In order to truly understand how a company is doing, one will usually have to take a peek at their financial statements and applicable accounting standards. Although this may not be sufficient to finalize a potential investment decision, it should provide a high-level overview of the entity and their performance during the previous year.
To be able to fully read and understand the complex financial statements that often confuse new investors, it is essential to know the accounting standards that have to be followed closely when creating a financial statement. In this article we will discuss the primary role of accounting standards, the benefits of following them, and any shortcomings.
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The primary role and ultimate objective of the Federal Accounting Standards Advisory Board accounting standards is quite simple: minimize the risk of intentional or unintentional errors while giving everyone a consistent way of showcasing financial achievements for the prior year. That way, there will be a high level of consistency throughout every single industry that relies on investors who make monetary donations through purchases of stock or venture capital. To truly understand how devastating a world without any standards for financial reporting would be, consider the following scenario below.
If Generally Accepted Accounting Principles (GAAP) did not exist, entities could pretty much report whatever they wanted to say in their yearly report. This means that some Company X could make a claim that they brought in north of $100 million in revenue while spending $20 in total expenses. Although such numbers are controversial enough to make one laugh, the lack of widely accepted standards would mean that there is nothing that can prove those numbers to be wrong. Fortunately, the standards come with principles that demand things like professionality, fair valuations, consistency, honesty, integrity, ethical thinking, and more. Thus, they directly reduce the likelihood of companies falsifying their figures.
Other benefits of accounting standards include things like professional guidance . In other words, they give current CPAs input on how certain things should be done. For instance, auditing standards clearly outline how every audit should be performed from start to finish. Moreover, standards issued by entities like the AICPA set professional requirements to become a CPA. These include things like the mandatory educational levels, passing of the CPA exam, proof of moral character, and much more.
Of course, since nothing is truly perfect, the standards in accounting come with a fair share of shortcomings, according to Forbes. Their main pitfall relates to the fact that people often have to update them based on the current conditions in a market. For example, financial standards hardly discussed anything in relation to cryptocurrency prior to 2017. After that, they slowly began implementing the right guidelines to address the unprecedented growth of this market. Unfortunately, there are sometimes delays that can cause the standards obsolete for a certain period of time and expose investors to increased risk.
Regardless of the shortcomings, these rules are the glue that hold the entire financial sector together and help individuals and entities reach their goals. So, saying that accounting standards are the key to a well-balanced market is not a far-reaching statement whatsoever.