Difficulty: Introductory | Prerequisites: Companion notes on core financial statements (balance sheet, income statement, equity statement, cash flows)
Knowing the four financial statements is only half the picture. This material covers the rules and institutions that govern how those statements are prepared, the qualities that make financial information useful, and the specific reports that public companies must file. If the first set of notes is "what the statements are," this set is "who writes the rules, what standards they enforce, and how to tell whether the information is any good." You will need this for any exam question about GAAP, the SEC, or the qualitative characteristics framework.
Accounting standards in the U.S. are set by the FASB (GAAP), enforced by the SEC, and audited under the oversight of the PCAOB. Useful financial information must be relevant and faithfully represented, with enhancing qualities like comparability and timeliness. Public companies disclose their financials through periodic SEC filings (10-K, 10-Q, 8-K), all searchable on EDGAR.
GAAP (Generally Accepted Accounting Principles)
The authoritative set of accounting standards, rules, and conventions used in the United States for preparing financial statements.
In simple terms, GAAP is the rulebook that tells companies how to record and report their financial information so everyone is speaking the same language.
FASB (Financial Accounting Standards Board)
The independent, private-sector body that develops and issues GAAP in the United States.
Think of the FASB as the people who write the accounting rulebook.
SEC (Securities and Exchange Commission)
The U.S. federal agency that regulates publicly traded companies. The SEC enforces compliance with GAAP and oversees the securities markets.
In simple terms, the SEC is the government watchdog that makes sure public companies follow the rules and tell the truth in their reports.
PCAOB (Public Company Accounting Oversight Board)
A nonprofit oversight body created by the Sarbanes-Oxley Act to oversee the audits of public companies, ensuring that auditors do their job properly.
Think of the PCAOB as the auditors’ auditor.
EDGAR (Electronic Data Gathering, Analysis, and Retrieval)
The SEC’s online database where all public company filings (10-K, 10-Q, 8-K, and others) are stored and made freely accessible to the public.
Form 10-K
A public company’s annual report filed with the SEC, due within 60 to 90 days of the fiscal year-end. Contains comprehensive audited financial statements and detailed disclosures.
Form 10-Q
A public company’s quarterly report filed with the SEC, due within 40 to 45 days of the quarter-end. Contains unaudited financial statements and interim updates.
Form 8-K
A current report filed with the SEC to disclose significant events such as mergers, acquisitions, leadership changes, or other material developments. Filed promptly when the event occurs.
Relevance (qualitative characteristic)
Financial information is relevant if it is capable of making a difference in a decision. This includes predictive value (helps forecast future outcomes) and confirmatory value (confirms or corrects prior expectations).
Faithful representation (qualitative characteristic)
Financial information faithfully represents an economic event when the depiction is complete, neutral, and free from material error.
In simple terms, the numbers should tell the truth about what happened, without spin or gaps.
Comparability
The quality that allows users to identify similarities and differences across companies or across time periods for the same company. Achieved through consistent application of accounting methods.
Verifiability
The quality that ensures independent observers, using the same methods, would reach the same conclusions from the financial data.
Timeliness
Making information available to decision-makers before it becomes stale and loses its ability to influence decisions.
Understandability
Presenting information clearly enough that a reasonably knowledgeable user can comprehend it.
Notes to financial statements (footnotes)
Supplementary disclosures attached to the financial statements that explain accounting policies, provide breakdowns of line items, and disclose contingencies and off-balance-sheet items.
FASB (Financial Accounting Standards Board)
Independent, private-sector organisation.
Develops and issues GAAP, the accounting standards that U.S. companies must follow.
Issues Accounting Standards Updates (ASUs) when rules change.
SEC (Securities and Exchange Commission)
U.S. federal government agency.
Has legal authority to set accounting standards for public companies, but delegates standard-setting to the FASB.
Enforces compliance: public companies that violate GAAP face SEC action.
Requires periodic filings (10-K, 10-Q, 8-K) to ensure transparency.
PCAOB (Public Company Accounting Oversight Board)
Created by the Sarbanes-Oxley Act of 2002 in response to major accounting scandals (Enron, WorldCom).
Oversees the audits of public companies and broker-dealers.
Sets auditing standards and inspects audit firms to ensure quality.
How they relate
The FASB writes the rules. The SEC enforces them. The PCAOB makes sure the auditors checking the books are doing their job. Together, these three bodies create a system designed to ensure consistency, transparency, and comparability in financial reporting, which in turn supports investor confidence and functioning capital markets.
The FASB’s conceptual framework identifies two fundamental qualities and four enhancing qualities.
Fundamental qualities (both must be present)
Relevance: information capable of influencing a user’s decision.
Predictive value: helps users forecast future outcomes.
Confirmatory value: confirms or corrects prior expectations.
Faithful representation: the depiction is complete, neutral (unbiased), and free from material error.
Enhancing qualities (improve usefulness when the fundamentals are met)
Comparability: users can identify similarities and differences between entities or across periods. Achieved by applying accounting methods consistently.
Verifiability: independent, knowledgeable observers would reach consensus that the information is faithfully represented.
Timeliness: information is available early enough to be useful for decisions.
Understandability: presented clearly so a reasonably informed user can comprehend it.
Hierarchy to remember
Relevance and faithful representation are the gatekeepers. If information fails on either, the enhancing qualities cannot rescue it. Once both fundamentals are satisfied, the enhancing qualities make the information progressively more useful.
Public companies (those with shares traded on a stock exchange) must file periodic reports with the SEC. These filings are the primary way investors, analysts, and regulators access a company’s financial information.
Key filings
Form 10-K (annual report)
Filed within 60 to 90 days of the company’s fiscal year-end.
Contains audited financial statements, management’s discussion and analysis (MD&A), and extensive disclosures.
The most comprehensive public filing a company makes.
Form 10-Q (quarterly report)
Filed within 40 to 45 days of the quarter-end.
Contains unaudited (but reviewed) financial statements and interim updates.
Filed for each of the first three quarters; the fourth quarter is covered by the 10-K.
Form 8-K (current report)
Filed promptly to disclose material events: mergers, acquisitions, CEO changes, bankruptcy filings, and similar developments.
No fixed calendar; triggered by the event itself.
EDGAR
All SEC filings are publicly available through the EDGAR database. Anyone can search for a company’s filings free of charge, which supports the transparency goals of the regulatory system.
The notes (also called footnotes) are an integral part of the financial statements, not optional reading.
What the notes disclose
Accounting policies and methods: how the company recognises revenue, values inventory (FIFO, LIFO, weighted average), and depreciates assets (straight-line, declining balance).
Detailed breakdowns of line items: for example, what makes up the "inventories" figure or the composition of long-term debt.
Commitments and contingencies: future obligations such as operating leases, pending lawsuits, and guarantees.
Off-balance-sheet items: arrangements that may not appear directly on the balance sheet but carry financial risk.
Why they matter
The numbers on the face of the statements tell you how much. The notes tell you how and why. Without the notes, a user cannot fully assess whether two companies’ reported figures are comparable or what risks lurk beneath the surface.
When an investor pulls up Target’s 10-K filing on EDGAR, they can trace changes in the company’s assets, liabilities, and cash flows year over year, then read the footnotes to understand any unusual items. That entire process relies on GAAP ensuring the numbers are prepared consistently, the SEC requiring the filing, and the PCAOB ensuring the audit was done properly.
The qualitative characteristics framework is what allows an analyst to trust that the information is comparable across companies. Without comparability, comparing Target’s margins to Walmart’s would be meaningless.
Students often think the SEC writes accounting standards. The SEC has the legal authority to do so but delegates standard-setting to the FASB. The SEC’s role is enforcement.
Students sometimes confuse the PCAOB with the FASB. The FASB sets accounting standards; the PCAOB oversees auditors. They are separate organisations with separate mandates.
Relevance and faithful representation are sometimes treated as interchangeable. They are distinct: information can be relevant but poorly represented (biased estimate), or faithfully represented but irrelevant (accurate data that does not bear on the decision).
The 10-K and annual report are sometimes assumed to be the same document. The 10-K is the SEC filing; a company’s glossy "annual report" to shareholders is a separate, less regulated publication.
⚠️ Know the roles of all three bodies: FASB sets standards, SEC enforces, PCAOB oversees auditors. Exams love to test which body does what.
⚠️ Be able to name and distinguish the two fundamental qualitative characteristics (relevance, faithful representation) and the four enhancing ones (comparability, verifiability, timeliness, understandability).
⚠️ Memorise the three SEC filing types and their deadlines: 10-K (annual, 60–90 days), 10-Q (quarterly, 40–45 days), 8-K (event-driven, filed promptly).
⚠️ Understand what the notes to financial statements contain and why they are considered an integral part of the financial statements, not optional supplementary reading.
⚠️ The qualitative characteristics hierarchy matters: relevance and faithful representation are fundamental; the enhancing qualities only add value once the fundamentals are met.
True or False: The SEC develops GAAP.
False. The FASB develops GAAP. The SEC enforces it.
Fill in the blank: The two fundamental qualitative characteristics are relevance and ______.
Faithful representation.
True or False: A Form 10-Q is filed annually.
False. The 10-Q is filed quarterly. The 10-K is the annual filing.
Fill in the blank: The PCAOB was created by the ______ Act.
Sarbanes-Oxley.
True or False: Notes to financial statements are optional supplementary material.
False. Notes are an integral part of the financial statements.
Q: Which organisation is responsible for developing Generally Accepted Accounting Principles in the United States?
A: The Financial Accounting Standards Board (FASB).
Q: Name the two fundamental qualitative characteristics of useful financial information and briefly distinguish them.
A: Relevance (information that can influence a decision, with predictive or confirmatory value) and faithful representation (information that is complete, neutral, and free from material error). Relevance asks "does it matter?" and faithful representation asks "is it accurate and unbiased?"
Q: A company’s CEO resigns unexpectedly. Which SEC filing would the company use to disclose this event, and when is it due?
A: Form 8-K. It is filed promptly when a material event occurs; there is no fixed calendar deadline.
Q: What is the role of the PCAOB, and why was it created?
A: The PCAOB oversees the audits of public companies. It was created by the Sarbanes-Oxley Act of 2002 in response to major accounting scandals to restore confidence in audited financial reports.
Q: Give two examples of information typically found in the notes to financial statements.
A: Accounting policies (e.g. the depreciation method used) and detailed breakdowns of balance sheet line items (e.g. the composition of long-term debt or the types of inventory held).
This material connects to the core financial statements notes (the companion doc) because the regulatory framework exists to govern how those statements are prepared. You cannot fully answer an exam question about the balance sheet or income statement without understanding the GAAP standards behind them.
Later topics on auditing will expand on the PCAOB’s role. Topics on international accounting will introduce the IASB and IFRS as the global counterparts to the FASB and GAAP.
The qualitative characteristics reappear throughout the course whenever you are asked to evaluate whether a particular accounting treatment produces useful information.
GAAP, Generally Accepted Accounting Principles, FASB, Financial Accounting Standards Board, SEC, Securities and Exchange Commission, PCAOB, Public Company Accounting Oversight Board, Sarbanes-Oxley, SOX, EDGAR, 10-K, 10-Q, 8-K, annual report, quarterly report, current report, qualitative characteristics, relevance, predictive value, confirmatory value, faithful representation, completeness, neutrality, freedom from error, comparability, verifiability, timeliness, understandability, notes to financial statements, footnotes, accounting policies, off-balance-sheet items, contingencies, commitments, auditing standards, investor confidence, financial reporting framework, introduction to management accounting, University of Minnesota