The new GAAP hierarchy: important changes affecting audits, reviews, and compilations. (generally accepted accounting principles)(includes related articles)by Sauter, Douglas P.
As a result of the issuance of SAS 69, there has been a major change in the composition of the GAAP Hierarchy. The issuance of certain pronouncements from the FASB, EITF, and the AICPA which could be ignored previously, may now result in accounting changes in audit, review, and compilation engagements.
Only days after the beginning of 1992, the AICPA Auditing Standards Board issued Statement on Auditing Standards (SAS) 69, The Meaning of "Presents Fairly in Conformity With Generally Accepted Accounting Principles" in the Independent Auditor's Report. SAS 69 revised the so- called "GAAP Hierarchy" in many ways. The changes are of critical importance to accountants that perform audits, reviews, and compilations of financial statements, and preparers of financial statements.
No single reference source exists for GAAP. SAS 69 states, "GAAP is a technical accounting term that encompasses the conventions, rules, and procedures necessary to define accepted accounting practice at a particular time. It includes not only broad guidelines of general application, but also detailed practices and procedures." Also, the authoritative pronouncements that comprise GAAP are of varying levels of authority. The GAAP Hierarchy sets forth the levels of authority achieved by the various sources of accounting principles. SAS 69 is the one place where GAAP is defined and the levels of authority are described.
Auditors use the GAAP Hierarchy as a benchmark to determine whether the financial statements being audited are fairly presented in conformity with GAAP. But the GAAP Hierarchy is not only of interest to auditors but also to preparers of financial statements. Since financial statements are the responsibility of the entity's management, preparers need to refer to the GAAP Hierarchy in the preparation of their financial statements.
In late 1992, the AICPA issued SSARS 7, Omnibus Statement on Standards For Accounting and Review Services -- 1992, which stated that the GAAP Hierarchy applies to compilation and review engagements. This underscores that the accounting principles to be followed in compiled and reviewed financial statements are the same as those in audited financial statements. Thus, the level of the accountant's engagement--a compilation, review, or audit--should not affect the choice of accounting standards by an entity preparing GAAP financial statements. GAAP is GAAP.
The GAAP Hierarchy is nothing new. It has existed in auditing standards since 1975. Although revisions to the hierarchy have been made several times since then, the revisions effected by SAS 69 are the most extensive to date. The three major changes nwere to 1) create two separate hierarchies, 2) elevate the authority of Emerging Issues Task Force (EITF) consensus positions and AICPA Accounting Standards Executive Committee (AcSEC) practice bulletins, and 3) make each category of the hierarchy a separate level of authority. Exhibit 1 compares the new hierarchy with the old hierarchy.
Two Separate Hierarchies
The main purpose of revising the hierarchy was to prevent state and local governments from being required to change accounting practices to methods required by a newly issued FASB pronouncement even when GASB was considering the same subject. Under the old hierarchy, FASB statements had the potential to change GAAP for state and local governments even though those entities were subject to GASB jurisdiction. They had this ability because both FASB and GASB statements and interpretations held the top spot of the old hierarchy. If the accounting treatment of a transaction or event was not specified by a GASB pronouncements, applicable FASB pronouncements would apply to state and local governments. This arrangement caused some disruption of the GASB project agenda.
In 1986 and again in 1988, the GASB issued so-called "negative standards," which told state and local governments not to follow a specific FASB standard (See Exhibit 2). By creating two separate but parallel hierarchies, (one for state and local governments and one for non-government entities) the new hierarchy prevents FASB pronouncements from requiring changes in state and local government accounting practices and eliminates the need for so-called "negative standards."
In creating a separate hierarchy for TABULAR DATA OMITTED state and local governments, SAS 69 does not create a new definition of the type of entities required to follow that hierarchy. Rather, it parrots the definition of "state and local government" included in the GASB's Codification of Governmental Accounting and Financial Reporting Standards. It states that state and local governmental entities include public benefit corporations and authorities, public employee retirement systems, and governmental utilities, governmental hospitals and other health care providers, and governmental colleges and universities.
The GAAP Hierarchy does not apply to the Federal government. Current efforts are underway by the Federal Accounting Standards Advisory Board to develop such standards. Federal accounting standards have heightened importance since the passage of the Chief Financial Officer's Act of 1990, which requires certain Federal agencies and executive departments to prepare annual audited financial statements.
Elevation of EITF Positions and AcSEC Practice Bulletins
SAS 69 elevates EITF consensus positions and AcSEC practice bulletins from "other accounting literature" to the authority of "established accounting principles." Distinguishing between "established accounting principles" and "other accounting literature" is important. Established accounting principles, which are described in categories a) through d), are those requirements that the auditor needs to know and apply. Category a) pronouncements also must be followed under Rule 203 of the AICPA Code of Professional Conduct which applies to audits and reviews.
Conversely, the auditor does not need to be knowledgeable of all the requirements in "other accounting literature," (category e) in the summary shown in Exhibit 1. Rather, the auditor views these requirements as a research source, and consults them only if the pronouncements in higher categories are not relevant. Thus, moving FASB EITF consensuses and AcSEC practice bulletins from category e) to category c) dramatically increases the significance of those pronouncements. (The new hierarchy provides for a GASB EITF, although it has not yet been formed.)
This change has the greatest effect on small practitioners and nonpublic companies. Public companies that register with the SEC have always been required to follow EITF consensuses. However, since the elevation of the authoritative status of the EITF Consensuses, all entities are affected by EITF guidance.
Separate Levels of Authority
SAS 69 revises the GAAP Hierarchy to make each category of the hierarchy a separate level of authority (in the previous hierarchy, old categories b) and c) were equal in authority). This change has a very important result. Whereas pronouncements in category b) were equal to industry practice in the previous hierarchy, the new GAAP Hierarchy renders category b), which includes FASB Technical Bulletins, AICPA Industry Auditing & Accounting Guides, and AICPA Statements of Position, a higher level of authority than industry practice. Thus, these pronouncements now have the authority to change established industry practice.
Paragraph 15 of SAS 69 (AU Sec. 411.15) notes that before its issuance, most of the pronouncements or practices in categories b), c), and d) of the hierarchy had equal authoritative standing. However, as described above, SAS 69 rendered each category a different level of authority and stated, "If there is a conflict between accounting principles relevant to the circumstances from one or more sources in category b), c), or d), the auditor should follow the treatment specified by the source in the higher category."
To prevent these revisions from triggering unnecessary accounting changes, SAS 69 provides transition guidance in paragraph 15.
Paragraph 15 states, "An entity following an accounting treatment in category c) or d) as of March 15, 1992, need not change to an accounting treatment in category b) or category c) pronouncement whose effective date is before March 15, 1992."
For example, the new hierarchy requires a non-governmental entity that follows an industry accounting practice to change to an accounting treatment specified by AICPA Statement of Positions (SOP) and EITF consensuses that become effective after March 15, 1992. Also, for initial application of an accounting principle after March 15, 1992, (except for EITF consensuses which become effective in the hierarchy for initial application of an accounting principles after March 15, 1993), the auditor should follow the new hierarchy, including AICPA SOPs and EITF consensuses effective before March 15, 1992, in determining whether an entity's financial statements are fairly presented in conformity with GAAP.
Since SAS 69 was issued, questions about the meaning of the phrase "following an accounting treatment in categories c) and d) as of March 15, 1992" have arisen. The following example highlights the issue.
A nonpublic entity engages in sale-leaseback transactions each year, including its fiscal year ended December 31, 1991. EITF consensus 89-16 provides that executory costs in sale leaseback transactions be excluded from the calculation of profit to be deferred. Before the issuance of SAS 69, the entity had always included executory costs in its calculation of deferred profit since the entity was not required to follow EITF consensuses. If the entity is considered to be "following an accounting treatment" for sale-leaseback transactions as of March 15, 1992, the entity is not required to change to follow EITF 89-16 in future years. Most would probably conclude that this is the case. However, when the accounting requirements involve disclosures or classification issues (for example, EITF Consensus 86-30, Classification of Obligations When a Violation Is Waived by the Creditor), whether the entity is required to follow the guidance is less clear. Most believe that the phrase "following an accounting treatment in categories c) and d) as of March 15, 1992" refers to accounting for a class of recurring transactions in fiscal years prior to that date. That interpretation maintains that the phrase does not apply to requirements in categories c) and d) pronouncements that pertain to financial statement disclosures, financial statement classifications, or transactions of a non-recurring nature. Thus, pronouncements in those categories related to disclosures, classifications, or non-recurring transactions would apply regardless of their effective date.
Rather than getting into murky interpretations about whether the elevated pronouncements apply, auditors would be well served by applying all guidance in categories b) and c). The AICPA's Audit Risk Alert--1992 states, "The Auditing Standards Division staff recommends that, because category b) and c) pronouncements, which include AICPA SOPs and EITF consensuses, often represent the best available guidance, auditors consider all existing pronouncements in categories b) and c) even if not required by SAS 69." By so doing, the chance of making a mistake is virtually eliminated.
Shopping For GAAP
Some have questioned whether an entity subject to the jurisdiction of the GASB, say a government hospital or university, could follow the nongovernment hierarchy as an "other comprehensive basis of accounting" (OCBOA). SAS 62, Special Reports sets forth what constitutes OCBOA. Following a hierarchy other than the one applicable does not constitute OCBOA nor GAAP. Therefore it must be treated as a departure from GAAP. Thus, an auditor asked to report on such a presentation would be required to issue a modified report--qualified or adverse--depending on the materiality of the departures from GAAP.
GAAP Not Included in the GAAP Hierarchy
Accountants should be aware that certain accounting disclosure requirements are not mentioned in the GAAP Hierarchy. Rather, these disclosure requirements are implicitly required by GAAS or SSARS and are enforced through Rule 202 of the AICPA Code of Professional Conduct. These requirements are summarized in Exhibit 3 and address, for example, going concern disclosures. Accountants should consider these requirements, when preparing, reviewing, or auditing financial statements in accordance with GAAP.
Douglas P. Sauter, CPA is the Director of Auditing Standards at the AICPA. He is a member of the New York State Society of CPAs and the American Accounting Association and frequent contributor to The CPA Journal. Mr. Sauter is an employee of the AICPA and his views, as expressed in this article do not necessarily reflect the views of the AICPA. Official positions are determined through specific committee procedures, due process, and deliberation.
EXHIBIT 2 NEGATIVE STANDARDS
Under the GAAP Hierarchy existing before SAS 69, both FASB and GASB Statements were in category (a) for state and local governments. Thus, FAS 87, Employers Accounting for Pensions, was applicable to those entities when it was issued in December 1985. Since the GASB had a project on its agenda to consider the appropriate pension accounting for governments, the GASB issued Statement 4 so that pension accounting for governments would not be affected by SFAS 87. Statement 4 stated that "state and local governmental employers ... should not change their accounting and reporting of pension activities as a result of the issuance of FASB Statement 87." Since Statement 4 in effect "eliminated" a standard that would have applied to governments, it is referred to as a "negative standard." A similar situation occurred in 1988, when Statement 8 was issued to clarify the applicability of SFAS 93, Recognition of Depreciation by Not-for-Profit Organizations, to certain state and local governments.
EXHIBIT 3 GAAP NOT INCLUDED IN THE GAAP HIERARCHY
Although not formally recognized in the GAAP Hierarchy, the following guidance is generally held to be part of GAAP.
Going Concern Disclosures
Interpretation 11 of SSARS 1, Reporting on Uncertainties (AR Section 9100.33 - .34) acknowledges that "the accounting literature does not provide specific guidance on disclosure of uncertainties caused by concern about the entity's ability to continue as a going concern." In evaluating the disclosure of those uncertainties, the interpretation refers the accountant to SAS 59, The Auditor's Consideration of an Entity's Ability to Continue as a Going Concern (AU Section 341). SAS 59 requires the auditor to consider the adequacy of disclosures about an entity's ability to continue as a going concern when he or she has a substantial doubt about that ability.
SAS 1, Codification of Auditing Standards and Procedures, (AU Sec. 560) describes two types of subsequent events, which are events or transactions materially affecting the financial statements that occur subsequent to the balance-sheet date but before issuance of the auditor's report. The first type, Type I events, are those that relate to events that provide additional evidence about conditions that existed at the balance sheet date and affect estimates used in preparing the financial statements. The financial statements are required to be adjusted for Type I events. Type II events are those that provide evidence about conditions that did not exist at the balance sheet date but occurred subsequently. The financial statements are not to be adjusted for Type II events. However, AU Sec. 560 states that some of Type II events "may be of such a nature that disclosure of them is required to keep the financial statements from being misleading." Paragraph 11 of SFAS No. 5, Accounting for Contingencies, makes the same statement about certain losses or loss contingencies. In addition, some Type II events may have such a material effect on the financial statements that the auditor may choose to describe it in an explanatory paragraph in the auditor's report.
SSARS 1 states that the accountant may wish to consider the guidance in AU Sec. 561 in determining an appropriate course of action when he or she becomes aware of subsequent events, giving due consideration to the different objectives of compilation, review, and audit engagements. An interpretation to SSARS 1 (AR Sec. 9100.13 - 15) discusses how the accountant's judgments would be affected by the nature of the service provided.
Financial statements group items with similar characteristics in order to present a more comprehendible picture. Changes in these groupings may occur from year to year. Accounting Research Bulletin 43, Chap. 2A, paragraph 3, requires explanation of the changes in presentation of comparative statements. For single-year presentations, AU Sec. 420 notes that "although changes in classification are usually not of sufficient importance to necessitate disclosure, material changes in classification should be indicated and explained in the financial statements or notes."
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