Hierarchy of GAAP: Definition, Components, and Application
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Summary:
The hierarchy of generally accepted accounting principles (GAAP) provides a structured framework for selecting the most authoritative accounting standards for financial reporting. This article explores the meaning, organization, and requirements of the GAAP hierarchy, including its four levels and the role of key regulatory bodies such as the Financial Accounting Standards Board (FASB), the U.S. Securities and Exchange Commission (SEC), and the American Institute of Certified Public Accountants (AICPA).
Understanding the hierarchy of GAAP
The hierarchy of generally accepted accounting principles (GAAP) serves as a structured framework for selecting the most authoritative accounting standards for financial reporting. It consists of four tiers, each representing varying levels of authority and applicability to financial statements of nongovernmental entities.
Financial accounting standards board (FASB)
The FASB, established in 1973, is an independent nonprofit organization responsible for setting accounting and financial reporting standards for public and private companies as well as nonprofit organizations in the United States. Its standards aim to enhance comparability and consistency in financial reporting, facilitating informed decision-making by investors and other stakeholders.
The FASB operates through a due process system that involves public exposure of proposed standards, thorough deliberations, and consideration of input from stakeholders. This process ensures that accounting standards are developed in a transparent and inclusive manner, with the ultimate goal of improving financial reporting quality and relevance.
Securities and exchange commission (SEC)
The SEC, founded in 1934, is a federal government agency tasked with protecting investors, maintaining fair and orderly securities markets, and facilitating capital formation. It mandates reporting standards and regulations for public companies, ensuring transparency and accountability in financial disclosures.
The SEC’s oversight role in financial reporting includes reviewing and approving financial statements filed by public companies, enforcing compliance with reporting requirements, and investigating potential violations of securities laws. Through its regulatory efforts, the SEC aims to promote investor confidence and market integrity.
American institute of certified public accountants (AICPA)
The AICPA, established in 1887, is a professional organization representing certified public accountants (CPAs) in the United States. It develops standards for external audits of private companies, promoting integrity and ethical behavior in the accounting profession.
In addition to setting auditing standards, the AICPA offers professional development resources, conducts research on emerging accounting issues, and advocates for the interests of CPAs and the accounting profession as a whole. Through its diverse range of activities, the AICPA contributes to the advancement of accounting practice and professionalism.
Requirements for the hierarchy of GAAP
The hierarchy of GAAP comprises four levels, with the top level being the most authoritative. Accountants researching a specific topic should consult the highest level for relevant guidance. If no information is available at the higher levels, they should refer to the next level down for applicable pronouncements.
- Top level: Statements and interpretations by the FASB, rules and interpretive releases by the SEC (for all SEC registrants), and accounting research bulletins and opinions issued by the AICPA.
- Second level: FASB Technical Bulletins and, if cleared by the FASB, the AICPA Industry Audit and Accounting Guides and Statements of Position.
- Third level: AICPA Accounting Standards Executive Committee Practice Bulletins, consensus positions of the FASB Emerging Issues Task Force (EITF), and topics discussed in Appendix D of EITF Abstracts.
- Lowest level: FASB implementation guides, AICPA Accounting Interpretations, and AICPA Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB. Also included are widely recognized accounting practices, either general or industry-specific.
The bottom line
In conclusion, understanding the hierarchy of GAAP is essential for accountants and financial professionals to navigate the complex landscape of accounting standards and ensure accurate and reliable financial reporting. By following the hierarchy’s structured framework, organizations can adhere to the most authoritative guidance and enhance the transparency and comparability of their financial statements.
Frequently asked questions
What is the purpose of the hierarchy of GAAP?
The purpose of the hierarchy of GAAP is to provide a structured framework for selecting the most authoritative accounting standards for financial reporting.
How many levels are there in the GAAP hierarchy?
The GAAP hierarchy comprises four levels, each representing varying levels of authority.
Who is responsible for setting accounting standards for public companies in the United States?
The Financial Accounting Standards Board (FASB) is responsible for setting accounting standards for public companies in the United States.
What is the role of the Securities and Exchange Commission (SEC) in financial reporting?
The SEC mandates reporting standards and regulations for public companies, ensuring transparency and accountability in financial disclosures.
Why is it important for accountants to understand the hierarchy of GAAP?
Understanding the hierarchy of GAAP is important for accountants to navigate the complex landscape of accounting standards and ensure accurate financial reporting.
Key takeaways
- The hierarchy of GAAP serves as a structured framework for selecting authoritative accounting standards.
- There are four levels in the GAAP hierarchy, each representing varying levels of authority.
- The Financial Accounting Standards Board (FASB) is responsible for setting accounting standards for public companies in the United States.
- The Securities and Exchange Commission (SEC) mandates reporting standards and regulations for public companies, ensuring transparency in financial disclosures.
- Understanding the hierarchy of GAAP is essential for accurate financial reporting and decision-making.
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