Financial and Accounting Compliance

Financial and Accounting Compliance refers to the adherence to laws, regulations, and standards that govern the preparation and disclosure of financial information by businesses, particularly publicly traded companies. Accurate financial reporting is vital for informed decision-making by management, investors, and regulators, as historical events like the Great Depression and corporate scandals have shown the potential consequences of financial misrepresentation. In the U.S., compliance is primarily enforced by the Securities and Exchange Commission (SEC), which mandates that companies disclose substantial financial data following Generally Accepted Accounting Principles (GAAP). These principles are established by the Financial Accounting Standards Board (FASB) and govern how financial statements are prepared to ensure consistency and transparency. The SEC also oversees various divisions, including those focused on market regulation and corporate finance, to ensure that the securities industry operates fairly and efficiently. As globalization progresses, there is a growing movement towards convergence between GAAP and International Financial Reporting Standards (IFRS), aiming to create a unified accounting framework for businesses worldwide. Understanding these compliance standards is essential for stakeholders in making sound financial judgments and fostering investor confidence.

Published in: 2021

By: Azria, Seth M.

Subject Terms

Financial and Accounting Compliance

Accurate financial information is critical for decision making within the business world and governments alike. The absence of honest and accurate financial reporting to support sound financial decisions can cause economic calamities, as evidenced by the Great Depression and the business collapses of the early 2000's. In the United States, the SEC compels financial disclosure from companies that seek funds from the investing public. The generally accepted accounting principles (GAAP), established by a number of public and private organizations, provides the language in which those statements must be delivered. This article discusses the sources and history of US financial reporting law and the organizations responsible for establishing the GAAP. The article concludes with a brief discussion of the rise of an international accounting standard that seems poised to become the new standard; possibly replacing the GAAP.

Keywords Accounting Standards; Audit; Bonds; Compliance; Debentures; Federal Register; Financial Reporting; GAAP; Note; Proxy; SEC; Tender Offer

Accounting > Financial Accounting & Compliance

Overview

A business's financial condition can be summarized by the major and familiar financial statements including the balance sheet, income statement and statement of cash flow. Those statements provide valuable information to management for internal company decisions and are also important to parties outside the business such as lenders and investors. Businesses can be generally divided into two categories: Public and private. Publicly traded companies are corporations whose stock is held by the general public and openly traded as opposed to a privately owned or closely held corporation whose stock is not offered for public sale and is typically owned by a few individuals. Accurate financial information is, of course, valuable to every business but in the case of the publicly traded company, preparation and disclosure of financial statements are mandated by laws administered by the United States Securities and Exchange Commission (SEC). Financial statements for external distribution are prepared according to guidelines referred to as the generally accepted accounting principles (GAAP). An independent body called the Financial Accounting Standards Board (FASB) takes the lead in determining and promoting those practices. With that general introduction, the remainder of this article discusses the governmental and private bodies that determine financial and accounting standards and rules relevant to the company that seeks investment from the general public.

Public Finance Law

Formation of the SEC

The SEC was created by the Security Exchange Act of 1934 following the great stock market crash of 1929. Prior to 1929, there was little support for government regulation of the securities markets. In the post-World War I economic prosperity of the roaring twenties, many people turned to the stock markets to make their fortunes with little thought of the danger of investing in an unregulated market. It has been estimated that half of the $50 billion of new securities issued during that time became worthless. After the crash in 1929, many personal fortunes were lost and many banks, who also invested in the market, suffered heavy losses. As a result, depositors became concerned that their bank may not survive and withdrew their funds. This run on the banks caused many banks to close. The great depression followed and the consensus in government was that confidence in the capital markets needed to be restored for the economy to recover.

In response, Congress held hearings to identify solutions and based on their findings, passed the Security Exchange act of 1933 (often called the "truth in securities law") and the Security Exchange Act of 1934. The Securities Act of 1934 created the SEC and granted it broad authority over the securities industry. The essential purposes of the Acts were twofold.

First, to compel companies who offered their securities for public sale to be honest about their business, the securities for sale, and the risks involved in investments.
Second, the Acts sought to ensure that people selling those securities such as brokers, dealers and exchanges were treating investors justly and truthfully and put investor interests in a prioritized position.

SEC Regulations

The SEC is headquartered in Washington DC and is composed five presidentially appointed Commissioners, four divisions and eighteen offices. The SEC is charged with regulating the practice of selling securities (a document that indicates the ownership-such as a stock certificate or bond) to the general public. The laws that govern the securities are based on the idea that all investors, regardless of size, should have access to basic facts about a business or investment opportunity before they purchase that security and for the time period during which that investor may hold that security. Consequently, the SEC necessitates that public businesses reveal significant economic data to the public. All investors are therefore enabled to discover for themselves whether buying, selling or holding a certain security is worthwhile. To ensure that investors and other interested parties had the information upon which they could base a sound judgment, financial reporting to the SEC must be timely, comprehensive and accurate. Beyond the benefit to an individual investor, the SEC financial reporting requirements encourage economic growth because transparent and efficient capital markets facilitate capital formation.

The SEC also manages the most crucial players of the capital market (which includes securities markets, brokers and dealers, investment advisors and mutual funds) to make sure that the important market information is disclosed.

Four Divisions of SEC

The SEC Division of Market Regulation creates and carries on the standards for just, organized and effective markets, specifically through the regulation of brokers, dealers, stock exchanges and other major players in the securities industry.
The Division of Investment Management manages the $15 trillion investment management industry by administering security law relevant to investment advisors and mutual funds.
The Division of Enforcement investigates likely breaches of the law and recommends civil action to the Commission which brings civil enforcement lawsuits against individuals and companies for infractions such insider trading, accounting fraud and providing false or misleading information. Having only civil enforcement control, the Division also cooperates with various criminal law enforcement agencies when appropriate.
The Division of Corporation Finance is relevant to the accounting profession and compliance. The Division of Corporation Finance supervises the required business announcements of information to the public; both when a stock is initially offered for sale and then on continued periodic basis. Required documents include: Registration statements for new securities, annual and quarterly reports, proxy matters given to stockholders prior to an annual meeting, annual reports to stockholders, paperwork about tender proposals, and filing related to mergers and acquisitions. The Division reviews submissions, offers compliance assistance to companies and recommends new rules to the SEC Commission. The Division, in cooperation with SEC’s Office of the Chief Accountant, monitors the accounting profession. The Chief Accountant is the principal advisor to the Commission on accounting and auditing matters and consults with accounting bodies that set standards including the FASB, the International Accounting Standards Board (IASB), the American Institute of Certified Public Accountants (AICPA) and the Public Company Accounting Oversight Board (PCAOB).

Additional SEC Governance

In addition to the foundational Securities Laws of 1933 and 1934, the SEC enforces other laws related to the securities industry. The Trust Indenture Act of 1939 involves bonds, debentures and notes intended for public sale. The Investment Company Act of 1940 controls the framework of businesses (namely mutual funds) that work closely with the contributions and trades of securities. The Investment Advisors Act of 1940 regulated investment advisors and requires registration and compliance with regulations designed to protect investors. More recently (in the wake of the well publicized corporate scandals of the early 2000's including the collapses of WorldCom and Enron and their accountants Arthur Andersen), Congress passed the Sarbanes-Oxley Act of 2002. Sarbanes-Oxley made several reforms in order to improve shared responsibility and economic disclosure and battle corporate and accounting fraud. The Act also created an independent nonprofit entity called the Public Company Accounting Oversight Board. The PCAOB oversees the auditors of public companies and has four main responsibilities:

First, to register accounting firms that audit public companies trading in U.S. security markets.
Second, to inspect registered accounting firms.
Third, to establish quality control, ethics, and independent standards for registered public accounting firms.
Fourth, to investigate and discipline registered accounting firms for violations of the specified law and professional standards (PCAOB, 2007, p. 3).

Accounting Standards

The disclosures required by securities law to be must be uniform to be helpful to the various public users of such information. That uniformity comes from a common accounting language called the GAAP standards.

Financial Accounting Standards Board

The FASB is a private sector and independent organization that establishes standards for financial accounting and reporting. While the SEC has the authority under the Securities and Exchange Act of 1934 to establish those standards, the SEC has historically relied on the private sector for those standards and particularly on FASB. FASB seeks to improve accounting standards by applying a number of principles. FASB seeks to:

Make reports more useful by focusing on characteristics such as relevance, reliability, comparability and consistency;
Reflect changes in methods of doing business and the economic environment in current standards;
Act quickly to address deficiencies in reporting susceptible to cure with appropriate standards;
Promote the convergence of international accounting standards; and, improve understanding of the purposes and nature of financial reports.

To promote the above aims, FASB develops broad accounting concepts and financial reporting standards. This framework of concepts and standards provides a guidance in resolving accounting issues and guidance in preparing reports.

Federal Accounting Standards Advisory Board

The Federal Accounting Standards Advisory Board (FASAB) is a federal advisory committee that develops accounting standards and publicize common and well-established accounting principles for the federal government entities. The FASAB was established under the authority of the Secretary of the Treasury, the Director of the Office of Management and Budget, and the Comptroller General of the United States. The FASAB considers the economic and budgetary needs of governmental supervision groups, administrative agencies and the requirements of other users of economic information to develop rules that maximize the usefulness of the information. The FASAB board has ten members; four federal and six private sector members. After FASAB has completed their procedure for issuing concepts and standards, they are announced in the Federal Register and become effective.

Hierarchy of Information

As with all law and regulatory frameworks it is important to be aware of the hierarchy of a particular source of information and this is especially true when dealing with a subject like accounting that applies to so many entities both public and private. Consequently, both FASB, for the private sector, and the FASAB have a hierarchies of authority for GAAP interpretations as applied to federal agencies. The FASAB hierarchy gives an example of how those hierarchies are generally arranged and includes GAAP interpretations of the FASB, discussed above, and the American Institute of Certified Public Accountants (AICPA). The most authoritative pronouncement of the GAAP for federal bodies is the categories of officially established accounting principles.

Category (a) consists of FASAB advisory board statements and FASB and AICPA pronouncements specifically interpreted as applicable to the federal government by FASAB.
Category (b) consists of FASAB technical bulletins and those AICPA industry audit and accounting guides and statements of position that AIPCA has made applicable to the federal government and FASAB has cleared.
Category (c) consists of the practice bulletins issued by the Accounting Standards Executive Committee of the AICPA made applicable to federal government and cleared by FASAB, in addition to Technical Releases of the FASAB Accounting and Auditing Committee.
Finally, category (d) consists of implementation guides published by FASAB staff and widely recognized practices in the federal government (FASAB, 2007).

In the absence of guidance from these categories, a federal auditor may consider other accounting literature as appropriate under the circumstances.

The need for reliable financial disclosure became starkly apparent after the Great Depression and motivated the federal government to create the SEC and then again in 2002 with the passage of Sarbanes Oxley Act. The success of the SEC and other bodies that perform financial audits to protect the public and prevent fraud are dependent upon the reliability of the documents offered for disclosure. Reliability is dependent upon a coherent system of assembling and reporting financial data. That entire system, of course, is called the GAAP. The GAAP is a set of principles that when translated into complex rules and applied to a specific entity determine a particular result. GAAP interpretations are issued for the private sector (FASB), the public sector (FASAB) and for specific industries and practices.

The Emerging Issues Task Force

The private sector also has a similar four category system that ranks the authoritative weight of accounting principles in which FASB and the AICPA figure prominently. The Emerging Issues Task Force (EITF), formed in 1984 by the FASB, is another entity that has bearing on GAAP interpretation. The EITF is a twelve member body composed primarily of members of public accounting firms and is designed to identify emerging issues and recommend positions before problems become widespread and entrenched. While the FASB is primarily concerned with private sector standards and FASAB with federal entity reporting, the Governmental Accounting Standards Board (GASB) is concerned with the accounting and financial reporting standards for state and local governments. Consequently, practitioners seeking to apply permissible methods should be aware of the relevant and authoritative GAAP interpretations bearing on their particular task.

Insights

Financial Reporting in Global Business

Accounting and the resulting financial reports are relevant to all business operations of global importance. The International Accounting Standards Board (IASB), a London based non-profit corporation (organized under the Laws of Delaware) develops international accounting standards called the International Financial Reporting Standards (IFRS). In 2005, public companies in the European Union began using the IFRS and those standards have been adopted by some 70 other countries. In April 2005, the US and the EU agreed to mutually accept both IFRS and GAAP. The process of making the GAAP and other national accounting standards (for example those in Japan, China and Canada) compatible with IFRS is called convergence. The IFRS are on the road to becoming the international language of accounting.

GAAP/IFRS Convergence

The GAAP is a rules-based system while the IFRS is a principle based system. The GAAP is composed of over 2,000 separate pronouncements, each of which may be several hundred pages. Those pronouncements, as reviewed above, are issued by a number of different bodies. The IFRS is a principle based system whose regulations fill approximately 2,000 pages. The difference could be thought of as the difference between telling a child to return home at a reasonable hour (principle based) and telling that child to be home at midnight but then listing 10 exceptions that would allow a later arrival (rules based). The differences between the two systems may result in significantly different reports for the same company. However, because of continued convergence projects, those differences are shrinking. For example, while IFRS balance sheets must contain certain information, there is no requirement on how that information must be presented. There are several other differences and consistent with the convergence initiative, the IFRS may adopt some GAAP positions.

Convergence & the SEC

The SEC was initially supportive of the convergence project. SEC rules require that companies that issue securities in the US provide a reconciliation of IFRS statements to GAAP. That reconciliation requirement was set to be eliminated by 2009 when the SEC would accept IFRS. Moreover, the SEC Chairman, Christopher Cox, suggested that not all differences between US GAAP and the IFRS would need to be reconciled before the SEC will accept IFRS based financial reports (Gill, 2007). Nevertheless, the SEC repeatedly delayed adoption of the IFRS, still not satisfied that convergence had achieved an acceptable form. By 2012, all of the world's ten largest economies were supportive of the IFRS and/or of convergence, but not one had fully adopted it.

Conclusion

Accurate financial information is critical for decision making within the business world and governments alike. The absence of honest and accurate financial reporting to support sound financial decisions can cause economic calamities, as evidenced by the Great Depression and the business collapses of the early 2000's. In the United States, the SEC compels financial disclosure from companies that seek funds from the investing public. The GAAP, established by a number of public and private organizations, provides the language in which those statements must be delivered. However, with the apparent acceptance of the US, our era of globalization has witnessed the rise of an international accounting standard that seems poised to become the new standard.

Terms & Concepts

Audit: An analysis performed by a trained accountant of a business’s economic documents. The evaluation involves the observing of irregular practices, advice for improvements, and bookkeeping. Audits that employees themselves perform are called “internal audits,” while independently-performed audits by outside accountants are known as “independent audits.”

Bonds: A document of debt that the government or a business issues as a means to guarantee re-payment of the initial investment (including interest) prior to a specific due date.

Debentures: An unsecured bond issued by a civil or government corporation or agency and backed only by the credit standing of the issuer.

Federal Register: A daily newsletter published by the American government. The bulletin contains the hearings schedule regarding Congressional and Federal agencies and the arrangements made public by the U.S. executive branch.

Note: A paper acknowledging a debt and promising payment; promissory note.

Proxy: A written permission that gives control and responsibility to another person so that they can act on the signer’s behalf (such as during a meeting of shareholders).

Tender Offer: A proposal to purchase many shares in a certain business, generally at premium or above the market price.

Bibliography

Ehoff Jr., C., & Fischer, D. (2013). Why the SEC is delaying adoption of international financial reporting standards. International Business & Economics Research Journal, 12, 223-227. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=89544608&site=ehost-live

Federal Accounting Standards Advisory Board. (2007). FASAB facts 2007. Washington D.C., Retrieved August 24, 2007, from www.fasab.gov

Gill, L. (2007). IFRS: Coming to America. Journal of Accountancy, 203, 70-73. Retrieved August 24, 2007, from EBSCO Online Database Business Source Premier. http://search.ebscohost.com/login.aspx?direct=true&db=buh&AN=26165798&site=ehost-live

Holzmann, O., & Robinson, T. (2005). The hierarchy of GAAP. Journal of Corporate Accounting & Finance (Wiley), 16, 83-86. Retrieved August 24, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19358991&site=ehost-live

Ibarra, V., & Suez-Sales, M. G. (2011). A comparison of the international financial reporting standards (IFRS) and generally accepted accounting principles (GAAP) for small and medium-sized entities (SMES) and compliances of some Asian countries to IFRS. Journal of International Business Research, 1035-62. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=69927678&site=ehost-live

Kaya, D., & Pillhofer, J. A. (2013). PoteU of IFRS by the United States: A critical view. Accounting Horizons, 27, 271-299. Retrieved November 15, 2013, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=88222027&site=ehost-live

Nolke, A. (2005). Introduction to the special issue: The globalization of accounting standards. Business & Politics, 7, 1-7. Retrieved August 24, 2007, from EBSCO Online Database Business Source Complete. http://search.ebscohost.com/login.aspx?direct=true&db=bth&AN=19358991&site=ehost-live

Public Company Accounting Oversight Board. (2007, May 1). Strategic Plan 2007-2012. Retrieved August 24, 2007, from http://www.pcaobus.org/About%5fthe%5fPCAOB/Strategic%5fPlan.pdf

Financial and Accounting Compliance

On this Page

Subject Terms

Financial and Accounting Compliance

Accounting > Financial Accounting & Compliance

Overview

Public Finance Law

Formation of the SEC

SEC Regulations

Four Divisions of SEC

Additional SEC Governance

Accounting Standards

Financial Accounting Standards Board

Federal Accounting Standards Advisory Board

Hierarchy of Information

The Emerging Issues Task Force

Insights

Financial Reporting in Global Business

GAAP/IFRS Convergence

Convergence & the SEC

Conclusion

Terms & Concepts

Bibliography

Suggested Reading