The accounting law definition is the system used to record, summarize, analyze, and categorize the financial transactions of an individual or a business. This is used in legal cases to determine the amount of damages owed to a plaintiff. This is sometimes called accounting for profits.

Methods of Accounting

Common methods of accounting include:

  • Accrual — shows income earned and expenses incurred over a specific period, regardless of whether they were received or paid during that period.
  • Cash — records only income and expenses that have been paid or received during a specific period.
  • Completed contract — reports the income and expenses associated with specific long-term contracts.
  • Installment — calculates depreciation of regulated utilities for income tax.
  • Cost — shows the value of assets at their actual cost.
  • Fair value method — indicates the current market value of assets.
  • Price level — values assets in a financial statement by comparing their current value to the gross national product.

Court-Ordered Accounting

If the court requires accounting in a lawsuit, the defendant must account for his or her administration of the affairs in question. This may include:

  • The management of an estate by an executor.
  • The disclosure of the business actions of a partner.

This legal remedy dates back to ancient courts of equity, in which the officers of the chancery served as auditors on behalf of the king.

Today, plaintiffs can request accounting when a jury has difficulty resolving the complexity of the accounts referenced in a case or when a position of trust has been violated. U.S. courts have both law and equity jurisdiction. Moreover, they can order an accounting when needed.

In addition to the examples mentioned above, this could occur if the court wants to prevent a party from profiting from a wrong it has committed. For example, a bank teller who has invested embezzled funds in the stock market may be stripped of all the associated earnings, not just the original amount stolen. He or she must trace all financial transactions that have resulted from the injury in question.

Failures of Accounting

Major changes have been made to professional accounting standards owing to a series of industry mishaps beginning in the late 1990s. Since 1973, the Financial Accounting Standards Board (FASB) has served to establish these professional accounting and reporting standards. Although this is a private organization, the American Institute of Certified Public Accountants and the Securities and Exchange Commission (SEC) recognize its authority.

The FASB revised standards after investors lost approximately $200 billion in collective earnings because of financial reporting and auditing failures involving:

  • Sunbeam
  • Superior Bank
  • Bausch and Lomb
  • Dollar General
  • Other major companies.

The most famous of these incidents was the collapse of the Enron Corporation in the third quarter of 2001, resulting in U.S. history's largest bankruptcy. Thousands of employees lost their retirement plans, and accounting firm Arthur Anderson was found guilty on federal charges of obstruction of justice. The courts found that Andersen:

  • Did not follow generally accepted accounting principles (GAAP).
  • Destroyed thousands of paper and digital documents.
  • Improperly categorized hundreds of millions of dollars.

After the Enron case, the FASB took a central role in leading the industry's self-regulation. New accounting rules were announced in early 2003.

Generally Accepted Accounting Principles (GAAP)

The existence of these rules, guidelines, and procedures creates public faith in the system by those who participate in the economic marketplace. The aftermath of the 1929's stock market crash showed the disastrous financial consequences of a lack of public faith.

Organizations including the SEC, the FASB, and the American Institute of Certified Public Accountants (AICPA) have developed modern accounting principles. The latter formed the Committee on Accounting Procedures in 1937 with the aim of standardizing industry practices. In 1959, the Accounting Principles Board replaced this committee, and it maintained responsibility until the 1973 formation of the FASB.

This board consists of seven compensated full-time members who identify, research, and resolve accounting issues. A vote of five to two or greater is required to make changes to the Statements of Financial Accounting Standards. The Financial Accounting Foundation oversees the FASB, which a 16-member Board of Trustees governs.

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