Small businesses establish accounting practices when handling bookkeeping in-house or working with an accountant. Applying accounting standards helps keep your books accurate, making it easier to understand your company’s performance, plan for the future, and build trust with lenders or investors.
To see how accounting standardization works, explore the types of accounting standards, including the differences between generally accepted accounting principles and International Financial Reporting Standards.
What are accounting standards?
Accounting standards are the principles and rules that define how companies record, measure, and report financial transactions. They’re also the basis for ensuring consistency and transparency in financial reporting.
For example, let’s say you own a bakery and accept pre-payment for a dozen donuts. Do you immediately record that entry in your accounting software or wait until the order is picked up?
Under GAAP (generally accepted accounting principles), which requires accrual, not cash accounting, you would list the phone card payment as “deferred revenue” and record it as “revenue” after they pick up the donuts. With cash-basis accounting, you enter the payment when money changes hands, regardless of when the goods or services change hands.
Accounting standards provide clear rules that determine how you set up your accounting system, how you automate workflows in software, and when you run reports. Likewise, financial reporting standards help investors and lenders compare companies and understand statements.
Types of accounting standards
GAAP and International Financial Reporting Standards (IFRS) are the two main types of accounting standards. In the United States, publicly traded companies must adhere to GAAP; IFRS is essentially the global equivalent. Here’s how these types of accounting standards apply to your company.
U.S. GAAP accounting principles
Most public and private U.S.-based organizations refer to GAAP accounting principles when standardizing financial reporting for external stakeholders. The Financial Accounting Foundation oversees the Financial Accounting Standards Board (FASB), an independent nonprofit organization that manages the U.S. GAAP principles.
Although private companies aren’t required to use FASB standards, many follow them to enhance transparency or secure funding. The U.S. Securities and Exchange Commission (SEC) requires publicly traded businesses to file reports that meet GAAP standards.
Within these U.S. accounting principles, GAAP provides industry-specific standards to bring uniformity to unique challenges. For instance, it gives guidelines for patient revenue recognition in healthcare and rules for nonprofit financial reporting.
In the United States, publicly traded companies must adhere to GAAP; IFRS is essentially the global equivalent.
International Financial Reporting Standards (IFRS)
Over 160 jurisdictions worldwide rely on the International Financial Reporting Standards (IFRS). Like the U.S. accounting principles, IFRS guidelines aim to improve company and investor financial reporting communication.
The IFRS Foundation, an independent, not-for-profit organization, oversees the International Accounting Standards Board (IASB), which sets IFRS principles. This board replaced the International Accounting Standards Committee (IASC) in 2000.
However, some older International Accounting Standards (IAS) are still in use. For example, a company that leases retail or warehouse space internationally would use newer IFRS rules for lease accounting. But when valuing inventory, IFRS follows IAS 2 guidelines.
International Financial Reporting Standards for SMEs
These accounting standards are a simpler version of the IFRS for small and medium-sized entities that don’t publicly trade shares or debt. They cover financial statements, leases, and revenue recognition but aim to make it easier and less expensive for small businesses to prepare financial reports.
A company might use these standards in accounting when expanding to export overseas. Foreign stakeholders like distributors may ask for financial statements that meet IFRS standards.
Tax accounting standards
Internal Revenue Service rules for tax reporting can differ from GAAP, cash basis accounting, and IFRS. Understanding tax accounting standards is essential for taking advantage of small business deductions and submitting accurate forms.
Consider the Section 179 deduction. You may be able to deduct the equipment cost from your taxes immediately, but under GAAP, you depreciate them over time. Some companies keep two sets of books for financial reporting and tax purposes.
IFRS vs. GAAP differences in accounting
There are several differences between IFRS and GAAP accounting methods. For example, IFRS provides more flexibility for classifying cash flows, whereas GAAP is stricter. This can make cash flow statements look different when comparing prepared reports.
GAAP doesn’t let businesses revalue fixed assets, whereas IFRS allows revaluation if the fair value increases or decreases. Lastly, IFRS doesn’t allow the LIFO inventory valuation method, whereas GAAP supports first in, first out (FIFO); last in, first out (LIFO); and weighted average.
CO— aims to bring you inspiration from leading respected experts. However, before making any business decision, you should consult a professional who can advise you based on your individual situation.
CO—is committed to helping you start, run and grow your small business. Learn more about the benefits of small business membership in the U.S. Chamber of Commerce, here.
