Ac­count­ing prin­ci­ples: National and in­ter­na­tion­al standards

In the United States, there is a set of standards in place for annual financial ac­count­ing called the US GAAP (United States Generally Accepted Ac­count­ing Prin­ci­ples). These prin­ci­ples are set in place by the Financial Ac­count­ing Standards Board, or FASB, and are a national version of the in­ter­na­tion­al ac­count­ing standards set by the IFRS. The ac­count­ing prin­ci­ples contained in the GAAP are only required for publicly traded companies, though many private busi­ness­es choose to follow them as well. Following the prin­ci­ples helps to guarantee con­sis­ten­cy and accuracy in finances, which helps companies to secure the trust of their investors, employees, and financial backers. Com­pli­ance to the GAAP also depends on the state: Some states require full GAAP com­pli­ance, while others require none at all.

Ac­count­ing standards exist to ensure that ac­count­ing decisions are made in a unified and rea­son­able way. They should be com­pa­ra­ble: so it is easy to compare the financial standing of similar entities. They should be trans­par­ent: leaning in the direction of openness when deciding how to provide in­for­ma­tion to observers. Standards make sure the in­for­ma­tion in the financial state­ments is relevant: this makes it more difficult for or­ga­ni­za­tions to misdirect observers.

The aim of the standards is to organize a company in such a way as to provide all of the necessary in­for­ma­tion to any in­de­pen­dent observer. The US GAAP system actually functions under 10 basic tenets, all intended to promote the con­sis­ten­cy and trans­paren­cy of official financial records.

It goes without saying that capital-market-oriented companies are obliged to protect the interests of their investors and share­hold­ers. Compliant annual financial state­ments aim to provide an objective insight into the economic situation of a company within the scope of the share­hold­er pro­tec­tion principle so that those share­hold­ers can form their own es­ti­ma­tion of possible returns and risks. Com­mer­cial books and financial state­ments also assist in tax planning and op­ti­miza­tion.

Creditor pro­tec­tion, share­hold­er pro­tec­tion, and tax struc­tur­ing are reflected in two basic functions of the annual financial state­ments: How easily the business can pay its bills and the prof­itabil­i­ty of the business.

• The income of the business year serves as a basis for the taxation of a company as well as the de­ter­mi­na­tion of per­for­mance-related dis­tri­b­u­tions (dividends and profit sharing)
   
• The balance sheet displays the financial health of a company at a point in time and serves as the basis for financial planning and resource al­lo­ca­tion.

Annual con­sol­i­dat­ed financial state­ments, when prepared according to uniform ac­count­ing standards, are reliable and mean­ing­ful sources of in­for­ma­tion. The other 10 basic tenets of the US GAAP are as follows:

• Reg­u­lar­i­ty
• Con­sis­ten­cy
• Sincerity
• Per­ma­nence of Methods
• Non-Com­pen­sa­tion
• Prudence
• Con­ti­nu­ity
• Pe­ri­od­ic­i­ty
• Ma­te­ri­al­i­ty / Good Faith
• Utmost Good Faith

Ac­count­ing standards are national or in­ter­na­tion­al prin­ci­ples set in various areas of business ac­count­ing. The aim is to regulate book­keep­ing and ac­count­ing in relevant legal areas by means of statutory re­quire­ments, thereby stan­dard­iz­ing the process of reporting on company finances and making state­ments relevant and com­pa­ra­ble.

For ac­coun­tants in the US, this means a divide between the national standards of the FASB and the in­ter­na­tion­al standards of the IFRS. The standards laid out by the FASB in the US GAAP translate easily to many in­ter­na­tion­al markets. US companies that have non-US sub­sidiaries preparing financial state­ments using an IFRS framework should keep up-to-date on IFRS de­vel­op­ments.

Ac­count­ing standards have a long tradition. As early as 5,000 years ago, merchants in Egypt and Mesopotamia organized their business using an ancient version of financial state­ments and accounts. In the Roman Empire, bankers were obliged to use sys­tem­at­ic ac­count­ing. Even double-entry ac­count­ing, the most commonly used system of com­mer­cial business income and ex­pen­di­ture recording today, found its origins in 17^th century northern Italy.

In the States, ac­count­ing standards were first in­tro­duced by the American Institute of Ac­coun­tants (AIA) in the 1930s. After the global economic crisis of the 1920s and the stock market crash of 1929, the overly lax ac­count­ing practices of many busi­ness­es shoul­dered a lot of the blame. Without strict standards of financial pre­sen­ta­tion, companies could ma­nip­u­late their reports to suit whatever needs they had, making their finances appear in better shape than they actually were. The Se­cu­ri­ties and Exchange Com­mis­sion (SEC) began enforcing leg­is­la­tion for public companies with the Se­cu­ri­ties Act of 1933 and the Se­cu­ri­ties Exchange Act of 1934. Ac­count­ing standards in the US are now monitored by the FASB, an in­de­pen­dent or­ga­ni­za­tion that is re­spon­si­ble for setting ac­count­ing standards for public companies in the US.

While the ac­count­ing prin­ci­ples contained in the US GAAP only apply to US companies, there are national ac­count­ing prin­ci­ples in Canada, France, Germany, the UK, China, India, Nepal, and Russia.  Though there is some overlap (for example, Germany has vol­un­tar­i­ly signed the US GAAP in addition to their own standards), prin­ci­ples are only really applied to domestic business. Any companies doing business with or from foreign nations typically apply in­ter­na­tion­al ac­count­ing standards, such as the IFRS format.

The ap­pli­ca­tion of the IFRS standards is much less prevalent in the US, however. While public companies are required to uphold US GAAP standards, private companies are allowed to choose their own ac­count­ing methods and there are no laws in place requiring the ap­pli­ca­tion of IFRS standards. IFRS is also only required for the con­sol­i­dat­ed accounts of EU listed companies and any companies not included in that pop­u­la­tion are only subject to national standards.

While operating according to IFRS is generally all that’s required for con­duct­ing foreign business, the following table will provide a quick overview of the national ac­count­ing standards for the DACH countries (Germany, Austria, and Switzer­land) as well as the other major players in Europe: the UK, France, Spain, and Italy.

Han­dels­ge­set­zbuch (HGB)

The German Com­mer­cial Code (HGB in German) forms the legal basis for the man­age­ment of business books and creation of annual financial state­ments in Germany. This requires every merchant to disclose trans­ac­tions and assets in ac­cor­dance with proper ac­count­ing prin­ci­ples. Details on these can be found in the Com­mer­cial Code and aren’t ex­plic­it­ly defined by the leg­is­la­ture. Instead, the prin­ci­ples are formed based on educated rec­om­men­da­tions and generally accepted practice.

Deutsche Rech­nungsle­gungs­stan­dards (DRS)

German ac­count­ing standards (DRS in German) must be used if the company in question is a parent company. These standards are set by the German Ac­count­ing Standards Committee (DRSC), a private ac­count­ing body that operates on behalf of the Federal Ministry of Justice (BMJ). Financial state­ments can also be vol­un­tar­i­ly prepared in ac­cor­dance with the IFRS. These replace HGB and DRS standards, as long as the sup­ple­men­tary trade reg­u­la­tions are observed.

In­ter­na­tion­al Financial Reporting Standards (IFRS)

Capital-oriented parent companies, on the other hand, are not held to HBG or DRS standards. Instead, the in­ter­na­tion­al ac­count­ing standards of IFRS rec­og­nized by the EU are applied through­out Europe.

Un­ternehmensge­set­zbuch (UG)

The German Corporate Code (UG in German) is used in Austria for drawing up annual financial state­ments. Austrian law also refers to the prin­ci­ples of proper ac­count­ing. Unlike in Germany, these are described directly in the legal text and so are official leg­isla­tive standards.

IFRS

Similar to the situation in Germany, parent companies in Austria have the right to choose between IFRS and the national standard. According to EU reg­u­la­tions though, capital-market-based parent companies must account in ac­cor­dance with IFRS.

Oblig­a­tio­nen­recht (OR)

The Swiss Code of Oblig­a­tions (OR in German) contains statutory minimum re­quire­ments for ac­count­ing in Switzer­land. The OR reg­u­la­tions are binding for all com­mer­cial trans­ac­tions of companies and or­ga­ni­za­tions with account oblig­a­tions. Strict rules apply to companies listed on the largest Swiss stock exchange, SIX Swiss Exchange. In this case, it’s required to either follow the rec­om­men­da­tions for ac­count­ing (Swiss GAAP FER) or in­ter­na­tion­al ac­count­ing standards (IFRS).

Swiss GAAP FER

For Swiss companies listed on the SIX Swiss Exchange in the secondary segment, the rec­om­men­da­tions for ac­count­ing (Swiss GAAP FER) apply as a minimum standard. Companies that aren’t listed can choose to use Swiss GAAP FER for their ac­count­ing as well. These rec­om­men­da­tions include:

• A framework concept
• Core expert rec­om­men­da­tions
• Swiss GAAP FER 30 for con­sol­i­dat­ed financial state­ments
• Swiss GAAP FER 31 for listed companies

Small companies only have the option to align them­selves with the framework concept and select expert rec­om­men­da­tions. Medium-sized or­ga­ni­za­tions must observe all standards for their ac­count­ing. The Swiss GAAP FER 30 is also required for companies, co­or­di­nat­ed with the con­sol­i­dat­ed financial state­ments. Exchange-listed companies also must take the Swiss GAAP FER 31 (“Com­ple­men­tary rec­om­men­da­tion for listed companies”) into account. Industry-specific rec­om­men­da­tions are offered for insurance companies, pension in­sti­tu­tions, non-profit or­ga­ni­za­tions, health insurers, and building insurers.                         

IFRS or US GAAP

Since 2005, a financial statement prepared according to in­ter­na­tion­al standards (IFRS or US GAAP) has been mandatory for Swiss companies listed on the SIX Swiss Exchange in the main segment.

New UK-GAAP Generally Accepted Ac­count­ing Practice (New UK-GAAP)

New national ac­count­ing standards have been in place in the UK since January 1, 2015, called the New UK GAAP. The ac­count­ing framework is aimed at non-capital-oriented companies and covers the six standards FRS 100 to FRS 105.

• FRS 100 - Ap­pli­ca­tion of Financial Reporting Re­quire­ments: FRS 100 explains the framework for financial state­ments prepared in ac­cor­dance with national laws, reg­u­la­tions, and ac­count­ing standards.
  
  
• FRS 101 - Reduced Dis­clo­sure Framework: FRS 102 presents a reduced ac­count­ing concept that allows companies to prepare con­sol­i­dat­ed financial state­ments in ac­cor­dance with the in­ter­na­tion­al IFRS re­quire­ments, without having to comply with all IFRS dis­clo­sure re­quire­ments.
  
  
• FRS 102 - The Financial Reporting Standard Ap­plic­a­ble in the UK and Republic of Ireland: FRS 102 is the actual financial reporting standard for the UK and Ireland. This covers 250 pages and replaces all previous Old UK GAAP standards.
  
  
• FRS 103 - Insurance Contracts: FRS 103 contains separate ac­count­ing standards for companies that issue insurance contracts.
  
  
• FRS 104 - Interim Financial Reporting: FRS 104 is based on the in­ter­na­tion­al standard for interim reporting, IAS 34, and serves as a basis for the prepa­ra­tion of interim financial state­ments for companies that use FRS 101 or FRS 102 ac­count­ing.
  
  
• FRS 105 - The Financial Reporting Standard Ap­plic­a­ble to the Micro-entities Regime: FRS 105 is a modified version of FRS 102, directly tailored to the re­quire­ments and needs of micro-en­ter­pris­es.

The FRS is issued by the Ac­count­ing Standards Board (ASB), a division of the Financial Reporting Council (FRC).

IFRS

Listed companies also have to prepare accounts according to the IFRS in­ter­na­tion­al ac­count­ing standards in the UK.

Plan comptable général (PCG)

The Comptable Général (PCG) is the minimum standard for the ac­count­ing of non-listed companies in France. The framework contains the following content:

• Overview of the topics and prin­ci­ples of the ac­count­ing
• De­f­i­n­i­tion of core concepts such as the balance sheet, profit and loss account, li­a­bil­i­ties, assets, income, as well as profits and losses
• Pre­sen­ta­tion of ac­count­ing and valuation rules
• Account man­age­ment and naming rules
• Doc­u­men­ta­tion re­quire­ments
• Special ac­count­ing rules
• State­ments by the National Audit Office (Conseil National de la Compt­abil­ité) and the Committee on Urgency (Comité d’Urgence)

IFRS

Like any other EU member state, France also requires listed parent companies to prepare con­sol­i­dat­ed financial state­ments in ac­cor­dance with the IFRS.

Código de comercio (CCom) und Ley de so­ciedades anónimas (LSA)

Merchants and trading companies in Spain are also obligated to prepare business books according to com­mer­cial prin­ci­ples. Cor­re­spond­ing re­quire­ments can be found in the Spanish Com­mer­cial Code (Código de comercio, CCom) and the Spanish Stock Cor­po­ra­tion Act (Ley de so­ciedades anónimas, LSA). These are largely based on the European guide­lines and differ only slightly.

Plan general de con­tabil­i­dad

One criticism of the CCom and LSA ac­count­ing standards concerns their overall account plan (Plan general de con­tabil­i­dad, PGC), which was approved by Royal Decree 1514/2007 and is a broad adap­ta­tion of the in­ter­na­tion­al ac­count­ing standard IFRS. A sim­pli­fied account plan for small and medium-sized companies is available in ac­cor­dance with Decree 1515/2007.

IFRS

Spanish capital-oriented parent companies report according to the IFRS, just like all other EU member states.

Codice Civile

The legal basis for ac­count­ing standards in Italy is contained in Article 2423 of the Italian Civil Code (Codice Civile, CC). The pos­si­bil­i­ty of a condensed financial statement is the subject of Article 2435.

Ac­count­ing prin­ci­ples of the OIC

An in­ter­pre­ta­tion and clar­i­fi­ca­tion of the Italian Civil Code of ac­count­ing prin­ci­pals is available to companies by the ac­count­ing prin­ci­ples of the Organismo Italiano di Con­tabil­ità (OIC). In the case of reg­u­la­to­ry gaps in the national guide­lines, resorting to in­ter­na­tion­al standards (generally IFRS) is possible.

IFRS

Listed companies and insurance agencies in Italy are required to create in­di­vid­ual and con­sol­i­dat­ed financial state­ments according to IFRS. Non-listed companies are allowed to choose between IFRS and the national standards.

To make annual and con­sol­i­dat­ed financial state­ments that are com­pa­ra­ble across national borders, in­ter­na­tion­al har­mo­niza­tion has been underway for a number of years. The goal is to provide companies with a uniform framework for financial state­ments. The in­ter­na­tion­al ac­count­ing standards in use today are the IFRS, created by the IASB, as well as the US GAAP, created by the FASB, which are used primarily in America but are also applied abroad. The following is a brief recap of these standards, which were discussed earlier as well.

The In­ter­na­tion­al Financial Reporting Standards (IFRS) were published by the In­ter­na­tion­al Ac­count­ing Standards Board (IASB) as basic prin­ci­ples for in­ter­na­tion­al company ac­count­ing. The goal was to achieve a worldwide har­mo­niza­tion of the ac­count­ing system.

The framework consists of three parts:

• Framework: The IFRS framework forms the the­o­ret­i­cal basis of the standards as a framework concept. It describes the goals and the main premise of the in­ter­na­tion­al re­quire­ments, as well as qual­i­ta­tive re­quire­ments for the IFRS fi­nan­cials state­ments. It also provides framework de­f­i­n­i­tions of the central terms such as assets, li­a­bil­i­ties, income, or expenses.
  
  
• Standards (IFRS/IAS): The actual ac­count­ing and valuation re­quire­ments are in the form of in­di­vid­ual standards. These include both the IFRS from the IASB as well as the IAS (In­ter­na­tion­al Ac­count­ing Standards) from the pre­de­ces­sor or­ga­ni­za­tion, the IASC (In­ter­na­tion­al Ac­count­ing Standards Committee).
  
  
• In­ter­pre­ta­tions: To unify the un­der­stand­ings of the in­ter­na­tion­al re­quire­ments, the third part of the framework includes official in­ter­pre­ta­tions of the standards published by IFRS In­ter­pre­ta­tions Committee (IFRS IC).

Ap­pli­ca­tion of the IFRS: In the event of a conflict, the IFRS standards and in­ter­pre­ta­tions have a higher liability as special reg­u­la­tions than the overall spec­i­fi­ca­tions of the framework. The framework itself doesn’t have a default status.

Since 2005, all capital-oriented parent companies with locations in Europe are required to create financial state­ments according to the IFRS.

The United States Generally Accepted Ac­count­ing Prin­ci­ples (US GAAP) are ac­count­ing standards issued by the Financial Ac­count­ing Standards Board (FASB) for the US. They obtain legal status with the approval of the US Se­cu­ri­ties and Exchange Com­mis­sion (SEC) as well as the largest pro­fes­sion­al as­so­ci­a­tion of American auditors, the AICPA (American Institute of Certified Public Ac­coun­tants).

US GAAP also enjoys a high in­ter­na­tion­al status, since a listing on the US stock exchange requires reporting in ac­cor­dance with the rules of the SEC. Until 2007, foreign companies wishing to meet their capital re­quire­ments on the US capital market were also required to fulfill the US GAAP or a compliant tran­si­tion to the US standard. But since December 21, 2007, with the ac­cep­tance of the IFRS by the SEC, this re­quire­ment has been omitted.

The focus on the capital market means that in­vest­ment-oriented finance reports based on in­ter­na­tion­al standards are aimed at meeting needs within a given period. IFRS state­ments are based on the accrual principle  - income and expenses are recorded in the period in which they’re generated and not in the period in which the payment receipts or payments actually appear. By contrast, the US GAAP places a larger emphasis on the prudence principle that strives to remove spec­u­la­tion from the reporting of fact-based financial data. The prudence principle is intended to protect lenders from the overly op­ti­mistic pre­sen­ta­tion of fi­nan­cials. For example, revenue is not rec­og­nized unless it is certain.

The concrete im­ple­men­ta­tion of the principle of prudence works with the two other prin­ci­ples: non-com­pen­sa­tion and ma­te­ri­al­i­ty/good faith.

• Principle of non-com­pen­sa­tion: The non-com­pen­sa­tion principle requires full trans­paren­cy of both negative and positive values in the financial statement, without the inclusion of any expected debt com­pen­sa­tion.
  
  
• Principle of ma­te­ri­al­i­ty: This principle means trivial matters are to be dis­re­gard­ed and all important matters are to be disclosed.
  
  
• Principle of utmost good faith: All involved parties are assumed to be acting honestly with every necessary dis­clo­sure doc­u­ment­ed.

Click here for important legal dis­claimers.