I'm Larry Walther, this is principlesofaccounting.com, Chapter 15.
And in this module,
we're going to consider the development of generally accepted accounting principles.
Really a brief history into the development of generally accepted
accounting principles.
GAAP encompass the rules, practices, and
procedures that define the proper execution of accounting.
This includes specific rules of course, but it also includes
longstanding methodologies and assumptions that are inherent to accounting.
Currently, the Financial Accounting Standards Board is the primary
rule making body within the United States of America.
They've held that role since the early 1970s.
The FASB is a private sector body that's entrusted and in charge with
setting the specific accounting standards that govern the practice of accounting.
Prior to the FASB's existence,
the rules were set by the Accounting Principles Board.
They issued a number of opinions that constituted the rules base,
and some of which are still in existence today.
The Accounting Principles Board was created in the late 1950s by
the American Institute of CPAs.
The AICPA is essentially a club, it's a large association of professional
accountants who seek to advance the practice of accounting.
Before the late 1950s, the Committee on Accounting Procedure, which was also part
of the AICPA, was entrusted with drafting guidelines for accounting practice.
They issued a number of accounting research bulletins.
Over the many years, they evolved in terms of their relative weight of authority, so,
in their earliest formulative stage, they were essentially guide posts that over
time took on greater weight and credibility.
The International Accounting Standards Board is the global counter part to
the FASB.
Standards they develop are often referred to or
give the foundation to the International Financial Reporting Standards or IFRS.
The FASB and IASB are currently working toward a process of global harmony,
a convergence in accounting standards so
that perhaps one day there will only be one set of worldwide accounting standards.
We're clearly moving closer to that as time converges.
It's possible that FASB and
IASB may eventually themselves converge into a singe standard setting body.
The United States has a governmental organization that also has
significant oversight, the SEC.
It was created by the US Congress in the mid 1930s.
They administrated laws that regulate the reporting practices of
companies with publicly traded stocks.
They also regulate the securities markets themselves.
US companies must register and report to the SEC on a continuing basis.
There's also an audit function.
Financial reports of public companies are required to be audited
by independent CPAs.
Auditors evaluate the systems and
data that lead to the reported financial statements.
The auditor usually issues an opinion on the fairness of financial reports.
Here's an example of part of an opinion.
In our opinion, the financial statements present fairly, in all material respects,
the financial position of the company as of certain dates given,
and the results of operations in cash flows for
each of the three years of the period ending, in this case 20X3.
In conformity with US generally accepted accounting principles.
So importantly, what the auditor does is issues an opinion that the financial
reports comply with generally accepted accounting principles thereby presenting
fairly the results of operations and financial position of the firm.
Conformity with GAAP is the key.
Fraud detection is important but
it's secondary to reporting on the fairness of financial statements.
There is another act, the Sarbanes-Oxley Act, or
SOX, that was established by Congress in 2002.
It followed some significant frauds of the day, some significant
financial failures that occurred in the early 2000s and Congress intervened.
It imposed stringent financial statement certification requirements on corporate
officers.
So now CEOs and CFOs of companies need to certify under penalties of perjury,
which could potentially involve jail time, that the financial statements are fair.
This raised the corporate fiduciary duty of boards of directors.
It forced systematic awareness of ethical standards.
It requires public companies to implement a robust system of internal controls.
This is refered to often times as Section 404,
a significant section of the Sarbanes-Oxley Act.
And an independent auditor, must now also issue a separate report,
I haven't produced it here, but in addition to the audit option,
there's a separate report on the effectiveness of this control system.
So it's significantly increased the importance of a company's control system,
the ability to attest to its existence.
It also created a Public Accounting Oversight Board or PCAOB.
This is a private sector, non-profit corporation that oversees
the auditors of public companies and poses peer review requirements among firms.
And a number of other obligations that are imposed on audit firms to try to
protect the integrity of the process and ensure
that rules are indeed being followed in the audit process and reporting process.