Accounting Standards – Ultimate Guide

Accounting standards are accounting policies issued by expert institutions or government to bring harmonization in follow up of accounting practices.

Establishment of accounting standards

Accounting records traces a thousand years ago. However, there have been little efforts to develop the standards in the US prior to 1930s. One of the most important attempts in developing accounting standards began shortly after onset of the Great Depression in 1929.

There was a series of meetings in early 1930s, between New York stock exchange representatives and American Institute of Accountants (which later became American Institute of Public Accountants). The meetings were meant to discuss accounting and reporting issues that involve the interest of investors, accountants and New York Stock Exchange.

The results of these meetings were auditor’s opinion that was similar to the current one. Specifically, fairness and consistency concepts in the application of accounting principles were introduced into auditoria’s opinion.

Fairness here means that accounting methods and procedures adopted by companies to comply with the traditional practices and that there’s portraying of economic reality of such companies.

The need to develop accounting standards


In along time, controversy on ‘whose rules should we play by, and what should they be’ has remained in the accounting standards field. The answer to the question can’t be easily established as users of financial accounting statements have both conflicting and coinciding needs for various types of information.

To meet such needs, and also satisfy the fiducial responsibility of management, preparation of general purpose financial statements is crucial. Such statements are expected to provide fair, clear and complete financial operation of the enterprise.

As a result, accounting profession has tried to develop a set of accounting standards that are generally accepted and practiced universally. The common set of standards is referred to as GAAP (Generally Accepted Accounting Principles).

Hence, GAAP are guidelines, procedures and practices that businesses or companies use in recording and reporting accounting information in the audited financial statements. Such principles acts as laws and are rules which must be followed in financial reporting.

Accounting concepts and principles development from research, pronouncements and accepted accounting practices of regulators. Within the US, Financial Accounting Standards Board (FASB) has a primary role for development of accounting principles.

FASB establishes the Statements of Financial Accounting Standards and interpretation of such standards. In addition, security and exchange Commission (SEC) has authority over accounting and financial disclosures for companies whose ownership shares are sold and traded to the public. Most countries outside the US use GAAP.

PARTIES INVOLVED IN ACCOUNTING STANDARDS

There are a number of organizations which are instrumental in development of financial accounting standards (GAAP) in the US. The four major organizations are;

  • American Institute of Certified Public Accountants (AICPA)
  • Governmental Accounting Standards Board (GASB)
  • Securities and Exchange Commission (SEC)
  • Financial Accounting Standards Board (FASB)

American Institute of Certified Public Accountants (AICPA)

The AICPA is a national professional organization of practicing CPA (Certified Public Accountants. It has been vital in the development of GAAP. Various boards and committees established since founding of AICPA have contributed to this effort:

The APB’s main responsibilities were:

  • 1) Advancing written expression of the accounting principles
  • 2) Narrowing areas of differences and inconsistency in practice
  • 3) Determine appropriate practices

To achieve this, the Boards’ mission was to develop overall conceptual framework to help in resolution of problems as and when they became evident and do substantive research on industrial issues before issuing of financial pronouncements.

The board was constituted by 18-21 members that were selected primarily from the public account. Also included were representatives from the industry and academic community. Te board official pronouncement, also called APB opinions were intended on search studies and be supported by analysis and reasons.

Role of AICPA

For decades, AIPCA provided leadership in development of accounting principles and rules. The board regulated accounting profession, developed and enforced the practice of accounting more than any other professional organization.

When APB was dissolved and replaced with FASB, AIPCA established accounting standards division to function as its official voice on the accounting and reporting issues. AIPCA does various roles among them;

  • Audit and accounting guidelines: this includes the summarizing of accounting practices of specific industries and providing specific guidance on the maters not addressed by FASB. Examples are accountings for colleges and banks, casinos, and insurance companies.
  • Statements of Position (SOP): this provides guidance on the financial reporting topics until FASB sets standards on the issue in question. SOP may revise, update and clarify audit and guides for accounting.
  • Practice bulletins: narrows the financial reporting issues indicated by AcSEC’s views that are not considered by FASB.

Securities Exchange Commission (SEC)

External financial auditing and reporting evolved in tandem with growing of America’s industrial economy and its capital markets. Nevertheless, when stock market crashed in 1929, and the economy plunged into a state of Great Depression, there were calls for increased government supervision and regulation of business generally, especially yin the stock markets.

Due to that, the federal government established SEC to assist in developing and standardizing financial information presented to stakeholders. SEC is a federal agency. It administers the 1934’s Security Exchange Act and other several Acts as well. Most companies which issue the public or listed in the stock exchange are required to file audited financial statement with SEC.

In addition, SEC has powers to prescribe in whoever detail it desires, the accounting standards and practices to be employed by the companies falling within is jurisdiction.

As a result, SEC exercises oversight for more than 12,000 companies listed on major exchanges (such as NASDAQ and New York Stock exchange)

Public or private ownership

During the establishment of SEC, no private or public group issued accounting standards. SEC encouraged creation of private body to set standards because it believed that private sector has talent and the resources to develop accounting standards.

The result has led to the development of accounting standards by the private sector either through financial accosting Standards Board (FASB) or American Institute of Certified Public Accounting (AICPA). SEC has affirmed its support for FASB by showing the financial statements that conform to FASB set standards will be presumed to have authoritative support. Simply, SEC requires registrants to adhere to the GAAP.

SEC OVERSIGHT

The partnership between SEC and the private sector has worked well. The commission has acted with remarkable restraint in area of developing accounting standards. Over history however, the involvement of SEC in accounting standards development has varied. In some cases, SEC has refused the attempts of private sector to establish accounting standards while in other cases it has prodded private sector in to quickening their actions on certain reporting problems, such as reporting for derivative equipment and acting for investment in equity and debts.

SEC has the authority for establishing accounting standards. Hence, the private sector must carefully listen to the views of the commission. In some cases, private sector formulates ad implements the standards.

While partnership between SEC and private sector is recommendable, it can be strained when problems are not quickly addressed as SEC may want.

Enforcement

As said earlier, companies listed on stock exchange are required to make their financial statements submission to SEC. if the commission believes that there exists irregularity in accounting or disclosures regarding the content or form of financial statements, it sends a deficiency letter to the involved company.

Usually, such letters are solved quickly. In case of continual disagreements, SEC may issue ‘stop order’ which prevents the company from trading or issuing security on the stock exchange.

SEC program, civil and criminal litigation and private sector initiatives help in ensuring integrity in the financial reporting by the public companies.

Financial accounting Standards Board (FASB)

Members of FASB are elected by financial accounting federation (FAF) and the advisory council funds the activities ad oversees FASB overall activities. The mission of FASB is to establish and improve financial accounting standards and report for education and guidance of the public, including auditors, issuers and users of financial information.

Expectations of support and success of the new FASB were based on significant differences between the board and APB, its predecessor, which includes:

  • Greater autonomy: APB was a senior committee of AIPCA, whereas FAB is not an organ of any professional organization. It’s only answerable to FAF.
  • Broader representation: all the APB members are required to be certified Public Accountant, for them to be members of FASB
  • Increased independence: all the APB members retained their private positions with companies, firms and institutions. Members of FASB must serve such ties.
  • Full time remunerated membership: members of FASB are well paid, full-time appointed members with 5-year renewable term. Members of APB were part-time and unpaid.
  • Smaller membership: FASB is composed of 7 members replacing the 18 APB members.

FASB, in addition to research from its staff, relies on expectations of various groups task force formed by financial accounting standards advisory council (FASAC) for various projects. FASAB consults with FASAC on technical issues and major policies and assists several members of task forces.

Due process of FASB

Passage of new FASB standard statements requires support of 4-7 members of the board. GAAP considers FASB statements and hence are binding in practice. All APB and ARB opinions that were in effect in 1973, a time when FASB became effective for, continued to be effective until when they were superseded by the FASB pronouncements.

In recognition of possible misconceptions of the term ‘principles’ FASB uses the term financial accounting standards when making its pronouncements.

Types of pronouncements

  • Financial accounting concepts
  • Standards and interpretation
  • Emerging issues Task force statements
  • Technical bulletins

Financial accounting principles

In an effort to move away from problem-by-problem approach, FASB issued its first in a series of statements of Financial accounting concepts in 1978, as part of its conceptual project framework.

The purpose of this series is to set forth fundamental concepts and objectives that he Board will use to develop the future standards of financial accounting. They intend to from conceptual framework, and cohesive set of interrelated concepts that will serve as tools for solving existing and emerging accounting issues in a consistent manner.

Standards and interpretations

Accounting standards issued by FASB are considered GAAP. Further, the Board issue interpretations that represent the modification or extensions of the existing standards. The interpretations by the Board have the same authority as standards. Nevertheless, there was no interpretation required for FASB full view operation of the public that the due system required by FASB standards.

Technical bulletin

Lots of guidelines sources on the application, implementation and interpretation on FASB standards come to the Board. In addition, it also receives accounting Research Bulletin and APB opinions. There is also a strong need for a timely guidance on problems of financial accounting and reporting. For example, there was a change in tax law and hence companies that incurred income taxes liabilities were forgiven. The question was; how should the forgiven taxes be treated-as price adjustments of current period income tax expense, as tax expense reduction or as extraordinary item?

A technical Bulletin that required the reduction in the tax case to be reported as reduction of current period income tax expense was constituted.

A technical bulletin is constituted only when:

  • The cost of implementation is low
  • There is no expectation t o have major impact on accounting practice for a number of practices
  • Guidance provided by the technical bulletin doesn’t conflict with the Board’s fundamental principles of accounting.

Emerging Issues Tax Force Statement (EITF)

Emerging Issues Tax Force Statement-EITF was created in 1984. It is composed of 14 members who represent Certified Public Accounting firms and preparation of financial statements. Also in attendance to EIFT’s meetings are observers from AICPA and SEC.

The purpose of this task force is to reach consensus on how new and unusual financial transactions should be accounted. Examples include how pension plan terminations should be accounted.

EITF helps FASB in many ways especially on emerging issues which often attracts public attention. If not quickly observed, they can bring financial crises which can undercut the public confidence in current reporting practices.