Accounting Standards

Financial reporting—balance sheets—profit and loss statements—financial notes and disclosures—is the language we use to communicate information about the financial condition of a company, public or private, a not-for-profit organization, or a state or local government.

The accounting standards developed and established by the FAF’s standard-setting boards—the Financial Accounting Standards Board and the Governmental Accounting Standards Board—are the rules – the grammar and the punctuation – that determine how that language is written. Those rules are known collectively as U.S. Generally Accepted Accounting Principles—or U.S. GAAP.

Companies, not-for-profits, governments, and other organizations use accounting standards as the foundation upon which to provide users of financial statements with the information they need to make decisions about how well an organization or government is managing its resources.

That information is used to decide….
  • How to invest capital
  • Where to lend money
  • Where to donate money
  • Whether public officials are spending tax dollars wisely.
That information must be clear, concise, comparable, relevant and reliable.

High-quality financial reporting standards are essential to the efficient functioning of our capital markets. High quality standards lead to better financial information about an organization. Better financial information brings greater transparency to the economics of an organization.

For companies to attract the capital they need to hire workers, build plants, and invest in research and development, they must report financial information in a way that investors find useful. Greater transparency results in better capital allocation decisions—investors and lenders make wiser decisions about where to put their money. Better investing decisions inspire greater confidence in the markets, which ultimately strengthens our economy. In the end, it represents a “virtuous” cycle.

Accounting has a long history. Double entry bookkeeping—debits on the left, credits on the right – began in Italy, hundreds of years ago. It was first codified in the 15th Century by a Franciscan monk named Luca Bartolomes Pacioli. His work was built on that of another Italian scholar, Benedetto Cotrugli.

Portrait of Luca Bartolomes Pacioli, 1495

The extent to which improvements in financial reporting have affected our country’s economic growth has been the subject of much scholarly research—and there is evidence that improved financial reporting helped spur investment at critical moments in our economic history.

During the Industrial Revolution, as America’s transportation links were being forged, railroad companies pioneered standardized financial reporting to attract public and private capital for projects. Companies reporting clear, comparable and reliable financial information to investors produced an influx of capital investment that led to a revolution in the way that goods were brought to market – and to unprecedented economic growth.

Pacific Railroad Bond, May 1, 1865
For many years, public companies themselves took the lead in accounting innovation. The expansion of the U.S. automobile industry in the 1920s can partially be attributed to accounting modernization. General Motors, by presenting its financial information in the form of ratios such as return on investment and return on equity, was able to provide the market with more detailed and useful metrics. As a result, the company could adapt more quickly to market changes and make better decisions regarding capital investments. This type of analysis ushered in a new system of data reporting that benefited GM, its investors and the highly competitive automobile industry.

The pivotal economic event of the 20th century, the Great Depression, focused the U.S. on the need for comprehensive accounting reform. Many market participants felt that poor accounting and reporting procedures helped cause the downturn. In 1930, the American Institute of Accountants (known as the AICPA since 1957) and the New York Stock Exchange began an attempt to revise financial reporting requirements. Shortly thereafter, passage of the Securities Act of 1934 chartered the Securities and Exchange Commission, and gave the SEC the power to oversee accounting and auditing methods.

For nearly 40 years, the SEC looked to bodies established by the accounting profession to develop and establish accounting standards.

SEC Commission, 1936 (Courtesy, SEC Historical Society)

By the 1970s, market participants’ thinking about accounting standard setting evolved, as they came to believe in the importance of an independent standard-setting structure, separate and distinct from the accounting profession—so that the development of standards would be insulated from the self-interests of practicing accountants and their clients. Following a detailed study, the accounting profession in 1972 recommended creation of a new body, the Financial Accounting Foundation, to serve as the nation’s accounting standard-setting authority.

Through the FAF, the FASB in 1973 became the designated organization in the private sector for setting standards that govern the preparation of corporate financial reports along with not-for-profit organizations.

In 1984, the Government Accounting Standards Board (GASB) was formed under the FAF umbrella to issue standards and other communications that result in decision-useful information for users of government financial reports. Today owners of municipal bonds, members of citizen groups, legislators, and oversight bodies rely on this financial information to shape public policy and make wise investments.

Throughout its history, the SEC has relied on the private sector to create and implement accounting standards. Today, the FASB and GASB remain at the forefront of fulfilling the SEC’s mandate on behalf of the U.S. capital markets.

Today, the need for relevant comparable financial reporting is greater than ever. Moreover, this need applies across the international landscape of our increasingly global economy. The United States controls some $15 trillion in foreign assets, and the global capital markets depend on a constant flow of reliable, comparable financial data from U.S. companies to make decisions about moving assets into and out of the world’s most powerful economy.

American companies must supply the market with high-quality financial information to enable both U.S. and international investors to make better decisions. Without clear accounting standards and an open, independent process for creating and improving these standards, capital markets around the world would function less efficiently, driving up costs for all participants and sectors of the economy.

In the past, weak or inconsistent accounting standards have negatively impacted the U.S. and global economies. But today, a proven, open process, based on strong accounting principles, exists to enable the U.S. to constantly update and improve accounting standards. An infrastructure that allows for public comment and constant evaluation of accounting standards will produce the most accurate and reliable financial information.

The global economy is dynamic and often unpredictable. In order to maintain stability, institutional and retail investors must be able to trust publicly-available financial information. Accounting principles are created to meet this need, and accounting standards are enacted to guide reporting companies along this path. For the U.S. and global capital markets, there is simply no other alternative.