Exam 1: The Development of Accounting Theory

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One result of the meetings between the AICPA and members of the NYSE following the onset of the Great Depression was a revision in the wording of the certificate issued by CPAs. The opinion paragraph formerly stated that the financial statements had been examined and were accurate. The terminology was changed to say that the statements are "fairly presented in accordance with generally accepted accounting principles." This expression is now interpreted as encompassing the conventions, rules, and procedures that are necessary to explain accepted accounting practice at a given time. Therefore, financial statements are fair only to the extent that the principles are fair and the statements comply with the principles.
The expression generally accepted accounting principles (GAAP) has thus come to play a significant role in the accounting profession. The precise meaning of the term, however, evolved rather slowly. In 1938 the AICPA published a monograph titled Examinations of Financial Statements, which first introduced the term. Later, in 1939, an AICPA committee recommended including the wording, 'present fairly…in conformity with generally accepted accounting principles' in the standard form of the auditor's report.
The meaning of the term was not specifically defined at that time, and no single source exists for all established accounting principles. However, later Rule 203 of the AICPA Code of Professional Ethics required compliance with accounting principles promulgated by the body designated by the Council of the Institute to establish such principles, except in unusual circumstances. Currently, that body is the FASB.
The guidance for determining authoritative literature was originally outlined in Statement of Auditing Standards (SAS) No. 5. Later, SAS No. 5 was amended by SAS No. 43. This amendment classified the order of priority that an auditor should follow in determining whether an accounting principle is generally accepted. Also, it added certain types of pronouncements that did not exist when SAS No. 5 was issued to the sources of established accounting principles. SAS No. 43 was further amended by SAS No. 69; whose stated purpose was to explain the meaning of the phrase "present fairly … in conformance with generally accepted accounting principles" in the independent auditor's report. SAS No. 69 noted that the determination of the general acceptance of a particular accounting principle is difficult because no single reference source exists for all such principles. In July 2003, the SEC issued the Study Pursuant to Section 108(d) of the Sarbanes-Oxley Act of 2002 on the Adoption by the United States Financial Reporting System of a Principles-Based Accounting System (the Study). Consistent with the recommendations presented in the Study, the FASB undertook a number of initiatives aimed at improving the quality of standards and the standard-setting process, including improving the conceptual framework, codifying existing accounting literature, transitioning to a single standard-setter regime, and converging FASB and International Accounting Standards Board (IASB) standards.
In 2008, the FASB issued SFAS No 162 The Hierarchy of Generally Accepted Accounting Principles. SFAS No 162 categorized the sources of accounting principles1 that are generally accepted into descending order of authority. Previously, the GAAP hierarchy had drawn criticism because it was directed toward the auditor rather than the enterprise, it was too complex, and it ranked FASB Concepts Statements, which are subject to the same level of due process as FASB Statements, below industry practices that are widely recognized as generally accepted but are not subject to due process.
According to SFAS No 162, the sources of generally accepted accounting principles were:
a. AICPA Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by action of the FASB, FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, and FASB Staff Positions.
b. FASB Technical Bulletins and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position.
c. AICPA Accounting Standards Executive Committee Practice Bulletins that have been cleared by the FASB and consensus positions of the FASB Emerging Issues Task Force (EITF).
d. Implementation guides published by the FASB staff, AICPA accounting interpretations, and practices that are widely recognized and prevalent either generally or in the industry.
Finally, in 2009, the FASB issued SFAS No. 168, The FASB Accounting Standards Codification and the Hierarchy of Generally Accepted Accounting Principles-a replacement of FASB Statement No. 162. SFAS No. 168 identified the FASB ASC as the official source of U. S. GAAP.
Despite the continuing effort to narrow the scope of GAAP, critics maintain that management is allowed too much leeway in the selection of the accounting procedures used in corporate financial reports. These criticisms revolve around two issues that are elaborated on later in the text: (1) Executive compensation is frequently tied to reported earnings, so management is inclined to adopt accounting principles that increase current revenues and decrease current expenses and (2) the value of a firm in the marketplace is determined by its stock price. This value is highly influenced by financial analysts' quarterly earnings estimates. Managers are fearful that failing to meet these earnings estimates will trigger a sell-off of the company's stock and a resultant decline in the market value of the firm.
Previously, SEC Chairman Levitt noted these issues and indicated his belief that financial reports were descending "into the gray area between illegitimacy and outright fraud." As a consequence, the SEC has set up an earnings management task force to uncover accounting distortions. Some companies have already voluntarily agreed to restructure their financial statements as a result of this new effort by the SEC. For example, SunTrust Bank, Inc., of Atlanta, though not accused of any wrongdoing, agreed to a three-year restructuring of earnings for the period ended December 31, 1996.