What Is an Accounting Standard?

An accounting standard is a common set of principles, standards, and procedures that define the basis of financial accounting policies and practices.

Understanding Accounting Standards

Accounting standards improve the transparency of financial reporting in all countries. In the United States, the generally accepted accounting principles (GAAP) form the set of accounting standards widely accepted for preparing financial statements. International companies follow the International Financial Reporting Standards (IFRS), which are set by the International Accounting Standards Board and serve as the guideline for non-U.S. GAAP companies reporting financial statements.

The generally accepted accounting principles are heavily used among public and private entities in the United States. The rest of the world primarily uses IFRS. Multinational entities are required to use these standards. The International Accounting Standards Board (IASB) establishes and interprets the international communities’ accounting standards when preparing financial statements.

Accounting standards relate to all aspects of an entity’s finances, including assets, liabilities, revenue, expenses, and shareholders’ equity. Specific examples of accounting standards include revenue recognition, asset classification, allowable methods for depreciation, what is considered depreciable, lease classifications, and outstanding share measurement.

The American Institute of Accountants, which is now known as the American Institute of Certified Public Accountants, and the New York Stock Exchange attempted to launch the first accounting standards in the 1930s. Following this attempt came the Securities Act of 1933 and the Securities Exchange Act of 1934, which created the Securities and Exchange Commission. Accounting standards have also been established by the Governmental Accounting Standards Board for accounting principles for all state and local governments.

Accounting standards specify when and how economic events are to be recognized, measured, and displayed. External entities, such as banks, investors, and regulatory agencies, rely on accounting standards to ensure relevant and accurate information is provided about the entity. These technical pronouncements have ensured transparency in reporting and set the boundaries for financial reporting measures.

U.S. GAAP Accounting Standards

The American Institute of Certified Public Accountants developed, managed, and enacted the first set of accounting standards. In 1973, these responsibilities were given to the newly created Financial Accounting Standards Board. The Securities and Exchange Commission requires all listed companies to adhere to U.S. GAAP accounting standards in the preparation of their financial statements to be listed on a U.S. securities exchange.

Accounting standards ensure the financial statements from multiple companies are comparable. Because all entities follow the same rules, accounting standards make the financial statements credible and allow for more economic decisions based on accurate and consistent information.

Financial Accounting Standards Board (FASB)

An independent nonprofit organization, the Financial Accounting Standards Board (FASB) has the authority to establish and interpret generally accepted accounting principles (GAAP) in the United States for public and private companies and nonprofit organizations. GAAP refers to a set of standards for how companies, nonprofits, and governments should prepare and present their financial statements.

What Is the 80-20 Rule?

The 80-20 rule, also known as the Pareto Principle, is a familiar saying that asserts that 80% of outcomes (or outputs) result from 20% of all causes (or inputs) for any given event.

In business, a goal of the 80-20 rule is to identify inputs that are potentially the most productive and make them the priority. For instance, once managers identify factors that are critical to their company’s success, they should give those factors the most focus.

Although the 80-20 rule is frequently used in business and economics, you can apply the concept to any field. Wealth distribution, personal finance, spending habits, and even infidelity in personal relationships can all be the subject of the 80-20 rule.

How Does the 80-20 Rule Work?

You may think of the 80-20 rule as simple cause and effect: 80% of outcomes (outputs) come from 20% of causes (inputs). The rule is often used to point out that 80% of a company’s revenue is generated by 20% of its customers.

Viewed in this way, it might be advantageous for a company to focus on the 20% of clients that are responsible for 80% of revenues and market specifically to them. By doing so, the company may retain those clients, and acquire new clients with similar characteristics. However, there’s a more fundamental meaning to the 80-20 rule.

Core Principle

At its core, the 80-20 rule is about identifying an entity’s best assets and using them efficiently to create maximum value. For example, a student should try to identify which parts of a textbook will create the most benefit for an upcoming exam and focus on those first. This does not imply, however, that the student should ignore the other parts of the textbook.

Misinterpretations

People may not realize that the 80-20 rule is a precept, not a hard-and-fast mathematical law. Furthermore, it is isn’t necessary that the percentages equal 100%. Inputs and outputs simply represent different units. The percentages of these units don’t have to add up to 100%. It’s the concept behind the rule that matters.

There’s another way in which the 80-20 rule is misinterpreted. Namely, that if 20% of inputs are most important, then the other 80% must not be important. This is a logical fallacy. The 80% can be important, even if the decision is made to prioritize the 20%.

80-20 Rule Background

The 80-20 rule is also known as the Pareto principle and is applied in Pareto analysis. It was first used in macroeconomics to describe the distribution of wealth in Italy in the early 20th century. It was introduced in 1906 by Italian economist Vilfredo Pareto, who is best known for the concepts of Pareto efficiency.

Pareto noticed that 20% of the pea pods in his garden were responsible for 80% of the peas. Pareto expanded this principle to macroeconomics by showing that 80% of the wealth in Italy was owned by 20% of the population.

In the 1940s, Dr. Joseph Juran, a prominent figure in the field of operations management, applied the 80-20 rule to quality control for business production.

He demonstrated that 80% of product defects were caused by 20% of the problems in production methods. By focusing on and reducing the 20% of production problems, a business could increase the overall quality of its products. Juran referred to this phenomenon as “the vital few and the trivial many.”

Benefits of the 80-20 Rule

Although there is little scientific analysis that either proves or disproves the 80-20 rule’s validity, there is much anecdotal evidence that supports the rule as being essentially valid, if not numerically accurate.

Performance results of salespeople in a wide range of businesses have demonstrated success by incorporating the 80-20 rule. In addition, external consultants who use Six Sigma and other management strategies have incorporated the 80-20 principle in their practices with good results.

Example of the 80-20 Rule

A Harvard graduate student, Carla, was working on an assignment for her digital communications class. The project was to create a blog and monitor its success during the course of a semester.

Carla designed, created, and launched the site. Midway through the term, the professor conducted an evaluation of the blogs. Carla’s blog, though it had achieved some visibility, generated the least amount of traffic compared with her classmates’ blogs.

Define the Problem

Carla happened upon an article about the 80-20 rule. It said that you can use this concept in any field. So, Carla began to think about how she might apply the 80-20 rule to her blog project. She thought, “I used a great deal of my time, technical ability, and writing expertise to build this blog. Yet, for all of this expended energy, I am getting very little traffic to the site.”

She now understood that even if a piece of content is spectacular, it is worth virtually nothing if no one reads it. Carla deduced that perhaps her marketing of the blog was a greater problem than the blog itself.

Apply the 80-20 Rule

To apply the 80-20 rule, Carla decided to assign her 80% to all that went into creating the blog, including its content. Her 20% would be represented by a selection of the blog’s visitors.

Using web analytics, Carla focused closely on the blog’s traffic. She asked herself:

• Which sources comprise the top 20% of traffic to my blog?
• Who are the top 20% of my audience that I wish to reach?
• What are the characteristics of this audience as a group?
• Can I afford to invest more money and effort into satisfying my top 20% readers?
• In terms of content, which blog posts constitute the top 20% of my best-performing topics?
• Can I improve upon those topics, and get even more traction from my content than I’m getting now?

Carla analyzed the answers to these questions, and edited her blog accordingly:

1. She adjusted the blog’s design and persona to align with her top 20% target audience (a strategy common in micromarketing).
2. She rewrote some content to meet her target reader’s needs more fully.

Significantly, although her analysis did confirm that the blog’s biggest problem was its marketing, Carla did not ignore its content. She remembered the common fallacy cited in the article—if 20% of inputs are most important, then the other 80% must be unimportant—and did not want to make that mistake. She knew it was necessary to address aspects of the content, as well.

Results

By applying the 80-20 rule to her blog project, Carla came to understand her audience better and therefore targeted her top 20% of readers more purposefully. She reworked the blog’s structure and content based on what she learned, and traffic to her site rose by more than 220%.

What Is Acceptable Quality Level (AQL)?

The acceptable quality level (AQL) is a measure applied to products and defined in ISO 2859-1 as the “quality level that is the worst tolerable.” The AQL tells you how many defective components are considered acceptable during random sampling quality inspections. It is usually expressed as a percentage or ratio of the number of defects compared to the total quantity.

How Acceptable Quality Level (AQL) Works

Goods in a sample are tested at random, and if the number of defective items is below the predetermined amount, that product is said to meet the acceptable quality level (AQL). If the acceptable quality level (AQL) is not reached for a particular sampling of goods, manufacturers will review the various parameters in the production process to determine the areas causing the defects.

As an example, consider an AQL of 1% on a production run. This percentage means that no more than 1% of the batch can be defective. If a production run is composed of 1,000 products, only 10 products can be defective. If 11 products are defective, the entire batch is scrapped. This figure of 11 or more defective products is known as the rejectable quality level (RQL).

The AQL is an important statistic for companies seeking a Six Sigma level of quality control, which is a quality-control methodology developed in 1986 by Motorola, Inc. AQL is also known as the acceptable quality limit.

Industry Differences in AQL Standards

The AQL of a product can vary from industry to industry. For example, medical products are more likely to have more stringent AQL because defective products can result in health risks.

In contrast, a product with benign side-effects from a possible defect may have a less strict AQL, such as the remote control for a TV. Companies have to weigh the added cost associated with the stringent testing and potentially higher spoilage due to a lower defect acceptance with the potential cost of a product recall.

Customers would, of course, prefer zero-defect products or services; the ideal acceptable quality level. However, sellers and customers usually try to arrive at and set acceptable quality limits based on factors typically related to business, financial, and safety concerns.

Using AQL Tables

AQL tables (also sometimes called AQL charts) are designed to allow users to reference a standard for what qualifies as an acceptable number of defects in manufacturing. They allow a person to see how many defects would be allowed for a company to achieve a certain AQL. The tables are part of ISO 2859.

So for example, let’s say a company orders 30,000 hats from a clothing manufacturer that will be produced in one batch, and the buyer and producer have agreed on AQL 0.0 for critical defects, AQL 3.0 for major defects, and AQL 5.0 for minor defects. Referencing the AQL tables would allow the buyer and producer to determine how many hats would need to be inspected to ensure that the agreed upon AQL is being met during production.

AQL Defects

Instances of failure to meet customer quality requirements are termed as defects. In practice, there are three categories of defects:

1. Critical defects: Defects that, when accepted, could harm users. Such defects are unacceptable. Critical defects are defined as 0% AQL.
2. Major defects: Defects usually not acceptable by the end-users, as they are likely to result in failure. The AQL for major defects is 2.5%.
3. Minor defects: Defects not likely to reduce materially the usability of the product for its intended purpose but that differ from specified standards; some end users will still buy such products. The AQL for minor defects is 4%.

AQL in Practice

Acceptable quality level (AQL): AQL is typically considered to be the worst quality level that is still considered satisfactory. It is the maximum percent defective that can be considered satisfactory. The probability of accepting an AQL lot should be high. A probability of 0.95 translates to a risk of 0.05.

Rejectable quality level (RQL): This is considered an unsatisfactory quality level and is sometimes known as lot tolerance percent defective (LTPD). The consumer’s risk has been standardized in some tables as 0.1. The probability of accepting an RQL lot is low.

Indifference quality level (IQL): This quality level is somewhere between AQL and RQL. Different companies maintain different interpretations of each defect type. However, buyers and sellers agree on an AQL standard that is appropriate to the level of risk each party assumes. These standards are used as a reference during a pre-shipment inspection.

The Bottom Line

AQL can be a useful figure to help ensure that large orders for manufacturing are completed to a level of standard that a buyer demands. It also allows the seller to be efficient in their production while maintaining the standard set by the buyer. It is generally used in large-scale orders of production, and is helpful in keeping both buyer and seller happy while producing good quality products.

What’s an Actuarial Life Table?

An actuarial life table is a table or spreadsheet that shows the probability of a person at a certain age dying before their next birthday. It’s often used by life insurance companies to calculate the remaining life expectancy for people at different ages and stages, and the probability of surviving a particular year of age.

Because men and women have different mortality rates, an actuarial life table is computed separately for men and women. An actuarial life table is also called a mortality table, life table, or actuarial table.

How an Actuarial Life Table Works

Insurance companies utilize actuarial life tables to help price products and project future insured events. Mathematically and statistically based actuarial life tables assist life insurance companies by showing event probabilities, such as death, sickness, and disability.

An actuarial life table can also include factors to differentiate variable risks such as smoking, occupation, socio-economic status, and even gambling, and debt load. Computerized predictive modeling allows actuaries the ability to calculate for a wide variety of circumstances and probable outcomes.

Actuarial Science

Actuarial science uses primarily two types of life tables. First, the period life table is used to determine mortality rates for a specific time period of a certain population. The other type of actuarial life table is called the cohort life table, also referred to as a generation life table. It is used to represent the overall mortality rates of a certain population’s entire lifetime.

The population selection must be born during the same specific time interval. A cohort life table is more commonly used because it attempts to predict any expected change in mortality rates of a population in the future.

A cohort table also analyzes observable mortality patterns over time. Both types of actuarial life tables are based on actual populations of the present and educated predictions of a population’s near future. Other types of life tables may be based on historical records. These types of life tables often undercount infants and understate infant mortality.

Insurance companies use actuarial life tables to primarily make two types of predictions: the probability of surviving any particular year of age and the remaining life expectancy for people of different ages.

Other Uses of Actuarial Life Tables

Actuarial life tables also play an important role in the sciences of biology and epidemiology. In addition, the Social Security Administration in the United States uses actuarial life tables to examine the mortality rates of people who have Social Security in order to inform certain policy decisions or actions.

Actuarial life tables are also important in product life cycle management and for pension calculations.