This chapter covers the role of accounting setting standard such as AICPA, SEC, FASB and the objective of financial reporting.

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Chapter 1 describes the environment that has influenced both the development and use of the financial accounting process. The chapter traces the development of financial accounting standards, focusing on the groups that have had or currently have the responsibility for developing such standards. Certain groups other than those with direct responsibility for developing financial accounting standards have significantly influenced the standard-setting process. These various pressure groups are also discussed.

Nature of Financial Accounting

The essential characteristics of accounting are (1) the identification, measure­ment, and communication of financial information about (2) economic entities to  (3) interested parties. Financial accounting is the process that culminates in the preparation of financial reports on the enterprise for use by both internal and external parties.

Financial statements are the principal means through which a company communicates its financial information to those outside it. The financial statements most frequently provided are (1) the balance sheet, (2) the income statement, (3) the statement of cash flows, and (4) the statement of owners’ or stockholders’ equity. Other means of financial reporting include the president’s letter or supplementary schedules in the corporate annual report, prospectuses, reports filed with government agencies, news releases, management forecasts, and social or environmental impact statements.

Accounting and Capital Allocation

Accounting is important for markets, free enterprise, and competition because it assists in providing information that leads to capital allocation. The better the information, the more effective the process of capital allocation and then the healthier the economy.

Objective of Financial Reporting

The objective of general-purpose financial reporting is to provide financial information about the reporting entity that is useful to present and potential equity investors, lenders, and other creditors in decisions about providing resources to the company. General-purpose financial statements provide financial reporting information to a wide variety of users

The objective of financial reporting identifies investors and creditors as the primary users for general-purpose financial statements. As part of the objective of general-purpose financial reporting, an entity perspective is adopted. Companies are viewed as separate and distinct from their owners. When making decisions, investors are interested in assessing (1) the company’s ability to generate net cash inflows and (2) management’s ability to protect and enhance the capital providers’ investments.

The accounting profession has developed a common set of standards and procedures known as generally accepted accounting principles (GAAP). These prin­ciples serve as a general guide to the accounting practitioner in accumulating and reporting the financial information of a business enterprise.

Securities and Exchange Commission (SEC)

After the stock market crash in 1929 and the Great Depression, there were calls for increased government regulation and supervision—especially of financial institutions and the stock market. As a result, the federal government established the Securities and Exchange Commission (SEC) to help develop and standardize financial information presented to stockholders. The SEC is a federal agency and administers the Securities Exchange Act of 1934 and several other acts. Most companies that issue securities to the public or are listed on a stock exchange are required to file audited financial statements with the SEC. In addition, the SEC has broad powers to prescribe the accounting practices and standards to be employed by companies that fall within its jurisdiction.

At the time the SEC was created, it encouraged the creation of a private standards-setting body. As a result, accounting standards have generally been developed in the private sector either through the American Institute of Certified Public Accountants (AICPA) or the Financial Accounting Standards Board (FASB). The SEC has affirmed its support for the FASB by indicating that financial statements conforming to standards set by the FASB will be presumed to have substantial authoritative support.


The FASB represents the current rule-making body within the accounting profession. The mission of the FASB is to establish and improve standards of financial accounting and reporting for the guidance and education of the public, which includes issuers, auditors, and users of financial information. The FASB differs from the predecessor APB in the following ways:

  1. Smaller membership (7 versus 18 on the APB).
  2. Full-time remunerated membership (APB members were unpaid and part-time).
  3. Greater autonomy (APB was a senior committee of the AICPA).
  4. Increased independence (FASB members must sever all ties with firms, companies, or institutions).
  5. Broader representation (it is not necessary to be a CPA to be a member of the FASB).

Two basic premises of the FASB are that in establishing financial accounting standards: (a) it should be responsive to the needs and viewpoints of the entire economic community, not just the public accounting profession, and (b) it should operate in full view of the public through a “due process” system that gives interested persons ample opportunity to make their views known.