Next, you meet the financial accounting standard-setting bodies and find out why publicly owned companies (those whose shares are freely traded on a public stock exchange) abide by different standards than privately owned companies.
Throughout this book, I refer to the acronym GAAP, which stands for generally accepted accounting principles. In this chapter, I explain that GAAP define for financial accountants the acceptable practices in the preparation of financial statements in the United States. Finally, I explain how GAAP have been restructured by the Financial Accounting Standards Board (FASB) into a more user-friendly format.
I hope you’re hungry, because in this chapter, you get out your spoon and dive into your alphabet soup!
Walking through the Origins of Number Crunching
I’d bet money that your financial accounting textbook takes a walk down memory lane in its first chapter, introducing you to the history of accounting. So I want to touch on a few major points to round out your textbook discussion before I explain current financial accounting standard setting.
If you’ve already taken an accounting history course, you know that accounting dates back to prehistoric times. If not, here are just a few number-crunching historic facts that place accounting in the context of world history:
Cavemen traded beads and other trinkets to acquire food and other basic necessities. These trades required some equitable method of measuring what trinkets were exchanged for how much food, for example, thus originating the concept of keeping track of — or accounting for — items.
Later in history, formal accounting records were kept to make sure subjects were paying the required amount of taxes to the Holy Roman and other empires.
The Industrial Revolution in the 18th and 19th centuries ushered in the mass production of goods through the use of machinery rather than craftsmen working with their hands. Mass production required a more sophisticated approach to recording the movement of goods, services, and money, ramping up the activities and professionalism of the accounting field. It also resulted in the separation of ownership from management.
Accountants plied their trade in a mostly unmonitored environment until the stock market crash of 1929. After this horrific event, the American Institute of Accountants, which is now the American Institute of Certified Public Accountants, partnered with the New York Stock Exchange to agree upon five principles of accounting.
Fast-forwarding to the present, these five principles have expanded into hundreds of principles covering every accounting topic imaginable, from how financial statements are prepared to accounting for different types of businesses.
If the financial accounting class you’re taking now is your first accounting or business class, you may be wondering why you have to record accounting events in such a nit-picky fashion. You may also wonder who the head nit-pickers are and from whence they get their authority. This chapter answers both questions and gives you a good foundation to tie into the information given in your financial accounting textbook.
ADVICE FOR THE BEFUDDLED FINANCIAL ACCOUNTING STUDENT
Most of my financial accounting students are relative newbies to the wonderful world of accounting and business-related classes. Even at the MBA level, a preponderance of my students know nothing about accounting because they transferred into business after getting their undergraduate degrees in non-business-related disciplines.
If you’re an accounting novice, my best advice to you is to forget all your preconceived notions of accounting — especially as they tie into what you feel is logical. Many times, I’ve seen students banging their heads against the wall because the way GAAP or the AICPA works doesn’t make sense to them. Sometimes, financial accountants handle transactions in a certain way simply because that’s the way it’s done. After you go through the alphabet soup of regulatory agencies in this chapter, I hope you come to realize that for this class, at least, you need to have a good overview of the regulatory system and just go with the flow.
Knowing the Role of the American Institute of Certified Public Accountants (AICPA)
Financial accountants absolutely must maintain the highest level of ethical behavior and operate using a code of conduct. This means that financial accountants must always attempt to act in an ethical manner and do the right thing — regardless of whether doing the right thing at that particular moment is the best choice for the accountant personally.
So what exactly does the AICPA do? Through its senior technical committee, which is called the Auditing Standards Board (ASB), the AICPA is responsible for establishing auditing and attestation standards for nonpublic companies in the United States. Before we move on, let me define three key terms in that explanation:
The purpose of financial statement auditing is to gather enough evidence about a company’s documents to be able to issue an opinion on whether the documents are free of material (significant) misstatements.
A financial accountant provides an attestation service when she issues a report on a subject that is the responsibility of another person or business. For example, a company can hire you to calculate the rate of return on the company’s investments (see Chapter 14), making sure your figures match the company’s report on the same topic.
Nonpublic companies are closely held (meaning privately owned). Their stock is not traded on any open-to-the-public stock exchange. For example, if you start a corporation, you aren’t required to sell any of your shares of stock unless you want to. In contrast, a publicly traded company’s shares are available for purchase in stock exchanges, such as the American Stock Exchange, or over-the-counter markets, such as the NASDAQ.
The AICPA also enforces a code of professional conduct for its members, which governs how financial accountants perform their duties. In the next two sections, I provide more information about each key role of the AICPA. First up is an explanation of the audit and attestation standards set by the ASB.
ASB audit and attestation standards
The Auditing Standards Board