Financial Accounting

The Financial Accounting Standards Board (FASB) is a private, non-profit organization standard setting body whose primary purpose is to establish and improve generally accepted accounting principles (GAAP) within the United States in the public’s interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. The FASB replaced the American Institute of Certified Public Accountants’ (AICPA) Accounting Principles Board (APB) on July 1, 1973.

In 2009 Reuters, the Wall Street Journal, USA Today and others claimed that the FASB succumbed to “political pressure” and lobbyists and tweaked mark-to-market accounting to accommodate “banks with toxic assets on their books.” Since 2009 the FASB added the disclosure framework project to its conceptual framework in order to make financial statement disclosures “more effective and coordinated and less redundant. As part of this process, in September 2015 the FASB issued a controversial proposal regarding “the use of materiality by reporting entities” and an amendment of the definition of the legal conceptmateriality. Materiality is “a mainstay of corporate financial disclosure that determines what a company must tell investors about its operations and result. Harvard professor, Karthik Ramanna and lawyer, Allen Dreschel claim FASB’s proposed revised definition of materiality “could put the economy at greater risk of another huge accounting fraud, like Enron or Lehman Brothers” by weakening disclosure which is “the cornerstone of fair and efficient markets.” For example, if the new proposal is enacted—a pharmaceutical company would be allowed to not disclose to its investors that its new drug in the pipeline performed poorly in drug trials because there is a “substantial likelihood” that the information could sway investment decisions. Some Fortune 500 companies and the United States Chamber of Commerce argue that investors and companies suffer from “disclosure overload.”

FASB and the International Accounting Standard Board are working closely together to develop a common Conceptual Framework. The goal is develop standards that are objectives-based, internally consistent, and internationally converged. Currently Statement of Financial Accounting Concepts No. 8 “Conceptual Framework for Financial Reporting” is being used in the United States. The Conceptual Framework include: measurement attributes used to measure and report economic transactions, events, and arrangements in financial statements; and accounting principles and assumptions that guide recognition, derecognition, and disclosure, as well as the classification and presentation of information in financial statements.

Fundamental qualitative characteristics, relevance and faithful representation allow for decision usefulness. Information that is capable of making a difference in decisions made by financial statement users is relevant. The three components of relevance are:

  • Predictive Value – information that should help users form expectations about the value
  • Confirmatory Value – information that provides feedback to confirm or correct prior predictions and expectations
  • Materiality – refers to the nature and magnitude of an omission or misstatement of accounting information that would influence the judgment of a reasonable person relying on that information

Faithful representation is when the words and numbers accurately predict the economic substance of what they purport to represent. The three components of faithful representation are:

  • Complete representation – provides a user with full disclosure of all information necessary to understand the information being reported, with all necessary facts, descriptions, and explanations
  • Neutral representation – not biased, slanted, emphasized or otherwise manipulated to achieve a pre-determined result or to influence users’ behavior in a particular direction
  • Free from error – the information is measured and described as accurately as possible, using a process that reflects the best available inputs