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US GAAP and Foreign Companies Essay Sample

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US GAAP and Foreign Companies Essay Sample

Introduction

In order to develop homogeneous accounting rules, customs and basic framework of accounting norms, General Accepted Accounting Principles (GAAP) have emerged as standardized parameters for preparation of financial statements. The accounting and financial services have occupied a pre- dominant position in the present day context  specially when the corporates of one country get their shares listed in another country for raising capital or as an investment avenues. In this context US GAAP assume great importance, as multinationals connected with US economy need to follow US GAAP for preparation of financial statements. Therefore, US GAAP is the new mantra for accounting and corporate finance professionals world over.

Sources of US GAAP  

There is no legal system prevalent in US to formulate or set accounting standards. It is believed that business and professional community in private sector have knowledge and resources to set standards for their own purposes. In other words, US GAAP is not written in law, though certain reporting requirements have been set up by Security and Exchange Commission (SEC) for public trading companies to follow and comply with. The ‘Financial Accounting Standards Board’ (FASB) has emerged to be an institution that set standards after consulting professional and business community and providing them adequate time to debate the pros and cons of the matters underlying the standards. GASB (Governmental Accounting Standard Board) is another body that care for standards to be followed by local and state governments. Without having a legal framework accounting standards are framed by the bodies those have emerged mostly out of compulsion of standardization and harmonization of financial accounting systems in the United States.

However, there are some organizations that influence the development of GAAP in the United States. These organizations are:

  1. United States Securities and Exchange Commission (SEC):

The SEC encourages the establishment of private standard- setting bodies through AICPA and FASB. SEC also works closely with private organizations setting GAAP, but does not set GAAP itself.

  1. American Institute of Certified Public Accountants (AICPA)

AICPA appointed Committee on Accounting Procedures (CAP) in 1939 that issued 51 Accounting Research Bulletins. Then it created the Accounting Principles Board (APB), whose mission was to develop overall conceptual framework. APB issued 31 opinions and was dissolved. After the creation of FASB, AICPA established the Accounting Standards Executive Committee. It publishes Audit and Accounting Guidelines, Statements of positions and practice bulletins.

  1. Financial Accounting Standard Board (FASB):

AICPA council designated FASB as the body that establishes accounting principle for  federal entities. FASB has four major types of publications, namely i) Statements of Financial Accounting Standards, ii) Statements of Financial Accounting concept, iii) Interpretations, and iv) Technical Bulletins.

Objectives of US GAAP

The companies are required to follow GAAP so that at least a minimum level of consistency in the financial statements is maintained. Investors analyze companies’ financial statements for investment purposes. GAAP cover such things as revenue recognition, balance sheet item classification, and necessary disclosures about changes in accounting principles.  That means all companies, whether domestic and foreign are expected to follow GAAP rules when reporting their financial data via financial statements.

The objectivity of US GAAP is to meet fundamental purposes of financial reporting and needed disclosure. The purpose of GAAP is that financial reporting should provide information that is:

  1. Useful to present or potential investors and creditors and other users in making rational investment, credit and other financial decisions.
  2. Helpful to present or potential investors and creditors and other users in assessing the amounts, timing and uncertainty of cash receipts.
  3. About economic resource, the claim to those resources and change in them.

The objectives of US GAAP are best understood by evaluating the purposes served by the financial statements;

  • The balance sheet provides direct information about the entity’s financial position.
  • The statement of income provides direct information about entity’s performance.
  • The statement of cash flows provides direct information about the entity’s cash flows.
  • Financial statements taken as a whole provide indirect information about the performance of management.

US GAAP is based on following assumptions, principles and constrains.

Assumptions

  1. Economic Entity Assumption, that is to say, business is separate from its owners or other businesses. This applies even for partnership and the sole proprietorship, but as a body corporate, they are considered separate legal entities.
  2. Going Concern assumption: It means that the business will be in operation for long time. Only when liquidation is certain this assumption is not applicable.
  3. Monetary Unit assumption: That means a stable currency is going to be the unit record. The FASB accepts the nominal value of the US Dollars as the monetary unit
  4. Public Reporting assumption: That means the business operations can be recorded

and reported into different accounting periods.

Principles

  1. The Historical Cost principle

This principle requires companies to account and report on acquisition cost rather than fair market value cost of most assets and liabilities.

  1. The Revenue Recognition Principle:

This principle requires companies to record revenue when revenue is realized or realizable and earned and not when cash is received.

  1. The Matching Principle:

Under this expenses have to be matched with revenue as long as it is reasonable to do so. Expenses are recognized not when the work is performed, or when a product is produced, but when the work or product actually makes contribution to revenue.

  1. The Full Disclosure Principle

Information is presented in the main body of financial statement, in the notes or as supplementary information.

Constraints

  • Cost Benefit Relationship:

The benefit of providing the financial information should also weighed against the cost of providing it. This recognizes that there is a cost associated with providing useful information and that the cost should not exceed the benefit of having the information.

  • Materiality

The significance of an item should be considered when it is reported. An item is considered significant when it would affect the decision of a reasonable individual.

  1. Industry practices:

Accounting procedures should follow industry practices.

  1. Conservatism

When choosing between two solutions, the one that will be least likely to overstate assets and income should be picked.

Foreign companies need to comply strictly with US GAAP

Any foreign company that offers securities in the US must comply with accounting rules and regulations prevalent in US. That is to say such company have to follow US GAAP with respect to formulation of and disclosures in the financial statements. Securities and Exchange Commission (SEC) keeps an eye on such observances of accounting principles. Failures to do so can mean significant time delays and possible civil and criminal penalties for company officers.

Though US GAAP is not a written legislation, but strict compliance to it by foreign company doing business or registered with stock exchanges in the US is the main requirement.

Jerry Arnold and others1 in the article ‘What Foreign Filers Need to Know’ state “The ‘cultural shocks’ to a foreign company seeking to comply with US regulatory structure can be enormous. The SEC has virtually absolute authority to question the propriety of application of US GAAP in a filing, and can and does force companies to restate financial statements and will initiate enforcement proceedings when it believes such are warranted. In egregious situations, cases are referred by the SEC to US Department of Justice for possible criminal prosecutions. Foreign companies must assure that they, their auditors and legal counsel have sufficient expertise to minimize compliance problems with US laws and regulations.”

SEC has granted certain concession to foreign companies with regard to filings. For example foreign companies are not required to file interim financial reports with SEC unless they make such information available in their home countries.  Also interim reports do not have to be reconciled to US GAAP.

Accordingly understanding of US GAAP by foreign companies will help such companies in meeting with necessary compliances.

References

1 Jerry Arnold and others, 2001 ‘What Foreign Filers Need to Know’ , http://www.thefreelibrary.com/WHAT+Foreign+Filers+Need+to+KNOW-a074887661

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