Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CPA] FAR: The Architects of GAAP: Inside the FASB and GASB Standard-Setting Process
Transcript
- Welcome to VoraPrep Audio. Today we're covering a topic you'll definitely see on the FAR exam. It's also a fundamental concept in accounting. Imagine you're an analyst looking at two airlines. They fly the same routes and the same planes. Their business models are nearly identical. But one reports a massive profit, while the other reports a tiny one. You dig in and find the reason. One company capitalizes its major engine overhauls. This spreads the cost over several years. The other company expenses those overhauls all at once. So, who’s right? Without a common set of rules, you wouldn't know. It would be the Wild West. Financial statements would be completely incomparable. They'd be useless for making investment decisions. And that’s why we have standard-setting bodies. To become a CPA, you have to understand who writes the rules of accounting, and how they do it. This is the language you're going to be speaking. Who are these architects of U.S. GAAP.? First, get this straight: the rules don't come directly from the government. The SEC, the Securities and Exchange Commission, has the legal authority to set accounting standards for public companies. But the SEC has delegated that responsibility to a private-sector system. It's a carefully designed hierarchy. Think of it like this. At the very top is the parent organization. This is the Financial Accounting Foundation, or the FAF. The FAF is like the board of directors for the whole operation. It doesn't write any accounting rules itself. Its job is to oversee and fund the standard-setting process. And this is key. It also appoints the board members for the two groups that do write the rules. The FAF’s purpose is to ensure the process is independent and has integrity. Underneath the FAF are the two standard-setting boards. First is the one you'll deal with most: the fazz-bee. That's the Financial Accounting Standards Board. The fazz-bee sets the rules for all non-governmental entities. That’s a huge umbrella. It covers public companies, private companies, and not-for-profit organizations. The board has seven full-time members. They must cut all ties with their former employers to ensure they're completely independent. When the fazz-bee issues a standard, it creates the U.S. GAAP we all know. That guidance lives in the Accounting Standards Codification. The other board is the gaz-bee, the Governmental Accounting Standards Board. As the name suggests, the gaz-bee sets accounting standards for state and local governments. This includes cities, states, public universities, and government-owned utilities. Their job is to create rules that help the public see if their tax dollars are being used well. So, the FAF is the parent. The fazz-bee and gaz-bee are its two children, each with a specific jurisdiction. How does the fazz-bee actually create a new standard? They don't just invent rules in a locked room. They follow a very public and deliberate process. It's called their "due process," and it’s designed to get input from everyone. To issue a new standard, they only need a simple majority vote of the board. It all starts with identifying a topic. An issue might arise because investors are confused. Or a new type of transaction emerges, like accounting for digital assets. The topic could come from anywhere. The fazz-bee staff then does extensive research to understand the scope of the problem. Next, the Board has a public meeting to decide whether to officially add the project to its agenda. This is a big deal. It means they're committing serious time and resources. Once it's on the agenda, the real work begins. They hold public meetings to debate the issue from every angle. After all that deliberation, they issue an Exposure Draft. This is basically the proposed new rule, available for everyone to see. They explain their thinking and open it up for public comment. The comment period is usually 30 to 90 days. And people do comment. Companies, auditors, investors, and academics all send in comment letters. The fazz-bee might even hold public roundtables. This lets them hear directly from people about the practical challenges of a new rule. Then comes a critical step: redeliberation. The Board and its staff go through all that feedback, piece by piece. They take valid concerns seriously. In fact, they often make big changes to their original proposal based on what they heard. Finally, after sorting through everything, they take a vote. With a majority, they issue an Accounting Standards Update, or an ASU. And that’s how a new rule is born. Okay, this next point is a detail that can easily trip you up on the exam. The ASU itself is not the new GAAP. Let me say that again. An ASU is not the new rule. The single, authoritative source for U.S. GAAP is the fazz-bee Accounting Standards Codification, or the ASC. Think of the ASC as the official law book of accounting. It’s a huge, organized online database. An ASU is just the vehicle used to announce a change to that law book. It’s like an official memo. It says, "Go to Topic 606, Subtopic 10, Section 25, Paragraph 1, and change the wording to this." So the ASU is the instruction. The Codification is the authority. Sometimes, a narrow or specific accounting question comes up. It doesn't need the full, multi-year due process. For these situations, the fazz-bee has a rapid-response team. It's called the Emerging Issues Task Force, or the EITF. The EITF’s job is to quickly identify and resolve limited, implementation-level problems. If the task force members agree on a solution, they send it to the fazz-bee. If the fazz-bee board ratifies it, that consensus becomes an ASU and officially amends the Codification. It's just a faster path for smaller issues. Let's apply this to a real-world example. We can walk through the recent issue of accounting for crypto. Step 1 is identification. Companies started holding Bitcoin. Investors and preparers wrote to the fazz-bee. They said, "Reporting Bitcoin at its purchase price from five years ago is useless information. Its value is all over the place." The problem was identified. Step 2 is the agenda decision. The fazz-bee did its research and saw this was a widespread problem. The Board voted to add a project on accounting for crypto assets to its formal agenda. Step 3 is deliberation and the Exposure Draft. The Board debated how to account for it. Should it be historical cost? Or fair value? If fair value, where do the gains and losses go? Net income? Or OCI.? They tentatively decided that measuring it at fair value was the most useful approach. The changes would hit net income. So they issued an Exposure Draft proposing that. Step 4 is feedback. The comments flew in. Hundreds of them. Investors loved the fair value idea. But many companies were worried. They said the volatility would make their earnings bounce around like crazy. Step 5 is redeliberation and the ASU. The Board took that feedback to heart. They stuck with the fair value model because it provides the best information. But to address the companies' concerns, they added new disclosure requirements. These new rules required more information about the nature and amount of a company's crypto holdings. Once they finalized the details, they voted. Then they issued an ASU to officially amend the ASC. And now we have new guidance. See how that process works? It's all about deliberation and feedback. It's important to keep the two boards, the fazz-bee and gaz-bee, straight. Their processes are similar, but their missions are fundamentally different. This is because their users are different. The fazz-bee's main users are investors, lenders, and creditors. Its focus is on providing information that's useful for allocating capital. It helps people decide where to put their money. The gaz-bee's users are citizens, lawmakers, and creditors of the government. So its focus is on public accountability. Is the government using resources wisely? Can it meet its future obligations? One board is about making money. The other is about public trust. Here’s a common pitfall to watch out for. It's easy to think the SEC writes GAAP for public companies. But it doesn't. Remember, the SEC has the legal power to do so. But it has formally recognized the fazz-bee as the designated standard-setter. The SEC keeps a very close eye on the fazz-bee and can influence its agenda. But the fazz-bee holds the pen. Okay, that due process has a lot of steps. If you need a way to keep them straight, here’s a mnemonic that might help. The phrase is: I Am Doing Excellent Really Rad Accounting. Let's repeat that: I Am Doing Excellent Really Rad Accounting. The 'I' is for Identify the Topic. 'A' is for Add to Agenda. 'D' is for Deliberate. 'E' stands for Exposure Draft. The first 'R' is for Receive Public Comment. The second 'R' is for Redeliberate. And the final 'A' is for ASU. Issued. On exam day, questions about this topic are often about the hierarchy of authority. Just remember the chain of command. The FAF is the parent. It oversees and funds everyone. The fazz-bee sets the rules for businesses and not-for-profits. The gaz-bee sets them for state and local governments. And remember the SEC. It's the ultimate authority for public companies, but it lets the fazz-bee do the actual standard-setting. Knowing who's in charge of what is half the battle. VoraPrep is a full exam-prep app — lessons, practice questions, and an AI tutor in one place. Get started at Vora Prep dot com.