Peeling away financial reporting issues one layer at a time

The World of Accounting Would Be a Better Place Without 4 – 3 FASB Votes

The Financial Accounting Foundation is the body that oversees the FASB and the GASB (Governmental Accounting Standards Board).  A few months ago, this august group published a seven-page document with eleven specific recommendations: "Request for Comments on Proposed Changes to Oversight, Structure, and Operations of the FAF, FASB, and GASB."  Is seven pages not much to go on?  That's right; a more descriptive title might have been "Request for Comments on Proposed Solutions to Unspecified Problems that Currently Exist, or May Exist in the Future."  Here's a sample of the FAF's collective ruminations:

"Recent commitments by many countries to use International Financial Reporting Standards (IFRS) have opened a broad-ranging debate on issues related to accounting standards convergence and globalization. At its core, this debate must include a realistic assessment of how IFRS will work in actual application across the world and what contributions can be made by the FAF and FASB to the quality and consistency of those standards. The outcome of this debate will affect the future role, structure, and influence of the FAF and FASB on the global standard-setting process. However, regardless of the outcome, the FASB likely will continue to have a meaningful role in how international standards are set, and it may have continuing responsibility for setting standards for private enterprises and not-for-profit organizations in the United States."

Notice that FAF thinks that the "core" of the IFRS debate is how it will work throughout the world, and not whether IFRS will protect U.S. investors better than U.S. GAAP.  I also leave it to you to contemplate the purpose of the last two sentences, because it totally eludes me.  If anything, the words indicate that changes to FASB operations would be premature until we actually know what the status of IFRS will be in the U.S. 

Oh, well.  Let's pretend FAF has reasons to discuss the eleven proposals, and they just haven't told us much about them.  The four receiving the most publicity are as follows (for example, see this article at

  1. Pare down FASB membership from seven to five, so as to make it more "nimble" and "efficient."
  2. Retain 'majority rule' voting (apparently, whether or not the membership is seven or five).
  3. Vest the power to set the technical agenda solely with the chair (currently, members vote on whether to add items to the agenda).
  4. "Realign" the FASB "composition" –code for kicking out those pesky academics and investor representatives.  Although I haven't studied the issue, I would not be surprised if they were the two most frequent dissenters in finalized pronouncements.

Of these proposals, the one thing I would change about the FASB is the one that FAF seems not to want to change: majority rule voting (#2, above).  Unlike all of the comments on the proposal I have read (they are on-line, here), and the FAF's proposal document, I'm actually going to base my position on evidence. 

Specifically, I decided to compare the FASB pronouncements passed by a 4-3 vote with those passed by 5-2.  As best as I can tell by a text-based search of the original FASB pronouncements, there have been a total of 17 4-3 votes and 21 5-2 votes.  I have prepared a spreadsheet listing them. 

Is there a significant difference between 4-3 pronouncements and 5-2 pronouncements?  That's probably as much a matter of opinion than fact or inference, but the table below will help me express my own views (read on, if you care!).  These are my choices from the population of 4-3 and 5-2 pronouncements that have been 'momentous' in their impact on financial reporting.

All of the 4-3 pronouncements I deem momentous were fiascoes:

  • FAS 52 replaced FAS 8, a principles-based standard with rules that allow a company to multiple convert foreign-currency-denominated historic costs by current exchange rates, created dollar-denominated random numbers.  (See my earlier posts on this here and here).
  • FAS 34 created rules directly contrary to fundamental principles of financial economics by conflating interest and operating costs — in order to help capital intensive companies smooth earnings and defeat analysts' separate assessment of operating profitability (See my earlier post here).
  • FAS 87 has obscured the economics of pensions for years, and has contributed to massive social costs by promoting mismanagement of defined benefit pension plans (See earlier posts here and here).
  • FAS 95 blithely allows companies to adopt the indirect method of presentation of the statement of cash flows, depriving investors of information regarding actual operating receipts and disbursements.

The 5-2 pronouncements are much more ambivalent:

  • FAS 114 provided a consistent, albeit flawed approach to recognition and measurement of impaired loans.
  • In a first for U.S. GAAP, FAS 115 called for fair value of most marketable securities.  However, the artificial concepts of held-to-maturity and available-for-sale investment categories were created out of a need for political compromise of absolutely no benefit to investors.
  • FAS 123 and FAS 130 were significant steps forward, at least by providing transparent disclosures of the income statement effects of stock option grants, and the components of 'dirty surplus.'
  • FAS 140 is still quite controversial, but was a significant improvement over FAS 125.
  • Although FAS 13 provides plenty of opportunity to avoid lease capitalization or manipulate revenue from leases, at least some leases are accounted for properly.  The sad part is all the money companies spend on lawyers and consultants to devise contracts that keep all one's tootsies on the right side of the bright lines.  Admittedly, however, if FAS 13 shouldn't be considered a complete fiasco, it's a close call.

The Data Speaking to Me

It's quite apparent to me that the world would be a better place without each of these 4-3 pronouncements; there is nothing good about any of them.  Although there is much to criticize about some of the 5-2 pronouncements, they all constitute a step forward in some respects.  It also appears that the FASB has already learned this lesson — albeit through hard experience — as there has not been a single 4-3 decision in the last twenty years.  If my data is correct, there can be no mistaking that 5-2 votes have become the de facto criterion.  Thus, one could argue that FAF merely would be formalizing current practice by moving to a 5-2 vote requirement; but, I believe it would be one added safeguard against future fiascoes. 

BUT, if FAF would consider requiring that the FASB re-consider all past 4-3 pronouncements, that would be progress toward solving real problems.

So, that's my view of the evidence.  You also have my data; use it in good health to make your own lists, and draw your own conclusions. 

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