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This GAAP Review Series is designed for the accountant or practitioner who needs a detailed review of standards that apply to nonspecialized companies. The series provides a comprehensive study of FASB Statements and Interpretations and APB Opinions that apply to all companies and presents implementation guidelines and disclosure illustrations.
GAAP Review Series — Part 1
Objectives:
Prerequisite: Experience in financial reporting.
Also available in the GAAP Review Series:
Chapter 7
Latest Developments
Chapter 1
The Financial Reporting Environment
Learning Objectives
As a result of this chapter you will
Introduction
In the past few years there have been three important changes in how accounting standards are
set or, more specifically, by whom they are set. The first change is a relatively subtle one. Over
the last 10 years the prominence of the role played by the SEC in setting accounting standards
has varied over time, with some administrations taking a very active role, and others taking more
of an oversight role.
The Sarbanes-Oxley Act of 2002 required the SEC to designate an organization as having the
authority to promulgate accounting standards for public companies in the United States, which it
did in April 2003 when it reaffirmed the FASB as the designated private-sector standard setter
for public companies. The FASB has established a working protocol with the SEC for its staff to
Copyright AICPA ∗ Unauthorized Copying Prohibite1-2 d
first refer issues it identifies that may have accounting standard setting implications to the FASB
for consideration, with the understanding that the SEC staff reserves the right to exercise its
legislative authority to deal with any issues it identifies.
The second important change in standard setting began in the fall of 2002 when the FASB and
the AICPA agreed that, after a transition period, the AICPA and AcSEC would no longer issue
authoritative accounting guidance. Previously, SOPs and Industry Accounting and Audit Guides
were cleared by the FASB and were placed in level B under the GAAP hierarchy. Going
forward, the FASB will no longer clear any AICPA or AcSEC documents; consequently, any
such documents now fall under level D in the current GAAP hierarchy.
And third, beginning in 2003, the operation of the EITF has been fundamentally changed. In an
effort to provide greater direction to the EITF in terms of the issues addressed by that group, two
FASB members were added to the EITF Agenda Committee. The FASB also took greater direct
ownership of GAAP established by the EITF by requiring that consensus positions be ratified by
the Board.
The objective of those changes was to simplify the accounting standard-setting process by
eliminating the various organizations that might potentially deal with an accounting issue and
giving constituents the ability to do “one-stop shopping” at the FASB. Consistent with this
notion, the FASB also examined how they have historically issued accounting guidance and
acknowledged that they had contributed to the complexity of GAAP by issuing accounting
guidance in a variety of forms.
For example, in 2002, the FASB introduced a new form of guidance, FASB Staff Positions
(FSPs). The original reason for introducing FSPs was to eliminate further use of other forms of
guidance. Another reason was to have a means to solicit constituent comments on proposed staff
guidance, which had not been standard practice with some of the prior forms of guidance.
Observers of the FASB process may have noticed that the use of FSPs has evolved rapidly over
their short history such that they are not only being used to provide interpretive guidance, but
also to make minor amendments to existing standards.
Regardless of the form of the final guidance (e.g., a Statement or an FSP), the FASB staff will
study the issue, the FASB will deliberate the issue and expose it for public comment, the staff
will analyze the comments, and the FASB will redeliberate the issue before the guidance is
finalized. The ultimate vision for simplification of standard setting is one process and one form
of guidance.
The GAAP Hierarchy and the Codification Project
While the FASB is charged with setting accounting standards, the authoritative guidance on what
constitutes generally accepted accounting principles and the relative authority of those principles
(i.e., the GAAP hierarchy) resides in the auditing literature. After concentrating standard setting
with the FASB, it became obvious to the FASB (and the SEC) that the GAAP hierarchy should
be embedded in the accounting literature, not the auditing literature.
The FASB is in the process of preparing an Exposure Draft of a standard that will move the
GAAP hierarchy into the accounting literature. The FASB has discussed this with representatives
of both the AICPA and the Public Company Accounting Oversight Board (PCAOB), who have
agreed to take actions necessary to effectively acknowledge the GAAP hierarchy once it
becomes a part of the accounting literature. The Board decided to adopt the GAAP hierarchy in
the same fundamental form as it now exists in the auditing literature.
However, the Exposure Draft will include a vision of the future GAAP hierarchy – only two
levels, authoritative and non-authoritative. Users of GAAP will no longer have to worry about
what literature trumps other literature. In fact, there will be only one set of “authoritative”
literature, which will be identified as the Codification.
During the summer of 2004, the trustees of the Financial Accounting Foundation approved the
largest project ever addressed by the FASB. Prior to obtaining that approval, the FASB obtained
permission from both the AICPA and the SEC to use in the Codification their literature that is
currently part of GAAP. The Codification will be a compilation of existing U.S. GAAP,
organized by accounting topic, regardless of its source (i.e., FASB Statement, EITF consensus,
AcSEC SOP, etc.). There will be a standard structure to the Codification, such that users will
quickly know what subsections address the specific aspects of a topic (e.g., recognition,
measurement, disclosure, implementation guidance, etc.).
While the Codification will present existing GAAP differently, its purpose is not to change the
requirements of GAAP. Nevertheless, as the various sources of literature are put together to
prepare the Codification, inconsistencies in accounting requirements will be identified and
resolved by the FASB. Constituents will have an opportunity to comment on the resolution of
identified inconsistencies, as well as other aspects of the Codification, during an extended
“verification process.” The verification process will begin once a sufficient portion of the
Codification has been completed. The Codification is a multiple year project whose time has
arrived.
Rules-Based vs. Principles-Based Standards
The last and perhaps most challenging aspect of the path to simplification of accounting
standards relates to the topic of “principles-based” standards. The nature of the challenge is that
while it may appear that such a movement (towards principles-based guidance) is totally within
the control of the FASB as the promulgator of accounting standards, in reality, it is not.
A number of factors will influence how successful the FASB is in moving toward principlesbased
standards, and that success will be subject to each individual’s interpretation of what is
meant by “principles-based.” The goal should be that there are few scope exceptions, few bright
lines, and understandable objectives upon which reasonable people can exercise judgment that
will not be the subject of second guessing by auditors, regulators, and the plaintiffs’ bar
supported by good implementation guidance. The FASB has stated that they hope that other
forces that influence the financial reporting system will allow them to move toward that goal.
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