The Evolution of Financial Reporting
In recent years, the accounting rules have undergone significant changes, including updated standards for reporting revenue, leases and credit losses. While business owners and managers often express frustration over the complexity of these rules, they’re more than an exercise in compliance. They help promote investor confidence and efficient capital markets. Here’s an overview of why standardized financial reporting is essential and how it’s changed over the last century.
Need for guidance
In response to the stock market crash of 1929 and the Great Depression, the U.S. government created the Securities and Exchange Commission (SEC). Its mission is to regulate the securities industry and enforce standardized financial reporting standards. Around the same time, the American Institute of Certified Public Accountants (AICPA) was established to develop accounting principles.
In the mid-20th century, the AICPA issued a series of pronouncements that laid the groundwork for U.S. Generally Accepted Accounting Principles (GAAP). These principles provide a framework for financial reporting, ensuring consistency and comparability across U.S. companies. The Financial Accounting Standards Board (FASB) was established in 1973 to take over the standard-setting responsibilities from the AICPA’s Accounting Principles Board (APB). Ever since, the FASB has been responsible for developing and updating GAAP.
GAAP instructs businesses on how to report their historical financial results. It promotes transparency and consistency in financial reporting, allowing business owners and investors to compare companies’ results over time and across industries. U.S. public companies are required to follow GAAP, and many private businesses follow suit.
Global standards
The need for worldwide financial reporting standards arose as global trade expanded. In 1973, the International Accounting Standards Committee (IASC) was established mainly to develop a set of international accounting standards. The IASC issued International Accounting Standards (IAS) to coordinate accounting practices across different countries.
In 2001, the International Accounting Standards Board (IASB) replaced the IASC. The IASB’s goal was to create a single set of high-quality, globally accepted accounting standards. It developed the International Financial Reporting Standards (IFRS) that are used today.
Convergence efforts
In the early 2000s, the FASB and IASB launched a major project to align U.S. GAAP and IFRS. The goal was to reduce differences between the two sets of standards and improve the comparability of financial statements globally.
One convergence success story is the standards on revenue from contracts with customers, Accounting Standards Update (ASU) No. 2014-09 and IFRS 15. The updated guidance required U.S. companies that followed GAAP to abandon roughly 180 business- and transaction-specific guidelines for a principles-based approach to recognizing revenue. The FASB and IASB issued these standards in 2014, which went into effect for publicly traded companies in 2017 and private ones in 2018.
The joint project on accounting for leases was less successful, but it narrowed the differences between reporting leases under GAAP and IFRS. After a decade of debate, the standard-setting bodies published divergent lease reporting standards — ASU 2016-02 and IFRS 16 — in 2016.
While significant progress has been made toward aligning the standards, some differences remain. Essentially, GAAP tends to be more prescriptive, while IFRS tends to be more principles-based and require less-detailed disclosures. It’s clear that the United States isn’t yet ready to abandon GAAP for IFRS. However, the FASB and the IASB are still working toward greater comparability in global reporting. For instance, the FASB participates in the IASB’s Accounting Standards Advisory Forum (ASAF). This group was created in 2013 to advise the IASB as it develops accounting standards. In addition to participating in ASAF meetings, the FASB also meets individually with standard setters from various countries to exchange ideas on improving their respective standards.
The future of financial reporting
The financial reporting standards continually evolve to address emerging issues and challenges, including sustainability and environmental, social, and governance (ESG) reporting. The standard setters are increasingly focused on developing frameworks for nonfinancial reporting to provide stakeholders with a comprehensive view of a company’s performance and impact.
From the early days of unregulated financial reporting to the development of GAAP and IFRS, accounting standards have played a crucial role in the financial markets. However, staying atop the ever-changing accounting rules can be challenging for public and private businesses alike. Contact us to help ensure you’re in compliance and aware of impending changes.
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