ACCOUNTING FRAMEWORKS
An accounting framework is a published set of criteria that are used to measure, recognize, present, and disclose the information appearing in an entity’s financial statements. It is of paramount importance that a recognized framework is used to construct an organization’s financial statements, or else auditors will not issue a clean audit opinion for them.
The most commonly-used accounting frameworks are “generally accepted accounting principles” (GAAP) and” international financial reporting standards (IFRS). GAAP is used by entities in the United States, while IFRS is used in most other parts of the world. As these two frameworks are broad-based, they are applicable to most types of businesses. There are other accounting frameworks, known as Other Comprehensive Basis of Accounting (OCBOA), designed for special situations.
- GAAP
Generally Accepted Accounting Principles (GAAP or US GAAP) are a collection of commonly-followed accounting rules and standards for financial reporting. The specifications of GAAP, which is the standard adopted by the U.S. Securities and Exchange Commission (SEC), include definitions of concepts and principles, as well as industry-specific rules. The main objective of GAAP is to ensure that there is transparency in financial statements and are consistent from one organization to another.
US GAAP Standards
As a set of standards, GAAP only improves the transparency in financial statements. However, they do not provide any assurance that the company’s financial statements are sans errors or omissions that are intended to mislead investors.
The SEC has stated that it intends to move from GAAP to the International Financial Reporting Standards (IFRS). However, the latter differs considerably from GAAP, and progress toward adoption or convergence has been slow.
As GAAP is not government regulated and exists as the result of the combined efforts of Government and business. The use of GAAP is not mandatory for all businesses, but the SEC requires publicly traded and regulated companies to follow GAAP for the purpose of financial reporting.
Companies that issue stock are held to this standard by SE, as it requires yearly external audits by independent accountants. Companies without external investors are not obliged to follow this standard. Despite the mandate, the SEC is not responsible for the standards associated with GAAP. Alternatively, At the corporate level, the changes in financial reporting standards are impacted by the Financial Accounting Standards Board. The FASB Advisory Council (FASAC) advises the FASB on all matters that may influence GAAP rules.
Government entities, on the other hand, are influenced by a set of standards that are slightly different from GAAP. Those standards are managed by the Government Accounting Standards Board (GASB). Other countries, however, have their own GAAP rules. These rules completely vary from those in the United States. Each country’s own version of the FASB, such as the Canadian Institute of Chartered Accountants (CICA), creates these rules.
In 2008, A “preliminary Roadmap” was issued by the Securities and Exchange Commission. The Roadmap may lead the United States to abandon GAAP in the future and join more than 100 countries around the world in using the London-based International Financial Reporting Standards (IFRS).
- IFRS
IFRS is the acronym for International Financial Reporting Standards. It is the international accounting framework to properly organize and report financial information. It is derived from the pronouncements of the London-based International Accounting Standards Board (IASB). It is currently the required accounting framework in more than 120 countries. IFRS requires businesses to report their financial results and financial position using the same rules. This ensures considerable uniformity in the financial reporting of all businesses using IFRS without any fraudulent information, making it easier to compare and contrast their financial results.
IFRS is used primarily by businesses reporting their financial results anywhere in the world except the United States. Generally Accepted Accounting Principles or GAAP, which is established by the Financial Accounting Standards Board (FASB), is the accounting framework used in the United States. GAAP is much more rules-based than IFR whereas IFRS focuses more on general principles than GAAP. It makes the IFRS body of work much smaller, cleaner, and easier to understand than GAAP.
IFRS covers a broad array of topics including presentation of financial statements, revenue recognition, employee benefits, borrowing costs, income taxes, investment in associates, inventories, fixed assets, intangible assets, leases, retirement benefit plans, business combinations, foreign exchange rates, operating segments, subsequent events, industry-specific accounting, such as mineral resources and agriculture.
Developed by the International Accounting Standards Board (IASB), the intent of IFRS is to create a single set of standards that are understandable, enforceable, and of high quality. IFRS helps companies to prepare their financial statements, disclose information, and report their financial results. IFRS also provides investors with reliable and transparent information about a company’s financial strength, market position, and performance.
| GAAP | IFRS |
| A rules-based approach that includes site-specific guidelines for handling various transactions | A principles-based approach that provides general guidance in most accounting situations |
| Only used in the US | Applied internationally in more than 160 jurisdictions |
| Can be easier to compare companies to one another because of strict regulations | Potentially more difficult to compare companies because of different interpretations |
| Can use both First In, First Out (FIFO) or Last In, First Out (LIFO) inventory cost methods | Can only use First In, First Out (FIFO) inventory cost methods |
- Other Comprehensive Basis of Accounting (OCBOA)
Based on an earlier proposal, The AICPA has issued a draft containing its Financial Reporting Framework for SMEs. The exposure-related draft has been issued with the intention to acquire comments on it. The OCBOA (Other Comprehensive Basis of Accounting) draft or framework that has been designed for an important purpose focuses on over twenty million private United States businesses which are not expected to follow Generally Accepted Accounting Principles. This is undertaken with the aim to provide them with a reporting mechanism that is relevant, simple, and reliable.
Other Comprehensive Basis of Accounting (OCBOA) is a non-GAAP accounting framework that is used to generate financial statements. Examples of OCBOA are the cash basis of accounting, the modified cash basis of accounting, and the income tax basis of accounting. The OCBOA may apply when financial statements are needed either for a specific purpose or when the preparer wants to use a simpler system than GAAP with fewer disclosures. It is frequently less expensive to use an OCBOA to prepare financial statements. The pitfall in OCBOA is that the resulting information tends to be skimpier or more summarized than what would have been the case if GAAP had been used.
Other Comprehensive Basis of Accounting (OCBOA) includes financial statements prepared using a system of accounting that differs from GAAP, the most common being tax-basis and cash-basis financial statements. Other Comprehensive Basis of Accounting (OCBOA) systems also include a statutory basis of accounting such as that used by insurance companies to comply with the rules of a state insurance commission, as well as the financial statements prepared using defined criteria that are well-supported in popular literature.
| GAAP | OCBOA |
| A method of creating financial statements based on principles issued by the Financial Accounting Standards Board (FASB); public U.S. companies must follow GAAP. | A non-GAAP accounting protocol is used to generate financial statements. |
| Fair value measurement and disclosure requirements are required. | Fair value measurement and disclosure requirements need not be incorporated because tax basis statements account for measurements in accordance with the measurements included in the tax returns, whereas, cash basis financial statements incorporate measurements on the basis of cash receipt and cash payments. |
| Financial statements prepared can be very complex, and due to this complexity, it will be costly to prepare these statements. | Financial statements prepared are easier to understand and prepare. Moreover, they are less complex and less expensive to prepare. |
| Financial statements prepared require a statement of cash flows. | Financial statements prepared do not require a statement of cash flows. |
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