High quality financial statement report based on many accounting standards have been questioned in terms of costs, efficiency and too much regulation to be followed. However, many have supported the existence of many accounting standards as a way of reducing risks and protect the users. The question that has groped in the minds of many is where were these accounting standards when managers and other directors were mismanaging companies like Enron, WorldCom and the many financial institutions, which have contributed to the current financial crisis? To answer this question we need to critically analyse the role played by accounting standards, the costs associated with this standards and the importance of these standards. To begin with; businesses are supposed to prepare their accounting information based on the economic conditions prevailing at that time and the information provided by financial statement is primarily intended to be used for decision making. Although is argued that the accounting standards increased the costs. I believe is not the case since they help businesses disclose accounting information.
The Development of Accounting Standards
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Accounting principles and procedures have evolved over a hundred years. The formal standard-setting process that exists today has developed in the past fifty years. Due to the rapid growth of accounting during the advent of the Industrial Revolution, accounting procedures were often developed without extended debate or discussion. Accountants developed methods that seemed to meet the needs of their respective companies, resulting to diverse procedures and methods among companies in accounting for similar activities. The comparability of the resulting financial reports, therefore, was often questionable.
It was in the 1920’s that these differences led to financial statements that were often inflated in value. Market values of stocks rose higher than the underlying real values warranted until the entire structure collapsed and the stock market crashed in 1929. The government of the United States attacked the ensuing depression and, among many other things, created the Securities and Exchange Commission or SEC (Loren and Bazely, 1988).
SEC was now given the responsibility to protect the interest of investors by ensuring full and fair disclosure in the regulation of the capital markets. The establishment of SEC forced the accounting profession in the U.S. to unite and to become more diligent in developing accounting principles and ethics to govern the profession. Over time, this led to the formulation of several different private sector organizations, each having the responsibility of issuing accounting standards. One example of such an organization is the Financial Accounting Standards Board, an independent organization consisting of seven full-time members drawn from professional accounting, business, government, and the academe. Read also about s ources of accounting standards
Financial Accounting Standard Board (FASB) strongly suggests that the liabilities related to the retirement benefits promised by the entities to its employees, is required to be recognized at the time of the promise itself, instead of considering the later payment time. An entity is required to disclose the details regarding its separate operating segments. By this way the investors will be informed about the different risk factors involved in the diverse operations. It is also required that derivative instruments and hedging transactions which were not earlier reflected in the financial statements, are to be reflected. In the case of acquisition of one company by another, in the past it was not reflected in the financial statement, in the same way for all entities. Now it is required that the total amount paid for acquisition must be accounted and the same must be reflected in the financial statement. FASB as an independent private sector organization is remaining free from political pressure. (Financial Accounting Standard Board).
In the context of the ongoing financial crisis, proposals were published by the International Standard Accounting Board (IASB) with an intention to identify the entities controlled by the company. These proposals were made with an aim of improving the accounting for the off balance sheet items. At the same time changes in discloser are proposed by the IASB and the Financial Accounting Standard Board (FASB), together. These proposed changes were regarding disclosure requirements for impairments. By following these proposals the companies will be able to disclose the profit or loss on the basis of amortized cost (IASB provides update on steps taken in response to the global financial crisis).
Management is directly responsible for the financial statement of the company as they are the people who prepare it. Their responsibility towards internal control structure and in the company’s financial reporting process is high and it includes the adopting of necessary steps to reduce risks by understanding, assessing, and implementing policies. Regarding the assumptions used for getting the final numbers and the extent of information disclosed, the management is directly responsible.
Costs of Accounting Standards
Creating and establishing accounting standards, changing existing ones, not to mention its implementation, makes accounting reporting look very expensive. Every standard is based on careful study and research, suiting it best to answer the needs of the people who use it. Every standard established, procedure changed and needs to undergo several hearings before it is fully approved. However, not all approved and implemented provisions, procedures, standards and principles are easily accepted by the public.
Just as the FASB establishes accounting standards for the entities in the United States, other countries have their own standard-setting bodies. The international differences create many reporting problems for foreign companies doing business in the U.S. and vice versa. In an attempt to harmonize conflicting standards, the International Accounting Standards Committee or IASC was formed in 1973 to develop worldwide accounting standards. This body now represents more than 100 accountancy bodies from 75 countries (Loren and Bazely p.30). However, formation of a body to promote harmonization is quite different from actually achieving harmonization. Even within the European Community, where great progress has been made in dismantling trade barriers and creating a single market covering 19 countries and 380 million people, there is o reasonable prospect of quickly establishing a single set of common accounting standards (Hagery, 1992).
All is not smooth-sailing for the FASB for there are also those who hate the organization. In recent years, the FASB has been criticized for overly complex deferred tax accounting, market value accounting leading to more volatile earnings, postretirement benefit accounting that has significantly increased reported liabilities, and difficult stock option accounting that many users think is unnecessary. The various criticism fall into to categories: 1. the standards are too theoretical and too costly to implement, and 2. the standards negatively impact companies’ bottom lines. The organization has made a great effort to address the first concern.
Proposed standards are often field tested to ascertain how costly they will be to implement. Recent standards like statement no. 115, which requires recording most securities at market value, have included explicit discussion of the expected cost and benefits of the standard (Dyckman et al 1989). The FASB board views the standard-setting process as a balancing act – balancing the desire to make financial reporting technically and theoretically sound against the need to avoid overly radical and costly changes in the current system.
Some often people often wonder if lobbying improve the quality of accounting standards. The due process system undertaken by the FASB encourages public input into the standard-setting process. Written comments are invited, public hearings are held, and proposed standards are often changed in response to this input. However, some observers have suggested that this process makes the setting of accounting standards less a technical exercise and more a political one. Parties are known to lobby for or against proposed standards according to their economic interest.
Lobbying is a term used to describe the efforts of individual and entities or organizations to either support or block the rules set by the FASB (Sutton 1984). Like for instance when the FASB issued SFAS No. 91, entitled Accounting for Nonrefundable Fees and Costs Associated with Originating or Acquiring Loan and Initial Direct Costs of Loans, on the 31st of December 1986. The restriction of loan fee accounting practice, as stated in the standard, is said to have bad effects on commercial and savings banks as well as loan associations; and because of such, many people and establishments lobbied against this provision (Moyer and Kelly, 1995).
People have all the freedom and right to lobby for and against a certain FASB rule or changes in the standard; and there are also times when the SEC would show whose side it is on. Like for instance, SEC expressed that it is backing up FASBs Options Rule, regarding stock options, by allowing the organization to treat stock options as expenses in the corporate income statements (Los Angeles Times, 2004). In the many researches and studies conducted on people who lobby against or in favor of a certain FASB rule or regulation, it is more evident that people or establishments who lobbies are the one who are greatly affected the newly issued regulation than those who are not lobbying (probably only observing); and that “collective action is proportional to firm size; just like in the case on Employer’s Pension Accounting wherein “If the benefits of accounting lobbying, avoiding adverse financial statement effects, are also proportional to firm size, then lobbying should be explained solely by firm size; but in a case where a sample of lobbying firms totaled 218 and 582 for the non-lobbying firms, the results of the empirical tests show that there is are potentially negative effects which are independent in a cross-sectional way in terms of firm size and that both firm size and the potential for adverse financial statement consequences explain the decision to lobby (Francis, 1987).”
At least, three bodies in the United States have authority to establish accounting standards that govern the financial reporting for business entities. They are the FASB, IRS and the SEC. Conflicts between SEC requirements and FASB requirements must be resolved since companies must follow the SEC rules if they fall under its jurisdiction. Little attempt is made, however, to reconcile the accounting standard differences between the IRS and the FASB mainly because their differences are recognized as arising from their differences in their organization’s objectives. The existing differences require companies to keep two different set of records in some areas: records that follow the FASB pronouncements and those that follow the IRS rules and regulations. These differences create the need to introduced deferred income tax accounting in the U.S. to reflect the tax impacts of the different treatments.
In the modern era of increased level of global economic activities, the accounting standards prescribed by FASB and IASB must be developed in such a way that the financial reporting frame work is globally accepted. It is also essential to maintain its standard of high quality. The high quality accounting standards must also be interpreted appropriately with the support of an efficient infrastructure. The management of the reporting company is responsible for the implementation of generally accepted accounting standards. Rigorous interpretation and application of standards with a properly supported infrastructure is essential for providing transparent, comparable, and consistent financial information. Comparable, transparent, and reliable information are required to be provided to the investors in order to achieve fair and efficient capital markets, allover the world. In this context, both domestic and international levels of business activities are to be taken into consideration. Fair representation of financial statements according to the accounting standard is ensured by the auditors. (International Accounting Standards)
The most significant and recent historical incident regarding the breach of ethical values in financial reporting happened in the case of the Enron. This has said to be happened because of the fact that at that time disclosure was not mandatory for financial reporting. It caused lack of transparency regarding off the book entities. Therefore the business environment in the U S, and else where in the world, are worried about scandals, especially after the Enron revelations. Integrity of the financial records and related must be kept up and transparency, fairness, and accuracy of financial reporting must be ensured through proper internal control mechanism and auditing processes. At the same time differences in domestic and international standards must be incorporated properly with support of suitable infrastructure.
- American Institute of Certified Public Accountants (1970). “Basic Concepts and Accounting Principles Underlying Financial Statement of Business Enterprises.” Statement of Accounting Principles Board No.4. New York.
- Financial Accounting Standards Board (1978). “Objectives of Financial Reporting by Business Enterprises.” Statement of Financial Accounting Concepts No.1. Stamford.
- Los Angeles Times (2004). “SEC Backs FASBs Role on Options Rule.” 5 May 2004. Latimes.com. retrieved: 12 November 2008, from <http://articles.latimes.com/2004/may/05/business/fi-wrap5.2
- Sutton, T.G. (1984). “Lobbying of Accounting Standard-setting Bodies in the U.K. and the U.S.A.: A Downsian Analysis.” Accounting Organization and Society. Vol.9, issue 1. University of Maryland. U.S.A.
- Francis, J.R. (1987). “Lobbying Against Proposed Accounting Standards: The Case of Employers’ Pension Accounting.” Journal of Accounting and Public Policy. Vol. 6, Issue 1.
- Dyckman, Thomas R., Dukes, Roland E., and Davis, Charles S. (1989). Intermediate Accounting. 3rd Edition, vol.2. Richard D. Irwin Inc.
- Nikolai, Loren A., and Bazely, John D. (1988). Intermediate Accounting. 4th Edition. Boston: PWS-Kent Publishing Co.
- Hagery, Bob. (1992). “Differing Accounting Rules Snarl Europe.” The Wall Street Journal.
- Moyer, Susan and Kelly, Lauren. (1995). “Accounting for Loan Fees: Stock Market Reactions To Policy-making Deliberations.” Journal of Accounting and Public Policy. Vol. 14, Issue 2.
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