Process of Setting Accounting Standard in UK and USA

In this article we will discuss about the process of setting accounting standard in UK and USA.

Setting Accounting Standard in United Kingdom:

The first substantial British interest in the area of accounting policy making seems to have been seen in the 1940s. The underlying cause of this concern was discontent with the accounting establishment.

The first committee of the Institute of Chartered Accountants of England and Wales (ICAEW) charged with laying down guidelines concerning accounting practice emerged as a by-product of a compromise which allowed Council to continue to be composed of mainly practicing members.

However, up to 1960, there was little concern with the process of accounting policy making. There was some evidence of fresh thinking in the 1960s and a research committee was formed in 1964.

The strong concern was felt by many academic accountants who suggested research programmes to explore the possibility of setting accounting standards. All these (and other) pressures led the ICAEW to issue a Statement of Intent on Accounting Standards in the 1970s. Subsequently, the Accounting Standards Committee (ASC) was established in 1970.

The ASC has been replaced by Accounting Standards Board (ASB) in 1990.

In establishing the ASC, the ICAEW stated its intention to advance accounting standards along five lines as follows:

(1) Narrowing the areas of difference and variety of accounting practice. This was to be achieved by publishing authoritative statements on best accounting practice.

(2) Disclosure of accounting bases. This was to be required when accounts include significant items whose values depend upon judgement.

(3) Disclosure of departures from established definitive accounting standards.

(4) Wider exposure for major proposals on accounting standards.

(5) Continuing programme for encouraging improved accounting standards in legal and regulatory measures.

In seeking to meet its terms of reference the ASC set Statement of Standard Accounting Practices (SSAPs) by a process which entailed effectively four elements research; drafting; evaluation; and approval. Similar characteristics determined the preparation of another type of document which was introduced by the ASC, the Statement of Recommended Practice (SORP).

SORPs were designed to apply to matters of less general applicability than SSAPs and could be produced by the ASC itself or by groups of organizations representing an economic sector. In the case of latter, if SORPs were judged to have been properly prepared, they would be franked by the ASC.

Following a continuing concern that the standard setting process needed a thorough revision, the accounting bodies in 1987 set up a review committee, named after its chairman, Sir Ron Dearing, to review procedures for developing and enforcing accounting standards in Great Britain and Ireland.

The Dearing Report recommended the establishment of a new body, the Financial Reporting Council (FRC). This was to oversee two independent entities, the Accounting Standards Board (ASB) and the Review Panel. These recommendations were accepted and implemented, with effect from August 1990.

The FRC, comprising 20 members, gives guidance to the ASB on priorities, work programme and issues of public concern, and acts as an instrument for promoting good accounting practice. The ASB comprises nine members including a full-time chairman and technical director. An Urgent Issues Task Force (UITF) is an offshoot of the ASB. Its role is to tackle urgent matters not covered by existing standards.

The Review Panel has fifteen members. It is concerned with monitoring the accounts of large companies to note and investigate any departure from accounting standards. In the last resort, the Review Panel may bring civil proceedings against a company which will not revise its accounts in order to give a true and fair view.

In 1991, the ASB published its “Statement of Aims” which stated that it aims to establish and improve standards of financial accounting and reporting, for the benefit of users, preparers and auditors of financial information.

The Board intends to achieve its aims by:

(1) Developing principles to guide it in establishing standards and to provide a framework within which others can exercise judgement in resolving accounting issues.

(2) Issuing new accounting standards, or amending existing ones, in response to evolving business practices, new economic developments and deficiencies being identified in current practice.

(3) Addressing urgent issues promptly.

The Board follows certain guidelines in conducting its affairs:

(1) To be objective and to ensure that the information resulting from the application of accounting standards faithfully represents the underlying commercial activity. Such information should be neutral in the sense that it is free from any form of bias intended to influence users in a particular direction and should not be designed to favour any group of users or preparers.

(2) To ensure that accounting standards are clearly expressed and supported by a reasoned analysis of the issues.

(3) To determine what should be incorporated in accounting standards based on research, public consultation and careful deliberations about the usefulness of the resulting information.

(4) To ensure that a process of regular communication of accounting standards is produced with due regard to international developments.

(5) To ensure that there is consistency both from one accounting standard to another and between accounting standards and company law.

(6) To issue accounting standards only when the expected benefits exceed the perceived costs. The Board recognizes that reliable cost/benefit calculations are seldom possible. However, it will always assess the need for standards in terms of the significance and extent of the problem being addressed and will choose the standard which appears to be most effective in cost/benefit terms.

(7) To take account of the desire of the financial community for evolutionary rather than revolutionary change in the reporting process, where this is consistent with the objective outlined above.

In 1983, the Accounting Standards Committee (ASC) obtained a written opinion from counsel on the meaning of true and fair with particular reference to the role of accounting standards. The opinion states that financial statements will not be true and fair unless the information they contain is sufficient in quantity and quality to satisfy the reasonable expectations of the readers to whom they are addressed.

But the expectations of the readers are likely to be influenced by the practices of accountants because, by and large, they will expect to get what they ordinarily get and that, in turn, will depend upon (he normal practices of accountants. Therefore, the compliance with accepted accounting principles is treated as prima facie evidence that the financial statements are true and fair.

The opinion states that since the function of the ASC is to formulate what it considers should be generally accepted accounting principles, the value of a Statement of Standard Accounting Practice (SSAP) to a court is:

(а) A statement of professional opinion which readers may expect in financial statements which are true and fair.

(b) That readers expect financial statements to comply with standards.

The opinion concludes, therefore, that financial statements which depart from standards may be held not to be true and fair, unless a strong body of professional opinion opts out of applying the standard.

The Companies Act, 1989 introduced a requirement to state whether the accounts have been prepared in accordance with applicable accounting standards and give details of, and the reasons for, any material departures.

Statement of Standard Accounting Practices (SSAPs), which are produced mainly by a committee after a period of exposure and comment on the proposed statements, are mandatory for all qualified accountants involved in producing company financial statements.

Such accountants (preparers) must ensure that stated standards are implemented by the companies by whom they are employed, unless circumstances dictate that there should be a departure; in which case, this has to be fully disclosed in the published financial statements. Company auditors are also required to verify that companies have been following standard accounting practices and to report any disagreement with the departures made.

Despite these impositions on accountants, however, Statements of Standard Accounting Practices (SSAPs) are not mandatory on the persons ultimately responsible for the production and quality of financial statements (company directors), unless they also happen to be accountants to whom the statements apply.

Thus it appears to be quite conceivable that company managements can deviate from the stated accounting standards, irrespective of the circumstances, though this will require to be verified by their auditors. In other words, professional statements of this kind do not appear to have the same force as those contained in statutory provisions such as the Companies Acts.

The onus for implementation appears to be largely with individual accountants. However, Part II Schedule and Companies Act, 1948 and Companies Acts of 1980 and 1981, contain most of the main accounting principles underlying the present series of SSAPs. Also, SSAPs intended to add to truth and fairness are effectively to be considered by the company and its management when preparing its financial statements.

Thus, those persons responsible for presenting company financial statements cannot ignore such SSAPs. But the ASB, whose authority is not backed by a government agency like SEC in USA, has to rely on acceptance of its pronouncements on the existence of a consensus of views among practicing accountants, industry, commerce, and on occasion, the government.

UK accounting standards always indicate, in an appendix, whether or not they are consistent with IASB standards. Companies which apply UK standards are therefore to a considerable extent applying IASs implicitly but seldom acknowledge that fact in their annual reports.

The ASB has identified three different strategies for reacting to the mounting pressure for harmonization:

i. Adopt international standards for domestic purposes

ii. Develop domestic requirements without regard to international standards, or

iii. Harmonize national requirements with international standards where possible.

Analysis of benefits and limitations led the ASB to support the third strategy. The Board has taken the view that it will depart from international consensus only when:

i. There are particular legal or fiscal problems which dictate such a cause, or

ii. The Board genuinely believes that the international approach is wrong and that an independent UK standard might point the way to an eventual improvement in international practice.

Setting Accounting Standard in USA:

In USA until the early 1930’s, accounting evolved in accordance with the best professional judgment of CPAs and managers. Heavy dependence was placed on the leadership of thoughtful practitioners. Then, the Securities and Exchange Commission (SEC) was created in 1934 to administer the Securities Act of 1933 and the Securities Exchange Act of 1934.

The Commission is given the responsibility and authority to prescribe accounting standards and rules for reports filed pursuant to the securities acts. Further, the Commission defines the conditions under which public accountants who attest to the statements are considered independent, and disciplines attesting accountants who violate these conditions.

In 1936, the American Institute of Certified Public Accountants (AICPA) established a Committee on Accounting Procedure. The AICPA devoted its attention almost entirely to resolving specific accounting problems and topics rather than developing general accounting principles.

The Accounting Principles Board (APB) succeeded the Committee on Accounting Procedure of AICPA in 1959. The APB was created partially in response to criticism of the old Committee as being too concerned with putting out bush fires, as being too wedded to an ad hoc approach that lacked an overall conceptual framework.

In contrast, the APB pronouncements were supposed to sprout from fundamental research that would formulate a grand set of tightly integrated, internally consistent accounting principles. Indeed, the APB commissioned such research, but the APB’s series of 31 opinions was often criticised for being unrelated to any overall framework.

Despite the good intention of the APB programme, history repeated itself. The APB approach was similar to the piecemeal approach of its predecessor. In fact, the Wheat Study Group that gave the APB the kiss of death devoted a section of its report to a negative appraisal of the APB research Programme.

Of course, this kind of criticism of the APB flowed from many other sources. For instance, the academic community and many practitioners flayed the APB because it was working without any accounting objectives or any collection of general principles. In short, observers alleged that there was not enough tidy rationality embedded in the process of accounting policy making.

As a result of the criticism of the Accounting Principles Board, the Financial Accounting Standards Board was set up in 1972 as a designated organisation in the private sector for establishing standards of financial accounting and reporting in U.S.

Financial Accounting Standards Board (FASB):

In October 1985, the FASB issued a statement of what is conceived to be its mission:

“To establish and improve standards of financial accounting and reporting for the guidance and education of the public including issuers, auditors and users of financial information.”

The statement further says that the Board seeks to accomplish its mission by the following measures:

(1) Improving the usefulness of financial reporting by focusing on certain primary characteristics (relevance, reliability, comparability, and consistency).

(2) Keeping standards up to date.

(3) Considering areas of financial reporting that need improvement.

(4) Improving the general understanding of financial reporting, its nature, and its purposes.

In pursuing these aims, the Board says that it follows the following precepts:

(1) To be objective in its decision making and preserve neutrality in the information that results from its standards.

(2) To weigh the views of its constituents but ultimately to rely on its own judgment.

(3) To issue standards only when benefits are expected to exceed costs

(4) To minimise disruption when making needed changes.

(5) To review past decisions and to make changes when necessary.

Before the FASB promulgates a major standard, it is required by its rules to follow extensive ‘due process’ procedures that gives those concerned with the subject-matter of the standard plenty of opportunity to influence the outcome of the Board’s deliberations.

In connection with each of its major standards, the Board:

(a) Appoints a task force of technical experts representing a broad spectrum of preparers, auditors and users of financial information to advise on the project.

(b) Studies existing literature on the subject and conducts such additional research as may be necessary.

(c) Publishes a comprehensive discussion of issues and possible solutions as a basis for public comment.

(d) Conducts a public hearing.

(e) After the results of the public hearing and other responses have been analysed by the Board’s staff and have been considered by the Board, an exposure draft of a proposed standard is issued for the public comment and 90 to 120 days are allowed for comment. If the comments indicate that substantial revisions of the exposure draft are necessary, a second exposure draft may be issued, with further time allowed for public comment.

The end product of the above elaborate and costly procedure is the promulgation of a statement of financial accounting standards (SFAS). Besides the formal statement, the Board also issues, Statements of Concepts, Interpretations, and Technical Bulletins. Statements of Standard establish new standards or amend those previously issued.

Statements of Concepts do not establish new standards or require any change in application of existing accounting principles. They establish new general concepts that will be used to guide the development of standards, and to provide guidance in solving problems.

Because of their long range importance, Statements of Concepts are developed under the same extensive ‘due process’ the FASB must follow in developing Statements of Financial Accounting Standards on major topics. Interpretations clarify, explain or elaborate on existing standards.

Since 1979, the Board’s staff has been authorised to issue technical bulletins giving guidance on the interpretation of a standard. These (bulletins) have to be reviewed by the Board members before they are issued, but they are not pronouncements by the Board. The Board has carried out many research projects also.

Enforcement of Standards:

The FASB itself, as a private rule making agency, has neither enforcement powers, nor the Financial Accounting Foundation. The force behind the FASB, standards comes from two other bodies, the SEC and the AICPA. A few months after the establishment of the FASB in 1973, the SEC issued ASR 150, and it is from that release that the FASB derives most of its authority.

ASR 150 stated that “for purposes of this policy, principles, standards and practices promulgated by the FASB in its statements and interpretations will be considered by the Commission as having substantial authoritative support, and those contrary to such FASB promulgations will be considered to have no such support.”

More recently, in ASR 280 (September 1980), the SEC reaffirmed its intention to rely on the FASB “for leadership in establishing financial accounting and reporting standards,” while recognising that “there is, of course, always the possibility that the Commission (SEC) may conclude it cannot accept the FASB standard in a particular area but such events have been rare.”

Similarly, FASB derives authority from the Rules 203 and 204 of the Rules of Conduct of the AICPA’s Code of Professional Ethics. Rule 203 places a duty on auditors to report on departures from FASB standards in financial statements audited by them.

An Interpretation of Rule 203 states categorically that rule “relates solely to the provisions of Statements of Financial Accounting Standards (SFASs) which establishes accounting principles with respect to basic financial statements (balance sheets, statements of income, statement of changes in retained earnings, disclosure of changes in other categories of stockholders equity, statements of changes in financial position, and descriptions of accounting policies and related notes).”

SFASs that stipulate that certain information should be disclosed outside the basic financial statements are not covered by Rule 203. However, Rule 204 gives authority to pronouncements of the FASB on such matters.

The SEC has statutory authority to establish financial accounting and reporting standards for publicly held companies under the Securities Exchange Act of 1934. Throughout its history, however, the Commission’s policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfil the responsibility in the public interest.

Since its inception, the approach of the Commission has been to delegate its authority, import, to the private accounting profession to determine—subject to its oversight—the proper disclosure and measurement rules. The Commission’s hesitation probably stems from its realisation that the costs potentially incurred would exceed the benefits to it as an agency.

The costs include disagreements among the constitutions {e.g., accountants, auditors, investors, financial analysts, brokers, companies, press, government, legislators) as to which standards apply. The commission perhaps also realizes that general content standards that imply economic measurements are open to potential criticisms.

While the Commission (SEC) has steadfastly maintained its general policy of reliance on the accounting profession for accounting standard setting, it has nevertheless not adopted a totally passive role. It has established presentation standards and a very large number of specific rules that attempt to govern almost every situation that has come to its attention.

Thus, companies and public accountants are faced with the expense of learning and following these regulations’ while it is doubtful that users have achieved much in the way of benefit.

Benston stated that “The USA’s experience with the SEC leads me to conclude that it is not likely that such an agency will or even can determine the optimal set of information to be disclosed or ‘the best’ accounting standards to be followed. To the contrary, the agency has incentives to add considerable costs and few benefits to the disclosure process, and tends to do so.”

Recently, a survey made about the attitudes towards the US Financial Accounting Standards Board shows that most of the financial community thought it produced too many standards, stressed technically correct solutions at the expense of practicability, did not consider significant areas of deficiency which could be improved by standard setting quickly enough and was not sufficient by responsive to the needs of small business.

However, the survey also showed that over the last five years awareness and positiveness about FASB, its work and overall performance have increased. FASB statements were seen as effective since they improved generally accepted accounting principle and dealt with the right issues.