Chapter 3: Development of the Institutional Structure of Financial Accounting

Historical background in USAHow FASB differs from

CAPAPB

Standards setting processInstitutional problems facing FASBSarbanes-Oxley ActLiability crisis

Periods of Accounting Development

Pre 1930

1930-46

1946-59

1959-present

Accounting largely unregulated

Formative years, initiated by 1929 stock market crash

Post-war period

Modern period

Accounting in USA prior to 1930

UnregulatedAccounting practices and procedures used were considered confidential, lack of uniformityBankers and other creditors provided the only real direction in accounting practices Little investment in private corporations until post World War I lump-sum retirement of Liberty Bonds fueled the ”people’s capitalism”

Key Events in USA prior to 1930

1886: American Association of Public Accountants (AAPA) formed1896: AAPA plus another group, The Institute of Bookkeepers and Accountants, were both behind the successful passage in New York State of the law that created the professional designation of “Certified Public Accountant.”

Key Events in USA prior to 1930

1905: The Journal of Accountancy founded by AAPAAmerican Institute of Accountants (AIA) was formed in 1916 from the old AAPA

took a unified national outlook relative to issues such as examinations and qualifications name later changed to the American Institute of Certified Public Accountants (AICPA) in 1957

Stock Market Crash of 1929

Investors began to question the adequacy of accounting and reporting practicesAccounting reports

Based on widely varying accounting practicesFrequently misleading

Formative Years: 1930-36

NYSE/AICPA1933: AICPA formed Special Committee on Development of Accounting PrinciplesCooperative effort to develop accounting principles to be followed by all companies1st formal attempt to develop GAAPConcept allowed corporations to choose those methods and procedures most appropriate for them within GAAP

Formative Years: 1930-36

Securities & Exchange Commission (SEC)Created in 1934 to administer the Securities Act of 1933Eventual message (April 25, 1938) was that unless the profession established an authoritative body for the development of accounting standards,

• the SEC would do so and • SEC would mandate the required reports

Formative Years: 1936-46

Committee on Accounting Procedures (CAP) formed 1936

Used primarily inductive approach to developing accounting rulesAAA preferred a deductive approach

Uniformity improved significantlyPrivate sector was firmly established as the source for accounting policy making in the USA

Postwar Period: 1946-59

Number of stockholders in USA

1940: 4 million1952: 7 million1962: 17 million

Primary problem of comparability of earnings among different companies

Postwar Period: 1946-59

Committee on Accounting Procedures (CAP)

Created an ”oversupply” of ”good” accounting principlesDevoted its time to solving problems on a piecemeal approach without developing fundamental principles of accountingNo underlying accounting theoryConflicts with the SEC

Modern Period: 1959-present

1959-73: APB and Accounting Research Division

APB form similar to CAPAccounting Research Division published Accounting Research Studies (ARSs)Criticisms of APB opinions

1972-73: Wheat and Trueblood Committee Reports

Modern Period: 1959-present

1973-present: FASBIndependent of AICPAWas to establish standards in the most efficient and complete manner possibleLaunched the conceptual framework projectOperations differ from CAP and APB

FASB’s organizational structure...

THE CONSTITUENCY

The Foundation (FAF)

Sponsoring Organizations

Explain and Seek Views

Explain and Seek Views

Discuss & Express Views

Nominations from Sponsors Elects

Board of Trustees of FAF

Funds Select Oversee

The FASB Financial Accounting StandardsAdvisory Council (FASC)

Appoint & Fund

Compare CAP, APB, and FASB

Independence CAP APB FASB

OrganizationPart ofAICPA

Part ofAICPA

Separate from AICPA

MembersOther full-

time employer

Other full-time

employer

Full-time FASB

employee

Compare CAP, APB, and FASB

Characteristic CAP APB FASB

Breadth of Membership

Must be CPA

Must beCPA

Need not be CPA

Due Process Little, if any Very limitedMore

extensive; open hearings

Compare CAP, APB, and FASB

Characteristic CAP APB FASB

Theoretical document supporting standards

Not attempted

Postulates and principles

failed

Conceptual framework completed

Research usage Very limitedMain use was probably in

ARSs

More extensive

FASB’s Standard-Setting Process1. Identify problem2. Form task force3. Produce discussion

memorandum4. Circulate to

interested parties5. Convene a public

hearing

6. Issue exposure draft and request comments

7. Consider written comments

8. Another exposure draft or a final vote is taken by the board

9. 4 of 7 votes needed to issue a standard (2002)

Institutional problems facing FASB

SEC has the legal authority to set standards whenever it choosesAICPA

Accounting Standards Executive CommitteeEmerging Issues Task Force (EITF)

GASB overlapping responsibilitiesCongressional investigationsSarbanes-Oxley Act

Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002

Established Public Company Accounting Oversight Board (PCAOB)

Regulatory body of public accounting firmsOverseen by SECRegister & inspect public accounting firmsSet audit standards

Step away from self-management by the profession

Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002

Act is in response to series of high profile corporate accounting scandals; objective is to restore investor confidence.Requires FASB funding to be an assessment from annual fees, not contributions.

Significant loss of independenceFunding is dependent on recognition by SEC

Liability Crisis

Pressure to turn the audit into a fraud detection exerciseJoint and several liability allows that a single defendant may be held liable for the entire loss attributable in a specific case

Chapter 3: Development of the Institutional Structure of Financial Accounting

Historical background in USAHow FASB differs from

CAPAPB

Standards setting processInstitutional problems facing FASBSarbanes-Oxley ActLiability crisis