The accounting standard-setter for companies in the United States, the Financial Accounting Standards Board (FASB) is celebrating its 40th anniversary this year—and for all 40 years of the FASB’s existence, I have been practicing as a certified public accountant (CPA), both in public and industry accounting. I currently author this blog and work on a consulting basis with companies to help them understand the accounting rules as well as the way in which they are developed and issued by the FASB and other standard-setters. From this perspective, I will provide a mix of historical facts and some of my own personal views on the development of U.S. accounting rules.
I am proud of my contribution to society as an accountant, and, for the most part, of the work the FASB has completed over its 40-year history. The FASB has tried to improve accounting such that non-CPAs can understand the financial statements of a company—financial literacy helps, but a CPA designation should not be a requirement to understand a set of financial statements.
Early Days: The AICPA Gives Way to the FASB
Prior to the FASB, the American Institute of Certified Public Accountants (AICPA), through various committees, set the accounting rules for companies to use in the United States. This was seen by some to be a conflict of interest, as the AICPA is effectively a professional trade organization for CPAs.
The FASB was created in 1973 based primarily on the recommendations in the 1972 “Wheat Report,” and the AICPA agreed that it would no longer be the primary author of accounting rules in the United States. I have to hand it to the AICPA for not only funding the Wheat Report but also concluding that having an independent body establish accounting rules was in the best interests of the profession.
The new and independent FASB was set up to be overseen by its parent, the Financial Accounting Foundation (FAF), which approves funding for the FASB, hires its seven-member board, and performs other “corporate governance” roles. Nevertheless, the early years of the FASB were somewhat rocky, and included an effort by some to move accounting standard-setting to the federal government.
The Basic Concept of Accounting Rules
A company sells a product or service and such effort results in a profit or loss. If a company sells a car for $40,000 and it cost $30,000 to make and bring to market, the company earns a profit of $10,000. Typically, determining the selling price (i.e., revenue) is the “easy” part of this equation. The difficulty comes in determining cost: how to allocate the compensation of a person who worked on building the car for a period of time, as well as the related costs of the purchasing and sales departments, lawyers, and so on. That is where the accountants come in, who are trained to make those determinations—generally using rules “approved” by the FASB.
Major FASB Rulemaking Achievements
Fixing Stock Option and Postretirement Benefit Accounting
The FASB has fixed what I believe were egregious flaws in accounting methodology—in stock option accounting, for example. Before the FASB arrived, a company would grant stock options to employees and most transactions would not require any cost to be reflected in the company’s financial statements. It was as if the good fairy provided the benefit.
In my own case, when working as a CPA in industry, I received a cash salary plus stock options. Mentally, I placed more “value” on the stock options than on my salary and, as it turned out, I did realize more money from the options over the years. My salary was reflected in the company’s income statement but the value of my options was not.
In addition to addressing stock options, the FASB issued guidance that requires a company to record the cost of healthcare being provided to retirees when they earn such benefits, not when they are retired and playing golf in Florida. Prior to this change, most companies reflected this cost when benefits were paid out, rather than when they were earned.
Fixing the Accounting for Business Combinations
The FASB also issued rules requiring that a business combination be recorded at fair value, not following an arcane concept termed a “pooling-of-interests” that provided financial statement users with “smoke and mirror” accounting results.
In my former corporate role, I was embarrassed (even though such accounting was allowed at the time), when senior management asked me to ensure a business combination could be accounted for as a pooling-of-interests. It made no sense and would distort, favorably I might add, the company’s income statement for years to come.
Improvements Still Needed for Financial Instruments, Leases, and Pensions
The FASB made other changes, for example, to the accounting for financial instruments, leases, and pensions. On these three topics, I would give the FASB a C- because it improved prior accounting rules, but, as they specifically relate to financial instruments, including derivatives, the accounting is complex and even in 2013, the FASB continues to make changes.
The same holds true for lease accounting—the current FASB rules are so arbitrary that you need pages and pages of interpretations to ensure you are following the rules as intended. However, the topic of lease accounting is currently being addressed by the FASB as discussed in various prior blog articles, including “Possible New Lease Accounting Rule—An Update.”
When it comes to pension accounting, the FASB needs to “tweak” the rules companies must follow, due in part to new pension schemes that are being developed by compensation consultants and that were not originally contemplated, changing demographics of the population, interest rates, etc. While the FASB added a project on pensions to its agenda in 2005, the progress has been slow and much needs to be done.
A Slow-but-Robust Process for Establishing Accounting Rules
The FASB periodically seeks input from financial statement users regarding changes in accounting that might be necessary. In addition, the U.S. Securities and Exchange Commission (SEC) provides suggestions to the FASB on desired enhancements to the accounting rules. As a result of the SEC’s ongoing reviews of filings of U.S. public companies, it may identify transactions that lack substance or clarity and suggest to the FASB that new rules should be established or, at a minimum, that enhanced disclosures be required.
The good news is that the FASB seeks input. But the bad news is that once the FASB decides to clarify an accounting rule or concept, it can take years to reach a final decision that CPAs and companies can follow.
Here is the typical process:
A research project is initiated.
This is followed by long deliberations on how best to create a new rule.
Then there are more deliberations, followed by drafting and issuing of an “exposure draft” for public comment.
Then such comments are received and evaluated.
Then another exposure draft may be issued—this is happening with the FASB’s lease project in the next month or so.
Ultimately, a final standard intended to improve the accounting rules is issued.
Some would argue the standard-setting process moves more slowly than a glacier while others believe the lengthy process is necessary to achieve the “correct answer.” The reality is probably somewhere in the middle.
Political Realities affecting Standard-Setting
Over the years, very few people serving in the U.S. Congress have been trained CPAs. Lawyers are the norm, but, even if there were more CPAs in Congress, I am not sure it would make much of a difference.
For example, when the FASB considered “fixing” the previously discussed “free stock option issue,” various members of Congress tried to stop it. The FASB knew what the right accounting answer was, but, in 1994, the U.S. Senate urged the FASB to drop its project by a whopping 88–9 vote. While the vote was nonbinding, the end result was that the FASB issued the requirement that companies had to calculate the cost of such options but could “hide” the cost in the financial statement footnotes that many investors never read. It wasn’t until 2004 that the political pressure subsided and the FASB finally required the cost of stock options to be transferred from the footnotes to the income statement.
As a practicing accountant, I hope I never see politicians get involved in an accounting issue to such an extent again. Hiding a gold dog under a cheap blanket doesn’t do anyone any good—sooner or later, the truth will be revealed, even if it takes a decade!
Some Final Thoughts
The creation of the FASB has been good for standard-setting in the United States. The FASB has made standard-setting more transparent and has gotten stakeholders interested in the process.
Yes, it is slow, but people from around the world admire the process even if it is “not perfect.” The International Accounting Standards Board (IASB), which develops accounting rules for many countries outside the United States, has modeled many of its standards and much of its standard-setting process on the FASB’s standards and processes. In recent years, the FASB and the IASB have been developing certain standards jointly—with the big one scheduled to arrive next month: a new revenue recognition standard!
I would like to see the FASB move more quickly and develop rules that aren’t so complex—for example, for derivatives. But that is probably wishful thinking.
I have personally worked with the departing FASB chairman, Leslie F. Seidman, before she was appointed to the FASB and knew the incoming FASB chairman, Russell G. Golden, when he was “just” a member of the FASB staff. They represent solid ambassadors of the accounting profession and I hope Mr. Golden keeps the direction of the FASB on course for the years to come.
About the Author
Ron Pippin is an experienced CPA based in Wheaton, IL. His 40 plus year career includes being an audit partner in Arthur Andersen, a member of Andersen’s Professional Standards Group (“national office”) in Chicago, the Director of Financial Reporting for a Fortune 50 company and most recently, the editorial director of CCH’s Accounting Research Manager. Currently, Ron does independent writing and analysis together with accounting consultation on a variety of topics.