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How are GAAP Rules Determined?

written by: ciel s cantoria•edited by: Ronda Bowen•updated: 5/31/2011

The authorities of the Securities and Exchange Commission maintain, that they rely on the private sector to provide bases for GAAP rules imposed on public companies. Perhaps this statement has aroused curiosities, as to how are GAAP rules determined. Find out the answers from this article.

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    The Creation of an Independent Standards-Setting Board for the Private Business Sector

    In seeking for answers as to how GAAP rules are determined, we will have to refer to the Financial Accounting Standards Board (FASB) as source of information. The FASB was created in1973 to represent the private business sector in assisting the federal government, in its process of developing and formulating the GAAP accounting rules. It may be worth mentioning that the groundwork of the Generally Accepted Accounting Principles briefly called as GAAP were laid out by the American Institute of Certified Public Accountants (AICPA). Thus, GAAP’s basic rules are also founded on academically prescribed accounting principles and procedures.

    Adherence to GAAP accounting rules were initially developed as an essential requirement of the Securities and Exchange Commission (SEC) among public companies, as standard guidelines for financial accounting and reporting. However, the effectiveness of GAAP’s imposition became widespread; hence, the importance of GAAP, extended not only to investors but to a host of different financial statement users in the business community.

    In view of this, the federal government deemed it necessary to engage the private sector in contributing to the standard rules imposed as GAAP, by creating the Financial Accounting Foundation (FAF). The foundation is an independent structure composed mainly of leaders with different established professions, as business or financial executives coming from capital markets, as certified public accountants, securities lawyers, state and local government officials as well as accounting educators. These professionals are collectively known as the FAF Board of Trustees, tasked to oversee not only the operations of the FAF but also that of the Financial Accounting Standards Board (FASB) and the Government Accounting Standards Board (GASB). These two units were established to set the standards for financial accounting and reporting. The FASB is in charge of the rules and policies that will be set forth as GAAP in the private business sector, while the GASB acts as FASB’s counterpart for government-owned organizations.

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    How the FASB Determines the GAAP Rules

    (1) Through the Financial Accounting Standards Advisory Council (FASAC), created by the FAF Board of Trustees, to work hand in hand with FASB by giving advise about FASB’s project agendas and the prioritization of projects by considering which issue requires FASB’s immediate attention. The members of this advisory council are selected and appointed by the FAF Board of Trustees according to their knowledge, expertise and exposure to the financial accounting and reporting aspects of the issues involved. The membership in the Advisory Council will not be dominated by any single profession, which will include creditors, investors, accounting educators, issuers, auditors and those with government experience.

    As individual members of Advisory Council, each member will be expected to communicate to the FASB, their personal opinions and perceptions of the possible effects of the proposed standards to be issued. They are likewise required to give comments regarding FASB’s adherence to the guiding principles set forth in FASB Rules of Procedures, in determining the standard to be set-up as proposed GAAP Rules, particularly the aspect of cost-to-benefit considerations. Comments should also include observations if due process was carried out in formulating the standards proposed. Members of Advisory Councils are likewise encouraged to consult with each other by exchanging views and opinions in public, regarding the accomplishments of FASAC and FASB.

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    How Public Consultations and Opinions of the Private Sector are Solicited

    (2) By conducting consultation proceedings, public forums and publicly held discussions with the private business entities in their roles as users of financial reports presented by other business units. At the same time, their views in their capacities as presenters of financial statements themselves to serve similar purposes, are also considered. The Chairman of the FASB will supervise specific groups who will arrange such conferences with stakeholders through outreach meetings or to any one interested to participate in public forums or open discussions. Results of consultations with stakeholders will also be communicated through written reports. The following are the methods on how discussion proceedings are carried out as means of actively seeking the views and opinions of the private sector:

    • The FASB Chairman may form an Advisory Group or Committee to provide expertise and different viewpoints and to undertake the tasks of communicating with stakeholders in behalf of FASB. The advisory group will also be tasked to know the potential issues that may crop up regarding the proposed standards before they are actually implemented. The meetings held between advisory board members with the stakeholders will be open to public observations.
    • The FASB may form an Emergency Issues Task Force (EITF) to help in the early determination, deliberations and resolutions of immediate financial accounting and reporting issues concerning the private business sector. This group will be responsible for coming up with Accounting Standards Update that will amend any Accounting Standards Codification, after a consensus has been reached by the members of the EITF for its amendment. For this purpose, the members of the EITF are knowledgeable and experts in accounting and financial reporting and are in positions where they are aware of such emergency issues. Their proposed amendments must initially be in the form of an Exposure Draft, open for public comment and approval of the FASB majority, before they are officially released as Accounting Standards Update.
    • The FASB Chairman may launch a Research Project regarding technical information that are of problem solving nature, wherein the research data will form part of FASB’s public file.
    • The FASB will hold public forums, if it deems necessary to hold such forums as means of obtaining financial accounting and reporting information. Public Forums are usually held for Exposure Drafts or Discussion Papers. The public forums will be held 30 days after FASB's public announcements that such as forum shall be held. Any individual may take part in these publicly held discussions, provided a written request is submitted ; a written comment may also be required as condition in granting a request to participate in a public forum conducted by the FASB. A transcript of all held public forums will form part of FASB’s public files.
    • A Discussion Paper containing an invitation to comment may be created, as a form of communication to solicit a wide range of input while the proposed standard is at the technical stage or even before it becomes a project agenda. The FASB Chairman may approve invitations to comment on the Discussion Paper, based on necessity and relevancy to a standard-setting project.

      These are the methods used, performed or undertaken by the FASB under the direct supervision of its Chairman, to answer queries on how are GAAP rules determined. All documents, except working papers, internal memorandums and minutes of closed-in meetings, but only those in support of the standard-setting projects are available for public review at the FASB office. Some information including FASB’s current activities and projects, may be available or requested at FASB’s website at www.fasb.org.

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      Reference Material Section

      Reference Materials:

      • http://www.fasb.org/faf/nr022608.pdf
      • http://business-accounting-guides.com/gaap-accounting/
      • http://www.fasb.org/cs/ContentServer?c=Document_C&pagename=FASB/Document_C/DocumentPage&cid=1176156951613
        FASB Rules of Procedure- Amended and REstated through May 01, 2010