Definition
The Hierarchy of Generally Accepted Accounting Principles (GAAP) refers to a system of ranking various sources of accounting standards and practices. These rankings establish the level of importance and authority for resolving accounting issues and conflicts. The hierarchy starts with the most authoritative, recognized standards and goes down to lower-level, less authoritative guidance.
Phonetic
The phonetics for the keyword “Hierarchy of GAAP” is: Hierarchy: /ˈhaɪ(ə)rɑːrki/of: /əv/ or /ɒv/GAAP: /ɡæp/
Key Takeaways
The Hierarchy of Generally Accepted Accounting Principles (GAAP) is a system that classifies the sources of accounting principle and the framework for selecting the principles used in the preparation of financial statements of nongovernmental entities. Here are the three main takeaways.
- Establishes Importance of Sources: The Hierarchy of GAAP was established to provide transparency and consistency in financial reporting. The structure is designed in a way that categorizes the different accounting prerequisites and guidelines, ranking them by their level of authority and influence.
- Four Levels of Hierarchy: The Hierarchy of GAAP is composed of four different levels – A, B, C, and D. Each level provides a range of different standards, principles, practices, and literature that accountants use as reference for their work. Level A includes the highest authority with standards issued by the Financial Accounting Standards Board. Levels B through D represent less authoritative standards and government principles.
- Reduction to Two Levels: The GAAP Hierarchy was reduced to just two categories effective for interim and annual periods ending after September 15, 2009, by the Statement No. 168 of the Governmental Accounting Standards Board. This change was made to simplify the categorization and to increase the clarity on which guidelines have the highest level of authority.
Importance
The hierarchy of Generally Accepted Accounting Principles (GAAP) is important because it provides a clear system for the order of priority for sources of accounting principles to be applied in the preparation of financial statements. This hierarchy helps to standardize the methods and processes used in accounting, ensuring consistency, comparability, and fairness across all business entities. It dictates that more authoritative sources, such as the Financial Accounting Standards Board (FASB), take precedence over secondary, interpretive sources. By following this hierarchy, businesses can uphold credibility and transparency, and stakeholders can make informed decisions based on accurate and reliable financial information.
Explanation
The Hierarchy of GAAP, which stands for Generally Accepted Accounting Principles, serves a central role in ensuring that financial reporting is maintained and executed to a standard that provides consistency, clarity, and comparability across different entities and sectors. The main purpose of the hierarchy is to establish a classification system for accounting values, thus providing a framework for resolving any potential discrepancies or conflicts regarding the application of accounting methods or the interpretation of financial information. The hierarchy of GAAP is utilized by accountants and auditors to determine the most appropriate and relevant accounting principle or guidelines to follow for specific transactions or financial events. When encountering a situation where various GAAP principles could be applied, the hierarchy helps decipher which principle takes precedence. This is fundamentally important in maintaining the integrity of financial reporting, as it addresses the complexity and variation of financial transactions by guiding decision-making through a well-organized system of accounting standards.
Examples
The Hierarchy of Generally Accepted Accounting Principles (GAAP) refers to the system of guidelines and regulations that govern financial accounting and reporting. It orders the level of authority of various financial reporting standards. Here are three real-world examples:1. Financial Reporting by Corporations: Large corporations are required to prepare their financial statements according to the GAAP hierarchy. For example, a company like Apple needs to adhere strictly to the GAAP principles when reporting their revenues, expenditures, profits, and losses to their shareholders and the Securities and Exchange Commission (SEC). It ensures consistency and accuracy in financial reporting that gives shareholders fair representation of the company’s financial condition.2. Auditing Professional Services: Auditing firms like Price Waterhouse Coopers use the hierarchy of GAAP to audit their clients’ financial records. They will assess whether a company’s financial reports follow the rules and standards outlined in the hierarchy of GAAP, which contributes to the overall transparency and integrity of the financial markets.3. Non-profit Organizations: Non-profit organizations such as the American Red Cross also adhere to the GAAP hierarchy when preparing their financial statements. This helps to maintain trust among donors and regulatory bodies by ensuring the organization’s funds are efficiently and effectively used. Under GAAP, these organizations must provide details on the flow of their resources, including their revenues, expenses, gains, and losses.
Frequently Asked Questions(FAQ)
What is the hierarchy of Generally Accepted Accounting Principles (GAAP)?
The Hierarchy of GAAP is a system that organizes the accounting principles and guidelines based on their level of authority and importance in handling various business transactions.
Why is the hierarchy of GAAP important?
The hierarchy of GAAP allows accountants and business professionals to understand which accounting principles should be applied first when dealing with complex business transactions. Its importance is to create uniformity and standardization in financial reporting.
Who are responsible for setting the GAAP hierarchy?
The Financial Accounting Standards Board (FASB) and the Securities and Exchange Commission (SEC) are responsible for setting and maintaining the GAAP hierarchy.
What are the classifications within the hierarchy of GAAP?
The hierarchy of GAAP consists of four levels: (1) FASB Statements and Interpretations, APB Opinions, and ARBs; (2) FASB Technical Bulletins and AICPA Industry Audit & Accounting Guides and Statements of Position; (3) AICPA Accounting Standards Executive Committee Practice Bulletins and Positions of the FASB Emerging Issues Task Force; and (4) Implementation guides, AICPA accounting interpretations, opinions of the Accounting Principles Board and practices that are widely recognized and prevalent in the industry.
Have there been changes to the Hierarchy of GAAP over time?
Yes, there have been changes to the hierarchy of GAAP. In 2009 FASB Statement No.168 changed the structure of the hierarchy, essentially replacing the old structure with just two categories – authoritative and non-authoritative. The aim was to simplify the system and clarify the guidance to be followed.
Is the hierarchy of GAAP utilized internationally?
The GAAP hierarchy is primarily utilized in the United States. However, many international countries use similar hierarchies for their own accounting standards, such as the International Financial Reporting Standards (IFRS).
How often is the hierarchy of GAAP updated?
GAAP’s hierarchy isn’t updated on a regular schedule. It changes when new standards or interpretations are issued by authoritative bodies like the FASB or the SEC.
Where can I find the latest updates on the Hierarchy of GAAP?
The latest updates on the Hierarchy of GAAP can be found on the official FASB website or other authoritative bodies like SEC and AICPA.
Related Finance Terms
- Generally Accepted Accounting Principles (GAAP)
- Financial Accounting Standards Board (FASB)
- Securities and Exchange Commission (SEC)
- International Financial Reporting Standards (IFRS)
- Auditing Standards Board (ASB)
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