The Politicization of Accounting Standard Setting

At one time I would have smacked myself for saying “Amen, Arthur Levitt!” In a Washington Post OpEd, “Weakening A Market Watchdog: An Accounting Rule Change’s Real Costs,” Levitt observes that FASB’s action on fair value measurement in inactive markets and other-than-temporary-impairment is a first erosion of the independence of the accounting standard setting process.

With the passage of Proposed FASB Staff Positions FSP FAS 157-e, “Determining Whether a Market is Not Active and a Transaction is Not Distressed,” and FSP FAS 115-a, FAS 124-a and EITF 99-20-b, “Recognition and Presentation of Other-Than-Temporary Impairments,” the question many are asking is “has the FASB bowed to political pressure on fair value measurement, compromising investor transparency?”

Many have called for further guidance on mark-to-market accounting in illiquid markets (see discussion of “investor views”), and FASB members had asserted that these staff positions clarify much of the intent of the original standards. However, as Levitt observes, while the theory of the latest FASB staff positions may be arguable (not by him,) that doesn’t resolve his fundamental concerns about (1) responding to Congressional pressure to act quickly, and (2) a rush to action without the typical due process of an independent standards setting process.

In a press conference following the FASB decision, Board members responded to criticism that they had succumbed to political pressure, insisting that due process had been achieved, judging from the number of comment letters received during the two-week comment period. A Board member also defended the FASB’s continued role as an independent standard setter, noting however, that it was not immune to observing the current turmoil in the markets.

The CPA profession has long defended the necessity for independence in the standard setting process. In December 2008, outgoing SEC Chair Christopher Cox appealed to the new administration to understand that:“

Accounting standards should not be viewed as a fiscal policy tool to stimulate or moderate economic growth, but rather as a means of producing neutral and objective measurements of the financial performance of public companies.”

Responding to those who advocate setting aside independence in abnormal periods for quick fixes, Cox stated:

“The truth is that the value of independent standard setting is greatest when the going gets tough. The more serious the stresses on the market, the more important it is to maintain investor confidence.”

FASB Chair Robert Herz made the same argument in 2003, citing the lasting truth of a 1978 Journal of Accountancy quote from Professor David Solomons:

“if it ever became accepted that accounting might be used to achieve other than purely measurement ends, faith in it would be destroyed just as faith in speedometers would be destroyed once it were realized that they were subject to falsification for the purpose of influencing driving habits.”

This plea is being lost, as the U.S. House of Representatives considers a non-independent governmental accounting oversight board under HR 1349 — the Federal Accounting Oversight Board Act. This “regulatory reform” would truly be an expansion of government authority over what has historically been an independent process.

Will the SEC bow to political pressure as FASB may have done? Observers state that application of the new rules will be dependent on whether they are supported by auditors and those who regulate the auditors. As a new administration calls for increased scrutiny of large institutions, particularly the financial sector, and also for relaxing of accounting rules, who will be blamed when balance sheets are overly optimistic? The auditors, perhaps?

Rarely will there be an accounting standard that is perfect for all users, but adequate due process provides the opportunity for all voices to be part of the debate. Opening the standard setting process to political interference does not protect the public interest, but instead provides protection for those best able to exert political influence.

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7 Responses to The Politicization of Accounting Standard Setting

  1. Bravo on a fantastic post bringing light to the subject of politicization of accounting. I happen to disagree with those who claim that FASB ‘caved’ to political pressure on the recent fair value guidance; I think the only aspect that even remotely approaches ‘caving’ is in terms of the time pressure in meeting Congress’ ultimatum of delivering final guidance within 3 weeks of the Match 12 Congressional hearing on M2M ; the 3 week deadline-ending on April 2-coincided with the G-20 meeting, and fair value was among the issues listed on the Washington Action Plan at the November G-20 mtg in Washington, DC (as well as transparency issues like off balance sheet accounting).

    I am glad to see you quoting Prof. David Solomons (via FASB Chairman Bob Herz’ quoting him)-I was very lucky to have Dr. Solomons as my Accounting Theory professor at Penn in 1982, and I would say that while he did staunchly defend the qualitative characteristic of Neutrality (and freedom from bias, including political pressure) which is central to FASB’s Conceptual Framework, I would also like to point out that, as he has been referred to by some as the ‘father of Concepts Statement No. 2′ – The Qualitative Characteristics of Accounting Information’ (I believe it says that in his bio in the Accounting Hall of Fame)- I believe he would have also reminded people of the need to balance Relevance and Reliability- a balance which some believe, particularly in the fair value debate, had passed the tipping point toward sacrificing reliability for what some perceive to be relevant. Although we cannot ask him today (since he passed away in the mid-1990’s) I am not sure if Dr. Solomons would be entirely pleased with the changes to the Conceptual Framework going on right now, specifically as relate to what some perceive to be a weakening of the balance between reliability (now less of a direct factor than the more amorphous Representational faithfulness’) vs. Relevance.

    Why does this matter in terms of the fair value debate? If you ask someone, ‘Do you want to know the Fair Value’ of something, I.e. I’d it more relevant to them than, say, Historical Cost, some of many may say sir , they’d prefer to know the fair value, at least for certain assets under certain circumstances. But, if they truly understood the tradeoff in reliability, including suditsbility and verifiability, of information that they are told is a ‘fair value’ and they perceive to be a ‘market value’ but is not a widely agreed upon market value compared to , say, listed stocks, that calls into question the representational faithfulness and ubderstandability of the information to all but the most highly sophisticated investors.

    Thank you for posting on this important topic. Some other commentary on the FAS 157 developments and reactions to some of the points in Arthur Levitt’s OpEd which you open with can be found in some of the posts over the past 12 days or so in the FEI blog.

  2. Sorry for typos in my comment above, e.g. ‘Sir’ should be ‘sure,’ one of the downfalls of iPhone autospell. To read more about Dr. Solomons, Google: ‘David Solomons and Accounting Hall of Fame’ and you’ll see the link to his bio on the Accounting HOF website, hosted by The Ohio State University’s Fisher College of Business.

  3. Laura Hay says:

    Welcome Edith, and thanks for the added insight! To follow the story behind the story, read Edith’s Financial Reporting Blog for FEI at http://financialexecutives.blogspot.com/.

  4. Greg Gibson says:

    The obvious point this article misses is that FASB and the SEC have THEIR OWN political agendas that they have been actively promulgating for at least the last decade!!! “Transparency” has become FASB’s equivalent of “We must save the Children”, which is every politician’s rallying cry to push an otherwise untenable position on a sceptical public. Fair value accounting is just such an agenda and produces little if any additional “transparency” especially with respect to Level 3 assets. In fact, in many cases mark to market injects unnecessary complexity and volatility into financial statements, particularly those of financial services companies without any tangible benefit. I remember vividly a very wise lecture from one of my university accounting professors who stated “Accountants are scorekeepers, they should not be and are not referees, coaches, players or owners, they should not even be on the field but rather in the scorers box keeping score.” This is certainly not the agenda upon which FASB and the SEC have embarked in the recent past. I personally am adamantly opposed to regulatory creep and the interjection of the Federal government into the private sector. However, until FASB and the SEC learn to admit they can be wrong and reverse themselves of their own accord without direct threat from Congress or some other oversight group, they have not proven they have the wisdom to act as an unelected governance entity who directly impact the lives of all in our country and have not earned the right to operate independently without some form of oversight.

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