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S ome have asserted that the term “generally accepted accounting principles”
(i.e., GAAP) has lost its “general” acceptability over time, and that it is now time to make accounting standards both relevant to users and relatively simple for professionals to understand and implement. This article briefly explores the evolution of the term
GAAP, and whether it ever actually meant broad-based acceptability.
The earliest seeds of the term generally accepted accounting principles were planted in 1938 when the SEC issued Accounting
Series Release (ASR) 4, stating that it would accept financial statements based on accounting for which there was “substantial authoritative support,” a similarly vague term that the SEC did not define. Following
ASR 4, the AICPA’s Committee on
Accounting Procedure began issuing a series of Accounting Research Bulletins (ARB) asserting that they constituted “rules which may be subject to exception” with the burden of proof accruing to those who would depart from them. The stated objective of the
ARBs was not, however, to constitute a comprehensive framework of accounting principles; their scope was limited to specific issues as they were identified.
Each of the early ARBs was accompanied by a caveat stating that their authority rested on their general acceptability, again, without definition or elaboration. To this day, many well-established and common alternative accounting practices exist in use
(whether approved by an authorized standardssetting body or not), making them often inconsistent and irreconcilable with one another on conceptual grounds.
Even before the first ARB was issued in
1939, the AICPA had formed its Committee on Auditing Procedures in response to the infamous McKesson & Robbins fraud, and the expression “generally accepted accounting principles” appeared in the same milestone year in the very first United States auditing standard, Statement on Auditing
Procedures (SAP) 1. The term was used in
SAP 1 as a frame of reference in what was then called the “short form” audit report, much as it is still used in today’s standard audit reports in conjunction with the (thennew and undefined but now common) term,
“presents fairly.” None of these early sources showed any attempt to define GAAP.
In 1961, noted author and accounting professor, Robert K. Mautz, together with
H.A. Sharaf, wrote in The Philosophy of
Auditing (a then widely respected monograph published by the American Accounting
Association) that “there does not exist any authoritative, comprehensive system of accounting principles [but only] … the rather odd assortment of authoritatively established principles is presumably what auditors now refer to as generally accepted accounting principles.” They also wrote, “It is unfortunate that the word ‘general’ was selected for use in describing the extent of acceptance of accounting principles, because it carries a connotation of consensus or majority rule that is not intended … the term merely means that there is some substantial support.”
Recognizing the problem two years earlier, in 1959, the Accounting Principles
Board (APB)—successor to the AICPA’s
Committee on Accounting Procedure—set out for the first time to research and develop “a fairly broad set of coordinated principles … [that] should serve as a framework for the solution of detailed problems.” This is an objective that remains elusive today, as standards setters and users continually seek to eliminate accounting alternatives that can produce materially inconsistent results in similar circumstances or that are otherwise conceptually unsound, and, most recently, as the relative merits of “principles-based” vs.
“rules-based” accounting standards are debated. Each APB pronouncement (interestingly labeled “opinions”) contained the same caveat as in the predecessor ARBs (i.e., that their authority rested on their general acceptability, which still lacked definition or elaboration).
The older SEC-originated language returned in 1964 in the first “official”
AICPA definition of GAAP, adopted by governing council. It stated (as vaguely as ever) that “generally accepted accounting principles are those principles which have substantial authoritative support.” It also asserted that APB opinions constituted evidence of substantial authoritative support, but that other principles may also have such support. Despite the introduction of this first formal (albeit incomplete) definition of GAAP, what was needed to constitute substantial authoritative support remained unclear, and thus enabled a given practice to be seen as included in GAAP even if it was not derived from an APB opinion.
In 1969, the last reference in an authoritative accounting standard to general acceptability as a basis for its authority appeared in APB Opinion 15. Beginning in 1972, the last few APB opinions (28–31) cited Rule 203 of the AICPA’s Code of
Professional Conduct as their authoritative basis, which burdened members to justify any material departures on a basis that compliance would be misleading. This rule is still in place, albeit in a new, codified format (now ET 1.320.001 of the Code of
Professional Conduct).
Since 1973, FASB has been the designated private sector accounting standards setter at the highest level of authority in the United States, and until recently, the only source that was backed by Rule 203. In 1992, the AICPA’s
Auditing Standards Board set forth a
GAAP hierarchy in Statement on
Auditing Standards (SAS) 69 that established the relative authority of various sources of accounting standards for the first time. However, to further confuse matters, the notion of general acceptability returned in SAS 69, with this responsibility again falling on the auditor. But in 2008, FASB issued SFAS
162, rescinding SAS 69 and bringing a four-level GAAP hierarchy from the auditing literature—without the notion of general acceptability—into the standards.
In 2009, FASB completed its
Accounting Standards Codification
(ASC), the most recent step in the neverending effort to develop a comprehensive set of accounting principles. This process also established a two-level hierarchy, with the ASC as the sole private sector source of authoritative GAAP for nongovernmental entities in the
United States other than the SEC for publicly held entities; everything else was designated as nonauthoritative.
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Although ASC 105-10-05 is titled
“Generally Accepted Accounting Principles,” it still fails to clarify what that old term means.
It subtly suggests, however, that, in the absence of applicable authoritative GAAP
(i.e., the ASC in the United States), other sources of nonauthoritative guidance and literature are nevertheless part of the broad expression GAAP. (An incomplete list of such sources appears in ASC subtopic 105-10-05-
03.) U.S. GAAP remains today an illdefined and boundless universe in which only the very brave (or very foolish) should dare to venture far beyond their comfort zone.
Today’s business environment is subject to increasing challenges and complexities, laden with ever more complicated transactions and financial instruments, valuation issues, and difficult questions of substance versus form. My research and almost 48 years of experience as an accountant and an auditor tell me that the selection of appropriate accounting principles was 1) never intended to be based on a democratic popularity contest among unschooled, nonexpert voters, and 2) clearly should not be based on what is “relatively simple to understand and implement” (or what is inexpensive), as some may believe.
In my opinion, to advocate the “dumbing down” of accounting standards to be simple to understand and implement essentially means failing to recognize those challenges and the immeasurably valuable contributions of highly intelligent and dedicated individuals to our common body of knowledge over the last three quarters of a century—most of whom have been volunteers (but for the seven paid members of FASB). Making financial reporting “simple to understand and implement” would significantly diminish the value of what we, as accountants and professionals, produce—and what we are.
The Wheat Report, released in 1972, effectively began a 40-year long debate over the proposed bifurcation of U.S.
GAAP (often called the “big GAAP, little
GAAP” issue), into separate sets of standards for private companies and public companies. Many seem to prefer this approach of, in effect, maintaining two
GAAPs. Critics contend that this makes comparability between private and public companies virtually impossible, but I think this kind of comparability is a questionable objective to start with, because users’ needs and focus differ. Principal users of financial statements of small business, whether privately or publicly held, generally tend to be lenders and other creditors rather than outside equity investors; however, such is not always the case.
In my view, it makes little sense to have, in effect, two comprehensive GAAPs (or
GAAP alternatives) that are divided along
when the principal users are lenders who do not have access to the assets of variable interest entities or other subsidiaries.
In my opinion, encouraging the use of a special-purpose GAAP alternative framework, such as a cash or income tax basis
(formerly OCBOA) or the AICPA’s
Financial Reporting Framework for Smalland Medium-Sized Entities circumvents conceptually sound accounting, and does not serve the needs of probable thirdparty users (see Nicholas J. Mastracchio
Jr., and Heather M. Lively, “How Many
Accounting Frameworks Are Enough?,”
The CPA Journal , August 2013). In addition, the widescale acceptability of such alternatives tends to further dilute the meaning of “generally” accepted. some arbitrary line based on company size or public vs. private ownership. But consistent with the direction currently being taken by FASB, I do believe that certain alternatives should be available within GAAP standards—not to be selected based upon the self-serving reporting objectives of management, but rather by applying sound judgment as to the distinctly different, fundamental needs of the principal intended users (usually creditors or equity investors).
Moreover, I believe that the accounting choices to be made available within the authoritative GAAP standards should not be “cherry-picked,” but rather made consistently throughout the financial statements, as appropriate to the primary intended users, and accompanied by a general accounting policy disclosure such as,
“The selection of accounting policies from among available alternatives has been made based on management’s judgment so as to best serve the needs of principal intended financial statement users, consisting of the company’s lenders [or equity investors].” Most alternatives would likely be in the area of required disclosures, but some might entail measurement or presentation matters. For example, consolidation rules might be relaxed or eliminated
Despite FASB’s occasionally successful attempts over recent years to converge U.S.
GAAP with IFRS, global enterprises often opt to issue their financial statements in accordance with the latter. Although still using the term GAAP, the PCAOB’s Interim Auditing
Standards (AU 411.01) require identifying in audit reports the country of origin of the accounting standards in use, but ASB standards have been revised to GAAP references and refer more broadly and directly to a financial reporting framework (AU-C 200.14), which must be clearly and specifically identified in reports.
Ultimately, is it appropriate any longer to refer to the accounting standards of one country as “generally” accepted—and was it ever? Or should a new term, such as “United States Accounting Principles,” be substituted?
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Howard B. Levy, CPA, is a principal and director of Technical Resources at Piercy
Bowler Taylor & Kern, Las Vegas, Nev.
He is a former member of the AICPA’s
Auditing Standards Board and its
Accounting Standards Executive Committee, and a current member of the Center for
Audit Quality’s Smaller Firms Task Force.
This article has been revised and updated from an earlier version published in the
November 2011 Silver State CPA , a publication of the Nevada Society of CPAs.
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