Latest / VoraPrep Audio — Professional Licensure & Certification Exam Prep / [CPA] FAR: The Architecture of Authority: Navigating U.S. Standard-Setting Bodies (FASB, GASB, SEC, PCAOB)
Transcript
- Marcus: Welcome to VoraPrep Audio. I'm Marcus. Ava: And I'm Ava. Today we're talking about the architecture of authority in U.S. accounting. Marcus: It’s a foundational topic. Imagine a company develops a new drone delivery system. The controller has to figure out how to account for that fleet of drones. Where does the rule for that come from? It has to be created by an authoritative body. Ava: So, who writes the rules of the game? Is there one single organization in charge of everything? Marcus: Not quite. It’s more like a legal system with a clear hierarchy. At the very top, you have the Financial Accounting Foundation, or FAF. Ava: The FAF. What's their role? Are they writing the standards? Marcus: No, think of the FAF as the parent organization. It doesn't set the standards itself. Its job is to oversee, fund, and appoint the members of the two boards that do write the rules. It provides the structure. Ava: Okay, so the FAF is the parent. Who are its two children, the standard-setting boards? Marcus: The first, and the one you'll see most often, is the FASB.—the Financial Accounting Standards Board. The FASB sets the rules for all nongovernmental entities. Ava: Nongovernmental. That sounds broad. What does it include? Marcus: It’s very broad. It covers public companies, private for-profit companies, and not-for-profit organizations. If it's not a government, the FASB writes its accounting rules. Ava: And what is the official output from the FASB called? Where do I find these rules? Marcus: They are all housed in one place: the FASB. Accounting Standards Codification, usually just called the ASC or the Codification. It is the single, authoritative source of U.S. GAAP for all those nongovernmental entities. Ava: Okay, so FASB covers businesses and not-for-profits. That must mean the second board, the GASB, handles the rest. Marcus: Exactly. The Governmental Accounting Standards Board, or GASB, sets the standards for state and local governmental entities. We're talking about cities, counties, states, and even public universities or government-owned hospitals. Ava: So if a state university needs to account for something, it looks to GASB, not FASB. Marcus: That’s the rule. The entity type determines the rule-maker. Ava: That makes sense. But for public companies, I've always heard the SEC is the ultimate authority. Where does the SEC fit into this picture with the FASB.? Marcus: That’s a critical point. The SEC, the Securities and Exchange Commission, is a U.S. government agency. It absolutely has the legal authority to set accounting standards for public companies. Ava: But you just said the FASB does that. Marcus: Correct. This is a great example of delegation. The SEC has formally recognized the FASB's standards as authoritative. So, while the SEC holds the ultimate power and can override or add to the rules, it lets the FASB handle the complex work of writing GAAP. Ava: It’s like the SEC is the building owner. They have the final say, but they hire the FASB as the master architect to design the blueprints. Marcus: That's a perfect analogy. And the SEC does add its own requirements on top, like Regulation S-X and S-K, which govern the form and content of filings. But the core accounting principles come from the FASB. Ava: Okay, that clarifies the accounting side for public companies. What about the auditing side? Marcus: For that, we have another major player: the PCAOB, the Public Company Accounting Oversight Board. It was created by the Sarbanes-Oxley Act. Ava: And what is the PCAOB's specific job? Marcus: The PCAOB oversees the audits of public companies. It sets the Auditing Standards, or AS, that auditors must follow for those public company engagements. Its entire mission is to protect investors by making sure the audit is independent and high-quality. Ava: So for a public company, the FASB sets the accounting rules and the PCAOB sets the auditing rules. What about for everyone else? Who sets the auditing standards for private companies or a city government? Marcus: That's where the AICPA, the American Institute of Certified Public Accountants, comes in. Its Auditing Standards Board sets the rules for audits of all non-issuers. Ava: Non-issuers meaning private companies, not-for-profits, and governments. Marcus: Precisely. The AICPA's rules are called Statements on Auditing Standards, or SAS. So, PCAOB for public company audits, AICPA for all other audits. Ava: Let's put this all together with an example. Say I’m an auditor, and I have a new client that's a public company. What are the rules for their financial statements? Marcus: First step is always to identify the entity. It’s a public company, an issuer. So, for the accounting standards—how they prepare their financials—the authority is the FASB, and the source is the Accounting Standards Codification. Ava: And for the audit of that public company? Marcus: It’s a public company audit, so the rules come from the PCAOB. The source would be PCAOB. Auditing Standards. Ava: Got it. Now, what about a second client, a city government? Marcus: Okay, the entity is a local government. So for their accounting standards, we look to the GASB and its Statements. Ava: And the audit of that city government? It’s not a public company. Marcus: Right, it’s a non-issuer. Therefore, the auditing standards come from the AICPA.—the Statements on Auditing Standards. Ava: Perfect. And one last client: a private chain of coffee shops. Marcus: The entity is a private company, a non-issuer. For accounting, that brings us back to the FASB and the ASC. For auditing, again, it's a non-issuer, so the AICPA sets the standards. Ava: That example really clarifies the jurisdictions. And I see a potential trap. For that public company example, an exam answer choice might list the SEC as the source for accounting standards. Marcus: A very common trap. You have to remember that while the SEC has the ultimate legal authority, it has delegated the function of writing GAAP to the FASB. The primary source of GAAP itself is the FASB's Codification. Ava: So we know who makes the rules. But how does a new rule actually get made? How does the FASB create a new standard? Marcus: It’s a very transparent and public "due process." It starts when the FASB identifies a financial reporting issue—maybe from investors, or companies, or auditors—and votes to add it to their agenda. Ava: Okay, so they've decided to tackle a problem. What happens then? Marcus: The Board and its staff do deep research and hold public meetings to debate different approaches. All of this work leads to the creation of an Exposure Draft. Ava: An Exposure Draft. Is that like a beta version of the new rule? Marcus: Exactly. It's a proposed standard that explains the new rule and the Board's reasoning behind it. And then comes the most important part: they release it for public comment. Ava: So anyone can send in their feedback? Marcus: Yes, and they actively ask for it. They'll get letters from companies, accounting firms, and investor groups. They might hold roundtables to hear feedback directly. This isn't done in a vacuum. Ava: So after they've collected all this feedback, what's the final step? Marcus: They analyze everything they've heard and redeliberate, again in public meetings. The feedback often leads to significant changes from the original proposal. Finally, the Board members vote. A majority is required to issue a final Accounting Standards Update, or ASU. Ava: And that ASU is what officially changes the Codification. Marcus: You've got it. The ASU itself isn't the standard; it's the vehicle, the official document that communicates the amendments to the ASC. Ava: When you lay it all out, the biggest point of confusion seems to be mixing up who writes the accounting rules versus who writes the auditing rules. Marcus: That is the single most important distinction to keep straight. There's a bright line. The FASB and GASB write the rules for creating the financial statements. That's GAAP. Ava: While the PCAOB and AICPA write the rules for checking the financial statements. That's GAAS, or Generally Accepted Auditing Standards. Marcus: If you can keep that one distinction clear—making the financials versus checking the financials—you'll avoid a lot of wrong answers. Ava: That’s a huge help. Are there any memory aids for keeping all these acronyms straight? Marcus: I like to use a simple map. Think of FAF as the Foundation—the parent. FASB is for Businesses and not-for-profits. GASB is for Governments. Ava: Okay, FAF is Foundation, FASB for Business, GASB for Government. What about the others? Marcus: For the SEC, think it Supervises Exchange-listed Companies. And for the PCAOB, its job is the Oversight of Big-company audits. Ava: That’s great. So the most critical skill on exam day is to read the question and immediately identify the entity. Marcus: It is the absolute first step. Public company, private company, or government? Answering that one question tells you which universe of rules you're in and cuts your choices in half. It’s the most efficient way to solve the problem. Ava: VoraPrep is a full exam-prep app — lessons, practice questions, and an AI tutor in one place. Get started at Vora Prep dot com.