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FAS 162 and the GAAP Hierarchy

California CPA magazine: July 2008

By A. Christine Davis, CPA and Michael J.McPartlan, CPA

Up until now, the GAAP hierarchy resided in the auditing standards. A decade and a half after the issuance of Statement on Auditing Standards No. 69, The Meaning of Present Fairly in Conformity with Generally Accepted Accounting Principles (SAS 69), the GAAP hierarchy is finally home—in the accounting standards. Statement on Financial Accounting Standards No. 162, The Hierarchy of Generally Accepted Accounting Principles (SFAS 162), was issued by the FASB in May 2008 for nongovernmental entities.

It is widely known that the GAAP hierarchy sets forth the level of authority attributed to a given accounting pronouncement or document. For example, an SFAS pronouncement, which is in category (a) of the GAAP hierarchy, has a higher authority than a FASB Technical Bulletin, which is in category (b). Preparers of financial statements will look to category (a) GAAP in selecting and applying appropriate accounting principles, and turn to categories (b), (c) and (d), in that order, only if the accounting for a transaction or event is not specified in category (a). Where there might be conflicting guidance between two categories, the more authoritative category will prevail.

SFAS 162 comes in response to an SEC study in July 2003, which, in part, endorsed an improvement to the SAS 69 GAAP hierarchy (“old GAAP hierarchy”). The old GAAP hierarchy has been described as complex, directed to the auditor, and ranks the Concepts Statements too low in the chain of command. Indeed, it is in the Concepts Statements that some of the most fundamental terms of our profession are defined: assets, liabilities, equity, income, expense, accrual basis of accounting and materiality, along with a profound discussion of the often-quoted “objectives of financial reporting.”

In issuing SFAS 162, the FASB does not expect a change in current practice. What has changed is to whom the application of the GAAP hierarchy is directed. By being officially part of GAAP, SFAS 162 imposes the GAAP hierarchy on the reporting entities, not their auditors, based on the long-standing mandate that the entity’s management, not their auditors, is responsible for selecting and applying the appropriate GAAP to their financial statements. The auditors’ responsibility is to comply with GAAS as a basis for issuing their audit opinion.

SFAS 162 improved the GAAP hierarchy in three ways: (1) in its presentation, (2) in defining the driver for category (a), and (3) in making additions to the hierarchy.

Simplified Presentation
The old GAAP hierarchy presented the sources of GAAP in two ways: based on certain characteristics (SAS 69, par. 5), and according to document type (SAS 69, par. 10). SFAS 162 presents the sources of GAAP according to document type, such as the SFASs, FINs, APBs and ARBs.

What Drives Category (a)
As the most authoritative GAAP, category (a) was previously defined by what pronouncements encompass it, collectively called “officially established accounting principles,” such as the SFASs, APBs and ARBs. SFAS 162 clarifies and states the one characteristic essential to category (a) GAAP: the FASB’s “due process.” Therefore, FAS 162 has expanded category (a) to include all GAAP “issued after being (a) deliberated by the Board or its designee in a public forum, (b) exposed to the public for comment, and (c) approved by the Board.” As a result, new documents have been added to category (a) as discussed below. For SEC registrants, SEC rules and interpretive releases continue to be sources of category (a) GAAP.

One exception to this expansion is the retention of EITF consensuses, which have been subjected to the FASB’s due process only since 2003, within category (c). The reason is the FASB’s desire to reduce the complexities of implementing SFAS 162, along with staying consistent with the EITF’s majority position that its consensuses “should remain interpretive and, therefore, should be not be elevated in the GAAP hierarchy.”

New Documents Added
Because of the new definition of category (a) GAAP, the following documents are now included in category (a): FASB Staff Positions and SFAS 133 (Accounting for Derivative Instruments and Hedging Activities) Implementation Issues.

In addition, because EITF consensuses are already in category (c), the FASB concluded that FASB staff announcements contained in EITF-D Topics should have the same authority as EITF consensuses and, therefore, are now part of category (c) GAAP. It is notable that the SEC, at times, utilizes EITF-D topics to publicly announce its views on accounting issues impacting SEC registrants. Therefore, not all EITF-D topics are applicable to non-SEC registrants.

Added to category (d) are AICPA Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB.

Where Do the Concepts Statements Stand?
SFAS 162 did not change the standing of the Concepts Statements, maintaining the status of Concepts within “other authoritative literature.” Similar to the old hierarchy, the application of “other authoritative literature” in selecting the most appropriate GAAP in preparing financial statements is triggered in the absence of similar transactions or events within categories (a) through (d). Still, SFAS 162 reiterated that the Concepts Statements “would normally be more influential than other sources of ‘other authoritative literature.’ ”

The FASB, however, has expressed plans to elevate the Concepts Statements within the GAAP hierarchy and has indicated it would address the role of Concepts Statements in its ongoing conceptual framework project.

The effective date of SFAS 162 has yet to be determined; it becomes effective for both SEC registrants and nonpublic entities 60 days after the SEC approves the PCAOB’s amendments to AU Section 411 of the AICPA Professional Standards, the codified version of SAS 69. What is certain is the GAAP hierarchy is, finally, home at last. 

A. Christine Davis, CPA and Michael J. McPartlan, CPA are director and manager, respectively, at Hemming Morse, Inc. They can be reached at davisc@hemming.com and mcpartlanm@hemming.com.