We all use accounting in our everyday lives. When we go to work, we exchange our time, talents and energy for money. Then we exchange the money for goods and services that we need or want. These exchanges are called transactions. We compare our bank balances to our loan and credit card balances to check our financial health. We prepare our tax returns listing how much money we made and how much money we spent on tax-deductible items. Any summary of transactions into a report is a financial statement. In plain English, accounting is really pretty simple!
The Accounting Language
Accounting is the language of economic activity, and particularly of business. Like English or any other language, it has rules of grammar which we will call accounting principles. Each individual accounting rule is a word in this accounting language. In addition, there are a number of dialects in this accounting language. In the U.S. we usually use generally-accepted accounting principles, often abbreviated as GAAP. Much of the rest of the world uses international financial reporting standards, often abbreviated as IFRS. Small private companies in the U.S. often produce their financial statements based on the tax code, called tax-basis accounting. These dialects, along with some others are each referred to as a Comprehensive Basis of Accounting. No matter the dialect used, the purpose is to define how a series of transactions will be presented to the reader as a financial statement or report. This site and related discussions will be primarily focused on GAAP and SEC rules.
Accounting Standard Setters
Each Comprehensive Basis of Accounting is defined and administered by a central authority. Some of the more commonly used are:
| GAAP | Financial Accounting Standards Board |
| Additional requirements for US publicly-traded companies | U.S. Securities and Exchange Commission |
| IFRS | International Accounting Standards Board |
| Tax-basis accounting | U.S. Internal Revenue Service |
The good news is…
The purpose of accounting principles, regardless of the dialect, is to try to achieve comparability and consistency in financial statements. In Through the Looking Glass, Humpty Dumpty said “When I use a word, it means just what I choose it to mean – neither more nor less.” Imagine trying to communicate when words have no agreed-upon meaning! Financial Statements absent an underlying comprehensive basis of accounting would have the same problem. The intent is that a reader can compare the financial statements of a company over time and assume that they were prepared using the same rules, that is the words mean the same thing on each of the reports. Similarly, the financial statements of two different companies could be compared with each other.
But the bad news is…
The downside of the comprehensive basis of accounting is that in trying to be comprehensive, it is also complex and difficult to understand. The rules are written to try to address every conceivable circumstance that could arise in a given topic and often leave little room for judgement. Again, the intent is that the words (returning to Humpty Dumpty) should always mean the same thing. Inherently simple ideas can be made complex and difficult to understand. It can take 200 pages to explain how to account for a lease, for example.
Why Accounting in Plain English?
The Accounting in Plain English project is dedicated to trying to make the complex simple and understandable. That is, translate the language of accounting back into plain English. This is not an education site for accountants, it is intended for company management, and users and readers of financial statements. The intent is not to turn you into an accountant, but to help you avoid being confused by one.
In these uncertain times, evaluating your business as a going-concern has never been more important. Check out the blog post “Is My Company a Going-Concern in a COVID Pandemic?“
I welcome questions or suggestions for topics from readers. If you see something that doesn’t quite make sense, or may even be incorrect, please let me know. This will be an ongoing project.