Last Updated 10 Aug 2020

History and Development of Accounting Standards

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Accounting has been around since the beginning of civilization. ¡§Accountants participated in the development of cities, trade, and the concepts of wealth and numbers.¡¨ (Giroux) The importance of accounting cannot be overemphasized. Equally important are the standards used to guild the application of accounting practice. Without principles and standards, financial reporting would not fairly present the financial position of a company. Accounting has changed and evolved vastly over time and continues to change. I will discuss the evolution and history of accounting, the Conceptual frame work of accounting, and the governing bodies which shape the standards and principles of accounting practice.

The beginning of civilization occurred during the transition from hunter-gatherer to farmer. Farming led to crop surplus and therefore the need to trade and barter. Jericho, the oldest city known to historians was the first known trading center for surplus goods. Personal wealth created the need to keep track of inventories. Ancient bookkeepers used small clay balls called tokens to count and keep track of existing wealth. These tokens were used as evidence of transactions. Over time, the tokens were used to make impressions in clay along with pictures which represented the first attempts at accounting.

These events took place around 5000 B.C. (Giroux) Evidence suggests that double entry bookkeeping developed in Italy around 1200 B.C. The first book written on double entry bookkeeping was written by Luca Pacioli in 1494. (Smith) Pacioli was referred to as the father of accounting, but he did not actually invent the system he described. He simply wrote about the business practices used by merchants in Venice at the time. Many of his writings were used for several centuries. With the development of technology, wealth, and trade came the need to adequately account for the complexity involved. Scribes became accountants and in the process invented numbers and writing.

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Accounting played a central role in the development of civilizations. Accountants invented writing, participated in the development of money and banking, invented double entry bookkeeping, and helped develop the confidence in capital markets. The industrial revolution started around 1750. As industry, mass transportation and capital markets were established, the role of accountants expanded. By the mid to late 19th century there was a strong need for professional accountants. The earliest of the big four accounting firms was started by William Deloitte in 1845.

Today the firm still bears his name, Deloitte and Touche. Samuel Price and Edwin Waterhouse formed their partnership in 1849. William Cooper started his firm in 1854. By this time, the profession of accountants was firmly established. The United States took its lead from entrepreneurs in Europe. During the late 1800¡¦s cost accounting was developed to increase efficiencies in the factories. The expansion and development of big business, such as Standard Oil and U.S. Steel, created the need for more sophisticated accounting systems to keep track of expanding divisions within these large corporations.

Around the turn of the century the United States overtook Britain as the leading industrial power in the world. This rapid growth created the need for greater regulation. Insiders benefited from price fixing, stock manipulation, and various schemes of questionable legality. Financial statements were audited, but the auditors usually worked for the company and did not have motivation to protect the interests of third party investors. World War I ended in 1919. (Library of Congress) After the War there was a surge of securities activity. ¡§During the 1920s, approximately 20 million large and small shareholders took advantage of post-war prosperity and set out to make their fortunes in the stock market. It is estimated that of the $50 billion in new securities offered during this period, half became worthless.¡¨ (SEC)

Before the stock market crash in 1929, there was little support for reform of financial reporting. Black Friday changed all that. People and banks lost huge fortunes, and the public lost faith in the capital markets. There was a consensus that for the economy to recover, the public's faith in the capital markets needed to be restored. Congress held hearings to identify the problems and search for solutions. Based on the findings in these hearings, Congress passed the Securities Act of 1933 and the Securities Exchange Act of 1934. Congress established the Securities and Exchange Commission in 1934 to enforce the newly-passed securities laws, to promote stability in the markets and, most importantly, to protect investors.

The SEC was given the mandate to establish accounting principles. Although the SEC was given the authority to govern accounting practice, they believed the private sector had the resources and talent to develop appropriate accounting standards. (Kieso, 6-7) The American Institute of Certified Public Accountants and its predecessors have a history dating back to 1887, when the American Association of Public Accountants was formed. In 1916, the American Association was succeeded by the Institute of Public Accountants, at which time there was a membership of 1,150. The name was changed to the American Institute of Accountants in 1917 and remained so until 1957, when the name was again changed to the American Institute of Certified Public Accountants.

The American Society of Certified Public Accountants was formed in 1921 and acted as a federation of state societies. The Society was merged into the Institute in 1936. (AICPA) At the urging of the SEC, the AICPA appointed the Committee on Accounting Procedure in 1939. Between 1939 and 1959, The CAP issued 51 accounting research bulletins. These bulletins dealt with problems as they arose and failed to address accounting principles. Because accounting principles were not addressed, the AICPA created a new standard setting body. In 1959, the Accounting Principles board was created to determine appropriate practices, establish accounting principles, and to reduce the inconsistencies in practice.

Read also about s ources of accounting standards

The APB released APB opinions, which were based on research studies. The mission of the APB was to develop an overall conceptual framework. It issued 31 opinions and was dissolved in 1973 for lack of productivity and failure to act promptly. In 1971, many feared that the government would step in to regulate the profession. Because of that fear, a study group on accounting principles was formed. This group was referred to as the Wheat Committee. The Wheat Committee was named after its chair, Francis Wheat. The committee was instructed to examine the organization and operation of the APB. They were looking for a way to get better results. In 1972, the Wheat Committee submitted their findings to the AICPA.

This group determined that the APB must be dissolved and a new standard-setting structure be created. This structure is composed of three organizations: the Financial Accounting Foundation (it selects members of the FASB and funds and oversees their activities), Financial Accounting Standards Advisory Council (FASAC), and the major operating organization in this structure, the Financial Accounting Standards Board (FASB). FASB has 4 major types of publications. Statements of Financial Accounting Standards are the most authoritative GAAP setting publications. There are more than 150 issued to date. Statements of Financial Accounting Concepts, first issued in 1978 are a part of FASB conceptual framework project. Read about Ball and Brown Study

These seven concepts are not a part of GAAP. Interpretations modify or extend existing standards. There are about 50 interpretations published to date. Technical Bulletins are the forth type of publication and are guidelines on applying standards, interpretations, and opinions. Interpretations usually solve some very specific accounting issue that will not have a big, lasting affect. Generally accepted accounting principles (GAAP) are a collection of rules, procedures and conventions that define accepted accounting practice. GAAP is not written in law, although the SEC requires that it be followed in financial reporting by publicly traded companies.

Every day, accountants make judgments about how to record business transactions. GAAP are guidelines or, more precisely, a group of objectives and conventions that have evolved over time to govern how financial statements are prepared and presented. The Financial Accounting Standards Board, the American Institute of Certified Public Accountants, and the Securities and Exchange Commission provide guidance about acceptable accounting practices. GAAP has four basic assumptions, four basic principles, and four basic constraints. These are the Statements of Financial Accounting Concepts.

The first of the four basic assumptions is the economic entity assumption, which assumes that the business is a separate entity because the revenues and expenses are kept away from personal items. This applies even for partnerships and sole proprietorships. The going concern assumption assumes that the business will be in operation for a long time. This validates the methods of asset capitalization, depreciation, and amortization. The monetary unit assumption assumes a stable currency is going to be used. The FASB accepts the US dollar as the monetary unit of record. The periodicity assumption assumes that the business operations can be recorded and separated into different periods.

This is required for comparison between present and past performance. FASB also created for basic principles for public accounting to follow. The first of which is the historical cost principle. This principle requires companies to account and report based on acquisition costs rather than fair market value for most assets and liabilities. The revenue recognition principle requires companies to record revenue when it is realized or realizable and earned, not when cash is received. This way of accounting is called accrual basis accounting. The third principle is the matching principle.

Expenses must be matched with revenues as long as it is reasonable to do so. The last principle is called the full disclosure principle. The full disclosure principle states that any and all information that affects the full understanding of a company's financial statements must be include with the financial statements. Some items may not affect the ledger accounts directly. These would be included in the form of accompanying notes. Examples of such items are outstanding lawsuits, tax disputes, and company takeovers. The first of the four constraints is the cost-benefit relationship. The cost-benefit relationship states that the benefit of providing the financial information should also be weighted against the cost of providing it.

Materiality, the second constraint, states that significance of an item should be considered when it is reported. Materiality is based on weather or not the amount report will conceivably effect a third parties decision based on the information presented. The industry practice constraint states that accounting procedure should follow industry practices. This is important so that companies are easier to compare. Conservatism states that when choosing between two unfamiliar solutions, the conservative method should prevail. This is a simple concept that basically states that it is better to understate than to overstate financial information. In 1984 the FASB created the Emerging Issues Task Force, which deals with new and unusual financial transactions that have the potential for becoming common practice.

An example of an issue that would be addressed is accounting for Internet based companies. It acts more like a problem filter for the FASB and deals with short-term, quickly resolvable issues, leaving long-term, more pervasive problems for the FASB. During the 1990¡¦s there was a wide range of accounting scandals, which had not been seen in the past. It became evident that change was needed in the auditing profession. Auditors were being influenced by management at large corporations. SEC chairman Harvey L. Pitt made the following statement in a press statement on January 17, 2002: The past seven months have tested the mettle and resiliency of our country, our markets, and the investing public's confidence.

With the events of September 11th, the bankruptcy of Enron and, just last week, the indictment of Arthur Andersen, we have witnessed how critical our appropriately vaunted capital markets are to the strength, security and spirit of our Country and our economy. All Americans have felt, and continue to feel, the consequences of these events. In response to the unexpected and rapid bankruptcies of large companies such as the Enron Corporation and WorldCom, Inc., concerns about the integrity and reliability of financial disclosures, and the adequacy of regulation and oversight of the accounting profession, the Sarbanes-Oxley Act of 2002 was enacted into law on July 30, 2002. (Sarbanes)

The law is named after sponsors Senator Paul Sarbanes (D-MD) and Representative Michael G. Oxley (R-OH). It was approved by the House by a vote of 423-3. The Senate voted unanimously in favor (99-0). (Wikipedia) The foundation for this reform was the creation of the Public Company Accounting Oversight Board to oversee the audits of public companies. The PCAOB was given broad authority to regulate the auditing profession. The PCAOB has the authority to impose civil penalties, and possible permanent revocation of a firm¡¦s ability to audit public companies.

The potential impact of disciplinary actions was noted by former SEC Chief Accountant Lynn Turner, who told Securities Law Daily (August 27, 2004) that ¡§the PCAOB has to use these inspections to drive changes in the rules and, quite frankly, get tough on enforcement.¡¨ Looking high and low for any ¡§hot tip,¡¨ the PCAOB has even established online and telephone systems for anonymous tips and complaints. (Farrell) Over time, the importance of the PCAOB will only increase.

In October 2004, William McDonough (PCAOB Chairman) stated that more issuer restatements should be expected as the result of the 2004 inspections. The PCAOB is expected to grow to over 300 full time employees and 7 regional offices across the country. (Farrell) The PCAOB will likely expand its role, its responsibility, and its dedication to fulfill its mission to provide accurate and complete information to the investing public.

The accounting profession has grown and changed vastly based on the financial needs of the time. Accounting started with very basic inventory methods using stone markings in clay, and has evolved into a very complex combination of rules and regulations. The future of the profession is sure to see many more changes as the needs of investors and management change. What becomes apparent is that the future of accounting is extraordinarily bright. After all, so long as there are transactions, there will be the need for accountants to analyze, assess and recommend alternatives.

A case can be made that the reason the US is an international leader is the fact that we have such a well-developed system of accounting. As such, global investors can look at financial statements with a confidence that encourages more investment. We can take pride in knowing that one of our most important exports has been our system of financial reporting. No third world country can aspire to economic success without embracing rigorous accounting standards simply because no investor is likely to risk capital on a venture which cannot be quantified.

That is perhaps the greatest single problem that even countries as large as Russia and China must resolve. Without accounting, free enterprise cannot exist. As globalization continues, the role of the accountant takes on increasing importance in creating economic opportunities for every occupant of the world.

Works Cited

?«American Institute of Certified Public Accountants, Summary of AICPA Operations, August 21, 2005, ; http://www.aicpa.org/dues/summary.htm; ?«Farrell, James J. and Shadab, Houman B., The Focus of Future PCAOB Auditor Inspections, June 2005, ?«Giroux, Gary, A Short History of Accounting ; Business, ?«Kieso, Donald E., Weygandt, Jerry J., Warfield, Terry D., Intermediate Accounting 11th ed., Hoboken, N.J., 2004 ?«Library of Congress, America¡¦s story from America¡¦s Library, ?«Sarbanes, Paul S., PCAOB Selection Process, December 19, 2002, General Accounting Office Report, ?«Securities and Exchange Commission,

?«Smith, Murphy L., Luca Pacioli: The Father of Accounting, March 26, 2002, ; http://acct.tamu.edu/smith/ethics/pacioli.htm; ?«Solomons, David, Making Accounting Policy, New York; Oxford University, 1986 ?«Wikipedia, Sarbanes-Oxley Act, September 1, 2005,

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