Chapter 3 Development of the Institutional Structure of Financial Accounting

Chapter 3
Development of the Institutional Structure
of Financial Accounting

TRUE/FALSE

1.  The accounting profession has been regulated by Congress since the 1880’s, when it became clear that accounting was an important instrument in America for conducing business.
ANS: F

2.  The SEC was created by Congress to replace the AICPA’s standard-setting group.
ANS: F

3.  The SEC is legally empowered to regulate accounting principles.
ANS: T

4.  Most of the responsibility for establishing accounting principles has remained with the private sector rather than the SEC.
ANS: T

5.  The Securities Act of 1933 and the Securities and Exchange Act of 1934 were the first national securities legislation in the United States.
ANS: T

6.  The Journal of Accountancy was founded by the American Association of Public Accountants in1905.
ANS: T

7.  The American Accounting Association was originally called the American Society of Certified Public Accountants.
ANS: F

8.  The Committee on Accounting Procedures (CAP) used a formalized deductive approach to develop a comprehensive accounting theory.
ANS: F

9.  The Committee on Accounting Procedures (CAP) represented the profession’s first sustained attempt to develop workable financial accounting rules.
ANS: T

10.  APB Opinions were originally expected to be based on in-depth research studies.
ANS: T

11.  The Trueblood Study Group formed the FASB and called for significant changes in the establishment of financial accounting standards.
ANS: F

12.  The responsibility of the Financial Accounting Foundation is to elect the board of trustees, which selects FASB members, funds the board’s activities, and performs the oversight role.
ANS: T

13.  The FASB has made more extensive use of research than did its predecessors.
ANS: T

14.  FASB statements have resulted in a more conservative balance sheet and immediate recognition of events on the income statement.
ANS: T

15.  The Accounting Standards Executive Committee of the AICPA (AcSEC) and the Emerging Issues Task Force (EITF) were established to solve the problems of particular industries as well as narrow technical issues.
ANS: T

16.  Currently, a 4-3 vote is required to pass a FASB standard.
ANS: F

17.  The Federal Litigation Reform Act of 1995 replaced the previous proportionate liability requirement with joint and several liability for damages suffered by third parties who rely on the financial statement of firms attested to by CPAs.
ANS: F

18.  The FASB has exclusive authority in the private sector for promulgating auditing rules.
ANS: F

19.  Congress has recently been concerned with the laxity of auditors in detecting and disclosing fraud.
ANS: T

20.  An important role of the AICPA is to curb “shopping for accounting principles.”
ANS: T

21.  Ann annual report to stockholders prepared using FASB accounting standards generally has more disclosure of non-financial statement information than does the typical annual report filed with the SEC
ANS: F

22.  The Litigation Reform Act of 1995 requires that an audit include procedures designed to guarantee that illegal acts that would materially affect financial statements will be detected.
ANS: F

23.  The importance of the auditing function relative to the management consulting function is declining in major auditing firms.
ANS: T

24.  A problem with the increased importance of the management consulting function in auditing firms is the possible erosion of the integrity of the auditing function.
ANS: T

25.  The AICPA has developed an electronic filing of financial data called EDGAR.
ANS: F

MULTIPLE CHOICE

1.  Which of the following characteristics does not apply to accounting practices and procedures in the U.S. prior to 1930?
a. They were applied uniformly among companies. XXXXX
b. They were considered confidential by the companies applying them.
c. They met the needs of creditors to a greater extent than they met the needs of shareholders.
d. They emphasized the disclosure of cash and near-cash resources.

2.  Which of the following was an accomplishment of the American Association of Public Accountants?
a. The passage of a law in 1896 that created the professional designation of “Certified Public Accountant.”
b. The founding of The Journal of Accountancy in 1905
c. The development of a list of terms and definitions in 1915
d. All of the above. XXXXX

3.  In 1918 the American Institute of Accountants (AIA) worked with which of the following organizations to publish minimum standards for conducting a balance sheet audit?
a. The Federal Trade Commission (FTC) XXXXX
b. The Securities and Exchange Commission (SEC)
c. The American Society of Certified Public Accountants
d. The New York Stock Exchange (NYSE)

4.  What state passed the law that first created the designation “Certified Public Accountant”?
a. Massachusetts
b. California
c. Ohio
d. New York XXXXX

5.  Which of the following factors led to significant changes in accounting practices?
a. The Great Depression of 1929
b. The election of Franklin D. Roosevelt to the presidency in 1932
c. The enactment of the New Deal legislation
d. All of the above XXXXX

6.  Which of the following is not true regarding Accounting Series Release No. 4?
a. It stated that financial statements filed with the SEC and prepared in accordance with accounting principles for which there is no substantial authoritative support would be presumed to be misleading.
b. It implied that the SEC might in the future determine acceptable accounting practices and mandate methods to be used in reports filed with it.
c. It established an authoritative body for the development of accounting standards. XXXXX
d. It indicated that the SEC was growing impatient with the accounting profession.

7.  Which of the following is true regarding the Committee on Accounting Procedures (CAP)?
a. It developed a comprehensive statement of accounting principles.
b. It adopted a policy of attacking specific problems and recommending preferred methods of accounting when possible. XXXXX
c. It was formed by the SEC in 1936.
d. It eliminated the use of alternative accounting practices by establishing an underlying accounting theory.

8.  The Committee on Accounting Procedures (CAP) was immediately succeeded by
a. The Financial Accounting Standards Board (FASB)
b. The Accounting Principles Board (APB) XXXXX
c. The Accounting Research Board (ARB)
d. The Financial Accounting Foundation (FAF)

9.  Which of the following was a controversial issue faced by the Accounting Principles Board (APB)?
a. The investment tax credit
b. Income tax allocation
c. Business combinations and goodwill
d. All of the above. XXXXX

10.  What was the purpose of APB Statement 4, Basic Concepts and Accounting Principles Underlying Financial Statements of Business Enterprises?
a. To provide a foundation for evaluating existing accounting practices
b. To assist in solving accounting problems and to guide the future development of financial accounting
c. To enhance understanding of the purposes of financial accounting
d. All of the above XXXXX

11.  Criticism of the standard-setting process under the APB included:
a. Exposure for tentative opinions was too limited and occurred too late in the process.
b. The standard-setting process was too long and subject to too many outside pressures.
c. Both a and b XXXXX
d. None of the above

12.  In which of the following ways did the charge to the Financial Accounting Standards Board (FASB) differ from that given to the Accounting Principles board (APB)?
a. The FASB was to establish standards of financial accounting and reporting in the most efficient and complete manner possible. XXXXX
b. The FASB was to work toward standard setting with a two-pronged approach.
c. The FASB was expected to stipulate principles of accounting as an underlying framework.
d. The accounting standards established by the FASB were to be advisory rather than mandatory.

13.  Which of the following are true regarding the Financial Accounting Standards Board (FASB)?
a. The FASB includes ten members, each serving a term of three years.
b. Each member of the FASB must be a Certified Public Accountant.
c. There must be no conflict between the FASB members’ private interest and the public interest. XXXXX
d. All of the above are true.

14.  The establishment of which of the following groups has resulted in a challenge to the FASB’s standard-setting powers?
a. The Governmental Accounting Standards Board (GASB)
b. The Emerging Issues Task Force (EITF)
c. The Accounting Standards Executive Committee (AaSEC)
d. All of the above XXXXX

15.  The liability concept that restricts liability to each defendant’s share of the damages based upon the judge or jury’s assessment of their share of the damages is called
a. Proportionate liability XXXXX
b. Compensatory liability
c. Joint and several liability
d. Disproportionate liability

16.  The liability concept that can result in one party having to pay for more than its proportionate share of damages is called
a. Proportionate liability
b. Compensatory liability
c. Joint and several liability XXXXX
d. Punitive liability

17.  Which of the following bodies has exclusive authority in the private sector for promulgating auditing rules?
a. The FASB
b. The AICPA XXXXX
c. The SEC
d. None of the above

18.  Which of the following professional associations has an interest in the accounting standard-setting process?
a. The AICPA
b. The Financial Executives Institute (FEI)
c. The American Accounting Association (AAA)
d. All of the above XXXXX

19.  Which of the following events resulted in shareholders beginning to question whether accounting and reporting practices were adequate to assess investments?
a. The stock market crash of 1929 XXXXX
b. The federal government’s lump-sum payments for the retirement of Liberty Bonds
c. The creation of the SEC in 1934
d. None of the above

20.  In 1930 the AICPA began working with which of the following organizations to prepare “five broad accounting principles,” one of the most important documents in the development of accounting rule making?
a. The SEC
b. The NYSE XXXXX
c. The AAA
d. The FTC

21.  Which of the following represented the first formal attempt to develop “generally accepted accounting principles”?
a. “Approved Methods for the Preparation of Balance Sheet Statements” in 1918
b. “Five board accounting principles” in 1932 XXXXX
c. Accounting Research Bulletin (ARB) 43
d. The FASB’s conceptual framework project

22.  Which of the following is a true statement?
a. The SEC initially required the accounting profession to consult with it before setting any specific accounting principles
b. The SEC was created by Congress to oversee the accounting profession.
c. The SEC was given authority to prescribe the form and content of financial information filed with the SEC. XXXXX
d. The SEC formed the Committee on Accounting Procedure to develop a comprehensive set of accounting principles.

23.  Which of the following is true regarding the Emerging Issues Task Force (EITF)?
a. It has formal authority to establish GAAP.
b. Members of this group consist of CEOs of six major corporations and the chief accountant of the SEC.
c. It is concerned with highly technical issues, such as financial instruments, which may affect firms in virtually every industry. XXXXX
d. All of the above

24.  Major complaints aimed at the FASB’s standard setting process include:
a. The cost of preparing standards is too high.
b. Some standards are very difficult to understand.
c. Both a and b XXXXX
d. None of the above

25.  Which of the following bodies was created to deal with municipal accounting issues?
a. GASB XXXXX
b. FASB
c. FAF
d. EITF

26.  In which of the following ways has the Financial Executives Institute (FEI) become involved in the accounting standard-setting process?
a. By funding research projects in accounting and related areas
b. By reviewing FASB discussion memorandums and exposure drafts and communicating an official position to FASB.
c. By participating in FASB public hearings.
d. All of the above XXXXX

27.  Which of the following are characteristics of the FASB?
a. It is part of the AICPA.
b. Members are part-time employees of the FASB.
c. A member must be a CPA.
d. It makes more extensive use of research than its predecessors. XXXXX

28.  The accounting standard-setting process begins with which of the following steps?
a. A problem is identified. XXXXX
b. A task force is formed.
c. Public hearings are held.
d. An exposure draft is issued.

ESSAY QUESTIONS

1.  Why did accounting and reporting practices in the U.S. prior to 1930 not meet the needs of shareholder investors?
ANSWER: In the U.S. prior to 1930, accounting was unregulated and accounting practices and procedures were considered confidential. This resulted in a lack of uniformity in accounting practices among companies, both from year to year and within the same industry. Also, the American public did not invest large sums in private corporations until the 1920’s, when private corporations were expanding, and both they and government leaders encouraged the public to invest in stock. Before that time, banks and other creditors were the primary users of financial information, resulting in an emphasis on a company’s debt-paying ability. When individuals began investing in corporate stock, financial reporting lagged behind and continued to be prepared primarily for the needs of creditors. It wasn’t until the stock market crash of 1929 that shareholders began to question whether accounting and reporting practices were adequate to assess investments.

2.  Compare and contrast the characteristics of the CAP, APB, and FASB.
ANSWER: The FASB is separate from the AICPA, while the CAP and the APB were part of the AICPA. FASB members are more independent since they are full-time employees of the FASB. CAP and APB members were also employed elsewhere, usually by a CPA firm. FASB members need not be a CPA. CAP and APB members were required to be CPAs. The FASB allows for more extensive due process. The CAP engaged in little if any due process and the APB engaged in only very limited due process. The FASB succeeded in developing a conceptual framework, something the CAP did not attempt and the APB failed to accomplish. FASB also makes more extensive use of research than did its predecessors and has been more productive.

3.  Discuss the steps in the accounting standard-setting process and explain why it may not be capable of dealing with the complex environment of the 1990s and beyond.
ANSWER: The standard-setting procedure starts with the identification of a problem. A task force then explores all aspects of the problem and circulates a discussion memorandum that identifies the issues and possible solutions. The FASB then convenes a public hearing where interested parties may make their views known to the board. An exposure draft of the final standard is then issued and written comments requested. After consideration of written comments, either a revised exposure draft is issued or a final vote is taken by the board. Five votes are needed for the issuance of a final standard.
The FASB process developed in the 1970s may not be capable of dealing with the more complex environment of the 1990s and beyond. Financial markets are now globalized, communication is almost instantaneous, institutions are more competitive, and information technology makes it possible to better determine current evalulations of both assets and liabilities. Secondly, some non-financial measures may correlate more closely with security prices than financial measures such as income that are addressed in the typical financial statements generated under GAAP. An additional issue involves how the conceptual framework might need to be amended and extended to adapt to newly emerging types of business.