FASB and Standard Setting

The Securities and Exchange Commission (SEC)

A federal government agency that administers the securities laws of the United States. These laws affect firms that issue debt and equity securities to the public. Such firms register with the SEC and are called registrants. The financial statements of these firms must be filed with the SEC and must be audited by independent third parties (CPA firms). Has authority to establish GAAP for the firms within its jurisdiction (publicly traded firms) Gave this authority to a private sector body (currently, the FASB) SEC also has pressured the FASB to establish certain principles more quickly.

Recognition

A recognized item is recorded in an account and ultimately affects the financial statements.

Wheat Committee

Appointed by AICPA in 1971 Recommended the formation of yet another private sector body—the FASB—to take over the reins from the APB

FAF

Appoints the members of the FASB and its advisory councils, ensures adequate funding for the FASB, and exercises oversight over the FASB. Funding sources include fees levied on publicly traded firms under the Sarbanes-Oxley Act, contributions, and publication sales. The trustees of the FAF are appointed from organizations with an interest in accounting standards.

Disclosure

Many unrecognized amounts are reported in the footnotes to complete the portrayal of the firm's financial position and performance.

The American Institute of Certified Public Accountants (AICPA)

National professional organization for practicing CPAs Has had a great impact on accounting principles over the years. Mission = provide its members with resources, information, and leadership so that they may in turn provide valuable services for the benefit of their clients, employers, and the general public.

Enforcement of GAAP/Methods of Enforcement

1. Accounting standards are not laws; they are not determined by legislatures but rather by private sector bodies. They are generally accepted. 2. The private-sector bodies that contribute to the formulation of GAAP have no enforcement authority --> there are economic sanctions for firms not complying with GAAP. These sanctions include increased difficulty in raising debt and equity capital. 3. The SEC does have authority to penalize firms and managers subject to its jurisdiction when financial statements do not comply with GAAP. Public companies are violating the securities laws if they publish financial statements that materially depart from GAAP. 4. The SEC sends a deficiency letter to a registrant when an accounting irregularity is found. If the firm disagrees, the SEC may issue a "stop order" preventing trading in the firm's securities until the disagreement is resolved. Outright violations of the securities laws may result in criminal sanctions against managers or fines against the company. 5. The enactment of the Sarbanes-Oxley Act of 2002 significantly affects enforcement procedures relating to audits of public companies and penalties for noncompliance with GAAP.

FASB applies the following principles:

1. Accounting standards should be unbiased and not favor any particular industry; standards are for the benefit of financial statement users; 2. The needs and views of the economic community should be considered; the views of the accounting profession should not take precedence; 3. The process of developing standards should be open to the public and allow due process to provide opportunity for interested parties to make their views known; 4. The benefits of accounting standards should exceed their cost.

FASB Uses the Following Process when Issuing an Accounting Standard

1. Considers whether to add a project to its agenda, in consultation with the FAF—the FASB receives many requests from its constituencies including the SEC, auditing firms, investors, and reporting firms to address new financial reporting issues and clarify existing standards 2. Conducts research on the topic and issues a Discussion Memorandum detailing the issues surrounding the topic; the FASB's conceptual framework plays a role in this process by providing a theoretical structure for guiding the development of a specific standard 3. Holds public hearings on the topic 4. Evaluates the research and comments from interested parties and issues an Exposure Draft—the initial accounting standard 5. Solicits additional comments, modifies the Exposure Draft if needed 6. Finalizes the new accounting guidance and approves with a majority vote (four of seven affirmative votes) 7. Issues an Accounting Standards Update (ASU). The section on FASB Codification discusses the nature of an ASU in greater detail

The mission of the FASB (in brief) is to:

1. Improve the usefulness of financial reporting 2. Maintain current accounting standards 3. Promptly address deficiencies in accounting standards 4. Promote international convergence of accounting standards 5. Improve the common understanding of the nature and purposes of information in financial reports.

User groups (e.g., industry associations, financial institutions) influence the outcome of FASB standards by

1. Making their views public through the financial press 2. Providing input during the due process procedure 3. Putting pressure on the SEC directly to change a proposed standard, or through the U.S. Congress

ARBs and GAAP

CAP issued 51 Accounting Research Bulletins (ARBs). To the extent that an ARB has not been rescinded or superseded, it constitutes GAAP.

Committee on Accounting Procedure (CAP)

Created by AICPA in 1939 First private sector body charged with the responsibility of promulgating GAAP Issued 51 Accounting Research Bulletins (ARBs)

Accounting Principles Board (APB)

Created by AICPA in 1959 A committee that was to take over the work of CAP Second private sector group designated to formulate GAAP Members were required to be CPAs. The APB issued 31 opinions, many of which remain as GAAP, in whole or in part.

Financial Accounting Standards Board (FASB)

Currently the standard-setting body in the United States Seven full-time members with renewable (for one additional term) and staggered 5-year terms. Subject to FAF policies and oversight. Members cannot have employment or investment ties with other entities. Members need not be CPAs although typically the public accounting profession is represented; also the preparer (reporting firm) and investor communities are represented.

FASB

Establishes financial accounting standards for business entities. FASB is an independent body, subject only to the FAF.

Current accounting standard-setting mechanism in the United States

FAF FASB FASAC

Parties interested in the outcome of the standard-setting process

Firm managers (referred to as "preparers" or "preparer firms") often prefer standards with lower compliance costs and that tend to portray their firms in a more positive light (higher earnings and assets, lower liabilities). Financial statement users prefer unbiased, transparent reporting. They want the facts. Investors also want conservative reporting-disclosure of less positive results under conditions of uncertainty or where the firm has a choice of reporting alternatives under GAAP.

AICPA and FASB

In 1973, the FASB assumed the role of standard setter for the accounting profession. FASB is not affiliated with the AICPA.

Emerging Issues Task Force (EITF)

Part of FASB Formed to consider emerging reporting issues and to accelerate the process of establishing rulings on such issues. Acts as a "filter" for the FASB, enabling the FASB to focus on more pervasive issues. When a consensus of the 15 members is reached on an issue, no further action by the FASB is required. Pronouncements are included in GAAP. If unable to reach a consensus, FASB may become involved, ultimately revising an existing standard or adopting a new one.

FASAC

Provides guidance on major policy issues, project priorities, and the formation of task forces.

What GAAP Addresses

Recognition Measurement Disclosure

Recognition vs. realization

Recognition is an accounting concept that indicates that the item is recorded on the financial statements. Realization is an economic concept that indicates that cash is paid or received. GAAP focuses on accrual accounting and therefore is concerned with recognition more than with realization.

Generally Accepted Accounting Principles (GAAP):

The rules of financial reporting for business enterprises A type of regulation, imposed on the economic system by its constituents. --> without them, the economy and capital markets would not work Essentially, all companies that rely on external sources of capital require financial statements and, therefore, must comply with GAAP.

Measurement

an accounting concept that indicates that the item is recorded on the financial statements

FASB conceptual framework

the collection of Statements of Financial Accounting Concepts (SFACs) a "constitution" or underlying set of theoretical concepts in its deliberations