Accounting Theory ( 5th edition) Wolk, Tearney & Dodd Copyright March, 2000 Chapter 3: Development of the Institutional Structure of Financial Accounting Historical background in USA How FASB differs from CAP APB Standards setting process Institutional problems facing FASB Liability crisis Chapter 3: Development of the Institutional Structure of Financial Accounting

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/AICPA 1933: AICPA formed Special Committee on Development of Accounting Principles Cooperative effort to develop accounting principles to be followed by all companies 1st formal attempt to develop GAAP Concept 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 1933 Eventual 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: FASB Independent 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...

Accounting Theory ( 5th edition) Wolk, Tearney & Dodd THE CONSTITUENCY The Foundation (FAF) Sponsoring Organizations Explain and Seek Views Discuss & Express Views Nominations from Sponsors Elects Board of Trustees of FAF Funds Select Oversee The FASB Financial Accounting Standards Advisory Council (FASC) Appoint & Fund Copyright March, 2000 Sponsoring organizations: six (6) are members of the Financial accounting Foundation (FAF) AAA AICPA Financial Analysts Federation Financial Executives Institute (FEI) National Association of Accountants (name changed to the IMA) Securities Industry Association FAF elects Board of Trustees members from sponsoring organizations plus up to two members at large not included in the six sponsoring organizations Board of Trustees selects FASB members, funds the activities, and provides the oversight role. FASB includes seven (7) members serving five-year terms individual can serve maximum of two terms members must be ”independent” as to employment and investments Financial Accounting Standards Advisory Council (FASC) advises FASB on its operating and project plans appointed by Board of Trustees Chapter 3: Development of the Institutional Structure of Financial Accounting

Compare CAP, APB, and FASB Independence CAP APB FASB Organization Part of AICPA Separate from AICPA Members 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 CPA Need not be CPA Due Process Little, if any Very limited More 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 limited Main use was probably in ARSs More extensive

FASB’s Standard-Setting Process Identify problem Form task force Produce discussion memorandum Circulate to interested parties Convene a public hearing Issue exposure draft and request comments Consider written comments Another exposure draft or a final vote is taken by the board 5 of 7 votes needed to issue a standard

Institutional problems facing FASB SEC has the legal authority to set standards whenever it chooses AICPA Accounting 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

Accounting Theory ( 5th edition) Wolk, Tearney & Dodd Copyright March, 2000 Chapter 3: Development of the Institutional Structure of Financial Accounting Historical background in USA How FASB differs from CAP APB Standards setting process Institutional problems facing FASB Liability crisis Chapter 3: Development of the Institutional Structure of Financial Accounting