G is for GAAP

GAAP illustration design from Oracle Netsuite marketing site.

GAAP. FASB. AICPA. APB. If you studied accounting formally, the first few pages of your textbook typically listed a set of acronyms that would make your eyelids flutter. The Financial Accounting Standards Board, the American Institute of CPAs, the Accounting Principles Board, etc. Buncha old (white) guys doing boring talking, as my son used to describe it. Except that what these guys do (and a handful of gals*) is remarkable. Because they set the standards for every other company in the United States.

GAAP stands for Generally Accepted Accounting Principles, and it’s the prodigious set of rules that dictate how businesses should report their financial results. FASB is an independent group, elected from the community of practicing accountants. That means accountants are part of a guild.

G is also for Guild

If you remember your history of guilds, they arose in the Middle Ages as artisans developed their crafts and wanted to set their product standards. Rules were developed for certification to become part of the guild, and the guild stamp of approval reflected its authenticity and craftsmanship.

Venetian Cristallo glass, a classic guild product. Photo from wikipedia.

If you purchased cristallo glass, for example, you would know it was made on Murano Island, using special glassblowing techniques that only Venetian glass artisans were privy to learn. Murano glassmakers were so specialized and secretive that they passed a law in the 1270s which forbid the artisans from leaving town. The town burghers funded a group of assassins who would hunt down anyone who tried to the take the secrets elsewhere.

If you’re studying accounting, don’t worry. We don’t kill you if you take your understanding of LIFO inventory valuation to another country. Still, the Murano glassblowers and those who adhere to GAAP were seeking common ground. Cristallo glass was considered more valuable because it was made according to the standards. The reason that GAAP exists, the reason for accounting standards, is to make information more valuable. If financial data has to conform to agreed-upon rules, then it’s more consistent, comparable to other similar companies, and understandable.

Who Asked FASB Anyway?

FASB was formed in the early 1970s, but its charter really developed in parallel to the history of financial panics and cycles in the U.S. After the stock market crash of 1929, the accounting guild–the American Institute of Certified Public Accountants (AICPA)– conducted some heavy soul-searching to understand why publicly-held companies had been able to inflate or distort their financial statements.

Bank panic during the Depression after the stock market collapsed. Photo from Britannica.com.

People had been buying stock based on that financial data, even though at the time there weren’t formalized reporting rules. Suppose we’re playing a game. I decide scoring is based on crossing the goal line with the ball; you say scoring is based on kicking a ball into a net. Before we can even bring in a referee, we need an independent rule-maker to decide what counts as a score. That’s what FASB does.

The creation of a small, non-profit, independent accountant standards board was a bit of a revolution. The CPAs, the accounting guild, decided they needed to set and control rules, although it took them several decades. For example, the Accounting Principles Board (APB) that they created ended closely tied to the Securities and Exchange Commission (SEC), which sets rules for publicly-traded companies. But the SEC is a government entity. FASB, created in 1973 to replace the APB, is not; FASB is an independent body. It’s not subject to pressure from changes in political parties or public attitudes.

How Many Principles Do We Need?

When I sat for the CPA exam in 1983, you had to know by heart all 30 of the APB and 71 of the FASB pronouncements, as well as all the basic accounting ideas, like the definitions of assets and liabilities. There are now 168 FASB standards, and that’s not even counting any of the tax rules (“T” is coming).

If you research “accounting principles”…

Also, depending on what keywords you search, you might be told there are 3 accounting principles, or 4, 5, 10. All of these might lead to important accounting ideas: Match Revenue to Expenses, expense your Research and Development costs, or follow the principle of Full Disclosure, meaning you should tell people all the important limitations that underlie your business result.

It might seem like a lot, but I mentioned in “F is for Fraud” yesterday that there are many, many types of fraud. Thus, there need to be many, many rules to hem in the fraudsters.

So, if you want to know which of the accounting principles are important, the answer is Yes. The Accounting Guild adheres to all of them.

*Today’s Financial Accounting Standards Board of seven includes four men and three women.

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