creating GAAP for state and local government organizations. Many different parties rely on government financial statements, including constituents and lawmakers. Fairness and transparency are a priority of the GASB, and their own processes and communications are available for public review. ‘The GASB Standards-Setting Process hhiphwwrw accounting comresourcesigapaxnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com 1 Create an independent task force 2 Conduct research on the subject of the new standard 3 Engage the public through published commentary 4 Create an Exposure Draft of planned standard 5 Host public hearings before a standard is finalized MAJOR PROJECTS IN 2015 * Other Postemployment Benefit Accounting and Financial Reporting - Employer This initiative is designed to increase accountability among government employers and address the effectiveness of the reported data. * Other Postemployment Benefit Accounting and Financial Reporting - Plan Assessing how effective the other postemployment benefit (OPEB) standards are. * Pensions Not Within Statement 68 Scope Addressing amendments to Statements 67 and 68 that pertain to expenditures and liabilities for benefits and pensions. GAAP VS. NON-GAAP While publicly-traded companies are required to follow GAAP for the creation of financial reports, they have the freedom to release additional reports prepared using non-GAAP principles. According to Investopedia, many businesses assert that non-GAAP earnings more accurately reflect their positions. The two approaches can lead to vastly different numbers, though, especially in the short term. As The Wall Street Journal reported, 40 companies that had initial public offerings in 2014 reported losses under standard accounting rules, but showed profits using their own tailor-made measures, according to consulting firm Audit Anal The main difference between preparing reports with GAAP versus without has to do with when revenue and expenses are recognized. GAAP requires that companies use accrual accounting, which differs from cash accounting in that related revenues and expenses are reported together at the time of transaction rather than simply when cash is exchanged. This is especially impactful for purchases made on credit or paid for over a long period of time. If a product is purchased on credit, hhiphwwrw accounting comresourcesigap7016 “The Comprehensive Gude to Understanding GAAP | Accounting com cash accounting would call for recording the purchase once cash is received. This may be much later than the transaction itself, Accrual accounting under GAAP strives to more closely reflect a company’s financial position, regardless of cash-flow. The method used for preparing financial reports matters most to investors when it comes to earnings per share (EPS) reported by companies. Non-GAAP methods for calculating EPS often seek to more closely reflect cash flow, so EPS tends to be higher under these methods than under GAAP. EPS values prepared under non-GAAP are often referred to as “adjusted” earnings. The example below shows the degree to which earnings for one company can differ depending on whether or not they are prepared using GAAP: GAAP VS. NON-GAAP CASE STUDY: PEGASYSTEMS 2010-11 $ in '000s 2010 GAAP 2010 non-GAAP 2011 GAAP. 2011 non-GAAP Total Revenue $336,599 $348,236 $416,675 $420,652 Operating Income $(2,580) $37,491 $10,494 $38,466 Net Income $(5,891) $22,498 $10,108 $28,402 Basic Earnings per $(0.16) $0.57 $0.26 $0.72 Share Source: Pegasystems Inc. All $ amour in thousands, except per share data, There is some discrepancy in reported revenue when comparing GAAP and non-GAAP values. The real difference between the two methods shows up in operating income. Operating income is everything that is left after operating expenses have been subtracted. For both years, the non- GAAP values are considerably higher than the GAAP values, and GAAP operating income is even negative in one year. The large difference is likely because the non-GAAP calculation did not include several expenses, either because they are not recurring or because the company is not matching related revenues and expenses. The discrepancy between GAAP and non-GAAP. operating income leads to very different EPS, which is largely thought of as the most important determinant of a share’s price. Clearly, whether EPS was calculated using GAAP principles or not can greatly impact an investor's decision While the SEC prohibits false or misleading information in all financial reports, GAAP and non-GAAP. methods can still lead to different valuations. For investors, it is important to check footnotes to see how reports were prepared. hhiphwwrw accounting comresourcesigapaxnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com THE 10 BASIC TENETS OF GAAP. These 10 general principles can help you remember the main missi system 1. Principle of Regularity The accountant has adhered to GAAP rules and regulations as a standard. 2. Principle of Consistency Professionals commit to applying the same standards throughout the reporting process to prevent errors or discrepancies. Accountants are expected to fully disclose and explain the reasons behind any changed or updated standards. 3. Principle of Sincerity The accountant strives to provide an accurate depiction of a company's financial situation. 4. Principle of Permanence of Methods The procedures used in financial reporting should be consistent. 5. Principle of Non-Compensation Both negatives and posi expectation of debt compensation. es should be fully reported with transparency and without the 6. Principle of Prudence Emphasizing fact-based financial data representation that is not clouded by speculation. 7. Principle of Continuity While valuing assets, it should be assumed the business will continue to operate. 8. Principle of Periodicity Entries should be distributed across the appropriate periods of time. For example, revenue should be divided by its relevant periods. 9. Principle of Materiality / Good Faith Accountants must strive for full disclosure in financial reports. 10. Principle of Utmost Good Faith Derived from the Latin phrase “uberrimae fidei" used within the insurance industry. It presupposes that parties remain honest in transactions. LIMITATIONS OF GAAP While GAAP strives to alleviate incidents of inaccurate reporting, it is by no means comprehensive. Companies can still suffer from issues beyond the scope of GAAP depending on their size, business categorization, location and global presence. hhiphwwrw accounting comresourcesigapaxnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com DIVERSE TYPES OF COMPANIES TIMEFRAME GLOBAL VS. DOMESTIC IFRS: AN ALTERNATIVE TO GAAP While public companies in the United States are currently required to follow GAAP standards when filing financial statements, private companies are still free to choose their preferred standards system. This may soon change depending on an upcoming decision from the SEC, which has been deliberating on whether to move forward with recommending global standards, either partially or completely. According to Bloomberg BNA, SEC Chief Accountant James Schnurr “stressed that the IFRS-as- supplemental-reporting approach would be simply one alternative to full adoption of the standards issued by the International Accounting Standards Board.” Wide acceptance of the IFRS standards has yet to happen in the United States. The FASB and IASB are still working together to agree on and set standards that can be applied domestically and internationally. GAAP VS. IFRS Many sources state that the biggest difference between GAAP and IFRS reporting standards is the number of rules behind the principles. According to Scott Taub at Compliance Week, this is true, in a way; the GAAP principles are governed by more detailed rules and guidelines than IFRS. However, both sets of standards are in place to ensure that accountants remain honest on the job. The following is a look at what is required when reporting under the GAAP principles versus the IFRS standards. Balance Sheet GAAP: Recommended that current and noncurrent asset and liability categories are separated IFRS: These categories are required to be separated Intangible Assets tap hwwrw accounting comresourcesigaap 7axnot6 “The Comprehensive Guide to Understanding GAAP | Accounting com GAAP: Recognizes intangible assets at fair value IFRS: Only examines intangible assets if they can be associated with a future benefit Documentation GAAP: A Statement of Comprehensive Income is required IFRS: A Statement of Comprehensive Income is not required Inventory Write Downs GAAP: Inventory write down reversals are not permitted IFRS: Inventory write down reversals are possible under some conditions. Extraordinary Items GAAP: Listed separately under new income IFRS: Included with other items on the income statement FURTHER READING EXAMPLES OF FINANCIAL REPORTS These investor reports from major publicly traded companies give a high-level example of financial filings that follow GAAP: * Coca-Cola * Apple * Microsoft + Nordstrom hhiphwwrw accounting comresourcesigap2016 “The Comprehensive Gude to Understanding GAAP | Accounting com * Google REFERENCE TOOLS * Accounting Standards Codification: The FASB’s centralized reference tool for GAAP * FASAB Handbook: Standards guidelines for financial reporting at federal government organizations * GASB Frequently Requested Materials: Links include research briefs, the annual technical plan and a survey of users * SEC Small-Entity Compliance Guide: Recommendations for small business financial reporting * The Sarbanes-Oxley Act of 2002: Federal legislation regarding the accounting and IT requirements, security and disclosure requirements for public companies What is GAAP? | Who Determines GAAP? GAAP vs. Non-GAAP The 10 Basic Tenets of GAAP IFRS: An Alternative to GAAP Further Reading BACK TO TOP hhiphwwrw accounting comresourcesigap