Chapter 13- Summary

Standard setting is as much apolitical process as an economic one, as highlighted by the

fact that investors and firms are at odds over the amount of information a firm produces.

This difference in information, also known as information asymmetry, creates a demand

by investors for regulation of this information. There are two theories of regulation,

The Public Interest Theory, and The Interest Group Theory. The first theory suggests

that regulation is the result of a public demand for correction of market failures. The

regulatory body assigned is assumed to have the best interests of society in mind, and

therefore maximizes social welfare. The problems with this theory are first, that the task

of deciding on the right amount of regulation is very complex, and secondly and more

seriously, the motivation of a regulatory body. This can be a problem due to the difficulty

of monitoring the regulator, and forcing the regulator to act in the interest of the public is

weak.

The second theory takes the view that an industry operates in the presence of a number

of interests. For example consider any manufacturing industry, with multiple interest

groups: the firms, the customers, and environmentalists. These interest groups demand

various amounts and types of legislation that are in their best interest, and are therefore

thought of as demanders of regulation. The political authority, which can be thought of

as another interest group has the power to supply regulation, therefore the regulatory

body is in the middle, and is the vehicle which supplies the regulation and it does this by

balancing the demands of the constituents (interest groups) and at the same time

maximizing its own welfare. The constituent that is most politically effective in its

regulatory demands will receive most of the benefits of regulation. This is essentially a

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demand and supply model, and seems to be a better predictor of how regulation really

works.

The regulatory body for setting accounting standards in Canada is the Accounting

Standards Board as authorized by the Board of Governors of the Canadian Institute of

Chartered Accountants. The CICA Handbook contains standards for accounting and

auditing, set by the Accounting Standards Board, and also by the AuSB. The CICA

Handbook has authority through legal status given by legislation and by the CICA Board

of Governors, which requires that it publish accounting standards “on its own authority,”

essentially advocating their independence. The members of the Accounting Standards

Board are all volunteers, putting the cost on the organizations that employ them. This is

different from FASB members, as you will see in the section on U.S accounting

regulation.

The Ontario Securities Commission (OSC) regulates securities for the largest stock

exchange in the country, the Toronto Stock Exchange (TSE), and is one of the most active

securities commissions. The role of the OSC is to regulate all securities trading in

Ontario. Its’ authority comes from the Securities Act of Ontario, which allows an order

made by the OSC to be enforced in the same manner a court order by a judge would be

enforced. The OSC accepts the accounting standards outlined in the CICA Handbook,

although it permits certain exceptions. For example: if GAAP statements and not

reasonably practicable, and the OSC previously accepted non-GAAP statements and is

certain that the circumstances of the previous decision have not changed.

The regulatory body for accounting standards in the U.S. is the Financial Accounting

Standards Board (FASB). The FASB is one of a three-part organizational structure for

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financial accounting standard setting. The first body, the Financial Accounting

Foundation (FAF) has 16 trustees, who are a combination of elected and appointed

officials, and they appoint the FASB board members. The FASB board members are in a

paid salary position, compared to the volunteer membership of the Accounting Standards

Board in Canada, and must be independent in ”fact and appearance.” In effect the

members must agree to sever all ties with previous employers, not accept fees or

honoraria from any other institution, and declare a conflict of interest if necessary. There

is a definite process to deciding upon and establishing an accounting standard because

they place heavy emphasis on due process.

The regulator of securities in the U.S. is the Securities Exchange Commission (SEC),

which oversees most of the securities trading in the United States. The SEC has the

responsibility to ensure that investors are supplied with adequate information about the

firms they are investing in. The SEC has the authority to issue accounting standards but

has delegated this responsibility to the FASB similar to the OSC. However, the SEC will

intervene from time to time, for example, the Sec overrode SFAS 19, which required oil

and gas companies to use successful-efforts methods of accounting for exploration costs

over full-cost. The FASB then amended the SFAS 19 to include both successful-efforts

and full-cost. This example is not the norm, and it is fair to say that for the most part the

SEC give the responsibility of setting accounting standards to the FASB.

The International Accounting Standards Committee (IASC) was established in 1973 as a

way to improve the “harmonization of regulations, accounting standards, and procedures

relating to the presentation of financial statements” worldwide. This has become

especially important with the advent of the global economy. The IASC does not have the

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power to require anyone to comply with International Accounting Standards, so it

remains a voluntary adoption. However, it is in the best interest of multi-national firms to

follow these standards, if they wish to be eligible to be traded in more than one country.

All three regulatory bodies, the ASB, FASB, and IASC require a “super-majority” to pass

a new standard i.e.) the ASB requires a two-thirds majority. In addition, they are all

characterized by due process when deliberating a possible new standard. The structure of

all three bodies is most consistent with the interest group theory of regulation.

 Two important criteria for standard setting bodies are decision usefulness and
the reduction of information asymmetry. These criteria are important, but are
not sufficient to ensure successful standard setting. The interests of other
constituencies, especially management must be considered. That is why there is
such importance placed on due process. If the standard setting body is to
maintain its’ credibility, then it must be careful to preserve technical,
theoretical correctness, in the very least. The cost associated with setting
standards must also be considered, and since the burden of cost is imposed on
firms and management, a conflict situation is created. The conclusion has
been made that standard setting process seems most consistent with the interest
group theory of regulation.

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