Is there a gap in your knowledge of GAAP



Is there a gap in your knowledge of GAAP?

Stephen R Moehrle; Jennifer A Reynolds-Moehrle; Wilbur L Tomlinson

2,905 words

1 September 2002

Financial Analysts Journal

43

Volume 58, Issue 5; ISSN: 0015-198X

English

Copyright (c) 2002 ProQuest Information and Learning. All rights reserved. Copyright Association for Investment Management and Research Sep/Oct 2002

The Enron Corporation scandal and other high-profile accounting investigations have demonstrated the importance of understanding how accounting rules are applied in preparing financial statements. Thus, financial analysts and other users of financial statements need to increase the attention they pay to the rules underlying companies' financial statements. Most financial statement users are familiar with the term "generally accepted accounting principles" and are familiar with key U.S. accounting rules, but few users of financial statements know what constitutes the universe of GAAP or where such information can be found. We set forth precisely the constituents of the GAAP universe, the various sources of GAAP, the relative position of each source in the hierarchy of accounting authority, and where this information can be found.

The hierarchy of GAAP consists of five categories. Category A, the most authoritative level, includes Financial Accounting Standards Board (FASB) Statements of Financial Accounting Standards (SFAS) and Interpretations, Accounting Principles Board Opinions, and Accounting Research Bulletins issued by the American Institute of Certified Public Accountants (AICPA). Category B is a lower tier of authoritative documents issuing from the FASB and AICPA. An important part of Category C is consensus positions of FASB's Emerging Issues Task Force, which provides financial reporting guidance that is more timely than SEAS can be. Category D consists of such material as AICPA Accounting Interpretations and FASB Staff Implementation Guides, as well as sundry industry practices that are widely followed (but do not have the imprimatur granted GAAP in the first tier). Category E is a catchall group that includes written sources of accounting authority ranging from FASB Statements of Financial Accounting Concepts to accounting textbooks.

Also in the GAAP universe are pronouncements and rules established by the U.S. SEC under its power to establish accounting standards for publicly traded companies.

Unfortunately, no single source contains all these materials. We describe several paper and online sources, however, that can be consulted. The primary electronic resource for materials promulgated by the FASB is the Financial Accounting Research System, which is available on CD-ROM. Most of the same material is also available in a printed volume, Annual Bound Editions of FASB Original Pronouncements and Current Text. Many of the AICPA materials are now available through a new service, reSOURCE, which is offered by the AICPA via CD-ROM or via a fee-based Internet service. For relevant SEC material, the most

As recent accounting scandals have demonstrated, an understanding of the accounting rules underlying financial information is important before analysts or users of financial statements can rely on that information. Accounting guidance comes from numerous sources. We summarize the sources of generally accepted accounting principles, explain the hierarchy of these sources of guidance, and indicate where analysts and users of financial statements can find the electronic and printed texts of the rules.

Is There a GAP in Your Knowledge of GAAP?

Stephen R. Moehrle, Jennifer A. Reynolds-Moehrle, and Wilbur L. Tomlinson

comprehensive source is Lexis-Nexis, a fee-based service that is now available on the Web. In addition, a number of specialized accounting databases are available.*

Keywords: Financial Statement Analysis: financial accounting standards; Financial Statement Analysis: accounting and financial reporting issues; Equity Investments: fundamental analysis and valuation models

The Enron Corporation scandal and other high-profile accounting investigations have demonstrated the importance of understanding how accounting rules are used to prepare financial statements. Thus, financial analysts and other users of financial statements need to increase the attention they pay to the rules underlying financial statements. Most financial statement users are familiar with the term "generally accepted accounting principles" (GAAP) and are familiar with key accounting rules. However, few financial statement users know what constitutes the universe of GAAP or where such information can be found. We set forth precisely the constituents of the GAAP universe and describe the various sources of GAAP, the relative position of each source in the hierarchy of accounting authority, and where this information can be found.

As stated in Statement on Auditing Standards (SAS) No. 69:

The phrase "generally accepted accounting principles" is a technical accounting term that encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. (AICPA 2000, p. 715)

"Generally accepted" connotes that each rule enjoys widespread favor. However, that is not the case. Some rules are quite controversial. The generally accepted method may be but one approach among several possibilities, none of which would command a plurality if put to a vote of the members of the accounting profession. Other accounting practices are generally accepted in the sense that they enjoy widespread use and approval but are not within GAAP

Financial statement users do have a source for finding out what constitutes the universe of GAAP. The American Institute of Certified Public Accountants (AICPA) defined GAAP specifically in SAS No. 69, and it ranked the various sources of GAAP so that accountants can identify which principle governs in the event of a conflict between two potential sources of GAAP. As summarized in Exhibit 1, SAS No. 69, as modified by SAS Nos. 91 and 93, established categories A through D and then added a catchall for "other accounting literature," which is designated Category E.

GAAP Hierarchy of Authority

Some of the details of the categories of GAAP summarized in Exhibit 1 are spelled out in this section. In addition, because the U.S. SEC has the power to require certain information in the reports of publicly traded companies, we also discuss SEC interpretations of existing standards.

Category A. The first category consists of the highest level of authority as to what GAAP is, namely, Statements of Financial Accounting Standards (SFAS), Financial Accounting Standards Board Interpretations (FINs), Accounting Principles Board Opinions, and Accounting Research Bulletins (ARBs). SFAS and FINs are promulgated by the Financial Accounting Standards Board (FASB), an autonomous board established in 1973 as the primary source of accounting standards constituting GAAP. However, although the FASB is the supreme arbiter of financial accounting standards, it does not act in a vacuum. Before a SFAS or FIN becomes effective, it must be made available for public examination. The public and the accounting profession may then comment on the proposed standard or interpretation. The FASB then reconsiders the proposal in light of the comments. Often, the FASB modifies the proposed standard or interpretation as a result of the commentary process. Occasionally, a proposal is dropped altogether. Exhibit 1.

Prior to the creation of the FASB, the highest accounting standards body was the AICPA Accounting Principles Board, which promulgated accounting standards in the form of APB Opinions (APBs). Earlier still, the AICPA Committee on Accounting Procedure (CAP) was the highest accounting standards body. The CAP promulgated accounting standards in the form of CAP ARBs. If they have not been superseded by a more recent pronouncement, the pronouncements of each of these standard-setting bodies constitute the most authoritative sources of accounting principles. Therefore, if a SFAS, FIN, APB, or ARB is relevant to the issue, all the researcher need do is confirm that it has not been superseded.

Category B. The second tier of authorities consists of FASB Technical Bulletins (FTBs), AICPA Industry Audit and Accounting Guides, and AICPA Statements of Position (SOPs). FTBs are a lesser authority than SFAS and FINs because the bulletins are created by the FASB staff, not the board itself. Furthermore, FTBs are not subject to the same rigorous review and commentary process that is required for SFAS and FINs. The AICPA guides are created by committees or task forces of the AICPA, and SOPs are established by the AICPA Accounting Standards Executive Committee (AcSEC).

Category C. Consensus positions of FASB's Emerging Issues Task Force (EITF) and AcSEC practice bulletins constitute the third tier of accounting authorities. The EITF, the FASB's rapidresponse team, was formed in 1984 in response to a recommendation that the FASB provide financial reporting guidance that is more timely than SFAS can be. Unfettered by the notice and comment procedures applicable to the formal pronouncements by the FASB, the EITF can deal with accounting issues before they become widespread and before divergent practices become entrenched. For example, a little over a week after the 11 September 2001 terrorist attacks, the EITF met to discuss various issues relating to the treatment of the financial repercussions of the disaster. By 28 September, the EITF had reached a consensus, which was made public on 2 October 2001 on the FASB Web site ().

Category D. The fourth tier of accounting authority consists of AICPA Accounting Interpretations (AINs), FASB Staff Implementation Guides, and "practices that are widely recognized and prevalent either generally or in the industry" (AICPA 2000, p. 718). The fact that "widely recognized and prevalent" practices are in the fourth tier is significant. The obvious implication is that any of the sources in Categories A through C can alter such widespread, widely recognized practices. Presumably, AINs and FASB Staff Implementation Guides, being also in Category D, cannot. The fact that a SFAS trumps "widely recognized and prevalent" practices also underscores the point that the technical term "generally accepted" does not carry its usual meaning in the context of accounting rules. In lay terms, "widely recognized and prevalent" practices would be regarded as "generally accepted," but they are not GAAP in the technical sense if they conflict with a SFAS. If they were GAAP, the FASB, which is the ordained standardsetting body, would be merely recognizing rather than establishing standards.

Category E-Catchall. In the absence of other sources of established accounting principles (i.e., a source in one of the preceding categories), SAS No. 69 includes a catchall provision that embraces essentially all other written sources of accounting authority. The list includes FASB Statements of Financial Accounting Concepts (SFACs); AICPA Issues Papers; International Accounting Standards Committee Statements; Government Accounting Standards Board Statements, Interpretations, and Technical Bulletins; Federal Accounting Standards Advisory Board Statements, Interpretations, and Technical Bulletins; pronouncements of other professional associations or regulatory agencies; AICPA Technical Practice Aids; and accounting textbooks, handbooks, and articles.

It may seem odd that the SFACs are ranked at the bottom of the hierarchy. After all, SAS No. 69 provides that the appropriateness of other accounting literature depends on its relevance to particular circumstances, the specificity of the guidance, and the general recognition of the issuer or author as an authority. (AICPA 2000, p. 718)

The issuer of SFACs is the highest authority on accounting standards, so SAS No. 69 goes on to note that SFACs would normally be more influential than other sources in the catchall category. The concepts are ranked so low because of their very general nature and lack of specificity. They are so broad that they often conflict with one another.

SEC Prescriptions. Section 13b.1. of the Securities Exchange Act of 1934 provides that for the company reports it requires, the SEC

may prescribe, in regard to reports made pursuant to this title, the form or forms in which the required information shall be set forth, the items or details to be shown in the balance sheet and the earnings statement, and the methods to be followed in the preparation of reports, in the appraisal or valuation of assets and liabilities, in the determination of depreciation and depletion, in the differentiation of recurring and nonrecurring income, in the differentiation of investment and operating income....

Therefore, the SEC clearly has the power to establish accounting standards for publicly traded companies. Notwithstanding this authority, the SEC has historically deferred to accounting standards bodies in the private sector, such as the FASB. Exhibit 2.

Although the SEC has not exercised its authority to create standards, it does make its interpretations of existing standards known through three primary sources of guidance, which are summarized in Exhibit 2. Moreover, for publicly traded companies, the guidance from the SEC carries much greater weight than its ranking as a Category E authority in SAS No. 69 would suggest.

In the wake of Enron, the SEC has been under considerable pressure to broaden its role in the financial accounting arena. Recently, it announced its intention to form a Public Accountability Board to oversee the accounting profession and to restore the public's faith in the audited financial information provided by publicly traded companies. The SEC has reiterated its long-standing position that the private sector should develop accounting standards, but it has also indicated that it will take a greater interest in the process. In that vein, the SEC is actively prodding the FASB to speed up its rulemaking process and move toward principles-based accounting standards. Only time will tell whether this heightened interest by the SEC will endure after the Enron headlines have faded.

Where to Find GAAP

Unfortunately, no single source exists for the materials discussed in the previous section. Very recent pronouncements can often be found in the Journal of Accountancy, a monthly magazine published by the AICPA. The FASB also publishes some of its most recent pronouncements, such as EITF consensus reports, on its Web site. The FASB is protective of its materials, however; only summaries of the SFAS are available on the FASB Internet site. Most SFAS must be purchased from the FASB.

The availability of electronic and printed versions of various pieces of GAAP literature is summarized in the last two columns of Exhibit 1. The primary electronic resource for materials promulgated by the FASB is the Financial Accounting Research System (FARS), a system based on compact discs (FASB 2001b). FARS contains five information databases: Original Pronouncements, Current Text, EITF Abstracts, Implementation Guides, and a comprehensive Topical Index. Most of the same material is available also in printed form in the Annual Bound Editions of FASB Original Pronouncements and Current Text (FASB 2000). Collections of the original pronouncements and current text can also be purchased separately in loose-leaf form, and one can purchase individual original statements, but they cannot be downloaded from the Internet at this time. For more information on ordering these publications, see public/index.html.

The FARS Original Pronouncements information database contains the complete, original texts of SFAS, FINs, SFACs, APBs, and CAP ARBs. Therefore, all of the Category A authorities are included in the FARS. In addition, the FARS contains FASB Technical Bulletins (a Class B authority) and AICPA AINs (a Category D authority).

The FARS EITF Abstracts information database contains the Class C ET`Fs, and the Implementation Guides database contains the Class D FASB Staff Implementation Guides. The Current Text section is a useful compilation of the foregoing authorities by topic. In addition to the topical arrangement, the Current Text omits those portions of the original pronouncements that have been superseded.

Many AICPA materials are now available through a new service, reSOURCE, offered by the AICPA on CD-ROM or via a fee-based Internet version at . All of the Category B AICPA industry guides are provided by reSOURCE. The database also includes a compiled version of the Category B SOPs. Unfortunately, reSOURCE does not contain the SOPs in their original, full text. It does contain the Category C AcSEC Practice Bulletins and the AICPA's Technical Practice Aids, which are in Category E.

With respect to SEC pronouncements, only the more recent Staff Accounting Bulletins (SABs) can be found at the SEC Web site (). Most of the SEC materials are available, however, through Lexis-Nexis, a fee-based service that can be accessed on the Web at . For example, SEC Financial Reporting Releases (FRRs), SEC Accounting and Auditing Enforcement Releases (AAERs), and older SABs are available on Lexis-Nexis.

In addition to the foregoing sources, a number of specialized accounting databases are available for a fee. Examples include the Accounting Research Manager (at www2.arm.) and GAAP Compliance and FASB on Checkpoint (at estore/).

Conclusion

Recent accounting scandals have demonstrated that lack of understanding of the accounting rules that were applied to generate financial statements is dangerous. Accounting rules come from numerous sources, so it is understandable that nonaccountants have difficulty becoming fluent in-or even finding-the rules. Our intention was to clarify where the rules are and how their text can be accessed.

The accounting principles that constitute GAAP inhabit a prescribed hierarchy. Understanding the GAAP universe and how the various sources of authoritative guidance relate to each other can help a practitioner analyze a company's use of the rules. Through the resources we listed, analysts and other users of financial statements can find answers to their questions about accounting rules.

Stephen R. Moehrle is assistant professor of accounting at the University of Missouri, St. Louis. Jennifer A. Reynolds-Moehrle is assistant professor of accounting at the University of Missouri, St. Louis. Wilbur L. Tomlinson is an attorney with Armstrong Teasdale LLP in St. Louis, Missouri.

References:

AICPA. 2000. AICPA Professional Standards. New York: American Institute of Certified Public Accountants.

FASB. 2000. Annual Bound Editions of FASB Original Pronouncements and Current Text. New York: John Wiley & Sons. 2001a. Original Pronouncements. New York: John Wiley & Sons.

-. 2001b. Financial Accounting Research System. New York: John Wiley & Sons.

Ziebart, David A. 2002. Applied Professional Research for Accountants. 2nd ed. Upper Saddle River, NJ: Prentice-Hall.

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