American Accounting System: Simplified for Newcomers

American Accounting System: Simplified for Newcomers

“Debit what comes in, credit what goes out.”

“Debit the receiver, credit the giver.”

“Debit expenses and losses, credit incomes and gains.”

Do any or all of these golden rules of accounting ring a bell from high school, or from when your accountant led you through tax season? Have they flown right out the window since?

Tracking finances and accounting are not everyone’s cup of tea. In a new country, it can feel almost impossible. But, as a law-abiding resident who has got to suck it up and do it, you deserve every stepping stone you can get.

Let’s jog your memory with the basics.    

The ABCs of Accounting

AssetAny resource that does or can yield monetary benefits for the owner.
BookkeepingThe practice of documenting all financial dealings of an entity. 
Balance SheetAka “statement of financial position,” summarizing the economic value of a business.   
Chart of AccountsA preliminary list of all the accounts in an organization’s general ledger.
Certified Public AccountantLicensed professionals qualified by the CPA exam to handle public accounting in America.
CreditMoney that exits an account. 
DebitMoney that enters an account.
Double-entry BookkeepingA bookkeeping method that balances every entry in an account with a complementary entry in a different account. 
Enrolled AgentAdvisors certified by the U.S. Department of the Treasury to represent taxpayers.
Fixed CostRecurring expenses (weekly, monthly, yearly, etc.). 
General LedgerA tangible or computerized bookkeeping record. 
Income StatementA time-bound list of an entity’s revenues and expenses, indicating its financial health.
JournalA chronological record of transactions preceding the general ledger, classified into primary and subsidiary forms based on the transaction type. 
Journal EntryEach input in a journal that describes pertinent information like date, account number, and nature of the transaction.
LiabilityMoney an individual or business owes.
Profit and Loss StatementAnother name for income statement. 
Return on InvestmentA measure of the profitability of an investment.
Trial BalanceThe consolidation of the balances of general ledgers, tallying debit and credit columns.

With the jargon down, it’s time to don your thinking cap to understand how American accounting works.

The U.S. Accounting System

Generally Accepted Accounting Principles (GAAP) guide accounting in the U.S. It ensures excellence, transparency, timeliness, and uniformity across the board in financial reporting.

American businesses which are traded on stock exchanges and/or whose financials are publicly available, adhere to GAAP. Adopting it is optional for private companies. A third of medium and large organizations do so. The rest opt for tax-basis reporting, or alternative bases of accounting.

Within the U.S., GAAP is overseen by the:

  • American Institute of Certified Public Accountants (AICPA) – As the leading organization enlisting CPAs in the U.S., the AICPA regulates accounting certification and auditing procedures.
  • Financial Accounting Standards Board (FASB) – Created by the AICPA in 1973, the FASB establishes American accounting standards using the Accounting Standards Codification.
  • Governmental Accounting Standards Board (GASB) – GASB functions similar to FASB in the context of state and local governments.
  • U.S. Securities and Exchange Commission (SEC) – The SEC enforces accounting guidelines and often collaborates with the FASB to formulate them. 

GAAP isn’t law, though its implications are no less severe. The SEC has fined corporations between $25,000 and $180 million for violations. Shirking GAAP has caused many to lose face in front of competitors and investors.

GAAP accounting is guided by ten principles, namely:

  1. Conservatism principle – Accountants should be cautious to note potential losses in case of uncertainties, and disregard potential gains until they are verified.  
  2. Cost principle – The costs of assets, liabilities, and equities should be recorded as per the time of purchase, not present value.
  3. Economic entity principle – The financial undertakings of a business owner are unrelated to the business and must be tracked as such.
  4. Full disclosure principle – A company’s financial statements should comprehensively cover information important to stakeholders and concerned parties. 
  5. Going concern principle – The notion that a business will continue to function without the threat of liquidation within the financial year. 
  6. Matching principle – If a business expense has a cause-and-effect relationship with a revenue (e.g. commissions and sales), they should be reported in the same period.
  7. Materiality principle – Amount discrepancy in financial statements is acceptable when its impact is nil or negligible.
  8. Monetary unit principle – Records can only include transactions made in currency, i.e. the U.S. dollar. 
  9. Revenue recognition principle – Incomes should be taken into consideration when they are secured, not when the money is received.
  10. Time period principle – Financial activities of a business must be disclosed periodically in weekly, monthly, quarterly, or annual intervals.

While GAAP defines the preparation of statements, Generally Accepted Accounting Standards (GAAS) pertain to their evaluation. Auditors review both public and non-public financial statements based on GAAS. Standards for public entities are drafted by the Public Company Accounting Oversight Board.

Differences between American and International Accounting

The global counterpart of GAAP is the International Financial Reporting Standards (IFRS).

Regulated by the IFRS Foundation and the International Accounting Standards Board (IASB), IRFS declares its mission as promulgating “transparency, accountability and efficiency to financial markets around the world.” Its guidelines are followed by 166 countries.

GAAP is often pitted against IFRS, despite the efforts of IASB and FASB to bridge the gap. The biggest spark that fuels the fire is that GAAP is spearheaded by rules, whereas the tenets of IFRS allow leeway in interpretation.

Without delving into extensive detail, here’s an overview of GAAP vs IFRS yardsticks:

Last-in, first-out (LIFO) accountingAllowedNot allowed
Documents requiredP&L statement
Balance sheet
Statement of comprehensive income
Cash flow statement
Changes in equity
P&L statement
Balance sheet
Cash flow statement
Changes in equity
Asset revaluationNot allowedAllowed
Balance sheet treatment1. Distinct current and noncurrent assets and liabilities is optional
2. Deferred taxes can be included with assets and liabilities
3. Liabilities contain minority interests
1. Distinct current and noncurrent assets and liabilities is mandatory
2. Deferred taxes must be individual line items
3. Equity contains minority interests
Irregular items Allowed conditionallyNot allowed

Did some of that go over your head?

We don’t blame you; you’re not here for the love of accounting. But, you’re no longer a taxpayer or an investor without an inkling of how the numbers come and go. 

Bonus: you’ve earned bragging rights for knowing the fundamentals of not one, but both of the world’s leading accounting systems.

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