The History of the Financial Accounting Standards Board

The History of the Financial Accounting Standards Board

Davenport University

Abstract

This paper discusses the history and background of the Financial Accounting Standards Board (FASB). The primary goal of the FASB is to devise the Generally Accepted Accounting Principals (GAAP) in the United States. This paper will also discuss the structure and function of the FASB and its standards. Finally, the paper will discuss the future as the FASB and the International Accounting Standards Board (IASB) as they work together to transition to a common world wide standard.

In 1494, 2 years after the discovery of America, Luca Pacioli wrote a book on mathematics entitled Summa de Arithmetica, geometria, proportioni et Proportionalita. (Accounting Theory, 2009) "It was a little survey and should have been treated like ordinary books of the time and read then disappeared into historical archives and forgotten. A few brief chapters on practical mathematics made this one special." (LeMoine, 2004)

These chapters were written on practical mathematics, specifically mathematics of business. Luca stated that a merchant requires three things to ensure he is successful in his business venture: "sufficient cash or credit, an accounting system that can tell him how he's doing, and a good bookkeeper to operate it." The accounting system proposed by Luca consisted of journals and ledgers and invented double entry bookkeeping. "Debits were on the left side because that's what "debit" meant, "the left". The numbers on the right were named credits." (LeMoine, 2004)

The double entry system allowed the bookkeeper to check his progress quickly and easily; he simply needed to add up all of the debits, and then add up all of the credits. If the totals matched then the bookkeeper had done everything correctly, if there was a discrepancy in the totals, "that would indicate a mistake in your Ledger, which mistake you will have to look for diligently with the industry and intelligence God gave you." Luca wrote. (LeMoine, 2004)

This system of bookkeeping, invented by a Franciscan monk, proved to be so easy to use and well suited to the needs of the merchant class it became the standard for business. (Accounting Theory, 2009). Accounting standards remained largely unchanged until the financial collapse of 1929 and the depression that followed.

In October of 1929, the stock market crashed; companies that had recently showed huge profits went bankrupt and private investors lost their life savings. Everyone questioned how such a thing could happen, how was it possible that a company is highly profitable one day and bankrupt the next, the only answer was fraud. "So far, these events could be chalked up to fraud (albeit widespread fraud) and handled through the ordinary course of justice." (LeMoine, 2004) The fact that the accountants proved that no fraud had been committed, that in fact, the rules of GAAP had been followed, further eroded the public's confidence in the financial markets. If GAAP allowed companies to report unrealized profitability and reserve funds, serious changes were needed in the rules of accounting. Furthermore, it was determined that the only way to emerge from the depression was to restore the public confidence in the capital markets. The United States Congress began a series of hearings to determine what had happened, what was required to resolve the issues, and what legislation was needed to ensure it didn't happen again. (How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, 2009)

Congress held a series of hearings on interstate frauds known as the Pecora Commission and eventually passed the Securities Act of 1933, which regulates the sale of securities at the federal level. This was followed in 1934 by Securities Exchange Act of 1934 which regulates the sale of securities in the secondary market, section 4 of the 1934 Act created the Securities and

Exchange Commission (SEC). "Both laws are considered part of Franklin Roosevelt's "New Deal" raft of legislation." (Wikipedia contributors, 2009) Roosevelt appointed Joseph Kennedy as the first Chairman of the SEC. The Act and the creation of the SEC was intended to restore the publics confidence in the markets by providing reliable and guaranteed information that could be used to determine the strength of a companies portfolio. "The main purposes of the laws can be reduced to two common-sense notions:

* "Companies publicly offering securities for investment dollars must tell the public the truth about their business, the securities they are selling, and the risks involved in investing." (How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, 2009)

* "People who sell and trade securities - brokers, dealers, and exchanges - must treat investors fairly and honestly, putting investors' interests first." (How the SEC Protects Investors, Maintains Market Integrity, and Facilitates Capital Formation, 2009)

The commission is made up of five members appointed by the United States President; they serve a term of five years, one of the commissioners serves as the chairman. The terms of the commissioners are staggered so that one ends each year. The commissioner's terms end on June 5th, and by law, there can be no more than three commissioners from the same political party to ensure that the commission remains non-partisan. (Wikipedia contributors, 2009)

The commission includes four divisions; Corporate Finance, Trading and Markets, Investment Management, and Enforcement. Uniform accounting standards needed to be enacted and the financial reports of publically traded companies needed to be accurate and consistent from one company to the next. "The New York Stock Exchange (NYSE) and what is now the American Institute of Certified Public Accountants (AICPA) ventured preliminary guidelines in the jointly published Audits of Corporate Accounts of 1934. The congressional Securities Act of 1933 and the Securities Exchange Act of 1934 threatened to supersede such efforts by establishing the U.S. Securities and Exchange Commission (SEC), which was authorized, among other functions, to prescribe standards for the preparation of financial reports. In 1938, however, the SEC voted to forgo this prerogative and allow the private sector to regulate its accounting practice--a policy that the commission has maintained to date." (Sprinkle,