CPAs Must Stand Firm in Standard-Setting Process.

Accounting professionals want to serve the public interest. It is therefore imperative that the profession maintains its self-regulation. We should be alarmed when even a slight erosion of self-regulation results from restrictions imposed from outside the CPA profession. Self-regulation lies at the very core of our capacity to retain public trust and confidence.

In recent years, frequent political intervention has shown little regard for the long-term damage it can do to the profession's prerogative for self-regulation and to the integrity of its due process for setting accounting standards and policies.

Accounting is a service activity. It can retain its relevancy and ability to provide value-added services to clients only if it remains a dynamic profession. It must adapt to the constantly changing environment in which it operates. However, any change has to be credible and orderly, respecting the due process of formulating accounting standards. Without retaining due process, standard-setting processes will become arbitrary and will be subjected to whatever strong influences happen to be present at the moment, no matter how harmful the long-term societal and economic consequences.

FASB'S DUE PROCESS FOR STANDARD-SETTING

Since its inception in 1934, the SEC has always deferred to the accounting profession in setting accounting and reporting standards-with one exception. In 1978, yielding to aggressive lobbying by the oil industry, the SEC rejected Statement of Financial Accounting Standard No. 19, "Accounting and Reporting by Oil and Gas Producing Companies." This hurt the perception of FASB's role in the eyes of many who felt FASB had caved to the SEC, since it had to issue Statement No. 25 to amend No. 19.

The most authoritative source of accounting principles is FASB's statements and interpretations. To ensure that concerns and opinions of all stakeholders are considered, FASB's due process gives all interested parties ample opportunities to express their viewpoints before a standard is issued. The process consists of nine steps:

1. FASB selects project for agenda;

2. Task force to define issues appointed;

3. FASB technical staff researches issue;

4. Discussion memorandum drafted and released to the public;

5. Public hearings held;

6. Comments on discussion memorandum evaluated;

7. Exposure draft of the proposed standard released;

8. Exposure draft comments evaluated and incorporated into document;

9. Statement of Financial Accounting Standard released after approval by a majority of FASB members.

This process ensures that all constituents, including lobbying groups, have several opportunities to provide input and suggestions for modifications before the standard is issued.

ROLE OF POLITICS IN STANDARD-SETTING

It is a common myth that self-regulation precludes any exercise of political influence during the standard-setting process. On the contrary, due process provides ample opportunities for political influence. There is nothing inherently improper or undesirable about the political influences exercised during the standard-setting process. Our democratic system encourages all constituents in our political system to influence the outcome of decisions that are of interest or concern to us all.

A problem arises when attempts are made, whether successful or unsuccessful, to exercise political influence that circumvents or bypasses due process for accounting standard-setting. It should be looked upon as what it is--an assault on the profession's ability to self-regulate. FASB is a private organization, one for and by the profession. Its pronouncements have profound societal and economic consequences. The U.S. legal system and government allows professionals to set their own standards. These standards are, consequently, developed in the private sector.

Revisions of old and issuance of new standards are necessary outgrowths of changing economic conditions. Various interest groups, understandably, want particular economic events or transactions accounted for or reported in a way that suits them best. The most effective and desirable way to influence standard-setting is to participate in formulating these standards.

FASB has increasingly become the target of many pressure groups to influence changes in existing standards and in the development of new ones. All past FASB chairmen, as well as the current chairman, have acknowledged that many projects have been targets of political pressure and such pressures are increasingly frequent and intense.

FASB must accommodate many competing and conflicting interests. It should not be surprising, therefore, that it has been accused of both being "too restrictive" and "allowing too much latitude and discretion," albeit at different times and by different parties. Some industry groups demand that FASB act more quickly to solve existing accounting and reporting problems. Others prefer that any changes be implemented slowly. Such diverse reactions are fair and expected, as it is the right of constituents to express their negative opinion on any pronouncement either before or after its issuance. This is the strength of self-regulation.

One can provide all the cogent arguments during the standard-setting process while retaining the right to express displeasure with the standard if it is inconsistent with preferences of the party concerned.

WHAT IS THE PROBLEM?

A serious problem arises when there are attempts to block due process. This is contrary to any acceptable norm of self-governance and must not be allowed. Unfortunately, this has been happening too often recently.

FASB must carefully consider the economic consequences of its pronouncements. What it must not do is issue pronouncements that are solely, or mostly, based on political expediency. Its standards should be conceptually sound and take into account economic reality. However, troubling events in recent years have invited a serious attack on accounting standard-setting due process.

The first occurred when FASB proposed to require that stock options issued to employees be recorded as an expense on the income statement. The opponents of the proposed standard--mostly high-tech startups--argued that, if implemented, the outcome would be disastrous. Small companies would not be able to attract top-quality employees because stock option plans involve too high a charge to income. Moreover, being cash starved, most, if not all of them would go bankrupt. They also claimed that since small companies create most of the jobs in the United States, implementation of the proposed standard would lead to a high unemployment rate in the country with dire consequences for the economy. FASB pointed out that stock options are compensation. Like any type of compensation, their cost should be recorded as an expense.

Two bills were introduced in Congress: One would have prohibited recording of stock options as compensation expense and the other would have required it. FASB was compelled to change its proposal and ended up requiring disclosure only. Now with the fallout of literally hundreds of dot-com companies a few years later, one wonders if FASB's original proposal could have prevented this dismal situation. We will never know.

The next case involved the FASB project on derivatives. It resulted in bills being introduced both in the House and Senate. The bills, if they'd been signed into law, would have intervened in FASB's standard-setting process.

Finally, last year there were congressional hearings on FASB's proposal on business combinations. Thirteen percent of U.S. senators sent a letter to FASB urging it to postpone requiring implementation of the proposed standard on business combinations.

These attempts to circumvent FASB's due process do harm in at least two ways. First, they potentially make FASB gun shy, and less proactive, because understandably FASB has to take a defensive position in response to such circumventions. Second, they consume FASB's time and resources in fighting unnecessary battles.

THE SOLUTION

It is imperative that we, as a profession, express our firm commitment to private-sector standard-setting where we have due process. What we must not do is run to Congress whenever we disagree with the outcome of the participatory standard-setting due process. Otherwise, we are parties to the demise of private sector standard-setting. It is not a good idea to let short-run concerns harm the long-run interests of the profession. To do so would be to let the urgent preempt the important.

M. Zafar Iqbal, CPA, Ph.D, is a professor of accounting at Cal Poly State University. San Luis Obispo and a member of the state Global Opportunities Committee. He has served as an external expert reviewer to FASB on international accounting standards projects.