Critically evaluate the current accounting standard-setting process and identify its strengths and weaknesses. Synthesize and summarize conflicting points of view about a controversial t

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The politics of establishing accounting standards Armstrong, Marshall S Journal of Accountancy (pre-1986); Feb 1977; 143, 000002; ProQuest pg. 76

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The marketing of accounting standards Horngren, Charles T Journal of Accountancy (pre-1986); Oct 1973; 136, 000004; ProQuest pg. 61

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Accounting Standards: Conceptual or Political? Wyatt, Arthur Accounting Horizons; Sep 1990; 4, 3; Accounting, Tax & Banking Collection pg. 83

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STATEMENTS IN QUOTES

How to keep politics out of standard setting: making private sector rule-making work

On June 9, 1978, Donald J. Kirk, chairman of the Financial Ac- counting Standards Board, ad- dressed the finance and accounting division of the American Petro- leum Institute, a trade group.* He chose as his topic one of the timeliest in the profession today— the accounting standard-setting process. We present here an adaptation of Kirk's speech.

In the long run, the solution to a particular technical problem must be seen as part of a process. What is important is whether the meth- od of reaching a decision on a particular problem contributes to the development of a sound pro- cess for standard setting.

Taking that long-run view, I would like to share with you some of my thoughts on the process of establishing accounting standards, some of the challenges facing the private sector's effort, and I will highlight what I believe to be some of the more essential ingredients that must be present if a private sector effort is to succeed.

Serving as a member of the Fi- nancial Accounting Standards Board over the last five years has been not only a rewarding en- deavor but a frustrating one as well.

It has been rewarding in the

•Tbe Financial Accounting Standards Board, as a matter of policy, disclaims responsibility for any publication or speech by any of its members of staff. Accordingly, any views so expressed are those of the author or the speaker and do not necessarily refleet the views of the board or the American Institute of CPAs or the Journal of Accountancy.

sense that I have had the opportu- nity to see close up what I believe to be significant progress on the part of the private sector to im- prove the quality of financial ac- counting and reporting and to improve the process by which fi- nancial accounting standards are established.

But the experience has also been frustrating because at times I get the impression that we are in the business of producing a product nobody wants. Nevertheless, the process always involves coping with strong and often confiicting opinions and ideas as to what that product should be. Tn any case, I think we all must proceed from a realistic assumption that the product—accounting s tandards- will continue to be produced.

The only questions are n Who should establish the stand- ards? n Through what sort of process should they be developed?

I will pass by the first question quickly, not because of limited time, but because I trust you agree with me that the answer is clear— standards should be set in the pri- vate sector. The answer to what type of process is not so clear.

The process presently followed by the FASB is still quite close to the one that was originally sug- gested by the Study on Establish- ment of Accounting Principles (the Wheat committee) in 1972. However, the structure committee of the trustees that oversees the FASB recommended, in a 1977 report, that more consideration should be given to the question of the nature of standard setting. That committee concluded that ". . . it is important that all con- cerned agree on the nature of the standard-setting process." I agree with that and would like to ex- plore various possibilities with you.

First, there are many who be- lieve that the process should be of a legislative nature. For instance, Robert Mautz, a partner of Ernst & Ernst, wrote several yeare ago that "The standard-setting process is a legislative kind of activity. A legislature is expected not only to legislate but to be responsible and responsive to its constituency."

In part, I agree with Mautz. In a sense, accounting standards are legislated and the process must be "responsible and responsive to its constituency," But the constitu- ency of the standard-setting pro- cess is a broad one consisting of groups that often have different and conflicting interests. It is in dealing with these varying interests that, I believe, the process of es- tablishing financial accounting and reporting standards should differ somewhat from the legislative pro- cess.

The typical legislative process, as we know it, seeks to compromise conflicting interests on an issue- by-issue basis—the standards-set- ting process should not. Account- ing standards need a constant fo- cus, and in today's times the focus must be on needs of financial statement users. If each account- ing standard is compromised to ac- commodate solely the views of pre- parers of financial statements or auditors, at the expense of users or of the system, the process will not succeed.

A purely legislative process can result in chaos. There is a need for a high degree of stability in accounting standards and a high degree of predictability about fu- ture standards. Uncertainty about standards can only cause uncer- tainty in the capital markets.

While there is a legislative as- pect to standard setting, there is also a judicial one. However, the judicial process is primarily inter- pretative and therefore can only be a part—although an important part—^of a successful standard- setting process.

There is in our governmental process a relatively new hybrid— the independent regulatory agency. The regulatory process, 1 believe, is the best available model for standard setting in the private sec- tor. Across our country, legislative

92 The Journal of Accountancy, September 1978

bodies have recognized that cer- tain technicai but highly important public interest matters require a mechanism responsive to the pub- lic need but insulated as much as possible from the political process. The resulting regulatory process has both legislative and judicial qualities:

• It is legislative because it es- tablishes authoritative rules con- sistent with a legislated mandate. n It is judicial because it inter- prets its own rules.

This type of process generally requires a body of experts whose experience enables them to act in the broad public interest under an explicit mandate.

If, as I believe, the regulatory model offers the most promise for successful private sector standard setting, the process first requires an explicit mandate or objective that is accepted by those affected and, if necessary, enforced by those with the power to do so. Second, for such a process to suc- ceed in the private sector, it must demonstrate its ability to adapt to changing needs. I am confident that the private sector, with some prods from the public sector, can adapt its procedures to a chang- ing environment or changing ex- pectations. I am not quite as con- fident that the private sector, with only prods from the public sector, can convert the FASB's very gen- eral charge to establish and im- prove standards of financial ac- counting and reporting into an explicit, workable mandate or ob- jective that serves the public in- terest.

I believe that the private sector has shown its ability to adjust its procedures during the past year. Of course, when you have a dedicated group of trustees as that which makes up the Finan- cial Accounting Foundation, a competent federal agency with oversight responsibility and in- volved subcommittees of the House of Representatives and the Senate, all pushing for change, you can see that the FASB has had a great deal of encouragement to respond to the pressures for change.

Significant changes that have

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The Journal of Accountancy, September 1978 93

taken place in the last year include the following; • Stimhine. Meetings of the trus- tees, advisory council, task forces and the FASB are open to public observation. n FAS AC. The Financial Ac- counting Standards Advisory Council now has its own part-time chairman, independent but sup- portive of the board. • Task forces. They continue to advise the board beyond the pub- lic hearing stage. • Board memher.ship. No longer must four of the seven members be practicing CPAs. The only re- quirement is "Knowledge of ac- counting, finance and business and a concern for the public interest in matters of financial accounting and reporting." • Trustees. The American Insti- tute of CPAs no longer has veto power over the selection process. Selection of trustees is a responsi- bility of the six sponsoring or- ganizations. • Due process. The FASB is working to perfect its communica- tion of technical issues via simpli- fied summaries of its discussion memorandums and improvement of its public hearing procedures. |~1 Internal operations. The FASB has increased its technical staff and instituted planning and eontrol procedures to increase its produc- tivity. We now publish our de- tailed technical plan quarterly. n Fostenactment review. The FASB recently announced a for- mal postenactment review of state- ments that have been in effect at least •two years.

TTiose improvements that I just described are indeed important, but they may prove to be only cos- metic if the process does not result in sound standards that are per- ceived to be in the public interest. To achieve those sound standards, there must be what I referred to before—an explicit, workable mandate or objective that is ac- cepted by those affected as being in the public interest.

The achievement of that goal in the private sector, without the

benefit of a legislated mandate, re- quires some changes in attitude, a great deal of voluntary restraint and, at times, a staunch defense of the system.

The FASB is working hard on its part of the joint effort that is required to make standard setting in the private sector work. We be- lieve that we have resolved many major controversies in the last four years, if not in a popular fashion, at least in a generally consistent and evenhandcd way. We plan this year to finalize a statement of the objectives of financial report- ing. In my judgment, that state- ment will confirm the board's earlier proposals that financial re- porting should focus primarily on the needs of the external user of the financial statements—not the needs of the preparer. And that statement also will make clear the need for greater comparability in reporting.

Those objectives by themselves do little, however, to bring about a needed increase in compara- bility. The second part of the ob- jectives project—the part that deals with definitions of assets, lia- bilities, revenues and expenses—is the first conceptual step to accom- plish that increase in comparabil- ity. It is also the vehicle for put- ting greater discipline into the standard-setting process, for it fur- nishes the basic tools needed to solve future problems in a consis- tent manner.

Now for your side of the bar- gain—what does all this theoreti- cal effort by the FASB mean to you? For the private sector system of standard setting to succeed, it requires the following from you: n Recognition that the legitimate needs of the external users of fi- nancial statements will be the guiding objective of fmancial ac- counting and reporting standards.

D Recognition that users' needs for comparable information will lead to similar situations being ac- counted for in similar ways. Dif- ferences in management styles or sizes of companies will not, per se, be justifications for continuation of accounting alternatives. n Recognition that increased dis- cipline in the determination of rev- enues and expenses will restrict previous freedoms. • Restraint. When standards hurt in the short run, try to look to the long run. Stop, look and listen be- fore appealing to federal agencies, the courts or your congressional representatives. Objectives, defini- tions and discipline are essential ingredients for credible financial reporting. Credible financial re- porting is essential for a credible business community. D Defense. If the system is worth saving, it is worth defending. Ac- ceptance and restraint may at times be enough but when tough decisions are made there will at times also be a need for an aggres- sive defense.

If we fail in this joint effort, the standard-setting process can be- come one of legal negotiation, in- tergovernmental agency negotia- tion or. worse yet. a totally poli- ticized process. Any of those possibilities would be devastating to business and the accounting profession, and certainly damaging to the efficiency of our capital markets. •

94 The Journal of Accountancy, September 1978

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The politicization of accounting Solomons, David Journal of Accountancy (pre-1986); Nov 1978; 146, 000005; ProQuest pg. 65

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