UNDERSTANDING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND THE STANDARD SETTING PROCESS

Transcription

1 UNDERSTANDING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND THE STANDARD SETTING PROCESS JEFF B. FERGUSON, CPA KPMG LLP 717 North Harwood Street Suite 3100 Dallas, Texas State Bar of Texas 2 ND ANNUAL ADVANCED IN-HOUSE COUNSEL COURSE August 14-15, 2003 San Antonio, Texas CHAPTER 19

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3 Jeff Ferguson, CPA Manager Forensic & Litigation Services 717 North Harwood Street Suite 3100 Dallas, TX Tel Fax Service lines Forensic and Litigation Services Education and certification Certified Public Accountant, Licensed in Texas BBA - Accounting The University of Texas at Austin Professional associations American Institute of Certified Public Accountants Texas Society of Certified Public Accountants Jeff Ferguson is a manager in KPMG s Forensic Services practice in Dallas. Jeff has assisted clients in a variety of industries. His primary responsibilities include financial analysis / investigation, project execution and administration, plus deliverable development and presentation. Jeff s clients represent the Healthcare, Telecommunications, Energy, and Travel Services industries. Experience Recent examples of Jeff s advisory experience include: Provided expert witness testimony and rebuttal analysis for a national healthcare company in relation to a post-acquisition dispute. Provided privileged consulting services to counsel in relation to a postacquisition purchase price dispute. Performed financial analysis, composed an expert report, and assisted in project management for a local transportation services company in postacquisition arbitration. Examined a public insurance company s related party transactions determine whether those transactions were properly disclosed in company s financial statements and determine whether the Board Directors properly approved those transactions. Reviewed the settlement process of a class action suit to ensure that fun were properly disbursed to the class members. Performed expert testimony and rebuttal analysis for an oil and gas roya case. Performed forensic analysis of an energy company s financial stateme relating to a business fraud dispute. Examined oil and gas royalty pricing practices to detect wrongful relat party pricing tactics. Other Experience Prior to joining KPMG, Jeff was a Manager at Arthur Andersen, LLP where he gained experience in fraud investigation, forensic accounting practices, analysis of damages, and related financial issues. Before joining Andersen, Jeff gained accounting and financial experience with an energy firm, Amerada Hess Corporation, in Houston Texas. His previous experience dealt with various types of oil and gas accounting including revenue, royalty, production, joint venture and gas plant accounting.

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5 TABLE OF CONTENTS I. INTRODUCTION... 1 II. WHAT ARE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES?... 1 III. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES VS. GENERALLY ACCEPTED AUDITNG STANDARDS... 1 IV. WHO CREATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES?... 2 A. The Securities and Exchange Commission... 2 B. The Financial Accounting Standards Board The FASB s Standard Setting Process The FASB s Emerging Issues Task Force The Standard Setting Process in a Political Environment... 6 C. The American Institute of Certified Public Accountants... 6 D. The Governmental Accounting Standards Board... 7 E. The International Accounting Standards Board... 8 V. CONCLUSION... 8 APPENDICES: The House of GAAP Financial Accounting Foundation Organizational Structure i

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7 UNDERSTANDING GENERALLY ACCEPTED ACCOUNTING PRINCIPLES AND THE STANDARD SETTING PROCESS I. INTRODUCTION In today s information-based business environment where current and potential investors frequently visit online chat rooms and bulletin boards to find investment opportunities, timely financial information is at a premium. However, recent accounting scandals have demonstrated that timely information is useless if it is not reliable and relevant. Through certain authoritative organizations, most notably the Financial Accounting Standards Board ( FASB or Board ), the accounting profession has developed a set of standards and procedures known as Generally Accepted Accounting Principles ( GAAP ) to ensure that financial information is not only timely but also reliable and relevant. This paper will discuss the purpose and structure of the authoritative organizations that establish the standards encompassed by GAAP as well as the process by which such standards are created. II. WHAT ARE GENERALLY ACCEPTED ACCOUNTING PRINCIPLES? Management has a fiduciary duty to a company s owners to manage the company s assets with care and trust. To satisfy its reporting responsibility, management typically prepares general-purpose financial statements. The Securities and Exchange Act of 1934 requires companies that issue securities to the public or are listed on a stock exchange to file audited financial statements to the Securities and Exchange Commission ( SEC ). 1 Financial statement users expect this information to accurately reflect the company s economic existence. To ensure that the financial statements are relevant and reliable, the FASB and other authoritative organizations have developed a common set of principles, rules, and procedures known as Generally Accepted Accounting Principles. GAAP is a conceptual framework that serves financial statement preparers, auditors and users alike. Without GAAP it would be almost impossible to prepare comparable financial statements across companies or industries. As such, the SEC has 1 Further, Section 302 of the Sarbanes -Oxley Act of 2002 ( Act ) requires that in every periodic report filed with the SEC each principal executive and financial officer must affirm, based on his or her knowledge, that the financials statements and other financial information included in the report fairly present in all material respects the financial condition, results of operations, and cash flows of the issuing company. 1 historically required its registrants to adhere to GAAP as set by the FASB and other authoritative organizations. GAAP is made up of a hierarchy of pronouncements and sources that have been considered authoritative. 2 The most authoritative pronouncements that constitute GAAP are FASB Statements and Interpretations, APB Opinions, and AICPA Accounting Research Bulletins. Often, specific accounting transactions are not covered by any of these documents. In such instances, other authoritative literature must be used. Other literature may include FASB Technical Bulletins, AICPA Industry Audit and Accounting Guides and Statements of Position. These documents have historically been considered GAAP and have had substantial authoritative support because recognized professional bodies have voted on their issuance. Therefore, financial statement users could rely on such documents to the extent that they do not contradict a more authoritative source of GAAP, such as FASB Standards. However, a problem does exist in that some standards are inconsistent with concept statements as well as each other. This problem was created by a large number of exceptions to standards that were allowed to satisfy certain constituencies. This is a problem that the FASB will certainly have to consider in the near future. 3 As will be discussed later, passage of the Sarbanes Oxley Act has clouded the view of which pronouncements are and are not considered authoritative. III. GENERALLY ACCEPTED ACCOUNTING PRINCIPLES VS. GENERALLY ACCEPTED AUDITNG STANDARDS GAAP provides management and audit committees the standards and conceptual framework for the preparation of financial statements. While it is management s responsibility to prepare the financial statements in accordance with GAAP, it is the job of the independent auditor to verify and to attest to the public that the financial statements are materially prepared in accordance with GAAP. 4 In the past, the Auditing Standards Board, which is part of the American Institute of Certified Public Accountants ( AICPA ), issued the professional standards that 2 See Appendix A 3 Similarly, many people feel that the Board should adopt one principle that all accountants should follow. That is the requirement to place economic substance over form in financial reporting. 4 Statement of Auditing Standards No. 69 requires auditors to opine as to whether the financial statements present fairly, in all material respects, an entity s financial position, results of operations, and cash flows in conformity with GAAP.

8 governed the audits of financial statements. 5 These standards are known as Generally Accepted Auditing Standards ( GAAS ). The Auditing Standards Board has issued approximately one hundred Statements of Auditing Standards ( SAS ), which are considered GAAS. Again, it is important to note that GAAS does not govern the preparation of financial statements and is not considered GAAP. Instead, GAAS governs areas of auditing such as technical competence, independence, fieldwork, and guidelines for communicating the auditor s findings to interested parties. In 2002, the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board ( PCAOB ). The PCAOB is a nonprofit organizationnot a U.S. government agency- whose primary responsibilities under the Act are: Inspect and register public accounting firms that prepare audit reports Establish, adopt, or modify auditing standards including standards on quality control, ethics, independence, and other standards Enforce compliance with the Act, the rules of the PCAOB, professional standards, and securities laws that relate to the issuance of audit reports Investigate potential violations of applicable auditing standards and impose sanctions for violations Set its budget and manage its operations SEC registrants and registered public accountin g firms fund the PCAOB. The Act gives the SEC the authority to appoint and remove the five members of the PCAOB. The SEC must approve all PCAOB rules and has the ability to modify or nullify such rules. Finally, the SEC has the authority to censure the PCAOB or its members, or to limit its activities, if it determines that doing so would be in the public s interest. In short, the PCAOB has replaced the AICPA as the audit standard setting body. The Act now gives the PCAOB the authority to set the standards that govern financial audits of public companies. However, the Act does not authorize the PCAOB to promulgate GAAP. It also mandates that the PCAOB convene expert advisory groups to make recommendations concerning auditing, quality control, ethics, independence, or other standards. The PCAOB has recently announced its intention to establish new professional auditing standards. 6 On April 18, 2003, the PCAOB announced that it has 5 A more detailed discussion of the AICPA is presented later. 6 PCAOB Release No determined that GAAS promulgated by the AICPA should be adopted as Interim Auditing Standards. 7 Accordingly, registered accounting firms are required to comply with the Interim Auditing Standards in the performance of financial statement audits. Finally, the SEC has stated that it will not accept an audit report on the financial statements unless that report states that the audit was conducted in accordance with GAAS in the United States. 8 While recent events have brought much scrutiny to the auditing profession and the U.S. Congress has created a new entity to govern the auditing industry, it is important to remember GAAS and Professional Auditing Standards are not considered GAAP. Simply put, GAAP governs the preparation of financial statements while GAAS and Professional Auditing Standards govern the work of independent auditors who attest to the accuracy of those financial statements. IV. WHO CREATES GENERALLY ACCEPTED ACCOUNTING PRINCIPLES? Numerous organizations play a part in the development of financial accounting rules in the United States and abroad. The major organizations are: The Securities and Exchange Commission The Financial Accounting Standards Board The American Institute of Certified Public Accountants The Governmental Accounting Standards Board The International Accounting Standards Board A. The Securities and Exchange Commission Prior to the stock market crash of 1929, the disclosure of financial information was limited and there was little support for regulation of the securities markets. As a result, the federal government created the SEC 9 - a federal agency- to help develop and standardize financial information presented to stockholders. The SEC administers the Securities Exchange Act of 1934, among others. It also has broad powers to prescribe, in whatever detail it deems appropriate, the methods to be followed in the preparation of accounts and the form and content of financial statements filed by companies that fall within its jurisdiction. While the SEC filing requirements and accounting opinions are not necessarily considered GAAP, they are authoritative to all companies within 7 PCAOB Release No Ibid. 9 The SEC is made up of five presidentially-appointed Commissioners, four Divisions and eighteen offices.

9 the SEC s jurisdiction. The SEC filing requirements and accounting opinions are detailed in the following: Financial Reporting Releases Regulation S-X, 10 and Decisions on cases brought before the SEC The SEC s Division of Corporate Finance oversees corporate disclosure of information to investors. It provides interpretation of the Securities Act of 1933 and the Securities Exchange Act of 1934 and recommends regulations to administer these statutes. The Division of Corporate Finance also monitors the activities of the FASB. Historically, the partnership between the SEC and the private sector has worked reasonably well. The SEC has generally relied upon the Board and the AICPA to regulate the accounting profession. The SEC has had a varied involvement in establishing GAAP. At times, the SEC has refused to accept standards established by the FASB. In other instances, the SEC has prodded the Board to take quicker action on certain reporting issues, such as accounting for stock options. 11 In still other instances, the SEC has provided the FASB with counsel and advice upon request. Because the SEC has the mandate to establish accounting principles, the private sector, mainly the FASB, must listen carefully to the SEC s views. Section 108 of the Sarbanes-Oxley Act specifies, among other things, the criteria that must be met in order for the SEC to recognize a standard setter s work product. On April 25, 2003, the SEC announced that it would continue to recognize the pronouncements of the FASB as being generally accepted. 12 As a result, registrants are required to comply with the financial accounting and reporting standards set by the Board 13 in preparing financial statements filed with the SEC. 14 However, at this time, the SEC has not commented on less authoritative literature historically accepted as GAAP (e.g. AICPA Industry Accounting and Auditing Guides and SOPs). 15 The SEC s silence on such pronouncements has left the public accounting profession in a precarious position. The SEC also has the authority to enforce the adherence to accounting standards by public U.S. 10 Regulation S-X sets forth the form and content of and requirements for financial statements filed with the SEC. 11 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, SEC Press Release Financial accounting and reporting standards set by predecessors of the Board that have been recognized by the Board are thought to be accepted by the SEC as well (i.e. APB Opinions and AICPA Accounting Research Bulletins). 14 SEC Release See Appendix A 3 companies. If the SEC believes that an accounting or disclosure problem exists regarding the financial statements of a company within its jurisdiction, it normally issues the company a deficiency letter. If the issue is not resolved, the SEC has the power to prevent the registrant from issuing securities or trading on the stock exchanges. B. The Financial Accounting Standards Board The FASB is a private sector organization that is independent of all other business and professional organizations. Its purpose is to promulgate and improve financial accounting and reporting standards for the guidance and education of issuers, users of financial information, and auditors. 16 Although this function legally resides with the SEC for public companies, the SEC has traditionally provided the private sector with the opportunity for self-regulation. Since 1973, the SEC has relied on the Board for standard setting. The Wheat Committee, a study group formed in 1971 by leaders of the accounting profession, created the FASB in The Wheat Committee examined the organization and operation of the FASB s predecessor, a board created by the AICPA known as the Accounting Principles Board ( APB ). The Wheat Committee submitted its recommendations to the AICPA Council in Those recommendations were adopted in total and implemented in The Wheat Committee s recommendations resulted in the creation of a new standard-setting structure. This structure was composed of three organizations - the Financial Accounting Foundation ( FAF ), the FASB, and the Financial Accounting Standards Advisory Council ( FASAC ). 17 The FAF is the Board s parent organization. 18 It is comprised of independent trustees 19 and is responsible for oversight of the FASB, the appointment of FASB members, and the selection of FASAC members. The FASAC is an operating arm of the FAF that consults with the FASB on major policy and technical issues. Its thirty-three members are drawn from the ranks of CEO s, CFO s, senior See Appendix B 18 The FAF is incorporated to operate solely for charitable, educational, scientific and literary purposes within the meaning of Section 501 (c)(3) of the Internal Revenue Code. 19 A sixteen member Board of Trustees runs the FAF. Eleven members of the FAF s Board of Trustees are nominated by eight organizations: the AICPA; the American Accounting Association; Association for Investment Management and Research; Financial Executives International; Government Finance Officers Association; Institute of Management Accountants; National Association of State Auditors, Comptrollers and Treasurers; and Securities Industry Association. The Board of Trustees selects five additional, long-term, trustees.

10 partners of accounting firms, senior members of academia, as well as leaders of professional organizations. The FASB is composed of seven members who are required to sever all connections with firms or other institutions that they served prior to joining the Board. The FAF appoints each Board member to renewable five-year terms. The following people are members of the FASB as of June 30, : Robert H. Hertz, Chairman G. Michael Crooch John M. Foster Gary S. Schieneman Katherine Schipper Edward W. Trott John K. Wulff In the past, the FAF was responsible for the funding of the FASB. These funds came from the AICPA, large accounting firms, large corporations, and the sale of public ations. However, the Sarbanes Oxley Act provided that a mandatory fee on all public companies fund the FASB. While the Act calls for mandatory funding for the FASB, it does not intend to federalize it or subject it to political pressures. 21 It is not possible to determine at this time whether this arrangement will be successful. 1. The FASB s Standard Setting Process The Board operates through an open decisionmaking process. Basically, the FASB s two major premises regarding the standard setting process are that (1) it should be responsive to the entire economic community and not just the public accounting industry, and (2) it should operate through an extensive due process system that is open to public observation and participation. 22 The FASB receives many requests for action on accounting and reporting issues from various members of the business community as well as from the SEC. These requests for action include new topics as well as suggested review or reconsideration of existing pronouncements. The FASB stays current to financial reporting trends through its observation of published reports and discussions with the Emerging Issues Task Force ( EITF ), which will be discussed later in more detail. The Board looks to various other organizations and groups for advice on certain matters including its f htm 22 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, technical agenda. 23 The Board then makes its own decisions regarding its agenda. When evaluating proposed topics for purposes of its agenda, the FASB considers factors such as the pervasiveness of the issue, technical feasibility, practical consequences, available resources, and available expertise. 24 Once a major project is added to the FASB s technical agenda, a task force is appointed that meets with the Board and its staff to assist in the definitio n and scope of the project. The task force is typically comprised of financial statement preparers and users, auditors, and experts from other disciplines who are knowledgeable about the subject matter. Before the Board deliberates on a new issue, it typically asks its staff to prepare a discussion memorandum. The task force usually provides significant assistance with this effort. The discussion memorandum generally defines the issue and the scope of the project, discusses research findings, and presents alternative solutions to the issue along with arguments and potential implications relative to each. 25 The discussion memorandum is then issued for public comment before the Board begins its deliberations. The FASB often holds a public hearing, usually sixty days after the discussion memorandum is made public, to evaluate the public s viewpoints and response. 26 After the Board has analyzed the public s response to the discussion memorandum, it deliberates on the issues and then votes on whether or not to issue an exposure draft. A written vote is taken amongst the seven-member Board. Approval of the document requires a minimum of four votes. The exposure draft explains the proposed accounting standard, the background information, the standard s proposed effective date, the transition method, and the basis for the FASB s conclusions. Sometimes, the Board will hold a public meeting to gather information and viewpoints from constituents who participated in the comment process. A period of time is allowed for the Board to receive comments and position papers from the public. The FASB uses this time to gather new information and persuasive arguments from the public regarding the issues. The Board members then review the comment letters and consider the information in reaching conclusions. Public recommendations are often incorporated in the final document. If the Board 23 The FASB sometimes makes agenda proposals available for public comment as part of the agenda process. Also, the FASAC regularly reviews the Board s agenda priorities and provides consultation on all major projects added to the technical agenda Ibid. 26 Any organization or person can request to be heard at a public hearing. The Board tries to accommodate all public requests.

11 believes that major modifications are necessary, it will issue a revised exposure draft for more public comments. In the past, users have not communicated with the Board as frequently and effectively as many would like. Many users do not have as much time, interest, and resources to participate in the exposure draft process as large financial statement preparers and auditors have. Recently, the Board has approached mutual funds, investment and commercial banks, rating agencies, and other groups to gather nominations for a user advisory council in the hopes of obtaining more frequent and effective input from users. 27 When the Board believes that it has considered all reasonable alternatives, it votes on the final document. Again, four votes are required to adopt a pronouncement. 28 Normally, a Statement of Financial Accounting Standards ( SFAS ) is the product of the Board s technical projects. A SFAS is among the most authoritative pronouncement and is considered GAAP. 29 It includes much of the same information included in the exposure draft such as the actual standards, the method of transition to the new standard, the effective date, the background information, a summary of research performed, and the basis for the Board s conclusions. A SFAS also identifies which Board members voted for and against the standard as well as reasons for any dissenting votes. 30 In addition to SFAS, the Board issues other types of pronouncements. For example, the FASB sometimes issues Interpretations. Interpretations represent changes to or extensions of existing standards. Interpretations are considered authoritative GAAP 31 and require the same votes for passage as standards although the FASB is not required to operate in such a public forum as is necessary for the passage of a SFAS. Also, the Board s staff may issue guidance that deals with issues relating to the implementation of existing standards or other problems that may arise in practice. This guidance is issued in question-andanswer form and is considered GAAP although it is thought of as among the least authoritative 32 (i.e. more authoritative pronouncements such as SFAS supersedes implementation guides) f htm 28 The FAF recently changed the approval requirement for exposure drafts and final statements from five votes to four votes to improve the Board s timeliness in its reaction to the investing community s needs. 29 See Appendix A The FASB s predecessor, the APB also issued Interpretations of APB Opinions prior to the creation of the FASB. Both APB and FASB Interpretations are currently considered authoritative GAAP. 32 See Appendix A 5 In a rapidly changing business environment, a need exists for instruction on the application of FASB standards. For example, tax law changes can cause accounting and reporting problems; and companies look to the FASB for guidance. On such occasions, the Board will issue Technical Bulletins when it does not cause a major change in the accounting practice, is reasonable to implement, and does not conflict with fundamental accounting principles. Technical Bulletins are considered authoritative GAAP. The FASB also establishes Statements of Financial Accounting Concepts. Financial Accounting Concepts provide a framework for the Board in developing future standards. These concepts are designed to provide a consistent foundation for setting standards and useful tools for solving problems. 33 This conceptual framework is not considered authoritative GAAP, but because of its long-term importance, the FASB uses the same due process system to establish Financial Accounting Concepts as it does SFAS. 2. The FASB s Emerging Issues Task Force The FASB created the EITF in The EITF is made up of thirteen members from public accounting firms and financial statement preparers, and meets publicly six times a year. Members of the SEC and AICPA regularly attend EITF meetings. Task force members are thought to be in a position to identify emerging issues within the financial reporting community before they become widespread. As previously mentioned, the EITF assists the FASB with its technical agenda. The EITF identifies oftencontroversial accounting problems as they arise and determines whether they can be quickly resolved or whether the FASB should become involved. 34 If the EITF believes a problem can be quickly resolved, it will consider the issue. If the EITF can reach a consensus regarding how to resolve the problem, it will issue and Emerging Issues Task Force Statement. A consensus is reached when no more than two of the thirteen members object. An Emerging Issues Task Force Statement is considered GAAP. The EITF plays a significant role in the establishment of authoritative standards. For example, in a recent year, the EITF examined sixty-one emerging accounting and reporting issues and arrived at a consensus on approximately seventy five percent of them. 35 The EITF s focus on short term emerging issues allows the FASB to concentrate on more pervasive long-term problems. However, there is some thought that the FASB intends to take more responsibility for all aspects of accounting standards setting. It is likely that the EITF Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, Ibid.

12 may begin to function more as an implementation group for FASB principles and less as an auxiliary standards setter The Standard Setting Process in a Political Environment While the FASB is an independent organization, it does not operate in a vacuum. The standard setting process occurs in a public forum and is as much a product of political action as it is logic and empirical findings. 37 For example, the FASB chairman recently denounced the U. S. Congress efforts to block the Board s decision to require companies to expense employee stock options. Some members of Congress fear that a requirement to expense employee stock options would deter companies from using them and cost jobs. When the FASB tried to require the expensing of options a decade ago, Congress threatened to strip the FASB of its powers but the FASB subsequently backed down at the urging of Arthur Levitt, Jr., the SEC chairman at that time. Currently, Congress is considering a bill to get the SEC to study the stock option issue for three years. Many people in the financial and accounting communities fear that Congress actions would prompt others to seek political intervention in the FASB s future activities. Others fear that if Congress attempts to override the FASB s decisions, accounting standards will lose consistence, coherence, and credibility. 38 While the Board must pay attention to its constituencies, it must base it standards on sound research and a conceptual framework that is based on economic reality. Even so, the FASB can continue to expect to work in an environment filled with political and special interest pressures. 39 C. The American Institute of Certified Public Accountants The American Institute of Certified Public Accountants is the national professional organization for practicing CPAs. The AICPA and its predecessors have served the accounting profession since Currently, it boasts over 333,000 regular members. 40 Its primary purpose is to respond to the needs of CPAs in public practice. The AICPA created the Committee of Accounting Procedure ( CAP ) in 1939 at the urging of the SEC f htm 37 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, During its existence from 1939 to 1959, the CAP issued fifty-one Accounting Research Bulletins ( ARBs ) dealing with a variety of accounting issues of the time. All ARBs that were in effect when the FASB was created in 1973 continue to be authoritative and are still considered GAAP unless they have been amended or superseded by the Board. The CAP operated under a reactive problem-by-problem approach that failed to provide a structured and consistent body of accounting principles. Therefore, in 1959 the AICPA created the Accounting Principles Board. The APB was composed of eighteen to twentyone members pulled mostly from public accounting. It focused on creating written accounting principles, determining appropriate accounting practices, and resolving areas of inconsistency in practice. To accomplish its objectives, the APB s mission was to create a conceptual framework that would resolve accounting problems as they became evident and perform substantive research on issues on which to base pronouncements. 41 Early in its existence, the APB came under fire by the accounting profession for a lack of productivity and for failing to promptly respond to alleged accounting abuses. The APB was regularly faced with industry opposition and occasional government interference. Between the APB s formation in 1959 and its dissolution in 1973, it issued thirty-one official pronouncements known as APB Opinions. 42 APB Opinions that have not been amended or superseded by the FASB are still considered GAAP. For much of its history, the AICPA provided leadership in the development of accounting principles, regulated the accounting profession, and enforced public accounting practices. When the FASB was established, the AICPA s primary publications and standard-setting activities became constrained to auditing issues. It created the Accounting Standards Division to influence the form and content of pronouncements issued by the FASB and other bodies with authority over accounting and reporting standards. The AICPA s Accounting Standards Division created the Accounting Standards Executive Committee 43 ( AcSEC ) within the division to act as the AICPA s official spokesperson regarding financial accounting and reporting standards. Historically, the AcSEC accomplished its goal through various written documents. First, the AcSEC published Audit and Accounting Guidelines, which provide guidance on industry-specific issues not addressed by the FASB to 41 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, Ibid. 43 The AcSEC is composed of fifteen members selected from public accounting firms, industries and academia.

13 auditors in examining and attesting to financial statements covering various industries and also to financial statement preparers. Second, the AcSEC published Statements of Position ( SOPs ). SOPs provide guidance on financial reporting issues until the FASB sets standards on the topics in question. They can update, revise, and clarify Audit and Accounting Guidelines or provide freestanding guidance. 44 Typically, Audit and Accounting Guidelines and SOPs are considered GAAP and considered authoritative unless a FASB pronouncement states otherwise. However, as previously mentioned, the SEC has not yet commented on whether it believes such pronouncements are considered generally accepted under the Sarbanes Oxley Act. Therefore, there is no definitive answer as to whether such AICPA pronouncements are currently considered GAAP. Finally, the AcSEC published Practice Bulletins, which address certain narrow reporting or accounting issues not considered by the FASB. Recent events not withstanding, Practice Bulletins are considered GAAP although they are less authoritative than other AICPA publications in the GAAP hierarchy. 45 The AcSEC also publishes other non-authoritative publications. For example, the AcSEC publishes Issues Papers that provide information on financial accounting and reporting issues it believes the FASB should consider and provide guidance to resolve. Also, Letters of Comment are published to communicate the AcSEC s views on financial accounting and reporting proposals issued by groups outside of the AICPA. 46 In November 2002, in cooperation with the FASB, the AICPA agreed to focus on industry-specific accounting and auditing guidance and to no longer publish general purpose SOPs. This decision was made to achieve the mutual goal of creating principlebased accounting standards in the United States. The AcSEC continues to speak for the AICPA regarding financial reporting matters, continues to publish Audit and Accounting Guidelines, and continues to help the financial statement preparer community and CPAs in public practice. The AICPA, through the AcSEC, also continues to develop comment letters to the FASB and to the International Accounting Standards Board on proposed new standards and continues to assist its members by applying accounting guidance. 47 The AICPA continues to develop and enforce professional ethics and provides the accounting profession with continuing professional education. Further, the AICPA develops, administers, and grades the CPA examination, which is given in all fifty states. 44 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, See Appendix A 46 htm 47 AcSEC UPDATE, Vol. 7 No. 2- February An alphabet soup of standard setting exists today. However, the Sarbanes Oxley Act and subsequent actions taken by the SEC, FASB and AICPA have led to a reduction in the number of standard setting groups. Although it is currently somewhat unclear as to what pronouncements are considered authoritative, a reorganization of the current process is probably necessary to increase public confidence in the standard setting process. D. The Governmental Accounting Standards Board Financial Statements issued by state and local governments are not necessarily comparable with financial statements issued by private companies. For example, many government entities have relied on a simple cash basis of accounting instead of an accrual basis, which is required by GAAP. During the 1970 s, this lack of comparability was highlighted when a number of large U.S. cities faced potential bankruptcy. Therefore, the Governmental Accounting Standards Board ( GASB ) was formed in 1984 by the FAF to establish financial accounting and reporting standards for state and local governments. 48 The GASB is the successor to the National Council on Governmental Accounting ( NCGA ). 49 The GASB shares many organizational and procedural similarities with the FASB. For example, both boards are arms of the FAF. The FAF is responsible for selecting members of both boards and their advisory councils. Further, the FAF exercises general oversight for both board s activities. The GASB s mission is to establish and improve standards of state and local governmental accounting and reporting that will result in useful information for financial statement users and to educate the public, including issuers, auditors and users alike. 50 The Governmental Accounting Standards Advisory Council ( GASAC ) was created to consult with the GASB on matters such as technical issues, project priorities, and selection and organization of task forces. The GASB operates under the same open decision-making process as is used by the FASB. The due process followed by the GASB is designed to permit timely, thorough and open study of financial accounting and reporting issues by financials statement preparers, auditors, and users. 51 The GASB publishes Statements of Governmental Accounting Standards, which set forth the actual standard, the effective date and method of transition, the background information, and the reasons for 48 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, It is important to note that NCGA standards remain in force unless amended or superseded by the GASB

14 rejecting significant alternative solutions, among other things. Statements of Governmental Accounting Standards are considered authoritative. Also, the GASB produces Statements of Governmental Accounting Concepts, which do not establish new standards, but provide guidance in solving problems. Because of their long-range importance, Statements of Concepts are developed under the same extensive due process the GASB follows in establishing Statements of Governmental Accounting Standards. 52 Finally, the GASB issues authoritative Technical Bulletins and question-and-answer formed Special Reports on narrowly defined subject matter, just like its counterpart the FASB. E. The International Accounting Standards Board Accounting standards are not necessarily consistent throughout different parts of the world. For example, under international standards, intangible assets (e.g. patents, trademarks, etc.) are amortized up to twenty years. In the United States, intangible assets with finite lives are amortized over their useful lives while those with indefinite lives are not amortized at all. In Mexico, assets are adjusted for changes in price-levels. In the United States, assets are typically recorded at historical cost. 53 These types of differences in reporting practices led to the creation of the International Accounting Standards Committee in 1973, the same year the FASB was created. Its purpose was to attempt to narrow the areas of divergence between the accounting standards of different countries. In March 2001, the IASC Foundation was incorporated in Delaware as a not-forprofit corporation. The IASC Foundation is the parent entity of the International Accounting Standards Board ( IASB ), based in London, UK. Effective April 1, 2001, the IASB assumed accounting standard setting responsibilities for its predecessor, the International Accounting Standards Committee. 54 The IASB Foundation is an independent organization made up of two bodies, the trustees and the IASB 55, as well as the Standards Advisory Council, and the International Financial Reporting Interpretations Committee. The IASC Foundation trustees exercise oversight and fund the IASB, as well as appoint IASB members. The IASB is solely responsible for its technical agenda and setting international accounting and reporting standards. 52 Ibid. 53 Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York, The IASB is made up of fourteen members (twelve fulltime members and two part-time members) from nine countries that have a variety of business backgrounds. 8 Financial reporting standards published by the IASB are known as International Financial Reporting Standards ( IFRS ). The publication of an IFRS requires an approval of at least eight of the fourteen board members. The IASB has also adopted the body of accounting standards issued by its predecessor, the International Accounting Standards Committee. Those pronouncements continue to be designated International Accounting Standards ( IAS ) and are authoritative. 56 In many countries, stock exchange listing requirements or securities legislation permits foreign companies that issue securitie s in those countries to adhere to International Accounting Standards. Some examples are Australia, Germany and the United Kingdom. However, other countries do not allow companies to use IAS without reconciliation to domestic GAAP. This requirement applies in countries such as the United States, Hong Kong, and Canada. 57 Recently, more than ninety countries, in Europe and elsewhere, decided to either require or permit the use of IFRS during the next five years. This means that thousands of companies throughout the world will transition to the international rules and break away from national practices and standards. Similarly, the FASB and IASB have recently agreed to work together toward greater convergence between U.S. GAAP and international standards. 58 Many people believe this is a positive step for investors. It is thought that a reduction in the differences between the two widely used set of standards will benefit users of financial information. However, U.S. GAAP is thought to be overly rule-based, whereby international standards are more principle-based. Further, the United States is generally viewed to have the most rigorous and comprehensive standards in the world. Thus, while it may be important to move toward a single set of accounting standards worldwide, those standards must remain that of high quality. Currently, both the FASB and IASB are working towards developing a set of common principles that each national standards-setter could agree to and then interpret for the issues of its own country. 59 V. CONCLUSION The FASB is in its thirtieth year of existence. In that time the Board has had to juggle political pressures and the needs of its constituents, namely financial statement users. Now more than ever, the accounting profession is challenged by people in government, people in the financial community, and even some in Ibid htm

15 the profession to assume more responsibility and to react quicker to the needs of financial statement users. While the accounting profession does have identifiable shortcomings, it is trying to develop and maintain high standards. Due to the significant expertise and resources available to the private sector, most notably the FASB, the accounting profession should be able to continue to develop its own standards without significant intervention from government or other organizations. 9

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17 Appendix A The House of GAAP The House of GAAP Least Authoritative FASB Concepts Statements; AICPA Issues Papers; International Accounting Standards Board IFRS; International Accounting Standards Committee IAS; GASB Statements, Interpretations, and Technical Bulletins AICPA Accounting Interpretations and Implementation Guides Questions and Answers published by FASB staff Prevalent industry practices AICPA AcSEC Practice Bulletins* FASB Emerging Issues Task Force Consensus Positions AICPA Industry Audit and Accounting Guides* AICPA Statements of Position* FASB Technical Bulletins Most Authoritative FASB Statements ( ) FASB Interpretations ( ) AICPA APB Opinions ( ) AICPA Accounting Research Bulletins ( ) 1973 GAAP rests on a foundation of basic concepts and broad principles such as the going concern assumption, substance over form, the accrual basis, conservatism, and materiality. * AICPA *AICPA Industry industry Audit audit and and Accounting accounting Guides, guides, AICPA statements SOPs, and of AICPA position, Practice and AICPA Bulletins practice have bulletins historically are only been included in the hierarchy included only in if the hierarchy FASB has if cleared the FASB the has pronouncements. cleared the pronouncements. Further, the SEC s has not currently stated whether such literature is currently considered authoritative under Section 108 of the Sarbanes Oxley Act of NOTE: If the accounting treatment of a transaction or event is not specified by a pronouncement in Category A (first floor), the auditor should consider whether one or more sources in category (b), (c), or (d) is relevant to the circumstances. The auditor should be prepared to justify a conclusion that another treatment is generally accepted. One should follow the treatment specified by the most authoritative source if there is a conflict between accounting principles relevant to a certain If there transaction. is a conflict If between one follows accounting the treatment principles specified relevant to by the a less circumstances authoritative from source, one or more one sources should in be category prepared (b), to (c), justify or (d), the the auditor should follow the treatment specified by the source in the more authoritative category for example, follow category (b) conclusion treatment that over the chosen category treatment (c) or be better prepared presents to justify the a substance conclusion of that the a transaction treatment specified under by the a circumstances. source in the less authoritative category better presents the substance of the transaction in the circumstances. Becker, Becker Conviser CPA Review- Financial Reporting, DeVry/Becker Educational Development Corp., Canada, 2002, Page F1-5 11

18 Appendix B Financial Accounting Foundation Organizational Structure Financial Accounting Foundation (FAF) The FAF s purpose is to select members of the FASB and GASB and their Advisory Councils and exercise general oversight. Financial Accounting Standards Board (FASB) The FASB s purpose is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers, auditors and users of financial information. The SEC has recognized pronouncements issued by the FASB as generally accepted under the Sarbanes Oxley Act of Governmental Accounting Standards Board (GASB) The GASB s purpose is to establish and improve standards of financial accounting for state and local government. Staff and Task Forces Purpose: To assist respective Boards on reporting issues by performing research, analysis, and writing functions. The role of certain task forces, such as the EITF, may change due to the FASB s effort to take more responsibility for all aspects of accounting standards - setting. Financial Accounting Standards Advisory Council (FASAC) The FASAC s purpose is to consult on major policy issues, technical issues, project priorities and selection and organization of task forces. Governmental Accounting Standards Advisory Council (GASAC) The GASAC s purpose is to consult on major policy issues, technical issues, project priorities and selection and organization of task forces. Donald E. Kieso and Jerry J. Weygandt, Intermediate Accounting, 9 th ed., Wiley, New York,