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People, Process, Politics, Economics and Other Trends Affecting Accountants & InvestorsR. Harold SchroederFASB Member
September 20, 2013
The views expressed in this presentation are those of the presenter. Official positions of the FASB and the IASB are reached only after extensive due process and deliberations.
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2
Overview of Topics…
Trends Affecting Outcome Internal . . . People & Process External . . . Politics & Economics External . . . Convergence
Outlook for Accountants & Investors What’s the FASB doing? What’s the FASB hearing?
Projects of Note Politics . . . Leases Economics . . . Impairment
“…we must recognize that with the first decision the new board is going to gore somebody’s ox and that will be the time for us to pull together—not to splinter apart.”
GE Chairman Reginald Jones, in 1973 urging business community to stand behind the newly created FASB
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Improve Usefulness of Financial Reporting aka “decision useful”
Keep Standards Current Business & economic environment
Consider Where Standards are Deficient
Improve Common Understanding of Financial Statements
Overview of FASB…Mission
4
Conduct Independent Standard-Setting Process Due Process Outreach with stakeholders Assess feedback and redeliberate
Ensure New Standards Improve US GAAP Better reflect economics Reduce complexity Assess Costs / Benefits
Advance Global Comparability of Standards aka “Convergence”
Overview of FASB…Trustee Guidelines
6
Overview of FASB…Stakeholders
Public vs PrivateLarge vs SmallComplex vs SimpleFinancial vs Non-financialDomestic vs Multi-national
Portfolio Manager vs Analyst Generalist vs Specialist Domestic vs Multi-nationalR
ole
Str
ateg
y
Growth vs Value Macro vs Fundamental Long vs Short Equity vs Debt Buy & Hold vs Trading
Ana
lysi
s Cost vs Fair value More- vs Less-aggregation Rollfoward vs Narrative Quarters vs Years
Users
Preparers
Principles vs Rules-based Materiality vs Expedient
Auditors
Users
Preparers
Auditors
9
People…Board MembersArmstrong Kirk Beresford Jenkins Herz Seidman Golden
Num
ber
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Num
ber
44 4443 4342 4241 4140 4039 3938 3837 3736 3635 3534 3433 3332 3231 3130 3029 2928 2827 2726 2625 2524 2423 2322 2221 2120 2019 1918 1817 1716 1615 1514 1413 1312 1211 1110 10
9 98 87 76 65 54 43 32 21 1
Happy
40th!!
People…Perspectives
10
4 sellside analysts; 2 investors
Mostly National
Office technical partners
Mostly CFOs, Controllers; current from
private company
4, includes 2 SEC chief
accountants
People . . . Environment
11
High oil & inflation,
Federal bailouts of corporations
& NYC
Banking Crises of the 1980s and early 1990s
Tech boom & bust
Accounting frauds
Banking Crisis
2007-2009
Slow recovery
Bigger Federal government Period of Deregulation
Return to bigger Federal
government
12
People…Past Experiences (Current Board)Armstrong Kirk Beresford Jenkins Herz Seidman Golden
Num
ber
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Golden 41
Audit Staff National
M&A Services / Tech Cos. National FASB Staff / EITF Chair
Kroeker 44
Audit Staff National National SEC Office of the Chief Accountant
Siegel 40
Audit Staff Litigation SupportSellside Forensic Accounting
Analyst
Buck 42
Audit Staff Private Co. CFO / Retail--Grocery
Schroeder 43
Audit Staff / Mostly Private Cos.
National--Financial Services
Audit--Line Partner / Financials
Private Co. CFO
Sellside Equity Analyst--Banks Hedge Fund Portfolio Manager--Financials
Linsmeier 38
Accounting Professor with extensive research
Smith 39
Audit Staff / Mostly Public Cos. NationalAudit--Line Partner /
Mostly Public Cos. FASB Staff / EITF Chair
FASB Fellow
SEC
People…Structured Turnover
13
Example…Leases Added to Agenda on 7/19/2006 Hundreds of decisions Over 8 years By 13 different Board members
including 3 Chairmen
Armstrong Kirk Beresford Jenkins Herz Seidman Golden
Num
ber
1973
1974
1975
1976
1977
1978
1979
1980
1981
1982
1983
1984
1985
1986
1987
1988
1989
1990
1991
1992
1993
1994
1995
1996
1997
1998
1999
2000
2001
2002
2003
2004
2005
2006
2007
2008
2009
2010
2011
2012
2013
2014
2015
2016
2017
2018
Num
ber
44 4443 4342 4241 4140 4039 3938 3837 3736 3635 3534 3433 3332 3231 3130 3029 2928 2827 2726 2625 2524 2423 2322 2221 2120 2019 1918 1817 1716 1615 1514 1413 1312 1211 1110 10
9 98 87 76 65 54 43 32 21 1
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Accounting Wars…CongressMetcalf Committee (1977-1978) Issues report, “The Accounting Establishment”
- First serious challenge to FASB independence
- Recommends Federal takeover of accounting standards Leads to SEC overruling FASB
- FASB 19, Financial Reporting and Accounting for Oil and Gas Companies
Stock Compensation (1993-2004) “Exhibit A”
Fair Value Accounting (2009) Congress holds hearings
- Suggests FV exacerbated financial crisis
Change in Economic
Environment
Change in Economic
Environment
16
1993, FASB Proposes Expensing of Stock Options- Not well received…
• Silicon Valley organizes “Rally in the Valley” to protesto During “Tech Bubble,” internet startups pay employees in stock options
• Senate host hearing
1994, U.S. Senate Votes 88-9 for Non-Binding Resolution - Urges FASB drop project
1995, FASB Issues Statement 123 - By 5-2 vote, requires disclosure of compensation
• Result: expensing is optional• Dissenters…
o “high level of controversy and a perceived threat [to FASB]…inappropriate reasons for not requiring recognition”
Exhibit A…Stock-Based Compensation
Change in Business
Environment
17
2002-2003, Environment Begins to Change- Companies begin expensing cost of stock options
• “massive shift from paying wages…to granting stock options”*• Expensing becomes “standard of excellence”
- Then-Fed Chairman Greenspan supports expensing• To do otherwise, assumes…“real resources that contributed to the
creation of the value of the output were free”*
Standard setters react…- IASB issues ED that proposes expensing
- FASB unanimously votes to reconsider issue• Results in 2004 proposal to require expensing
Exhibit A…Stock-Based Compensation
*Source: Greenspan, Alan. The Age of Turbulence: Adventures in a New World. 2007
Change in Business
Environment
18
2004, Strong Response to Proposal- 14,000-plus comment letters are received by FASB
• Most are form letters
- House passes Stock Option Accounting Reform Act• WEB writes op-ed ridiculing bill
o 1897 Indiana House of Rep votes 67-0o pi would no longer be 3.14159, but 3.2 instead
• It’s an election year…bill passes 312-111
- Bill fails to get out of Senate Banking Committee• Chairman Richard Shelby states in op-ed…
o “The success of the FASB depends on its ability to remain insulated from the political process”
Exhibit A…Stock-Based Compensation
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Finally...Issuance of FASB Statement 123 (revised 2004)- Requires expensing of all stock-based compensation
- SEC supplements with SAB No. 107• In part, supported by Office of Economic Analysis
Decade-long Process Highlights Conflict Between… - FASB’s mission to set standards that produce greater
transparency for investors
versus
- Those who believe financial reporting standards should achieve a particular economic effect
Exhibit A…Stock-Based Compensation
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Accounting Wars…Industry
Troubled debt restructurings (1977) 1975 NYC near “bankruptcy,”* banks restructure debts
- Payments are postponed, rates lowered
- But banks don’t recognize losses FASB pressured by Federal Reserve and Banks Result: softened standard heavily criticized for ignoring economic reality
Marketable Securities (1992-1993) ABA pushes FASB into retreat
- Backstory: Break changes votes, but not outcome Result: “available for sale” created; changes in fair value flow only
through equity, not earnings
* Formal petition attesting to municipal default was signed by Mayor Abraham D. Beame on October 17, 1975, but never invoked after all parties agree to restructure debts.
Accounting Wars…Vote, Size, Mix
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TimePeriod
Vote to Pass Source of Changes
1973 - 1976 5-2 supermajority Original requirement
1977 - 1989 4-3 majority Accounting profession argues that supermajority vote was slowing process; meetings opened to public
1990 - 2002 5-2 supermajority Industry persuades FAF to raise voting requirement back to supermajority
2003 - 2007 4-3 majority Early step toward convergence efforts, post 2002 Norwalk Agreement
2008 - 2010 3-2 majority Board reduced to facilitate convergance, quick response to issues
2011 - present 4-3 majority Board expanded to provide greater investor and private company representation
Bank Loan Loss Reserves (1998-1999)
SEC expresses concerns about earnings management - Chairman’s speech, “The Numbers Game” (September 1998)
• Includes concerns about using “cookie jar” reserves
- Delays approving bank merger• In 11th hour deal, acquirer reduces reserves
Congress holds hearings- Supports SEC over bank regulators
- FASB staff issues supportive document
Result: lower reserves for bad loans- Arguably sets stage for 2007-2009 banking crisis
War on “Earnings Management”…
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H.R. 1062, SEC Regulatory Accountability Act (Garrett) 5/17/13: Passed House by a vote of 235-161 Requires SEC to conduct cost-benefit analysis of its rules
H.R. 1750, The Community Lending Enhancement and Regulatory
Relief Act of 2013 (Luetkemeyer) Requires SEC or FASB to conduct cost-benefit analyses of new or amended
accounting standards Benefits must “significantly” outweigh costs
H.R. 1628 / S. 779, The Public Employee Pension Transparency Act (Nunes/Burr) Requires state and local pension plans to report assets and liabilities according to
conservative estimates of fair market value and discount rates
S. 450, Financial Regulatory Responsibility Act of 2013 (Shelby) Requires SEC to undertake cost-benefit analysis before issuing a proposed rule Does not include FASB or GASB
Recent Examples…Pending Legislation
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Pre-Agenda Process- Make assessment earlier
- Ensure cost-beneficial alternatives exist
Benefits Should Justify Costs- Need not be greater than costs
Better Communications about Assessment- What was learned during outreach efforts
Cost-Benefit Analysis- Not an analysis of economic consequences
- Provide neutral information to portray the economics
Greater Emphasis on…
Process Changes…“Cost-Benefit” Analysis
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Main Ideas about Capitalism
Policy Tools
Monetarism
“Laissez-faire”; Minimal state inventervention and regulation of the economy
Preferably few; only used when necessary to help market function well
Keynesian
State primes (injects money / liquidity) into economy to restore confidence and stablize
Promote “fair trade” policies including some protectionist measures
Developmental State Model
State plays a proactive role in guiding economy and protecting major industries
Protectionist industrial and trade policies often necessary to make markets work
Social
Democracy
State cooperates with businesses to promote economic growth and distribution
State uses monitary policy to redistribute income
Convergence…Varying Economies
Source: Adapted from Introduction to International Political Economy, Edition No. 5, David N. Balaam and Bradford Dillman
Convergence…Varying Economies
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Hold to collect cash flows AND sell assets
Hold to collect cash flows
ONLY?
Are cash flows solely Principal and Interest?
Amortized Cost Trade receivables Loans held for investment Some debt securities Senior securitization tranches
FV-OCI* Debt securities Potentially some loans
FV-NI* Equity securities Certain debt securities Loans held for sale Convertible debt investments Residual securitization
interest Certain hybrid assets Derivatives
Form of instrument not considered(e.g. loan vs. securities)
Ho
ld t
o c
oll
ec
t
Ho
ld t
o c
oll
ec
t&
se
ll
Oth
er
bu
sin
es
s
mo
de
ls
Step 1
Step 2
Yes
Yes
No
Yes No
No
*Distinction between these two categories is generally not important for non-healthcare NFPs
29
Convergence…Varying EconomiesProposed definition of “interest”
“Interest is consideration for . . . the time value of money and for the credit risk associated with the principle outstanding during a particular time period which may include a premium for liquidity.”
What does “time value of money” mean? Not currently defined Should it reflect . . .
any market in which entity operates?
“free market”? Example: “student loans”?
What about other components of interest? Administrative and other costs Profit margin
How much is too much? Example: Payday loans? Versus credit cards and
other lines of credit?
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Fee
db
ack
Exp
osu
re D
raft
31
Convergence…Different Processes
IASB
EFRAG
Accounting Regulatory Committee
EuropeanCommission
(27 member states)
Interest Groups
Council of the
EU
EuropeanParliament
Supervisory Board
Standards Advice Review Group
Endorsement Process in the E.U.
33
Convergence…Different Approaches
“Single Set”
“Endorsement”
“Comparable”
“Advance Comparability”
Improvement Convergence
Principles Only
Principles Plus . . .
PCC vs OCBOA
Public vs Private
MoreLess
34
Convergence…Varying DegreesSingle
SetDifferent Models
Now
AFI - Impairment
2009IASB
IASB 2011Joint2010
FASBFASB
AFI - Classification &
Measurement
2009IASB 2010
FASB
2011IASB 2011
FASB
IASBFASB
Leases IASBFASB
Revenue Recognition
IASBFASB
1997IASB 2008
FASB
Insurance Contracts
IASBFASB
“Advance Comparability” MoreLess
Convergence…Clear Path
35
“One challenge is to ensure other jurisdictions move forward swiftly with reforms as strong as our own. We will coordinate our efforts with our foreign partners who are pushing forward with similar reforms abroad. It is important to have clear and consistent rules both in the United States and beyond our borders. Our financial system is global in nature, and globally active firms face many rules and regulators.
But make no mistake: we will not let the pursuit of international consistency force us to lower our standards. The United States has demonstrated important global leadership in putting in place tough new reforms. And the clarity and reliability of our laws do not just provide a bulwark against danger, they serve as an impetus for a race to the top rather than a race to the bottom.”
– excerpt, Remarks of Treasury Secretary Jacob J. Lew, July 17, 2013
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Convergence…Unclear PathConsideration of incorporating IFRS into the financial reporting system for U.S. issuers
Final SEC Staff Report issued in July 2012…
No recommendation on how U.S. should proceed
Describes positive aspects of IFRS
Identifies continuing concerns
Costs of transition Inconsistent application Permanent funding mechanism
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Convergence…Our Path Forward
FASB’s mission is to ensure capital providers benefit from… High-quality standards That can be consistently applied, interpreted and enforced to provide best
financial reporting
FASB will continue to work with national, regional and international standard setters Primarily through ASAF and IFASS Develop more comparable global accounting standards
FASB will focus on continuing to improve U.S. GAAP
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Nearing completion of “convergence projects”
Top priorities through next year… Final standards on… - Revenue Recognition
- Accounting for Financial Instruments• Classification & Measurement (early 2014)• Impairment (early 2014)
Final standards also possible for…- Leasing (ED issued)
- Insurance (ED issued)
What’s the FASB… Doing (near term) ?
40
“Completion” may be too strong a word Issuing final standards is just the beginning- Expect considerable time addressing
• Implementation issues• Education issues
For each significant project… Create transition resource group
Each group focused on… - Education
- Amendments
- Interpretation
What’s the FASB . . . Doing (near term) ?
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Expect Resource Groups to… Spend most time on Education
Include a mix of…- Preparers
- Auditors
- Users
Meet in public with full Board
Publish minutes
What’s the FASB…Doing (near term) ?
42
Us
ers
(by
pro
ject
) • RevRec• Specialists• Generalists
• Impairment• Better
information• Simpler
• C&M• Business
models make sense
• “Own credit” through OCI
• Leases• Balance sheet
more informative
Pre
pa
rers
(th
em
es
) • Systems• Long lead times• Booked IT
schedules• Data Collection• Not always
available• Not always
“clean”• Global
gathering• “SOX-ifying”• Making it
auditable• Judgments
Au
dit
ors
(th
em
es
) • “SOX-ifying”• Judgments• PCAOB
What’s the FASB…Hearing?No surprise, varies by constituent…
Transition Small changes in assumptions- Drive big differences
Examples- Insurance…computing “margin”
- Impairment…“soft adoption”
Investor confusion Just-in-time modeling
Minimal to no time spent thinking about changes- Until “sellside” posts estimates
What’s the FASB…Hearing?
43
Other issues to think about…
Participate in IASB’s new ASAF…
First meeting was April 2013
Focus on - Conceptual Framework
- Impairment
FASB decides case-by-case how to contribute- Importance to US GAAP
- How to conduct “due process”
FASAC agenda survey
Results
What’s the FASB…Doing (longer term) ?
44
Once convergence projects are complete…
45
Projects on backburner… financial statement presentation financial instruments with characteristics of equity
Issues highlighted in news stories and commentaries… pension accounting
Potential convergence items… whether the FASB should incorporate specific areas of
IFRS into US GAAP
Issues with existing US GAAP… based on results of FAF’s Post-Implementation Review
(PIR) process
What’s the FASB…Doing (longer term) ?FASAC Survey will help assess…
46
Views of Stakeholders…Top Priorities*
Users Academics IndustryIndustry
OrganizationsA&A
Profession Other
Disclosure Framework
Hedging Conceptual Framework
Characteristics of Equity Financial Statement
Presentation
OtherLiquidity /
Interest Rate
Disclosures
OCI Intangible Assets
NFP Reporting and Income
TaxesPensions
* Recommended priorities of FASB for next three to five years.
47
Views of Stakeholders…Top Priorities
Costly to provide information
Other
Good convergence opportunity
Missing information
Current information does not provide decision-useful information
Better information needed
Simplification needed
0 2 4 6 8 10 12 14Users Preparers Others
Reasons for ranking . . .
49
Why a Leases project?
“Reaching a solution has proved difficult . . . Identifying what exactly is a lease, defining the lease term, and measuring payments have been problematic. Add political sensitivity due to the size of the lease market and you have a potent mix.”
Fitch Ratings, August 5, 2013
Hidden Leverage
$1.25 trillion
of off-balance- sheet operating lease
commitments for SEC registrants*
* Estimate according to the 2005 SEC report on off-balance-sheet activities
How Proposals Improve Financial Reporting
50
How the proposals address those
issuesExisting
accounting issues
Most assets and liabilities are off-
balance-sheet
Insufficient information
provided about operating leases
Recognition of lease assets and liabilities
for all leases of more than 12
months
Enhanced disclosures
Greater transparency
about leverage, assets used in
operations and cash flows
How the proposals improve financial
reporting
How Proposals Improve Financial Reporting
Assumption: $200 million annual lease payment
Lease Term2 year 5 year 10 year 20 year 30 year
$0
$1,500
$3,000
$4,500 Lease liability at varying terms and interest rates
4%
6%
10%
7x
$ in
mil
lion
s
Right-of-use asset and lease liability reflect contractual commitments
Fixed non-cancellable lease payments
- Options?
- Variable lease payments?
Interest rate implicit in contract
- Incremental borrowing rate
51
52
Leases…Politics & Economics
An illustrative PR headline reads…
“Proposed Lease Accounting Standards to Cost 190,000 Jobs and
Companies $10.2 Billion Annually
Study Shows Negative Impact on Job Creation, Health of U.S. Real Estate Sector, and Liabilities of U.S. Publicly Traded Companies”
Source: US Chamber of Commerce press release, 2/16/12
Leases…Politics & Economics
53
PR goes on to say…
“The report analyzes the current proposal and under a best case scenario estimated its economic impacts as: Increasing liabilities for U.S. public companies by $1.5 trillion; Increasing costs to U.S. public companies by $10.2 billion annually; Potentially leading to job losses of over 190,000; Reducing U.S. household earnings by $7.8 billion annually; and Lowering U.S. GDP by $27.5 billion annually.
The coalition is calling on the Boards to conduct a comprehensive examination of the costs and benefits.”
Source: US Chamber of Commerce press release, 2/16/12
Leases…Politics & Economics
54
And a response…
“On February 16, 2012, the U.S. Chamber of Commerce (COC) issued a report that purportedly examined the economic impact of capitalizing leases as outlined in a recent FASB exposure draft. . . . The study claims dire consequences for the U.S. if the FASB continues on its course, including the loss of millions of jobs and the destruction of between $27.5 and $478.6 billion in U.S. Gross Domestic Product (GDP). If this were true, the Congress and the White House should declare the FASB a national villain, strip it of its funding, dissolve its charter, and tar-and-feather the board members and their advisers. Shame on the FASB!
Source: Anthony H. Catanach, Jr. & J. Edward Ketz, 2/27/12
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/538
Leases…Politics & Economics
55
Response then says…
“These doomsday predictions border not only on the ridiculous, but also the whimsical. The study is flawed and would be easily rejected by all mainstream accounting and finance journals. Research rigor is absent. The real shame rests with the economists who carried out this awful ‘research.’”
And concludes with…
“The U.S. Chamber of Commerce might be in favor of accounting distortions, but we are not. Let’s present in our financial reports improved information which reflects economic reality. Shame on the Chamber of Commerce for publishing this worthless research just to achieve its political goals!
Source: Anthony H. Catanach, Jr. & J. Edward Ketz, 2/27/12
http://blogs.smeal.psu.edu/grumpyoldaccountants/archives/538
Financial Crisis Advisory Group (FCAG) Formed in 2008 by FASB and IASB 15-20 senior leaders with broad experience with international
financial markets
Primary function to advise on standard-setting implications of… Global financial crisis Potential changes to global regulatory environment
FCAG recommended… Exploring alternative to “incurred loss” accounting model Utilizing forward-looking information in alternative model
Background…2008 Financial Crisis
57
58
Impairment…Rules vs RealityEconomic Debate . . .
When is a loan loss “incurred”? At origination? When there’s
deterioration?
59
Impairment…Rules vs RealityWhen do investors believe loan loss is “incurred”?
Tracking “price” and “book value” “Book Value”
may conform to accounting rules
But what if…rules don’t conform to economic reality as reflected in “price”
60
Impairment…Rules vs Reality
Note: Graph is only illustrative; assumes closed pool of commercial loans with most losses emerging in periods 2 and 3, with rise in total expected loss in period 3.
Cumulative Credit Lossesas % of Loan Balance
Three examples . . . Current US GAAP (as
applied) FASB proposal IASB proposal
Accounting outcome affected by how Boards view economics of lending Origination Deterioration
Broad Support for Objective Improve effectiveness of notes by more clearly communicating
information important to users; Sharper focus should reduce volume
But, Stakeholder Concerns About . . . Forward-looking information (boundary) Similar information in SEC requirements (boundary) How standard setters make standards flexible How preparers implement flexibility (materiality and/or relevance
guidance) Accounting policy note
Framework…Disclosures
62
63
Previts, Gary John and Barbara Dubis Merino. A History of Accountancy in the United States: The Cultural Significance of Accounting. Columbus, Ohio: Ohio State University Press, 1998.
Herz, Robert H. CPA, FCA, CGMA. Accounting Changes: Chronicles of Convergence, Crisis, and Complexity in Financial Reporting. Durham, NC: AICPA, 2013
U.S. Securities and Exchange Commission. Work Plan for the Consideration of Incorporating International Financial Reporting Standards into the Financial Reporting System for U.S. Issuers. Final Staff Report, July 13, 2012. Washington, D.C.: Securities and Exchange Commission, 2012.
Suggested Reading…
64
Miller, Paul B. W., Rodney J. Redding, and Paul R. Bahnson. The FASB: The People, the Process, and the Politics. 4th ed. Boston: Irwin McGraw-Hill, 1998.
Storey, Reed K., and Sylvia Storey. The Framework of Financial Accounting Concepts and Standards. Norwalk, Conn.: Financial Accounting Standards Board, 1998.
Street, Donna. Inside G4+1: The Working Group’s Role in the Evolution of the International Accounting Standard Setting Process. London: Institute of Chartered Accountants in England and Wales, 2005.
Suggested Reading…