CA1-11 (Models for Setting GAAP) SOLUTION

CA1-11
(Models for Setting GAAP) Presented below are three models for setting GAAP.
1. The purely political approach, where national legislative action decrees GAAP.
2. The private, professional approach, where GAAP is set and enforced by private professional actions only.
3. The public/private mixed approach, where GAAP is basically set by private-sector bodies that
behave as though they were public agencies and whose standards to a great extent are enforced
through governmental agencies.
Instructions
(a) Which of these three models best describes standard-setting in the United States? Comment on your answer.
(b) Why do companies, financial analysts, labor unions, industry trade associations, and others take
such an active interest in standard-setting?
(c) Cite an example of a group other than the FASB that attempts to establish accounting standards.
Speculate as to why another group might wish to set its own standards.

Solution

(a) The public/private mixed approach appears to be the way rules are established in the United States. In many respects, the FASB is a quasi-governmental agency in that its pronouncements are required to be followed because the SEC has provided support for this approach. The SEC has the ultimate power to establish GAAP but has chosen to permit the private sector to develop these rules. By accepting the standards established by the FASB as authoritative, it has granted much power to the FASB. (It might be useful to inform the students that not all countries follow this model. For example, the purely political approach is used in France and West Germany. The private, professional approach is employed in Australia, Canada, and the United Kingdom).

(b) Publicly reported accounting numbers influence the distribution of scarce resources. Resources are channeled where needed at returns commensurate with perceived risk. Thus, reported accounting numbers have economic effects in that resources are transferred among entities and individuals as a consequence of these numbers. It is not surprising then that individuals affected by these numbers will be extremely interested in any proposed changes in the financial reporting environment.

(c) The Accounting Standards Executive Committee (AcSEC of the AICPA), among other groups, has presented a potential challenge to the exclusive right of the FASB to establish accounting principles. Also, Congress has been attempting to legislate certain accounting practices, particularly to help struggling industries.

Some possible reasons why other groups might wish to establish GAAP are:

1. As indicated in the previous answer, these rules have economic effects and therefore certain groups would prefer to make their own rules to ensure that they receive just treatment.

2. Some believe the FASB does not act quickly to resolve accounting matters, either because it is not that interested in the subject area or because it lacks the resources to do so.

3. Some argue that the FASB does not have the competence to legislate GAAP in certain areas. For example, many have argued that the FASB should not legislate GAAP for not-for-profit enterprises because the problems are unique and not well known by the FASB.