Accounting Interpretation: What it is, How it Works, Example

What Is an Accounting Interpretation?

An accounting interpretation is a statement, issued by accounting standards bodies, clarifying how existing accounting standards should be applied. Interpretations are generally not requirements, but rather outline best practices and provide further explanation. 

Understanding an Accounting Interpretation

As financial transactions continue to evolve, new situations develop that may not have been foreseen by the existing accounting standards. When questions arise, accounting boards, such as the Financial Accounting Standards Board (FASB), the American Institute of Certified Public Accountants (AICPA), and the International Accounting Standards Board (IASB), may choose to issue an interpretation outlining the recommended practices for accounting. The IASB operates under the oversight of the International Financial Reporting Standards Foundation (IFRS).

In other cases, an entirely new standard may be issued for a class of financial transactions that did not previously exist, for example for industries that recently emerged, such as certain components of the tech sector in the last two decades. Alternatively, a standard could be updated, known as "ASU," or Accounting Standard Update, in the parlance of the FASB, if the nature of a change in a transaction is significant enough to warrant an adjustment.

Accounting interpretations clarify and elaborate on the financial reporting rules currently in circulation, helping to ensure that financial statements are accurate and comparable.

Accountants and other individuals responsible for putting together financial statements are expected to abide by new or revised accounting standards, as well as pay careful attention to the interpretations that accompany them. Interpretations serve as a useful guide. They help to weed out ambiguity and eliminate the risk that a lack of understanding of existing rules could lead to accountants mistakenly applying different methodologies and, in sinister cases, coming up with creative ways to cook the books.

Accounting Interpretation vs. Accounting Standard

Accounting interpretations are intended to expand on the concepts laid out by an accounting standard: a common set of principles and procedures that define the basis of financial accounting policies and practices.

Accounting standards underline the requirements for how to report business transactions. Their objective is to standardize financial statements and improve the transparency of financial reporting in all countries.

Advantages of an Accounting Interpretation

The clarity offered by an accounting interpretation ensures that reported financial figures are more likely to be relevant, accurate, and comparable across different companies. Making sure that everyone follows the same principles is in the best interest of investors because it helps them make better-informed decisions about which stocks to invest in.

In some cases, investors might even opt to consult accounting interpretations. Investors with a greater, up-to-date grasp of reporting requirements are much better placed to assess the financial health of a company than those with just basic knowledge.

Real World Example

In December 2006, the Financial Accounting Standards Board (FASB) issued Interpretation No. 48, offering clarifying remarks on the standards outlined in FASB Statement No. 109, regarding accounting for income taxes, after determining that there were too many uncertainties regarding its application.

In the interpretation, the accounting board "prescribes a recognition threshold and measurement attribute for the financial statement recognition and measurement of a tax position taken or expected to be taken in a tax return." The interpretation describes the two-step process of recognition and measurement and the resulting impact on financial statements with respect to income taxes payable or receivable, as well as the impact on deferred tax assets and liabilities.

When the FASB releases an interpretation, it will also cite the reason for it and explain how the interpretation will improve financial reporting. In the case of No. 48, FASB states that "this Interpretation will result in increased relevance and comparability in financial reporting of income taxes because all tax positions accounted for in accordance with Statement 109 will be evaluated for recognition, derecognition, and measurement using consistent criteria."