The Challenges of Complying with Accounting Standards

Financial Accounting Standard (FASB) is responsible for creating standards that must be followed by all US companies. The accounting body creates generally accepted accounting principles that guide bookkeepers and accountants when recording transactions.

A private company, FASB, is responsible for setting rules for creating financial statements. All companies registered with the Securities and Exchange Commission must prepare financial statements in compliance with the rules and standards set by the body.

Criticism of Current Accounting Standards

Experts say that existing accounting standards are not relevant to the demands of modern companies. Capital Group that owns assets worth $2.7 trillion has criticized the FASB by stating that it is not effective in meeting the investors’ demand for complete, timely, and relevant accounting information.

Investors demand overhaul of ‘outdated’ US accounting rules | Financial Times (ft.com)

Accountants have criticized standards set by the FASB for failing to keep up with the changed corporate landscapes. According to the CFA Institute, the legacy accounting standards are largely outdated as they were prepared with the demands of manufacturing firms.

Corporate landscapes have changed dramatically over the past few decades with the emergence of a large number of IT and non-IT companies. The SEC’s advisory committee had noted that the FASB standards do not cater the changing needs of public companies.

Let’s discuss the key issues with the current accounting standard that create difficulty for accountants and bookkeepers in maintaining accurate and timely records.

Issue 1: Recognition of Revenues

One of the main criticisms of the current accounting standards is the recognition of revenues. Let’s suppose that your company sells services to a company worth millions of dollars. The contract for service or product typically includes upgrade costs that cannot be estimated at the start of the contract. This means that it is not possible to determine how much revenues the company will generate from the sale in an objective manner.

The GAAP rules state that a company cannot record revenues that cannot be objectively estimated. A company is not allowed to record revenues due to upgrading services until the amount can be ascertained.

The restrictions in revenue recognition forces companies to quote the upgrade price separately from the price of core services. This prevents a company from creating an attractive bundle that will attract customers. The outdated accounting rules prevent companies from optimizing profitability by offering attractive price packages to customers.

The revenue reporting issue creates problems particularly for companies that provide software as a service (SaaS). The reporting requirements cause companies to use creative accounting techniques to provide information that may not represent an accurate picture of the financial position of a company.

Issue 2: Determining Fair Value of Assets

Another shortcoming of the accounting standards that create challenges for accountants is ascertaining the value of assets. The accountants can determine the fair value of the assets in two ways: 

One way is to record the value of assets based on how much they can be sold in the market today. The second method is to record the original price of the product.

Complying with the principle of fair value is difficult. It is challenging to determine the accurate fair value of the product. Assigning fair market value to intangible assets such as patents, good will, and R&D costs is particularly challenging.

The disclosure requirements of reporting the method for intangible assets like earn-out agreement is even more challenging. This disclosure requirement does not take into account the issues in selecting a method that helps in objectively generating estimates for a company.

Full disclosure about the methods used for determining fair value of a product can be a time intensive process. It can result in financial reports that are 100 or more pages that will add to the complexity in understanding the financial position of firms.

Issue 3: Reporting Unofficial Earnings

Companies have been reporting earnings not recognized by the FASB and IFRS in their financial statements for a long time. One of the most common unofficial earnings is the EBITDA that provides critical information to investors. The earnings figure shows the amount of cash that is available for making debt payments.

Biggest Accounting Challenges and Solutions in 2022 | NetSuite

The unofficial earnings figures are rife in reports prepared by tech companies. Companies use such unofficial figures to convince investors that their company is in a good financial position. But these measures are not recognized by the standard setting bodies that create difficulties in comparing financial performance of different firms.

One of the requirements of Sarbanes-Oxley Act is that companies must reconcile GAAP and non-GAAP accounting measures. This requirement is also imposed by the IFS. Moreover, the SEC also requires that the management must justify the inclusion of alternative measures for reporting financial information. This creates a problem for accountants as it results in extra steps when preparing financial reports.

Conclusion

The accounting setting boards in the US have announced intent to address issues related to existing standards. A change in accounting standards is important to ensure that they are in alignment with the needs of investors in the present.

Accountants must also make efforts to present an accurate financial picture of a company at a particular period. It is important to develop and report indicators that will be useful for both the company regulatory body and the investors.

Outsourcing small business accounting is a step in the right direction when it comes to standardizing bookkeeping tasks. A reputable outsourced accounting firm will record expenses in a way that meets the demands of different stakeholders.

Maxim Liberty is a reliable virtual bookkeeping service provider. Our team of highly experienced CPAs can record business expenses based on FASB’s generally accepted accounting principles and standards. We can accurately record all types of business expenses and revenues that will help in making informed business decisions. You can contact us by dialing (703) 957-6938.