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Oct 1991

Where would we be with it? (Financial Accounting Standards Board's supermajority voting rule)

by Edwards, Randal K.

    Abstract- The potential effects of the super-majority rule for voting of the Financial Accounting Services Board are examined in terms of the present state of accounting standards as embodied in the generally accepted accounting principles (GAAP). The super-majority rule requires a 5-2 vote (about 71%) as compared to the original 4-3 vote (about 57%) for adopting rules for inclusion in the Statement of Financial Accounting Standards (SFAS). A historical perspective of majority qualifications based on the 4-3 vote illustrates the GAAP's present state in terms of specific SFAS rules, such as the error adjustments of prior period financial statements, capitalization of interests accumulated during asset construction, preparation of financial reports for defined benefit pension plans, debt extinguishment, cash flow statements, inflation-adjusted accounting, and foreign exchange translation.

The preceeding article presented the immediate background and the discussions surrounding the change to a supermajority for FASB voting. This article examines the history of majority requirements by the prior authoritative boards and what the state of GAAP would be had the supermajority always been in place.

History of Majority Requirements

The FASB's original requirement was a simple majority of 4-3 (approximately 57%). In contrast, the two predecessor boards, the Committee on Accounting Procedure and the Accounting Principles Board (APB), required a two-thirds majority (67%). The supermajority vote of 5-2 (approximately 71%) is the closest the FASB can come to a two-thirds vote and thus would then be more consistent with its predecessors.

Even though the APB had a two-thirds majority requirement, there were still a number of opinions that passed with quite a few dissenters. Also, the demise of the APB is often attributed to the failure to build a consensus among users and others. Perhaps the FASB could have avoided some of the criticism it has received if the supermajority had always been in place.

Prior Statements

Figure 1 of the preceeding article summarizes the FASB statements that passed with a 4-3 or 4-2 vote. A review of the topics identifies several major items and controversial issues, such as pensions, foreign currency, inflation accounting, and cash flows. Table 1 in this article summarizes present and previous GAAP for selected statements, which are examined in the following sections. Obviously, it is impossible to determine what the present status of GAAP would be if the supermajority has always been in place. At a minimum, it is probably safe to assume that many, if not all, of the contested statements would not be in their present form.

Table : FIGURE 1












































Prior Period Adjustments

SFAS 16 limits prior period adjustments to the "correction of an error in the financial statements of a prior period" (the other type of prior period adjustment was eliminated by SFAS 96). The three dissenters to SFAS 16 believed that there were other items that should be recorded as prior period adjustments. SFAS 16 requires that those items be reported on the income statement, possibly increasing the volatility of earnings. Also, except for errors, all items that clarify uncertainties recorded earlier or in some way relate to prior years are included in the current income statement.

Capitalization of Interest Cost

SFAS 34'requires that interest incurred during construction of assets be capitalized during the "capitalization period." The three dissenters believed that interest should be an expense of the current period and should not be attributed to a product as are materials, labor, and overhead. Because there was no prior authoritative statement, if the FASB had been unable to garner five positive votes, capitalization of interest would not be required. With that scenario, some would believe that no requirements for interest capitalization would contribute to a lack of comparability and consistency. Others might argue that the lack of guidelines would allow companies to follow the true economic substance of a situation.

Accounting and Reporting for

Defined Benefit Pension Plans

SFAS 35 establishes guidelines for annual financial statements of defined benefit pension plans (but not accounting and reporting by the employer). The dissenters believed that too much information was provided, actuarial information was not reliable enough to be included in the statements, and comparability between plans would be reduced. An acceptable alternative might have required less detail and/or moved information from the financial statements to the footnotes.

Foreign Currency Translation

SFAS 52 defines the functional currency, requires the current rate method of statement translation except when the functional currency is the U.S. dollar, and prescribes accounting for foreign currency transactions. The previous statement, SFAS 8, required the temporal method of translation. Current rate translation adjustments in SFAS 52 are a component of stockholders' equity but temporal adjustments are recorded in the income statement.

The dissenters to SFAS 52 suggested, among other things, that the best approach would have "essentially retained Statement 8's translation method" and "recognized all gains and losses in net income ... but allowed for a separate and distinct presentation of those gains and losses within the income statement." Because many in the accounting public were not pleased with SFAS 8, a new statement was probably inevitable. However, the requirements would undoubtedly be different if the supermajority had been in place.

Extinguishment of Debt

The primary change that SFAS 76 makes in the requirements of APBO 26, the prior authoritative support, is to include legal forgiveness and in substance defeasance as extinguishment of debt. The dissenters did not believe that in substance defeasance, where the "debtor is not legally released from being the primary obligor under the debt obligation," should be extinguishment of debt and thus reported as an extraordinary item on the income statement.

Employers Accounting for


SFAS 87 establishes specific guidelines for computing net periodic pension cost, which is the amount recorded as pension expense. If the current company contribution to the plan does not equal the expense, an asset or liability is created for the over- or underfunding. Also, an additional liability is recorded if the accumulated benefit obligation at year-end exceeds the fair value of plan assets. The additional liability is offset by a debit to an intangible asset, which cannot exceed the unamortized (unrecognized) prior service cost. Any excess is debited to an equity account.

The dissenters to SFAS 87 disagreed with various specific computations and assumptions. Two of the dissenters also did not believe the intangible asset should be recorded. Obviously, accounting for pensions is complicated; at minimum, it is safe to assume that present requirements would be different with a supermajority vote.

Inflation Accounting

In 1979, the FASB initiated a five-year inflation accounting experiment. Large companies were required to present certain inflation- adjusted information as supplemental disclosures. Five years later, SFAS 82 eliminated some of the requirements. Finally, in 1986, during a period of relatively low inflation, SFAS 89 changed the required disclosures to "encouraged."

The dissenters to SFAS 89 believed that inflation accounting should not be "written off as lost cause." They were concerned that inflation accounting should be reconsidered, especially when there was not a "crisis atmosphere." This seems to be an especially prophetic statement, given the recent oil price increases, federal and state budget problems, and renewed concern about inflation.

Statement of Cash Flows

SFAS 95 replaced the statement of changes in financial position with the statement of cash flows. The new statement is consistent with one of the three objectives of financial reporting set forth in the FASB's Conceptual Framework. The dissenters to SFAS 95 objected primarily to how certain items are classified on the statement of cash flows. For example, interest revenue, dividend revenue, and interest expense are classified as flows from operating activities and not in the categories to which they are related (i. e., interest revenue is earned on an investment, not from operations). Although the supermajority vote would probably not have prevented the statement of cash flows from being required, a compromise satisfactory to at least one dissenter would have changed the nature of the statement.

Would More Compromise Have

Been Helpful?

Eighteen of the FASB's statements have passed with only four affirmative votes. As the above review illustrates, some of the statements have related to major topics. Requiring the FASB to reach more consensus among the seven members would have undoubtedly led to more compromise, possibly substantially reducing criticism which the Board has received.

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