Chapter 3
Development of the Institutional Structure
of Financial Accounting
TRUE/FALSE
1.
The accounting profession has been regulated by Congress since the 1880’s, when
it became clear that accounting was an important instrument in America for
conducing business.
ANS: F
2.
The SEC was created by Congress to replace the AICPA’s standard-setting group.
ANS: F
3.
The SEC is legally empowered to regulate accounting principles.
ANS: T
4.
Most of the responsibility for establishing accounting principles has remained
with the private sector rather than the SEC.
ANS: T
5.
The Securities Act of 1933 and the Securities and Exchange Act of 1934 were the
first national securities legislation in the United States.
ANS: T
6.
The Journal of Accountancy was founded by the American Association of Public
Accountants in1905.
ANS: T
7.
The American Accounting Association was originally called the American
Society of Certified Public Accountants.
ANS: F
8.
The Committee on Accounting Procedures (CAP) used a formalized deductive
approach to develop a comprehensive accounting theory.
ANS: F
9.
The Committee on Accounting Procedures (CAP) represented the profession’s
first sustained attempt to develop workable financial accounting rules.
ANS: T
10.
APB Opinions were originally expected to be based on in-depth research studies.
ANS: T
11.
The Trueblood Study Group formed the FASB and called for significant changes
in the establishment of financial accounting standards.
ANS: F
12.
The responsibility of the Financial Accounting Foundation is to elect the board of
trustees, which selects FASB members, funds the board’s activities, and performs
the oversight role.
ANS: T
13.
The FASB has made more extensive use of research than did its predecessors.
ANS: T
14.
FASB statements have resulted in a more conservative balance sheet and
immediate recognition of events on the income statement.
ANS: T
15.
The Accounting Standards Executive Committee of the AICPA (AcSEC) and the
Emerging Issues Task Force (EITF) were established to solve the problems of
particular industries as well as narrow technical issues.
ANS: T
16.
Currently, a 4-3 vote is required to pass a FASB standard.
ANS: F
17.
The Federal Litigation Reform Act of 1995 replaced the previous proportionate
liability requirement with joint and several liability for damages suffered by third
parties who rely on the financial statement of firms attested to by CPAs.
ANS: F
18.
The FASB has exclusive authority in the private sector for promulgating auditing
rules.
ANS: F
19.
Congress has recently been concerned with the laxity of auditors in detecting and
disclosing fraud.
ANS: T
20.
An important role of the AICPA is to curb “shopping for accounting principles.”
ANS: T
21.
Ann annual report to stockholders prepared using FASB accounting standards
generally has more disclosure of non-financial statement information than does
the typical annual report filed with the SEC
ANS: F
22.
The Litigation Reform Act of 1995 requires that an audit include procedures
designed to guarantee that illegal acts that would materially affect financial
statements will be detected.
ANS: F
23.
The importance of the auditing function relative to the management consulting
function is declining in major auditing firms.
ANS: T
24.
A problem with the increased importance of the management consulting function
in auditing firms is the possible erosion of the integrity of the auditing function.
ANS: T
25.
The AICPA has developed an electronic filing of financial data called EDGAR.
ANS: F
MULTIPLE CHOICE
1.
Which of the following characteristics does not apply to accounting practices and
procedures in the U.S. prior to 1930?
a.
They were applied uniformly among companies. XXXXX
b.
They were considered confidential by the companies applying them.
c.
They met the needs of creditors to a greater extent than they met the needs
of shareholders.
d.
They emphasized the disclosure of cash and near-cash resources.
2.
Which of the following was an accomplishment of the American Association of
Public Accountants?
a.
The passage of a law in 1896 that created the professional designation of
“Certified Public Accountant.”
b.
The founding of The Journal of Accountancy in 1905
c.
The development of a list of terms and definitions in 1915
d.
All of the above. XXXXX
3.
In 1918 the American Institute of Accountants (AIA) worked with which of the
following organizations to publish minimum standards for conducting a balance
sheet audit?
a.
The Federal Trade Commission (FTC) XXXXX
b.
The Securities and Exchange Commission (SEC)
c.
The American Society of Certified Public Accountants
d.
The New York Stock Exchange (NYSE)
4.
What state passed the law that first created the designation “Certified Public
Accountant”?
a.
Massachusetts
b.
California
c.
Ohio
d.
New York XXXXX
5.
Which of the following factors led to significant changes in accounting practices?
a.
The Great Depression of 1929
b.
The election of Franklin D. Roosevelt to the presidency in 1932
c.
The enactment of the New Deal legislation
d.
All of the above XXXXX
6.
Which of the following is not true regarding Accounting Series Release No. 4?
a.
It stated that financial statements filed with the SEC and prepared in
accordance with accounting principles for which there is no substantial
authoritative support would be presumed to be misleading.
b.
It implied that the SEC might in the future determine acceptable
accounting practices and mandate methods to be used in reports filed with
it.
c.
It established an authoritative body for the development of accounting
standards. XXXXX
d.
It indicated that the SEC was growing impatient with the accounting
profession.
7.
Which of the following is true regarding the Committee on Accounting
Procedures (CAP)?
a.
It developed a comprehensive statement of accounting principles.
b.
It adopted a policy of attacking specific problems and recommending
preferred methods of accounting when possible. XXXXX
c.
It was formed by the SEC in 1936.
d.
It eliminated the use of alternative accounting practices by establishing an
underlying accounting theory.
8.
The Committee on Accounting Procedures (CAP) was immediately succeeded by
a.
The Financial Accounting Standards Board (FASB)
b.
The Accounting Principles Board (APB) XXXXX
c.
The Accounting Research Board (ARB)
d.
The Financial Accounting Foundation (FAF)
9.
Which of the following was a controversial issue faced by the Accounting
Principles Board (APB)?
a.
The investment tax credit
b.
Income tax allocation
c.
Business combinations and goodwill
d.
All of the above. XXXXX
10.
What was the purpose of APB Statement 4, Basic Concepts and Accounting
Principles Underlying Financial Statements of Business Enterprises?
a.
To provide a foundation for evaluating existing accounting practices
b.
To assist in solving accounting problems and to guide the future
development of financial accounting
c.
To enhance understanding of the purposes of financial accounting
d.
All of the above XXXXX
11.
Criticism of the standard-setting process under the APB included:
a.
Exposure for tentative opinions was too limited and occurred too late in
the process.
b.
The standard-setting process was too long and subject to too many outside
pressures.
c.
Both a and b XXXXX
d.
None of the above
12.
In which of the following ways did the charge to the Financial Accounting
Standards Board (FASB) differ from that given to the Accounting Principles
board (APB)?
a.
The FASB was to establish standards of financial accounting and reporting
in the most efficient and complete manner possible. XXXXX
b.
The FASB was to work toward standard setting with a two-pronged
approach.
c.
The FASB was expected to stipulate principles of accounting as an
underlying framework.
d.
The accounting standards established by the FASB were to be advisory
rather than mandatory.
13.
Which of the following are true regarding the Financial Accounting Standards
Board (FASB)?
a.
The FASB includes ten members, each serving a term of three years.
b.
Each member of the FASB must be a Certified Public Accountant.
c.
There must be no conflict between the FASB members’ private interest
and the public interest. XXXXX
d.
All of the above are true.
14.
The establishment of which of the following groups has resulted in a challenge to
the FASB’s standard-setting powers?
a.
The Governmental Accounting Standards Board (GASB)
b.
The Emerging Issues Task Force (EITF)
c.
The Accounting Standards Executive Committee (AaSEC)
d.
All of the above XXXXX
15.
The liability concept that restricts liability to each defendant’s share of the
damages based upon the judge or jury’s assessment of their share of the damages
is called
a.
Proportionate liability XXXXX
b.
Compensatory liability
c.
Joint and several liability
d.
Disproportionate liability
16.
The liability concept that can result in one party having to pay for more than its
proportionate share of damages is called
a.
Proportionate liability
b.
Compensatory liability
c.
Joint and several liability XXXXX
d.
Punitive liability
17.
Which of the following bodies has exclusive authority in the private sector for
promulgating auditing rules?
a.
The FASB
b.
The AICPA XXXXX
c.
The SEC
d.
None of the above
18.
Which of the following professional associations has an interest in the accounting
standard-setting process?
a.
The AICPA
b.
The Financial Executives Institute (FEI)
c.
The American Accounting Association (AAA)
d.
All of the above XXXXX
19.
Which of the following events resulted in shareholders beginning to question
whether accounting and reporting practices were adequate to assess investments?
a.
The stock market crash of 1929 XXXXX
b.
The federal government’s lump-sum payments for the retirement of
Liberty Bonds
c.
The creation of the SEC in 1934
d.
None of the above
20.
In 1930 the AICPA began working with which of the following organizations to
prepare “five broad accounting principles,” one of the most important documents
in the development of accounting rule making?
a.
The SEC
b.
The NYSE XXXXX
c.
The AAA
d.
The FTC
21.
Which of the following represented the first formal attempt to develop “generally
accepted accounting principles”?
a.
“Approved Methods for the Preparation of Balance Sheet Statements” in
1918
b.
“Five board accounting principles” in 1932 XXXXX
c.
Accounting Research Bulletin (ARB) 43
d.
The FASB’s conceptual framework project
22.
Which of the following is a true statement?
a.
The SEC initially required the accounting profession to consult with it
before setting any specific accounting principles
b.
The SEC was created by Congress to oversee the accounting profession.
c.
The SEC was given authority to prescribe the form and content of
financial information filed with the SEC. XXXXX
d.
The SEC formed the Committee on Accounting Procedure to develop a
comprehensive set of accounting principles.
23.
Which of the following is true regarding the Emerging Issues Task Force (EITF)?
a.
It has formal authority to establish GAAP.
b.
Members of this group consist of CEOs of six major corporations and the
chief accountant of the SEC.
c.
It is concerned with highly technical issues, such as financial instruments,
which may affect firms in virtually every industry. XXXXX
d.
All of the above
24.
Major complaints aimed at the FASB’s standard setting process include:
a.
The cost of preparing standards is too high.
b.
Some standards are very difficult to understand.
c.
Both a and b XXXXX
d.
None of the above
25.
Which of the following bodies was created to deal with municipal accounting
issues?
a.
GASB XXXXX
b.
FASB
c.
FAF
d.
EITF
26.
In which of the following ways has the Financial Executives Institute (FEI)
become involved in the accounting standard-setting process?
a.
By funding research projects in accounting and related areas
b.
By reviewing FASB discussion memorandums and exposure drafts and
communicating an official position to FASB.
c.
By participating in FASB public hearings.
d.
All of the above XXXXX
27.
Which of the following are characteristics of the FASB?
a.
It is part of the AICPA.
b.
Members are part-time employees of the FASB.
c.
A member must be a CPA.
d.
It makes more extensive use of research than its predecessors. XXXXX
28.
The accounting standard-setting process begins with which of the following
steps?
a.
A problem is identified. XXXXX
b.
A task force is formed.
c.
Public hearings are held.
d.
An exposure draft is issued.
ESSAY QUESTIONS
1.
Why did accounting and reporting practices in the U.S. prior to 1930 not meet the
needs of shareholder investors?
ANSWER: In the U.S. prior to 1930, accounting was unregulated and
accounting practices and procedures were considered confidential. This resulted
in a lack of uniformity in accounting practices among companies, both from year
to year and within the same industry. Also, the American public did not invest
large sums in private corporations until the 1920’s, when private corporations
were expanding, and both they and government leaders encouraged the public to
invest in stock. Before that time, banks and other creditors were the primary users
of financial information, resulting in an emphasis on a company’s debt-paying
ability. When individuals began investing in corporate stock, financial reporting
lagged behind and continued to be prepared primarily for the needs of creditors.
It wasn’t until the stock market crash of 1929 that shareholders began to question
whether accounting and reporting practices were adequate to assess investments.
2.
Compare and contrast the characteristics of the CAP, APB, and FASB.
ANSWER: The FASB is separate from the AICPA, while the CAP and the APB
were part of the AICPA. FASB members are more independent since they are
full-time employees of the FASB. CAP and APB members were also employed
elsewhere, usually by a CPA firm. FASB members need not be a CPA. CAP and
APB members were required to be CPAs. The FASB allows for more extensive
due process. The CAP engaged in little if any due process and the APB engaged
in only very limited due process. The FASB succeeded in developing a
conceptual framework, something the CAP did not attempt and the APB failed to
accomplish. FASB also makes more extensive use of research than did its
predecessors and has been more productive.
3.
Discuss the steps in the accounting standard-setting process and explain why it
may not be capable of dealing with the complex environment of the 1990s and
beyond.
ANSWER: The standard-setting procedure starts with the identification of a
problem. A task force then explores all aspects of the problem and circulates a
discussion memorandum that identifies the issues and possible solutions. The
FASB then convenes a public hearing where interested parties may make their
views known to the board. An exposure draft of the final standard is then issued
and written comments requested. After consideration of written comments, either
a revised exposure draft is issued or a final vote is taken by the board. Five votes
are needed for the issuance of a final standard.
The FASB process developed in the 1970s may not be capable of dealing with the
more complex environment of the 1990s and beyond. Financial markets are now
globalized, communication is almost instantaneous, institutions are more
competitive, and information technology makes it possible to better determine
current evalulations of both assets and liabilities. Secondly, some non-financial
measures may correlate more closely with security prices than financial measures
such as income that are addressed in the typical financial statements generated
under GAAP. An additional issue involves how the conceptual framework might
need to be amended and extended to adapt to newly emerging types of business.
4.
How has the Government Accounting Standards Board (GASB) challenged the
FASB’s standard setting powers?
ANSWER: The GASB established another jurisdiction. It was created by the
FAF in 1984 to deal with municipal accounting issues. However, its
responsibilities overlap with those of the FASB. Separately issued generalpurpose financial statement of such entities as hospitals, colleges and universities,
and pension plans are supposed to utilize FASB standards except where the
GASB has issued a particular standard covering a specific type of entity or a
precise economic practice or activity. As a result of this overlap, GASB standards
tend to “muscle out” particular FASB standards for governmental entities.
5.
Discuss what is meant by “the liability crisis in public accounting.” How did the
Federal Litigation Reform Act of 1995 address this issue?
ANSWER: There has been tremendous pressure to turn the audit into a fraud
detection mechanism with the auditor to report to the SEC, in the case of publicly
traded companies, if management and the board of directors do not take corrective
action. Though auditors share some of the blame when fraud is undetected, there
have been some inherent problems in the legal system combined with the fact that
auditors are seen to have very “deep pockets.” Prior to the Federal Litigation
Reform Act of 1995, auditors in both federal and state cases were subject to joint
and several liability for damages suffered by third parties who relied on the
financial statements of firms attested to by CPAs. Auditors could be stuck with
more than their proportional share of judgments. Under the 1995 Act, joint and
several liability is not applicable in federal court unless the defendant knowingly
violates security laws. The Act replaced joint and several liability with
proportionate liability which restricts liability to each defendant’s proportionate
share of the damaged based upon the judge or jury’s assessment of their share of
the damages.
6.
Describe the controversy surrounding the issuance of APB Opinion No. 2, which
addressed the investment tax credit? How did the APB resolve this controversy
and what was the resulting effect on the board’s authority?
ANSWER: The accounting profession was divided on how to account for the
investment tax credit. Two alternatives existed: (1) recognize the tax benefit in
the year received (the flow through method), or (2) recognize the tax benefit over
the life of the related asset (the deferral method). The APB did not commission a
research study on the subject and issued Opinion No. 2, which opted for the
deferral method. Three large CPA firms made it known that they would not
require their clients to follow the opinion and the SEC continued to allow its
registrants to use either method. As a result of this challenge to its authority the
APB issued Opinion No. 4, which permitted the use of either method. This
successful challenge caused the binding authority of APB opinions to be
questioned in the press for several years.
7.
Discuss the current roles of the AICPA and the SEC.
ANSWER: The AICPA, through its Auditing Standard Board, has exclusive
authority in the private sector for promulgating auditing rules. The board issues
Statements on Auditing Standards. Rule 202 of the Rules of Conduct requires
AICPA members to adhere to all applicable Statements on Auditing Standards in
conducting audits. The AICPA has also been attempting to strengthen
professional standards of conduct and rules of performance and behavior to curb
“shopping for accounting principles,” where a client tries to find an auditor who
will either lowball its bid or go along with a questionable accounting method.
The SEC is legally empowered to regulate accounting practices, but it has, as a
matter of policy, been supportive of private-sector standard setting. The primary
differences in accounting standard promulgated by the SEC and FASB have been
in the area of disclosures. The annual filings with the SEC require significantly
more disclosure of non-financial statement information than does the typical
annual report to stockholders. Another aspect of the SEC operations involves the
implementation of electronic filing and retrieval of financial data through its
EDGAR system.