Question

What‘s wrong with this statement: Management is required by GAAP to reduce information risk，even if the costs overwheigh the benefits. Please explain the reason.

Answer 1

Please mentioned below the answer :

The Financial Accounting Standards Board's generally accepted accounting principles, or GAAP, set the accounting standards a United States company must follow. Internal controls are designed to prevent fraud and clerical errors that may compromise the accuracy of a company's financial statements. Solid internal controls can also reduce losses from theft of company assets and identify underperforming employees. These controls should be implemented by the company before any financial information is given to external auditors, lenders or investors.

Segregation of Duties

Separating duties among different employees reduces the opportunity for any one person to commit fraud. It also creates double-check procedures to cut down on clerical errors. The employee who handles record keeping should not have physical custody of the asset. For example, the person responsible for bank reconciliations should not also receive payments from customers or prepare the bank deposits.

Access

Physical controls ensure that only authorized employees may access company assets. Some common controls include lockboxes for petty cash, key cards for warehouses and unique passcodes for employees using cash registers. These controls may also be digital, such as requiring a password to access the company's computer system.

Authorization

Your company should also develop specific written procedures for financial transactions, including a list of the people with authority to approve each type of transaction. You can list standard transactions and acceptable amounts, then require manager approval to exceed these limits. Approvals should be reviewed to ensure managers are not permitting fraudulent transactions. Major transactions may require approval from more than one person. For example, you may permit all employees to execute purchase orders under $5,000 and require manager approval for any amount over this. The level of seniority required for approval should rise as the dollar amount increases.

Record Keeping

All financial statements should be backed up by general ledger reports or additional schedules. You can also reduce fraud and accidental errors by using standardized forms for financial transactions whenever possible, such as purchase orders or sales invoices. These forms should be sequentially numbered so you can identify missing forms in the sequence or new forms used to backdate a previously undocumented transaction.

Verification

A supervisor should periodically review all key general ledger accounts for accuracy. The supervisor must be an employee who was not involved in preparing the report. Some companies also employ internal auditors to verify the supervisor's approval. The reviewing employee must sign and date the document as proof of his approval. Supervisors should also look at relevant financial metrics to find areas that may be experiencing efficiency problems. This may be an indication of fraud or improperly recorded transactions.

Generally accepted accounting principles (GAAP) refer to a common set of accounting principles, standards, and procedures issued by the Financial Accounting Standards Board (FASB). Public companies in the United States must follow GAAP when their accountants compile their financial statements. GAAP is a combination of authoritative standards (set by policy boards) and the commonly accepted ways of recording and reporting accounting information. GAAP aims to improve the clarity, consistency, and comparability of the communication of financial information.

GAAP may be contrasted with pro forma accounting, which is a non-GAAP financial reporting method. Internationally, the equivalent to GAAP in the United States is referred to as International Financial Reporting Standards (IFRS). IFRS is followed in over 120 countries, including those in the European Union (EU).

Understanding GAAP

GAAP helps govern the world of accounting according to general rules and guidelines. It attempts to standardize and regulate the definitions, assumptions, and methods used in accounting across all industries. GAAP covers such topics as revenue recognition, balance sheet classification, and materiality.

The ultimate goal of GAAP is ensure a company's financial statements are complete, consistent, and comparable. This makes it easier for investors to analyze and extract useful information from the company's financial statements, including trend data over a period of time. It also facilitates the comparison of financial information across different companies.

These 10 general concepts can help you remember the main mission of GAAP:

1.) Principle of Regularity

The accountant has adhered to GAAP rules and regulations as a standard.

2.) Principle of Consistency

Accountants commit to applying the same standards throughout the reporting process, from one period to the next, to ensure financial comparability between periods. Accountants are expected to fully disclose and explain the reasons behind any changed or updated standards in the footnotes to the financial statements.

3.) Principle of Sincerity

The accountant strives to provide an accurate and impartial depiction of a company’s financial situation.

4.) Principle of Permanence of Methods

The procedures used in financial reporting should be consistent, allowing comparison of the company's financial information.

5.) Principle of Non-Compensation

Both negatives and positives should be reported with full transparency and without the expectation of debt compensation.

6.) Principle of Prudence

Emphasizing fact-based financial data representation that is not clouded by speculation.

7.) Principle of Continuity

While valuing assets, it should be assumed the business will continue to operate.

8.) Principle of Periodicity

Entries should be distributed across the appropriate periods of time. For example, revenue should be reported in its relevant accounting period.

9.) Principle of Materiality / Good Faith

Accountants must strive to fully disclose all financial data and accounting information in financial reports.

10.) Principle of Utmost Good Faith

Derived from the Latin phrase “uberrimae fidei” used within the insurance industry. It presupposes that parties remain honest in all transactions.

Compliance with GAAP

If a corporation's stock is publicly traded, its financial statements must adhere to rules established by the U.S. Securities and Exchange Commission (SEC). The SEC requires that publicly traded companies in the U.S. regularly file GAAP-compliant financial statements in order to remain publicly listed on the stock exchanges.² GAAP compliance is ensured through an appropriate auditor's opinion, resulting from an external audit by a certified public accounting (CPA) firm.

Although it is not required for non-publicly traded companies, GAAP is viewed favorably by lenders and creditors. Most financial institutions will require annual GAAP compliant financial statements as a part of their debt covenants when issuing business loans. As a result, most companies in the United States do follow GAAP.

If a financial statement is not prepared using GAAP, investors should be cautious. Without GAAP, comparing financial statements of different companies would be extremely difficult, even within the same industry, making an apples-to-apples comparison hard. Some companies may report both GAAP and non-GAAP measures when reporting their financial results. GAAP regulations require that non-GAAP measures be identified in financial statements and other public disclosures, such as press releases.

The hierarchy of GAAP is designed to improve financial reporting. It consists of a framework for selecting the principles that public accountants should use in preparing financial statements in line with U.S. GAAP. The hierarchy is broken down as follows:

• Statements by the Financial Accounting Standards Board (FASB) and Accounting Research Bulletins and Accounting Principles Board opinions by the American Institute of Certified Public Accountants (AICPA)
• FASB Technical Bulletins and AICPA Industry Audit and Accounting Guides and Statements of Position
• AICPA Accounting Standards Executive Committee Practice Bulletins, positions of the FASB Emerging Issues Task Force (EITF), and topics discussed in Appendix D of EITF Abstracts
• FASB implementation guides, AICPA Accounting Interpretations, AICPA Industry Audit and Accounting Guides, Statements of Position not cleared by the FASB, and accounting practices that are widely accepted and followed

Special Consideration

GAAP is only a set of standards. Although these principles work to improve the transparency in financial statements, they do not provide any guarantee that a company's financial statements are free from errors or omissions that are intended to mislead investors. There is plenty of room within GAAP for unscrupulous accountants to distort figures. So, even when a company uses GAAP, you still need to scrutinize its financial statements.