What are Accounting Standards and Why are They Important?
Accounting standards are a set of rules and guidelines that define how financial information should be reported and disclosed. Accounting standards aim to improve the quality, consistency, and comparability of financial statements across different entities and countries.
In this article, we will explain what accounting standards are, how they are developed and enforced, and why they are important for businesses, investors, regulators, and other stakeholders.
What are Accounting Standards?
Accounting standards are a common set of principles, standards, and procedures that specify how financial transactions and events should be recorded, measured, classified, presented, and disclosed in financial statements. Accounting standards provide a framework for preparing and auditing financial reports, as well as ensuring compliance with legal and regulatory requirements.
Accounting standards can be classified into two types: International Accounting Standards (IAS) and National Accounting Standards.
International Accounting Standards (IAS) are issued by the International Accounting Standards Board (IASB), an independent body that sets accounting standards for public interest entities around the world. The IASB’s main objective is to develop a single set of high-quality, globally accepted accounting standards that enhance transparency, accountability, and efficiency in financial markets. The IASB’s current set of standards is called the International Financial Reporting Standards (IFRS), which are adopted by more than 140 countries.
National Accounting Standards are issued by national standard-setters or authorities in each country, such as the Financial Accounting Standards Board (FASB) in the United States, the Accounting Standards Board (ASB) in the United Kingdom, or the Institute of Chartered Accountants of India (ICAI) in India. National accounting standards may differ from IAS in some aspects, such as recognition, measurement, presentation, or disclosure rules. However, many national standard-setters are converging their standards with IAS to achieve greater harmonization and comparability across jurisdictions.
How are Accounting Standards Developed and Enforced?
Accounting standards are developed through a due process that involves consultation and participation of various stakeholders, such as preparers, auditors, users, regulators, academics, and the public. The due process typically includes the following steps:
The standard-setter identifies a topic or issue that needs to be addressed by a new or revised accounting standard.
The standard-setter conducts research and analysis on the topic or issue and publishes a discussion paper or exposure draft for public comment.
The standard-setter considers the feedback received from the public comment period and revises the proposal accordingly.
The standard-setter issues the final accounting standard and sets an effective date for its implementation.
Accounting standards are enforced by various mechanisms, such as:
Auditing: Independent auditors examine the financial statements of entities and express an opinion on whether they comply with the applicable accounting standards.
Regulation: Regulatory bodies, such as the Securities and Exchange Commission (SEC) in the United States or the Financial Conduct Authority (FCA) in the United Kingdom, oversee the financial reporting practices of entities and ensure that they comply with the relevant laws and regulations.
Professional Ethics: Professional bodies, such as the American Institute of Certified Public Accountants (AICPA) or the Institute of Chartered Accountants in England and Wales (ICAEW), set ethical codes and standards for their members and impose sanctions for non-compliance or misconduct.
Market Discipline: Market participants, such as investors, creditors, analysts, or rating agencies, monitor the financial performance and position of entities and reward or penalize them based on their adherence to accounting standards.
Why are Accounting Standards Important?
Accounting standards are important for various reasons, such as:
Reliability: Accounting standards ensure that financial information is relevant, reliable, faithful, consistent, and comparable across different entities and periods. This enhances the credibility and usefulness of financial statements for decision