Principles Driving Today’s Accounting Standards
- Unmatched Events Will Mislead Investors
- Updating to Current Prices Creates Non-Existent Value
- Opinions Do Not Matter to Investors
- Industry Is Futile Absent Credibility
- Uniform Adherence Constitutes Consistency
Most individuals who deal with accounting standards may know what the basic wording is. However, many of them may fail to understand the concept behind the definition. This mostly happens because a lot of the industry standards were made a long time ago and are now taken at face value. In other words, people simply accept them without looking further into the reasoning behind the notions. Here are five of the key principles that drive today’s accounting standards.
Unmatched Events Will Mislead Investors
Arguably, the most popular accounting standard would have to revolve around proper matching. What does this mean? Well, it demands that companies record their revenues in the same period in which they record expenses for such revenues. So, if someone spends $10,000 fixing a house that is sold for $100,000, both numbers must be recognized at the same time. Doing so allows the financial statements to be represented fairly. If this was not demanded, people could record all expenses in one year and all revenues in another. The investors would be completely misled and unable to make sound decisions.
Updating to Current Prices Creates Non-Existent Value
If companies buy assets and then realize that those assets appreciate in value, they should not upgrade the cost on their books to the higher number. Such a boost in valuation would not actually be existent since it is just based on unverified market terms. No transaction has occurred to warrant the increase in the current valuation. It is okay to drop the value when needed. But boosting it every time that the market is showing an increase in valuation would rapidly snowball into major misstatements.
Opinions Do Not Matter to Investors
The accounting standard related to objectivity is based on the fact that investors are completely indifferent to opinions. While this assumption is not entirely true, the idea that the readers of the financial statements will mostly care about the number is right. After all, people seldom go through income statements and balance sheets looking for how someone in the company felt about the venture. Instead, they are seeking facts that will allow them to make informed decisions.
Industry Is Futile Absent Credibility
The accountancy standard related to practicing utmost care and good faith is another extremely important one. According to Accounting Weekly, the reasoning behind it is fairly simple. It deals with the idea that people would not care for findings if there is no public trust in the accountants. In other words, if the only goal of the profession was to report whatever numbers someone wanted to write without any type of verification, the entire industry would collapse. Investors would have no need for CPAs once their credibility plummets.
Uniform Adherence Constitutes Consistency
Finally, the standard demanding that businesses stick to the Generally Accepted Accounting Policies (GAAP) was created for a wide variety of reasons. One of them is based on the need to have consistent financial representations that are further comparable in and across industries. So, if investors want to weigh their chances of success among multiple public organizations, they can rest assured that all of them will at least have followed the same legal reporting requirements.
Conclusion
Other principles that should be mentioned include the importance of providing timely data and preventing fraudulent representations from reaching the market. Thus, the accounting standards are simply an oversimplified description of the principles that have been derived over the course of the accounting history. To truly and effectively follow accounting standards, it is imperative to understand the underlying principles behind them.
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