Chapter 3: Development of the Institutional Structure of Financial Accounting

Historical background in USAHow FASB differs from

CAPAPB

Standards setting processInstitutional problems facing FASBLiability 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

Unregulated

Accounting practices and procedures used were considered confidential, lack of uniformity

Bankers 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) formed

1896: 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 AAPA

American 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 practices

Accounting reports Based on widely varying accounting practices

Frequently 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 rules

AAA preferred a deductive approach

Uniformity improved significantly

Private 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 million

1952: 7 million

1962: 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 principles

Devoted its time to solving problems on a piecemeal approach without developing fundamental principles of accounting

No underlying accounting theory

Conflicts with the SEC

Modern Period: 1959-present

1959-73: APB and Accounting Research Division

APB form similar to CAP

Accounting 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 AICPA

Was to establish standards in the most efficient and complete manner possible

Launched the conceptual framework project

Operations differ from CAP and APB

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 of

AICPA

Part of

AICPASeparate 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 be

CPANeed 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 ProcessIdentify problem

Form task force

Produce discussion memorandum

Circulate to interested parties

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. 5 of 7 votes needed to issue a standard

Institutional problems facing FASB

SEC has the legal authority to set standards whenever it chooses

AICPAAccounting Standards Executive Committee

Emerging Issues Task Force (EITF)

GASB overlapping responsibilities

Congressional subcommittee reports

Liability Crisis

Pressure to turn the audit into a fraud detection exercise

Joint 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 FASBLiability crisis