Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CPA] FAR: The Architects of GAAP: Inside the FASB and GASB Standard-Setting Process
Transcript
- Marcus: Welcome to VoraPrep Audio's Office Hours. I’m Marcus. Ava: And I’m Ava. Today we’re talking about the architecture of U.S. GAAP. Who actually writes the rules we all have to follow? Marcus: It’s a foundational question. Because without a common set of rules, financial reporting would be the Wild West. Ava: What does that mean in practice? Why can’t a company just account for things in a way that makes the most sense for its specific business? Marcus: Imagine two airlines. Same planes, same routes. One decides to capitalize a major engine overhaul, spreading the cost over several years. The other expenses it all immediately. They could report wildly different profits, even though their underlying operations were identical. Ava: So investors looking at those two financial statements would have no way to make a meaningful comparison. Marcus: Exactly. The numbers would be unreliable and useless for allocating capital. That’s why we have independent standard-setting bodies. Ava: Okay, so who are they? Is it a government agency, like the SEC, that sets these standards? Marcus: That’s the most common misconception. The SEC does have the legal authority to set standards for public companies. But it has long delegated that responsibility to a carefully designed private-sector system. Ava: So there’s a whole structure in place. Where does it start? Marcus: It starts at the top with the Financial Accounting Foundation, or the FAF. Think of the FAF as the parent organization. Ava: So the FAF is like the board of directors for the rule-makers, but they don't write the actual accounting rules themselves? Marcus: Precisely. The FAF’s job is to oversee, fund, and appoint the members of the two boards below it. Its most critical function is to ensure the entire process is independent and has integrity. Ava: Okay, so the FAF oversees two different boards. Let’s start with the one most candidates will deal with. Who writes the rules for a company like Microsoft or a local private business? Marcus: That would be the Financial Accounting Standards Board, or FASB. It’s the primary standard-setter for all non-governmental entities. That’s a huge jurisdiction—it covers public companies, private companies, and not-for-profits. Ava: And you mentioned independence. How does the FASB ensure that? Marcus: Its seven members are full-time and must sever all ties with their previous employers. Their only job is to serve the public interest by improving financial reporting. Ava: So if the FASB covers non-governmental entities, who handles the government side? Say, the state of California or a public university? Marcus: That’s the Governmental Accounting Standards Board, or GASB. It sets the standards for all state and local government entities. Ava: So we have the FAF at the top. It oversees the FASB for the private and non-profit sector. And it oversees the GASB for the state and local government sector. Marcus: That’s the hierarchy. Ava: Let’s focus on the FASB. When they decide a new rule is needed, how does that happen? Do the seven board members just lock themselves in a room and vote? Marcus: Not at all. They follow a very public and rigorous system called "due process" to make sure all stakeholders have a voice. It starts with simply identifying a topic. Ava: Where do these potential new rules or changes come from? Marcus: They can come from anywhere. Investors might raise a concern. A new business practice, like accounting for digital assets, might emerge. Sometimes implementation questions come from the profession itself. Ava: So an issue is identified. Do they just start writing a rule then? Marcus: Not so fast. First, the FASB staff does a lot of pre-agenda research. They need to understand the scope of the problem and see if it's pervasive enough to need a new standard. Ava: And if it is? Marcus: Then the Board holds a public meeting to formally vote on whether to add the project to its technical agenda. This is a big step, because it commits significant FASB resources to solving the problem. Ava: Okay, the project is on the agenda. Now the real work begins? Marcus: Now the deliberation starts. The Board holds a series of public meetings to debate the technical issues. They’ll discuss different approaches and the conceptual merits of each one. Ava: Once they’ve debated and have a direction they want to go, how do they get feedback from the public? Marcus: They issue what’s called an Exposure Draft, or an ED. This is the proposed new standard, sent out for public comment. It includes the specific wording changes they’re proposing and explains the board’s reasoning. Ava: And that’s when companies, auditors, and investors get to weigh in? Marcus: Exactly. There's a public comment period, usually 30 to 90 days. The FASB receives formal comment letters and might even hold public roundtables to hear feedback directly and better understand any potential challenges. Ava: Does that feedback actually change anything? Or is the proposal pretty much set in stone by then? Marcus: Oh, it absolutely makes a difference. The next step is redeliberation. The Board and staff analyze every piece of feedback they receive. They often make significant changes to the original proposal based on the valid concerns that were raised. Ava: And after all of that—the research, the debate, the public comment, the redeliberation—what’s the final step? Marcus: Once the Board is satisfied and a majority vote is achieved, the FASB issues an Accounting Standards Update, or an ASU. That's the document that finalizes the new guidance. Ava: Okay, you said they issue an ASU. So is that ASU the new piece of GAAP.? Marcus: That is the perfect question, and it's a critical point for the exam. The ASU is not GAAP itself. The ASU is the vehicle used to communicate an amendment to GAAP. Ava: What does that mean? If it’s not GAAP, what is? Marcus: Think of it this way. The single, authoritative source for all U.S. GAAP is the FASB. Accounting Standards Codification, or the ASC. The ASC is the official rulebook. Ava: Okay, so the ASC is the comprehensive library of all the rules. Marcus: Exactly. The ASU is like a page that you add to that book, or a set of instructions on how to revise an existing page. The ASU contains the background and the board’s reasoning. It also has the literal instructions for how to change the text of the ASC. But the ASC itself remains the single authoritative source. Ava: That makes sense. Before the Codification, the rules were scattered across all sorts of different documents, right? Marcus: They were. It was a mess. The Codification, created in 2009, organized everything into one logical, searchable online database. Every piece of guidance has a specific address, down to the topic, subtopic, section, and paragraph. Ava: That whole due process, from identifying a topic to issuing an ASU, sounds like it could take years. What happens with smaller, more urgent accounting issues that pop up? Marcus: That’s a great point. For those, the FASB has the Emerging Issues Task Force, the EITF. It’s designed to be a faster-response mechanism. Ava: So the EITF tackles more narrow, implementation-level questions? Marcus: Precisely. Their goal is to resolve these issues quickly. If the EITF can reach a consensus, they present it to the FASB. If the Board ratifies that consensus, it’s issued as an ASU. Then it becomes authoritative GAAP. Ava: Could we walk through a real-world example? The source material mentions digital assets. How would that work through the due process? Marcus: Perfect example. It starts with Identification. Investors and companies tell the FASB that reporting Bitcoin at its original purchase price from years ago isn't useful when its market value has changed so dramatically. Ava: Right. So the Board agrees it’s a pervasive problem, researches it, and votes to add it to the agenda. Marcus: Correct. Then comes Deliberation. They debate the best approach. Should it be historical cost? Or fair value? If fair value, should the gains and losses go into net income? They tentatively decide on a fair value model and issue an Exposure Draft for public comment. Ava: And then the feedback comes pouring in. Marcus: Hundreds of letters. Investors strongly support the fair value model. But some companies express concern that reporting unrealized gains and losses in net income will cause huge swings in their earnings. Ava: So how does the FASB resolve that conflicting feedback during redeliberation? Marcus: They weigh the arguments. They affirm their decision to use fair value because it provides the most decision-useful information, which is their primary goal. But, to address the preparers’ concerns about volatility, they add enhanced disclosure requirements. Ava: So companies using the new rule would also have to provide more details, like the nature and amount of their crypto holdings. Marcus: Exactly. It provides context for the numbers. With that compromise in place, a final vote is taken, and the FASB issues an ASU to amend the ASC. And just like that, new authoritative GAAP is born. Ava: Let's go back to the FASB versus the GASB. You said they have different jurisdictions, but are their core objectives also different? Marcus: Fundamentally different. The difference is who uses the financial statements. For the FASB, who are the main users of a company’s reports? Ava: Investors, lenders, creditors… people making decisions about where to invest their capital. Marcus: Exactly. So the FASB’s entire focus is on decision-usefulness for capital allocation. The standards are designed to help those users make efficient buy, sell, and hold decisions. Ava: Okay, and for the GASB.? Who are the primary users for a state or city’s financial report? Marcus: It’s a broader audience: citizens, legislative bodies, and also creditors. Ava: So their focus isn't purely on investment decisions. Marcus: Correct. The GASB’s focus is on public accountability. The standards are designed to help citizens and lawmakers assess whether the government used its resources appropriately. They also show if the government is in a position to meet its obligations in the future. Different users, different focus. Ava: That’s a key distinction. On the exam, what's the one area on this topic that trips up candidates? Marcus: Confusing the roles of the SEC and the FASB. It's very common to think that because the SEC is the government regulator for public companies, it must be the one writing the accounting rules. Ava: But as you said, they delegate that authority. Marcus: They do. The SEC has the statutory power. But it officially recognizes the FASB as the designated standard-setter for public companies. The SEC works closely with the FASB and can influence its agenda. But the FASB writes the rulebook—the ASC. Ava: That due process has a lot of steps. Is there a good way to keep them straight for exam day? Marcus: There is. A helpful mnemonic is: I Am Doing Excellent Really Rad Accounting. Ava: "I Am Doing Excellent Really Rad Accounting." Okay, what does each part stand for? Marcus: Let's walk through it. "I" stands for Identify the Topic. "A" is for Add to Agenda. "D" is for Deliberate. "E" is for issue the Exposure Draft. Then come the two R's. The first "R" is for Receive Public Comment and hold Roundtables. And the second "R" is for Redeliberate. Ava: And the final A must be for… ASU. Issued, to amend the ASC. Marcus: You’ve got it. It’s a reliable path to follow. Ava: This is a great foundation, Marcus. It's so important to understand not just what the rules are, but where they come from and why they exist. Marcus: Exactly. Understanding the framework is crucial. Ava: Great. So, to recap the big exam takeaways. The FAF is the parent organization. The FASB sets rules for non-governmental entities. The GASB handles state and local governments. And an ASU isn’t GAAP itself. It’s the document that amends the ASC, which is the single authoritative source. Marcus: That’s the core of it. Know the players, the process, and the purpose. Ava: Perfect. Thanks for the time, Marcus. Marcus: Always a pleasure, Ava. Ava: We'll see you at the next Office Hours. Marcus: VoraPrep is a full exam-prep app — lessons, practice questions, and an AI tutor in one place. Get started at Vora Prep dot com.