CHAPTER 1
Financial Accounting and Accounting Standards
ASSIGNMENT CLASSIFICATION TABLE
Topics 1. 2. 3. Subject matter of accounting. Environment of accounting. Role of principles, objectives, standards, and accounting theory. Historical development of accounting standards. Authoritative pronouncements and standards-setting bodies. Questions 1 2, 3, 4 5, 6, 7, 8 Cases 1 3, 4 2, 4

4.

8, 9, 10, 11, 12

5, 17

5.

13, 14, 15, 16, 17, 18, 19, 20, 21, 22 23, 24, 25, 26, 27 28 29

6, 7, 8, 10, 11, 12, 13, 15, 16

6. 7. 8.

Role of pressure groups. International accounting. Ethical issues.

9, 18, 19 15 14

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ASSIGNMENT CHARACTERISTICS TABLE
Item C1-1 C1-2 C1-3 C1-4 C1-5 C1-6 C1-7 C1-8 C1-9 C1-10 C1-11 C1-12 C1-13 C1-14 C1-15 C1-16 C1-17 C1-18 C1-19 Description Financial accounting. Objectives of financial reporting. Accounting numbers and the environment. Need for accounting standards. AICPA’s role in standards setting. FASB role in standards setting. Government role in standards setting. Meaning of generally accepted accounting principles. Politicalization of standards setting. Models for setting accounting standards. Standards-setting terminology. Accounting organizations and documents issued. Accounting pronouncements. Issues involving standards setting. Securities and Exchange Commission. Standards-setting process. History of standards-setting organizations. Economic Consequences. Standards-setting process, economic consequences. Level of Difficulty Simple Moderate Simple Simple Simple Simple Simple Moderate Complex Simple Moderate Simple Simple Complex Moderate Moderate Moderate Moderate Moderate Time (minutes) 15-20 20-25 10-15 15-20 20-25 20-25 10-15 20-25 30-40 15-20 30-40 15-20 10-15 20-25 30-40 25-35 25-35 25-35 25-35

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ANSWERS TO QUESTIONS
1. Financial accounting measures, classifies, and summarizes in report form those activities and that information which relate to the enterprise as a whole for use by parties both internal and external to a business enterprise. Managerial accounting also measures, classifies, and summarizes in report form enterprise activities, but the communication is for the use of internal, managerial parties, and relates more to subsystems of the entity. Managerial accounting is management decision oriented and directed more toward product line, division, and profit center reporting. Financial statements generally refer to the four basic financial statements: balance sheet, income statement, statement of cash flows, and statement of changes in owners’ or stockholders’ equity. Financial reporting is a broader concept; it includes the basic financial statements and any other means of communicating financial and economic data to interested external parties. Examples of financial reporting other than financial reports are annual reports, prospectuses, reports filed with the government, news releases, management forecasts or plans, and descriptions of an enterprise’s social or environmental impact. If a company’s financial performance is measured accurately, fairly, and on a timely basis, the right managers and companies are able to attract investment capital. To provide unreliable and irrelevant information leads to poor capital allocation which adversely affects the securities market. Some major challenges facing the accounting profession relate to the following items: Non-financial measurement – how to report significant key performance measurements such as customer satisfaction indexes, backlog information and reject rates on goods purchased. Forward-looking information – how to report more future oriented information. Soft assets – how to report on intangible assets, such as market know-how, market dominance, and well-trained employees. Timeliness – how to report more real-time information. In general, the objectives of financial reporting are to provide (1) information that is useful in investment and credit decisions, (2) information that is useful in assessing cash flow prospects, and (3) information about enterprise resources, claims to those resources, and changes in them. More specifically these objectives state that financial reporting should provide information: a. that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. b . to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors and creditors’ cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and other assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. c. about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities), owners’ equity, and the effects of transactions, events, and circumstances that change its resources and claims to those resources.

2.

3.

4.

5.

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Questions Chapter 1 (Continued) 6. A common set of standards applied by all businesses and entities provides financial statements which are reasonably comparable. Without a common set of standards, each enterprise could, and would, develop its own theory structure and set of practices, resulting in noncomparability among enterprises. General-purpose financial statements are not likely to satisfy the specific needs of all interested parties. Since the needs of interested parties such as creditors, managers, owners, governmental agencies, and financial analysts vary considerably, it is unlikely that one set of financial statements is equally satisfying. Accounting was affected and changed between 1900 and 1930 by the newly developed corporate form of enterprise with its absentee ownership, the imposition of tax on business and individual income, and the stock market crash and subsequent great depression. The SEC has the power to prescribe, in whatever detail it desires, the accounting practices and principles to be employed by the companies that fall within its jurisdiction. Because the SEC receives audited financial statements from nearly all companies that issue securities to the public or are listed on the stock exchanges, it is greatly interested in the content, accuracy, and credibility of the statements. For many years the SEC relied on the AICPA to regulate the profession and develop and enforce accounting principles. Lately, the SEC has assumed a more active role in the development of accounting standards, especially in the area of disclosure requirements. In December 1973, in ASR No. 150, the SEC said the FASB’s statements would be presumed to carry substantial authoritative support and anything contrary to them to lack such support. It thereby supports the development of accounting principles in the private sector.

7.

8.

9.

10. The Committee on Accounting Procedure was a special committee of the American Institute of CPAs that, between the years of 1939 and 1959, issued 51 Accounting Research Bulletins dealing with a wide variety of timely accounting problems. These bulletins provided solutions to immediate problems and narrowed the range of alternative practices. But, the Committee’s problem-by-problem approach failed to provide a well-defined and well-structured body of accounting theory that was so badly needed. The Committee on Accounting Procedure was replaced in 1959 by the Accounting Principles Board. 11. The creation of the Accounting Principles Board was intended to advance the written expression of accounting principles, to determine appropriate practices, and to narrow the differences and inconsistencies in practice. To achieve its basic objectives, its mission was to develop an overall conceptual framework to assist in the resolution of problems as they became evident and to do substantive research on individual issues before pronouncements were issued. 12. Accounting Research Bulletins were pronouncements on accounting practice issued by the Committee on Accounting Procedure between 1939 and 1959; since 1964 they have been recognized as accepted accounting practice unless superseded in part or in whole by an opinion of the APB or an FASB standard. APB Opinions were issued by the Accounting Principles Board during the years 1959 through 1973 and, unless superseded by FASB Statements, are recognized as accepted practice and constitute the requirements to be followed by all business enterprises. FASB Statements are pronouncements of the Financial Accounting Standards Board and currently represent the accounting profession’s authoritative pronouncements on financial accounting and reporting practices.

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Questions Chapter 1 (Continued) 13. The explanation should note that generally accepted accounting principles or standards have “substantial authoritative support.” They consist of accounting practices, procedures, theories, concepts, and methods which are recognized by a large majority of practicing accountants as well as other members of the business and financial community. Bulletins issued by the Committee on Accounting Procedure, opinions rendered by the Accounting Principles Board, and statements issued by the Financial Accounting Standards Board constitute “substantial authoritative support.” 14. It was believed that FASB Statements would carry greater weight than APB Opinions because of significant differences between the FASB and the APB, namely: (1) The FASB has a smaller membership of full-time compensated members; (2) the FASB has greater autonomy and increased independence; and (3) the FASB has broader representation than the APB. 15. The technical staff of the FASB conducts research on an identified accounting topic and prepares a “discussion memorandum” that is released by the Board for public reaction. The Board analyzes and evaluates the public response to the discussion memorandum, deliberates on the issues, and issues an “exposure draft” for public comment. The discussion memorandum merely presents all facts and alternatives related to a specific topic or problem, whereas the exposure draft is a tentative “statement.” After studying the public’s reaction to the exposure draft, the Board may reevaluate its position, revise the draft, and vote on the issuance of a final statement. 16. Statements of financial accounting standards constitute generally accepted accounting principles and dictate acceptable financial accounting and reporting practices as promulgated by the FASB. The first standards statement was issued by the FASB in 1973. Statements of financial accounting concepts do not establish generally accepted accounting principles. Rather, the concepts statements set forth fundamental objectives and concepts that the FASB intends to use as a basis for developing future standards. The concepts serve as guidelines in solving existing and emerging accounting problems in a consistent, sound manner. Both the standards statements and the concepts statements may develop through the same process from discussion memorandum, to exposure draft, to a final approved statement. 17. Rule 203 of the Code of Professional Conduct prohibits a member of the AICPA from expressing an opinion that financial statements conform with GAAP if those statements contain a material departure from an accounting principle promulgated by the FASB, or its predecessors, the APB and the CAP, unless the member can demonstrate that because of unusual circumstances the financial statements would otherwise have been misleading. Failure to follow Rule 203 can lead to a loss of a CPA’s license to practice. This rule is extremely important because it requires auditors to follow FASB standards. 18. FASB Standards, FASB Technical Bulletins, AICPA Practice Bulletins. 19. The chairman of the FASB was indicating that too much attention is put on the bottom line and not enough on the development of quality products. Managers should be less concerned with short-term results and be more concerned with the long-term results. In addition, short-term tax benefits often lead to long-term problems. The second part of his comment relates to accountants being overly concerned with following a set of rules, so that if litigation ensues, they will be able to argue that they followed the rules exactly. The problem with this approach is that accountants want more and more rules with less reliance on professional judgment. Less professional judgment leads to inappropriate use of accounting procedures in difficult situations.

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Questions Chapter 1 (Continued) In the accountants’ defense, recent legal decisions have imposed vast new liability on accountants. The concept of accountant’s liability that has emerged in these cases is broad and expansive; the number of classes of people to whom the accountant is held responsible are almost limitless. 20. FASB Technical Bulletins provide guidance on financial accounting and reporting problems, and are designed to provide prompt responses to specific questions. They are interpretive in nature and do not establish new financial accounting standards or amend existing standards. Unlike FASB Interpretations, FASB Technical Bulletins are not written by members of the FASB but by members of its staff. They are not formally voted upon by members of the FASB, and they are not enforceable under the AICPA’s Code of Professional Conduct. 21. The Emerging Issues Task Force often arrives at consensus conclusions on certain financial reporting issues. These consensus conclusions are then looked upon as GAAP by practitioners because the SEC has indicated that it will view consensus solutions as preferred accounting and will require persuasive justification for departing from them. Thus, at least for public companies which are subject to SEC oversight, consensus solutions developed by the Emerging Issues Task Force are followed unless subsequently overturned by the FASB in a FASB Statement, Interpretation, or Technical Bulletin. 22. AcSEC is the senior technical committee within the Accounting Standards Division of the AICPA and is authorized to speak for the AICPA in the area of financial accounting and reporting. AcSEC issues Statements of Position on accounting matters, Issues Papers, and Industry Accounting Guides. It is not related to the FASB in any way. Its membership consists of appointed practitioners and professors who meet for several days monthly and are unpaid for their services. Because of AcSEC’s proliferation of pronouncements, the FASB in late 1978 publicly expressed concerns that the AICPA (through AcSEC) was becoming a competing standards-setting body. In its most recent proposal, the FASB had labeled the specialized accounting and reporting principles and practices contained in designated AICPA Industry Accounting Guides, Industry Audit Guides, and Statements of Position as “preferable accounting principles for purposes of justifying a change in accounting principle.” 23. The sources of pressure are innumerable, but the most intense and continuous pressure to change or influence accounting principles or standards come from individual companies, industry associations, governmental agencies, practicing accountants, academicians, professional accounting organizations, and public opinion. 24. Economic consequences means the impact of accounting reports on the wealth positions of issuers and users of financial information and the decision-making behavior resulting from that impact. In other words, accounting information impacts various users in many different ways which leads to wealth transfers among these various groups. If politics plays an important role in the development of accounting standards, standards will be subject to manipulation for the purpose of furthering whatever policy prevails at the moment. No matter how well intentioned the standards setter may be, if information is designed to indicate that investing in a particular enterprise involves less risk than it actually does, or is designed to encourage investment in a particular segment of the economy, financial reporting will suffer an irreplaceable loss of credibility.

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Questions Chapter 1 (Continued) 25. No one particular proposal is expected in answer to this question. The students’ proposals, however, should be defensible relative to the following criteria: 1. The method must be efficient, responsive, and expeditious. 2. The method must be free of bias and be above or insulated from pressure groups. 3. The method must command widespread support if it does not have legislative authority. 4. The method must produce sound yet practicable accounting principles or standards. The students’ proposals might take the form of alterations of the existing methodology, an accounting court (as proposed by Leonard Spacek), or governmental device. 26. Concern exists about fraudulent financial reporting because it can undermine the entire financial reporting process. Failure to provide information to users that is accurate can lead to inappropriate allocations of resources in our economy. In addition, failure to detect massive fraud can lead to additional governmental oversight of the accounting profession. 27. The expectations gap is the difference between what people think accountants should be doing and what accountants think they can do. It is a difficult gap to close. The accounting profession recognizes it must play an important role in narrowing this gap. To meet the needs of society, the profession is continuing its efforts in developing accounting standards, such as numerous pronouncements issued by the FASB, to serve as guidelines for recording and processing business transactions in the changing economic environment. 28. Some of the reasons for difference are: 1. The objectives of financial reporting are often different in foreign countries. 2. The institutional structures are often not comparable. 3. Strong national tendencies are pervasive and therefore there is reluctance to adopt any one country’s approach. 29. Accountants must perceive the moral dimensions of some situations because GAAP does not define or cover all specific features that are to be reported in financial statements. In these instances accountants must choose among alternatives. These accounting choices influence whether particular stakeholders may be harmed or benefited. Moral decision-making involves awareness of potential harm or benefit and taking responsibility for the choices.

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TIME AND PURPOSE OF CASES
Case 1-1 (Time 15-20 minutes) Purpose–to provide the student with an opportunity to distinguish between financial accounting and managerial accounting, identify major financial statements, and differentiate financial statements and financial reporting. Case 1-2 (Time 20-25 minutes) Purpose—to provide the student with an opportunity to explain the basic objectives of financial reporting. Case 1-3 (Time 10-15 minutes) Purpose—to provide the student with an opportunity to describe how reported accounting numbers might affect an individual’s perceptions and actions. Case 1-4 (Time 15-20 minutes) Purpose—to provide the student with an opportunity to evaluate the viewpoint of removing mandatory accounting standards and allowing each company to voluntarily disclose the information it desired. Case 1-5 (Time 20-25 minutes) Purpose—to provide the student with an opportunity to explain the evolution of accounting standardssetting organizations and the role of the AICPA in the standards-setting environment. Case 1-6 (Time 20-25 minutes) Purpose—to provide the student with an opportunity to identify the sponsoring organization of the FASB, the method by which the FASB arrives at a decision, and the types and the purposes of documents issued by the FASB. Case 1-7 (Time 10-15 minutes) Purpose—to provide the student with an opportunity to identify the governmental entity that oversees the FASB and indicate its role in the standards-setting process. Case 1-8 (Time 20-25 minutes) Purpose—to provide the student with an opportunity to discuss the nature of accounting principles and the basis of their general acceptance. Case 1-9 (Time 30-40 minutes) Purpose—to provide the student with an opportunity to focus on the types of organizations involved in the standards-setting process, what impact accounting has on the environment, and the environment's influence on accounting. Case 1-10 (Time 15-20 minutes) Purpose—to provide the student with an opportunity to focus on what type of standards-setting environment exists in the United States. In addition, this case explores why user groups are interested in the nature of financial reporting standards and why some groups wish to issue their own standards. Case 1-11 (Time 30-40 minutes) Purpose—to provide the student with an opportunity to identify and define acronyms appearing in the first chapter. Some are self-evident, others are not so.

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Time and Purpose of Cases (Continued) Case 1-12 (Time 15-20 minutes) Purpose— to provide the student with an opportunity to identify the various documents issued by different accounting organizations. The case should help the student to better focus on the more important documents issued in the financial reporting area. Case 1-13 (Time 10-15 minutes) Purpose—to provide the student with an opportunity to match the descriptions of a number of authoritative pronouncements issued by standards-setting bodies to the pronouncements. Case 1-14 (Time 20-25 minutes) Purpose—to provide the student with an opportunity to consider the ethic dimensions of implementation of a new accounting standard. Case 1-15 (Time 30-40 minutes) Purpose—to provide the student with an assignment that explores the role and function of the Securities and Exchange Commission. Case 1-16 (Time 25-35 minutes) Purpose—to provide the student with an assignment that explores the role of the FASB and the standards-setting process. Case 1-17 (Time 25-35 minutes) Purpose—to provide the student with a writing assignment on the evolution of accounting standardssetting organizations. Case 1-18 (Time 25-35 minutes) Purpose—to provide the student with the opportunity to discuss the role of Congress in accounting standards-setting as well as to discuss the core standards project related to international accounting. Case 1-19 (Time 25-35 minutes) Purpose—to provide the student with an opportunity to comment on a letter sent by business executives to the FASB and Congress on the accounting for derivatives.

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SOLUTIONS TO CASES
CASE 1-1
(a) Financial accounting is the process that culminates in the preparation of financial reports relative to the enterprise as a whole for use by parties both internal and external to the enterprise. In contrast, managerial accounting is the process of identification, measurement, accumulation, analysis, preparation, interpretation, and communication of financial information used by the management to plan, evaluate, and control within an organization and to assure appropriate use of, and accountability for, its resources. (b) The financial statements most frequently provided are the balance sheet, the income statement, the statement of cash flows, and the statement of changes in owners' or stockholders' equity. (c) Financial statements are the principal means through which financial information is communicated to those outside an enterprise. As indicated in (b), there are four major financial statements. However, some financial information is better provided, or can be provided only, by means of financial reporting other than formal financial statements. Financial reporting (other than financial statements and related notes) may take various forms. Examples include the company president's letter or supplementary schedules in the corporate annual reports, prospectuses, reports filed with government agencies, news releases, management's forecasts, and descriptions of an enterprise's social or environmental impact.

CASE 1-2
(a) In accordance with Statement of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises," the objectives of financial reporting are to provide information to investors, creditors, and others 1. that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions. The information should be comprehensible to those who have a reasonable understanding of business and economic activities and are willing to study the information with reasonable diligence. 2. to help present and potential investors and creditors and other users in assessing the amounts, timing, and uncertainty of prospective cash receipts from dividends or interest and the proceeds from the sale, redemption, or maturity of securities or loans. Since investors' and creditors' cash flows are related to enterprise cash flows, financial reporting should provide information to help investors, creditors, and others assess the amounts, timing, and uncertainty of prospective net cash inflows to the related enterprise. 3. about the economic resources of an enterprise, the claims to those resources (obligations of the enterprise to transfer resources to other entities and owners' equity), and the effects of transactions, events, and circumstances that change its resources and claims to those resources. (b) Statement of Financial Accounting Concepts No. 1 established standards to meet the information needs of large groups of external users such as investors, creditors, and their representatives. Although the level of sophistication related to business and financial accounting matters varies both within and between these user groups, users are expected to possess a reasonable understanding of accounting concepts, financial statements, and business and economic activities and are expected to be willing to study and interpret the information with reasonable diligence.

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CASE 1-3
Accounting numbers affect investing decisions. Investors, for example, use the financial statements of different companies to enhance their understanding of each company's financial strength and operating results. Because these statements follow generally accepted accounting principles, investors can make meaningful comparisons of different financial statements to assist their investment decisions. Accounting numbers also influence creditors' decisions. A commercial bank usually looks into a company's financial statements and past credit history before deciding whether to grant a loan and in what amount. The financial statements provide a fair picture of the company's financial strength (for example, short-term liquidity and long-term solvency) and operating performance for the current period and over a period of time. The information is essential for the bank to ensure that the loan is safe and sound.

CASE 1-4
It is not appropriate to abandon mandatory accounting standards and allow each company to voluntarily disclose the type of information it considered important. Without a coherent body of accounting theory and standards, each accountant or enterprise would have to develop its own theory structure and set of practices, and readers of financial statements would have to familiarize themselves with every company's peculiar accounting and reporting practices. As a result, it would be almost impossible to prepare statements that could be compared. In addition, voluntary disclosure may not be an efficient way of disseminating information. A company is likely to disclose less information if it has the discretion. Thus, the company can reduce its cost of assembling and disseminating information. However, an investor wishing additional information has to pay to receive additional information desired. Different investors may be interested in different types of information. Since the company may not be equipped to provide the requested information, it would have to spend additional resources to fulfill such needs; or the company may refuse to furnish such information if it's too costly to do so. As a result, investors may not get the desired information or they may have to pay a significant amount of money for it. Furthermore, redundancy in gathering and distributing information occurs when different investors ask for the same information at different points of time. To the society as a whole, this would not be an efficient way of utilizing resources.

CASE 1-5
(a) One of the committees that the AICPA established prior to the establishment of the FASB was the Committee on Accounting Procedures (CAP). The CAP, during its existence from 1939 to 1959, issued 51 Accounting Research Bulletins (ARB). In 1959, the AICPA created the Accounting Principles Board (APB) to replace the CAP. Before being replaced by the FASB, the APB released 31 official pronouncements, called APB Opinions. (b) Although the ARBs issued by the CAP helped to narrow the range of alternative practices to some extent, the CAP's problem-by-problem approach failed to provide the well-defined, structured body of accounting principles that was both needed and desired. As a result, the CAP was replaced by the APB. The APB had more authority and responsibility than did the CAP. Unfortunately, the APB was beleaguered throughout its 14-year existence. It came under fire early, charged with lack of productivity and failing to act promptly to correct alleged accounting abuses. The APB also met a lot of industry and CPA firm opposition and occasional governmental interference when tack-

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CASE 1-5 (Continued) ling numerous thorny accounting issues. In fear of governmental rule-making, the accounting profession investigated the ineffectiveness of the APB and replaced it with the FASB. Learning from prior experiences, the FASB has several significant differences from the APB. The FASB has: (1) smaller membership, (2) full-time, compensated membership, (3) greater autonomy, (4) increased independence, and (5) broader representation. In addition, the FASB has its own research staff and relies on the expertise of various task force groups formed for various projects. These features form the bases for the expectations of success and support from the public. In addition, the due process taken by the FASB in establishing financial accounting standards gives interested persons ample opportunity to make their views known. Thus, the FASB is responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession. (c) The AICPA supplements the FASB’s efforts in the present standard-setting environment. The issue papers, which are prepared by the Accounting Standards Executive Committee (AcSEC), identify current financial reporting problems for specific industries and present alternative treatments of the issue. These papers provide the FASB with an early warning device to insure timely issuance of FASB standards, Interpretations, and Technical Bulletins. In situations where the FASB avoids the subject of an issue paper, AcSEC may issue a Statement of Position to provide guidance for the reporting issue. AcSEC also issues Practice Bulletins which indicate how the AICPA believes a given transaction should be reported. In addition, the AICPA is still the leader in developing auditing standards through its Auditing Standards Board. These standards are the guidelines for regulating auditing practice and for developing and enforcing professional ethics.

CASE 1-6
(a) The Financial Accounting Foundation (FAF) is the sponsoring organization of the FASB. The FAF selects the members of the FASB and its Advisory Council, funds their activities, and generally oversees the FASB's activities. The FASB follows a due process in establishing a typical FASB Statement of Financial Accounting Standards. The following steps are usually taken: (1) A topic or project is identified and placed on the Board's agenda. (2) A task force of experts from various sectors is assembled to define problems, issues, and alternatives related to the topic. (3) Research and analysis are conducted by the FASB technical staff. (4) A discussion memorandum is drafted and released. (5) A public hearing is often held, usually 60 days after the release of the memorandum. (6) The Board analyzes and evaluates the public response. (7) The Board deliberates on the issues and prepares an exposure draft for release. (8) After a 30-day (minimum) exposure period for public comment, the Board evaluates all of the responses received. (9) A committee studies the exposure draft in relation to the public responses, reevaluates its position, and revises the draft if necessary. (10) The full Board gives the revised draft final consideration and votes on issuance of a Standards Statement. The passage of a new accounting standard in the form of an FASB Statement requires the support of five of the seven Board members. (b) The FASB issues three major types of pronouncements: Standards and Interpretations, Financial Accounting Concepts, and Technical Bulletins. Financial accounting standards issued by the FASB are considered GAAP. In addition, the FASB also issues interpretations that represent modifications or extensions of existing standards and APB Opinions. These interpretations have the same authority as standards and APB Opinions in guiding current accounting practices.

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CASE 1-6 (Continued)
The Statements of Financial Accounting Concepts (SFAC) are a part of a long-range effort of the FASB to move away from the "problem-by-problem approach.” These statements set forth fundamental objectives and concepts that the Board will use in developing future standards of financial accounting and reporting. They are intended to form a cohesive set of interrelated concepts, a body of theory or a conceptual framework, that will serve as tools for solving existing and emerging problems in a consistent, sound manner. The FASB may issue a technical bulletin when there is a need for guidelines on implementing or applying FASB Standards or Interpretations, APB Opinions, Accounting Research Bulletins, or emerging issues. A technical bulletin is issued only when (1) it is not expected to cause a major change in accounting practice for a number of enterprises, (2) its cost of implementation is low, and (3) the guidance provided by the bulletin does not conflict with any broad fundamental accounting principle. In addition, the FASB's Emerging Issues Task Force (EITF) issues statements to provide guidance on how to account for new and unusual financial transactions that have the potential for creating diversity in reporting practices. The EITF identifies controversial accounting problems as they arise and determines whether they can be quickly resolved or whether the FASB should become involved in solving them. In essence, it becomes a "problem filter” for the FASB. Thus, it is hoped that the FASB will be able to work on more pervasive long-term problems, while the EITF deals with short-term emerging issues.

CASE 1-7
The Securities and Exchange Commission (SEC) is the governmental entity that provides oversight over the accounting standards-setting process. Until the 1960s, the SEC acted with remarkable restraint in the area of developing accounting standards. Generally, it relied on the AICPA to regulate the accounting profession and develop and enforce accounting standards. During the APB era, however, the SEC took a more active interest in the development of accounting standards, pressing for quicker action, specific pronouncements, and eventually for the demise of the APB. Recently, the SEC has interacted with the FASB as both a supporter and a prodder. Because it confronts the financial accounting and reporting practices of U.S. business on a daily basis, the SEC frequently identifies emerging problems for the FASB to address. The Commission communicates these problems to the FASB, responds to FASB drafts and exposures, and provides the FASB with counsel and advice upon request. The SEC has reaffirmed its support for the FASB, indicating that "financial statements conforming to standards set by the FASB will be presumed to have authoritative support." In short, the SEC requires public companies to adhere to GAAP.

CASE 1-8
(a) The term "accounting principles" in the auditor's report includes not only accounting principles but also the practices and the methods of applying them. Although the term quite naturally emphasizes the primary or fundamental character of some principles, it includes general rules adopted or professed as guides to action in practice. The term does not connote, however, rules from which there can be no deviation. In some cases the question is which of several partially relevant principles has determining applicability. Neither is the term "accounting principles" necessarily synonymous with accounting theory. Accounting theory is the broad area of inquiry devoted to the definition of objectives to be served by accounting, the development and elabora-

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CASE 1-8 (Continued) tion of relevant concepts, the promotion of consistency through logic, the elimination of faulty reasoning, and the evaluation of accounting practice. (b) Generally accepted accounting principles are those principles (whether or not they have only limited usage) that have substantial authoritative support. Whether a given principle has authoritative support is a question of fact and a matter of judgment. The CPA is responsible for collecting the available evidence of authoritative support and judging whether it is sufficient to bring the practice within the bounds of generally accepted accounting principles. Opinions of the Accounting Principles Board, pronouncements of the American Institute of CPAs, statements of the Financial Accounting Standards Board, and releases of the Securities and Exchange Commission (if there are any on the subject in question) would be given greater weight than other single sources. Opinions of the Accounting Principles Board and statements and interpretations of the FASB constitute substantial authoritative support, and the evidence would tend to be conclusive if the Securities and Exchange Commission has issued an affirmative opinion on the same subject. However, substantial authoritative support also can exist for accounting principles that differ from those recommended in the opinions of the Accounting Principles Board or statements of the Financial Accounting Standards Board. Other support for generally accepted accounting principles can come from AICPA Accounting and Auditing Guides, AICPA Statements of Position, and FASB Technical Bulletins (Level Two). In addition, AICPA Practice Bulletins and FASB Emerging Issues Task Force Statements are identified as Level Three type documents.

CASE 1-9
(a) CAP. The Committee on Accounting Procedure, CAP, which was in existence from 1939 to 1959, was a natural outgrowth of AICPA committees which were in existence during the period 1933 to 1938. The committee was formed in direct response to the criticism received by the accounting profession during the financial crisis of 1929 and the years thereafter. The authorization to issue pronouncements on matters of accounting principles and procedures was based on the belief that the AICPA had the responsibility to establish practices that would become generally accepted by the profession and by corporate management. As a general rule, the CAP directed its attention, almost entirely, to resolving specific accounting problems and topics rather than to the development of generally accepted accounting principles. The committee voted on the acceptance of specific Accounting Research Bulletins published by the committee. A two-thirds majority was required to issue a particular research bulletin. The CAP did not have the authority to require acceptance of the issued bulletins by the general membership of the AICPA, but rather received its authority only upon general acceptance of the pronouncement by the members. That is, the bulletins set forth normative accounting procedures that "should be" followed by the accounting profession, but were not "required' to be followed. It was not until well after the demise of the CAP, in 1964, that the Council of the AICPA adopted recommendations that departures from effective CAP Bulletins should be disclosed in financial statements or in audit reports of members of the AICPA. The demise of the CAP could probably be traced to four distinct factors: (1) the narrow nature of the subjects covered by the bulletins issued by the CAP, (2) the lack of any theoretical groundwork in establishing the procedures presented in the bulletins, (3) the lack of any real authority by the CAP in prescribing adherence to the procedures described by the bulletins, and (4) the lack of any formal representation on the CAP of interest groups such as corporate managers, governmental agencies, and security analysts. 1-14

CASE 1-9 (Continued)
APB. The objectives of the APB were formulated mainly to correct the deficiencies of the CAP as described above. The APB was thus charged with the responsibility of developing written expression of generally accepted accounting principles through consideration of the research done by other members of the AICPA in preparing Accounting Research Studies. The committee was in turn given substantial authoritative standing in that all opinions of the APB were to constitute substantial authoritative support for generally accepted accounting principles. If an individual member of the AICPA decided that a principle or procedure outside of the official pronouncements of the APB had substantial authoritative support, the member had to disclose the departure from the official APB opinion in the financial statements of the firm in question. The membership of the committee comprising the APB was also extended to include representation from industry, government, and academe. The opinions were also designed to include minority dissents by members of the board. Exposure drafts of the proposed opinions were readily distributed. The demise of the APB occurred primarily because the purposes for which it was created were not being accomplished. Broad generally accepted accounting principles were not being developed. The research studies supposedly being undertaken in support of subsequent opinions to be expressed by the APB were often ignored. The committee in essence became a simple extension of the original CAP in that only very specific problem areas were being addressed. Interest groups outside of the accounting profession questioned the appropriateness and desirability of having the AICPA directly responsible for the establishment of GAAP. Politicization of the establishment of GAAP had become a reality because of the far-reaching effects involved in the questions being resolved. FASB. The formal organization of the FASB represents an attempt to vest the responsibility of establishing GAAP in an organization representing the diverse interest groups affected by the use of GAAP. The FASB is independent of the AICPA. It is independent, in fact, of any private or governmental organization. Individual CPAs, firms of CPAs, accounting educators, and representatives of private industry will now have an opportunity to make known their views to the FASB through their membership on the Board. Independence is facilitated through the funding of the organization and payment of the members of the Board. Full-time members are paid by the organization and the organization itself is funded solely through contributions. Thus, no one interest group has a vested interest in the FASB. Conclusion. The evolution of the current FASB certainly does represent "increasing politicization of accounting standards setting." Many of the efforts extended by the AICPA can be directly attributed to the desire to satisfy the interests of many groups within our society. The FASB represents, perhaps, just another step in this evolutionary process. (b) Arguments for politicalization of the accounting rule-making process: 1. Accounting depends in large part on public confidence for its success. Consequently, the critical issues are not solely technical, so all those having a bona fide interest in the output of accounting should have some influence on that output. 2. There are numerous conflicts between the various interest groups. In the face of this, compromise is necessary, particularly since the critical issues in accounting are value judgments, not the type which are solvable, as we have traditionally assumed, using deterministic models. Only in this way (reasonable compromise) will the financial community have confidence in the fairness and objectivity of accounting rule-making. 3. Over the years, accountants have been unable to establish, on the basis of technical accounting elements, rules which would bring about the desired uniformity and acceptability. This inability itself indicates rule-setting is primarily consensual in nature.

1-15

CASE 1-9 (Continued)
4. The public accounting profession, through bodies such as the Accounting Principles Board, made rules which business enterprises and individuals "had" to follow. For many years, these businesses and individuals had little say as to what the rules would be, in spite of the fact that their economic well-being was influenced to a substantial degree by those rules. It is only natural that they would try to influence or control the factors that determine their economic well-being.

(c)

Arguments against the politicalization of the accounting rule-making process: 1. Many accountants feel that accounting is primarily technical in nature. Consequently, they feel that substantive, basic research by objective, independent and fair-minded researchers ultimately will result in the best solutions to critical issues, such as the concepts of income and capital, even if it is accepted that there isn't necessarily a single "right" solution. 2. Even if it is accepted that there are no "absolute truths" as far as critical issues are concerned, many feel that professional accountants, taking into account the diverse interests of the various groups using accounting information, are in the best position, because of their independence, education, training, and objectivity, to decide what generally accepted accounting principles ought to be. 3. The complex situations that arise in the business world require that trained accountants develop the appropriate accounting principles. 4. The use of consensus to develop accounting principles would decrease the professional status of the accountant. 5. This approach would lead to "lobbying" by various parties to influence the establishment of accounting principles.

CASE 1-10
(a) The public/private mixed approach appears to be the way standards are established in the United States. In many respects, the FASB is a quasi-governmental agency in that its standards are required to be followed because the SEC has provided support for this approach. The SEC has the ultimate power to establish standards but has chosen to permit the private sector to develop these standards. By accepting the standards established by the FASB as authoritative, it has granted much power to the FASB. (It might be useful to inform the students that not all countries follow this model. For example, the purely political approach is used in France and West Germany. The private, professional approach is employed in Australia, Canada, and the United Kingdom.) (b) Publicly reported accounting numbers influence the distribution of scarce resources. Resources are channeled where needed at returns commensurate with perceived risk. Thus, reported accounting numbers have economic effects in that resources are transferred among entities and individuals as a consequence of these numbers. It is not surprising then that individuals affected by these numbers will be extremely interested in any proposed changes in the financial reporting environment. (c) The Accounting Standards Executive Committee (AcSEC of the AICPA), among other groups, has presented a potential challenge to the exclusive right of the FASB to establish accounting principles. Also, Congress has been attempting to legislate certain accounting practices, particularly to help struggling industries. Some possible reasons why other groups might wish to establish standards are: 1. As indicated in the previous answer, standards have economic effects and therefore certain groups would prefer to make their own standards to ensure that they receive just treatment. 2. Some believe the FASB does not act quickly to resolve accounting matters, either because it is not that interested in the subject area or because it lacks the resources to do so. 1-16

CASE 1-10 (Continued)
3. Some argue that the FASB does not have the competence to legislate standards in certain areas. For example, many have argued that the FASB should not legislate standards for not-for-profit enterprises because the problems are unique and not well known by the FASB.

CASE 1-11
(a) AICPA. American Institute of Certified Public Accountants. practicing certified public accountants. The national organization of

(b) CAP. Committee on Accounting Procedure. A committee of practicing CPAs which issued 51 Accounting Research Bulletins between 1939 and 1959 and is a predecessor of the FASB. (c) ARB. Accounting Research Bulletins. Official pronouncements of the Committee on Accounting Procedure which, unless superseded, remain a primary source of GAAP.

(d) APB. Accounting Principles Board. A committee of public accountants, industry accountants and academicians which issued 31 Opinions between 1959 and 1973. The APB replaced the CAP and was itself replaced by the FASB. Its opinions, unless superseded, remain a primary source of GAAP. (e) FAF. Financial Accounting Foundation. An organization whose purpose is to select members of the FASB and its Advisory Councils, fund their activities, and exercise general oversight. (f) FASAC. Financial Accounting Standards Advisory Council. An organization whose purpose is to consult with the FASB on issues, project priorities, and select task forces.

(g) SOP. Statements of Position. Statements issued by the AICPA (through the Accounting Standards Executive Committee of its Accounting Standards Division) which are generally devoted to emerging problems not addressed by the FASB or the SEC. (h) GAAP. Generally accepted accounting principles. A common set of standards, principles, and procedures which have substantial authoritative support and have been accepted as appropriate because of universal application. (i) CPA. Certified public accountant. An accountant who has fulfilled certain education and experience requirements and passed a rigorous examination. Most CPAs offer auditing, tax, and management consulting services to the general public. FASB. Financial Accounting Standards Board. The primary body which currently establishes and improves financial accounting and reporting standards for the guidance of issuers, auditors, users, and others. SEC. Securities and Exchange Commission. An independent regulatory agency of the United States government which administers the Securities Acts of 1933 and 1934 and other acts. IASB. International Accounting Standards Board. An international group, formed in 1973, that is actively developing and issuing accounting standards that will have international appeal and hopefully support.

(j)

(k) (l)

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CASE 1-12
1. 2. 3. 4. 5. (d) (b), (f) (a) (c) (e), (g)

CASE 1-13
1. 2. 3. 4. 5. 6. (d) (f) (c) (e) (a) (b)

CASE 1-14
(a) Inclusion or omission of information that materially affects net income harms particular stakeholders. Accountants must recognize that their decision to implement (or delay) reporting requirements will have immediate consequences for some stakeholders. (b) Yes. Because the FASB standard results in a fairer representation, it should be implemented as soon as possible—regardless of its impact on net income. SEC Staff Bulletin No. 74 (December 30, 1987) requires a statement as to what the expected impact of the standard will be. (c) The accountant’s responsibility is to provide financial statements that present fairly the financial condition of the company. By advocating early implementation, Popovich fulfills this task.

(d) Potential lenders and investors, who read the financial statements and rely on its fair representation of the financial condition of the company, have the most to gain by early implementation. A stockholder who is considering the sale of stock may be harmed by early implementation that lowers net income (and may lower the value of the stock).

CASE 1-15
(a) The Securities and Exchange Commission (SEC) is an independent federal agency that receives its authority from federal legislation enacted by Congress. The Securities and Exchange Act of 1934 created the SEC. (b) As a result of the Securities and Exchange Act of 1934, the SEC has legal authority relative to accounting practices. The U.S. Congress has given the SEC broad regulatory power to control accounting principles and procedures in order to fulfill its goal of full and fair disclosure. (c) There is no direct relationship as the SEC was created by Congress and the Financial Accounting Standards Board (FASB) was created by the private sector. However, the SEC historically has followed a policy of relying on the private sector to establish financial accounting and reporting standards known as generally accepted accounting principles (GAAP). The SEC does not necessarily agree with all of the pronouncements of the FASB. In cases of unresolved differences, the SEC rules take precedence over FASB rules for companies within SEC jurisdiction.

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CASE 1-16
(a) The process by which a topic is selected or identified as appropriate for study by the Financial Accounting Standards Board (FASB) is described below. • Problems or issues come to the attention of the FASB from – the Emerging Issues Task Force which may identify significant emerging accounting issues that it feels the FASB should address. – the Financial Accounting Standards Advisory Council which addresses the FASB on the priority of problems and encourages the FASB to undertake new projects. – the Research and Technical Activities Staff of the FASB, which monitors business periodicals for stories concerning unusual transactions or events and may detect an emerging problem. – the close contact it maintains with various business, industry, government, professional financial groups, and the SEC. – its staff which may learn of emerging problems as it responds to technical inquiries received from preparers and auditors. • • • • Topics are then placed on the FASB agenda. The plan for major technical agenda projects is given prompt public notice in the FASB's newsletter “Status Report.” A task force of experts from various sectors is assembled to define problems, issues, and alternatives related to the topic. The task force inputs are submitted to the FASB's Technical Activities Division for research and analysis.

(b) Once a topic is considered appropriate for consideration by the FASB, major steps in the process leading to the issuance of a Statement of Financial Accounting Standards include the following: • • • • • • • Research and analysis is conducted by the FASB Technical Staff. A discussion memorandum is drafted and released for written comments. Written comments are submitted and a public hearing is held approximately 60 days after the memorandum is released. The Board analyzes and evaluates the public responses. The Board deliberates on the issues and prepares an exposure draft which is released for public comment. After a 30-day (minimum) exposure period and possible public hearings from industry groups, the Board evaluates all comments received. A committee studies the exposure draft in relation to the public responses, reevaluates its position, and revises the draft if necessary.

1-19

CASE 1-16 (Continued)
• (c) The full Board gives the revised final draft consideration and votes on the issuance of a Standards Statement.

At least three other organizations who can influence the setting of generally accepted accounting principles include the • • • American Institute of Certified Public Accountants. Securities and Exchange Commission. Financial Executives Institute.

CASE 1-17
Before the turn of this century, because most businesses were privately owned, the need for accurate financial statements was limited. Financial reports were used to help a company analyze its profitability and to allow lending institutions such as banks to determine whether or not the company was worthy of credit. Early in the twentieth century, the institution of income tax as well as the increasing number of large corporations created greater reasons for companies to report their financial positions more carefully. The stock market crash of 1929 further convinced the federal government as well as the accounting profession of the need to develop generally accepted standards by which all financial statements could be prepared. In an attempt to address this problem, the American Institute of Certified Public Accountants first created the Committee on Accounting Procedures (CAP). Taking a problem-byproblem approach to creating standards, CAP issued 51 Accounting Research Bulletins before the AICPA decided to abandon it and establish the Accounting Principles Board (APB). Created in 1959, the APB attempted to provide a more well-defined, structured approach to the development of financial accounting principles. Its purpose was to develop written accounting principles which would determine practice by narrowing any existing inconsistencies in practice. The Board had 18 to 21 members and issued 31 APB Opinions before it was disbanded in 1973. Unfortunately, it received much opposition from industry, CPA firms, and the government. In 1973, the Financial Accounting Standards Board (FASB) was created to replace the APB. This Board has enjoyed a great deal of success, owing to its structure. First, the board has only seven members, allowing it to achieve consensus more easily than its predecessor. Second, unlike the APB, the FASB considers membership a full-time job, so its members are more likely to devote the time necessary to deal with tough, ongoing accounting problems. Third, the FASB is independent of the AICPA. Fourth, because members cannot work for private entities, they are more independent and will thus not allow problems associated with certain industries to skew their decisions. Finally, the FASB membership is not limited to CPAs, giving it a broader perspective on important issues. Since its inception, the FASB has issued over 140 Statements of Financial Accounting Standards which establish GAAP. In addition, it has also issued a series of Statements of Financial Accounting Concepts whose purpose is to create a conceptual framework that will enable the profession to address future accounting problems. Still going strong, the FASB continues to be the United States' standards setter in the world of public accounting. With hope, its present success will accompany it through the turn of the century, as it determines accounting policy for the ever-changing, ever-challenging business environment.

1-20

CASE 1-18
a. Considering the economic consequences of many accounting standards, it is not surprising that special interest groups become vocal and critical (some supporting, some opposing) when standards are being formulated. The FASB’s derivative accounting standard is no exception. Many from the banking industry, for example, criticized the standard as too complex and leading to unnecessary earnings volatility. They also indicated that the proposal may discourage prudent risk management activities and in some cases could present misleading financial information. As a result, Congress is often approached to put pressure on the FASB to change its rulings. In the stock option controversy, industry was quite effective in going to Congress to force the FASB to change its conclusions. In the derivative controversy, Rep. Richard Baker introduced a bill which would force the SEC to formally approve each standard issued by the FASB. Not only would this process delay adoption, but could lead to additional politicalization of the standardssetting process. Dingell commented that Congress should stay out of the standards-setting process and defended the FASB’s approach to establishing generally accepted accounting standards. b. Attempting to set standards by a political process will probably lead to the following consequences: (a) Too many alternatives. (b) Lack of clarity that will lead to inconsistent application. (c) Lack of disclosure that reduces transparency. (d) Not comprehensive in scope. Without an independent process, standards will be based on political compromise. A classic illustration is what happened in the savings and loan industry. Applying generally accepted accounting principles to the S&L industry would have forced regulators to restrict activities of many S&Ls. Unfortunately, accounting principles were overridden by regulatory rules and the resulting lack of transparency masked the problems. William Siedman, former FDIC Chairman noted later that it was “the worst mistake in the history of government.” Another indication of the problem of government intervention is shown in the accounting standards used by many countries around the world. Completeness and transparency of information needed by investors and creditors is not available in order to meet or achieve other objectives.

CASE 1-19
(a) The “due process” system involves the following: (1) Identifying topics and placing them on the Board’s agenda. (2) Research and analysis is conducted and discussion memorandum of pros and cons issued. (3) A public hearing is often held. (4) Board evaluates research and public responses and issues exposure draft. (5) Board evaluates responses and changes exposure draft, if necessary. Final statement is then issued. (b) Economic consequences mean the impact of accounting reports on the wealth positions of issuers and users of financial information and the decision-making behavior resulting from that impact. (c) Economic consequences indicated in the letter are: (1) concerns related to the potential impact on the capital markets, the weakening of companies’ ability to manage risk, and the adverse control implications of implementing costly and complex new rules imposed at the same time as other major initiatives, including the Year 2000 issues and a single European currency.

1-21

CASE 1-19 (Continued)
(d) The principal point of this letter is to delay the finalization of the derivatives standard. As indicated in the letter, the authors of this letter urge the FASB to expose its new proposal for public comment, following the established due process procedures that are essential to acceptance of its standards and providing sufficient time for affected parties to understand and assess the new approach. (Authors note: The FASB indicated in a follow-up letter that all due process procedures had been followed and all affected parties had more than ample time to comment.) (e) The reason why the letter was sent to Congress was to put additional pressure on the FASB to delay or drop the issuance of a standard on derivatives. Unfortunately, in too many cases, when the business community does not like the answer proposed by the FASB, it resorts to lobbying members of Congress. The lobbying efforts usually involve developing some type of legislation that will negate the standard. In some cases, efforts involve challenging the FASB’s authority to develop rules in certain areas with additional Congressional oversight.

1-22

FINANCIAL REPORTING PROBLEM
(a) The key organizations involved in standard setting in the U.S. are the AICPA, FASB, and SEC. See also (c). (b) Different authoritative literature pertaining to methods recording accounting transactions exists today. Some authoritative literature has received more support from the profession than other literature. The literature that has substantial authoritative support is the one most supported by the profession and should be followed when recording accounting transactions. These standards and procedures are called generally accepted accounting principles (GAAP). There are three different levels, and the first level is the one with the most authoritative support. It consists of FASB Standards and Interpretations, APB Opinions and Interpretations, and CAP Accounting Research Bulletins. The second level consists of AICPA Accounting and Auditing Guides, AICPA Statements of Position, and FASB Technical Bulletins. The third level consists of AICPA Issues Papers and Practice Bulletins, FASB Concepts Statements, and other authoritative pronouncements. Note that a level between the second and the third level is also sometimes identified which consists of practices or pronouncements that are widely recognized as being generally accepted because they represent prevalent practice in a particular industry or the knowledgeable application to specific circumstances of pronouncements that are generally accepted. (c) Standards setting in the U.S. has evolved through the work of the following organizations:

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FINANCIAL REPORTING PROBLEM (Continued) 1. American Institute of Certified Public Accountants (AICPA)—it is the national professional organization of practicing Certified Public Accountants (CPAs). Outgrowths of the AICPA have been the Committee on Accounting Procedure (CAP) which issued Accounting Research Bulletins and the Accounting Principles Board (APB) whose major purposes were to advance written expression of accounting principles, determine appropriate practices, and narrow the areas of difference and inconsistency in practice. 2. Financial Accounting Standards Board (FASB)—the mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of the financial information. 3. Securities and Exchange Commission (SEC)—the SEC is an independent regulatory agency of the United States government which administers the Securities Act of 1933, the Securities Exchange Act of 1934, and several other acts. The SEC has broad power to prescribe the accounting practices and standards to be employed by companies that fall within its jurisdiction. (d) The SEC and the AICPA have been the authority for compliance with GAAP. The SEC has indicated that financial statements conforming to standards set by the FASB will be presumed to have authoritative support. The AICPA, in Rule 203 of the Code of Professional Ethics, requires that members prepare financial statements in accordance with GAAP. Failure to follow Rule 203 can lead to the loss of a CPA's license to practice.

1-24

INTERNATIONAL REPORTING PROBLEM
(Note to instructor: The answer to this question is very complete. Students will not be able to answer it as completely unless they are required to do additional research. The answer should provide material for additional discussion in class. Instructors may wish to direct students to the international discussion on the Take-Action!CD.) (a) Eliminating significant differences in international accounting and reporting practices to result in more useful information for international investors is the goal of current standards-setting efforts. The major bodies involved in the United States are the FASB and the SEC. In the international arena, two parties of considerable power are the International Accounting Standards Board (IASB) and the International Organization of Securities Commissions (IOSCO). We describe these two major international groups next. IASB The International Accounting Standards Board is an independent, privately funded accounting standards setter based in London, UK. Board Members come from nine countries and have a variety of functional backgrounds. The Board is committed to developing, in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require transparent and comparable information in general purpose financial statements. In addition, the Board cooperates with national accounting standards setters to achieve convergence in accounting standards around the world. The IASB replaces the International Accounting Standards Committee (IASC), which developed standards through 2000. The IASC, newly re-

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INTERNATIONAL REPORTING PROBLEM (Continued) structured, therefore is no longer involved directly in the development of standards. The new IASC provides oversight (selecting members for the IASB, helping with funding, and developing overall policy). Restructuring of the IASC Ed Jenkins, chair of the FASB, recently noted: “We have reached a historic milestone for the future of financial reporting that will benefit investors around the world. The FASB is pleased that the IASC—a standards setting organization based in London—has accepted the recommendations of its Strategy Working Party to restructure the IASC. When it is in place, the proposed restructuring would provide an independent, objective international standards setter whose standards could meet the needs of the global capital markets.” The new structure is very similar in nature to the way the present FASB works. It remains to be seen whether the IASB will issue standards of high quality. The IASB’s objectives specified in the report on restructuring are: 1 . to develop in the public interest, a single set of high quality, understandable and enforceable global accounting standards that require high quality, transparent and comparable information in financial statements to help participants in the world’s capital markets make sound economic decisions; 2. to promote the use and rigorous application of these standards; and 3. to bring about convergence of national accounting standards and International Accounting Standards to high quality solutions.

1-26

INTERNATIONAL REPORTING PROBLEM (Continued) The IASB is established as an independent organization such as a foundation; it has two main bodies, the Trustees and the Board, as well as a Standing Interpretations Committee and Standards Advisory Council. The trustees appoint the Board members, exercise oversight, and raise funds, whereas the Board has sole responsibility for setting accounting standards. Hopefully this new structure will work and successfully accomplish the objectives established by the IASC. A diagram of the structure is shown below. Trustees (19)

Standards Advisory Council

Board (14)

Standing Interpretations Committee

KEY Reports to Appoints Because it is a private organization, the IASB has no regulatory mandate and, therefore, no enforcement mechanism in place. In other words, unlike the U.S. setting, there is no SEC to enforce the use of IASB standards. Their use is completely voluntary.

1-27

INTERNATIONAL REPORTING PROBLEM (Continued) IOSCO IOSCO stands for International Organization of Securities Commissions. This organization is dedicated to ensuring that the global markets will be able to operate in an efficient and effective basis. IOSCO comprises securities regulators who are cooperating to accomplish this objective. The SEC, for example, is a member of IOSCO. (b) In summary, the following groups might gain most from harmonization of financial reporting: • Investors, investment analysts and stockbrokers: to facilitate international comparisons for investment decisions. • Credit grantors: for similar reasons to bullet point above. • Multinational companies: as preparers, investors, appraisers of products or staff, and as movers of staff around the globe; also, as raisers of finance on international markets (this also applies to some companies that are not multinationals). • Governments: as tax collectors and hosts of multinationals; also interested are securities markets regulators and governmental and nongovernmental rule makers. (c) The fundamental argument against harmonization is that, to the extent that international differences in accounting practices result from underlying economic, legal, social, and other environmental factors, harmonization may not be justified. Different accounting has grown

1-28

INTERNATIONAL REPORTING PROBLEM (Continued) up to serve the different needs of different users; this might suggest that the existing accounting is "correct" for a given nation and should not be changed merely to simplify the work of multinational companies or auditors. There does seem to be strength in this point particularly for smaller companies with no significant multinational activities or connections. To foist upon a small private family company in Luxembourg lavish disclosure requirements and the need to report a "true and fair" view may be an expensive and unnecessary piece of harmonization. The most obvious obstacle to harmonization is the sheer size and deep-rootedness of the differences in accounting. These differences have grown up over the previous century because of differences in users, legal systems, and so on. Thus, the differences are structural rather than cosmetic, and require revolutionary action to remove them. Another facet of this is that professional bodies are strong in certain countries such as the U.S. and U.K., but weak in other countries such as Italy, Japan, and Switzerland. This means that it is difficult for professional bodies directly to achieve international harmonization throughout the developed western world. Thus, although the professional bodies may be able to make some progress, government intervention would be necessary for a wider harmonization. This brings us to a consideration of the obstacle of nationalism, which may show itself in an unwillingness to accept compromises which involve changing accounting practices towards those of other countries. This unwillingness may be on the part of accountants and companies or on the part of states who may not wish to lose their sovereignty. Another manifestation of nationalism may be the lack of knowledge of or inter-

1-29

INTERNATIONAL REPORTING PROBLEM (Continued) est in accounting elsewhere. A rather more subtle and acceptable variety of this is the concern that it would be difficult to alter internationally set standards in response to a change of mind or a change of circumstances.

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