Accounting: The Language of Business - Vol. 2 (Intermediate: Part 4)

RICH, adj. Holding in trust and subject to an accounting the property of the indolent, the incompetent, the unthrifty, the envious and the luckless.

Ambrose Bierce

The Financial Reporting Environment

(Part D)

by

Charles Lamson

Role of Standard Setters

Standard setters work diligently to develop concepts, rules, and guidelines for financial reporting that will satisfy the requirement to accurately present the economic performance and financial position of the firm. These standards are designed to encourage transparent and truthful reporting. Publicly traded entities must follow the rules and guidelines set forth by the standard-setters to maintain public trust and to ensure the efficient functioning of capital markets. The FASB promulgates accounting standards in the United States, and the IASB issues global accounting standards, called International Financial Reporting Standards (IFRS).

The Importance of Understanding International Accounting Standards

Although U.S. GAAP [(Generally Accepted Accounting Principles)  collection of commonly-followed accounting rules and standards for financial reporting (cfainstitute.org)]and IFRS [The IFRS Foundation is a not-for-profit responsible for developing global accounting and sustainability disclosure standards, known as IFRS Standards. (ifrs.org)]  are converged in many areas, some differences still remain. Throughout Vol. 2 of this analysis, the U.S. GAAP standards will be presented in detail and pertinent differences with IFRS will be highlighted. Why is it important for an accountant in the United States to learn international accounting standards? There are several reasons:

• U.S. companies operate subsidiaries outside of the United States. Many of these subsidiaries report under IFRS in their home countries. Accountants must convert the subsidiaries' financial statements to U.S. GAAP when preparing consolidated financial statements to U.S. GAAP. For example, Johnson & Johnson operates in over 60 countries throughout the world.

•  Non-U.S. companies operate in the United States and prepare their financial statements using IFRS. Consequently, if you are working at or auditing an international firm, you will likely see IFRS. For example, GlaxoSmithKline is a worldwide pharmaceutical company based in the United Kingdom with 18% of its employees in the United States and a U.S. headquarters in Philadelphia.

•  The SEC permits the use of IFRS-based financial statements by international companies with shares on U.S. stock exchanges [The SEC eliminated the requirement that foreign issuers reconcile their financial statements from IFRS (or other accounting standards) to U.S. GAAP in 2007. To be clear, U.S. companies may not use IFRS in their financial statements. U.S. GAAP is required for us companies.]. U.S. accountants and auditors often assist these non-U.S. companies in preparing U.S. regulatory reports. As of September 2016, these companies represented a worldwide market capitalization in excess of $7 trillion across more than 500 companies.

•  The SEC promotes high-quality, globally accepted accounting standards. U.S. accountants and auditors need a working knowledge of IFRS to implement global standards in companies and perform audits. 

• Many U.S. accountants now spend time working outside of the United States. IFRS is required or permitted in over 130 countries worldwide. Exhibit 1.5 presents a map that highlights the countries that either currently require or anticipate requiring IFRS in green [As of 2018, there are 195 independent sovereign nations in the world. Approximately 126 of them require the use of IFRS, with another 12 permitting its use. IFRS governs almost all of the developed economy with an exception to the U.S. (medium.com)].

•  The accounting profession has determined that a working knowledge of IFRS is important for today's accountant. For example, the American Institute of Certified Public Accountants tests IFRS on the CPA exam.

EXHIBIT 1.5

To ensure that you are prepared to meet these challenges we address both U.S. GAAP and IFRS in this volume. We will introduce accounting practices in the United States first. We will then compare U.S. GAAP to IFRS, focusing on similarities and differences. Where there are differences, we will cover IFRS at the same level of detail as used for U.S. GAAP.

The Standard-Setting Process

We previously established in parts 6 (Vol. 1) and 3 (Vol. 2) that the FASB (Financial Accounting Standards Board) sets accounting standards in the United States and the IASB (International Accounting Standards Board) sets global accounting standards. The standard-setting processes are similar for the two Boards but there are some important differences that we will highlight.

Standard Setting

We begin with the history of U.S. standard setting, the structure of the standard-setting body, and the process of standard setting.

History of standard setting. U.S. financial reporting standard setting began with the 1934 Securities Exchange Act, which gave the SEC the power to promulgate accounting standards for all publicly traded firms. The SEC delegated its standard-setting power to the private sector, prompting the accounting profession to establish the first U.S. standard-setting board. The Committee on Accounting Procedures (CAP) was formed in 1939 as a subcommittee of the American Institute of Certified Public Accountants (AICPA) to reduce the number of accounting methods used in practice. Prior to the formation of the CAP, there were significant inconsistencies in the form and content of financial statements. For example, some companies would provide only a balance sheet while others would report only an income statement. During its tenure, the CAP produced 51 standards, referred to as Accounting Research Bulletins (ARBs or Bulletins).

The CAP accomplished its goal of reducing accounting alternatives and was replaced in 1959 by the Accounting Principles Board (APB). The APB, another subcommittee of the AICPA, issued pronouncements known as Opinions and Statements. The APB's primary objective was to respond to existing and emerging problems in financial reporting. The APB issued 31 APB Opinions and four APB statements.

The APB was criticized for being slow to develop accounting standards and inactive on several controversial issues. The part-time board members were all CPAs still affiliated with their employers. As a result, board members were not viewed as independent. Further, the APB did not develop standards in anticipation of changes in the accounting environment. Rather, the board simply responded to long-existing, controversial accounting issues. Due to these criticisms, the Financial Accounting Standards Board (FASB) replaced the APV in 1973.

The FASB is a more independent board than the APB. The seven members employed as full-time board members must sever all relationships with outside entities. In addition, board members of the FASB do not have to be accountants or CPAs---the members can join the board from industry, education, and public service. Members on the board have represented a broad range of constituencies, including members from the corporate world, the accounting profession, the investment community government, and academia. The FASB is not a subcommittee of the AICPA and is not affiliated with any professional organization.

The FASB currently issues Accounting Standards Updates (ASUs) as part of the Accounting Standards Codification (ASC). The Accounting Standards Codification (often referred to as the Codification) is the single source of GAAP in the United States and includes all pronouncements issued by any of the standard-setting bodies that have not been superseded.

Exhibit 1.6 presents the history of U.S. standard setting as well as pronouncements issued by each group. 

*GORDON, RAEDY, SANELLA, 2019, INTERMEDIATE ACCOUNTING, 2ND ED., PP. 8-10*

end