Accounting standards: Overview, definition, and example
What are accounting standards?
Accounting standards are a set of principles, guidelines, and procedures that companies must follow when preparing and presenting their financial statements. These standards are designed to ensure consistency, transparency, and comparability of financial information, making it easier for stakeholders (such as investors, regulators, and managers) to understand and analyze a company’s financial position. Accounting standards can be issued by national or international bodies, and they help govern how businesses record transactions, classify expenses, and report income and assets.
Common examples of accounting standards include the Generally Accepted Accounting Principles (GAAP) in the United States and the International Financial Reporting Standards (IFRS) used globally.
Why are accounting standards important?
Accounting standards are important because they ensure that financial statements are accurate, reliable, and comparable across different companies and industries. By following these standards, businesses can maintain consistency in their reporting, which helps stakeholders make informed decisions. For investors and creditors, knowing that a company’s financial reports follow established standards provides assurance that the financial data is trustworthy and reflects the true financial health of the company.
For businesses, adhering to accounting standards also ensures compliance with legal and regulatory requirements, helping to avoid potential penalties or legal issues. Additionally, standardized reporting simplifies audits and the review process by external parties.
Understanding accounting standards through an example
Imagine a company that purchases inventory for resale. Under accounting standards like GAAP or IFRS, the company must follow specific rules about how to account for the inventory’s cost, how to recognize revenue from sales, and how to value unsold inventory at the end of the financial period. For example, the company must use a consistent method (such as FIFO or LIFO) to track inventory costs, ensuring that financial statements are comparable to those of other companies.
In another example, if a company reports revenue from a sale, accounting standards will dictate when and how to recognize that revenue—such as when the product is delivered or when payment is received—to ensure it is reported accurately and consistently.
An example of an accounting standards clause
Here’s how an accounting standards clause might appear in a business agreement or financial statement:
"The financial statements of the Company shall be prepared in accordance with the applicable accounting standards, including the Generally Accepted Accounting Principles (GAAP) or the International Financial Reporting Standards (IFRS), as required. The Company will ensure that all transactions and financial reports comply with these standards to ensure accuracy, consistency, and comparability."
Conclusion
Accounting standards are essential for maintaining consistency, transparency, and trust in financial reporting. By following these standards, businesses can provide accurate and reliable financial statements, ensuring compliance with legal requirements and enabling investors and other stakeholders to make informed decisions. Understanding and applying accounting standards is critical for businesses of all sizes, as it helps ensure that their financial operations are properly documented and aligned with global practices.
This article contains general legal information and does not contain legal advice. Cobrief is not a law firm or a substitute for an attorney or law firm. The law is complex and changes often. For legal advice, please ask a lawyer.