The development of accounting frameworks in any country is part of its evolution process over the years. New vistas of development bring in mandatory modifications into the existing framework.
As the entire economic process of a country is dependent upon its financial regulatory structures, the accounting framework is bound to be affected by such regulations and economic developments. Keeping these facts in view, an effort has been made in this write up to evaluate the development of accounting framework in the United States, tracing the bygone era and analyzing the present and existing framework in the US economy.
American Institute of Accountants
The International Congress of Accountants held in 1904 marked the development of an organized form of the accounting profession in the United States. This congress was also important as in this meeting, the American Association of Public Accountants was formed.
It was the first American organized body of professional accountants. This body of accountants remained marred with internal infrastructural disputes till 1916 when this body was reorganized as the American Institute of Accountants (AIA).
World War I and the great depression
The business world in the US was completed changed with Word war I. Communities dealing with commercial transactions came to realize the importance of organized commercial transactions known as ‘business.’ All this because people realized that the success of the war was due to successful businesses.
With the result, the public realized that business had crossed the stage of external regulations. The role of accountants also changed. They were no longer the protectors of third parties. Rather accountants suddenly changed, and t became the protectors of business primarily.
Accountants started adopting a stewardship role and emphasized the needs of management in financial reporting. The flexibility crept into financial reporting, and financial statements became only the representations of the management.
Accounting principles were not being followed in the spirit of truth and fairness. Accounting manipulations became the crazy needs of the manipulative business. Great confusion and disturbances started persisting in the business world, and that resulted in hitherto unknown business depression. In 1929 the stock market crashed, and the corporate world was blamed for over-enthusiasm ignoring the principled financial reporting.
The depression affected a lot on all those concerned with the accountancy profession. In 1935 American Association of University Instructors changed its name to American Accounting Association (AAA) and came out with a publication titled ‘A Tentative Statement of Accounting Principles and Standards.’ This publication included accountancy principles of that time in a summarized form.
The legislation was introduced to license the auditors by the Federal Government after passing a civil service examination. “The US congress shaped the external auditing profession and created its primary audit objective with the passage of the Securities Act of 1933 and the Security Exchange Act of 1934.
Its purpose, in part, is to ensure that the financial status and operating performance of publicly traded companies are fairly presented and disclosed.” (Dennis Applegate, Oct. 2004)
Further, “the Securities Act of 1933 has two primary objectives: 1) to require that investors be provided with material information concerning securities offered for public sale: and 2) to prevent misrepresentation, deceit, and other frauds in the sale of securities.
The Securities Exchange Act of 1934 extended the “disclosure” doctrine (from Securities Act of 1933) to securities listed and registered for public trading on U.S.Stock Exchanges.” (Securities and Exchange Commission (SEC) Forum)
After the formulation of 1933 and 1934 legislations, there was an atmosphere in the professional accounting circle and elsewhere urging for some sort of accounting regulation or standards-based whereupon the financial statements of the companies were able to meet the disclosure and other requirements of the legislation.
In 1938 SEC decided to allow accounting principles to be set up in private circles. Responding to this, AIA published a ‘Statement of Accounting Principles,’ but this publication was reported as quite controversial as it did not contain any reformative principles. It was just a collection of prevalent accounting practices at that time.
American Institute of Certified Public Accountants (AICPA)
AIA merged with the American Society of Certified Public Accountants in 1937 and formed a bigger body called the American Institute of Certified Public Accountants (AICPA). AICPA established several committees like the Committee on Accounting Procedures (CAP), Accounting Principle Board (APB) to develop accounting principles.
From 1938 to 1958 the CAP churned out several accounting pronouncements as ‘Accounting Research and Terminology Bulletins’ and ‘Accounting Research Bulletins’
CAP worked sincerely to produce authoritative pronouncements. As per Report of Committee on Accounting procedures to Council dated September 1, 1939 and referred to in a book by Julius J Marke, “Accounting Research Bulletins represent the considered opinion of at least two-thirds of the members of the Committee on Accounting Procedures, reached on a formal vote after examination of the subject matter by the committee and research department.”
Unfortunately, CAP pronouncements could not create mandatory practices but received authority only because of their general acceptance. As there was no other authoritative source of accounting principles, professionals generally accepted whatever was available but could not implement those pronouncements because of divergent and sometimes contradictory views on issues involved. Moreover, the fact that all members of CAP were mandatorily required to be members of AICPA created doubt about the experiences of members.
Accounting Principle Board (APB)
APB was formulated by AICPA because of the shortcomings of CAP. The objectives of the APB were:
- To encourage the written expression of GAAP. That means to encourage the practice of GAAP in practice by professionals.
- To narrow down practical indifferences over GAAP
- To discuss widely unsettled and controversial accounting issues.
At earlier stages, the pronouncements of APB called ‘opinions’ were not a mandatory practice, but later, the term was retained to create an authoritative impression.
It is believed that APB Opinion lost its creditability when three of the big eight accounting firms refused to follow APB Opinion No. 2 with regard to accounting for Investment credit. APB decided that tax credit should be accounted for by the deferred method, but three of the then big eight accounting advised their clients not to follow the recommendations of APB Opinion No.2.
This issue shattered the image of APB and resulted in SEC issuing Accounting Series Release No. 96. This release permitted companies to use either ‘flow-through’ or ‘deferred method’ in their SEC filings. There were lots of criticisms in the 1960s over the development of accounting principles. Even the questions were raised on the independence of members of APB.
The Financial Accounting Standard Board (FASB)
To settle the controversy over APB, AICPA established FASB in 1973. The board that governs FASB is the Financial Accounting Foundation (FAF).
A board of trustees nominated by eight organizations whose members have special knowledge in financial reporting is selected. FAF appoints Financial Accounting Standards Advisory Council (FASAC) that advises FASB on major policy issues. The selection of seven members of the board of trustees is the responsibility of FAF.
FASB is now the officially designated body to issue financial accounting standards.
FASB has accepted all earlier pronouncements of both CAP and APB. Accordingly, US GAAP now consists of the pronouncements of FASB and the pronouncements earlier issued by CAP and APB and later adopted by FASB. FASB has been established to accomplish the following missions:
- Improve the usefulness of financial reporting.
- To maintain standards as per changes in the way of doing business and as per current economic developments
- Remove the deficiencies immediately in financial reporting by improving standards.
- Promote international convergence of accounting standards
- Improve the common understanding of the nature and purposes of the information contained in financial statements.
(Source: Facts about FASB, www. fasb.org)
FASB issues four types of pronouncements, namely, a) Statement of Financial Accounting Concepts, b) Statements of Financial Accounting Standards (SFAS), c) Interpretations, and d) Technical Bulletins. An Emergence Issues Task Force (EITF) has been established by FASB in 1984 to assist in identifying issues and problems that require timely and immediate action.
The Sarbanes and Oxley Legislation
A few years earlier, the US and other countries of the world were rocked by accounting scandals erupting out of misdeeds famous accounting firms and others. With the result, the Sarbanes Oxley Act was enacted in the year 2002 to bring control over the functioning of the management and accounting firms by way of putting specific responsibilities in SEC filings.
Under the SOX act, top management has to undertake responsibilities about the functioning of Internal Controls by certifying certain filings with SEC. Auditors are not supposed to undertake certain non- audit assignments of the auditee company among other regulations
Further, a Public Company Accounting Oversight Board (PCAOB) has been established under the SOX Act that has the responsibility of setting auditing standards. PCAOB also reviews the practices and procedures of public accounting firms with regard to audits conducted by them.
Convergence with IAS
As stated earlier, one of the objectives of FASB is to ensure convergence with International Accounting Standards. Both FASB and IASB are taking concrete steps with regard to settling controversial issues. The major step in this direction was the Newark agreement, where both FASB and ISAB are committed to bringing a convergence of accounting standards at the earliest possible time.
US accounting framework developed over a period of time is greatly influenced by periods like great depression and accounting scandals. The entire US accounting framework has been knitted around happenings that rocked the nation and other dependent countries.
The US has never taken precautionary measures. It has always developed its accounting framework based on disaster happenings. Otherwise, issues affecting convergence with IAS would not have been so controversial.
APB Opinion No. 2, “Accounting for ‘the Investment Credit’” (New York AICPA 1962)
Dennis Applegate, The U.S. Corporate Audit Function: despite fundamental similarities between External and Internal auditing, several key differences separate the two professions, BNet.
Facts about FASB, The Mission of the Financial accounting Standard Board.
Julius J. Marke, A Catalogue of Law Collections at New York University, published by New York Law Center of New York University, 1953.
Securities and Exchange Commission (SEC) Forum, Encyclopedia of Small Business. 2008.