Research Paper on Financial Accounting Theory

Historical Development of Financial Accounting Theory

We might have been dealing with a broad and somewhat complex accounting structure in today's world, but the accounting is present on the earth since the inception of trade and business. Accounting backs the managerial decision-making process and business management in an efficacious and effective manner. In 1494, Luco Pacioli wrote a book on math and included a chapter on the mathematics of business. The book is claimed to be the first literary work on accounting.

Is your time best spent reading someone else’s essay? Get a 100% original essay FROM A CERTIFIED WRITER!

Save 25%

According to Pacioli, a successful merchant needs three things: sufficient credit or cash, a reliable and good accounting system that keeps him apprised of his financial status, and a good bookkeeper to operate all the process which is equally relevant in today's world as well. Accounting theory used by Pacioli involved both journals and ledgers, which introduced the world to the double-entry concept of accounting. In a double-entry accounting system, the debt is listed on the left side of the sheet or ledger while the credits are mentioned on the right side.

This form of accounting was in existence for a long time until the world was hit by the depression of 1772 that shaped the accounting profession out and out. In addition to keeping records of financial activities, it became a common practice to know if the available resources, of every sort, were able to run the company aptly and adequately and produce satisfactory results. This new practice or theory was called cost accounting.

In such a practice, an accountant or a bookkeeper was able to find and determine the efficiency data and performance of the company based upon the numbers. This idea became the basis for the survival of the finance industry, which otherwise would have collapsed.

It was in 1789 at the end of the American Revolution that the first US governmental accounting system was set up. The purpose was to manage the treasury of the US efficiently. In addition to adopting the double entry accounting practice, there was the introduction of other regulations. Under the new rules adopted, it was decided that the assets were not to be included in the accounting. This system still prevails in the US as far as accounting is concerned. Seeking the need for professional accountants, the British Courts ruled in 1850 that there was a requirement for such professionals in the courts to deal with the cases that involved financial matters. Hence, it led to the introduction of the profession of Chartered Accountant. The same goes by the name Certified Public Accountant (CPA) in the US.

In 1923, General Motors came up with modern cost accounting. It helped the company cut the unnecessary costs and streamline its operations. The company followed this practice for almost the next half-century. Many other methods that were introduced to make the accounting more effective and efficacious. For instance, methods such as return on investment and return on equity together with different budget-oriented strategies.

Generally Accepted Accounting Principles (GAAP) were introduced in the US to make available a standard accounting practice in the US which was to be followed by all the companies operating in the country.

International Financial Reporting Standards (IFRS) also provides accounting practices, but unlike GAAP, it is not limited to any particular country. Almost all the companies present in the world follow IFRS. Considering the worldwide acceptance and ease of operation of IFRS, Efforts are being undertaken to converge US GAAP and IFRS.

Current GAAP

Generally, accepted accounting principles, or GAAP is a set of accounting rules that are followed in the United States of America. All the companies that are based in the US follow this system only to prepare their financial statements. It runs under the authority of the Financial Accounting Standards Board of the United States, which makes it mandatory throughout the country. GAAP is not spread globally as its accounting principles are applicable only to the US companies. It is a compilation of rules and regulations that are necessary to go through when a company performs the legal actions in corporate accounting or business.

GAAP is a rulebook in which companies have to follow whenever they accumulate the financial statements of an entity. All the GAAP guidelines are the base of any company in the US. It has several principles, and critical principles out of GAAP are as follows.

• Proper obey of rules and regulations by accountants.
• The standards must be followed at every step.
• Accuracy and unbiased behavior must be there.
• Use of permanent processes to get financial statements is a necessity.
• No debt compensation depends upon the company's performance.
• Only a clear fact can affect financial reporting.
• Valuation of assets confirms firm connection of the organization.
• Specific time slots must be there for revenue reports.
• Financial statements or reports depict the financial conditions of the company.
• Trust, loyalty, and honesty are the best policies.

Now comes the question about the current changes that have occurred in GAAP recently. In 2018, Financial Reporting Taxonomy has various new updates so get some improvements for US companies. The changes occurred in GAAP U.S. include a change in the number of elements in different terms. Those changes comprise of label changes, reference changes, data type changes, etc. However, all that matters is the improvement, which is more than expected when we see the graphs.

Comparison of U. S. GAAP and IFRS

The governing of financial reports and accounts does not follow a universal rule, whereas it varies everywhere across the globe. From country to country, there will be the difference in the principles that are adopted for the compilation of financial statements of a company. Now comes an accounting principle that contours all the scenarios that provide recognition to the revenue of a company. On the basis thereof, all the recognition principles either apply to the standards of the whole world or a specific company.

International Financial Reporting Standards (IFRS) provide a broader picture of the rules and standards that administer the financial reports formulation. IFRS is recognized worldwide and is followed by several countries and their companies.

However, when it comes to implementing IFRS in the US, the situation tends to turn upside down because the US already has its GAAP. Beholding this, the differences between U.S. GAAP and IFRS are as follows.

Area of Network

As the name suggests, U.S. GAAP is spread across the United States, whereas IFRS defines itself as the International Financial Reporting Standards, which have a vast network in approximately 100 countries. Thus, the people who want to get the financial statements from U.S face too many challenges. The reason behind it defines it as a battling task to work with certain rules and regulations, especially when these are different from the principles of IFRS, which is a globally recognized standard.

Theories to define revenue

The concepts of FASB explain revenue in a particular way by depicting it as inflows or resolution of the debts from endowing the consumers with goods production or other activities that comprise the flow of central operations. However, when the question is about IFRS, then the definition is a bit different which defines income with both the gains and revenues. According to IFRS, revenue gets to establish in the working of the ordinary tasks of an entity.

Liabilities classification

Under the terminologies presented by GAAP, liabilities can be differentiated into two types; one is current and other are noncurrent. These liabilities are based on the settlement of debt within one complete year or not. Nevertheless, the scenario is not identical in the case of IFRS, in which there is not any classification as there are only noncurrent liabilities that exist.

Arranging software

While considering principles of GAAP, there is proper guidance regarding revenue recognition in software arrangement. However, if we talk about IFRS, then there is no such guidance provided.

Customer loyalty programs

There is no revenue recognition for the programs conducted for customer loyalty, whereas such programs are performed in unique ways, such as multi-elemental or incremental cost models. However, in the case of IFRS, customer loyalty programs took place after redemption of pre-element revenue transactions.

Construction type contracts

Under the GAAP of U.S it is quite evident that it consists of essential guidance of the revenue recognition in case of construction type constructs. It defines that a customer can approve the price of change orders only before revenue recognition. However, IFRS ensures that the probability of approval can also lead to revenue recognition when construction type contracts are considered.

Concluding this, it is effortless to predict that there may be very much differences in goals of revenue recognition of the concept of GAAP and IFRS, but the main objectives of both the standards are identical to each other.

Problem Areas and Challenges in US GAAP and IFRS

US GAAP is followed in the US only, whereas IFRS is recognized worldwide; hence, the implementation of IFRS is not a cakewalk, or in other words, it is not possible at all. There are many complications and problems when it comes to considering the application of IFRS in the US. Efforts have been made here to address these problems.

It was believed that US GAAP was the most authentic and severe candidate whenever global financial reporting standards were the concern. However, the blush is off the rose now as the shortcomings reflected by the corporate scandals in the 21st century question the reliability of US GAAP. Obradovic and Karapavlovic (2014) are of the view that the blame is to be put on the rigid and comprehensive rules. Some investors feel that a principle-based system such as GAAP demands the disclosure of too much information from them, on the other hand, the working of IFRS is not that robust, especially when it comes to revenue recognition.

Ever since FASB has maintained that there was a need for a more robust and reliable structure to have uniform financial statement-making platform, talks have been going on to converge US GAAP and IFRS. However, the journey is not that easy as IFRS also replete with shortcomings. Many aspects are present in IFRS but are absent in US GAAP.

The decision of SEC to switch to IFRS from US GAAP is likely to cause a certain degree of mayhem among the investors and companies. It has also been debated that multinational companies will not have much problem when it comes to moving to IFRS; the challenge will be faced by the small and mid-sized enterprises, non-profit organizations, agricultural units, and governmental organizations.

The agricultural products are currently not considered for the sake of financial reporting under US GAAP, but if the transition takes place, and the US finalizes the adoption of IFRS, then the agricultural products will also fall under the purview of the financial report. Although IFRS will be providing the world with a common set of standards, the US where many small-scale and non-profit companies exist, the introduction of IFRS can cause somewhat disruption concerning the economic condition of the country.

Changes That Can Be Introduced

To have a uniform accounting structure all across the world, so all the companies follow that same standards...