What is the relationship between the Securities and Exchange Commission and accounting standard?

Who Enforces GAAP?

Responsibility for enforcement and shaping of generally accepted accounting principles (GAAP) falls to two organizations: The Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC).

The SEC has the authority under securities law to both set and enforce accounting standards, while the FASB, an independent non-governmental body tasked by the SEC, can only set standards. It does so via the Accounting Standards Codification.

Key Takeaways

• Responsibility for enforcement and shaping of generally accepted accounting principles (GAAP) falls to two organizations: The Financial Accounting Standards Board (FASB) and Securities and Exchange Commission (SEC).
• The SEC has the authority to both set and enforce accounting standards.
• The FASB can set standards, which it does via the Accounting Standards Codification.
• GAAP is not law, though violating GAAP can have costly ramifications.
• The SEC has issued many steep fines for GAAP violations, including several famous recent cases, like those of Hertz and Monsanto.

Understanding GAAP Enforcement

GAAP is not law, though violating GAAP can have costly ramifications. Errors and omissions can impact a company's credibility with lenders, investors, and other parties who rely on financial statements for an accurate picture of a company's finances. The SEC does not take a kind view of companies that fail to conform to GAAP. In 2019, it fined Hertz (HTZ) $16 million for reporting items that were not consistent with GAAP.

In 2016, the SEC hit Monsanto with an $80 million penalty for failing to accurately reflect the cost of rebates according to GAAP rules. It has also punished companies who put a shine on their earnings statements by highlighting non-GAAP financial measures "without giving equal or greater prominence" to comparable GAAP financial measures.

The FASB was given the task of establishing financial and reporting standards with its establishment in 1973. Between 1959 and 1973, the job belonged to the Accounting Principles Board under the American Institute of Certified Public Accountants (AICPA), but that role was relinquished as the SEC took a more active part in setting accounting standards, particularly on controversial issues where it disagreed with the board. The Committee on Accounting Procedure, which was also established under AICPA, set accounting standards from 1939 to 1959.

GAAP and Private Companies

Although they are not required to follow GAAP, private companies may choose to do so, especially if they wish to obtain loans or other financing, and if they have long-term plans to seek funding from private equity firms and institutionalize the company to be ready for public listing. The belief is that GAAP financial statements are widely understood by lenders and investors.

Private firms have alternatives to GAAP. AICPA has designed an accounting framework for small and medium-sized businesses. In addition, the FASB has established the Private Company Council as an alternative framework within GAAP.

WHY IT IS IMPORTANT TO HAVE MORE COMPARABLE GLOBAL ACCOUNTING STANDARDS AND HOW IT FITS WITH THE FASB’S MISSION

The first priority of the Financial Accounting Standards Board (FASB) is to improve financial reporting for the benefit of investors and other users of financial information in U.S. capital markets. We do that by striving to set the highest-quality standards, which collectively are known as Generally Accepted Accounting Principles (GAAP). By highest quality, we mean standards that provide users of financial statements with information that is clear, useful, and relevant to their needs, while considering whether the expected benefits of that information justify the costs of providing and using it.

The FASB believes that seeking more comparable global accounting standards—improving the quality of accounting standards used around the world while reducing differences among those standards—is consistent with its core mission. Investors, companies, auditors, and other participants in the U.S. financial reporting system benefit from the increased comparability that can result from the closer alignment of standards used internationally. More comparable standards have the potential to reduce costs for both users and preparers of financial statements and make worldwide capital markets more efficient. The Securities and Exchange Commission (SEC) expects the FASB to consider, in developing standards, the extent to which international comparability is necessary or appropriate in the public interest and for the protection of investors.

HOW THE FASB SEEKS GREATER COMPARABILITY

As we conclude the bilateral convergence program begun in 2002 by the FASB and the International Accounting Standards Board (IASB), the FASB has implemented a three-part strategy for seeking greater comparability in accounting standards internationally:

1. Developing high quality GAAP standards
2. Actively participating in the development of International Financial Reporting Standards (IFRS)
3. Enhancing relationships and communications with other national standards setters.

DEVELOPING HIGH QUALITY GAAP STANDARDS

The FASB continually strives to meet the needs of investors and other users of GAAP-based financial reports, both within and outside the United States, by improving the quality of GAAP. The FASB believes that the high-quality standards it develops will continue to influence the shape and future direction of international standards, as they have for more than 40 years. By creating high-quality standards through a best-in-class standard-setting process, the FASB serves as a reference point and benchmark for others. In other words, we will continue to lead by setting an example of excellence.

As it undertakes standard-setting projects, the FASB carefully evaluates whether U.S. financial reporting would be improved by implementing approaches consistent with particular IFRS standards. This also would enhance international comparability for the benefit of investors and other capital market participants. This evaluation happens on a standard by standard basis.

ACTIVELY PARTICIPATING IN THE DEVELOPMENT OF IFRS

The FASB participates actively in the development of IFRS, providing input on IASB projects through the IASB’s Accounting Standards Advisory Forum (ASAF) and through other means. The FASB contributes to the development of IFRS by sharing views based on its past experience or developed through the FASB’s due process, stakeholder outreach, analysis, and deliberations. We believe our efforts to improve GAAP benefit from the international perspectives gained through our interactions with the IASB.

ENHANCING RELATIONSHIPS AND COMMUNICATIONS WITH OTHER NATIONAL STANDARD SETTERS

The FASB works to maintain and strengthen its existing cooperative relationships with other national standard setters. The broader flow of information and ideas resulting from these relationships mutually informs each organization’s thinking and contributes to the shared understanding of perspectives and circumstances that can reduce or avoid unnecessary differences among standards used internationally. In some cases, however, the FASB (or other national standard setters) may conclude that the best interests of its own capital markets outweigh the goal of completely converged accounting standards.

PRACTICAL CHALLENGES TO ACHIEVING GREATER COMPARABILITY

Since 2000, significant progress has been made toward achieving greater comparability in accounting standards on an international level. The increasing number of countries around the world that have decided to require (or permit) the use of IFRS has increased the comparability of reporting internationally. The bilateral FASB and IASB convergence program increased the quality of reporting standards and enhanced the comparability of these standards in a number of important areas, including the accounting for business combinations, share-based payment transactions, fair value measurement, and revenue recognition.

But increasing the comparability of standards is not easy. It cannot be accomplished by the FASB alone; it requires cooperation and agreement among standard setters around the world. Different starting points, different business cultures, different regulatory environments, different financial reporting objectives, and different legal systems can make it difficult for standard setters around the world to agree on the same accounting alternative. Moreover, an alternative that is perceived as an improvement in one country may not be perceived as an improvement by another country.

Early in their bi-lateral convergence program, the FASB and IASB concluded that international comparability would be enhanced if GAAP and IFRS used the same words and phrases. Recent experiences raise questions about that conclusion. The FASB believes that international comparability may sometimes require the use of different words or additional guidance tailored to the U.S. reporting environment.

A BRIEF HISTORY

International convergence of accounting standards is not a new idea. The concept of convergence first arose in the late 1950s in response to post World War II economic integration and related increases in cross-border capital flows.

Initial efforts focused on harmonization—reducing differences among the accounting principles used in major capital markets around the world. By the 1990s, the notion of harmonization was replaced by the concept of convergence—the development of a unified set of high-quality, international accounting standards that would be used in at least all major capital markets.

The International Accounting Standards Committee, formed in 1973, was the first international standards-setting body. It was reorganized in 2001 and became an independent international standard setter, the International Accounting Standards Board (IASB). Since then, the use of international standards has progressed. As of 2013, the European Union and more than 100 other countries either require or permit the use of international financial reporting standards (IFRSs) issued by the IASB or a local variant of them.

The FASB and the IASB have been working together since 2002 to improve and converge U.S. generally accepted accounting principles (GAAP) and IFRS. As of 2013, Japan and China were also working to converge their standards with IFRSs. The Securities and Exchange Commission (SEC) consistently has supported convergence of global accounting standards. However, the Commission has not decided whether to incorporate International Financial Reporting Standards (IFRS) into the U.S. financial reporting system. The Commission staff issued its final report on the issue in July 2012 without making a recommendation.

The following is a chronology of some of the key events in the evolution of the international convergence of accounting standards.

• The 1960s—Calls for International Standards and Some Early Steps
• The 1970s and 1980s—An International Standard-Setting Body Takes Root
• The 1990s—The FASB Formalizes and Expands its International Activities
• The 2000s—The Pace of Convergence Accelerates: Use of International Standards Grows Rapidly, the FASB and IASB Formally Collaborate, and the U.S. Explores Adopting International Accounting Standards

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