The Hierarchy of Generally Accepted Accounting Principles (GAAP) refers to a framework for selecting the principles, standards, and guidelines to be used in the preparation of financial statements. This hierarchical structure is established to ensure consistency and reliability in financial reporting. It is crucial for governing bodies such as the Financial Accounting Standards Board (FASB) and the American Institute of Certified Public Accountants (AICPA) to rank their pronouncements by levels of authority.
Structure of the Hierarchy
The hierarchy is organized into four levels, each with a different degree of authority:
Level 1: Officially Established Standards
The most authoritative sources in the hierarchy:
- FASB Standards, Interpretations, and Staff Positions
- APB Opinions (Accounting Principles Board)
- AICPA Accounting Research Bulletins
Level 2: Authoritative Guidance
This includes:
- FASB Technical Bulletins
- AICPA Industry Audit and Accounting Guides
- Statements of Position (SOPs)
Level 3: Non-Authoritative Guidance
This level encompasses:
- FASB Emerging Issues Task Force (EITF) Abstracts
- AICPA Practice Bulletins
Level 4: Other Accounting Literature
The least authoritative level:
- FASB Concepts Statements
- AICPA Issues Papers
- International Financial Reporting Standards (IFRS)
- Accounting textbooks and articles
Requirements for Compliance
Organizations must adhere to the hierarchy when preparing financial statements. This requirement ensures that high-level standards are prioritized, maintaining consistency and reliability. Key compliance steps include:
- Identify the Relevant Level: Determine which level the accounting issue falls under.
- Apply the Appropriate Guidance: Use the respective standards to address the accounting issue.
- Documentation: Keep detailed records showing how the hierarchy was followed.
Examples
- Example 1: For a new revenue recognition issue, a company would first look to FASB Standards (Level 1).
- Example 2: If no clear guidance exists at Level 1, the company may look to FASB Technical Bulletins (Level 2) for additional directives.
Historical Context
The hierarchy was formalized to address inconsistencies and improve the clarity and comparability of financial statements. It was codified by the FASB in accounting literature, reflecting the evolution of financial reporting practices over decades.
Applicability
The Hierarchy of GAAP is applicable to all entities that prepare financial statements in accordance with U.S. GAAP. These entities include public companies, private companies, and non-profit organizations.
Related Terms
- FASB: Financial Accounting Standards Board, the primary body for establishing U.S. GAAP.
- AICPA: American Institute of Certified Public Accountants, a professional organization for CPAs in the U.S.
- IFRS: International Financial Reporting Standards, the global standard for accounting outside the U.S.
- FAQs: Q: What is the purpose of the GAAP hierarchy? A: To provide a structured method for selecting the most authoritative accounting principles, ensuring consistency and reliability in financial statement preparation. Q: Can the hierarchy change? A: Yes, the authoritative bodies such as FASB and AICPA can update the hierarchy to reflect new standards or interpretations.
Summary
The Hierarchy of GAAP is a critical framework ensuring that accounting practices adhere to the most authoritative and relevant standards. This hierarchy adds clarity and uniformity to financial reporting, thereby supporting stakeholder confidence and decision-making.
References
- Financial Accounting Standards Board (FASB). “Statements of Financial Accounting Concepts.”
- American Institute of Certified Public Accountants (AICPA). “Accounting Principles.”
- United States Generally Accepted Accounting Principles (U.S. GAAP).
This structured, comprehensive entry is designed to provide a clear, detailed understanding of the Hierarchy of GAAP for accounting professionals and students alike.
