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Wiley GAAP 2001 is a comprehensive guide to generally accepted accounting principles set forth by the FASB, including Emerging Issues Task Force Consensus summaries and Statements of Position of the AICPA's Accounting Standards Executive Committee (AcSEC). Featuring numerous examples, illustrations, and helpful practice hints that are extremely user friendly, Wiley GAAP 2001 is designed with the needs of the user in mind. Here are some highlights:
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• Easy-to-understand coverage of derivatives, income taxes, business combinations, leases, and segment reporting
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RESEARCHING GAAP PROBLEMS
Accounting principles have developed through both official pronouncements by authoritative bodies empowered to create and select accounting principles, and as a result of the evolution over time of accepted accounting practices. Accounting principles developed when rule-making bodies perceived a need and promulgated opinions and standards or--both prior to the existence of rule-making bodies, or during their existence, as a result of their failure to act, when conditions arose requiring solutions--by practicing accountants and academicians. Thus, given the rather broad definition of accounting principles, GAAP encompasses all standard, accepted practices both promulgated and nonpromulgated.
DEVELOPMENT OF GAAP
What Is GAAP?
Generally accepted accounting principles are concerned with the measurement of economic activity, the time when such measurements are made and recorded, the disclosures surrounding these activities, and the preparation and presentation of summarized economic information in the form of financial statements. Generally accepted accounting principles are a product of the economic environment in which they are developed. Complicated business activities usually result in complex accounting principles. It is fair to observe that the development of accounting and financial reporting standards has somewhat lagged the progression of increasingly intricate economic structures and transactions, however, and that the profession has struggled at times to maintain its relevance.
In APB 4, the Accounting Principles Board stated
Generally accepted accounting principles therefore is a technical term in financial accounting. Generally accepted accounting principles encompass the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. The standard of "generally accepted accounting principles" includes not only broad guidelines of general application, but also detailed practices and procedures.
Generally accepted accounting principles are conventional--that is, they become generally accepted by agreement (often tacit agreement) rather than by formal derivation from a set of postulates or basic concepts. The principles have developed on the basis of experience, reason, custom, usage, and, to a significant extent, practical necessity.
Accounting principles are usually directed toward solutions that are objective, conservative, and verifiable. There are two broad categories of accounting principles-- recognition and disclosure. Recognition principles determine the timing and measurement of items that enter the accounting cycle and impact the financial statements. These are quantitative standards that require economic information to be reflected numerically.
Disclosure principles deal with factors that are not always numerical. Disclosures involve qualitative information that is an essential ingredient of a full set of financial statements. Their absence would make the financial statements created by recognition principles misleading by themselves. Disclosure principles complement recognition principles by explaining assumptions underlying the numerical information and giving other information on accounting policies, contingencies, uncertainties, etc., which are essential ingredients in the analytical process of accounting.
The Hierarchy of GAAP
The Auditing Standards Board (ASB) is the senior authoritative organization in the promulgation of generally accepted auditing standards. Those standards require that an audit report should express an opinion about whether the financial statements "present fairly in conformity with generally accepted accounting principles." Thus, the ASB has undertaken to define the meaning of the above phrase and to delineate the sources of GAAP. The determination of which accounting principle is applicable under a particular set of conditions may be difficult or even impossible without a determination of the hierarchy of GAAP by an authoritative body.
In AU 411 (SAS 69), the ASB identified the following as the sources of established generally accepted accounting principles:
A. Accounting principles promulgated by a body designated by the AICPA Council to establish such principles, pursuant to rule 203 [ET section 203.01] of the AICPA Code of Professional Conduct.
B. Pronouncements of bodies, composed of expert accountants, that deliberate accounting issues in public forums for the purpose of establishing accounting principles or describing existing accounting practices that are generally accepted, provided those pronouncements have been exposed for public comment and have been cleared by a body referred to in category (A).
C. Pronouncements of bodies, organized by a body referred to in category (A) and composed of expert accountants, that deliberate accounting issues in public forums for the purpose of interpreting or establishing accounting principles or describing existing accounting practices that are generally accepted, or pronouncements referred to in category (B) that have been cleared by a body referred to in category (A) but have not been exposed for public comment.
D. Practices or pronouncements that are widely recognized as being generally accepted because they represent prevalent practice in a particular industry, or the knowledgeable application to specific circumstances of pronouncements that are generally accepted.
Compliance with accounting pronouncements included in category (A) is mandatory. An auditor should not express an unqualified opinion if the financial statements contain a material departure from category (A) pronouncements unless, due to unusual circumstances, adherence to the pronouncements would make the statements misleading. Rule 203 implies that application of officially established accounting principles almost always results in fair presentation in conformity with generally accepted accounting principles. If an accounting treatment is not specified by a pronouncement covered by Rule 203, the accountant/ auditor should proceed next to categories (B), (C), or (D) using the treatment specified by the source in the highest category. If an accounting pronouncement in category (B), (C), or (D) is relevant to the circumstances, an auditor must follow that pronouncement or be able to justify the conclusion that another treatment is generally accepted. For financial statements of entities other than governmental entities
a. Category (A), officially established accounting principles, consists of Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards and Interpretations, Accounting Principles Board (APB) Opinions, and AICPA Accounting Research Bulletins.
b. Category (B) consists of FASB Technical Bulletins and, if cleared by the FASB, AICPA Industry Audit and Accounting Guides and AICPA Statements of Position.
c. Category (C) consists of AICPA Accounting Standards Executive Committee (AcSEC) Practice Bulletins that have been cleared by the FASB and consensus positions of the FASB Emerging Issues Task Force.
d. Category (D) includes AICPA accounting interpretations and implementation guides (Qs and As) published by the FASB staff, and prac-tices that are widely recognized and prevalent either generally or in the industry.
In the absence of any source of established accounting principles, other accounting literature may be considered. These would include APB Statements, AICPA Issues Papers, FASB Statements of Financial Accounting Concepts, International Accounting Standards Committee Statements of International Accounting Standards, Governmental Accounting Standards Board Statements, Interpretations and Technical Bulletins, Technical Information Service Inquiries and Replies included in AICPA Technical Practice Aids, pronouncements of other professional associations or regulatory agencies, and accounting textbooks and articles. The use of those other sources depends upon their relevance to particular circumstances, the specificity of the guidance, and the general recognition of the author or issuing organization as an authority. This would mean that FASB publications in this category would be more influential in establishing an acceptable accounting practice than would an accounting textbook. Guidance in this category would require more judgment and a broader search of literature than would be true in the other three categories.Who Created GAAP?
In 1930, primarily as a consequence of the stock market crash of the 1920s and the widespread perception that an absence of uniform and stringent financial reporting requirements had contributed to that crash, the American Institute of Accountants, later to become the American Institute of Certified Public Accountants (AICPA), created a committee to work with the New York Stock Exchange (NYSE) toward the goal of establishing standards for accounting procedures. It was acknowledged that trading activities by an underinformed public had contributed to the speculative excesses of the 1920s. This admitted lack of full information, more than the stock market crash itself, caused the accounting profession to become involved in its first serious attempt to grapple with the concept of generally accepted accounting principles. There had been earlier efforts by the profession aimed at the creation of uniform accounting standards, but the establishment of this special committee was different because of the recognition that ownership dispersion required consistency in accounting measurements and in the selection of accounting procedures.
Committee on Accounting Procedure. The special committee recommended five rules to the Exchange which later (in 1938) were published as Accounting Research Bulletin (ARB) 1 of the Committee on Accounting Procedure. The Committee subsequently published 51 such bulletins, including Accounting Research Bulletin 43, which consolidated and superseded Bulletins 1-42. The Committee was also instrumental in attempting to achieve uniformity in accounting terminology. However, the Committee's limited resources and lack of serious research efforts in support of its pronouncements were more often questioned in the late 1950s, particularly as a number of very complex controversial topics loomed on the horizon.
Accounting Principles Board. The profession's response was to substitute the Accounting Principles Board (APB) for the Committee on Accounting Procedure, in order to facilitate the development of principles based primarily on the research of the Accounting Research Division. Under this new strategy, the Division was to undertake extensive and exhaustive research, publish its findings, and then permit the Accounting Principles Board to take the lead in the discussions that would ensue concerning accounting principles and practices. The Board's authority was enforced primarily through prestige and Rule 203 of the Code of Professional Ethics. Furthermore, formal approval of Board issuances by the Securities and Exchange Commission (SEC) gave additional support to its activities.
During the fourteen years of the Board, thirty-one opinions and four statements were issued. They dealt with amendments of Accounting Research Bulletins, opinions on the form and content of financial statements, and issuances requiring changes in both the recognition and disclosure principles of the profession. However, the Board did not utilize the Accounting Research Division, which published fifteen research studies during its lifetime. Both the Board and the Division acted independently in selecting topics for their respective agendas. The Board issued pronouncements in areas where little research had been done, and the Division performed research studies without seeking to be all-inclusive or exhaustive in analysis. The Accounting Principles Board did not operate differently than the Committee on Accounting Procedure.
Financial Accounting Standards Board. As a result of these operational problems and based on the recommendations of the Wheat Study Group, the Financial Accounting Standards Board (FASB) was formed in 1972. The Board consists of seven full-time members; they have diverse backgrounds with three coming from public accounting, two from private industry and one each from academia and an oversight body. The Board is assisted by a staff of professionals who conduct research and work directly with the Board. Although there is some controversy and disagreement as to its activities and pronouncements, the FASB continues to operate with the confidence of accounting practitioners and various business organizations.
The FASB is recognized as authoritative through Financial Reporting Release No. 1 by the Securities and Exchange Commission and through Rule 203, Rules of Conduct by the AICPA.
The FASB is an independent body relying on the Financial Accounting Foundation for selection of its members and receipt of its budgets. Funds are raised from contributions made to the Foundation. The Board of Trustees of the Foundation is made up from members of the
American Accounting Association
American Institute of Certified Public Accountants
Association for Investment Management and Research
Financial Executives Institute
Government Finance Officers Association
Institute of Management Accountants
National Association of State Auditors, Comptrollers, and Treasurers
Securities Industry Association
There is also a Financial Accounting Standards Advisory Council that has responsibility for consulting with the Board on major areas of inquiry and analysis.
The Board issues several types of pronouncements. Statements of Financial Accounting Standards and Interpretations are the most important of these because they are category (A) GAAP. Interpretations are used to clarify or elaborate on existing Statements or pronouncements of predecessor bodies. Technical Bulletins, which are category (B) GAAP, usually address issues not covered directly by existing standards and are primarily used to provide guidance where it is not expected to be costly or create a major change. Bulletins are discussed at Board meetings and subject to Board veto. Both Bulletins and Interpretations are designed to be responsive to implementation and practice problems on relatively narrow subjects.
American Institute of Certified Public Accountants (AICPA). The Accounting Standards Executive Committee (AcSEC) is the senior technical committee at the AICPA. It is composed of fifteen volunteer members, representative of industry, academia, analysts, and both national and regional public accounting firms. All AcSEC members are CPAs and members of the AICPA.
AcSEC is authorized to set accounting standards and to speak for the AICPA on accounting matters. The accounting standards that AcSEC issues are prepared largely through the work of AICPA committees and task forces. AcSEC issues Statements of Position (SOP) and industry audit and accounting guides, which are reviewed and cleared by the FASB and thus are category (B) GAAP. SOP provide guidance on financial accounting and reporting issues. Industry audit and accounting guides provide guidance to auditors in examining and reporting on financial statements of entities in specific industries and provide standards on accounting problems unique to a particular industry. AcSEC Practice Bulletins (category (C) GAAP) usually provide guidance on very narrowly defined accounting issues. AcSEC's standards-setting activities are often industry-specific or narrow in their scope, unlike the majority of FASB's projects, which are broader in scope.
AcSEC also issues technical practice aids, issues papers, and comment letters on other standards setters' proposed guidance. The AICPA Technical Information Service, which answers questions about accounting and auditing standards, publishes the answers to certain inquiries in a volume of Technical Practice Aids. AICPA Issues Papers are research documents about accounting and reporting problems that the AICPA believes should be resolved by the FASB. They provide information about alternative accounting treatments used in practice. These two AICPA publications, which are not approved by the FASB, have no authoritative status but can be helpful in understanding and resolving issues for which there is no authoritative literature. However, because the AICPA is the primary professional organization of accountants, those who depart from guidance in their nonauthoritative publications must be prepared to justify that departure based upon the facts and circumstances of the particular situation.
Emerging Issues Task Force (EITF). The Emerging Issues Task Force (EITF) was formed in 1984 by the FASB in order to assist the Board in identifying current or emerging issues and implementation problems that may need to be placed on the agenda of the Board. Task Force members are drawn primarily from public accounting firms but also include individuals who would be aware of issues and practices that should be considered by the group. The Task Force meets every other month with persons representing the SEC and FASB in attendance for discussion but not voting purposes.
For each agenda item, an issues paper is developed by members, their firms, or the FASB staff. After discussion by the Task Force, a consensus can be reached on the issue, in which case further action by the FASB is not needed. An EITF consensus is category (C) GAAP. If no consensus is reached, the problem may end up on the Board agenda or be resolved by the SEC or AICPA. It is also possible that no consensus is reached and the issue remains unresolved with no organization currently working on the problem. These may be in especially narrow areas having little broad-based interest. Occasionally, the FASB may include a narrow issue in the scope of a broader project and reaffirm or supersede the work of the Task Force.
The FASB publishes a volume of EITF Abstracts, which are summaries of each issue paper and the results of Task Force discussion. A listing of the Issues considered by the Emerging Issues Task Force and the status concerning resolution of each issue appears in the front of this publication following other more authoritative pronouncements.
The EITF has been severely criticized for promulgating GAAP without sufficient due process procedures. Only a limited audience is aware of each issue, and the period of exposure is sometimes very brief. However, the Task Force resolves problems in an environment where delay would often result in widespread and divergent practices of accounting becoming entrenched. The guidance provided is often on narrow issues that are of immediate interest and importance.
EITF discussion issues. As part of the issuances and consensus underlying the Emerging Issues Task Force (EITF) pronouncements, the FASB has also released discussions on various technical topics. These issuances are FASB staff announcements and SEC staff announcements that are discussed at EITF meetings. They represent discussions of technical matters that are deemed important by the FASB or SEC staff and do not relate specifically to a numbered EITF issue. These are designed to help and provide guidance on the application of relevant accounting concepts. A listing of the EITF Discussion Issues, with a short summary of each, appears in the front of this publication following the listing of the EITF Issues.
SEC relationships. The SEC believes that a Task Force consensus is GAAP for public companies, and they will question any accounting that differs from it. Remember, although EITF pronouncements are technically category (C) GAAP, they are so specialized that there is really no category (A) or (B) GAAP in front of it. In addition, the SEC feels that the EITF works to supply a forum to discuss accounting concerns and to assist in providing advice in a public forum. Thus, they are supportive of the Task Force work.
Materiality as a concept has great significance in understanding, researching, and implementing GAAP. Each Statement of Financial Accounting Standards (SFAS) issued by the FASB concludes by stating that the provisions of the statement are not applicable to immaterial items.
Materiality is defined by the FASB as the magnitude of an omission or mis-statement in the financial statements that makes it probable that a reasonable person relying on those statements would have been influenced by the information or made a different judgment if the correct information had been known. Thus, materiality judgments are primarily quantitative in nature. However, the nature of a transaction or event can affect a determination of whether that transaction or event is material. For example, a transaction that, if recorded, changes a profit to a loss or changes compliance with ratios in a debt covenant to noncompliance would be material even if it involved an otherwise immaterial amount. Also, a transaction that might be judged immaterial if it occurred as part of routine operations may be material if it occurs in abnormal circumstances.
Another factor in judging materiality is the degree of precision that is possible to attain when making an estimate. For example, accounts payable can usually be estimated more accurately than a possible loss from the incurrence of an environmental liability. An error that would be material in estimating accounts payable might be acceptable in estimating the contingency.
Materiality as a criterion has both qualitative and quantitative aspects. Certain events or transactions may be deemed to be material because of the nature of the item, regardless of the dollar amounts involved, and thus to require disclosure under any circumstance. The enactment of prohibition (outlawing the sale of most alcoholic beverages) was a significant event to companies that produced and sold such products. Offers to buy or sell assets for more or less than book value, litigation proceedings against the company pursuant to price-fixing or antitrust allegations, and active negotiations involving future profitability are all examples of items that would not be capable of being evaluated for materiality based solely upon numerical calculations.
Quantitatively, materiality has been defined in a few accounting standards. For example, in SFAS 131, Disclosures About Segments of an Enterprise and Related Information, a material segment or customer is defined as 10% or more of revenues. In general, FASB has resisted requests to define materiality.
The Securities and Exchange Commission has in several of its pronouncements defined materiality as 1% of total assets for receivables from officers and stockholders, 5% of total assets for separate balance sheet disclosure of items, and 10% of total revenues for disclosure of oil and gas producing activities.
Material information is that information whose absence makes the financial statements misleading. However, that definition does not sufficiently explain the concept to provide guidance in distinguishing material information from immaterial information. The individual accountant must exercise professional judgment in evaluating information and concluding on its materiality.
Another complexity in the search for accounting principles has arisen in recent years with the complaint that there are too many accounting standards and too many organizations issuing pronouncements that create accounting standards. Some say solutions are needed to reduce and simplify existing GAAP either for all entities or at least for those entities where enforcement of such standards is not cost justified. Both the FASB and the AICPA have undertaken studies in order to seek to simplify or eliminate certain accounting principles.
A list of onerous standards will vary depending upon personal preferences and problems. Generally, standards that are complicated, such as those on leases and income taxes, will find their way onto nearly everyone's list.
The search for simplicity is not an easy process. Complex business and economic activities may not lend themselves to simple accounting standards to measure and disclose them. If simplicity means having to make an incorrect measurement, many users will have to choose between erroneous financial statements, which do not reflect economic reality, and complicated accounting standards. A reduction in standards could ultimately reduce the quality of financial reporting.
Some have suggested that different entities should follow different standards. Differential standards require a selection of a system by which to categorize entities by the standards they should follow. Some recommend a size test with large entities following complete standards and small entities following a simpler set of standards. Size might be determined by assets, sales, net worth, or number of owners. Another possibility is an ownership test, with public companies following a different and more comprehensive set of standards than privately owned businesses. However, different disclosure standards may reduce the quantity of financial information available for certain entities selected. This may also reduce the quality of that information. Different recognition standards again may create erroneous financial statements in terms of economic reality. However, the difficulty in making a selection of which entities apply which standards and the added complexity caused by two sets of different standards obviously compounds the standard overload problem instead of reducing it.
The search for simpler accounting standards is not hopeless, however. Where research shows that disclosures are not utilized or understood by the users of financial data, such disclosures can be dropped. If recognition standards differentiate between events that are clearly not different from an economic viewpoint, those standards add nonessential complications and can be amended. For example, all business combinations constitute an economic union and the terms purchase and pooling have no meaning in economic theory. Also, all leases give rise to liabilities, as future obligations, and assets, as future economic benefits. The differentiation of some leases as capital and others as operating may be a highly subjective concept.
The search for easier, simpler, and fewer accounting standards will continue. Certain differential standards in terms of disclosures have already been adopted, allowing nonpublic entities to avoid disclosing earnings per share, segment data, and retroactive effects of a business combination. As the FASB considers future pronouncements on accounting standards, the issue of cost-benefit and applicability to all segments of the profession will be considerations. The standards overload issue will not fade away because there are numerous problems with the potential solutions that have been suggested.
RESEARCHING PUBLISHED GAAP
Researching Authoritative Sources of GAAP
Researching the appropriate GAAP to answer an accounting question begins with the analysis of publications issued by the entities that set the accounting standards in the GAAP hierarchy--the FASB, the AICPA, and the EITF.
The FASB publishes two sets of books (both looseleaf and bound) that can assist in researching accounting issues. (These and other materials are now also available on CD-ROM.) The Current Text integrates all of the currently recognized category (A) GAAP alphabetically in topic order (e. g., Accounting Changes, Business Combinations, etc.). The AICPA Research Bulletins, APB Opinions, and FASB Statements and Interpretations have been combined to create this integrated document. Supplemental guidance from the AICPA Accounting Interpretations and FASB Technical Bulletins are also incorporated. All the materials have been edited down from the original pronouncements and thus may lack the clarity that can be obtained only from the unedited version. Descriptive material including reasons for conclusions are missing. Each paragraph in the Current Text is referenced back to the original pronouncement for research or follow-up. The first volume of the Current Text deals with general standards, and the second volume contains standards for specialized industries.
The Original Pronouncements contains all of the AICPA Accounting Research Bulletins, Interpretations and Terminology Bulletins, the APB Opinions, Statements and Interpretations, the FASB Standards, Interpretations, Concepts, Technical Bulletins, and Exposure Drafts. The first volume contains only FASB Statements. The second volume contains all of the other pronouncements. Paragraphs containing accounting principles that have been superseded or dropped are shaded in order to make the user aware. Those changes are identified in detail by a status page placed at the beginning of each pronouncement that can reference the user to other areas and pronouncements.
Essentially, if you need a quick answer to a specific question, the Current Text can be accessed quickly. If you need to understand the answer and the reasons for it, the Original Pronouncements will afford you the opportunity to study the area in depth.
The FASB also publishes the EITF Abstracts (category (C) GAAP). Each EITF issue discussed by the Task Force is included in the book, regardless of whether a consensus was reached, in the order in which they were added to the EITF agenda. A status section at the end of each issue indicates whether the consensus has been superseded or remains relevant and whether any additional EITF discussion is planned.
The AICPA publishes all its outstanding Statements of Position (category (B) GAAP) and Practice Bulletins (category (C) GAAP) in AICPA Technical Practice Aids. That book is set up similar to FASB's Original Pronouncements, with the SOPs and Practice Bulletins included in the order in which they were issued. There are 22 audit and accounting guides (category (B) GAAP). They are
- Agricultural Producers and Cooperatives
- Banks and Savings Institutions
- Brokers and Dealers in Securities
- Common Interest Realty Associations
- Consideration of Internal Control in a Financial Statement Audit
- Construction Contractors
- Credit Unions
- Employee Benefit Plans
- Entities With Oil and Gas Producing Activities
- Federal Government Contractors
- Finance Companies
- Health Care Organizations
- Investment Companies
- Life and Health Insurance Entities
- Not-for-Profit Organizations
- Personal Financial Statements
- Property and Liability Insurance Companies
- Prospective Financial Information
- State and Local Governmental Units
- Use of Real Estate Appraisal Information
These publications are available in softcover and on CD-ROM.
The Securities and Exchange Commission issues Staff Accounting Bulletins and makes rulings on individual cases that come before it, which create and impose accounting standards on those whose financial statements are submitted to the Commission. The SEC, through acts passed by Congress, has broad powers to prescribe accounting practices and methods for all statements filed with it. Although it has usually preferred to encourage the development of standards in the private sector by deferring to the AICPA and FASB, the SEC has occasionally adopted policies that conflict with established standards. In each case, the result has been a veto by the SEC of the standard, and the AICPA or FASB has withdrawn or amended the standard to conform to SEC policy. However, the history of the SEC is one of co-operative assistance in the formulation of accounting standards. Congressional committees have been critical of the SEC in instances where they felt that too much power was ceded to the profession itself without adequate oversight by the Commission.Nonpromulgated GAAP
Not all GAAP came about because of a deliberation process and issuance of pronouncements by authoritative bodies. Certain principles and practices evolved into current acceptability without adopted standards. Depreciation methods such as straightline and declining balance are both acceptable, as are inventory costing methods such as LIFO and FIFO. There are, however, no definitive pronouncements that can be found to state this. There are many disclosure principles that evolved into general accounting practice because they were required by the SEC in documents submitted to them. Among these are reconciling the actual rate with the statutory rate used in determining income tax expense, when not otherwise obvious from the financial statements themselves. Even much of the form and content of balance sheets and income statements has evolved over the years.
Researching nonpromulgated GAAP consists of reviewing pronouncements in areas similar to those being researched, and careful reading of the relevant portions of the FASB Conceptual Framework (Appendix). Understanding concepts and intentions espoused by the deliberative authorities can give the essential clues to a logical formulation of alternatives and conclusions regarding problems that have not yet been addressed by these authorities.
In addition to the authoritative literature, both the AICPA and the FASB publish a myriad of nonauthoritative literature. The FASB publishes the documents it uses in its due process: Discussion Memorandums, Invitations to Comment, Exposure Drafts, and Preliminary Views. It also publishes research reports, Status Report, and implementation guidance. The AICPA also publishes its Exposure Drafts, as well as Issues Papers, its comment letters on proposals of other standard-setting bodies, and the Journal of Accountancy. Listings of their publications are available at their websites. (A list of website addresses is located at the end of this chapter, immediately before the Appendix.)
The American Accounting Association is an organization consisting primarily of accounting educators. It is devoted to encouraging research into accounting theory and practice. The issuances of the AAA tend to be normative, that is, prescribing what GAAP ought to be like, rather than explaining current standards. However, the monographs, committee reports, and The Accounting Review published by the AAA may be useful sources for research into applicable accounting standards.
Governmental agencies such as the Government Accounting Office and the Cost Accounting Standards Board have offered certain publications that may assist in researching written standards. Also, industry organizations and associations may be other helpful sources.
Certain publications are helpful in identifying practices used by entities that may not be promulgated as standards. The AICPA publishes an annual survey of the accounting and disclosure policies of many public companies in Accounting Trends and Techniques and maintains a library of financial statements that can be accessed through a computerized search process (NAARS). EDGAR (Electronic Data Gathering, Analysis, and Retrieval) publishes the SEC filing of public companies, which includes the companies' financial statements. Through selection of keywords and/ or topics, these services can provide information on whether other entities have had similar problems and the methods used in accounting for them.
Researching Using This Publication
This publication can assist in researching generally accepted accounting principles in order to find technical answers to specific inquiries. A listing of all authoritative accounting pronouncements still in effect appears in numerical order in the front of this publication immediately following the table of contents. The listed pronouncements are referenced both to the Current Text published by the FASB and to pages in this publication. Using this list, you can trace to or from this publication to both the original pronouncements and/ or the Current Text. The reader can there-fore find more detail on each and every topic covered in this publication and also be aware of which topics and pronouncements are not covered within this publication at all. This should make research cross-referencing quick and reliable.
With respect to the EITF pronouncements, the current status of each issues paper is indicated; that is, whether superseded, resolved, or consensus reached by the EITF. The reader can identify any or all of the EITF issues papers that would be relevant to the current research. We have included EITF issues for which a consensus was reached in this publication at the end of the chapters to which they relate. Some pervasive issues are included within the sections of the related chapters. Because EITF issues are generally on narrow issues, there is often no level A or B GAAP that would apply. Accordingly, EITF consensus represents the highest level of GAAP available for each topic. The inclusion in this publication of EITF summaries is recognizing the relative importance of these issues.
The reader, therefore, can be directed by this publication to the specific professional authoritative literature concerning the area of inquiry. In a like manner, the reader of the professional literature can use the listing of authoritative accounting pronouncements to quickly locate the pages in this publication relevant to each specific pronouncement.
The Conceptual Framework
The FASB has issued seven pronouncements called Statements of Financial Accounting Concepts (SFAC) in a series designed to constitute a foundation of financial accounting standards. The framework is designed to prescribe the nature, function, and limits of financial accounting and to be used as a guideline that will lead to consistent standards. These conceptual statements do not establish accounting standards or disclosure practices for particular items. They are not enforceable under the Rules of Conduct of the Code of Professional Ethics.
Of the seven SFACs, the fourth, Objectives of Financial Reporting by Nonbusiness Organizations, is not covered here due to its specialized nature.
SFAC 1, Objectives of Financial Reporting by Business Enterprises, identified three objectives of financial reporting. These were to provide useful information for economic decisions, to provide understandable information capable of predicting cash flows, and to provide relevant information about economic resources and the transactions, events, and circumstances that change them.
SFAC 2, Qualitative Characteristics of Accounting Information, identifies the qualities that make information useful. Under a cost benefit constraint, the primary qualities of useful information are that it be relevant and reliable. Relevant information is timely and either aids in predicting the future or in providing knowledge of the past (feedback value). Reliable information is verifiable and neutral and it faithfully represents events. In addition, such information must be comparable, consistent, and understandable.
SFAC 3, Elements of Financial Statements of Business Enterprises, has been replaced by SFAC 6. This statement has been amended by SFAC 6 to include financial reporting by not-for-profit organizations.
SFAC 5, Recognition and Measurement in Financial Statements of Enterprises, sets forth recognition criteria that determine what information should be in financial statements and the timing of when that information will appear. A full set of such statements would show financial position at the end of a period, earnings, comprehensive income and cash flows for the period, and investments by and distributions to owners during the period.
SFAC 6, Elements of Financial Statements, defines ten elements as the basic components of financial statements. Three of these elements (assets, liabilities, and equity) relate to the balance sheet and are discussed in depth in Chapter 2, Balance Sheet. The remaining elements (comprehensive income, revenue, expenses, gains, losses, investments by owners, and distributions to owners) relate to the performance of an entity over time and are discussed in Chapter 3, Statements of Income and Comprehensive Income. These would be displayed on the income statement, statement of changes in financial position, and statement of changes in equity.
SFAC 7, Using Cash Flow Information and Present Value in Accounting Measurements, provides a framework for using future cash flows as the basis for accounting measurements either at initial recognition or when assets are remeasured at fair value (fresh-start measurements). It also provides a framework for using the interest method of amortization. It provides the principles that govern measurement using present value, especially when the amount of future cash flows, their timing, or both are uncertain. However, it does not address recognition questions, such as which transactions and events should be valued using present value measures or when fresh-start measurements are appropriate.
The appendix to this chapter discusses SFAC 1, 2, 5, 6, and 7 in greater detail.
Solving GAAP Problems
The methods that are employed in solving existing accounting problems can be summarized in the following steps:
1. Research published GAAP. A search should be initiated at the highest level of published accounting standards, following the levels and sources of principles according to Statement on Auditing Standards 69. The researcher should look for specific pronouncements and issuances level by level. In the absence of pronouncements directly applicable to the topic, the investigation should be broadened to include related and analogous topics. Analysis of the economic factors influencing the transaction will help in the broader search.
2. Research other literature. Other literature beyond that recognized by SAS 69 may consist of periodical literature and general industry publications. These may be important since not all principles are promulgated and successful practice is a source of accounting standards.
3. Research practice. Inquiries of other entities regarding the accounting practices they follow may indicate a potential solution or at least allow consideration of alternatives.
4. Use theory. When published standards, other literature, and practice fail to provide the answers to problems, the researcher must fall back on accounting theory. The conceptual framework, textbooks, appendices to official pronouncements, FASB discussion memorandums, and the like are sources of theory to be analyzed. The use of theory constrained by the economic factors underlying the problem being researched may succeed in clarifying issues and alternatives when no other guidance is available.
Examples of unsolved accounting problems and potential solutions follow.
Example involving equity method
The equity method of accounting for investments in partnerships and significantly influenced and controlled corporations is in accordance with accounting principles stated in APB 18. However, there is no clearly defined solution to the problem of how to account for issuances of additional shares or interests by the investee. Assume the following:
A Company forms B Company by depositing $100,000. B then sells additional stock to outsiders, reducing A's percentage of ownership to 25%, for a total of $4,900,000. A under the equity method would see its investment account rise from $100,000 to $1,250,000 (or 25% of [$ 100,000 + $4,900,000]).
A did not do anything that constitutes an earning process. Furthermore, a capital transaction of an investee could have been a capital transaction by the investor. The increase in investment may be seen as a capital transaction and an increase in paid-in capital.
Another argument is that A owned 100% of an entity and now owns only 25%. Essentially, A could have sold its investment directly but chose instead to have the investment sold indirectly by the investee. Under this theory, the increase in investment may be seen as a sale by A of part of its investment, which resulted in a gain, or as a revenue transaction to be reported in the income statement.
There are various writings in accounting literature that speak on both sides of this question. Although, in general, most textbooks show the increase as a capital transaction, the Internal Revenue Service may tax it. The Securities and Exchange Commission in Staff Accounting Bulletin 51 states that it will accept both methods, and the AICPA in Issues Paper, Accounting in Consolidation for Issuances of a Subsidiary's Stock, states a preference for the revenue transaction method.
The issue is whether A's original acquisition was a bargain purchase (no revenue to be recognized) or the subsequent sale was an earning process (revenue is realized). The issue may revolve around what activities A pursued prior to B issuing its stock that may have caused the value of B's stock to rise. Such activities may qualify for revenue recognition.
Example involving consolidations
In consolidations of less than 100% ownership of a subsidiary, the question arises as to the use of the parent or entity theories of combination. Assume the following:
A Company purchases 80% of B Company for $46,000 when B has total book value of $50,000. Since 80% of $50,000 is $40,000, there is a $6,000 differential to be accounted for. Under the parent theory, since cost exceeds book value by $6,000, the entire amount represents either an identified or unidentified (goodwill) asset to be accounted for in the future. Under the entity theory, since 80% created a $6,000 value, then the entire value must be $7,500, of which $6,000 is attributed to the majority interest and $1,500 belongs to the minority interest.
Under the parent theory, the implied additional value is not acceptable because there is no cost associated with it. Under the entity theory, recognition of only the actual differential denies the market implication of value. There is no authoritative literature that speaks to these issues although the parent theory is derived from the proprietary theory (view everything from the standpoint of the owner), while the entity theory (view everything from the standpoint of the entity as a whole) is a predominant accounting concept.
Generally, if the additional value of $6,000 is unidentified (goodwill), the cost issue becomes persuasive because of the concept of acquisition of unidentifiable intangibles. If the additional value is identified, practice would push the value down to the subsidiary by entering the $7,500 increase in assets and increase in equity. B would then have a total book value of $57,500 and 80% of it would equal the investment of A of $46,000. The accounting then is B's accounting for its own asset. The argument justifying this is that the legal form of the various entities, A and B, is immaterial. A new economic entity began with A's purchase of the stock of B and the same thing could have been accomplished through a partnership to which assets were transferred or by a liquidation of B into a new corporation, with a stepped-up basis for assets. Substance over form would support equal accounting regardless of the form of the transaction.
There are, however, many who would support neither the push-down nor the implied value recognition. The answer is not definitive because there has yet to be a pronouncement on the parent and entity theories of consolidation.Example involving cancelable leases
A lease that is cancelable is not covered by SFAS 13, Accounting for Leases. However, assume that a firm has no intention of canceling the lease; would this intention alone be sufficient to cause capitalization of the asset and obligation, assuming the criteria were met? Most accountants would probably agree that the intention of the pronouncement would be met by such capitalization.
In a peculiar situation, assume a construction company bidding for state projects must maintain a 2: 1 current ratio in order to obtain such jobs. The company has various equipment subject to cancelable leases, which otherwise would qualify as capital leases. If the leases are capitalized, the ratio falls below 2 to 1 causing cancellation of the leases due to lack of construction jobs. If the leases are not capitalized, the ratio is above 2 to 1, and the company would intend to keep the equipment for the entire lease without cancellation. Such an accounting dilemma is conceivable, and the solution may not exist. However, since bidding does not guarantee getting a contract, the intention of the lessee with respect to cancellation is unclear at the time of bidding, and most likely, the leases would not be capitalized at that time.
Example involving employee capital accumulation plans
Such plans exist when companies reward employees by giving them stock or the right to benefit from the change in market price of the company's stock or both. There are two types of plans: (1) compensatory--the employee gets compensation and the company records an expense and liability, and (2) noncompensatory--no accounting recognition.
If a compensation plan is initiated at the then fair market value of the stock, no compensation can be reported because such compensation is measured only from the amount of the discount (market price less exercise price offered). Therefore, no discount means no accounting even though the plan is compensatory. So the difference between compensatory and noncompensatory plans can be meaningless (APB 25). However, in practice many plans exist. These include incentive plans, option plans, stock appreciation rights plans, phantom stock plans, restricted plans, and others. Let's look at two examples.
1. A nonqualified stock option plan
2. A stock appreciation right plan
The substance of these two plans is essentially the same because economic benefits that may be received by the employee can be identical.
Assume that both plans are issued at an exercise price equal to the market price of the stock and that market price increases over time. Under the nonqualified plan, although compensatory, the compensation is measured at the date of grant which is the date of issuance. No compensation would ever be recorded and the increase in market value would be ignored. The employee could exercise the option and sell the stock, earning the profit while the corporation would ignore the "cost."
Under the stock appreciation right, the employee gets the profit directly from the corporation without buying and then selling the stock. However, when the amount of market appreciation is paid out, the corporation records the compensation as the excess of the market price over the exercise price of the SAR.
These two plans are virtually identical, yet the accounting for them is different. Furthermore, the first plan could give the employee a fixed number of shares while the second plan could be identical except the shares may be reduced based upon some contingency. Obviously, the first plan would be more valuable than the second because of no contingency in it to the employee. The stock plan is a more valuable award to the employee than the stock appreciation right. Under current accounting, the plan would cost zero while the right would cost the entire amount of the employee's gain.
Unfortunately, the form of the transaction prevails over the economic substance, although it clearly shouldn't. The corporation can influence its accounting recognized costs by how the plan is structured. The FASB is working on this problem.
Other problems similar to the previous ones also exist. Should profit sharing and money purchase plans that are substitutes for pension plans be subjected to the accounting and disclosure requirements for pension plans? How should income tax expense allocated to individual companies in a consolidated group be accounted for? The expense could be allocated on the proportion of income or loss, on the proportion of income alone (no credit for losses to those entities that had losses), on the incremental basis of each company with the net benefit or cost of the consolidated tax return accruing to the parent company, or on any other basis. There are no pronouncements stating the methods that are acceptable.
Solutions to GAAP problems may not be definitive and may not be obtainable by looking up a pronouncement. The theory of accounting and analysis of the economic factors may be the path to their solution.
Table of Contents
Researching GAAP Problems.
Statements of Income and Comprehensive Income.
Statement of Cash Flows.
Cash, Receivables, and Prepaid Expenses.
Short-Term Investments and Financial Instruments.
Special Revenue Recognition Areas.
Business Combinations and Consolidated Financial Statements.
Current Liabilities and Contingencies.
Earnings Per Share.
Interim and Segment Reporting.
Accounting Changes and Correction of Errors.
Personal Financial Statements.
Specialized Industry GAAP.
2001 Self-Study CPE Program.