Key Concepts in Understanding Financial Statements

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Part I. There are a number of key concepts that can help with understanding accounting, and the importance of financial statements. The first of these is the generally accepted accounting principles (GAAP). The US GAAP is a set of guidelines for the preparation of financial accounting statements. This common set of standards, principles and procedures are authoritative and all public companies trading on US exchanges must produce GAAP statements (Investopedia, 2012). The reason that the GAAP were developed is so that investors would have a common set of accounting standards. This ensures a level of consistency among accounting standards that allows investors to compare information across companies and across time as well. There is, however, a certain amount of leeway within the GAAP so that companies can use different techniques that GAAP allows. It is therefore important to read the notes to the financial statements to understand which specific GAAP policies the company using. The international financial reporting standards (IFRS) are an alternative to the GAAP. IFRS has been adopted in over 100 countries around the world, including most of continental Europe. There is a growing movement to have the IFRS adopted globally, including the United States. There is a convergence project underway that will align the GAAP and the IFRS for American firms. Until that process has been completed, US companies still will use GAAP. When a company from an IFRS nation trades on an
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