Most of my financial accounting students are relative newbies to the wonderful world of accounting and business-related classes. Even at the MBA level, a preponderance of my stu- dents know nothing about accounting because they transferred into business after getting their undergraduate degrees in non-business- related disciplines.
If you’re an accounting novice, my best advice to you is to forget all your preconceived notions of accounting — especially as they tie into
what you feel is logical. Many times, I’ve seen students banging their heads against the wall because the way GAAP or the AICPA works doesn’t make sense to them. Sometimes, financial accountants handle transactions in a certain way simply because that’s the way it’s done. After you go through the alphabet soup of regulatory agencies in this chapter, I hope you come to realize that for this class, at least, you need to have a good overview of the regulatory system and just go with the flow.
Why is the accountant’s ethical behavior so crucial? The reports that financial accountants prepare are used by individuals to make important investment decisions that can have a mighty future effect on the users’ housing, retire- ment, and education options. The users of the financial reports must be given accurate, comparable financial statements so they can make educated deci- sions on how to invest their money.
The American Institute of Certified Public Accountants (AICPA) is the national professional organization for all certified public accountants (CPAs). You don’t have to be a CPA or a member of the AICPA to get work as a financial accountant. However, if you think financial accounting is a career path worth exploring, keep in mind that being a CPA is a must for advancement in the field. Also, membership in the AICPA has many rewards, such as automatically informing you about new accounting standards and providing great research and educational resources.
So what exactly does the AICPA do? Through its senior technical committee, which is called the Auditing Standards Board (ASB), the AICPA is responsible for establishing auditing and attestation standards for nonpublic companies in the United States. Before we move on, let me define three key terms in that explanation:
✓ The purpose of financial statement auditing is to gather enough evidence about a company’s documents to be able to issue an opinion on whether the documents are free of material (significant) misstatements.
✓ A financial accountant provides an attestation service when she issues a report on a subject that is the responsibility of another person or business. For example, a company can hire you to calculate the rate of return on the company’s investments (see Chapter 14), making sure your figures match the company’s report on the same topic.
✓ Nonpublic companies are closely held (meaning privately owned). Their stock is not traded on any open-to-the-public stock exchange. For example, if you start a corporation, you aren’t required to sell any of your shares of stock unless you want to. In contrast, a publicly traded company’s shares are available for purchase in stock exchanges such as the American Stock Exchange or over-the-counter markets such as the NASDAQ.
The AICPA also enforces a code of professional conduct for its members, which governs how financial accountants perform their duties. In the next two sections, I provide more information about each key role of the AICPA. First up is an explanation of the audit and attestation standards set by the ASB.
ASB audit and attestation standards
accountants must follow when conducting attestation and audit services for nonpublic companies. It also sets quality control standards to use when con- ducting peer reviews, which occur when one CPA firm evaluates the opera- tions of another CPA firm.
The ASB has 19 members, most of whom work for public accounting firms (such as KPMG LLP), are university professors, are governmental accoun- tants, or otherwise work in the field of accounting. Members serve one- to three-year terms and are jointly nominated by the director of the AICPA Audit and Attest Standards staff and the ASB chair. The responsibility of approving the nominations falls to the AICPA Board of Directors.
Curious about these mysterious ASB standards? They are called Statements on Auditing Standards (SAS), and as of this writing the AICPA Web site lists 120 of them. Here, I explain just a couple so you have some idea of what they cover:
✓ SAS No. 1 Section 410 says the auditor must state whether the financial statements are presented using generally accepted accounting prin- ciples (GAAP).
✓ SAS No. 85 defines the responsibilities that management of the company in question has for the preparation of the financial statements and the written representations about the preparation that auditors have to get from management.
A lot of information about the ASB standards and procedures is available free of charge on the AICPA Web site at www.aicpa.org. From the home page, select “Research” and then “Standards.” You can access all sorts of good financial accounting info on the topics of audit, attest, compilation, and review standards.
A compilation occurs when a financial accountant prepares financial state- ments for a company using only data given to him by company management.
A review occurs when the financial accountant gives limited assurance that no material modifications need to be made to financial statements prepared by company management.
AICPA Code of Professional Conduct
The AICPA’s Code of Professional Conduct contains six principles of profes- sional conduct by which its members must abide: responsibilities, serving the public interest, integrity, objectivity and independence, taking due care, and the scope and nature of services. You can read all about these six prin- ciples at www.aicpa.org/About/code/sec50.htm.
Note: In this section, I use the terms financial accountant and CPA synony- mously. I do so because most financial accountants are CPAs, and vice versa.
Here’s a brief explanation of each of the six principles:
✓ Responsibilities: As an accountant, you hold yourself to high moral and ethical standards so you maintain the public’s confidence in your finan- cial reporting. For example, financial accountants have the responsibil- ity to participate in self-governance by performing peer reviews of other CPA/financial accounting firms’ work to check for accuracy and consis- tency among the profession.
✓ Serving the public interest: A financial accountant’s public interest is the company for whom she is preparing the financial statements, as well as the users of the financial statements (such as people and entities thinking about purchasing shares of the company stock).
The public interest also includes banks and other businesses that are considering granting credit to the company, governmental agencies such as the Internal Revenue Service (which measures the company’s compliance with the tax code), investors, and other members of the business and financial community who rely on the objectivity and integ- rity of CPAs.
✓ Integrity: This characteristic means you are honest when dealing with others. In the world of financial accounting, integrity means that you serve the company for whom you are preparing the financial statements to the best of your ability, keeping in mind that this may not be the same thing as completely agreeing with the way the company wants its finan- cial statements prepared. You can’t be worried that business manage- ment is going to be mad at you or fire you if you disagree with them.
✓ Objectivity and independence: When you are objective, you are neutral and unbiased in all decision-making processes. You base your opinions only on facts and not on any preconceived notions you may have. You interpret rules and policies, such as generally accepted accounting prin- ciples (GAAP), in a truthful and sincere manner — staying true to both the form and spirit of the particular principle or regulatory issue.
Financial accountants who provide auditing and other attestation ser- vices must be independent in both fact and appearance. Being inde- pendent means you have no special relationship to or financial interest with the company that would cause you to disregard evidence and facts when evaluating them. For example, preparing the financial statements for a business owned by a close relative can justifiably cause those view- ing your report to doubt its veracity or your objectivity.
✓ Taking due care: In a nutshell, this principle means you have the edu- cation and experience to perform the work at hand. You must be both competent and practice diligence. In addition, due care means you plan and supervise adequately any professional activity for which you are responsible.
✓ Scope and nature of services: All the above principles lead up to this final one. Financial accountants consider all the preceding principles when determining whether they can provide specific services in indi- vidual circumstances.
If being a member of the AICPA isn’t mandatory in order to get a job as a finan- cial accountant, you may wonder why its code of conduct is such a big deal.
Well, if you want to be a financial accountant practicing as a CPA (see Chapter 2), you must be licensed by your state, which recognizes the authority of the AICPA. State and federal courts consistently hold that all practicing CPAs, regardless of membership in the AICPA, must follow the professional ethical standards contained in the AICPA’s Code of Professional Conduct.
Following Regulatory Issues
In addition to the AICPA, other organizations give financial accountants offi- cial guidance on how to prepare financial statements. Public and nonpublic corporations have different agencies monitoring them and keeping them on the right course.
In this section, I discuss the U.S. Securities and Exchange Commission (SEC), which was created during the Great Depression that followed the stock market crash of 1929. It was charged with regulating the stock market and preventing corporate abuses relating to the offering and sale of securities and corporate reporting. Also in this section, I explain the Sarbanes-Oxley Act of 2002 (SOX), which was enacted in response to corporate abuses that took place in the 1990s and early 2000s. Finally, you find out about the enforce- ment arm of SOX, the Public Company Accounting Oversight Board (PCAOB).
The U.S. Securities and Exchange Commission (SEC)
In response to the stock market crash of 1929 and the ensuing Great Depression, the Securities Exchange Act of 1934 created the SEC. The SEC’s mission is to make sure publicly traded companies tell the truth about their businesses and treat investors in a fair fashion by putting the needs of the investor before the needs of the company.
The SEC is run by five commissioners who are appointed to five-year terms by the president of the United States. Their terms are staggered, and no more than three commissioners can be from the same political party at the same time. These commissioners ride herd over the SEC’s power to license and regulate stock exchanges, the companies whose securities are traded on
The enforcement authority given by Congress allows the SEC to bring civil enforcement actions against individuals or companies alleged to have com- mitted accounting fraud, provided false information, or engaged in insider trading or other violations of the securities law. The SEC also works with criminal law enforcement agencies to prosecute individuals and companies alike for offenses that include criminal violations.
As a financial accountant, your exposure to the regulatory authority of the SEC will be limited unless you work for a company whose shares of stock are publicly traded or you work for a CPA firm conducting financial statement audits for publicly traded companies.
The Sarbanes-Oxley Act of 2002 (SOX)
Beware, fraudulent companies: SOX may sound like a cuddly kitten, but it has claws! The bankruptcies of Enron Corporation and WorldCom, Inc. — and the subsequent billions of dollars of investor losses — prompted the U.S Congress to pass the Sarbanes-Oxley Act of 2002 (SOX) in an effort to renew investor confidence in the regulation of publicly traded companies. (SOX got its name because the legislation was sponsored by U.S. Senator Paul Sarbanes and U.S. Representative Michael G. Oxley.)
Abiding by SOX is mandatory for all publicly traded organizations regardless of size. SOX introduced major changes to the regulation of financial practice and corporate governance.
SOX does not apply to privately held companies; the Auditing Standards