Financial Accounting and Accounting Standards

Learning Objectives

After studying this lesson, you should be able to:

1. Distinguish between financial accounting and management accounting, highlighting key differences in purpose, reporting scope, and users of financial information.

2. Understand the historical development of Generally Accepted Accounting Principles (GAAP), tracing its evolution from regulatory bodies such as the American Institute of Certified Public Accountants (AICPA) and FASB.

3. Explain the operating procedures of the Financial Accounting Standards Board (FASB) in the development and issuance of GAAP, including the standard-setting process, public consultation, and the role of due process.

Financial Accounting

The essential characteristics of accounting are:

(1)  The identification, measurement, analyzing, and communication of financial information

(2)  Economic Entities

(3)  Interested Parties

Financial accounting is the process that concludes in the preparation of financial reports on the enterprise for use by both internal and external parties. Users of these financial reports include Investors, Creditors, Managers, unions, and Government Agencies. In contrast, managerial accounting is the process of identifying, measuring, analyzing, and communicating financial information needed by management to plan, control, and evaluate a company’s operations.

Financial statements are the principal means through which a company communicates its financial information to those outside it. These statements provide a company’s history quantified in money terms.

The financial statements most frequently provided are:

(1) The income statement,

(2) The balance Sheet,

(3) The statement of owners’ or stockholders’ equity,

(4) The statement of cash flows and

(5) Note disclosures are an integral part of each financial statement.

Management Accounting 

Management accounting is a process that involves preparing, analyzing, and interpreting financial information to help managers make informed decisions within an organization. Unlike financial accounting, which is designed for external stakeholders like shareholders and regulators, management accounting is focused on internal users—particularly managers. Its primary purpose is to support decision-making related to the organization’s operations, cost control, budgeting, and strategic planning.

A key feature of management accounting is its focus on the future. Rather than simply reporting past financial results, it provides information that helps managers plan for the future and adjust their strategies as necessary. This future-oriented approach makes it an essential tool for setting goals, forecasting, and adapting to changing market conditions. Management accounting is also flexible, allowing organizations to tailor their systems and reports to meet their specific needs, unlike financial accounting, which must adhere to strict standards like GAAP or IFRS.

Common tools used in management accounting include budgeting, cost-volume-profit analysis, and activity-based costing. These techniques help managers evaluate performance, control costs, and make decisions regarding pricing, investment, and operations. For example, break-even analysis helps determine the level of sales needed to cover costs, while variance analysis highlights differences between actual performance and budgeted targets.

Comparison between Financial Accounting and Management Accounting

Financial Reporting

Financial reporting refers to the process of producing statements that disclose an organization’s financial status to management, investors, and the government. These reports provide information about the company’s performance, financial position, and cash flows over a specific period. Some financial information is better provided, or can be provided only, by means of financial reporting other than formal financial statements.

Examples include the president’s letter or supplementary schedules in the corporate annual report, prospectuses, reports filed with government agencies, news releases, management’s forecasts, and social or environmental impact statements.

Check your understandings _ Financial Accounting and Management Accounting MCQs

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Generally Accepted Accounting Principles (GAAP)

Generally accepted accounting principles are the guidelines, procedures, and practices that a company is required to use in recording and reporting the accounting information in its audited financial statements.

The evolution of GAAP in the United States took place over many years. Since the late 1930s, three organizations have been primarily responsible for the establishment of generally accepted accounting principles (GAAP) in the private sector of the United States:

American Institute of Certified Public Accountants (AICPA) Committee on Accounting Procedure (CAP) (1938–1959)

The CAP was the first group responsible for establishing accounting principles in the U.S. It issued Accounting Research Bulletins (ARBs) to address specific accounting issues.

 Accounting Principles Board (APB) (1959–1973):

The APB replaced the CAP and was responsible for issuing APB Opinions, which provided guidance on accounting principles. However, it faced criticism for its slow response to emerging issues and was eventually replaced.

Financial Accounting Standards Board (FASB) (1973–present)

FASB is the current body responsible for establishing GAAP. It issues Statements of Financial Accounting Standards (SFAS) and other guidance. FASB operates under the oversight of the Financial Accounting Foundation (FAF).

Types of Pronouncements

The FASB issues two major types of pronouncements:

1. Accounting Standards Updates

2. Financial Accounting Concepts

Operating Procedures

Before issuing a statement of Standards or, Concepts the FASB generally completes a multistage process as outlined in below in diagram.

• Initially, a topic or project is identified and placed on the FASB’s agenda. This topic may be the result of suggestions from the Financial Accounting Standards Advisory Council (FASAC), the accounting profession, industry, or other interested parties.
• On major issues, a Task Force may be appointed to advise and consult with the FASB’s Research and Technical Staff. This may involve, for instance, the scope of the project and the nature and extent of additional research.
• The Staff conducts any research specifically related to the project.
• Then the FASB usually publishes a Preliminary Views document or Invitation to Comment (which outlines the research related to the issues) and sets a public comment period.
• During this period, the FASB may hold public hearings. The intent is to receive information from and views of interested individuals and organizations on the issues.
• Many parties submit written comments (“position papers”) or make oral presentations. These parties include representatives of CPA firms and interested corporations, security analysts, members of professional accounting associations, and academics.
• After deliberating on the views expressed and the information collected, the FASB issues an Exposure Draft of the proposed Statement.
• Interested parties generally have 30 to 90 days to provide written comments of reaction. On major issues, the FASB may hold more public hearings. Sometimes, the FASB conducts “field tests” of the proposed standards with selected companies to evaluate implementation issues.
• A modified draft is prepared, if necessary, and brought to the FASB for a final vote. After a simple-majority vote is attained, the Statement is issued.
• The time involved to complete each of the steps varies depending on the complexity of the topic. For some complex topics, it takes several years; for other, less complex topics only a few months are needed.

Organizational Structure for Setting Accounting Standards

Check your understandings _ GAAP History MCQs

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Related Courses

Financial Accounting

Management Accounting

Intermediate Accounting

Advanced Accounting 

Corporate Finance

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