Accounting Standards

Most of the large company accounts you are likely to look at are listed companies (which have to use international standards) so we’ll focus on these standards.

Just be aware that if you look at a private company’s accounts that the standards they are using might be different.

International accounting standards are produced by a body called the International Accounting Standards Board (IASB).

Accounting Standards in the EU & US

A set of their standards has been adopted by the EU so all European companies that are required to use international standards are using this one set of standards.

Ultimately, it would be ideal if all listed companies in all countries use the same standards but as things stand, this is not the case, particularly since the US currently uses its own standards.

The standards issued by the IASB are identified either as:
– IAS xx (International Accounting Standard)
– IFRS xx (International Financial Reporting Standard)

The generally accepted accounting principles (GAAP) are mandated for the creation of uniform financial reports by publicly traded companies while private businesses are not required to follow GAAP.

Accountants adhere to it for consistency, fairness, and accuracy in measuring and disclosing financial information. Since a company’s fiscal reports have a significant impact on the decisions made by investors, employees and financial institutions, GAAP provides a set of foundational guidelines.

GAAP vs. Non-GAAP 

Though publicly-traded companies are require to create financial reports using GAAP, they have the freedom to release additional reports prepared using non-GAAP principles.

Many businesses assert that non-GAAP earnings more accurately reflect their positions – the two approaches can lead to vastly different figures though in the short term.

The main difference has to do with when revenue and expenses are recognized.

GAAP requires that companies use accrual accounting which differs from cash accounting in that related revenues and expenses are reported together at the time of transaction rather than simply when cash is exchanged.

The method used for preparing financial reports matters most to investors when it comes to earnings per share.

International Financial Reporting Standard (IFRS)

While public companies in the US are currently required to follow GAAP standards when filing financial statements, private companies are free to choose their preferred accounting system.

The biggest difference between the two reporting standards is the number of rules behind the principles. GAAP principle re governed by more detailed rules and guidelines then IFRS. However both standards are in place to ensure that accountants remain honest.

Historical Cost means that all the assets on our balance sheets to date have been based on the actual cost of the asset at the time it was bought.

However, international standards have moved to reporting assets and liabilities at ‘fair value’ rather than at cost.

Fair Value is defined as the price at which you could buy the asset or sell the liability in an orderly market at the market conditions on the balance sheet date.

The International Accounting Standards Board (IASB) defines fair value as “an amount at which an asset could be exchanged between knowledgeable and willing parties in an arms length transaction”.

Time Value of Money

Companies today enter into a lot of transactions where the resulting assets and liabilities change value significantly depending on what’s happening in the world economy.

The time value of money shows that there is a big difference in the value today between an amount of money that you don’t have to pay for a few years. If you can delay paying someone for several years that is valuable because you can invest the money in the meantime.

Present Value 

We can adjust for the time value of money by discounting future cash flows to give us their value today – the discounting is done by applying an annual percentage discount rate to the future cash flow.

Because money in the future is less valuable than money today, this always get you to a lower figure than the undiscounted figure.

Discount rates used by companies in their accounts vary, depending on what’s being valued from as low as 1% up to as much as 15-20%.

If a company has included in its balance sheet at discounted fair value a cash outflow that is two years away, then in it’s balance sheet a year later, the actual cash outflow will be one year nearer. This therefore affects the time value of money calculation. The present value of the outflow will now be higher and this has to be reflected in the balance sheet.

Effect on the balance sheet:
· increase future obligation
· decrease retained profit

This is known as unwinding of the discount.

Impairment

Another thing that you’ll frequently come across on a listed company’s accounts is something called impairment.

When there are assets that are not restated to fair value at each balance sheet date, there is a need to consider impairment.

This means that if the recoverable amount or fair value of such an asset is actually lower at the balance sheet date than the standard accounting shows, the company is obliged to write down the value of the asset to the fair value.