Accounting Several Terms and Definitions Are Valuable

Accounting

Several terms and definitions are valuable to understand financial statements. In the United States, financial statements of public corporations are produced in accordance with the U.S. Generally Accepted Accounting Principles. These principles govern how the information for financial statements is compiled and presented. The purpose of these principles is so that all stakeholders can easily understand the statements and make comparisons across both time and across different companies, because the statements are produced and presented in a consistent manner. The International Financial Reporting Standards (IFRS) are the international equivalent of GAAP. While several countries utilize a national version of GAAP (U.S., Canada, UK, etc.), more than 100 countries use IFRS, making this set of standards the most widely-adopted in the world. There is a move to converge national GAAP standards with IFRS, including a multi-year project to converge U.S. GAAP with IFRS. For now, however, IFRS represents a different set of standards. The public statements of most European countries are produced according to IFRS, so it is important to understand the differences between IFRS and U.S. GAAP when analyzing those statements.

The Securities and Exchange Commission (SEC) is the body in the United States that governs the securities that trade publicly in the U.S., including those of foreign firms traded on U.S. exchanges. With specific regard to financial statements, the SEC enforces the application of GAAP on U.S. financial statements. When there are violations with respect to the production and presentation of financial accounting statements in the United States, the SEC is charged with the enforcement the accounting standards.

The Public Companies Accounting Oversight Board (PCAOB) is a body created by the Sarbanes-Oxley Act that is charged with enforcing the provisions of that act with respect to companies that trade on U.S. exchanges. All companies that trade on U.S. exchanges are subject to SOX and to the oversight of the PCAOB.

It is also worth understanding the difference between an annual report and a 10-K form. The 10-K form is mandated by the SEC and must be completed by all public companies. This form is an external presentation of the firm's financial condition, and included the financial statements, a brief write-up about the company and its risks, and a few other components. The annual report will typically include the 10-K, but is not an official document produced to an SEC template. Rather, the annual report is not produced to any standard template, other than the 10-K portion.

II. The basic equation for accounting is that the liabilities and equities equals the assets of the firm. There are many accounts in each category. Some examples of assets are cash, inventories, property, equipment, and accounts receivables. Examples of liabilities include accounts payable, long-term debt, taxes payable, short-term notes payable and deferred taxes. Under equity, some accounts are common stock, retained earnings, treasury stock, preferred stock and paid-in capital.

III. The primary intended audience for financial statements is all stakeholders. The company produces these statements first and foremost for the SEC, in order to satisfy their requirements. There are other stakeholders as well, who benefit from the production of financial accounting statements in line with GAAP.

The first of these is investors. Investors and potential investors benefit from the financial statements in two ways. The first is that they can easily understand the financial condition of the firm, and the second is that this assessment can be compared. The comparison can either be with the firm's performance in previous time periods, or with other firms that the investor is analyzing. The financial statements therefore make investing more accurate, more reliable and less risky. This encourages more people to invest. In that way, the firm itself benefits from producing these statements. Indeed, sometimes firms that are not yet public will produce GAAP financial statements in order to help attract investors at such time as they do want to go to market.

There are other stakeholders as well who benefit from the production of financial accounting statements. Shareholders benefit from having an accurate picture of the company's financial condition, because they ultimately must make decisions about the members of the board. Managers, board members and executives also benefit from having this information because it can help guide decision making. Likewise, employees might benefit from this information as well. It helps them to understand some of the messages management is saying, and in many cases employees are also invested in the firm through some sort of share ownership plan.