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American Institute of Certified Public Accountants Jul 1991Some have likened the hierarchy of generally accepted accounting principles to a house, with different floors corresponding to the different levels of authority of the various standards. (See JofA, June84, page 122.) The "house of GAAP" rests on a foundation of general concepts, such as those outlined in Governmental Accounting Standards Board and Financial Accounting Standards Board concepts statements. In May, the American Institute of CPAs auditing standards board unveiled proposed revisions to the accounting standards hierarchy. The changes, in the form of an exposure draft of a proposed statement on auditing standards, The Meaning of "Present Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report, would remodel the house of GAAP by changing the levels of authority of certain accounting pronouncements.
MOTIVATION FOR THE PROJECT
The impetus for revising the GAAP hierarchy was the decision in late 1989 of the Financial Accounting Foundation (FAF), which oversees both the FASB and GASB, to request a change in the accounting hierarchy for state and local government entities. The existing hierarchy, described in AICPA Professional Standards, AU section 411, was established shortly after the GASB began operations in 1984. The existing hierarchy provides category (a) status for GASB statements and interpretation regarding state and local government entities; however, if the accounting treatment of a transaction or event is not specified by the GASB, applicable FASB pronouncements are presumed to apply. As a result, state and local government entities are required to follow a FASB standard even if the GASB is currently addressing the issue.
A 1989 FAF report, The Structure for Establishing Governmental Accounting Standards, found the existing hierarchy was causing difficulty for the GASB and its constituency. Because new FASB statements had the potential to change GAAP for state and local governments, the hierarchy was disrupting the GASB's project agenda.
On two occasions the GASB felt it necessary to issue "negative standards" telling state and local government entities not to follow a particular FASB standard. These included GASB Statement no. 4, Applicability of FASB Statement no. 87, "Employers' Accounting for Pensions," to State and Local Governmental Employers, and GASB Statement no. 8, Applicability of FASB Statement no. 93, "Recognition of Depreciation by Not-for-Profit Organizations," to Certain State and Local Governmental Entities. GASB Statement no. 9, Reporting Cash Flows of Proprietary and Nonexpendable Trust Funds and Governmental Entities That Use Fund Accounting, was added to the GASB project agenda because of confusion over the applicability of FASB Statement no. 95, Statement of Cash Flows, to state and local government entities.
To overcome the problems, the FAF (as part of its November 1989 jurisdiction determination) established a framework for a new GAAP hierarchy. The FAF said the objective of the hierarchy is for the FASB and GASB to each have primary responsibility for setting standards for those reporting entities subject to the jurisdiction of that board (the primary board). Specifically, "an entity subject to the jurisdiction of a primary board should not be required to change its reporting principles as a result of a standard issued by (the other board)."
THE PLAYERS
Soon after the FAF issued its jurisdiction determination, the ASB formed a task force to revise the GAAP hierarchy. The ASB task force includes representatives from the AICPA accounting standards executive committee (AcSEC), the FASB, the GASB and the ASB itself. That task force developed the revisions described in the ASB exposure draft.
WHAT CHANGED?
The three biggest changes to the existing hierarchy would
1. Set up two different but parallel hierarchies -- one for state and local government entities and one for other entities. This was done to eliminate the "negative standards" problem described earlier.
2. Make each successive category in the hierarchy a different level of authority. Although the existing hierarchy has four categories, it has only three levels of authority since categories (b) and (c) are equal. The exposure draft, on the other hand, says, "If there is a conflict between accounting principles relevant to the circumstances from one or more sources in categories (b), (c) or (d), the auditor should follow the treatment specified by the source in the higher category (for example, follow category (b) treatment over category (c)) or be prepared to justify a conclusion that a treatment specified by a source in the lower category better presents the substance of the transaction in the circumstances." This change would, for example, require entities to change from a widely recognized and prevalent industry accounting practice if it conflicted with a cleared AICPA statement of position, audit and accounting guide or practice bulletin issued in the future.
3. Create a new middle category for the FASB's emerging issues task force consensuses. Although for Securities Exchange Commission registrants, EITF consensuses had to be followed because of the endorsement of the SEC chief accountant, the EITF actually is in the bottom category of the existing hierarchy. Thus, the proposal would require all entities -- SEC registrants and nonregistrants alike -- to follow EITF guidance issued in the future, and, if the entity was following another accounting treatment, to change its accounting.
The proposed revisions go beyond those needed to implement the FAF's jurisdictional determination. The ASB task force believes these other changes will resolve certain ambiguities in the existing hierarchy. The exhibit on page 34 compares the proposed and existing hierarchies.
CLEARED V. UNCLEARED AcSEC STANDARDS
Recently, the AICPA board of directors approved revisions to AcSEC's operating policies that permit the committee to issue pronouncements without clearance by either the FASB or GASB, although AcSEC is required to submit a proposed pronouncement to these bodies for their consideration. If the FASB or GASB do not clear the guidance, AcSEC has the authority to revote on whether it should still issue the pronouncement.
To date, all AcSEC statements of position and audit and accounting guides have been cleared by the FASB or GASB. However, since the potential for uncleared AcSEC documents exists, the task force believes these documents should not have the authority to change industry accounting practice. Thus, the proposed hierarchy distinguishes between cleared and uncleared AICPA audit and accounting guides and statements of position.
SIGNIFICANCE OF DIFFERENT LEVELS
Where a pronouncement falls in the proposed hierarchy is significant since each of the categories has a different level of authority. The top category, (a), is referred to as a "rule 203 pronouncement." Rule 203 of the AICPA code of professional conduct says, "A member shall not (1) express an opinion or state affirmatively that the financial statements or other financial data of any entity are presented in conformity with generally accepted accounting principles or (2) state that he or she is not aware of any material modifications that should be made to such statements or data in order for them to be in conformity with generally accepted accounting principles, if such statements or data contain any departure from an accounting principle promulgated by bodies designated by Council to establish such principles that has a material effect on the statements or data taken as a whole." AICPA council has designated the FASB and GASB as bodies that may issue rule 203 pronouncements.
The second point in rule 203 quoted above was added to clarify that the rule applies to review engagements conducted in accordance with both statements on standards for accounting and review services (SSARS) and SAS no. 35, Review of Interim Financial Information. As a result, rule 203 requires category (a) pronouncements to be followed in those engagements. Although SSARS do not explicitly provide a hierarchy of accounting standards, it is commonly held that the entire hierarchy in AU section 411 -- not only category (a) pronouncements -- applies to compilation and review engagements as well as audits. The AICPA accounting and review services committee plans to address this particular issue in the future.
Rule 203 does allow departures from category (a) pronouncements in unusual circumstances in which following the pronouncements would cause the financial statements to be misleading. Although this situation may arise from "new legislation or the evolution of a new form of business transaction," it occurs rarely and requires the auditor to describe in the audit report the departure and its approximate effects. The auditor is also required to explain the reasons why compliance with the rule 203 pronouncement would result in misleading financial statements.
Categories (b) through (d) of the proposed hierarchy descend in authority: Category (b) takes precedence over categories (c) and (d), and category (c) takes precedence over category (d). Pronouncements in these categories are all considered sources of established accounting principles. The auditor needs to be aware of the requirements in these pronouncements and follow them if an accounting treatment is not specified by a category (a) pronouncement. If the treatment specified in categories (b) through (d) is relevant and the auditor concludes another accounting treatment is generally accepted, no mention of this is required in the audit report, although the auditor must be prepared to justify his conclusion.
If a situation is not covered by pronouncements in categories (a) through (d), the proposed hierarchy says the auditor may consider other accounting literature, referred to in the exhibit as category (e). The auditor need not be familiar with all pronouncements described as other accounting literature; the auditor would consult this literature only when pronouncements in higher categories are not relevant. Examples of other accounting literature include FASB and GASB concepts statements, pronouncements of professional associations (such as statements on management accounting issued by the National Association of Accountants) and accounting textbooks, handbooks and articles.
GRANDFATHER PROVISION
The task force that developed the proposed hierarchy believes the new hierarchy should not in itself trigger accounting changes. This could have occurred because the proposed hierarchy elevates certain pronouncements to new levels of authority.
To avoid such a problem, the proposal includes a grandfather provision that specifies, "An entity following an accounting treatment in category (c) or (d) as of the effective date of this statement need not change to an accounting treatment in a category (b) or (c) pronouncement whose effective date is before the effective date of this statement." This means, for example, even though cleared AcSEC statements of position (category (b)) have greater authority than established industry practice (category (d)), the exposure draft would not require an entity following an established industry practice to change to the treatment specified in a statement of position with an effective date preceding the proposed statement's effective date.
WHAT ABOUT NOT-FOR-PROFIT ORGANIZATIONS
In some cases, the applicability of accounting research bulletins, APB opinions FASB standards to not-for-profit organizations is unclear. This is due in part to the discussion in ARB no. 43, Restatement and Revision of Accounting Research Bulletins, of the applicability of opinions by the AICPA committee on accounting procedures. Although the proposed hierarchy does not address this issue, the AICPA accounting standards division plans to issue an exposure draft of a proposed statement of position that would require not-for-profit organizations to follow ARBs, APB opinions and FASB standards except for those pronouncements that explicitly exempt such organizations.
REBUILDING THE HOUSE OF GAAP
If finalized, the changes to the house of GAAP would be the most extensive renovations to date. In addition to solving the FASB/GASB hierarchy issue, the proposed changes would affect the authority of future standards issued by the EITF and AcSEC. Already, the proposed statement has had an effect on the accounting standard-setting process. (See the sidebar at left.) Additional effects are likely to be identified during the exposure process.
The ASB encourages practitioners to provide comments or suggestions about the proposed standard. The ASB is particularly interested in comments about the workability of the grandfather provision. Copies of the draft are available from the AICPA order department; call 1-800-334-6961 (in New York State, 1-800-248-0445). The ASB will consider comments received by the AICPA auditing standards division by August 1, 1991.
EXECUTIVE SUMMARY
* THE AUDITING STANDARDS board of the AICPA has proposed changes to the GAAP hierarchy that would modify the levels of authority of certain accounting pronouncements.
* THE CHANGES TO the GAAP hierarchy were brought about by conflicts in the applicability of FASB and GASB pronouncements to state and local government entities.
* TO ELIMINATE FASB/GASB conflicts, the proposed changes would set up two different hierarchies, one for state and local govenment entities and one for other entities.
* EACH SUCCESSIVE CATEGORY in the hierarchy would have a different level of authority. A new middle category would be established for consensus by the FASB emerging issues task force.
* FOR SITUATIONS NOT covered by pronouncements in categories (a) through (d), the proposed hierarchy would permit auditors to consider other accounting literature, referred to as category (e).
* A GRANDFATHER PROVISION in the proposal means the new hierarchy will not in itself trigger accounting changes because certain pronouncements now have greater authority.
* THE DEADLINE FOR comment on the ASB proposal is August 1, 1991.
HOW A PROPOSED GASB STATEMENT AFFECTS COLLEGE FINANCIAL REPORTING
The recent GASB exposure draft, Accounting and Financial Reporting by Governmental Colleges and Universities, illustrates the application of the proposed new GAAP hierarchy. As of this writing, neither the GASB nor its predecessor, the National Council on Governmental Accounting (NCGA), has issued standards outlining a comprehensive accounting and financial reporting model for governmental colleges and universities.
Some government higher education entities follow the AICPA College Industry Audit Guide model; some follow the NCGA government model; some purport to follow one or the other but do not fully comply with either. In the absence of a GASB pronouncement, GAAP would be found in category (d) of the proposed new hierarchy -- practices widely recognized and prevalent in state and local government.
If the proposed exposure draft becomes a statement, both the AICPA College Industry Audit Guide model and the NCGA government model (both as amended by GASB pronouncements) would be elevated to category (a) of the hierarchy and subject to AICPA ethics rule 203.
DOUGLAS SAUTER is a technical manger in the American Institute of CPAs auditing division. He is a member of the New York State Society of CPAs and the American Accounting Association. Mr. Sauter gratefully acknowledges the significant contributions to this article made by Martin Ives, vice-chairman of the Governmental Accounting Standards Board, and James J. Leisenring, vice-chairman of the Financial Accounting Standards Board.
Mr. Sauter is an employee of the American Institute of CPAs and his views, as expressed in this article, do not necessarily reflect the views of the AICPA. Official positions are determined through certain specific committee procedures, due process and deliberation.
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