Chapter 3: Development of the Institutional Structure of Financial Accounting

1. 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 • Sarbanes-Oxley Act • Liability crisis

2. Accounting largely unregulated Pre 1930 Formative years, initiated by 1929 stock market crash 1930-46 Post-war period 1946-59 Modern period 1959-present Periods of Accounting Development

3. 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”

4. 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.”

5. 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

6. 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

7. 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

8. 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

9. 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

10. 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

11. 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

12. 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

13. 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 • FASB’s organizational structure...

14. THE CONSTITUENCY Sponsoring Organizations The Foundation (FAF) Explain and Seek Views Explain and Seek Views Nominations from Sponsors Elects Board of Trustees of FAF Appoint & Fund Funds Select Oversee The FASB Financial Accounting Standards Advisory Council (FASC) Discuss & Express Views

15. Compare CAP, APB, and FASB

16. Compare CAP, APB, and FASB

17. Compare CAP, APB, and FASB

18. 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 4 of 7 votes needed to issue a standard (2002) FASB’s Standard-Setting Process

19. 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 investigations • Sarbanes-Oxley Act

20. Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002 • Established Public Company Accounting Oversight Board (PCAOB) • Regulatory body of public accounting firms • Overseen by SEC • Register & inspect public accounting firms • Set audit standards • Step away from self-management by the profession

21. Sarbanes-Oxley Public Company Accounting Reform and Investor Protection Act of 2002 • Act is in response to series of high profile corporate accounting scandals; objective is to restore investor confidence. • Requires FASB funding to be an assessment from annual fees, not contributions. • Significant loss of independence • Funding is dependent on recognition by SEC

22. 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

23. 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 • Sarbanes-Oxley Act • Liability crisis