Due process and the development of financial accounting standards An exploration of comment letters and their influence on financial accounting standards

Due process and the development of financial accounting standards An exploration of comment letters and their influence on financial accounting standards

Walden University

COLLEGE OF MANAGEMENT AND TECHNOLOGY

This is to certify that the doctoral dissertation by

Douglas P Letsch

has been found to be complete and satisfactory in all respects,

and that any and all revisions required by the review committee have been made

Review Committee

Dr Jeffrey Prinster, Committee Chairperson, Management Faculty

Dr Mary Dereshiwsky, Committee Member Education Faculty

Dr Elizabeth Gurley, Committee Member Management Faculty

Dr John Nirenberg, University Reviewer, Management Faculty

Chief Academic Officer David Clinefelter, Ph.D

Walden University

2010

ABSTRACT

Due Process and the Development of Financial Accounting Standards: An Exploration of

Comment Letters and Their Influence on Financial Accounting Standards

by Douglas P Letsch

M.B.A in Accounting, University of Phoenix, 2003 B.B.A in Accounting, University of Texas, 1995

Dissertation Submitted in Partial Fulfillment

of the Requirements for the Degree of

Doctor of Philosophy Applied Management and Decision Sciences in Accounting

Walden University July 2010

ABSTRACT The business community and public are extended the opportunity to participate in the development of financial accounting standards (FAS) Stakeholders are concerned about the reliability of due process provisions for meaningful public participation in changing FAS This study employed the conceptual framework of due process as explicated within the generally accepted accounting principles (GAAP) doctrine and incorporated in the Financial Accounting Standards Board (FASB) procedures to insure responsiveness and credibility of the system This research sought to determine if the FASB considers

comments received from constituents as part of its due process procedures Using a random, qualitative, cross-case analysis design, the comment letter component of due process was examined to determine if textual evidence supports or contradicts the

legitimacy of the role of due process procedures in FASB decision making Two FAS projects were randomly selected and then a predetermined number of comment letters were randomly selected from each FAS project The material aspects from each comment letter were traced to actual FASB discussions, public meetings, or roundtables to validate prior research, which utilized nonrandom sampling techniques apparently without

triangulation In this textual examination of all relevant documents associated with the two random cases, the FASB was found to follow their established due process protocol This research validates and builds upon prior research and provides triangulation The public‘s voice was duly considered justifying confidence in FASB‘s due process

procedures The study contributes to social change by providing empirical evidence that can be used to support information programs designed to increase stakeholder confidence regarding due process procedures followed by the FASB

Due Process and the Development of Financial Accounting Standards: An Exploration of

Comment Letters and Their Influence on Financial Accounting Standards

by Douglas P Letsch

M.B.A in Accounting, University of Phoenix, 2003 B.B.A in Accounting, University of Texas, 1995

Dissertation Submitted in Partial Fulfillment

of the Requirements for the Degree of

Doctor of Philosophy Applied Management and Decision Sciences in Accounting

Walden University July 2010

UMI Number: 3412939

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DEDICATION

I dedicate the pursuit of this degree (and the many long hours and sleepless

nights) to my wife, Carla, my sons, Timothy and Peter, and to all my family who have encouraged and supported me in this journey

ii

ACKNOWLEDGEMENTS

I wish to acknowledge the help and assistance of the members of my committee,

Dr Jeffrey Prinster, Dr Elizabeth Gurley, Dr Mary Dereshiwsky, and my academic reviewer, Dr John Nirenberg Their recommendations, guidance, and assistance were invaluable

iii

TABLE OF CONTENTS LIST OF TABLES Y

LIST OF FIGURES vi

CHAPTER 1: INTRODUCTION TO THE STUDY 1

Introduction 1

Background 3

FASB 6

Due Process 7

Research Questions 10

The Nature of the Research Study 11

Purpose of Research Study 11

Significance of the Research Study 12

Summary 13

CHAPTER 2: LITERATURE REVIEW 16

Introduction 16

The Procedure of Due Process at the FASB 18

The FASB and its Mission 25

Summary 28

CHAPTER 3: RESEARCH METHODS 29

Introduction 29

Research Design 32

General Methodology 33

Random Selection of Financial Accounting Standards 33

Coding of Financial Accounting Standards and Comment Letters 37

Validity 42

Role of Researcher 43

Summary 43

CHAPTER 4: RESULTS 44

Introduction 44

Determining the Sample for Each Case 44

Gathering Source Data 47

Research Design and Procedures 49

Case 1 52

Introduction 52

FASB Deliberations and Resolutions 53

Exposure Document 55

Comment Letters 57

FASB Analysis of Comment Letters 63

FASB Final Pronouncement 67

Case 1 Summary 70

Case 2 71

Introduction 71

FASB Deliberations and Resolutions 72

Exposure Document 75

iv

Comment Letters 76

FASB Analysis of Comment Letters 88

FASB Final Pronouncement 89

Case 2 Summary 90

Findings of the Cases 91

Discrepant Case 94

Observations of Patterns, Relationships, and Themes 95

Quality of Evidence 97

CHAPTER 5: SUMMARY, CONCLUSIONS, AND RECOMMENDATIONS 99

Overview 99

Interpretation of Findings 100

Social Change Implications 106

Procedural Recommendations 107

Recommendations for Further Research 111

Reflections 113

Conclusion 114

REFERENCES 115

APPENDIX 119

CURRICULUM VITAE 154

v

LIST OF TABLES

Table 1 Research Involving Comment Letters and FASB Due Process 17

Table 2 Validity Concerns 42

Table 3 Research Involving Comment Letters and FASB Due Process 45

Table 4 Possible Themes Created Prior to Comment Letter Review 59

Table 5 Case 1 Comment Letter Themes 61

Table 6 Case 2 Decisions of the FASB before FAS 114 ED 73

Table 7 Possible Themes Created Prior to Case 2 Comment Letter Review 79

Table 8 Case 2 Comment Letter Comments and Recommendations 81

Table 9 Case 2 Comment Letter Trace Log 87

vi

LIST OF FIGURES Figure 1 Adding Items to the FASB‘s Agenda 20 Figure 2 General Research Design 39

CHAPTER 1: INTRODUCTION TO THE STUDY

Introduction Established practice suggests that financial accounting standards serve the

purpose of systematically measuring economic activity in a uniform and consistent

manner Accounting standards are part of a body of rules and principles commonly

referred to as Generally Accepted Accounting Principles (GAAP) GAAP, as

promulgated by the Financial Accounting Standards Board (FASB), are developed using

a conceptual framework called due process The FASB uses ―a set of due process

procedures to ensure that the interests of its constituents are considered in the

development of accounting standards and other pronouncements‖ (Miller, Redding, & Bahnson, 1994, p 58) Miller et al also indicate that one component of due process is the solicitation and collection of comment letters on selected FASB projects Comment letters are requested by the FASB in an effort to better understand the opinions and

potential issues of FASB‘s constituents when developing financial accounting standards These comment letters are required as part of due process procedures at the FASB

Multiple studies have been published dealing with aspects of due process

(George, 2004; Hossain, 2003; Schalow, 1992; Tandy & Wilburn, 1992, 1996; Tyska, 2000), where one or more nonrandom financial accounting standards were selected and models (mostly quantitative) were used to explain the influence of comment letters on the development of financial accounting standards The nonrandom selection and failure to compare with a control group (Maxwell, 2005; Merriam, 1998; Singleton & Straits, 2005) increased the threat to external validity, limited generalizations to the tested

standard(s), and compromised the findings outside the group studied Prior research has

2 not been replicated using random selection methodologies This absence of replication can impose a threat to external validity According to Yin (1994), ―generalization is not automatic and therefore a theory must be tested through replications of the findings… and once replication has been made, the results might be accepted‖ (p 36) Therefore, prior research could not make legitimate inferences about the influence of comment letters as part of due process The problem is whether society can trust that comment letters are used according to FASB policy and therefore best serve society‘s needs This research helps to address this problem by exploring two randomly selected financial accounting standards using cross-case analysis methodologies and by providing

replication of prior research

Comment letters are important tools used by the FASB in the development of financial accounting standards According to FASB (2002b), ―accounting standards are essential to the efficient functioning of the economy because decisions about the

allocation of resources rely heavily on credible, concise, and understandable financial information‖ (p 2) Since the FASB uses comment letters as a part of due process to

―ensure that the interests of its constituents are considered‖ comment letters thus

influence the development of financial accounting standards Financial accounting

standards impact the reporting of net assets The reporting of net assets is essential in fully functioning financial markets and influence potential investment by stakeholders

As such, the comment letter process could influence society as a whole If financial accounting standards are added or amended without consideration of the views of

constituents, then the stated goal of the FASB‘s due process—to ensure constituents,

―have confidence that their needs were at least addressed and not completely

3 disregarded‖ (Miller et al., 1994, p 58)—would be hampered In addition, the FASB would violate its formal Rules of Procedure requiring the use of due process (FASB, 2010a, ¶ 15)

The goals of this research are to (a) explore the integration of the comment letter component of due process, (b) determine if any textual evidence is available to imply that the FASB did not follow the established procedures, (c) validate prior research, and (d) propose additional research opportunities This research should add to the body of

knowledge on, and increase understanding of, the comment letter component of due process within financial accounting standard setting To accomplish these goals, this research explores the impact of comment letters on the two separate cases drawn from the population of financial accounting standards The replication provided in this research supports generalizations to global financial accounting standards, which was previously not possible Validating prior nonrandom research on FASB‘s due process procedures helps assure that accounting standard pronouncements reflect the views of society rather than a small group of individuals, thereby protecting the public interest

Background Accounting has been decreed the language of business in many accounting

textbooks and articles ―Accounting is an information system It measures business

activities, processes data into reports, and communicates results to people Accounting is the language of business‖ (Harrison & Horngren, 2008, p 3) Accounting records,

presents, analyzes, and reviews the financial impact of decisions made or prospectively estimates the financial impact of future events An essential goal of accounting is to provide stakeholders (shareholders, creditors, employees, governmental agencies, and

4 others), with credible, concise, and understandable financial information (FASB, 2002a,

p 2) To be useful, accounting information, ―must be relevant, reliable, comparable, and consistent‖ (Harrison & Horngren, 2008, p 7) According to the FASB (2002a), financial analysis is enhanced if that information can be compared with a competitor during

various points in time Comparability requires standardization across the country and ultimately the world, especially in light of the globalization of financial accounting

standards by the International Accounting Standards Board (IASB)

The number of organizations and resulting journal entries into accounting systems makes accounting pervasive and therefore in need of regulations or financial accounting standards According to the FASB (2002a), ―the objectives set forth [identified above as relevant, reliable, comparable, and consistent] stem largely from the needs of those for whom the information is intended, which in turn depend significantly on the nature of the economic activities and decisions with which the users are involved‖ (p 9) In the United States, the Securities and Exchange Commission (SEC) is charged with the authority to issue and regulate financial accounting standards for listed (public) companies and to,

―recognize as generally accepted for the purposes of the securities laws, any accounting principles established by a standard setting body accepted by the SEC as having the capacity to assist the SEC in the performance of its duties and responsibilities‖

(Securities Act of 1933 (1933)"Securities Act of 1933,") Since 1973 the SEC has

recognized the FASB and its parent organization, the Financial Accounting Foundation (FAF), as having the capacity to assist the SEC in issuing and promulgating (but not regulating) financial accounting standards According to the FASB, the organization is a nonprofit corporation with a mission to ―establish and improve standards of financial

5 accounting and reporting for the guidance and education of the public, including issuers, auditors, users of financial information‖(FASB, 2010a) The United States Congress ratified the authority of the SEC to select appropriate standard-setting organizations in the ("Sarbanes-Oxley Act of 2002," 2002) in Section 108 (Sarbanes-Oxley) The SEC

previously recognized the predecessor organizations of the FASB: the Committee on Accounting Procedures (CAP) and the Accounting Principles Board (APB) According to (FASB, 2002a; Epstein, Nach, & Bragg, 2007) each group is, or was, responsible for issuing Generally Accepted Accounting Principles (GAAP) In addition, under the

direction of the FASB, the American Institute of Certified Public Accountants (AICPA) issues Statements of Position that are used by state-licensed Certified Public Accountants (CPA) to assist in financial reporting (Epstein, Nash, & Bragg, 2007) The AICPA also recognizes the FASB as the primary organization charged with establishing GAAP under Rule 203-2 of the AICPA‘s Code of Professional Conduct (AICPA, 2007) CPAs use their education and experience to provide professional opinions (audits) of the financial reports and internal controls of entities According to Dauber, Qureshi, Levine, & Siegel (2005), the opinion paragraph of an unqualified audit opinion includes

an opinion as to whether the financial statements present fairly, in all

material respects, the financial position of the company as of the balance

sheet date and the results of its operations and its cash flows for the period

then ended in conformity with GAAP (p 304)

The attestation function performed by CPAs is regulated by state licensure boards and by the Public Company Accounting Oversight Board (PCAOB) depending on the

circumstances Each of these agencies thus plays an integral role in the development of U.S financial accounting standards or GAAP

6

FASB

The FASB is an independent nonprofit corporation funded by fees assessed to public companies as directed by the Sarbanes-Oxley Since 1973, the FASB has been a subsidiary of the FAF The FAF is also a nonprofit corporation that is largely responsible for, ―selecting the board members of the FASB and providing oversight of the board‘s performance‖ (Miller et al., 1994) According to Epstein et al (2007), the FAF‘s Board

of Trustees includes members from, ―the American Accounting Association, American Institute of Certified Public Accountants, CFA Institute, Financial Executives

International, Government Finance Officers Association, Institute of Management

Accountants, National Association of State Auditors, Comptrollers, and Treasurers, and the Securities Industry Association‖ (p 3) The independence of the FASB was

questioned by its reliance on contributions from large corporations and by the SEC‘s authority to oversee the FASB budget As provided in The Sarbanes-Oxley Act of 2002 (2002), the SEC must approve the annual budget of the FASB since its principal funding resonates with fees assessed to public companies The SEC withheld approval of the annual FASB budget in the spring of 2007 until the FASB agreed to allow the SEC to nominate members to the FASB board (Rappeport & Leone, 2007) It is not known whether this single change will alter the independence of the FASB or at least change the FASB into a quasi-governmental entity Based on this recent SEC policy, the SEC and the FAF now provide nominations for the FASB Board, thereby shifting power from the FAF to the SEC As of June, 2010, the SEC had not pressed this matter and therefore the independence question was still open to debate

7 The FASB board members must sever all ties to previous employers or

associations They must become employees of the FASB and ―agree to serve a five-year term with the possibility of a one-term reappointment‖ (Miller et al., 1994) The current FASB board includes CPAs, consultants, academics, former FASB employees, and a former comptroller of Texaco (FASB, 2010a) According to the FASB (2010a), the purpose of this board of uniquely qualified individuals is

To be objective in its decision making and to ensure, insofar as possible, the

neutrality of information resulting from its standards

To weigh carefully the views of its constituents in developing concepts and

standards

To promulgate standards only when the expected benefits exceed the

perceived costs

To bring about needed changes in ways that minimize disruption to the

continuity of reporting practice

To review the effects of past decisions and interpret, amend or replace

standards in a timely fashion when such action is indicated (¶ 9)

Each of these purposes represents an integral part of the development of financial accounting standards and the fulfillment of the mission of the FASB Embedded in the second purpose statement is a concept called due process According to Miller, et al

(1994) due process is a, ―set of procedures used to ensure that the interests of [FASB‘s]

constituents are considered in the development of accounting standards and other

pronouncements‖ (p 58) The objective of due process is to gain consensus from

constituents whereby the view of the public is served rather than the needs of a few or one special interest group (Tichich, 1989, p 9)

Due Process

Due process involves many steps The FASB board members, the FASB staff or one of committees established to assist in the formation of financial accounting standards

8 are responsible for following due process procedures According to the FASB (2010b), the main due process steps detailed in its Rules of Procedure are as follows:

1 The Board receives requests/recommendations for possible projects and

reconsideration of existing standards from various sources

2 The FASB Chairman decides whether to add a project to the technical agenda, subject to oversight by the Foundation's Board of Trustees and after

appropriate consultation with FASB Members and others

3 The Board deliberates at one or more public meetings the various issues identified and analyzed by the staff

4 The Board issues an Exposure Draft (In some projects, a Discussion Paper may be issued to obtain input at an early stage that is used to develop an Exposure Draft.)

5 The Board holds a public roundtable meeting on the Exposure Draft, if

necessary

6 The staff analyzes comment letters, public roundtable discussion, and any other information The Board redeliberates the proposed provisions at public meetings

7 The Board issues an Accounting Standards Update describing amendments to the Accounting Standards Codification

Each step may or may not be used, depending on the requirements of the project

Regardless of when or if each step is completed, the overriding goal of due process (Miller et al., 1994) is to ―create an environment in which the constituent and other

members of the business community can feel that they have had an opportunity to effect the outcome [of setting financial accounting standards]‖ (p 58) Due process provides assurance to the public that the views of constituents are considered when standards are created or amended

In many instances, the FASB issues either a Discussion Memorandum (DM) or an Invitation to Comment (ITC) These documents contain the opinions and technical

assistance from constituents on potentially new financial accounting standards or

revisions to existing financial accounting standards Usually the ITC and DM do not

9 provide the FASB‘s position and therefore are neutral documents According to Miller et

al (1994), the ITC and DM interact:

In some major projects, the Task Force will assist the staff in publishing a

discussion document that solicits responses from the constituencies to help

identify the important issues and to help assess the merits of the different

positions on the previously identified issues The document may be called

a DM or an ITC A DM is typically drafted entirely by the staff and is

fairly broad in its scope An ITC is often partially drafted by those other

than the staff and is more narrowly focused (p 71)

Individuals or institutions who respond to the FASB‘s DMs or ITCs participate in the development of (or changes to) GAAP, as part of the consensus-building model In

addition, constituents may also submit unsolicited comment letters to the FASB on any accounting standard subject

Solicited and unsolicited comment letters are elements of due process The current chair of the FASB, Robert Herz, believes in a strong comment letter process In Sherman (2002), Herz was quoted as saying, ― It is true that the corporate community and

accounting firms have been more active in providing input and I would like to hear more voices, particularly from the users‖ (p 6) Comment letters published by the FASB are available on the FASB website FASB staffers read and analyze the comment letters and then provide copies along with their summaries to FASB board members Discussion of comment letters takes place at open meetings and in private sessions between FASB board members and staffers

After considering the opinions of constituents, staffers, and board members, the FASB board members vote on the issuance of an Exposure Draft or Exposure Document (ED) According to Miller et al., ―an ED must be published for all projects that lead to a

10 Statement of Financial Accounting Standards or a Statement of Financial Accounting Concepts‖ (1994, p 73) EDs contain an almost final pronouncement of a new or

amended financial accounting standard or concept statement As such, EDs contain the provisional positions of the FASB at the time of their release At this stage, the FASB also requests additional comments from constituents Depending on the nature of the project, there may be more than one ED With each round of EDs, comment letters are solicited and analyzed

Research Questions The purpose of this research is to increase understanding of the comment letter component of due process within the financial accounting standard setting Specifically, this research focused on the following questions:

1 How does the FASB use comment letters in the development of financial accounting standards?

2 According to published documents, what action does the FASB take when a majority of comment letters propose a course of action different from what was originally recommended by the FASB at the onset of the financial

accounting standard project?

3 How were the randomly selected financial accounting standards changed as a direct result of the comment letter process?

4 How did the change in each standard compare between the case of limited comment letter involvement and substantial comment letter involvement, as represented by the two cases?

The unit of analysis for this research contains two items The first unit is the actual comment letters received by the FASB as part of its due process The second is the financial accounting standard as promulgated by the FASB By exploring the comment letters from the randomly selected financial accounting standards and by viewing all of the supporting due process materials on those standards, research can answer the above questions Details of this process will be covered in chapter 3

11 The Nature of the Research Study

The research in this study relates the change in two randomly selected financial accounting standards to comments received from constituents as part of due process The research employs a cross-case analysis of comment letters at the FASB under a

methodological process defined by Creswell (1998) Creswell explains that the

methodological process or assumption will include detailed descriptions of each case, followed by a comparative analysis of the cases, and finally ―attaching meanings or clusters of meaning‖ (p 77) The two cases include two published (secondary archival data), randomly selected financial accounting standards

One case includes a financial accounting standard where 50 or fewer comment letters were submitted to the FASB (the control group) The second case includes a

financial accounting standard where more than 50 comment letters were received by the FASB The changes to the financial accounting standards were linked to the comments received as part of due process The actual changes to each financial accounting standard were examined to determine the extent to which adversarial positions presented within the comment letters were considered More detailed discussions of the methods used in the research can be found in chapter 3

Purpose of Research Study

In the research mentioned above, one or more nonrandom financial accounting standards were selected and models (mostly quantitative) were used to explain the

influence of comment letters on the development of financial accounting standards The nonrandom selection and failure to compare with a control group (Maxwell, 2005;

Merriam, 1998; Singleton & Straits, 2005), increased the threat to external validity,

12 limited generalizations to the tested standard(s), and compromised the findings outside the group studied Prior research has not been replicated using random selection

methodologies This absence of replication imposed a threat to external validity

According to Yin (1994), ―generalization is not automatic and therefore a theory must be tested through replications of the findings… and once replication has been made, the results might be accepted‖ (p 36) Therefore, prior research could not make legitimate inferences on the influence of comment letters as part of due process

Established practice suggests that financial accounting standards serve the

purpose of systematically measuring economic activity in a uniform and consistent

manner Accounting standards are part of a body of rules and principles commonly

referred to as Generally Accepted Accounting Principles (GAAP) GAAP as promulgated

by the FASB are developed using a conceptual framework called due process The FASB uses ―a set of due process procedures to ensure that the interests of its constituents are considered in the development of accounting standards and other pronouncements‖ (Miller et al., 1994, p 58) Miller, Redding and Bahnson also indicate that one

component of due process is the solicitation and collection of comment letters on selected FASB projects

Significance of the Research Study Studies have been published on aspects of comment letters and due process

(Brown & Feroz, 1992; George, 2004; Greaney, 1998; Handlang, 1991; Ho, 1998;

Hossain, 2003; Kerby, 1989; Moody & Flesher, 1986; Saemann, 1995; Schalow, 1992; Tandy & Wilburn, 1992, 1996; Tyska, 2000; and Wilburn, 1987) The research on

comment letters used publicly available data (FASB documents) and published comment

13 letters submitted by constituents to the FASB The main concepts involved in the studies dealt with the establishment of consensus by using comment letters, involvement of the academic community in standard setting, corporate involvement in standard setting, and a complete review of comment letters that were attributed to financial accounting

standards Additional analysis of the prior research is contained in chapter 2

The qualitative research presented in this study fills a gap left by prior research It randomly selects a financial accounting standard where comments letters were used and compares the change in this financial accounting standard to an additional randomly selected financial accounting standard where comment letters were utilized on a limited basis Analytic generalizations are presented in chapter 3to recommend alternative due process procedures

Because the research in this study supports previous quantitative research, the results should not be reviewed in vacuity but rather as a part of the total research on comment letters and due process Validating prior nonrandom research on FASB‘s due process procedures helps assure that pronouncements on accounting standards will reflect the views of society rather than a small group of individuals, and thus protect the interests

of everyone involved with financial reporting

Summary Prior research on due process and comment letters contained a nonrandom

selection of one or two financial accounting standards and as such, results could not be generalized to the population of financial accounting standards The goals of this research are to explore the integration of the comment letter component of due process, determine

if any textual evidence is available to imply the FASB did not follow the established

14 procedures, validate prior research, and propose additional research opportunities The research answers questions such as, how are comment letters are used by the FASB in preparing financial accounting standards; what action is taken when the comment letters recommend a course of action different from that proposed by the FASB; and does the use of comments follow prior research

In this research, two randomly selected FASB financial accounting standards were explored to ascertain whether pertinent changes to those standards were the direct result of recommendations provided on comment letters received during due process The change in these two random financial accounting standards were linked to comments received from constituents in comment letters addressed to the FASB or some variable other than comment letters The methodology selected for this qualitative exploration was cross-case analysis, whereby detailed descriptions of each of two distinct cases are

presented, ―followed by a thematic analysis across the cases‖ (Creswell, 1998)

In completing this research, the units of analysis are the randomly selected

financial accounting standards and their associated comment letters A qualitative case methodology is employed as the framework for the research

cross-Chapter 2 provides a review of the prior literature and research in this area

Chapter 3 presents the detailed research design Chapter 4 offers a complete picture of the actual research and summarizes findings from the two cases Chapter 5 summarizes the complete research and present possible avenues for future research efforts Validating prior nonrandom research on FASB‘s due process procedures helps assure that

accounting standard pronouncements reflect the views of society rather than a small

15 group of individuals, thereby protecting the interests of everyone involved with financial reporting

CHAPTER 2: LITERATURE REVIEW

Introduction The purpose of this research is to increase understanding of the comment letter component of due process within the financial accounting standard setting Prior research

on the use of comment letters by the FASB in the development of financial accounting standards did not include random selection of the projects or comment letters This lack

of bias protection limits the generalizations to the explored financial accounting standard

or project under review The intent of this literature review was to find any published research regarding due process and the use of comment letters in order to better

understand due process, the use of comment letters, and how prior research was

performed Since exploration was the intent of this research study, a gap in theory was not required

The literature reviewed for this research includes published peer-reviewed articles

on the subject of the FASB and due process over the last 20 years, as of June 1, 2010 The search includes a review of multiple online databases, member-only access to the archival libraries at professional associations, and complete analysis of dissertations published on this subject The key words used in the search included:

1 FASB

2 Due Process

3 With and without the added restriction of comment letters

The organization of the literature review is based on the main due process steps detailed

in FASB‘s Rules of Procedure as identified in chapter 1 Table 1 summarizes the specific research found on the comment letter aspect of due process and other research

17 Table 1 -

Research Involving Comment Letters and FASB due process

Research Involving Comment Letters and FASB due process

In-text Citation

FAS(s) Included in Research Research Type of Research Subject

Primary Model(s) Used Theory Brown & Feroz,

1992 FAS 33 Quantitative Corporate influence LOGIT and PROBIT Economic George, 2004 Numerous Quantitative

Academic involvement in comment letters ANOVA Greaney, 1998 FAS 96 and 109 Quantitative

Constituents influence via comment letters PROBIT

Individualistic constitutional calculus

Handlang, 1991 FAS 86, 87, and 96 Quantitative

Selected variable analysis within three EDs

Frequency distribution and chi- square

Ho, 1998 FAS 87 Quantitative

Due process factors used in setting accounting standards LOGIT and PROBIT Game theory model

Hossain, 2003 FAS 133 and 141 Mixed

Socio-political and socio-economic factors in due process Univariate analysis

Content analysis, capture theory, and process theory of regulation Kerby, 1989 FAS 87 Quantitative

Use of lobbying efforts against proposed standards

Univariate analysis and chi-square Moody &

Flesher, 1986 FAS 1 - 86 Quantitative

Analysis of FASB voting patterns and political activity Chi-square Saemann, 1995 FAS 87 Quantitative

Corporate consensus

on due process projects

Whitney U- analysis

Mann-Schalow, 1992 FAS 106 Quantitative

Positive accounting theory and downs model

of political behavior Tandy &

Wilburn, 1992 FAS 1 - 100 Quantitative

Constituents participation in due

Tandy &

Wilburn, 1996 FAS 1 - 117 Quantitative

Academic participation in due process Chi-square

18

In-text Citation

FAS(s) Included in Research Research Type of Research Subject

Primary Model(s) Used Theory Tyska, 2000 FAS 87, 109, and 115 Qualitative

Evaluate due process responses in certain constructs Content analysis Wilburn, 1987 FAS 87 Quantitative

Degree of constituent influence on FASB decisions ANOVA and regression Political power model

The Procedure of Due Process at the FASB The FASB has a difficult task in the development of financial accounting

standards (Beresford, 1988, 1993) According to Beresford (1988), the FASB considers four criteria: ―pervasiveness of the problem, availability of alternative solutions, technical feasibility, and practical consequences before adding a project to its agenda‖ (p 1)

Reither (1997) and Wilburn (1987) research similar to that of Beresford and arrived at

similar conclusions These four criteria are part of the preliminary evaluation of a

perceived problem that comes to the attention of the FASB from insiders, the

International Financial Accounting Standard Board (IASB), a selected task force,

committees, letters from constituents, other standard setting bodies, research from reviewed journals, and/or regulators such as the Securities and Exchange Commission

peer-and the U.S Congress In addition, professional accountants submit technical inquiries to the FASB asking for guidance on particular matters These inquiries are monitored by the FASB and if a substantial number of inquiries are made, the FASB could recommend

further research on that subject Figure 1 below demonstrates some of the steps necessary

to place an item on the agenda at the FASB The flow chart does not represent an actual decision analysis performed by the FASB but rather an accumulation of steps as outlined

in prior research and affirmed by various FASB procedures However, one FASB insider,

19 explains that, ―the board [FASB] does not approach each standard setting issue in an identical manner‖ (Reither, 1997, p 94) This inside view shows that the FASB does take liberties when deciding which projects to promote and which projects to chair The

general consensus is that the FASB tries to follow their guidelines

Issue Identification

SOURCES OF INPUT:

 FASB Meetings

 Securities and Exchange Commission - SEC

 American Institute of Public Accountants - AICPA

 Business Press

 United States Congress

 Internal Revenue Service -IRS

 Other Standard Setters

 International Financial Accounting Standards Board -IASB

 Letters from Constituents-Comment Letters

 Emerging Issues Task Force -EITF

 Financial Accounting Standards Advisory Committee - FASAC

 American Accounting Association- AAA

 Financial Accounting Foundation -FAF

Is this issue a candidate for the agenda?

Agenda Decision

Yes No

DECISION PACKAGE:

FASB Staffers prepared Agenda Decision Package Package is reviewed by Board May have public meetings

Is the issue pervasive?

Are there alternative solutions available?

Can a technically sound solution be developed?

Will the recommended solution be generally accepted?

Do regulators approve of the recommended solution?

No No

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Problem identification is the first step of due process According to Reither (1997), the

FASB is reactive in its approach to identifying financial reporting issues that warrant

consideration (p 94) Reither does agree with Miller et al., (1994) about how the FASB

uses the various sources of input shown in Figure 1 as inputs to the preliminary

evaluation stage Handlang (1991) believes the steps of FASB due process start by

determining if the problem is pervasive, based on the significance of the issue in the

financial statements and its impact (or cost versus benefits received) on the economy (p

15) Once a problem has been identified and there is justification to add a project to the

FASB agenda, the FASB begins the next step in the process

Adding a project to the FASB agenda is the next step in due process Constituents

of the FASB argue that some projects should not be added to the agenda due to,

―perceived negative economic effect on their company‖ (Beresford, 1988) Therefore,

before an item is added to the agenda, the FASB holds public meetings where the

perceived problem is reviewed to see if that problem is, ―sufficiently significant in terms

of its effect on the financial statements and its pervasiveness throughout the economy‖

(Miller et al., 1994, p 69) In addition, the perceived problem must be resolvable and the

solutions must present alternatives The procedural element of due process takes

considerable time and many perceived problems are not added to the FASB agenda

According to Reither (1997), the factors that the FASB uses to evaluate adding a project

to the agenda are as follows:

1 Pervasiveness of the problem: the extent to which an issue is

troublesome to users, preparers, auditors, or others; the extent to which

there is diversity of practice; and the likely duration of the problem;

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2 Alternative solutions: the extent to which one or more alternative

solutions that will improve financial reporting in terms of relevance,

reliability, and comparability are likely to be developed;

3 Technical feasibility: the extent to which a technically sound solution

can be developed or whether the project under consideration should await

completion of other projects; and,

4 Practical consequences: the extent to which an improved accounting

solution is likely to be acceptable generally and the extent to which

addressing a particular subject (p 97)

The next element of due process is called early deliberations The FASB staff,

assigned to the project, reviews available research on the agenda item while they attempt

to better classify the underlying issues and economic benefits (Miller et al., 1994) This

review is accomplished by assigning a task force or some other group/committee to study

the appropriate items According to Kerby (1989),

After an issue has been placed on the Board‘s agenda, a task force is often

appointed to work with the Board‘s staff on the project The objectives of

the task force are to provide input and direction to a project and to act as a

sounding board to the FASB‘s staff (p 2)

Reither (1997) believes the most significant part of this process is in, ―the development

by the staff of a memorandum that describes the issues to be discussed‖ (p 98)

according to Miller et al., (1994) most major projects require the issuance of a DM or an

ITC This DM or ITC is used by the FASB to seek out additional issues or assistance in

problem descriptions from constituencies (Schalow, 1992) After the comment letters are

reviewed and coded by the FASB staff, the Board may request a round of public hearings

before any formal document is published by the FASB This third element of due process

may take as long as 7 years to complete Some projects never leave the deliberation stage

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The next stage of due process is classified as the tentative resolution stage At this

time in the process, the Board determines if there is any agreement between members of

the Board on the perceived problems and possible solutions Once general agreement is

reached, the Board publishes an ED for dissemination to all constituents The ED

includes a problem description, proposed solution(s), a possible effective date, alternative

views by Board members who choose to dissent, and the underlying reasons for the

decisions reached by the Board (Miller et al., 1994, p 73) The ED, DM, and ITC are all

published and disseminated through publications and are available on the FASB website

The comment letters are reviewed, coded, and summarized by FASB staffers and

delivered to the Board for further analysis as the fifth stage of due process begins This

stage, called further deliberations, may possibly include an additional round of public

meetings The outcome of the project could include termination, a new ED (back to the

fourth stage), or the printing of a final pronouncement (Miller et al., 1994, p 74) One

researcher suggests that the role of comment letters is part of political policy-making

systems Tyska (2000) states that the ―role interest groups play in the political arena is to

provide an information link within policy-making systems‖ (p 9) The FASB uses this

―policy-making system‖ to determine the views of its constituents in current project It is

this stage that the research in this study is exploring

If the Board votes for the final pronouncement, the project moves into the final

stage of due process called the final resolution The issuance of the final pronouncement

requires a majority vote of the seven members of the FASB Board An issuance may

include dissent that is published as part of the pronouncement Due process does not stop

at this stage but continues for the life of the project (now a pronouncement) as the FASB

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moves into a period of official compliance by constituents Reither (1997) calls this stage

a post-issuance effort where the FABS monitors the consequences of the pronouncements

based on a number of inquiries (p 103) This established process is designed by the

FASB to allow the public to participate in the establishment of GAAP as provided for in

the FASB charter

The comment letter process is used by the FASB to create a portal between the

standard setter and its constituents According to Brown and Feroz (1992), ―numerous

groups and individuals make submissions before the FASB as part of the due process

procedure, but little is known regarding the role these submissions play in the process of

setting accounting standards‖ (p 715) The FASB, ―weighs carefully the views of its

constituents in developing concepts and standards‖ (Beresford, 1988, p 4) However, the

FASB acknowledges that even with its open due process environment, there is a problem

of trust between the FASB, corporations, and accounting firms (Beresford, 2006) So

much so, that Beresford added greater trust, ―particularly [between] the corporate

community and accounting firms‖ as his number one area needing improvement in

comments to the Financial Executives International (FEI) upon leaving his two-term role

as Chairman of the FASB Beresford did not explain in this paper why the FASB was so

interested in establishing trust between these groups but prior research in many papers

(Dereshiwsky), 1985; Kerby, 1988; Hossain, 2003; Moody & Flesher, 1986; Puro, 1984;

Schalow, 1992; Wyatt, 1990) examines the role of politics at FASB in standard setting

Capture theory contends that politics will change in an effort for each party to ―pursue his

or her self-interest to the point where the private marginal benefit… equals the private

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marginal cost‖ (Hossain, 2003, p 8) This theory is supported in the stated research

dealing with politics and standard setting at the FASB

The FASB and its Mission due process at the FASB is part of the mission of the organization, which is, ―to

establish and improve standards of financial accounting and reporting for the guidance

and education of the public, including issuers, auditors, and users of financial

information‖ (FASB, 2010a) That mission includes a precept that the views of

constituents must be considered as standards are promulgated The FASB has had trouble

getting everyone involved in due process George (2004) found that academics

―submitted only 2.7 percent of total comment letters‖ (p 54) This lack of involvement of

the academic community was supported in research (Mezias & Chung, 1989; Tandy &

Wilburn, 1996) Other research demonstrated the participation of corporations and other

constituents in due process (Brown & Feroz, 1992; Greaney, 1998; Tandy & Wilburn,

1992; and Wilburn, 1987)

Charges that the FASB was biased in setting accounting standards have appeared

in the press and research efforts since the FASB‘s inception in 1972 The most vicious

challenge recorded was by (Briloff, 1984), who wrote,

I impeach the Board [FASB] for its supine acceptance of overt violations

of its edicts I maintain that all this absolution, dispensation, abdication

and supine acceptance are manifestations of the Board‘s determination to

avoid disfavor from its principle constituents, i.e., the major accounting

firms and their corporate clients (p 483)

Handlang, in her dissertation, supported the views of Briloff when she stated,

―The FASB does not necessarily consider the responses given by its constituency nor

abide by its own conceptual framework‖ (Handlang, 1991) She goes on to say, ―One

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persistent criticism has been that the CAP and its successors, the APB, now the FASB,

have repeatedly compromised their positions by sacrificing principles for acceptability‖

(p 2) Handlang‘s research included due process procedures for FAS 96 and 109,

Accounting for Income Taxes that are the subject of research by Greaney (1988) As seen

below, Greaney contradicts the findings of Handlang

Beresford (1988), a FASB insider and former Chairman of the Board, believed the

FASB spends considerable time deliberating on projects of intense interest Beresford

believed that the FASB objective, ―in weighing comment letters and other input is not to

‗split the difference‘ between competing views Rather, we [FASB] try to keep in mind

our mission of improving financial reporting in general‖ (Beresford, 1988, p 5) In

research outside of the accounting arena, Harding (1979) determined that FASB is not

influenced or responsive to business interests (p 515)

One group of researchers presented a different explanation of the influence of

selected corporations on the FASB process They summarized ―that the FASB is

influenced by corporations‘ preferences expressed in their letters of comment, and that it

is not influenced equally by all corporations‖ (Brown & Feroz, 1992, p 728)

In Greaney (1998), empirical research concluded that the ―FASB did indeed

incorporate the issues and views raised in the constituent‘s comment letters into the

development of the SFASs‖ and that the FASB actually changed its position as a result of

those comment letters (p 120) In other research dealing with the influence of corporate

constituents, Saemann (1995) provided statistical evidence, ―that the board [FASB] is

influenced by the magnitude of corporate opposition, as stated in comment letters‖ (p

563) Saemann also believed that the FASB used due process as a tool to gain consensus

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of the constituents In that paper, she quoted a former FASB chair; however, that quote

was taken out of context, and in fact, the view of consensus building begins with

Saemann Her research shows a decline in opposition to FASB positions as additional

comments are solicited from constituents According to Saemann (1995), consensus is

defined as a ―decline in opposing comments‖ (p 556) The research in this study follows

the research in Greaney (1998) and Hardlang (1991) with the exception that the selected

standards were randomly chosen and that a control group was used

Within these debates on due process, there are a few researchers (Ho, 1998;

Beresford, 1988; Reither, 1997) who take the centrist view and believe that accounting

standards are the work of experts who consider the views of constituents but ultimately

make decisions based on all facts available at the time (Reither, 1997), a former FASB

staffer, ranks the role of comment letters in the standard setting process as more of a

learning process for the FASB when she states, ―the Board [FASB] considers the

practicality and operability of various alternatives during its deliberations leading to a

proposed standard; it learns more about those considerations from comment letters‖ (p

103)

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Summary While there is some debate in prior research regarding groups of people who

influence the FASB‘s due process, quantitative and qualitative studies on the use of

comment letters by the FASB agree The FASB uses selected comment letters when

developing financial accounting standards The quality of material provided within the

comment letters is the primary criterion utilized by the FASB The major limitations of

prior studies have been in the nonrandom selection of the reviewed standard(s) or

project(s) This study attempts to correct this deficiency by providing a reliable secondary

qualitative study based on a cross-case analysis of two randomly selected financial

accounting standards and their associated comment letters