The rules and the referees

You've now seen how a company's numbers flow through four statements and lock together. None of that is worth much if a company can define "revenue" however it likes, or quietly move a bad quarter into a better one. Before you trust a set of financial statements, you need to know who decided what the numbers mean, who checks that the company followed the rules, and who answers for it if they didn't. That chain of authority is also where a lot of accounting careers actually live.

Same rulebook, every company

GAAP stands for Generally Accepted Accounting Principles: the common set of rules U.S. companies use to measure and report their activities. A basketball game only works if both teams agree on what counts as a foul before tip-off. GAAP is the rulebook that lets you compare Costco's revenue to Target's, without first figuring out whether the two companies even mean the same thing by "revenue." That's the last time this section uses a sports comparison. But the idea carries the rest of it: shared rules are what make one company's numbers mean the same thing as another's.

GAAP itself is written by the FASB, the Financial Accounting Standards Board. The FASB is a private-sector board, not a government agency, made up of investors, preparers, auditors, and academics who study proposed rules, take public comment, and issue the standards that make up US GAAP. Any company that says its statements follow GAAP has to follow all of it, public or private. The SEC additionally requires GAAP of public companies, but that's a separate question from whether GAAP applies at all. That's why GAAP shows up throughout this course even though our example companies are small and privately held.

The regulator and the referees on the field

The FASB writes the rules, but it doesn't have legal power to force anyone to follow them. That power belongs to the SEC, the Securities and Exchange Commission, a federal agency Congress created with legal authority over financial reporting by public companies. The SEC could write every accounting rule itself. Instead, it has chosen to let the FASB do that detailed work, while keeping the authority to override or replace any rule it doesn't like. GAAP has teeth for public companies because SEC rules require their filed statements to follow it, and the SEC has formally recognized the FASB as the standard setter, not because the FASB can compel anyone on its own.

Writing the rules and enforcing them are two different jobs, and a third one still has to happen: someone has to check that a specific company actually followed the rules. That's the job of independent auditors, outside accounting firms hired to examine a company's financial statements and issue an opinion on whether they fairly reflect GAAP. "Independent" means the audit firm is hired and overseen by the company's board of directors, specifically its audit committee, rather than by the managers whose work it is checking. Independence rules also bar the firm from holding a financial stake in the client. The people who audit the auditors are the PCAOB, the Public Company Accounting Oversight Board, which sets the standards for audits of public companies and inspects the firms that perform them.

Why the rules have teeth

Rules and referees exist because the people producing financial statements often have a personal interest in them looking good: a bonus, a stock price, a loan covenant. A run of large corporate frauds in the early 2000s showed what happens when that pressure wins, and it led Congress to pass the Sarbanes-Oxley Act of 2002, which tightened auditor independence and created the PCAOB. The details of those cases aren't the point here; the point is that the rules you're learning exist because trust in financial statements has been broken badly enough, often enough, that lawmakers decided it needed backup. Outside the U.S., most countries use a similar but not identical rulebook called IFRS, International Financial Reporting Standards, written by the IASB, the International Accounting Standards Board. A foreign company's statements will look familiar but not identical to a GAAP-based one.

Where this shows up in a career

Every part of this chain hires people who understand this material. Public accounting firms do the independent audits you just read about, plus tax work, for a wide range of client companies. Corporate accounting teams work inside a single company, closing the books and preparing the statements the auditors will check. Consulting firms bring in accounting knowledge to fix reporting systems or evaluate a deal. Finance roles, inside a company or at a bank or investment firm, use financial statements to decide what to fund and at what price. A growing set of data and analytics roles apply the same statements at scale: screening thousands of companies, flagging unusual patterns, building the models investors and lenders rely on. If you want to sign an audit opinion yourself one day, you'll need to become a CPA, a Certified Public Accountant, which requires passing a licensing exam and meeting state requirements.

Where a number's authority comes from

When you see "Total revenue: roughly $250 billion" for fiscal 2024 in Costco's annual report, three separate things back that approximate number. GAAP defines what counts as revenue, the FASB and SEC stand behind that definition, and an independent auditor has checked that Costco actually followed it.

Common mistake: each company just makes up its own accounting rules

It's tempting to think a company's own accountants decide how to count things, since they're the ones doing the counting. They don't get to. GAAP is set by the FASB, with the SEC holding legal authority over the whole system, and an independent auditor checks that the company actually followed it. A company's accountants apply the rules; they don't write them.

Before you go on

You now know who sets the rules, who has the legal power behind them, and who checks that a specific company followed them. The optional next section looks at the ideas the FASB actually builds those rules on.