In January, just before the COVID-19 pandemic hit America head-on, FloQast raised around $ 40 million for product development and growth. Since then, the company has sat on its cash flow, planning and replanning for a rapidly changing short-term future. Today, the company is recruiting and has just added features to its automated reconciliation solution.
“We have defined three disaster scenarios,” said Mike Whitmire, co-founder and CEO of FloQast. “We planned to miss our budget by 75%, 50% or 25%. We made staff [decisions] and suspended hiring decisions based on 50% failure, but now we see that we only missed about 25%. We are hiring now – not as many as originally planned, but we are hiring 60 new people instead of 100, and evenly across the company. We had enough money so that we did not have to make hasty decisions.
Indeed, Whitmire, who is conservative by her CPA nature, believes the United States may be heading into Great Depression territory. With that in mind, it’s grateful that technology in general, and automation technology for accountants in particular, remains vital in this remote environment.
FloQast has added new depreciation reconciliation capabilities to FloQast AutoRec, an artificial intelligence-based solution to automate the often very manual and error-prone account reconciliation process. With the new features, FloQast can automatically calculate monthly amortization and remaining balance, and provide full account reconciliation for prepaid expenses and simple deferred income accounts. He then creates an Excel reconciliation to link to the general ledger balance.
“The money we have raised will go directly to the future of our product,” Whitmire said. “Today, we are helping with the month-end closing. We want to go further. Many customers use FloQast to manage their entire department for the entire month. . We want to build on that for broader workflow functionality. Damping is a great extension of our automation suite, but it’s just a product. I want FloQast to be a home for accountants – a place they work every day, not just the month-end close.
AutoRec damping is included at no additional cost with FloQast AutoRec. Up to three FloQast AutoRec accounts are now bundled with FloQast fence management software subscription plans. Auto-amortization is currently in limited availability and will generally be available in 30 days. For more information visit www.floqast.com/autorec.
Intangible assets are non-physical assets shown on a company’s balance sheet. These can be patents, intellectual property, trademarks and goodwill. Intangibles could even be as simple as a customer list or a franchise agreement.
Some of these intangible assets have a limited useful life.
While physical assets can wear out over time and lose value simply through use, their intangible counterparts wear out through contract expiration, obsolescence, and other non-physical factors. .
If an intangible asset has a finite useful life, the business is required to depreciate it, a process very similar to how physical assets are depreciated over time.
What does depreciation actually mean?
The amortization process in accounting reduces the value of the intangible asset on the balance sheet over time and reports an expense to the income statement each period to reflect the change in the balance sheet during the given period.
Like depreciation, there are several methods that a business can use to calculate the depreciation of an intangible asset, but the simplest is the straight-line method.
With the straight-line method, the business begins with the recorded value of the asset, its residual value and its useful life.
The recorded value is the initial value attributed to the asset on the books, i.e. usually its price or cost of creation.
Its residual value is the expected value of the asset at the end of its useful life.
For most intangible assets, residual value is zero because many intangible assets are considered worthless once they have been fully utilized.
The useful life of the asset is the period during which the business expects the intangible asset to provide economic value to the business.
The mechanics of the calculation of damping is also the same as that of the calculation of damping with the linear method. The business must subtract the residual value from the recorded cost and then divide that difference by the useful life of the asset.
Each year, this value will be deducted from the cost recorded on the balance sheet in an account called “accumulated depreciation”, reducing the value of the asset each year. The income statement will show the reduction each year as a “depreciation charge”.
An example of calculating the amortization of an intangible asset
Let’s say that a company has developed a software solution to be used internally to better manage its inventory.
The company does not intend to sell this software; it should only be used by company personnel. This software is considered an intangible asset and must be amortized over its useful life.
First, the company will record the cost of creating the software on its balance sheet as an intangible asset. The software cost the company $ 10,000 in this case.
Next, the company estimates that the software will have a useful life of only three years given the rapid nature of software innovation.
After three years, the company estimates that its internal software will no longer have residual value, so its residual value is zero.
The company will use the straight-line method to report software depreciation.
By subtracting the residual value – zero – from the recorded cost of $ 10,000, then dividing by the software’s three-year useful life, the company’s accountants determine the software’s annual depreciation at $ 3,333.
Each year, the net asset value of the software will be reduced by this amount and the company will report $ 3,333 in depreciation expense.
Here is a breakdown of how the balance sheet and income statement will reflect this amortization over the three year period.
When intangible assets should not be amortized
Most physical assets will depreciate over time.
Land is one of the few examples where a physical asset should never be depreciated. For intangibles, however, it is much more common to have an asset than not to be depreciated.
This follows from the fact that more intangible assets have an indefinite useful life than physical assets.
If an intangible asset continues to provide economic value without deterioration over time, it should not be amortized. Instead, its value should be periodically reviewed and adjusted with depreciation.
Goodwill, for example, is an intangible asset that should never be amortized.
If goodwill needs to be changed, this should happen through the impairment process, where the value of the asset is changed based on specific and changing conditions rather than on the basis of a calculated schedule as would be the case. with depreciation.
Goodwill is the part of a company’s value that is not attributable to other assets. Goodwill is a current result of acquisitions for which the purchase price is greater than the fair market value of the assets and liabilities.
The world of accounting is a labyrinth of numbers, formulas and calculations, with the aim of bringing order and balance between assets and liabilities.
One term that defines the intricacies of complex bookkeeping is depreciation, the Swiss Army Knife in an accountant’s toolbox.
Businesses and individuals can take advantage of depreciation to depreciate assets over the expected period of asset use and create faster ways to pay off installment loans – steps that can translate into a big financial benefit.
What is depreciation?
Amortization covers two definitions – one focused on business assets and the other focused on loan repayments.
What is depreciation for businesses?
Depreciation is an accounting tool that essentially directs assets from a balance sheet to an income statement. It does this by writing off the assets (mainly intangible) over their period of intended use. These assets can include copyrights, patents and trademarks.
Let’s say a company has a valuable patent, which has been active for 10 years. If the company paid $ 10 million to develop the patent, it would write $ 1 million each year as a depreciation expense and report it in the company’s income statement.
What is loan amortization?
Consumers may best recognize amortization as a term that describes the breakdown of a loan’s starting balance, less principal and interest owed over a period of time, such as a mortgage or car loan. On these loans, the amortization schedule weighs much more heavily on the interest payments on a loan at the start of the loan repayment period, with that interest decreasing throughout the life of the loan.
Let’s say a wealthy person has a $ 1 million mortgage. If that person repays $ 50,000 on an annual basis, then the borrower has amortized $ 50,000 of the loan each year.
For the purposes of this article, we’ll look at the impact of amortization on loans, specifically how it refers to the repayment of loan principal over time.
How does amortization work for loans?
Basically, amortization is a mechanism to pay off both principal and interest on a loan, bundled into one fixed monthly payment. Lenders calculate amortization down to the penny, so that the loan is repaid accurately, over the agreed period of time. (Accountants call this period the “term” of the loan.)
This way, each loan payment is exactly the same amount of money. Consider a mortgage of $ 165,000 over 30 years, with an interest rate of 4.5%. Since amortization refers to the repayment period of a loan, with a specific amount allocated to pay principal and interest, the amortization schedule is a total fixed monthly payment of $ 836.03 over the term of the loan. mortgage.
On a monthly basis, over 30 years, this is what is needed in terms of actual monthly payments to fully repay the mortgage.
How to calculate the amortization of a loan
Since amortization is the process of paying the same amount of money (usually) on a monthly basis, the calculation to do so depends on the principal and interest owed on the loan. The goal is to lower the interest payments over the life of the loan, while the principal amount of the loan increases.
Here’s how to do it step by step:
Collect all the loan information needed to calculate the loan amortization schedule. Basically all you need is the term of the loan and the payment terms. Let’s calculate the amortization rate on a monthly basis, like most mortgage or auto loans.
Find the main part of the current loan (say $ 100,000.)
Find the interest rate on the loan (say 6%).
Find the length of the loan (say 360 months, or 30 years.)
Monthly payment = $ 599.55
Although the actual loan amount is fixed, the amount you pay on a loan in terms of principal and interest is not. This is where a loan amortization schedule comes into play.
To correctly calculate amortization and find the correct balance between principal and interest payments, multiply the original loan balance by the periodic loan interest rate. The resulting figure will be the amount of interest due on a monthly payment. At this point, you can subtract the interest payment amount from the total loan amount to establish the portion of the loan required to repay the principal.
Suppose, for example, you have a mortgage loan of $ 240,000, for 360 months, at an interest rate of 4%. Your initial monthly mortgage payment is $ 1,146. Your periodic interest rate is 0.33%, or one twelfth of 4%.
Multiply $ 240,000 by 0.33% and you will find that the first interest rate payment on the mortgage is $ 792. Now take the total monthly loan of $ 1,146 and subtract the interest amount of $ 792.00. This leaves you with $ 354 as the monthly loan repayment amount which will go toward the principal owed on the loan.
To calculate your amortization rate in the future, take the remaining principal balance of the loan ($ 240,000 minus $ 354 = $ 239,646.) Then multiply $ 239,646 by 0.33% to determine the amount of your next interest payment. Simply repeat the calculation to determine the amortization schedules down the line on a monthly basis.
What types of loans can be amortized?
Typically, amortization schedules are used for the following loans – usually installment loans:
Loans that cannot be amortized include home equity loans, revolving debt, and credit cards, as these types of credit-based loans do not have fixed monthly payments.
Revolving debt and credit cards do not have the same characteristics as an amortized loan because they do not have a fixed payment amount or a fixed loan amount.
Basically, if your lender tells you exactly how many payments you need to make to honor the loan and tells you that each monthly payment will be the same amount, it can be amortized. If the total loan amount varies from month to month, it is likely that it cannot be amortized.
Advice on loan amortization
To pay off your amortized loans faster and get rid of the loan completely, incorporate these strategies into your loan repayment plan:
Add extra dollars to your monthly payment. If your total mortgage is $ 100,000 and your fixed monthly payment is $ 500, add $ 100 or more to each monthly mortgage payment to pay off the loan faster. Be sure to designate the payments as “principal payment” to your lender.
Make a lump sum payment. There is no law that says you have to spend a raise, bonus, or inheritance. Use the extra money towards your total loan amount, dramatically reduce your loan amount, and save on interest.
Make bi-weekly payments. Instead of paying off a loan once a month, pay half the monthly loan amount every two weeks. This way, you make 13 months of loan repayments every 12 months, paying off the loan faster and saving a lot of money on interest.
The Directorate General of Taxes (DGT) concluded that the accelerated depreciation regime can be used in the regime for small businesses, but only for goodwill and for intangible assets whose useful life does not exist. can be estimated reliably.
The special regime for small businesses allows a number of tax incentives. Among other things, article 103.5 of the law on corporation tax (LIS) provides that the intangible assets referred to in article 13.3 of the law (acquired when the conditions for claiming this special regime are met) can be depreciated at 150% of the amount determined under this article.
This article 13.3 is no longer valid, however, following the modifications introduced in the law on corporation tax (LIS) by law 22/2015 of July 20, 2015 which gave a new accounting treatment to intangible assets. Before the entry into force of Law 22/2015, the accounting and tax treatment of intangible assets was as follows:
Intangible assets with finite useful lives were amortized for accounting purposes over their useful life. From a tax point of view, any depreciation expense thus recorded was tax deductible (article 12.2 LIS).
Intangible assets with indefinite useful lives (including goodwill) have not been amortized for accounting purposes. Under the then current wording of section 13.3 of the DSL, however, 5% of their cost could be deducted each year without having to be recognized for accounting purposes.
In accordance with Law 22/2015, all intangible assets are considered to have a useful life, although in some cases they cannot be reliably estimated. Following this amendment, the law on corporation tax (article 12.2) provides that intangible assets are depreciated over their useful life; and if their useful life cannot be reliably estimated, their accounting depreciation charge is deductible within the annual limit of 5% of their cost. Goodwill can also be amortized within this same limit.
In other words, the system of amortization of intangible fixed assets is now contained in article 12.2, whereas before law 22/2005 the system of article 12.2 had to be used for intangible fixed assets with a useful life. defined and that of article 13.3 for intangible assets with an indefinite useful life. useful life, including goodwill. Now that section 12 is used for both plans, the provision of section 103.5 relating to accelerated depreciation in the small company plan has lapsed.
In view of this modification of the law, the DGT (in its resolution V3057-19 of October 30, 2019) concluded that accelerated depreciation can be used in the regime of small companies, but only for business assets and for intangible assets whose useful lives cannot be reliably estimated.
This interpretation surprisingly means that a more unfavorable regime has been adopted for intangible assets whose useful life can be reliably estimated in relation to other intangible assets, for which the regime for small companies allows also accelerated depreciation (in section 103.1 LIS).
Executives at two major accounting standard setters have said they hope to streamline goodwill accounting rules, although their boards largely disagree on the key question of whether companies should be authorized to amortize the intangible asset.
Goodwill is created when one company acquires another for more than the value of its durable goods. It was subject to goodwill amortization or impairment over several years.
The Financial Accounting Standards Board, which sets US accounting standards, abolished goodwill amortization in 2001 because companies wanted to make acquisitions without having to make large and periodic write-downs of their earnings. The International Accounting Standards Board, which sets standards in more than 140 countries, followed suit three years later. The FASB and IASB now require companies to test goodwill for potential impairment every year.
Organizations have attempted to establish standards with similar principles since they abandoned a joint effort in 2011 to make their standards identical.
Most FASB members want to reintroduce depreciation for public companies, President Russell Golden said at an event hosted by the International Financial Reporting Standards Foundation and the CFA Institute on Wednesday.
“If you like the amortization of goodwill, this is the good news,” Mr. Golden said. “The bad news is that we don’t have a clear agreement on how to proceed at the moment.”
The reintroduction of goodwill amortization would affect companies in different ways, depending on whether standard setters institute amortization over a defined period or use a weighted average asset life model with no defined period, among other variables.
Members of the IASB are widely opposed to reintroducing goodwill amortization, saying it might be more difficult to verify if an acquisition is working, but they are still considering changing its goodwill rules. The board decided not to reintroduce depreciation in 2017 and instead focus on improving the depreciation model, but this proved difficult.
The FASB gave private companies the option of amortizing goodwill over a 10-year period in 2014, and offered this option to nonprofits in May this year.
IASB chairman Hans Hoogervorst said he was in the minority on its board to support an initiative to amortize goodwill for international companies. He called the amortization of goodwill “ugly like a sin”, but agreed that it should be a necessary expense and perhaps the best solution to a difficult problem, as goodwill is “unlikely to lasts forever “.
“We see time and time again that goodwill is only written off when it is too late,” Hoogervorst said during a panel at the event.
The FASB, which is hosting a public roundtable on goodwill on November 15, recently looked at the profitability of the current goodwill rules for public companies, but the board is considering making more significant changes that would affect all companies.
Companies recently said in letters to the FASB that existing goodwill rules impose unnecessary costs on them and are too subjective.
A woman who lied to get a top accountant job has to pay back just over one percent of the £ 100,000 she made cheating on two companies.
Alaska Freeman’s only assets are electrical appliances, including a floor cleaner, a judge said.
She is serving a 53-month prison sentence after admitting ten fraud charges in June last year, but once lived on Derby Road, Radford.
Nottingham Crown Court had learned that she had secured a job as a management assistant accountant after sending a CV through a recruitment firm.
She was arrested for fraud four years later, in February 2016, but got a job at a second company while on bail and also duped them.
As she appeared in the same court via video link from prison, she learned that she had made £ 100,000 from her crimes.
Jonathan Dee, prosecuting, described this as the “benefit figure” and said: “The assets available are £ 1,250.
I am requesting a confiscation order for this sum.
“These available assets are effectively items in the possession of the police, a variety of electrical items, including a Hoover or a Dyson.
“There are plans to return them to the various owners. This is the order effectively fulfilled,” added Mr. Dee.
Ami Feder, who represented Freeman, said the figure was accepted. The documents would be signed so that the assets could be released.
Judge Rosalind Coe QC agreed to an amount of £ 100,000 and assets available of £ 1,250.
She said: “There will be a forfeiture order for this amount. The order will be satisfied by the signature of the document by the defendant.”
Freeman, 40, must sign the documents within a month or a day in jail will be added to his sentence, the judge added.
His crimes came to light after he got a job with Maun Industries in Hamilton Road, Sutton-in-Ashfield. Her first role was that of assistant accountant in management.
But she was promoted to management accountant and then became general manager of Ketchum Manufacturing, which had been bought by her employers in 2013. She also became treasurer of a professional association.
Freeman received bonuses, salary increases, and ran both firs while a manager was on a business trip.
But investigators found she made personal purchases on the company’s credit cards, transferred company money to her own bank accounts, and stole petty cash.
She also lied about her accounting qualifications, but escaped justice until August 2015 when tax officials said the company owed more than £ 100,000 in unpaid National Insurance and PAYE contributions. .
Freeman was suspended and fired for serious misconduct when further discrepancies were noted.
COURTS IN NOTTINGHAMSHIRE
After being released on bail six months later, she got a job as a financial controller at Nexor, a Nottingham company.
Six months later, she left when the company alerted the police to tell them that they had defrauded them.
In this business, she used corporate credit cards to purchase jewelry, clothing, hardware and beauty products worth over £ 3,200.
She transferred £ 10,000 to her personal bank account, lied on her CV and did not admit that she was arrested.
After his imprisonment, Maun Industries Managing Director Eddie Thomas said: “Never in my long career in business have I known such a total betrayal of trust and blatant deception.
“The financial impact on Maun Industries has been severe. It took three years of hard work by our dedicated employees for the business to recover and thrive again.
Generally Accepted Accounting Principles (GAAP) are a common set of accounting rules and standards that dictate how financial statements are prepared. Public enterprises, non-profit organizations and government entities are required to prepare financial statements in accordance with GAAP. These guidelines were developed over time by the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA).
Principles covered by GAAP GAAP encompasses a wide range of accounting practices and philosophies. Some key areas covered by GAAP include:
Recognition: How assets, liabilities, income and expenses are recognized in the financial statements
Valuation: How Profits and Losses Are Measured and Reported in Financial Statements
Presentation: How information should be presented in the financial statements
Disclosure: what information should be shared in the financial statements
Objectives of GAAP The objective of GAAP is to create a uniform standard for financial reporting. When financial information is made available to the public, it should be used to help investors make informed decisions about where to invest their money. Likewise, it should allow lenders to properly assess the financial condition of companies looking to borrow money.
When applied to not-for-profit and government organizations, the purpose of GAAP is to ensure full transparency from reporting entities. Information provided under GAAP must be not only clear, complete and easy to understand, but also verifiable by auditors and other external parties.
Importance of GAAP Without GAAP, companies wouldn’t be subject to a stringent set of standards, meaning they would have much more leeway in deciding what information they choose to share or keep hidden. GAAP therefore performs the very important function of ensuring that companies and organizations cannot “cheat” on their financial reports.
GAAP makes it easy for investors to assess companies by simply looking at their financial statements. If an investor is torn between two companies in the same industry, that investor can compare their respective returns to determine which one is most successful in generating income and managing cash flow.
However, this would not be possible if companies were allowed to choose which financial information to present. When applied to government entities, GAAP helps taxpayers understand how their taxes are spent.
GAAP also helps companies obtain key information about their own practices and performance. In addition, GAAP minimizes the risk of false financial information by putting in place numerous controls and safeguards. Information provided in GAAP financial statements can therefore generally be considered reliable and accurate.
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The accounting cycle is a collective process of identifying, analyzing and recording the accounting events of a company. This is a standard 8-step process that begins when a transaction occurs and ends with its inclusion in the financial statements.
The key steps in the eight-step accounting cycle include posting journal entries, posting to the general ledger, calculating trial balances, entering adjusting postings, and creating financial statements.
Key points to remember
The accounting cycle is a process designed to facilitate financial accounting of business activities for business owners.
The first step in the eight-step accounting cycle is to record transactions using journal entries, ending with the eighth step of closing the books after preparing the financial statements.
The accounting cycle typically consists of one year or other accounting period.
Today, accounting software primarily automates the accounting cycle.
How the accounting cycle works
The accounting cycle is a systematic set of rules designed to ensure the accuracy and compliance of financial statements. Computerized accounting systems and a uniform accounting cycle process have helped reduce mathematical errors. Most software today fully automates the accounting cycle, resulting in less human effort and errors associated with manual processing.
Stages of the accounting cycle
The accounting cycle has eight stages.
Identify transactions: An organization begins its accounting cycle by identifying the transactions that constitute an accounting event. This could be a sale, refund, payment to a seller, etc.
Rrecord transactions in a journal: Comes nextrecording transactions using journal entries. Entries are based on receipt of an invoice, recognition of a sale, or the occurrence of other economic events.
Assignment: Once a transaction is posted as a journal entry, it should be posted to a general ledger account. The general ledger provides a breakdown of all accounting activities by account.
Unadjusted trial balance: After the business posts the journal entries to the individual general ledger accounts, an unadjusted trial balance is prepared. The trial balance ensures that the total debits equal the total credits in the financial records.
Worksheet: The analysis of a spreadsheet and the identification of the adjustment entries is the fifth step of the cycle. A spreadsheet is created and used to ensure debits and credits are equal. If there are any discrepancies, adjustments will need to be made.
Adjustment of journal entries: At the end of the period, adjustment postings are made. These are the result of the corrections made on the spreadsheet and the results of the passage of time. For example, an adjusting entry can generate interest income that has been earned over the passage of time.
financial state: When posting adjustment entries, a company establishes a regularized trial balance followed by actual formalized financial statements.
Close books: An entity provisionally finalizes accounts, income and expenses, at the end of the period using closing entries. These closing entries include the transfer of net income to retained earnings. Finally, a company prepares the post-close trial balance to ensure debits and credits match and the cycle can start again.
Accounting cycle calendar
The accounting cycle begins and ends during an accounting period, when financial statements are prepared. Accounting periods vary and depend on different factors; however, the most common type of posting period is the annual period. During the accounting cycle, many transactions occur and are recorded.
At the end of the year, financial statements are usually prepared, which is often required by regulation. Public entities are required to submit financial statements by certain dates. Therefore, their accounting cycle revolves around the reporting requirement dates.
The accounting cycle vs. Budget cycle
The accounting cycle is different from the budget cycle. The accounting cycle focuses on historical events and ensures that financial transactions incurred are correctly reported. Alternatively, the budget cycle relates to future operational performance and the planning of future transactions. The accounting cycle helps produce information for external users, while the budget cycle is mainly used for internal management purposes.
Regulatory Accounting Principles (RAP) were introduced by the former Federal Home Loan Bank Board (FHLBB) for the savings and loan (thrifts) industry it oversaw in the 1980s with disastrous results. Regulatory accounting principles have been created to help low net worth savings and loan associations meet capital requirements. The flawed accounting procedures that the FHLBB allowed savings banks to use freely have been pointed out as one of the underlying causes of the collapse of the savings and credit sector in the late 1980s.
The relaxed PCR rules have allowed many otherwise insolvent institutions to artificially increase their reported profits and net worth. Some of the blatant accounting principles that savings banks were allowed to apply were as follows:
Record a loss on the sale of a mortgage loan as an asset that could be amortized over the remaining term of the mortgage. In the 1980s, savings banks held large portfolios of long-term mortgages carried at cost on their balance sheets. The sharp rise in interest rates over the decade caused the market value of these mortgages to drop significantly below book value, but the PAR allowed the losses to be classified as assets. In addition, loss carryforward has enabled thrifts to continue to operate assets with a 3% capital requirement, and to generate tax shields on the amortization of realized losses.
Full and immediate recognition of construction loan commission income. Active in the real estate market in the 1980s, thrift stores were able to account for fees (2.5% of loan amount) on original construction loans entirely in advance instead of an accounting partial to match the costs incurred for granting the loan, then pro-rated for the balance of the charges over the life of the loan.
Inclusion of “assessed equity” for the calculation of regulatory net worth. Measured equity, a new concept, was the amount that certain fixed assets such as property, plant and equipment had appreciated above their book value. Savings were allowed to be selective, recording these unrealized gains only for fixed assets whose market values exceeded book values; assets whose market values have fallen below book values could be ignored.
Amortization of goodwill over forty years of acquired savings funds. The distressed savings funds that were acquired carried significant amounts of mortgage assets well below their book value. By purchasing another thrift store with such assets at a steep discount (fair market value minus book value), the thrift store was able to record income over the estimated life of the assets based on a 10 year interest method. . Goodwill amortization, on the other hand, could be spread over 40 years, which meant that during the 10-year period following the acquisition, the acquirer could make a profit since the annual goodwill amortization expense was much higher. low than under a 10 year requirement that existed. before the implementation of the RAP.
In the aftermath of the savings and loan crisis, Congress eliminated the FHLBB and, with it, the RAP. The Resolution Trust Corporation was formed and the economies that survived were forced to start using GAAP rules.
What are the generally accepted accounting principles?
Generally Accepted Accounting Principles (GAAP) refers to a common set of accounting principles, standards and procedures published by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants prepare their financial statements.
GAAP is a combination of authoritative standards (established by policy boards) and generally accepted methods for recording and reporting accounting information. GAAP aims to improve the clarity, consistency and comparability of financial reporting.
GAAP can be compared to pro forma accounting, which is a non-GAAP financial reporting method. Internationally, the equivalent of GAAP in the United States is called International Financial Reporting Standards (IFRS). IFRS are applied in more than 120 countries, including those in the European Union (EU).
GAAP helps to govern the world of accounting according to general rules and guidelines. It attempts to standardize and regulate the definitions, assumptions and methods used in accounting in all industries. GAAP covers topics such as revenue recognition, balance sheet classification and materiality.
The ultimate goal of GAAP is to ensure that a company’s financial statements are complete, consistent and comparable. This makes it easier for investors to analyze and extract useful information from the company’s financial statements, including trend data over a specific time period. It also facilitates the comparison of financial information between different companies.
These 10 general concepts can help you remember the main mission of GAAP:
1. Principle of regularity
The accountant has adhered to GAAP rules and regulations as a standard.
2. Principle of consistency
Accountants are committed to applying the same standards throughout the reporting process, from period to period, in order to ensure financial comparability between periods. Accountants are required to disclose and fully explain the reasons for any change or update to the standards in the footnotes of the financial statements.
3. Principle of sincerity
The accountant strives to provide an accurate and unbiased description of a company’s financial position.
4. Principle of permanence of methods
The procedures used in financial reporting must be consistent, allowing a comparison of the company’s financial information.
5. Principle of non-compensation
Negative and positive points should be reported transparently and without expectation of debt compensation.
6. Principle of prudence
It is about emphasizing a factual representation of financial data that is not obscured by speculation.
7. Principle of continuity
While valuing assets, it must be assumed that the business will continue to operate.
8. Principle of periodicity
Registrations must be spread over the appropriate periods. For example, the income must be declared in the corresponding accounting period.
9. Principle of materiality
Accountants should strive to fully disclose all financial data and accounting information in financial reports.
10. Principle of the greatest good faith
Derived from the Latin expression “uberrimae fidei ” used in the insurance industry. It presupposes that the parties remain honest in all transactions.
If a company’s shares are publicly traded, its financial statements must follow rules set by the United States Securities and Exchange Commission (SEC). The SEC requires publicly traded companies in the United States to regularly file GAAP-compliant financial statements in order to remain publicly traded. Compliance with GAAP is ensured by the opinion of an appropriate auditor, resulting from an external audit carried out by an accounting firm (CPA).
Although not mandatory for unlisted companies, GAAP is viewed favorably by lenders and creditors. Most financial institutions will require annual financial statements in accordance with GAAP as part of their covenants when issuing business loans. As a result, most companies in the United States follow GAAP.
If a financial statement is not prepared in accordance with GAAP, investors should be careful. Without GAAP, it would be extremely difficult to compare the financial statements of different companies, even within the same industry, making it difficult to compare apples to apples. Some companies may report both GAAP and non-GAAP measures when reporting their financial results. GAAP regulations require that non-GAAP measures be identified in financial statements and other public information, such as press releases.
The GAAP hierarchy is designed to improve financial reporting. It consists of a framework for selecting the principles that public accountants should use in preparing financial statements in accordance with US GAAP. The hierarchy breaks down as follows:
Statements by the Financial Accounting Standards Board (FASB) and the Accounting Research Bulletins and Opinions of the Accounting Principles Board of the American Institute of Certified Public Accountants (AICPA)
FASB Technical Bulletins and AICPA Industry Accounting and Auditing Guides and Position Statements
AICPA Accounting Standards Executive Committee Practice Bulletins, FASB Emerging Issues Working Group (EITF) Positions, and Topics Covered in Appendix D of EITF Summaries
FASB Implementation Guides, AICPA Accounting Interpretations, AICPA Industry Audit and Accounting Guides, Statements of Position not approved by the FASB, and widely accepted and followed accounting practices
Accountants are advised to consult sources at the top of the hierarchy first, and then move to lower levels only if there is no relevant statement at a higher level. FASB Statement of Financial Accounting Standards No. 162 provides a detailed explanation of the hierarchy.
GAAP vs IFRS
GAAP focuses on the accounting and financial reporting of American businesses. The Financial Accounting Standards Board (FASB), an independent, not-for-profit organization, is responsible for establishing these accounting and financial reporting standards. The international alternative to GAAP are International Financial Reporting Standards (IFRS), established by the International Accounting Standards Board (IASB).
The IASB and FASB have been working on the convergence of IFRS and GAAP since 2002. As a result of the progress made in this partnership, the SEC in 2007 removed the requirement for non-U.S. Companies registered in America to reconcile their financial reports to GAAP if their accounts were already in compliance with IFRS. This was a great achievement because prior to the decision, non-US companies trading on US stock exchanges had to provide GAAP-compliant financial statements.
Some differences that still exist between the two accounting rules include:
LIFO inventory: Although GAAP allows companies to use the last in, first out (LIFO) method as the cost of inventory method, this is prohibited under IFRS.
Research and development costs: These costs should be expensed as they are incurred under GAAP. Under IFRS, costs can be capitalized and amortized over multiple periods if certain conditions are met.
Cancellation of depreciation: GAAP specifies that the amount of depreciation of an inventory or a fixed asset cannot be reversed if the market value of the asset subsequently increases. The depreciation can be reversed under IFRS.
As companies increasingly must navigate global markets and operate globally, international standards are becoming increasingly popular at the expense of GAAP, even in the United States. Almost all companies in the S&P 500 report at least one non-GAAP earnings measure in 2019.
GAAP is just a set of standards. Although these principles are intended to improve the transparency of financial statements, they do not provide any guarantee that a company’s financial statements are free from errors or omissions intended to mislead investors. There is plenty of room in GAAP for unscrupulous accountants to twist the numbers. So even when a company uses GAAP, you still need to review its financial statements.
Frequently Asked Questions
Where are generally accepted accounting principles (GAAP) used?
GAAP is a set of procedures and guidelines used by companies to prepare their financial statements and other accounting information. The standards are prepared by the Financial Accounting Standards Board (FASB), which is an independent, not-for-profit organization. The purpose of GAAP standards is to help ensure that financial information provided to investors and regulators is accurate, reliable and consistent with one another.
Why is GAAP important?
GAAP is important because it helps maintain confidence in the financial markets. Without GAAP, investors would be more reluctant to trust information presented to them by companies because they would have less confidence in its integrity. Without this confidence, we could see fewer transactions, which could lead to higher transaction costs and a less robust economy. GAAP also helps investors analyze businesses by making it easier to make “apple-to-apples” comparisons between one company and another.
What are the non-GAAP measures?
Companies are still allowed to submit certain numbers without complying with GAAP guidelines, as long as they clearly identify those numbers as non-GAAP compliant. Companies sometimes do this when they feel that GAAP rules are not flexible enough to grasp certain nuances about their operations. In this situation, they may provide specially designed non-GAAP measures, in addition to other information required under GAAP. Investors should be skeptical of non-GAAP measures, however, as they can sometimes be used in a misleading manner.