Chapter 3

A Brief Overview of GAAP and IFRS: the Framework for Financial Accounting

The primary objective of Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS) is to guide companies in producing economic information that helps external users make better decisions. To put it another way, the main purpose of corporate financial reporting from a broad economic perspective is to promote the efficient allocation of capital in the global capital markets. If accountants and auditors are doing their jobs properly, financial statements should facilitate the movement of capital to where it is likely to earn its highest risk-adjusted returns, thus maximizing wealth creation.

To achieve this goal, GAAP and IFRS are governed by a set of (1) core principles, (2) qualitative characteristics, (3) underlying assumptions, and (4) modifying conventions.

The core principles of GAAP and IFRS

Several principles exert a broad influence over the standards produced by the Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) and on the way in which financial statements are prepared. The most important of these principles deal with: asset valuation, revenue recognition, and the matching principle.

Asset valuation

For an asset to appear on a balance sheet, some basis must be chosen for assigning a value to it. The default option, and the dominant approach for certain classes of assets, is known as “acquisition ...

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