Recently, the FASB completed the first phase of its project on business combinations, which eliminated pooling-of-interests accounting, enhanced disclosure requirements relating to goodwill and intangible assets and moved towards international convergence.
The FASB took up this project, which was very controversial at the time, and promulgated a standard that not only improved financial reporting by requiring companies to account for their non-pension postretirement benefits on an accrual rather than a cash basis, but also served to increase corporate awareness of the underlying economics surrounding such postretirement benefits. Recently, in an effort to speed up the standard setting process, the FASB has initiated a reorganization of its staff.
The primary change is one that divides the Technical Director position into three separate positions, all reporting to the Chairman. Additionally, the FAF has recently appointed a new FASB chairman, effective July 1, and has instructed him to review, between now and the end of the year, the structure and procedures of the FASB, and to make recommendations to improve efficiency and timeliness. Previously, a supermajority of the seven-member board was required.
Critics of the supermajority requirement have commented that the need for five votes has resulted in a lack of accounting guidance in certain controversial or complex areas, as the FASB was unable to gather a sufficient number of votes. In addition, critics also comment that in an effort to obtain five votes, the FASB has compromised on certain aspects of a standard.
We are encouraged by these recent actions and hope that they will lead to more timely and improved guidance. In this day and age, one cannot talk about standard setting in the United States without discussing international convergence. On the international front, capital markets of the world are increasingly interdependent while technology is making borders disappear.
This trend has been accelerated by the European Commission's proposed regulation that would generally require all listed EU companies to apply international accounting standards for their consolidated financial statements. In light of this, there is a critical need to focus on the convergence of U. GAAP and international accounting standards. While convergence can have a variety of different meanings, it has generally assumed that, ultimately, all standard setters should agree on a single, high-quality accounting answer.
In the long-term, this definition of convergence is a laudable one to which all should aspire. However, there is an immeasurable need for the FASB and the International Accounting Standards Board, or IASB, to converge the high-level principles in their standards in the short-term, rather than the long-term, and so, much more needs to be done.
Now I would like to briefly address another critical and related part of the financial reporting process, which is the oversight of the accounting profession. Auditing is a critical component in the financial reporting process. It provides credibility to the financial statements and comfort to investors.
Accordingly, the Commission is exploring ways to strengthen the system of overseeing the work of the accountants that perform audits of public companies. This oversight is not presently, nor is it contemplated to be, under the umbrella of the FASB.
The oversight or "peer-review" system that has been used in the U. As a result, the Commission expects to soon make a proposal for a different system. The PAB would direct periodic reviews of accounting firms' quality controls for their accounting and auditing practices and also would discipline auditors for incompetent and unethical conduct.
There are several important aspects of the PAB that I want to mention. First, our proposal would call for the PAB to work as a complement to the enforcement efforts of the Commission and focus on ethical and competence requirements rather than existing statutory and regulatory requirements. We have seen success of such a two-tier system of regulation, specifically within the securities industry. The proposed system is aptly designed to handle behavior that is unethical or incompetent. Second, the PAB would be an organization that is dominated by members that are unaffiliated with the accounting profession.
Because there is a public benefit to having some expertise of the accounting profession, the PAB should have a minority of representation from that industry. Lastly, the source of funding of the PAB is one that must be secure and independent. Our proposal would include a system where involuntary fees would be imposed upon those who benefit from financial statements audits, whose quality would be overseen by the PAB.
Concepts Statements guide the Board in developing sound accounting principles and provide the Board and its constituents with an understanding of the appropriate content and inherent limitations of financial reporting. A Statement of Financial Accounting Concepts does not establish generally accepted accounting standards.
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Investopedia does not include all offers available in the marketplace. Related Articles. Financial Analysis Pro Forma Statements vs. Accounting IFRS vs. Partner Links. The calculation and purpose of book income in financial reporting and how it differs from taxable income. What Are Accounting Principles? Accounting principles are the rules and guidelines that companies must follow when reporting financial data. Accounting Standard Definition An accounting standard is a common set of principles, standards, and procedures that define the basis of financial accounting policies and practices.
The auditor is engaged to give an unbiased professional opinion on whether the financial statements and related disclosures are fairly stated in all material 26 respects for a given period of time in accordance with GAAP. As a consequence of financial accounting fraud in the early s, Congress passed the Sarbanes-Oxley Act of SOX was amended by the Dodd-Frank Act, 29 which established funding for the PCAOB's activities, primarily through the annual accounting support fees assessed on public companies and other issuers, as well as brokers and dealers registered with the SEC.
The different types of audit opinions an auditor may issue are discussed next, followed by a discussion of internal control integrated frameworks.
Auditors form audit opinions by examining the types of risks an organization might face and the types of controls that exist to mitigate those risks. Once the risks and controls to mitigate those risks have been determined, the auditors will examine the supporting evidence and determine if management is presenting the financial statements fairly in all material respects. There are four different types of audit opinions an auditor may express: Independent audit opinions do not fully guarantee the financial statements are presented fairly in all material respects for the following key reasons:.
Thus, the auditor provides only a reasonable assurance about whether the financial statements are free of material misstatement. Section of SOX requires management at public companies to select an internal control framework and then assess and report annually on the design and operating effectiveness of their internal controls. A requirement of SOX was for the SEC to create rules that would require public companies' annual reports to contain 1 a statement of management's responsibility for establishing and maintaining an adequate internal control structure and procedures; and 2 management's assessment of the internal control structure and procedures for financial reporting.
Under SEC's final rules, annual reports on internal control are required to contain. Internal control helps entities achieve important objectives and sustain and improve performance.
Entities, whether private or public, use internal controls as a means to achieve the objectives of the organization by designing processes that control the risk of the organization. An effective internal control framework requires an entity's management and board of directors to use judgment that is dynamic, integrated, and responsive to the needs of the company, 37 rather than rigidly adhere to past policies and procedures. A COSO framework, depicted in Figure 3 , was created to help practitioners assess internal controls not as an isolated issue, but rather as an integrated framework for how internal controls work together across an organization to help achieve the objectives as determined by management.
The cube represents the integrated perspective recommended by COSO for practitioners who are creating and assessing internal controls. The cube may be best understood by examining each set of components separately. The three objectives—Operations, Reporting, and Compliance—are represented by the columns. The objectives are designed to help an organization focus on different aspects of internal control to help management achieve its objectives.
The components represent what is required to achieve the three objectives. An entity's organizational structure—Entity-Level, Division, Operating Unit, and Function—is represented by the third dimension. For an organization to achieve its objectives, according to COSO, internal control must be effective and integrated across all organization levels. Figure 3. COSO Framework. Taxpayers want the government to use their economic resources effectively and efficiently. There is also considerable debate as to whether the current generation of citizens should shift the costs for the benefits derived in the near term to future taxpayers i.
Thus, periodically assessing if the government's financial position has improved or deteriorated is important not only from an economic perspective but also because it has social and political implications. The financial statements of the U. The financial statements report the U. The U. The Financial Report of the United States Government , issued by the Department of the Treasury, serves the same basic purpose as the annual report issued by a publicly traded company to its investors.
Although the underlying accounting and auditing concepts in the federal government closely follow those in the private sector, the expected outcomes are different. Thus, financial reporting and auditing standards in the federal government have a different focus than in the private sector.
The standard-setting body for federal auditing standards is the GAO. Figure 4. Stakeholders in the Federal Government. Budget ary Integrity. Federal financial reporting should assist the government in being accountable in its tax expenditures. Federal financial reporting should thus provide information that helps stakeholders determine.
Operating Performance. Federal financial reporting should provide information for evaluating the services, efforts, costs, and accomplishments of the government. Federal financial reporting should provide information that helps stakeholders determine. Federal financial reporting should help in the assessment of the government's operations and investments for the given period and how, as a result, the government's and the nation's financial condition has changed and may change in the future.
Federal financial reporting should provide information that helps to determine whether. Systems and Control. Federal financial reporting should assist stakeholders in determining whether financial management systems and internal accounting and administrative controls are adequate to ensure that. The financial statements of federal agencies and the U.
GAO is an independent, nonpartisan agency of Congress. GAO's mission is to support Congress in meeting its constitutional responsibilities and to help improve the performance and ensure the accountability of the federal government for the benefit of taxpayers. Some audit organizations within the federal government use a hybrid method of external and internal auditors.
Whether external or internal auditors perform the function, they are required to adhere to the standards established under GAGAS. The Yellow Book requires auditors to consider the visibility and sensitivity of government programs in determining the materiality threshold: Additional considerations may apply to GAGAS financial audits of government entities or entities that receive government awards.
For example, in audits performed in accordance with GAGAS, auditors may find it appropriate to use lower materiality levels as compared with the materiality levels used in non-GAGAS audits because of the public accountability of government entities and entities receiving government funding, various legal and regulatory requirements, and the visibility and sensitivity of government programs.
The Yellow Book further notes that audits performed in accordance with GAGAS can lead to improved government management through better decisionmaking and oversight, effective and efficient operations, and accountability and transparency for resources and results.
Similar to the requirements in the private sector, GAGAS requires federal financial reporting to disclose compliance with laws, regulations, contracts, and grant agreements that have a material effect on the entities' financial statements.
Whether from academia or other nonprofits that promote specific auditing techniques or guidance, over time practitioners adopt and incorporate best practices from various entities as part of the required audit practice. In addition to the Yellow Book 53 issued by the GAO, there are other standards or guidance promulgated by different organizations that influence the auditing standards of the federal government, including Similar to the expectations of the federal government, state and local taxpayers expect their respective governments to provide taxpayers and the legislature a comprehensive view of how the government is managing its resources.
The Comprehensive Annual Financial Report CAFR issued by each state or local jurisdiction serves the same purpose as the annual report issued by a publicly traded company to its investors. Those financial statements and annual reports are a means of communicating such information to multiple stakeholders see Figure 5. Figure 5. Stakeholders in the State or Local Governments. Because the Constitution limits the power of the federal government on matters that are within the jurisdiction of states, each state or territory has flexibility to choose the accounting and auditing standards that suit its needs.
There is also significant overlap with private-sector accounting and auditing concepts, but the expected outcomes are different. Thus, financial reporting and auditing standards for state and local governments have a different focus than in the private sector and are more closely aligned with the federal government's objectives. While publicly traded companies are required by the SEC to follow the accounting standards created by FASB, state and municipal governments are not required to follow accounting standards promulgated by GASB.
Generally, unless a local government is a recipient of federal funds through grants or shared revenue, it is not required to follow accounting or auditing standards that are applicable to the federal government. A higher-level government such as a state or a county can require all subordinate municipalities or tax authorities to follow GASB accounting standards. States and municipalities can adopt GASB accounting standards without any changes, choose not to adopt a specific standard, or modify a standard to meet their specific needs.
Not adopting or changing an accounting standard might allow the entity to report a more positive outcome, especially when revising an accounting standard leads to an economic prediction that is worse than the projection under the previously used standard.
According to a GASB study, there were 87, nonfederal government entities states and local governments and other government-created entities, such as utilities, water districts, and hospital authorities in Twenty-eight states require some or all of their counties to follow GAAP.
Thirty-six states have laws or regulations that require at least some of their political subdivisions to follow GAAP. Thirty-four states require some or all school districts to follow GAAP.
The study also noted that in some states, certain local jurisdictions are required to conform to GAAP, but they do not actually do so, and either no enforcement mechanism is available, or conformance is not enforced. In other words, broker-dealers that transacted state and municipal securities pay the accounting support fees for GASB. Section of the Dodd-Frank Act requires the SEC to collect the support fees from a national securities association that is registered under the Securities Exchange Act of The remainder of the expenses was paid through other revenue sources, such as sales of publications, or through subsidies from the Financial Accounting Foundation's FAF's excess reserve funds.
According to GASB, financial reporting plays a major role in holding the government accountable to the taxpayer—based on a belief that taxpayers have the right to know how the government is using its resources. GASB identifies three major objectives associated with publicly sharing financial information, and it recommends:.
Financial reporting should assist in fulfilling government's duty to be publicly accountable and should enable stakeholders to assess that accountability by. Evaluation by the Public. Financial reporting should assist stakeholders in evaluating the operating results of the governmental entity for the year by.
Current and Future Focus. Financial reporting should assist stakeholders in assessing the level of services that can be provided by the governmental entity and its ability to meet its obligations as they come due by. State and local governments seek to meet these objectives through issuing CAFR. The below text box explains the structure and contents of a CAFR. A Comprehensive Annual Financial Report is a detailed presentation of a state's or a municipality's financial condition.
Each of the three major sections—introductory, financial, and statistical—has subsections. This text box discusses some of the significant subsections. Introductory Section. The introductory section includes basic information about the reporting entity. Elements of the introductory section include the cover, title page, table of contents, list of principal officials, organization chart, and letter of transmittal.
If the entity received the Government Finance Officers Association's certificate of achievement for financial reporting, then the certificate will also be included. The letter of transmittal is considered the most important element of the introductory section. It is expected to address the accounting standards followed by the entity; provide a profile of the government; explain the local economy and long-range planning for the jurisdiction; and include the auditor's report.
Financial Section. The financial section includes the independent auditor's report, management's discussion and analysis, basic financial statements for the reporting entity and other significant subcomponents, required supplementary information RSI , combined financial statements, and individual fund statements.
RSI might focus on the funding progress of employees' pension plans and other postemployment benefit plans. Combined and individual fund financial statements and schedules present information on funds for which the reporting entity either has custodial or oversight responsibility.
Statistical Section. The statistical section typically provides stakeholders with historical perspective, context, detail, associated notes, and required supplementary information to understand and assess a government's economic condition. The statistical section is presented in five categories—financial trends information, revenue capacity information, debt capacity information, demographic and economic information, and operating information.
State and municipal government audits are conducted by either an elected or appointed auditor. Elected auditors conduct their work at all levels of government, from states to cities and towns. Appointed auditors are often appointed by the legislature or by the chief executive of the respective municipal organization with the consent of the legislature. While states or municipalities may have differences in their financial reporting and audit needs, the unifying theme of government accountability to its citizens creates more commonality than differences.
As an example, states such as California 70 and Florida 71 either utilize GAGAS for all state audits or tailor the standards to comply with state statute. In addition to states and local governments utilizing the Yellow Book issued by the GAO, there are other organizations that influence the auditing standards for state and municipal governments. The first is the relationship between accounting and auditing standards in the United States and other countries—in particular, whether or to what degree international accounting and auditing standards should influence U.
GAAS, respectively. The second is the newly emerging sustainability accounting standards for businesses, which encompass environmental, social, and governance ESG issues. Both of these policy issues are discussed in greater detail below. Figure 6 provides an overview of international accounting and auditing standard-setters and for sustainability accounting and auditing. Figure 6. International and Sustainability Standard-Setters. Capital markets are global.
Investors in the United States invest in foreign firms, and investors from other parts of the world invest in U.
Investors in the United States and elsewhere rely on financial statements to make informed decisions. The earlier discussion about financial statements as a means of communication with various private-sector stakeholders see Figure 2 is also applicable to international accounting and auditing standards.
Similar to how each state or municipality has discretion to either adopt or modify the accounting standards created by GASB, each country has discretion to either adopt or modify international accounting or auditing standards.
The EU also accepts U. A counterpart to U. This section of the report provides an overview of international accounting and auditing standards and discusses some policy issues that might be of interest to Congress and investors.
IFRS and U. GAAP fundamentally differ in their approach to creating accounting standards, but they share similar objectives of creating accounting and financial reporting standards that will facilitate efficient capital markets. IFRS is a principles-based accounting standard that provides broad, flexible guidelines that can be applied to a range of situations, but they can lead to inconsistent interpretation and application. Countries with lower levels of gross domestic product or less-developed economies can realize savings by working with other countries to develop accounting standards that they can tailor to suit their jurisdictional needs.
GAAP is generally understood to be a rules-based accounting standard that is less subject to interpretation. GAAP has evolved over 80 years within the U. GAAP require specific guidelines to be followed, but they may not address unforeseen issues that may arise in the normal course of business. GAAP may not be known until after it has weathered significant scrutiny from practitioners and the judicial system. Despite the differences, accounting and auditing regulators in the United States and international regulators at times try to coordinate on specific standards.
It was created to establish basic global accounting standards in response to increased economic integration and cross-border capital transactions. Since , more than countries in varying degrees have either adopted or converged with IFRS.
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