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CHAPTER HIGHLIGHTS
Accounting practice prior to 1930 was unregulated, and the procedures used by various
enterprises generally were confidential. During the 1920s, the American public began to invest
in corporate business far more extensively than in the past; however, it was not until the stock
market crash of 1929 that investors began to question the accounting and reporting practices in
use. A brief history of accounting in the United States prior to 1930 provides an overview and
background.
The SEC came into existence in 1934 and was (is) empowered to prescribe accounting
principles. It decided that self-regulation by the accounting profession was in the public’s best
interest. That position has remained unchanged for about 80 years; however, on many occasions
the U.S. profession has come close to losing its self-regulatory status. In recent years,
accounting scandals have severely affected its independence; it is experiencing more
governmental oversight, but less influence from organizations seeking preferential accounting
standards.
The Accounting Principles Board (APB) was designed to overcome the major deficiency of the
CAP. It was to operate on a dual approach: first by the establishment of a conceptual
framework and then by the deductive development of accounting standards. Unfortunately, the
attempt at a conceptual framework was a failure, and in a very short time the APB found itself in
the same position as the CAP. In the APB’s relatively short life (1959-1973), it made two very
significant steps forward. First, it issued APB Statement 4, which has served as groundwork for
the Trueblood Committee report and the FASB’s conceptual framework project. Second, it
greatly expanded the due process procedures for establishing accounting standards. The APB
was the first to experiment with discussion memorandums, exposure drafts, and the general use
of its constituency. The APB’s ultimate failure, however, was due to its inability to develop a
deductive approach and the lack of independence of its members.
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Although the FASB has been under constant attack, almost from its inception, it appears to have
weathered the storm and will, most likely, remain in some form of existence for the immediate
future. However, its role will likely differ. Sarbanes-Oxley of 2002 required that the SEC
review principles-based accounting for application to U.S. issuing companies. Today, the FASB
and IASB are pursuing convergence of their respective accounting standards (result of the
Norwalk Agreement of 2002 and the subsequent conceptual framework project). Assuming that
the convergence projects are successful, the need for redundant standards-setting bodies arises.
This suggests that the most serious threat to the FASB may come from an external standards-
setting body (IASB), not from the public sector. 100+ countries have adopted IASB standards to
some extent; this makes it very difficult to argue that U.S. GAAP should be the world’s Lone
Ranger of accounting. The challenge when IFRSs are adopted, not just converged with U.S.
GAAP, will be to find new roles for the FASB. Structures are must easier to build than to
dismantle.
Note that a separate Microsoft PowerPoint file is available on Sarbanes-Oxley, one that you may
want to review or lecture on at some point in the course. SOX provides for funding through
accounting support fees for FASB, a point that makes its independence from industry and its
funding significantly stronger than IASB’s. This will likely be something to be resolved before
the U.S. will actually adopt IFRSs, if it does.
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QUESTIONS
Q-1 How did the APB pave the way for the FASB?
The APB’s biggest contribution to the FASB was the due process procedures for the
establishment of accounting standards. The APB initiated the use of discussion memorandums,
Q-2 In what ways does the FASB differ most markedly from its two predecessors?
Perhaps the FASB’s biggest difference is its independence. The FASB, unlike its two
predecessors, is independent from and not part of the AICPA. All board members must maintain
complete independence. This not only applies to other employment arrangements, but also to
Q-3 What is the weakness of Grady’s approach in arriving at principles in ARS 7?
The primary weakness is that Grady codified existing pronouncements and then tried to derive
the profession’s existing structure of principles. The study blended inductive and deductive
Q-4 Do you think that the nonbinding status of the FASB’s statements of financial accounting
concepts (like that of APB Statement 4) is a good idea or not?
The purpose of SFACs is not to establish accounting standards but to set forth the fundamentals
on which financial accounting and reporting standards will be based. The FASB itself is likely
Q-5 Discuss the significance of the SEC’s ASR 150.
ASR 150 represented the first time that the SEC formally recognized that accounting standards
set in the private sector had substantial authoritative support. It said that SFASs and
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Accounting Theory (9
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Q-6 What has been the SEC’s role in the evolution of the rule-making process? How has that
role changed since the passage of SOX?
The SEC’s role in the evolution of the rule-making process has been as a behind-the-scenes
observer. It has played a definite role in practically all standards, but has chosen to take a low
profile in most situations. The SEC has chosen to pursue the low profile role because it has been
assumed to be best for the profession as a whole. By staying out of the limelight, the SEC may
also be maximizing its life span and survival. SOX has further strengthened the SEC’s authority.
Q-7 What were the politics that led to the demise of both the CAP and the APB?
The “politics” that led to the demise of both the CAP and the APB was the SEC’s belief that both
groups were unable to work effectively due to their lack of independence. The members of both
Q-8 “The FASB’s standard-setting procedure is a fairly narrow, cut-and-dried approach to
developing accounting standards.” Evaluate this statement.
The FASB’s standard setting procedure/process is anything but “cut and dried.” While there is
an overall sequence of steps involved, the consultations and politicking can be quite extensive.
Refer to the Johnson and Swieringa article discussed in the chapter on SFAS No. 115 on
Q-9 Should constituents have input into the FASB decisions, or should the FASB neutrally
and independently set standards?
Using constituents’ input and acting neutrally and independently are not mutually exclusive.
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Q-10 Explain how the role and form of research used by the APB and FASB differ.
The initial role of research used by the APB was to develop postulates and principles. That role,
however, quickly changed to one of completely examining certain narrow subjects, goodwill, for
example. The APB then used that research as a basis of its deliberations. The FASB uses
Q-11 What is the importance of the FAF and FASAC to the success of the FASB?
The FAF elects members to the Board of Trustees, whose responsibility is to select FASB
members and perform the oversight role. The FASAC’s role is to advise the FASB on its
Q-12 The three attempts at standard setting in the private sector (CAP, APB, and FASB) have
all dealt with the need for a theoretical foundation. Why were the CAP and the APB
unsuccessful at this endeavor?
The CAP never really attempted to develop a theoretical foundation. Although it recognized the
need for one, it did not believe that it could afford the time commitment. The APB attempted to
Q-13 Can any overall trend be detected in FASB pronouncements? Explain and cite examples
to substantiate your opinion.
At one time there was an attempt to “clean up” the balance sheet by expensing items such as
research and development costs (SFAS No. 2) and development stage enterprises (SFAS No. 7).
There is, however, a movement toward current values with marketable securities (SFAS No.
Q-14 In terms of financial reporting in the future, do you expect greater refinement of
measurements appearing in the body of the financial statements or increasing disclosure
with less effort directed toward refinement of measurements?
In the foreseeable future, if the recent past is any indication, accounting standards probably will
be directed more toward increasing disclosure with less effort on refinement of measurement.
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Q-15 How has Sarbanes-Oxley of 2002 affected FASB’s jurisdiction and independence?
Sarbanes-Oxley places more emphasis on auditing because the Auditing Standards board of the
AICPA will no longer be setting auditing standards. Pressure will also be placed on the public
Q-16 In late 1990s, the “Wyden Amendment” was stricken from the Crime Bill passed by
Congress. The amendment would have required reporting by auditors on internal
controls. Letters sent by FEI members opposing the amendment were instrumental in its
defeat. The AICPA supported the amendment. From an agency theory perspective, why
do you think the AICPA supported the amendment and the FEI was against it? Explain
The AICPA supported the Wyden Amendment because its members would have generated more
Q-17 “Since the FASB is independent from the AICPA, the latter is no longer concerned with
standard setting and related issues.” Evaluate this statement.
This is not true; the AICPA is still interested in standard setting. Its members must understand
Q-18 What is the relationship between the National Commission on Fraudulent Financial
Reporting and Private Securities Litigation Reform Act of 1995?
The activities of the National Commission on Fraudulent Financial Reporting were instrumental
Q-19 What is the difference between joint and severable liability and proportionate liability?
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CASES, PROBLEMS, AND WRITING ASSIGNMENTS
1. During its long tenure, the CAP produced a total of 51 ARBs. While the CAP was in
existence, another committee, the Committee on Terminology of the American Institute
of Accountants (the previous name of the AICPA), prepared certain definitions. Assess
their definitions of assets and liabilities (see Chapter 11 for the definitions). Do you see
any problems with one committee preparing rules and another making definitions?
Read Chapter 15 of ARB 43 on unamortized discount, issue cost, and redemption
premium on bonds refunded. Why do you think these issues concerned the committee?
What were the two acceptable alternatives for dealing with the costs of any issue? Why
would the definition of assets be helpful in analyzing a situation of this type? Are there
any other situations that might be somewhat analogous to the bond redemption situation?
The definitions of assets and liabilities contained in the terminology bulletin are of little value to
standard setters. They do not provide any discussion of the characteristics or attributes of assets
and liabilities that would help standard setters determine what is an asset or liability. Basically,
2. Read Chapter 15 of ARB 43 on unamortized discount, issue cost, and redemption
premium on bonds refunded. Why do you think these issues concerned the committee?
What were the two acceptable alternatives for dealing with the costs of any issue? Why
would the definition of assets be helpful in analyzing a situation of this type? Are there
any other situations that might be somewhat analogous to the bond redemption situation?
Make sure you check availability of ARB 43 to the students before assigning this case.
Accounting for unamortized discount, issue cost, and redemption premium was an issue because
the amounts involved very frequently are significant and the alternative accounting practices that
existed affected financial statements significantly. The object was to eliminate alternatives in
order to obtain uniformity. Unfortunately, the CAP was not successful because of a lack of good
asset and liability definitions. Therefore, it was acceptable to write-off immediately all such
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3. Read “FASB Response to SEC Study on Arrangements with Off-Balance Sheet
Implications, Special Purpose Entities, and Transparency of Filings by Issuers” (Feb
2006, available on FASB’s website). Ask how would you frame the tenor of the FASB’s
response. To what extent does it agree with the SEC’s study?
The FASB acknowledges that it was not asked to respond to the SEC’s report, a reminder that
the SEC, not the FASB, has statutory authority to set accounting standards. This omission by the
4. Five so-called broad principles of accounting were prepared by the AICPA’s Special
Committee on Cooperation with the Stock Exchange and approved by the NYSE’s
Committee on Stock List in 1932. They were to be followed by all firms listed on the
exchange.
Subsequently, these principles (along with a sixth item) were codified as Chapter 1 of
ARB 43 and two principles from ARS 7 are available in the text.
Terms such as principles of accounting have been used frequently since 1932. Describe
what you think the principles might be. Do any of the principles coming from ARB 43,
Chapter 1, or ARS 7 qualify as principles as you have construed them? How similar are
these two partial groups of principles?
Accounting principles are fairly broad in nature and few in number. In general, they specify how
accountants should approach recognition and measurement of transactions and events that affect
the financial position and results of operations of enterprises. Examples include the historical
cost principle, the revenue recognition principle, the matching principle, and the full disclosure
CRITICAL THINKING AND ANALYSIS
1. Why have management consulting operations created problems for the public accounting
industry? How has SOX affected these problems?
Consulting activities overshadowed auditing services in CPA firms during the 1990s. When
consulting fees exceeded audit fees, the audit firm’s independence came into question. The audit
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2. The FASB and AICPA are considering the addition of “baby GAAP” for private
companies. Take a position and argue why two GAAPs should or should not exist?
“Baby GAAP” is essentially a more simple GAAP for private companies. The argument for this
second GAAP is that it is too costly for a private (and likely smaller company) to implement the
GAAP standards for imposed on a publicly traded company. On the other hand, why should an
3. What role should the AICPA assume in the possible development of “baby GAAP”
standards?
We have a standards setting body, the FASB. The AICPA should allow it to function as that
body, provide input to projects and standards. However, the AICPA should not attempt to lead