Focus75YEARSIn

Controversial Standards TriggerSpecial-Interest Lobbying

Robert T. Sprouse,FASB Vice Chairman, 1973

The Evolution

of U.S.GAAP:

The Political Forces Behind Professional

Standards

By Stephen A. Zeff

his article, the second of a two-part com-

mentary about accounting standards setting,

chronicles the rising importance of financial

accounting standards in different sectors of

the U.S. economy, which has led to increasing

special-interest lobbying for accounting standards

with characteristics compatible with the desired

outcomes. Financial accounting standards

affect the U.S. economy in many ways, both in

the aggregate and in the distribution of income,

wealth, and risk. This commentary captures

many of the key issues that have preoccupied

standards setters, and especially identifies the

efforts of the Financial Accounting Standards

Board to implement an asset-and-liability

approach to recognition and a fair-value approach

to measurement.

T

1973The Financial Accounting Standards

Board (FASB) succeeds the AccountingPrinciples Board (APB) on July 1, 1973,two days after the International AccountingStandards Committee (IASC) is formed. In1969 and 1970, the Accounting StandardsSteering Committee had been establishedin the United Kingdom and Ireland, replac-ing the program of the Institute ofChartered Accountants in England andWales for issuing Recommendations onAccounting Principles.

Comment. In the early 1970s, the phrase“setting accounting standards” replaced“establishing accounting principles.” Theterm “standards setter” came into vogue.

1973Within the AICPA, the Accounting

Standards Executive Committee (AcSEC),composed entirely of accounting practi-tioners, succeeds the APB. It issuesStatements of Position (SOP) on account-ing practices in specific industries.

Comment. This was the last preserve ofthe AICPA in the area of accountingstandards setting, but the scope of thisactivity was narrow and Statements ofPosition were later subject to FASBapproval before they could take effect. In2002, FASB announces that, after a tran-sition period, this work of AcSEC will bephased out.

1973In Accounting Series Release 150, the

SEC announces that it will look to FASBfor leadership in setting accounting standards.

Comment. This was the SEC’s first for-mal statement of support for a private-sec-tor body setting accounting standards (orestablishing accounting principles). ChiefAccountant John C. (Sandy) Burton want-ed the SEC to give FASB its full backing.

1973The Trueblood Study Group, created by

the AICPA in 1971, issues a booklet,Objectives of Financial Statements, whichadvocates a “decision usefulness”approach to the development of account-ing standards.

Comment. This was a milestone in theseries of efforts by the accounting profes-sion to establish a conceptual framework.Unlike the traditional emphasis on stew-ardship reporting, the Trueblood StudyGroup’s approach was forward-looking: Itsaid that an objective of financial state-ments is “to provide information usefulto investors and creditors for predicting,comparing, and evaluating potential cashflows to them in terms of amount, tim-ing, and related uncertainty.” The groupcould not agree on whether value changesshould be reflected in earnings, but it didprovide a framework for thinking aboutthe issue.

1974–1975FASB unanimously issues Statement of

Financial Accounting Standards (SFAS) 2,on accounting for research and developmentcosts, and SFAS 5, on accounting for con-tingencies, which signal FASB’s commit-ment to the primacy of the “asset-and-lia-bility view” over the traditional “revenue-and-expense view.” Under the asset-and-lia-bility view, the definitions of assets andliabilities govern the recording of revenuesand expenses, not the other way around, asunder the matching principle.

Comment. FASB was troubled that therevenue-and-expense view perpetuatedunintelligible balance sheet accountsthat did not fit the definition of assets orliabilities, such as reserve for self-insur-ance and assorted deferred credits. RobertT. Sprouse, one of the original membersof FASB, had written an article titled

“Accounting for What-You-May-Call-Its”in the October 1966 issue of the Journalof Accountancy to elucidate this prob-lem implicit in the revenue-and-expenseview. The board concluded that the bet-ter approach was to agree first on whethera transaction had created an asset or lia-bility and then determine the amount ofany revenue or expense. This asset-and-liability view, which was to play a cen-tral role in FASB’s conceptual frame-work, was foreshadowed in these twoearly standards.

1974, 1976, 1979The 1970s are a decade of high infla-

tion in the United States. FASB issuesan exposure draft that would requirecompanies to report price-level-adjustedinformation in supplementary statements.But in 1976, under the leadership ofChief Accountant Burton, the SEC issuesAccounting Series Release 190, whichrequires approximately 1,300 large, pub-licly traded companies to disclose theeffects of changing replacement costs, in

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The Financial Accounting Standards Board(FASB) succeeds the Accounting PrinciplesBoard (APB) on July 1, 1973, two days afterthe International Accounting StandardsCommittee (IASC) is formed. FASBChairman Marshall S. Armstrong, right. 1

In its pursuit of conceptual goals, especially an asset-and-lia-bility approach to recognition and a fair-value approach to mea-surement, FASB has generated opposition to financial account-

ing standards controversial issues. Special-interest lobbyists, work-ing through Congress, have increasingly, and often successfully,influenced the standards-setting process, and there is no signthat this confrontational relationship will diminish.

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■ The Financial Accounting Standards Board and senior staff, circa 1974.

a supplementary disclosure. This rebuffembarrasses FASB, which in 1979 issuesSFAS 33. It requires approximately1,500 large companies to disclose theeffects of both current cost and constantdollar information, in a supplementaryformat.

Comment. Here was evidence of theinfluence of the SEC’s activist chiefaccountant. Burton could argue that hisrelease dealt with disclosure, not with mea-surements appearing in the body of thefinancial statements. Yet Release 190forced FASB’s hand. Meanwhile, in theUnited Kingdom, the government’sSandilands Committee, whose memberswere drawn from outside the accountingprofession, preferred current costs over thegeneral price-level information favoredby the profession’s Accounting StandardsSteering Committee. Because the govern-ment published general price-level indices,accounting numbers derived from them(known by FASB as constant dollarinformation) were easier to audit thancurrent or replacement costs.

1975The SEC’s Division of Corporation

Finance and Office of the ChiefAccountant begin to issue Staff AccountingBulletins (SAB), which represent the inter-pretations and practices followed by theDivision and the Chief Accountant inadministering the disclosure requirementsof the federal securities laws. More than100 SABs have been issued since.

Comment. This was a step, probablyinspired by Chief Accountant Burton, topublicize the accounting views held by theSEC’s staff without having to obtain theformal endorsement of the commissioners.

1975, 1981By a vote of 6–1, FASB issues SFAS

8, on accounting for foreign currency trans-lation, which requires that translation gainsand losses be reflected in earnings. Thestandard induces some major companies tominimize their accounting exposurethrough hedging, thus risking economicexposure. Industry places pressure onFASB to revise the standard; this is

achieved in 1981 by SFAS 52, whichexcludes certain translation adjustmentsfrom earnings, placing them instead in theshareholders’ equity section of the balancesheet until the related transactions are con-summated.

Comment. This was an example ofaccounting gains and losses not necessar-ily corresponding with economic gains andlosses. To avoid the adverse economiceffects of companies’ hedging against theiraccounting gains and losses, as well asbending to the pressure from companiesnot to magnify the volatility of their earn-ings trends, FASB decided to remove thetranslation adjustments from earnings untilthe eventual completion of the related trans-actions. SFAS 52 was approved by a 4–3vote; the dissenters disagreed with,among other things, the propriety of mak-ing direct entries in shareholders’ equity.FASB’s general dissatisfaction with clas-sifying gains and losses as shareholders’equity gave rise to “comprehensiveincome” in the board’s conceptual frame-work, a concept ultimately implemented asa standard in 1997.

1975By a vote of 5–2, FASB issues SFAS

12, on accounting for marketable securi-ties, which requires recognition in earningsof unrealized holding gains and losses oncurrent marketable equity securities, butplaces in shareholders’ equity such gainsand losses on noncurrent marketableequity securities.

Comment. This was another area whereaccumulated gains and losses wereparked in shareholders’ equity instead ofbeing included in earnings, even thoughthe market prices of the securities werereadily available. It revealed the board’sreluctance to reflect upward revaluationsof noncurrent assets in earnings.

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The Trueblood Study Group, created bythe AICPA in 1971, issues a booklet,Objectives of Financial Statements, whichadvocates a “decision usefulness”approach to the development of account-ing standards. 2

SFAS 2 and SFAS 5 signal FASB’s commit-ment to the primacy of the “asset-and-lia-bility view” over the traditional “revenue-and-expense view.” Robert T. Sprouse, one ofthe original members of FASB, had writtenin the October 1966 Journal of Accountancyabout the problems implicit in the revenue-and-expense view.

FEBRUARY 2005 / THE CPA JOURNAL 21

1975–1981Because of the Arab oil boycott and at

a time of rising crude oil prices, Congresspasses the Energy Policy and ConservationAct of 1975, which instructs the SEC torequire all oil and gas companies to adoptthe same accounting method instead ofchoosing between “successful effortscosting” and “full costing” in their finan-cial statements. In 1977, by a 4–3 voteFASB issues SFAS 19, which allowsonly successful efforts costing. Small oiland gas producers, which had all beenusing full costing, protest vigorously andenlist support in Congress, the Departmentsof Energy and Justice, and the FederalTrade Commission. Finally, in 1978’sAccounting Series Release 253, the SECsays it favors “reserve recognition account-ing,” a version of current value account-ing. The major oil and gas producersobject, and finally the SEC settles for alengthy footnote disclosure. Oil and gascompanies continue to use either success-ful efforts costing or full costing in theirfinancial statements.

Comment. FASB felt rebuffed by theSEC’s decision to propose a solution otherthan the one it had recommended. But SECChairman Harold M. Williams pointed outthat this had been a unique case, where theSEC had been expressly charged byCongress to find a solution. Apart fromAccounting Series Release 190 on replace-ment cost accounting (discussed above),this was the only instance in which theSEC overruled FASB on a substantiveaccounting issue.

It is a matter of interest that the SEC’sdecision was formulated by the commis-sioners themselves, and not by the SEC’saccounting staff. The commissioners hadbecome actively engaged in the account-ing issue—something that rarely occurs—because of the intense political lobbying

by the powerful oil and gas industry, whichsecured the eager support of members ofCongress from oil-producing states. Tononaccountants, historical cost accountingis not a solution that responds to theinformation needs of investors and credi-tors. The Sandilands Committee, men-tioned above, had earlier arrived at a sim-ilar result. Historical cost accounting is aconstruct understood by accountants anda puzzle to nonaccountants, who typicallybelieve that current market value is morerelevant for investors and creditors.

Concerned about their ability to obtainbank financing, small and medium-sizedoil and gas exploration companies hadresisted successful efforts costing,because it would make their earnings trendmore volatile and, in the near term, vastlylower their earnings. The EnergyDepartment did not like successful effortscosting because the exploration companies’more volatile earnings would be a disin-centive to explore in untried fields. TheJustice Department, together with theFederal Trade Commission, feared that suc-cessful efforts costing by small and medi-um-sized exploration companies wouldlead to bleak earnings pictures that mightdrive them into mergers with the bigcompanies, thus reducing the number ofcompetitors in the industry. These were allpolitical reasons, not accounting reasons,and after hearing all of the arguments, theSEC commissioners favored current valueaccounting instead of either version of his-torical cost accounting.

After the SEC proposed requiring oiland gas companies to report the gains fromthe increase in market value of theirproved reserves in their income state-ments—gains, because the OPEC cartelwas regularly raising the price of crude—the American public, which was alreadyconcerned about the rising price and

scarcity of fuel, had risen in wrathagainst the oil industry. The last thing thatthe major oil and gas companies (Exxon,Mobil, Gulf, Shell) wanted to report waseven higher accounting earnings, becauseof their concern over the appearance ofgouging the public.

In the end, the SEC withdrew the pro-posed requirement to record current valuesin the financial statements of oil and gascompanies and instead instructed FASB toissue a standard (which became SFAS69, approved 4–3 in 1982) that would spec-ify “a comprehensive package of disclo-sures for those engaged in oil and gasproducing activities,” reflecting current val-ues. The oil and gas industry had weath-ered the storm; as before, some companieswere using successful efforts costing, whileothers were using full costing. Historicalcosts continued to be used in the body ofthe companies’ financial statements.

1976After considerable pressure from the

leasing industry, FASB issues SFAS 13,approved 5–1, establishing the capitaliza-tion of long-term financing leases onlessees’ books. The standard is amendednumerous times as FASB seeks to closeloopholes, yet SFAS 13 nonetheless provesto be ineffective in requiring that mostlong-term leases be capitalized.

Comment. Because of the resourceful-ness of the leasing industry in findingloopholes in SFAS 13, this became themost frequently amended accounting stan-dard. It demonstrated that a standards set-ter should not establish explicit, arbitrarycutoff percentages, because companiesseeking to circumvent the intent of thestandard will inevitably find ways to doso. It may be the best example of a rule-based standard that fails to specify a guid-ing principle.

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FASB issues SFAS 12, on accounting for marketable securi-ties. This was another area where accumulated gains andlosses were parked in shareholders’ equity instead of beingincluded in earnings, even though market prices were readi-ly available.

The SEC’s Division of Corporation Financeand Office of the Chief Accountant (led byJohn C. (Sandy) Burton, left) begin to issueStaff Accounting Bulletins, which representthe interpretations and practices followedin administering the disclosure requirementsof the federal securities laws. 3

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1976–1977Two Congressional reports recommend

that the SEC no longer rely on FASB foraccounting standards but instead issue thestandards itself.

Comment. The reports were issued bythe staff of the Senate’s MetcalfCommittee and by the House’s MossCommittee. The issue of public-sector ver-sus private-sector standards setting wasraised in these reports, but, in the end,no Congressional action was taken onthese recommendations.

1977By a 5–2 vote, FASB issues SFAS 15,

on accounting by debtors and creditors fortroubled debt restructurings, which, ineffect, allows financial institutions that agreewith debtors to modify the terms of theirlong-term loan agreements (lengthening theterm and reducing the interest rate) to avoidrecording a loss on the restructuring. Thebanking industry argued that a require-ment to recognize a loss in such circum-stances would lead to reluctance by banksto renegotiate such loans, thus leading to ahigher rate of business failure.

Comment. In 1973, the City of NewYork was said to be bankrupt, and, with greatdifficulty, the banks that held the city’s debtinstruments restructured the debt by modi-fying its terms. The principal paymentswere postponed, and the interest rate on thedebt was lowered. The banks proposed notto reduce the balance on their books of theloan receivable from the city and thereforenot to recognize any immediate accountingloss. FASB began to study the question,and the possibility of recognizing a loss inthe event of such restructurings was put to apublic hearing. At the hearing, CiticorpChairman Walter B. Wriston said that if thebanks had known that they might be requiredto recognize an immediate accounting loss

from restructuring the city’s debt, “the restruc-turing just might not have happened.”Furthermore, the prospect of a required recog-nition of a loss in such cases led Wriston todoubt that such restructurings would be pos-sible in the future. His bombshell testimonyput considerable pressure on FASB. In theend, the board said in SFAS 15 that if, aftera restructuring, the total cash flows to bereceived under the new terms were nolower than the balance in the receivableaccount, no writedown or loss recognitionwould be required. The standard was heav-ily criticized because it ignored the econom-ic reality of the transaction altogether.

Application of SFAS 15 also prolongedand deepened the financial crisis faced bybanks and savings and loan institutions inthe 1980s. Many banks and thrift institu-tions effectively became insolvent becauseof many bad loans, especially at a time ofhigh interest rates. Federal regulatorsallowed them not to record writedowns orrecognize losses after they had restruc-tured loans to accommodate the debtors.Hence, many of these financial institutionscould issue balance sheets projecting anapparent solvency, when many should havebeen closed. SFAS 15 was used by regu-lators to justify this policy. As a result, thestandard was said by many to be theworst ever issued by FASB.

1977Responding to criticisms from within the

accounting profession, the FinancialAccounting Foundation’s (FAF) trusteesstrengthen FASB’s due-process proceduresand impose a 4–3 majority, instead of asupermajority of 5–2, to approve its stan-dards. It was believed that the required 5–2majority was holding back FASB approvalof several standards (notably SFASs 19 and34). The board also opens its meetings topublic observation.

1978–1985FASB issues its Concepts Statements on

objectives, qualitative characteristics, ele-ments (definitions), and recognition andmeasurement, constituting its conceptualframework for business enterprises. As theissues become more specific, eventuallydealing with the sensitive and practical mat-ters of recognition and measurement, theboard can agree only to be general and notprescriptive. This reflects the fact that eachof the board members has an individual con-ceptual framework, which becomes evidentwhen the core issues of recognition andmeasurement are taken up. The result of theboard’s conceptual framework discouragesthose who had hoped that it would point theboard toward a resolution of its most diffi-cult standards issues.

Comment. Although there was no sug-gestion in the Wheat Study Group’s reportthat FASB should develop a conceptualframework, the board discovered that sev-eral of the early standards—for example,on research and development costs andcontingencies—required it to defineassets and liabilities more clearly.Furthermore, the Trueblood Study Group’sbooklet, Objectives of FinancialStatements, was available as the first layerof such a framework.

The conceptual framework became amassive project. Between 1974 and 1985,the board issued 30 discussion memoran-da, research reports, exposure drafts, andother publications, totaling over 3,000 pages.The first Concepts Statement, Objectivesof Financial Reporting by BusinessEnterprises, was published in 1978. The sec-ond, Qualitative Characteristics ofAccounting Information, published in 1980,was widely imitated in other countries.

The series of Concepts Statements proveduseful to the board when facing novelaccounting questions. The board wanted to

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In 1975, Congress instructs the SEC to require all oil and gas companies to adopt the same accounting method insteadof choosing between “successful efforts costing” and “full costing.” In 1977, SFAS 19 requires successful effortscosting. Small oil and gas producers protest vigorously and enlist political support. In 1978’s Accounting Series Release253, the SEC favors “reserve recognition accounting,” a version of current value accounting. Large oil and gas pro-ducers object, and finally the SEC settles for footnote disclosure. Oil and gas companies may continue to use eithermethod. FASB was embarrassed by the SEC’s decision to propose a different solution. SEC Chairman Harold M.Williams called it a unique case, where the SEC had been expressly charged by Congress to find a solution.

FEBRUARY 2005 / THE CPA JOURNAL 23

be guided by principle wherever possible,and the framework contributed toward thatend. But it became evident that a consider-able amount of reasoning was needed toconnect the framework with the specificaccounting problems to be solved.

FASB was a pioneer in that it was thefirst accounting standards setter in theworld to complete work on a full-fledgedconceptual framework. Since then, the

standards setters in Australia, Canada, theUnited Kingdom, and New Zealand, aswell as the International AccountingStandards Board, have borrowed ideasfrom FASB’s framework. In later years,FASB has revisited the framework, forexample by issuing a Concepts Statementin 2000 on cash flow information andpresent values in accounting measurements.In October 2004, FASB and theInternational Accounting Standards Board

agreed to develop a common conceptualframework, building on the two bodies’respective frameworks.

1979By a 4–3 vote, FASB issues SFAS 34,

requiring that companies capitalize interestcost for certain self-constructed assets. Thestandard is issued to correct an abuse. In1974, at a time of rising inflation and inter-

est rates, a number of companies hadbeen capitalizing, rather than expensing,their interest cost, so as to report higherearnings. At this time, the SEC immedi-ately placed a moratorium on this practiceuntil FASB could decide whether it was aproper accounting practice.

Comment. The capitalization of thecost of interest had not been practiced inthe United States other than in the publicutility industry, where the rate of return

on investment was used by regulators toset prices. In that industry, the interest costincurred to expand plant capacity wasintentionally charged to future genera-tions of users through capitalization andthen amortization when the new capacitywent into service. To expense the cost ofinterest would, in effect, charge currentusers for the interest cost to build futurecapacity.

The matter had not previously been thesubject of an accounting standard anywherein the world, and there was no prohibitionagainst capitalizing the cost of interest. Fiveyears after the SEC, fearing that thesecompanies’ financial statements might bemisleading to investors and creditors,placed a moratorium on the practice, FASBissued its standard on the subject. In SFAS34, it narrowly defined the classes of assetson which interest could be capitalized.

1985, 1987, 1990, 1996On four occasions, as the flexibility to

produce favorable earnings grows in impor-tance to CEOs, industry places pressure onFASB to be more responsive to its objec-tions. Attempts are made to expand thenumber of industry representatives on theFASB board and to exercise more controlover its agenda. In 1990, industry persuadesthe FAE trustees to raise the majorityrequired to approve standards from 4–3 to5–2, hoping to slow the pace of standardssetting. In 1996, SEC Chairman ArthurLevitt, reacting to further pressure from theFinancial Executives Institute (FEI), forcesthe FAF to add four public interest mem-bers to its board of trustees.

Comment. This series of interventionsfrom industry epitomized the higher stakesthat companies placed on the flexibility tochoose their preferred accounting methods.The 1980s was a period of intense mergerand acquisition activity, and CEOs as well

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SFAS 15 allows financial institutions to avoid recording a losswhen they restructure the terms of long-term loan agreements(lengthening the term and reducing the interest rate) . SFAS15 eventually serves as a basis by which government pro-longed and deepened the 1980s savings-and-loan crisis. Thestandard is said to be the worst ever issued by FASB.

After considerable pressure from the leasing industry, FASBissues SFAS 13, approved 5–1, establishing the capitalizationof long-term financing leases on lessees’ books. The stan-dard is amended numerous times, but SFAS 13 nonethelessproves to be ineffective in requiring that most long-term leas-es be capitalized.

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■ FASB member John March, Pensions Public Hearing, 1984

as CFOs began to pay close attention toFASB’s proposals to disallow certainaccounting methods, impose additional dis-closures, and specify in greater detail howits standards were to be interpreted. As com-panies increasingly based annual bonuses onaccounting earnings, and increasingly turnedto employee stock options, executivesbecame more sensitive to how earnings weremeasured. In the 1990s, it became commonfor financial analysts to issue earnings fore-casts, and company executives knew thattheir share price would suffer if they report-ed earnings-per-share below the forecast. Allof these pressures were in turn transmittedto FASB, and industry sought to have moreinfluence over the actions of the standardssetter. Of course, the SEC would continueto enforce FASB’s standards strictly, impos-ing heavy penalties for noncompliance.

At the same time, top corporate execu-tives transmitted these pressures to theiraccounting departments and from there totheir external auditors, which is one expla-nation of the willingness of auditors toaccede to the marginal and even illicitaccounting practices that have come to beknown as “managed earnings.”

While industry enjoyed a few successesin influencing the composition and operat-ing procedures of FASB, the SEC intervenedto protect the independence of the board,especially in 1987 and 1996, when theBusiness Roundtable and FEI, respectively,sought to exert more industry control overthe operation and governance of FASB.

1985By a 4–3 vote, FASB issues SFAS 87,

on employers’ accounting for pension plans,after 11 years of study on the large andcomplicated subject of pension accounting,comprising three discussion memoranda,six exposure drafts, four public hearings,and six standards. While it represents an

improvement in pension accounting prac-tice, it significantly understates the fullaccounting impact of company pensionplans by a variety of smoothing rules andan extended adoption period. Also, the stan-dard appears at a time of strong stock andbond markets. Industry had successfullylobbied FASB to dampen the effect ofvolatility on companies’ earnings as a resultof market value fluctuations.

Comment. This was a sensitive subjectthat had been followed closely by theBusiness Roundtable since the 1970s. It wasespecially critical to companies in olderindustries, such as automobiles and steel.Once again, companies pressed FASB notto heighten the volatility of earnings.

1987By a 6–1 vote, FASB issues SFAS 94,

which requires parent companies to con-solidate subsidiaries with nonhomogeneousoperations, such as the finance subsidiariesof manufacturing parents. FASB alsoendorses the notion of control for deter-mining when investee companies shouldbe consolidated, but the board puts offimplementation. It makes several attemptsto implement it in the 1990s, but cannotagree on an adequate and workableapproach for doing so.

Comment. Companies were concerned thatthe consolidation of industrial parent compa-nies with their finance subsidiaries (e.g.,General Motors, Ford, and General Electric)would confuse readers about the debt-equityratio of the industrial parent. Finance compa-nies are much more heavily leveraged thanindustrial companies, and industry preferredthat their financial statements not be merged.General Electric has responded by publishingthree sets of financial statements in its annu-al report to shareholders: the consolidatedstatements, the parent company statements,and the finance subsidiary’s statements.

1987By a 4–3 vote, FASB issues SFAS 95,

which requires companies to publish a cashflow statement, replacing the Statementof Changes in Financial Position (fundsstatement). The standard implements a rec-ommendation in Concepts Statement 5, onrecognition and measurement. FASBallows companies to use either the director the indirect method of presentation.

Comment. The cash flow statementreplaced the Statement of Changes inFinancial Position, a funds flow statement,reflecting a worldwide trend. Standardsrequiring cash flow statements were issuedin Australia in 1983 and in Canada in 1985;hence, on this subject, FASB was not inthe vanguard.

1987–1992By a 5–2 vote, FASB issues SFAS 96,

which establishes an asset-and-liabilityapproach for determining deferred tax lia-bilities, but prohibits the recognition of taxbenefits expected to be realized in futureyears. Shortly after its issuance, FASB con-cludes that the standard is unworkable andtoo complex, and it postpones the effec-tive date of SFAS 96 three times. Finally,in 1992, FASB unanimously issues SFAS109, which allows deferred tax assets tobe recognized in many situations.

Comment. This was one of the bestexamples of how the asset-and-liabilityview led to a more defensible standard.

1990FASB unanimously issues SFAS 106, on

accounting for postretirement health-carecosts. This standard was strongly opposed byindustry because companies did not want toshow a liability for the contractual commit-ments they had given over the years to coverretired-employee health-care. General Motorsrecognizes a first-time expense and liability

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After many years of studying pension accounting, FASB issuesSFAS 87, on employers’ accounting for pension plans. Whileit represents an improvement, it understates the full impact ofcompany pension plans by smoothing rules and an extendedadoption period. Companies had successfully lobbied FASBto dampen the effect of volatility on companies’ earnings asa result of market value fluctuations.

SFAS 95 requires companies to publish a cash flow statement,implementing a recommendation in Concepts Statement 5.FASB allows companies to use either the direct or indirectmethod of presentation. The cash flow statement replaced theStatement of Changes in Financial Position, a funds flow state-ment, reflecting a trend occurring around the world.

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of $20.8 billion, which constituted 77% per-cent of its shareholders’ equity at the end ofthe previous year. The shareholders’ equitybalances of Chrysler, Ford Motor, AT&T,and IBM are also hit hard by the newly rec-ognized liability. Many regard SFAS 106 asthe best standard FASB ever issued, as itforces companies to face the true cost of theirfuture obligations for health-care benefitsgranted to employees. It gives rise to themaxim “You manage what you measure.”

Comment. Industry intensely dislikedthis standard and fought against it; after-wards, companies conceded its construc-tive effect on their decision making. It isan excellent example of how a standardcan have a considerable impact on corpo-rate behavior. SFAS 106 has been one ofthe board’s successes.

1993By a 5–2 vote, FASB issues SFAS 115,

on accounting for investments in certainequity and debt securities. Although the SECargues strongly for fair value accounting,with all gains and losses recognized in earn-ings, the banking industry vociferouslyopposes this solution because of the result-ing earnings volatility. A political compro-mise is thus forced on the board to recog-nize “trading securities” and “available forsale securities.” Both would be on the bal-ance sheet at fair value, but the unrealizedgains and losses on “available for sale secu-rities” would be parked in shareholders’equity, and not be taken to earnings.

Comment. This standard was a revisionof SFAS 12, which distinguished betweencurrent and noncurrent investments in secu-rities. This reconsideration began in earnestwhen SEC Chairman Richard C. Breedenmade it known in 1990 that he favored theuse of current value accounting for mar-ketable securities held by banks and thriftinstitutions. The SEC was an unusual

source for the advocacy of current value,or fair value, accounting in company finan-cial statements, as it had strongly assertedthe propriety of having financial statementsprepared on the basis of historical costaccounting since its founding in 1934 (thelone exception being reserve recognitionaccounting for oil and gas producers in1978). This marked the beginning of theSEC’s more yielding position toward fairvalue accounting in the 1990s, especiallyfor financial instruments.

As the board moved in the direction ofa current-value standard, with the gainsand losses taken into the income statement,the banking industry, including Secretary ofthe Treasury Nicholas Brady and FederalReserve Board Chairman Alan Greenspan,protested vigorously. Congress also becameinvolved. Their concern was not only overthe volatility of earnings that the standardwould create, but also over its possible effecton credit availability and the perceivedfinancial stability of the country’s bankingsector. The board’s political solution allowedgains and losses accruing on securities mostlikely to have large gains and losses (i.e.,those designated as available for sale secu-rities) to be buried in shareholders’ equity,while the more modest gains and losses ontrading securities (i.e., ones likely to bedisposed of very soon) would be shown inthe income statement.

1995In another application of fair value

accounting, by a 5–2 vote FASB issuesSFAS 121; it requires companies to rec-ognize the impaired values of assets but,at the same time, stops them from over-accruing provisions (i.e., “big bath”charges) that would artificially ensurelarger reported profits in the future.SFAS 121 (which is superseded in 2001by SFAS 144) provides a series of deci-

sion rules for such writedowns, includingthe fair value of the impaired assets or,in the absence of a determinable fairvalue, the present value of futureexpected cash flows.

Comment. SFAS 121 addressed a prob-lem that had attracted considerable attentionin the 1980s, when some companies werethought to have exaggerated the amounts oftheir impairment writedowns in order to pro-ject a rosy future. The market ignored mas-sive writedowns in such circumstances,because it was interested only in futureprospects, and the companies took full advan-tage of this tactic. The purpose of the stan-dard, which represented another step in thedirection of fair value accounting, was toimpose some discipline on companies record-ing impairment writedowns. As with manyof FASB’s standards, there were no prece-dents in other countries on which to build.

1995By a 5–2 vote, FASB issues SFAS

123, on accounting for employee stockoptions. This standard also involves an esti-mate of fair value, through the use ofoption-pricing models. But an unprece-dented political lobbying campaign bysmall, high-technology companies securesthe active support of Congress and preventsFASB from requiring the recognition ofthe stock option expense in companies’income statements. Instead, the amount ofthe expense for options recently grantedis to be disclosed only in a footnote to thefinancial statements.

Comment. The run-up to SFAS 123 wasone of the best-known examples of politicalpressure on FASB, including strong influenceexerted by Congress. Had FASB persistedin issuing a standard requiring the expensingof options, Congress might have passed leg-islation putting FASB, in effect, out of busi-ness. By the early 1990s, the awarding of

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FASB issues SFAS 106, on accounting for postretirement health-care costs. This standard was strongly opposed by industry becausecompanies did not want to show a liability for retired-employee health-care commitments. General Motors recognized a first-timeexpense and liability of $20.8 billion; Chrysler, Ford Motor, AT&T, and IBM were also hit hard. Many regard SFAS 106 as the best stan-dard FASB ever issued, as it forced companies to face up to the true cost of their obligations for health-care benefits granted toemployees over many years.

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employee stock options to corporate execu-tives and, often in the high-tech industry, toall employees, had burgeoned. The last pre-vious standard on the subject, issued by theAPB in 1972, had antedated the developmentof option-pricing models and said simply thatno compensation expense was to be record-ed unless the market price of the shares underthe option was greater than the exercise price.For income tax reasons, the exercise price wasalways set to equal the market price; hence,no compensation expense would be record-ed. Most observers considered that such stockoption compensation was not devoid of cost.

Taking advantage of the literature onoption-pricing models, FASB began devel-oping a standard that would require com-panies to expense the fair value of the stockoptions granted to executives and otheremployees. The reaction from industrywas swift and categorical: It was opposedto any such standard ever taking effect.FASB Chairman Dennis Beresford con-fessed that he had never seen a more lividreaction from CEOs to a proposed FASBstandard. A standard on the expensing ofstock options would directly affect their per-sonal compensation packages, becauseshareholders would criticize the companywhen its grants of stock options begandepressing the company’s reported earnings.

Even stronger objections came from thehigh-technology industry, especially compa-nies based in Silicon Valley. Many of themhad been reporting no earnings at all, andthey feared that expensing stock optionswould greatly increase their losses or removewhatever earnings they might ever report.When it became evident that FASB wasdetermined to proceed with the standard, theyappealed to members of Congress, claim-ing that the standard would threaten high-tech entrepreneurship. Members of Congresscan react in several ways: write letters toFASB (which usually are ineffective); hold

public hearings and ask FASB to defenditself before a hostile audience; or introducelegislation that would order the SEC not toenforce a proposed standard.

While some members of Congressfavored FASB’s proposed option-expensingstandard, a much larger number, under pres-sure from corporate political contributors,adamantly opposed it. Proposed legislationwas introduced in both the House and theSenate, either ordering the SEC to enforceFASB’s eventual standard or ordering theSEC not to enforce it. FASB held publichearings on the East and West Coasts; thehearing on the West Coast, on the edge ofSilicon Valley, was accompanied by a rau-cous protest rally in a nearby convention hallattended by thousands of high-tech compa-ny employees who had been given half aday off from work to sign petitions to thePresident and speak out against FASB.

As FASB proceeded toward issuing astandard, the “attack mentality” on CapitolHill intensified. The Senate passed a reso-lution, 88–9, urging FASB not to moveahead with its standard. Then one Senator,Joseph Lieberman (Democrat ofConnecticut), introduced a bill that wouldhave required the SEC to hold a public hear-ing and cast a vote on each future standardissued by FASB, which would, in effect,have led to the board’s demise. At that point,SEC Chairman Arthur Levitt, who had beenon record as strongly favoring FASB’s pro-posed standard, counseled FASB not tomandate options expensing, because theboard’s future existence might be at risk.Several years later, Levitt confessed that thisadvice to FASB was the biggest mistakehe made during his tenure.

Heeding the SEC Chairman and the warn-ings from Capitol Hill, FASB instead issueda standard that required footnote disclosureof the amount of the expense associated withstock options, with an indication of the impact

on earnings per share. The board encouragedcompanies to include the expense in theirincome statement, but only a few did so.

In recent years, owing to public pressuresarising from the Enron and WorldCom scan-dals, more than 825 listed companies—about 120 of them included in the Standard& Poor’s 500—have begun recording thestock option expense in their income state-ment or have announced that they will soonbegin doing so.

1997By a 5–2 vote, FASB issues SFAS 130,

on the reporting of comprehensive income,which will include those gains and lossesnot yet recognized in earnings. It proposesthis disclosure in either a separate statementof comprehensive income or an additionalsection in the income statement. Industry,however, successfully lobbies FASB to offera third alternative: disclosure in theStatement of Changes in Shareholders’Equity, a statement that financial statementreaders seldom examine carefully. The finalstandard includes all three alternatives, yetmost companies have opted to park othercomprehensive income in the Statement ofChanges in Shareholders’ Equity.

Comment. In a follow-up to ConceptStatement 3, this standard was an attemptby FASB to give greater prominence tothe gains and losses from foreign exchangetranslation and marketable securities that hadbeen relegated to shareholders’ equity. Theywere to be described as “other comprehen-sive income.” But the FEI pressuredFASB to allow the other comprehensiveincome to be reflected in a statement thatfew financial statement readers notice.

1997Amazon.com begins a practice, soon to

be adopted by other high-technology com-panies, of emphasizing “pro forma income,”

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FASB issues SFAS 121, requiring companies to recognize theimpaired values of assets while stopping them from overac-cruing provisions (i.e., “big bath”) that would artificially ensurelarger reported profits in the future. SFAS 121 (superseded bySFAS 144) provides a series of decision rules for such write-downs, including the fair value of the impaired assets.

SFAS 123, on accounting for employee stockoptions, is blocked by an unprecedented lob-bying campaign by high-technology compa-nies. This is one of the best-known exam-ples of Congressional pressure on FASB.SEC Chairman Arthur Levitt counseled FASBnot to mandate options expensing, becausethe board’s existence might be at risk.

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by which certain negative items, such asgoodwill amortization and impairmentcharges, are placed below the line, althoughthey are necessarily included in GAAP earn-ings. SEC Chief Accountant Michael Suttonand others criticize this practice of empha-sizing the positive and deemphasizing thenegative in pro forma income, thus biasinga company’s reporting. The Sarbanes-OxleyAct of 2002 requires that any such proforma income be explicitly and prominent-ly reconciled to GAAP earnings.

Comment. This was a further attempt byindustry, especially the high-tech sector, to

manage earnings by focusing readers’attention on the good news. One observerdescribed this practice as showing “earn-ings before the bad stuff.”

1998FASB unanimously issues SFAS 133, on

accounting for derivative instruments andhedging activities. Industry had fought hardagainst FASB’s fair-value proposals in thestandard. Legislation had been introducedin both the Senate and the House, and com-mittees had held hearings to persuade

FASB to back down. In the end, FASB suc-cessfully issues a fairly strong standard onan enormously complex subject.

Comment. As always, fair value account-ing was a highly sensitive subject, andSFAS 133 expanded its use.

2002By unanimous votes, FASB issues SFAS

141, on accounting for business combinations,and SFAS 142, on accounting for goodwilland other intangibles. The staff of the SEC’sOffice of the Chief Accountant, complainingthat 40% of its time is spent on the business

combinations issue, persuades FASB to addthe subjects to its agenda. For some time,FASB had wanted to ban the pooling-of-inter-ests treatment of business combinations, whichhad been seriously abused by acquisition-minded companies. In its exposure draft,FASB resolves to disallow pooling of inter-ests and to reduce the maximum life for amor-tizing goodwill and other intangibles to 20years (from 40 years, per 1970’s APBOpinion 17). Industry objects strongly to theseproposals, especially the required amortiza-tion of goodwill, and persuades Congress to

intervene. Ultimately, SFAS 141 disallowsuse of the pooling-of-interests method, andSFAS 142 imposes a mandatory annualimpairment test for goodwill and disallowsamortization. Under SFAS 142, other intan-gible assets may be amortized or be madesubject to an annual impairment test.

Comment. This began as an attempt byFASB to converge with the internationalstandard on the treatment of goodwill.While members of Congress did forceFASB to consider an impairment test forgoodwill, instead of mandatory amortiza-tion, the board concluded that it could

accept an impairment test as a matter ofprinciple, and it went ahead accordingly.

Ironically, because of the depressed eco-nomic conditions following the approvalof SFAS 142, quite a few companies hadto reduce their earnings by much morewhen applying the mandatory annualimpairment test for goodwill than theywould have recorded by amortizing good-will over a 20-year period.

The elimination, at long last, of the pool-ing-of-interests method to record mergerswas a triumph for FASB.

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Amazon.com emphasizes “pro formaincome,” placing certain negative itemsbelow the line. SEC Chief AccountantMichael Sutton and others criticize thispractice as biasing a company’s reporting.The Sarbanes-Oxley Act of 2002 requirespro forma income be prominently andexplicity reconciled to GAAP.

SEC Chairman Arthur Levitt, reacting to fur-ther pressure from FEI, forces the FAF toadd four public interest members to itsboard of trustees. The SEC intervened toprotect the independence of the boardwhen industry sought to exert more con-trol over operation and governance.

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■ The Securities and Exchange Commission with Division Directors and Office Heads, 1995.

2002–2003The Sarbanes-Oxley Act of 2002 (SOA)

requires that FASB be financed hence-forth by fees assessed against publicly trad-ed companies, instead of by donations fromthe private sector. The purpose of thischange is to enhance FASB’s indepen-dence. SOA also charges the SEC with des-ignating a private-sector standards setter thatmeets the criteria for establishing account-ing principles that are to be regarded as gen-erally accepted for purposes of the securi-ties laws. In April 2003, the SEC announcesthat it will continue to recognize FASB pro-nouncements as generally accepted.

SOA instructs the SEC to study the meritof principles-based accounting standards,in contrast to the traditional emphasis inthe United States on rule-based standards.Both FASB and the SEC respond posi-tively, but it is the SEC’s accounting staffthat had traditionally pressed FASB to issuemore and more detailed rules. The highlylitigious environment in the United Statesis another reason accounting standards hadbecome detail-oriented.

Comment. FASB is likely to emphasizeprinciples and objectives in its forthcom-ing standards, but it remains to be seenwhether its standards will become shorterand less detailed. There is no sign that theSEC accounting staff is becoming lessinsistent on company compliance withdetailed norms. The accounting culture inthe United States is one of highly specif-ic and prescriptive standards, and a changein culture is not simple to achieve.

2004FASB issues an exposure draft to con-

verge with the International AccountingStandards Board’s IFRS 2, on share-basedpayments. As in the 1993/1994 debate, thehigh-technology sector vigorously opposesa required expensing of employee stock

options in the income statement, andengages the strong support of more than 300members of Congress to support its posi-tion against FASB. In December, FASBissues SFAS 123(R) to require the com-pensation cost of share-based payments,including employee stock options, to be rec-ognized in financial statements.

Comment. As expected, FASB hasencountered fierce criticism from the samequarters as it had 10 years earlier with SFAS123. Congress has become even moreengaged on this occasion than before, andin July 2004, by a vote of 312–111, theHouse actually passed legislation, known asthe Stock Option Accounting Reform Act,which would limit the applicability ofFASB’s standard. Under this bill, the stan-dard would apply only to options issued tothe CEO and the next four most highly paidexecutive officers, for whom the expens-ing requirement would take effect immedi-ately. It also stipulated that volatility shallbe assumed to be zero when using anoption-pricing model to estimate the amountof the expense. It would delay any expens-ing for small companies until three yearsafter the initial public offering had takenplace. The bill required the Commerce andLabor Departments to complete, within oneyear, an economic impact study of theexpensing of stock options. One observerhas said that a Congressional mandate tochange economic reality does not changeeconomic reality. The Senate, which wasdivided on the contentious subject, did notact on the House-passed bill before Congressadjourned in December. The previousOctober, FASB said it would postpone theeffective date of SFAS 123(R) to June 2005.In doing so, it accepted the SEC’s argumentthat companies were already totally preoc-cupied at year-end with implementing theinternal controls mandated by Sarbanes-Oxley. By next June, it seems very likely

that the same coalition that opposed FASB’sstock option expensing initiative in 2004will press again for legislation to preventSFAS 123(R) from going into effect.

The Future of Standards SettingWhen a highly prescriptive standards set-

ter is coupled with a rigorous enforcementprocess used by a government regulator tosecure compliance with accounting stan-dards, especially in a confrontational soci-ety such as the United States, companiesand even branches of government willlobby the standards setter not to approvestandards that interfere with their businessplans and strategies. This is what has hap-pened increasingly in the United Statessince the 1970s, and there is no sign that,on sensitive and controversial issues, it willdiminish in intensity or frequency. ❑

Stephen A. Zeff, PhD, is the Herbert S.Autrey Professor of Accounting at the JesseH. Jones Graduate School of Management,Rice University, Houston, Texas.

The author used this outline as the basisof a lecture to the International Symposiumon Accounting Standards, organized by theChinese Ministry of Finance and held atthe National Accounting Institute in Beijingon July 12, 2004. Portions have beenupdated to reflect subsequent events.

Photos on pages 18, 20, 24 courtesy of theFinancial Accounting Standards Board.

Photo on page 28 courtesy of the SECHistorical Society (www.sechistorical.org).

Timeline photos 1, 2, 3, courtesy of theAccounting Hall of Fame at Ohio StateUniversity.

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The Sarbanes-Oxley Act of 2002 (SOA) requires that FASB be financed henceforth by fees assessed against pub-licly traded companies, instead of by donations from the private sector. The purpose is to enhance FASB’s inde-pendence. SOA also charges the SEC with designating a private-sector standards setter that meets the criteria forestablishing accounting principles; in April 2003, the SEC announces that it will continue to recognize FASB’s role.SOA also instructs the SEC to study the merit of principles-based accounting standards, in contrast to traditionalrule-based standards.