The Securities and Exchange Commission has the final say on matters of financial reporting by publicly owned corporations. The SEC has delegated the job of determining proper accounting standards to the accounting profession. However, the SEC sometimes overrides decisions the accounting profession makes. To fulfill its responsibility, the accounting profession has developed, and continues to develop, generally accepted accounting principles (GAAP)Accounting standards developed and applied by professional accountants. Generally accepted accounting principles must be followed by publicly owned companies unless they can show that doing so would produce information that is misleading.

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The SEC requires all publicly owned companies to follow generally accepted accounting principles. As new standards are developed or refined, accountants interpret the standards and adapt accounting practices to the new standards.

THE DEVELOPMENT OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

Generally accepted accounting principles are developed by the Financial Accounting Standards Board (FASB), which is composed of seven full-time members. The FASB issues Statements of Financial Accounting StandardsAccounting principles established by the Financial Accounting Standards Board. The FASB develops these statements and, before issuing them, obtains feedback from interested people and organizations.

First, the FASB writes a discussion memorandumAn explanation of a topic under consideration by the Financial Accounting Standards Board to explain the topic being considered. Then public hearings are held where interested parties can express their opinions, either orally or in writing. The groups that consistently express opinions about proposed FASB statements are the SEC, the American Institute of Certified Public Accountants (AICPA), public accounting firms, the American Accounting Association (AAA), and businesses with a direct interest in a particular statement.

The AICPA is a national association for certified public accountants. The AAA is a group of accounting educators. AAA members research possible effects of a proposed FASB statement and offer their opinions to the FASB.

After public hearings, the FASB releases an exposure draftA proposed solution to a problem being considered by the Financial Accounting Standards Board, which describes the proposed statement. Then the FASB receives and evaluates public comment about the exposure draft. Finally, FASB members vote on the statement. If at least four members approve, the statement is issued. The process used to develop GAAP is shown in Figure 1.2.

FIGURE 1.2   The Process Used by FASB to Develop Generally Accepted Accounting Principles

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Accounting principles vary from country to country. International accountingThe study of accounting principles used by different countries is the study of the accounting principles used by different countries. In 1973, the International Accounting Standards Committee (IASC) was formed. Recently, the IASC’s name was changed to the International Accounting Standards Board (IASB). The IASB deals with issues caused by the lack of uniform accounting principles. The IASB also makes recommendations to enhance comparability of reporting practices.

THE USE OF GENERALLY ACCEPTED ACCOUNTING PRINCIPLES

4  5.  OBJECTIVE Describe the process used to develop generally accepted accounting principles.

Every year publicly traded companies submit financial statements to the SEC. The financial statements are audited by independent certified public accountants (CPAs). The CPAs are called independent because they are not employees of the company being audited and they do not have a financial interest in the company. The financial statements include the auditor’s report. The auditor’s reportAn independent accountant's review of a firm's financial statements contains the auditor’s opinion about the fair presentation of the operating results and financial position of the business. The auditor’s report also confirms that the financial information is prepared in conformity with generally accepted accounting principles. The financial statements and the auditor’s report are made available to the public, including existing and potential stockholders.

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Businesses and the environment in which they operate are constantly changing. The economy, technology, and laws change. Generally accepted accounting principles are changed and refined as accountants respond to the changing environment.