Standardand Rule Setting in the Accounting Industry
Thereporting of financial statements requires comprehensive standards toensure conformity, comparison of statements, and conclusive reportson the management of organizations. In this regards, the assessmentof the standard and rule setting in the accounting industry willprovide a critical and comprehensive framework on the roles andinterconnections of different accounting bodies such as FASB, AICPA,and SEC. Here, the paper will utilize journals and books to draw abrief on the roles of the bodies and the way they relate with eachother. In addition, the paper will provide a historical context ofeach body and the way the bodies have accomplished their mandate.
Standardand rule setting in the accounting industry
Overviewof the standards setting industry
Profitand loss statements, balance sheets, financial disclosures and notespresent the language used in financial reporting. These reflect thefinancial conditions of an organization whether a private or publiccompany, not for profit organizations or state or local governmentinstitutions. The Financial Accounting Foundation establishes anddevelops accounting standards through several accounting standardsetting boards(Finkler, Ward & Calabrese, 2011 Palmon, Peytcheva, &Yezegel, 2011).These boards include the Governmental Accounting Standards Board andthe Financial Accounting Standards Board. These establish the rulesoutlining how firms should use financial reporting to communicate anorganization’s financial position. These rules collectively referto as the US Generally Accepted Accounting Principles (US GAAP)(Finkler, Ward & Calabrese, 2011 Bragg, 2005).This paper seeks to create an understanding of standards and rulesetting in the US accounting industry.
Accountingregulations in US require all organizations to apply these standardsas a basis to define how they accord financial statement users’information with which to base decisions on how well an organizationis managing its resources(Finkler, Ward & Calabrese, 2011).Such decisions include how a firm decide to invest capitaldonate/lend funds or whether organizational personnel are usingresources wisely. Here, the regulations require firms to provideconcise, comparable, clear, reliable and relevant financialstatements.
Theefficient functioning of capital markets is dependent on high qualityand flawless financial reporting standards as these are important toaccurate financial statements of organizations(Allen & Ramanna, 2013 Economist, 2004)).This enhances the transparency of organizational economics. Financialreporting is very useful to investors as it allows for gooddecision-making processes with regard to capital allocation. Improvedinvestment decisions not only inspire more confidence towards capitalmarkets but also serve to foster greater US economic growth.
Inthe 15thcentury, Italy became the first country to establish accountingstandards through double entry book keeping. Lucas BartolomesPacioli, invented double entry bookkeeping and refined by BenedettoCotrugli(Botzem, 2012).Further developments in financial reporting have over the yearsenabled the US to stimulate investor confidence during criticaleconomic moments.
Forinstance, during the American Industrial Revolution, railroadcompanies played a significant role in pioneering standardizedfinancial reporting(Botzem, 2012).This was in an effort to attract capital from the private and publicsectors to fund it huge projects. Reliable, clear and comparablefinancial reporting gave investors financial information, whichtranslated to abundance in capital investment. This led to arevolutionary way of transporting goods to ready markets furtherspurring economic growth in the US.
Duringthe Industrial Revolution i.e. in 1887, accounting professionsfounded the American Association of Public Accountants (AAPA) to setstandards for audits of government agencies, private companies, andnon-profit companies (Botzem,2012).The association later reestablished itself in 1916 as the Instituteof Public Accountants, and then changed its name in 1917 to AmericanInstitute of Accountants. In 1921, the American Society of CertifiedPublic Accountants and later merged with the Institute of PublicAccountants to form the American Institute of Certified PublicAccountants(Botzem, 2012).
Publiccompanies in the US took center stage in leading innovations infinancial reporting. For instance, Botzem (2012) hails the growth ofthe automobile industry in the 20’s for modernizing financialreporting and accounting standards. General Motors contributedgreatly in this regard by introducing financial information in termsof accounting ratios such as returns on equity and return oninvestment. This enabled GM quickly make suitable decisions incapital investment and respond better to prevailing changes in themarket enabling the company benefit its investors and the entireautomobile industry.
TheGreat Depression led to the US government to call broad reforms infinancial accounting standards. Scholars believed that poor financialreporting procedures contributed to the Great Depression(Botzem, 2012).In 1930, the New York Stock Exchange and the American Institute ofAccountants set out to have financial reporting standards revised. In1934, the US congress passed the Securities Act (1934) which gave astatutory charter to the Securities and Exchange Commission(Botzem, 2012 Bragg, 2005).Here, accounting regulations required SEC through a constitutionalmandate to administrate over accounting and auditing methods.
Forclose to 4 decades, the SEC relied on bodies founded by professionalaccounting institutions to establish and develop sound accountingstandards(Botzem, 2012).In the 70’s, the market players saw the need to seek an evolutionin the US accounting standards setting. This precipitated the needfor an independent standards setting structure, distinct and separatefrom bodies established by the accounting profession. This was toshield accounting standards from self-interests of the accountingprofession. After a detailed research study, these bodies founded theFinancial Accounting Foundation in 1972. This followedrecommendations of the accounting profession and the professionsaccorded FAF authority to set the US accounting standards(Botzem, 2012).
TheFinancial Accounting Standards Board
Botzem(2012) and Palmonet al (2011) assert that through the FAF, professional in theaccounting sector established FASB in 1973 as an organization withinthe private sector as a result expanding complexities in businessduring the 60’s. The professional tasked the body with settingaccounting standards governing the preparation financial reports forcorporate entities as well as not profit organizations. It is fullyindependent and dedicated to accounting standards setting andrelieved the AICPA of its role in standard setting(Botzem, 2012).The FASB initiated a process in 2009 establishing authority for theGAAP through the FASB Accounting Standards Codification. Thecodification integrates SEC guidance principles and the authoritativeGAAP into 90 topics(Botzem, 2012 Palmon et al, 2011).The accounting principles and standards established and developed bythe board aims at ensuring American organizations continue to offerinvestors and other market players with high quality financialinformation. This is to ensure capital markets remain stable andinformation users obtain publicly trusted financial informationeasily and efficiently.
TheU.S. Securities and Exchange Commission (SEC)
Therole of the US Securities Exchange Commission (SEC) is primarily toenhance capital formation, maintain efficient, orderly and faircapital markets and offer investor protection in an effort to ensuresustainable economic growth (SEC, 2013 Bragg, 2005). Towards thisend, the SEC requires all public companies in the US to provide clearand accurate financial information as well as other relatedinformation to members of the public.
TheUS Congress passed the Sarbanes-Oxley Act (SOX) in 2002, whichcreated PCAOB in an effort to restore confidence among the US public(SEC, 2013). This was after massive financial accounting anomaliesled to the collapse of Enron and WorldCom. Investors suffered greatlyfrom the collapse of these two companies, which led the public todeem financial reporting standards as unreliable. The act requiredthe subjection of all auditors to independent and external oversight,terminating the self-regulation of the profession.
TheSarbanes-Oxley Act passed in the congress established the PublicCompany Accounting Oversight Board (PCAOB) to superintend theinventories of all public companies to safeguard stakeholders and thepublic interest by indorsing precise and autonomous audit reports. Itis a non-profit entity with a statutory mandate to oversee theauditing processes of US public companies (SEC, 2013). PCAOB aims toaccord investors’ protection and public interest through promoting,independent, accurate and informative financial audits reporting. Theboard also supervises the auditing of brokerages and dealerships aswell as compliance reports prepared and filed as required underfederal securities laws. This is essentially towards promotinginvestor protection, as the industry was previously self-regulated.
TheSEC oversees the operations of the PCAOB, such as approving theBoard’s rules, budget and standards. Legislators furtheramended the SOX Act with the passing of the Dodd-Frank Act of 2010(SEC, 2013). As activity in the US markets grew during the 90’s,white-collar crimes increased. This law gave the SEC further powerstowards protecting market investors and public interests. SEC workswith other bodies, for example, federal and state agencies to executeactions against actors supposed to infringe securities regulations.In addition, SEC is a member of IOSCO (Internal Organization ofSecurities Commissions) and utilizes the IOSCO multilateral MOU andbilateral arrangements with other nations’ commissions to preventcross-border delinquency in securities market.
FinancialAccounting Standards Board
Thegovernment granted SEC statutory mandate towards the establishment offinancial accounting and reporting standards formulation anddevelopment through the Securities and Exchange Act (1934)(Edwards, 2013 Palmon et al, 2011).FASB was established in 1973 as a not for profit public organizationwith a mission to formulate and develop financial reporting andaccounting standards. This was to improve financial reporting fromnongovernmental organizations, which offer useful decision-makinginformation available to investors and other market players.
Themission defines the FASB goals, which are to independently andbroadly encourage objective considerations on stakeholder views,comprehensive participation and conform to the requirements of theFinancial Accounting Foundation (FAF) (Edwards, 2013 King, 2006).FASB has a special place in the financial reporting procedures in thecountry. The body provides leadership for public companies ininstituting and enhancing the accounting processes and approachesused to formulate financial statements. King (2006) asserts that thebody has dominion to set accounting benchmarks through the delegationframework provided by SEC, although it cannot enforce the standardssince this is the work of SEC, which it does not delegate to thebody. In this regards, the body takes approvals from SEC and AIPAwhen developing or enhancing standards, although both associations donot require FASB to do so. In addition, the body permits businessesto select how they depreciate or disparage assets on their accounts,but the businesses have to reveal the approaches they use and usethose approaches constantly for the lifespan of the asset.
King(2006) and Palmon et al (2011) assert that there exists a closecorrelation between SEC, an agency accountable for setting accountingbenchmarks and FASB, a private body to whom SEC has surrogated thisaccountability. In this regards, SEC is a national supervisoryagency with standard-setting power, which has selected to surrogatethe standard-setting accountability to FASB, a private and differententity. Here, scholars and representatives from FASB and SECacknowledge FASB as directly accountable to SEC. The AccountingPrinciples Board (APB) previously carried out the function of theFASB under authority from the SEC. Members of the accountingprofession in the private sector in 1962 to 1963 formed it (Edwards,2013 King, 2006). The members formed FASB to protect capital marketstakeholders from personal interests of members of the accountingprofession. TheWheat Study Group presented recommendations from its research studyfindings, which determined that the APB was not an independent body(Edwards, 2013).The SEC accepted these recommendations, which led to theestablishment of the FASB. It should however be noted that the FASBcontinues to work with the private sector towards improving financialaccounting and reporting principles.
Wheninvestors purchase stocks, buy bonds or public traded utilities, theyare in essence taking on an investment risk. The assets are valuedbased on the financial position of the issuing firm and its abilityto continue as a going concern. The FASB works under the authority ofthe SEC towards ensuring financial reporting is clear and ethicallysound in line with consistent accounting practices in an effort toprotect investors.
TheAmerican Institute of Certified Public Accountants
Inthe US accounting industry, the initial private sector body was knownas the Committee on Accounting Procedure (CAP). The private sectorbody assumed the role formulating and developing accounting standards(Edwards, 2013). The American Institute of Accountants (AIA)constituted the Committee on Accounting Procedure. In 1957, the AIAbecame the national organization of professional public accountantsunder the name the American Institute of Certified Public Accountants(AICPA).
TheFASB is made of a board of seven members tasked with settingaccounting standards in the US under authority from the SEC. AICPA onthe other hand accord technical support, accounting guidelines andstandards setting advise to the FASB (Edwards, 2013). The AICPAplays a critical role in setting auditing standards and guidance onsuch issues as rotation requirements for auditors. It also acts as aliaison between corporations and the market institutions. This is inan effort to develop better ways of communicating controls againstfraud.
TheEconomist (2004) writes that the International Standards AccountingBoard (IASB) is the internationally recognized accounting standardssetter. In 2008, the AICPA voted to designate the role ofestablishing professional accounting standards in the internationalfinancial accounting arena (AICPA, 2014). The AICPA however decidedthe role accorded to the IASB in 2013 (Edwards, 2013). This impliesthat the AICPA plays a significant role in setting standards in theinternational financial landscape and protecting American investors.
TheAICPA has a Governmental Audit Quality Center (GAQC), which served toaid members overcome hurdles limiting the carrying out of qualityaudits (AICPA, 2014). The AICPA has an expert panel charged withprotecting the public through creating forums for state experts andlocal experts within the industry to discuss on key issues.
TheAICPA works closely with the Healthcare Financial ManagementAssociation (HFMA) by offering technical expertise in auditing andaccounting standards. The HFMA is a membership organization forfinancial management professionals in the healthcare industry. Theycollaborate towards ensuring the healthcare sector keeps abreast withthe changes of the accounting industry to ensure the protection ofinvestors.
TheFinancial Accounting Foundation creates and progresses accountingcriterions through numerous accounting standard setting boardssuch asGovernmental Accounting Standards Board and the Financial AccountingStandards Board (Economist, 2004. These boards as aforementionedcreate the rules, which outline how firms should use financialreporting to communicate an organization’s financial position. Inaddition, accounting regulations require all organizations to applythese standards as a foundation for defining the way they accordfinancial statement users’ information with standards to base theirdecisions on management of organizations. Although most of thediscussed associations or bodies have independent mandate theyassociate closely and draw regulations from a common framework.
Allen,A. & Ramanna, K. (2013). Towards an understanding of the role ofstandard setters in standard setting. Journalof Accounting and Economics,55(1),66-90.
AmericanInstitute of CPAs. (2014). GASBMatters.Retrieved fromhttp://www.aicpa.org/INTERESTAREAS/GOVERNMENTALAUDITQUALITY/RESOURCES/GASBMATTERS/Pages/default.aspx
Botzem,S. (2012). Thepolitics of accounting regulation: Organizing transnational standardsetting in financial reporting.Northampton,MA: EdwardElgar Publishing.
Bragg,S. M. (2005). Theultimate accountants` reference including GAAP, IRS & SECregulations, leases, and more.Hoboken, N.J.: John Wiley.
Economist.(2004, October 23). A question of measurement Accountingstandards..TheEconomist, 3,14-15.
Edwards,J. R. (Ed.). (2013). Ahistory of financial accounting.London: Routledge.
Finkler,S. A., Ward, D. M. & Calabrese, T. (2011). Accountingfundamentals for health care management.Burlington, MA: Jones & Bartlett Publishers.
King,A. M. (2006). Fairvalue for financial reporting: meeting the new FASB requirements.Hoboken, N.J.: John Wiley & Sons.
Palmon,D., Peytcheva, M., & Yezegel, A. (2011). The Accounting StandardsSetting Process In The U.S.: Examination Of The SEC–FASBRelationship. GroupDecision and Negotiation, 20(2),165-183.
USSecurities and Exchange Commission. (2013). The Investor`sAdvocate: How the SEC Protects Investors, Maintains Market Integrity,and Facilitates Capital Formation. Retrieved fromhttp://www.sec.gov/about/whatwedo.shtml#.VDkdUGd3C1s