Accounting Framework, 50 Years in the Making, Finally Wraps Up

In the five decades since its creation in 1973, the standard-setter for US accounting rules has never had a complete operating manual to guide its work.

The Financial Accounting Standards Board’s internal handbook has been a patchwork of concepts laying out the purpose of financial reporting and defining some bedrock elements of financial statements. But the document, called FASB’s Conceptual Framework, had many holes and inconsistencies. The holes were a problem, but bigger problems sidetracked board attempts to plug them: the fallout from the Enron accounting scandal, the financial crisis, and the collapsed effort to converge US and international accounting standards.

That’s about to change. This summer, the board plans to publish the last chapter of the framework, addressing its trickiest set of concepts yet: how to measure assets and liabilities. With the final chapter’s release, FASB will end its long, sometimes controversial journey to spell out key concepts of financial reporting.

The framework exists so the board and future board members can—in theory—write consistent US generally accepted accounting principles, or GAAP, grounded in concepts with set parameters.

“We are very excited,” FASB Chair Richard Jones said. “It’s a good tool for the board going forward. It doesn’t change GAAP in and of itself, but it does give us things to think about.”

Indeed, finalizing the board’s handbook won’t change any existing accounting rules US companies and not-for-profit organizations use to tally their finances. But a fully formed framework could improve the process of creating those rules, which ultimately trickles down to accountants.

“When accounting problems come up and there’s circumstances we need to have answers for, it really begins with these definitions,” said Amanda Convery, associate accounting professor at the University of Delaware’s Lerner College of Business and Economics.

If FASB needs to craft new rules about an emerging transaction in cryptocurrencies, for example, board members unsure of whether something meets the definition of an asset or a liability could look to the framework’s new chapter on “elements of financial statements,” published last June, for a gut check. Questions about when an item should be incorporated into or removed from a financial statement? The chapter on recognition and derecognition issued in August may offer some clues.

“It’s not like you look it up and get an answer, but it does give the board certain considerations. So I think it can help us with a disciplined process,” Jones said.

Measurement Methods

For such an eat-your-vegetables endeavor, finalizing FASB’s framework has been surprisingly fraught over the years. The most controversial effort has involved figuring out how to measure assets and liabilities. FASB saved that chapter revamp for last, releasing a proposal in December that got vetted and finalized in May.

FASB had last addressed the topic in the early 1980s, when a deeply divided board couldn’t agree on which type of measurement produced the most useful information for financial statement readers. Tensions flared between proponents of a current value-based system—based on prices an item would fetch in the market—versus cost-based measures, which reflects prices paid in the past, said Paul Miller, accounting professor emeritus at the University of Colorado at Colorado Springs and author of a book on FASB’s history.

Unable to reach consensus, the board in 1984 produced a document saying several different measures can be used in practice. It described the status quo versus prescribing best practice, Miller said.

The measurement method makes a notable difference in what gets recorded in company financial statements. Consider Silicon Valley Bank. Under US accounting rules, the bank recorded its long-term holdings at amortized cost—the price the bank paid, plus some adjustments—versus their market value. The accounting method disguised that the holdings were billions underwater prior to the bank’s collapse last year, two prominent investor groups told FASB.

FASB’s to-be-published update will put more meat on the concept of measurement but doesn’t explicitly favor one measurement technique over another. Instead, it says measurement should be anchored in prices. Entry and exit price systems are the only two relevant systems, the chapter will state. In addition, assets shouldn’t be reported at more than what they can be recovered for, and liabilities should not be reported at less than what can be settled, according to the board’s latest decisions.

FASB landed in a realistic spot, board member Christine Botosan at a May 8 meeting. Debates about requiring fair value for all assets and liabilities “derailed progress, in my mind, on a measurement chapter for 50 years,” she said at the time.

Finally completing the framework, however, isn’t expected to free FASB from ongoing debate over asset measurement and other contentious issues.

“Issuing this chapter will not end the controversy,” Miller said. “It will not eliminate the issues.”