Securities and Exchange Commission Historical Society

The Richard C. Adkerson Gallery on the SEC Role in Accounting Standards Setting

Finding the Right Structure

Filling the Gaps in GAAP

- November 11, 1997 Annual Meeting of Coopers & Lybrand National Accounting, Auditing and SEC Consulting Partners

Over the years, some GAAP standards have been governed more by form than substance, and some measurements and recognitions under GAAP could be shaped by careful structuring of transactions. Examples of form-oriented accounting that proved troublesome are provided in Examples of Gaps in GAAP. As a result, some preparers viewed GAAP as more of a compliance exercise than the faithful reporting of financial activities.

The deft application of form-oriented GAAP is distinguished from “cooking the books.” However, one can only wonder if some who engaged in fraudulent financial reporting rationalized it as not that different from stretching the occasionally frail boundaries of GAAP. Enron may be an example of form-oriented accounting for “special purpose entities” extended beyond acceptable application.

Some managements who had a compliance view of GAAP would insist that any method was acceptable so long as it was not specifically proscribed by GAAP. Auditors often heard, “Show me where it says I can’t do it!” The status of GAAP was also eroded by the occasional quest for the “lowest common denominator” among presumably acceptable methods. Audit firms were sought out for opinions on the propriety of hypothetical transactions, and investment bankers would then use the opinions to sell structured transactions to registrant clients. If one major firm approved the accounting proposed for a hypothetical transaction, other auditors felt pressure to accept that conclusion.

In 2002, SEC Chief Accountant Robert Herdman successfully urged the AICPA’s Auditing Standards Board to prohibit an accountant’s accepting an engagement to report on hypothetical transactions.  

In 1975, the SEC began requiring auditors to state whether changes to an alternative accounting principle by registrant clients were preferable. GAAP now requires that management explain in its financial statements why a newly adopted accounting principle is preferable.

But all this led to accounting standards that are “rules-based” and highly detailed.(17) There are cries for “principles-based” standards that lay out general principles without the same level of detail and with more reliance on the application of judgment.(18)

How did the application of GAAP get so stressed for a while? One factor may have been the changes to the AICPA Code of Professional Conduct. During the 1970s, the U.S. Department of Justice and the Federal Trade Commission embarked upon a program to force professional organizations to repeal their rules banning advertising, solicitation, and competitive bidding. The AICPA became an early target. These changes – sometimes called “ethical deregulation” – resulted in competitive activities by accountants that previously were considered scurrilously unprofessional. Now it could mean grubby competition or slow business death. Some within and without the profession began pejoratively referring to audits as “commodities,” and urged accountants to expand non-audit services to enhance revenues.


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Footnotes:

(17) So-called “rules-based” standards are grounded in principles but go further to provide detailed implementation rules.

(18) Looking Forward

Related Museum Resources

Papers

October 19, 1937
transcript pdf (Courtesy of the American Institute of Certified Public Accountants)
October 8, 1952
transcript pdf (Government Records)
March 12, 1998
image pdf (With permission of Arthur Levitt Papers, Rare Book & Manuscript Library, Columbia University in the City of New York)
September 28, 1998
image pdf (With permission of Arthur Levitt Papers, Rare Book & Manuscript Library, Columbia University in the City of New York)
December 8, 1998
image pdf (With permission of Arthur Levitt Papers, Rare Book & Manuscript Library, Columbia University in the City of New York)
April 22, 1999
image pdf (With permission of Arthur Levitt Papers, Rare Book & Manuscript Library, Columbia University in the City of New York)
June 29, 1999
image pdf (With permission of Arthur Levitt Papers, Rare Book & Manuscript Library, Columbia University in the City of New York)

Oral Histories

14 February 2006

Walter Schuetze

16 June 2005

Lynn Turner

Programs

26 October 2010

Deloitte Fireside Chat IV: Responsibility for Preventing and Detecting Financial Reporting Fraud

Moderator: Ira Solomon

Presenter(s): Joseph Carcello, Cynthia Fornelli, Robert J. Kueppers

28 October 2009

Deloitte Fireside Chat II: Exploring Principles vs. Rules-Based Accounting and Auditing Standards

Moderator: Patricia Fairfield

Presenter(s): Robert Kueppers, Scott Taub

22 October 2009

Deloitte Fireside Chat I: The Role of Professional Judgment in Accounting and Auditing

Moderator: Zoe-Vonna Palmrose

Presenter(s): Gregory J. Jonas, Robert Kueppers

06 June 2006

Who's Counting? - The Critical Role of Financial Reporting in the Capital Markets (Seventh Annual Meeting)

Moderator: Robert Kueppers

Presenter(s): Pat McConnell, Donald Nicolaisen, Aulana Peters, Lawrence Salva, Scott Taub

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