Welcome back and happy new year! Now that we have established what is accounting, some of the terminology, and the principles, we are ready to discuss the frameworks. These are a system of guidelines on how transactions should be recorded. The type of transaction and nature of the business influence how to record a transaction. Some of the guidelines are strict rules, while others are very open to interpretation.
There are numerous accounting frameworks. The first two are what the largest companies in the world use. These frameworks are the best in assessing profitability.
Name: Generally Accepted Accounting Principles (GAAP)
Created By: Financial Accounting Standards Board (FASB, delegated to them by the Securities Exchange Commission)
Used By: Publicly traded companies, not-for-profit organizations
Accounting Method: Accrual
Name: International Financial Reporting Standards (IFRS)
Created By: The IFRS Foundation and the International Accounting Standards Board (IASB, originally started by the European Union)
Used By: Publicly traded companies and not-for-profit organizations headquartered in the countries that adopted IFRS, including the European Union, Canada, Australia, and many more
Accounting Method: Accrual
Both the FASB and IASB are working together on a convergence project, to make international and American accounting more similar. The reason being that it makes financial statements more comparable across industries, regardless of where the company is based. With a global economy, these organizations work together to make one set of rules for the largest companies.
For US governments there is a special accounting framework called Government Accounting Standards (GAS) and is created by the Government Accounting Standards Board (GASB). Not-for-profit organizations are covered by special rules in both GAAP and IFRS.
For small business owners there are other accounting frameworks that better suit their needs. They are less rigorous than GAAP and IASB and focus more on the cash basis of accounting. They are called Special Purpose Frameworks. If a basis is logically and consistently applied, businesses can use other non-GAAP frameworks. Examples include:
Cash Basis: transactions are recorded when cash is spent or received
Tax Basis: maintaining books in compliance with the Internal Revenue Source code
Modified-Cash Basis: blend of the cash and accrual bases; short-term balance sheet items are recorded using the cash basis and long-term balance sheet items are recorded using the accrual method.
Small businesses are not required to choose one accounting method and always follow it. For example, business management purposes a small business owner may prepare their books according to the cash basis. At year end their accountant will make adjusting journal entries to create their financial reports according the tax basis accounting.