1.6 Other Important Accounting-Related Organizations

In addition to the FASB, several other organizations, some of which are discussed below, impact accounting standards and practice.

Securities and Exchange Commission

In response to the stock market crash of 1929, Congress created the Securities and Exchange Commission (SEC) to regulate U.S. stock exchanges. Part of the SEC’s job is to make sure that investors are provided with full and fair information about publicly traded companies. The SEC is not charged with protecting investors from losing money; instead, it seeks to create a fair information environment in which investors can buy and sell stocks without fear that companies are hiding or manipulating financial data.

As part of its regulatory role, the SEC has been granted by Congress specific legal authority to establish accounting standards for companies soliciting investment funds from the American public. For now, the SEC refrains from exercising this authority and allows the FASB to set U.S. accounting standards. The SEC has generally been content to be publicly supportive of the FASB and to privately work out any disagreements. Remember, however, that the SEC is always looming in the background, legally authorized to take over the setting of U.S. accounting standards should the FASB lose its credibility with the public.

American Institute of Certified Public Accountants

The label “CPA” has two different uses—for individuals who are CPAs and for CPA firms. A CPA, or certified public accountant, is someone who has taken a minimum number of college-level accounting classes, has passed the dreaded CPA exam, and has met other requirements set by his or her state. In essence, the CPA label guarantees that the person has received substantial accounting training. However, not all CPAs work as accountants; they work in law firms or for the CIA and as business consultants, corporate managers, and even accounting professors.

The American Institute of Certified Public Accountants (AICPA) is the professional organizations of certified public accountants in the United States. Like other professional organizations (e.g., the American Medical Association and the American Bar Association), the AICPA provides continuing educational service to its members and also acts as a political voice to lobby on behalf of its membership. The AICPA is responsible for preparing and grading the CPA examination in addition to maintaining the integrity of the accounting profession through its Code of Professional Conduct.

The second use of the label “CPA” is in association with a CPA firm—a company that performs accounting services just as a law firm performs legal services. Obviously, a CPA firm employs accountants, not all of whom have received the training necessary to be certified public accountants. CPA firms might also employ attorneys, information technology specialists, experts in finance, and other business specialists. The firms help companies establish accounting systems, formulate business plans, redesign companies’ operating procedures, and do just about anything else along these lines you can think of. A good way to think of a CPA firm is as a freelance business advisory firm with a particular strength in accounting issues.

CPA firms are also hired to perform independent audits of a company’s financial statements. The important role of an independent audit in ensuring the reliability of financial statements is discussed in our “Overview of the Financial Statements.”

Public Company Accounting Oversight Board

Section 101 of the Sarbanes-Oxley Act created the Public Company Accounting Oversight Board (PCAOB). Without putting too fine a point on it, the creation of the PCAOB is a slap in the face of the AICPA. For years the AICPA has facilitated “peer reviews” wherein one CPA would review the audit practices of another firm. The creation of the PCAOB ends this period of voluntary self-regulation. Any audit firm that wishes to audit a company that is publicly traded in the United States must be registered with the PCAOB. The PCAOB inspects the audit practices of registered audit firms and has statutory authority to investigate questionable audit practices and to impose sanctions such as barring an audit firm from auditing SEC-registered companies.

The PCAOB is structured as a private, nonprofit organization, but it effectively serves as an arm of the SEC in registering, inspecting, and disciplining the auditors of all publicly traded companies. The SEC appoints the chairperson and members of the PCAOB. Like the FASB, the PCAOB is funded by registration fees paid by all publicly traded companies in the United States.

Internal Revenue Service

Imagine that you have a contract to design a computerized accounting system for a local business. Your fee is $100,000 and will be paid in full when the job is finished. By the end of the year, you’ve collected nothing but estimate that you’ve completed 80 percent of the work on the contract. If a potential partner asks how much money you have earned during the past year, what will you say? To say that you made $0, the amount you’ve collected on the contract, significantly understates the value of the work you have completed. If the 80 percent estimate is a fair reflection of the work you’ve done, it would seem reasonable for you to report to the potential partner that you’ve earned $80,000 ($100,000 x 0.80) during the year. And as you’ll see later in our discussion of revenue, this is exactly what you would report according to financial accounting rules.

Now if you are asked by the Internal Revenue Service (IRS) to state your income for the year, how much should you report? You do not have much leeway in the matter because the IRS has very specific rules about what is considered taxable income. Assume that IRS rules state that you must pay income tax on the $80,000 income from the estimated amount of the contract that you have completed. Two practical problems would arise:

• You do not have the money to pay the tax and won’t be able to pay it until the job is completed and you have collected your entire fee.

• You will have endless arguments with the IRS about the completion percentage. To avoid paying excessive tax, you could say that only 25 percent of the job is finished. The IRS could then send an agent to dispute your estimate, with the whole thing ending up in Tax Court.

The above example illustrates that what works for financial accounting purposes does not necessarily work for income tax purposes. Financial accounting reports are designed to provide information about the economic performance and status of a company. Tax rules must be designed to tax income and still to provide concrete rules to minimize inefficient arguing between taxpayers and the IRS.

The implication of this separation between financial accounting and tax accounting is that companies must maintain two sets of books—one set from which the financial statements can be prepared and the other set to comply with income tax regulations. There is nothing shady or underhanded about this—financial accounting and tax accounting involve different sets of rules because they are designed for different purposes.

International Accounting Standards Board

Just as the FASB establishes accounting standards for U.S. companies, other countries have their own standard-setting bodies. The international differences in standards create many reporting problems for foreign companies doing business in the United States and U.S. companies doing business abroad. In an attempt to harmonize conflicting national standards, the International Accounting Standards Board (IASB) was formed in 1973 to develop worldwide accounting standards. In 2001, the IASB restructured itself as an independent body with closer links to national standard-setting bodies. At that time the IASB adopted its current name and dropped its original name, the International Accounting Standards Committee (IASC).

The accounting standards produced by the IASB are referred to as International Financial Reporting Standards (IFRS). The IFRS are envisioned to be a set of standards that can be used by all companies regardless of where they are based. In the extreme, IFRS could supplement or even replace standards set by national standard setters such as the FASB. IASB standards are gaining increasing acceptance throughout the world. In fact, in 2008 the SEC began allowing non-U.S. companies with shares trading on U.S. stock exchanges to issue their financial reports using IASB standards. Before this change, all non-U.S. companies wishing to have their shares traded in the United States were required to provide financial statements in accordance with U.S. GAAP. So, even in the United States the international standards are now seen as a credible alternative to U.S. GAAP.

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