The FASB should consider economic consequences in the standard setting process; “ The Board cannot cease to be concerned about the cost-effectiveness of its standards. To do so would be a dereliction of its duty and a disservice to its constituents”. (SFAC No. 2 P. 144) FASB member Victor H. Brown identified the economic costs to consider: “ The costs of introducing a new standard, of course, include the out of pocket costs of converting to the new standard, the costs of processing and reporting the information required, and possible increases in audit cost….. But costs may also include disclosure costs, measured in terms of lost competitive advantage. Even harder to assess are the costs incurred by all parties in attempting to understand, digest, and adapt to new rules. The new rules can have an impact on existing and prospective contractual relationships, and internal management and organizational adjustments must often be made to understand and relate to new ways of measuring entity performance. External users of financial reports also must adjust to and interpret reported information produced in accordance with the changed standards”.
The FASB considers the economic consequences of a standard during the normal course of its political “ due process”. According to FASB’s The Structure of Establishing Accounting Standards, “ The process of setting accounting standards can be described as democratic because like all rule-making bodies the board’s right to make rules depends ultimately on the consent of the ruled”. One of the advantages of the process is that external parties are invited to comment on exposure drafts or present testimony during roundtable discussions. The history behind SFAS No. 123 provides us with a prime example of external parties influencing Board decision in order to avoid detrimental economic consequences on reported earnings and finally influencing to regulate because of the economic consequences. The 1993 Exposure Draft was extremely controversial and the Board received over 1, 700 comment letters objecting to the recognition of compensation costs for employee share options. The Board held six days of public hearings and representatives from 73 organizations presented testimony. Amazingly, legislative proposals addressing this accounting issue were introduced before Congress both opposing and supporting proposals in the 1993 exposure draft.
“ A Sense of the Senate resolution was passed that the FASB should not at this time change the current generally accepted accounting treatment of stock options and stock purchase plans”. However, a second resolution was passed stating, “ Congress should not impair the objectivity or integrity of the FASB’s decision making process by legislating accounting rules”. In light of the extraordinary controversy surrounding the 1993 Exposure Draft, the Board decided to encourage, rather than require, recognition of compensation cost based on a fair-value-based method and pursued expanded disclosure instead. Statement 123 was issued in October 1995 and entities continued to apply the provisions of Opinion 25. Given the serious corporate reporting failures in the early 21st century, (ex: Enron), Congress and regulators pushed for a focus on high-quality transparent financial reporting and a demand for entities to recognize compensation costs for employee share options. Numerous entities were voluntarily choosing to apply the fair-value-based method of accounting however; this raised a comparability issue across business organizations.
The IASB, in 2002, issued an exposure draft, Share-Based Payment, which proposed a single fair-value-based method for share-based compensation arrangements. The Board now concluded that the stipulations of No. 123 needed to be re-evaluated. In 2004, more than 10 years after the initial exposure draft, the FASB issued SFAS No. 123R requiring the recording of expense for incentive stock options. Conclusively, external parties will attempt to influence standard formulation based on the economic consequences of the issue at hand and clearly, the standard must be “ generally accepted” by both the regulated party and society as a whole despite the economic consequences involved. Assessing and quantifying these types of behavioral reactions regarding the economic consequences of a proposed standard will always pose difficulties for the FASB, “ There is no way of determining optimal regulatory policies that maximize the social welfare or the public interest.
The best that regulators can do is to try to determine that a net benefit exists-that is, an excess of benefits over costs.” (Wolk et al p 129) SFAC No. 8 addresses the cost constraint on useful financial reporting, “ Cost is a pervasive constraint that standard setters, as well as providers and users of financial information, should keep in mind when considering the benefits of a financial reporting requirement.” (SFAC No. 8 BC 3. 47) However, the ability to place a dollar value and fully enumerate a cost or benefit is almost an impossible task for standard-setters. Additionally, there is no way to successfully identify and measure all of the economic consequences associated with a new standard. The FASB should be applauded though for advancing uniformity in accounting standards, however; uniform financial reporting suggests a one size fits all approach. “ Smaller, non-publicly listed firms (and their auditors) argue that accounting standards are formulated mainly for larger, publicly traded firms” and that “ compliance costs are disproportionately higher and the benefits smaller since the firms’ securities are not traded”. (Wolk et al p 127) Therefore, smaller and medium sized entities remain economically disadvantaged by some standards despite the cost-constraint acknowledgements of the Board.
The IASB however has recognized the need for small to medium size firms to have separate standards and have issued a separate International Financial Reporting Standard for Small and Medium Sized Entities. Interestingly, the FASB and the IASB have been working together since 2002 to achieve convergence between US GAAP and IFRSs in order to develop a common set of high-quality compatible accounting standards. “ All companies compete for capital in the world equity markets. To survive and grow, companies have to have access to the cheapest money available. By migrating to IFRS, many executives believe they will be better able to attract foreign investment for growth” and “ enable analysts, shareholders, and company management to evaluate financial performance among industry competitors, no matter where they are domiciled around the globe”. (White, W. C.)
Without a doubt, the FASB has considered the economic consequences and impact of accounting standards on U. S. competitiveness in the global market place. According to CON 8, “ the objective of general purpose financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. Those decisions involve buying, selling, or holding equity and debt instruments and providing or settling loans and other forms of credit.” Since the objectives of general-purpose financial reports focus on the user, a new standard must therefore enhance the usefulness of the financial information. However, once again, the FASB encounters difficulty in measuring the economic consequences pertaining to usefulness to investors, creditors, managers, labor unions, government regulatory agencies, suppliers and the general-public’s utilization of the general purpose financial reports for decision-making.
Finally, there is the impact of a new standard on the preparer of financial information. Managerial accounting has taught us that direct costs are more easily measured than indirect costs. Preparer direct costs include amounts associated with the education of staff and management, audit costs, and most importantly the financial consequences on reported earnings resulting from the standard, (ex: SFAS 123R). Earnings management would be considered an indirect cost if a new standard tempted management to behave in a self-serving manner in order to increase compensation or positively reflect the entity for shareholders. Without a doubt, the FASB must consider the economic consequences associated with a new standard. However, allocation of weight between purist and economist is virtually impossible for the FASB when faced with the apparent measurement and quantification issues presented in this paper. The history of accounting warns us that when addressing accounting issues from a purist perspective, economic consequences are not considered in the decision process, results in standards that are not “ generally accepted”.
On the other hand, if the FASB decision process relied purely on economic consequences, standards would be constantly changing based on the dynamics of the financial environment and would put the integrity of financial reporting at risk. Calculating the weight to attribute to an economic consequence thus remains open. We must therefore rely on the professional judgment of the bodies entrusted with standard setting, the FASB, to forward standards that embody the fundamental qualitative characteristics of relevance and faithful representation and enhance financial report usefulness for the investor, lender, or creditor in making a decision. Henry Kissinger said it well when he described governmental policy matters without a conceptual framework, “ Policy makers are forced to respond to parochial interests, buffeted by pressures, without a fixed compass”. The FASB is our fixed compass.
Statement of Financial Accounting Concepts No. 2
Statement of Financial Accounting Concepts No. 8
Statement of Financial Accounting Standards No. 123R
Wolk, H., Dodd, J., & Rozycki, J. (2013). Accounting Theory: Conceptual
Issues in a Political and Economic Environment. The LIFO Conundrum: Convergence of US GAAP with IFRS
and Its Implications on US Company Competitiveness, by William C. White IV. http://www. qfinance. com/regulatory-compliance-best-practice/the-lifo-conundrum-convergence-of-us-gaap-with-ifrs-and-its-im? full.