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
Periods of Accounting Development
Pre 1930
Accounting largely unregulated
1930-46
Formative years, initiated by 1929
stock market crash
1946-59
Post-war period
1959-present
Modern period
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”
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.”
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
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
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
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
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
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
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
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
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...
THE CONSTITUENCY
Sponsoring Organizations
Explain and
Seek Views
The Foundation (FAF)
Nominations
from Sponsors
Elects
Board of Trustees of FAF
Funds
Select
Explain and
Seek Views
Appoint & Fund
Oversee
The FASB
Discuss & Express Views
Financial Accounting Standards
Advisory Council (FASC)
Compare CAP, APB, and FASB
Independence
CAP
APB
FASB
Organization
Part of
AICPA
Part of
AICPA
Separate from
AICPA
Members
Other fulltime
employer
Other fulltime
employer
Full-time
FASB
employee
Compare CAP, APB, and FASB
Characteristic
CAP
APB
FASB
Breadth of
Membership
Must be
CPA
Must be
CPA
Need not be
CPA
Very limited
More
extensive;
open hearings
Due Process
Little, if any
Compare CAP, APB, and FASB
Characteristic
Theoretical
document
supporting
standards
CAP
APB
FASB
Not
attempted
Postulates and
principles
failed
Conceptual
framework
completed
Main use was
Research usage Very limited probably in
ARSs
More
extensive
FASB’s Standard-Setting Process
1. Identify problem
2. Form task force
3. Produce discussion
memorandum
4. Circulate to
interested parties
5. Convene a public
hearing
6.
7.
8.
9.
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)
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
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
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
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
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