Fasb Standard Developments

Fasb Standard Developments

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In 1929 the stock market crashed and along with it went public and investor confidence in the fairness of the securities markets. In response to this congress created the Securities and Exchange Commission (SEC) in 1934, which was given the authority to stipulate the methods to be used when compiling financial reports. Although the SEC was given this power, it turned to the private sector for the establishment of GAAP. Nonetheless, the SEC has remained active in the process, demonstrating its statutory authority to create accounting standards as it sees fit. Today, standard setting remains in the private sector but not without periodical pressure from the SEC. Articles written by Stephen A. Zeff and Paul B. W. Miller offer insight into the development of accounting standards as well as the prosecution faced by standard-setting boards that create them.
The Zeff article is an assessment of the path of accounting standards setting over the last 75 years. It repeatedly offers examples of instances in which the standard-setting body at the time was pressured or threatened by the SEC. In such occasions, the standard-setting bodies had to find ways to survive these actions. In many situations they had to simply give in to the SEC’s rulings. In other situations the standard-setting body that existed at the time was forced into taking action. I will briefly discuss one example of each of these predicaments.
Since its creation, the SEC has insisted on historical cost accounting, believing it results in the least misleading information. The first standard-setting body, the AIA’s Committee on Accounting Procedure (CAP), knew that in order to maintain credibility with the SEC and keep standard setting in the private sector it had to reaffirm the SEC’s core beliefs. In 1947 to 1949, the CAP received ample pressure from major companies to allow the use of inflation-adjusted depreciation expense. Allowance of this practice would deviate from historical cost accounting and likewise would upset the SEC. The CAP, acting in a reserved manner, rejected this proposal, only allowing this practice to be used in supplementary disclosures. Moreover, the CAP knew that the SEC would not allow companies to use inflation-adjusted depreciation in determining income even if it had approved of the practice. Basically, the CAP wanted to retain the function of creating standards and didn’t want to test the SEC.

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In 1950, the CAP made a move to challenge the SEC by proposing a practice that deviated from historical cost accounting. The CAP attempted to suggest an upward revaluation of assets for companies in inflationary times. Their rationale was that this practice was like the accepted accounting method of revaluing assets downward, which is today’s impairment, for companies facing severe financial and economic difficulties. Obviously, the SEC did not support this practice and made it known that they would not allow it. In response the CAP gave in to the SEC and abandoned its attempt.
During the 1960s the Accounting Principles Board (APB) set the standards that were followed in the accounting world. During this time the financial media began paying more close attention to accounting controversies. This was the result of a growing, competitive U.S. securities market and an increase in mergers between companies. In response to these conditions, the SEC began criticizing the APB for not narrowing the areas of differences in the accounting practices. The SEC suggested that if the APB didn’t do so, they would do it themselves.
As time progressed the SEC began to become inpatient with the APB’s slow progress in promoting comparability and threatened that it might strip them of their standard setting responsibilities and begin to establish accounting principles itself. This became a serious worry of leaders of the accounting profession which were united in the view that this process should remain in the private sector. Although the SEC was not a passive observer of the process, it preferred that the private sector take the initiative for establishing accounting principles.
In 1970, three of the Big Eight accounting firms at the time became very critical of the intense political lobbying of the APB. This coupled with the pressure and threats from the SEC called for action to be taken by the APB. These criticisms resulted in the AICPA’s creation of the Wheat Study Group. The purpose of this group was to study the establishment of accounting principles and recommend resolutions that would prevent SEC interference and keep standard setting in the private sector.
In 1971, the Wheat Study Group recommended that an independent, full-time standard setting body, the Financial Accounting Standards Board (FASB), should replace the APB. This would be a drastic improvement which would empower a standard setting body that was not influence by politics as heavily and had more time to devote to standard setting. Thus, reconciling the conflicts that had previously arose with the SEC.
The replacement of the APB by the FASB is a great example of how the private sector and the people in charge of standard setting have thwarted SEC action. The FASB began operations on July 1 of 1973 and is currently the standard setting body in the U.S. Its longevity is evidence of the success it has had.
The Miller article, like the Zeff article, offers insight into the development of accounting standards in the United States. Miller’s paper elaborates on an intervention by SEC Chair Arthur Levitt on an argument between the President of the Financial Executives Institute (FEI), Norman Roy, and the Chairman of the Financial Accounting Foundation (FAF), J. Michael Cook. This intervention can be viewed as a case of policy making that is lacking in formal due process. It also magnifies the fact that accounting standards are political.
The controversy was set into motion by a letter sent from Roy to Cook and Levitt. In this letter Roy proclaims that the FASB “process is broken and in need of substantive repair.” The main issue surfaced because of the controversial role that corporate executives have tried to play in the FASB’s processes. It was believed that some constituencies within this group tried to gain domination and control over the standard setter’s output. Roy’s letter not only offended FASB but also alarmed Levitt.
Levitt defended FASB against the alleged chargers that it was unresponsive to the needs of prepares. He proclaimed that his beliefs were that investors and the public were much more important than anyone else. He also reaffirmed that the SEC had oversight power that gave them jurisdiction over the FASB’s affairs. Finally, Levitt emphasized that he would not allow any threat to exist to the FASB’s independence.
Levitt’s first course of action was to allow the FASB to support itself but “every new assault on the FASB was met with Silence.” Levitt was discontent with these unsatisfactory replies but held his position that he would oppose any initiative that would compromise the FASB’s effectiveness or the fact or perception of its independence. After all of this Cook sent a diplomatic letter to Roy which failed to rebut Roy’s criticisms. Again, Levitt was discontent and this caused him to take further, more drastic action.
Levitt formulated a plan for restructuring the FAF to give the trustees more power for turning aside threats. He believed that the present trustees were unsuitable. Thus, Levitt delivered an ultimatum that the trustees replace some of themselves with new members and demanded the power to approve specific appointments. He backed this ultimatum by expressing the willingness to amend ASR No. 150 which threatened the SEC’s endorsement of the FASB as the only authoritative source of GAAP.
After learning about Levitt’s position the FAF responded to Roy like Levitt Had sought four months earlier. They resisted Roy’s proposals. Then, Cook responded to Levitt by rejecting his demands for restructuring. Cook proclaimed that the FAF emphatically did not agree with Levitt. Cook also proclaimed that the FAF was capable of saying “no” to its critics. Levitt wasn’t slowed down by Cook’s response. He made it clear that he would consider the controversy resolved only if the FAF’s structure was changed.
When the controversy was resolved Levitt had won on two issues while losing on three of them. One issue that he had prevailed on was that the trustees had to convert two sponsoring organization positions into at-large seats. The other issue that he was victorious on was in respect to his influence in appointing trustees. He was able to appoint four specific individuals who met his criteria. On the other side of this outcome Levitt had failed to win separate trustee panels for the FASB and GASB and he ended up agreeing to classify two of three governmental trustees as public members. He also did not get veto power over trustee selections. The basic effect of the restructuring was to reduce the number of sponsored trustees to 11, while increasing the at-large seats to five.
Although it may seem as Levitt won, ultimately, this new structure did not necessarily ensure the permanency of Levitt’s achievements.
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