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Question 22Q

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Intermediate Accounting (Kieso)
Found in: Page 23

Short Answer

Some individuals have indicated that the FASB must be cognizant of the economic consequences of its pronouncements. What is meant by “economic consequences”? What dangers exist if politics play too much of role in the development of GAAP?

Economic consequences imply the consequences of accounting reports on the financial positions of issuers and the decision-making behavior emerging from the consequence.

Politicians' involvement can manipulate GAAP rules and regulations, and so the standards may not be more reliable.

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Step by Step Solution

Meaning of economic consequences

The term economic consequences is defined as the impact of accounting reports on the wealth of the users of financial statements and decision-making occurring from the impact. Remunerative behavior has an adverse financial outcome for the users of financial statements.

Dangers occurring in case of involvement of politics in the development of GAAP

Generally Accepted Accounting Principles (GAAP) is considered a political product similar to any law. In case too many politicians are caught up in the advancement role of GAAP, financial standards will lose their credibility, and the financial reporting rules will stand up for rich and powerful companies.

Moreover, suppose the information is outlined in a way that shows that investing in a certain firm requires less risk than the actual, or is outlined in a way to encourage investment in a certain economic sector. In that case, financial reporting will suffer an unparallel loss of credibility.

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Question: CA1-17 GROUPWORK (GAAP and Economic Consequences) The following letter was sent to the SEC and the FASB by the leaders of the business community.

Dear Sirs:

The FASB has been struggling with accounting for derivatives and hedging for many years. The FASB has now developed, over the last few weeks, a new approach that it proposes to adopt as a final standard. We understand that the

Board intends to adopt this new approach as a final standard without exposing it for public comment and debate, despite the evident complexity of new approach, the speed with which it has been developed and the significant changes to the exposure draft since it was released more than one year ago. Instead, the board plans to allow only a brief review by selected parties, limited to issues of operationality and clarity, and would exclude questions as to the merits of the proposed approach.

As the FASB itself has said throughout this process, its mission does not permit it to consider matters that go beyond accounting and reporting considerations. Accordingly, the FASB may not have adequately considered the wide range of concerns that have been expressed about the derivatives and hedging proposal, including concerns related to the potential impact on the capital markets, the weakening of companies` ability to manage risk, and the adverse control implications of implementing costly and complex new rules imposed at the same time as other major initiatives, including the year 2000 issues and a single European currency. We believe that these crucial issues must be considered, if not by the FASB, then by the Securities and Exchange Commission, other regulatory agencies, or Congress.

We believe it is essential that the FASB solicit all comments in order to identify and address all material issues that may exist before issuing a final standard. We understand the desire to bring this process to a prompt conclusion, but the underlying issues are so important to this nation`s businesses, the customers they serve and the economy as a whole that expediency cannot be the dominant consideration. As a result, we urge the FASB to expose its new proposal for public comment, following the established due process procedures that are essential to acceptance of its standards, and providing sufficient time to affected parties to understand and assess the new approach.

We also urge the SEC to study the comments received in order to assess the impact that these proposed rules may have on the capital markets, on companies` risk management practices, and on management and financial controls. These vital public policy matters deserve consideration as part of the Commission`s oversight responsibilities.

We believe that these steps are essential if the FASB is to produce the best possible accounting standard while minimizing adverse economic effects and maintaining the competitiveness of U.S businesses in the international market

place.

Very truly yours, (this letter was signed by the chairs of 22 of the largest U.S companies.)

Instructions

Answer the following questions.

(a) Explain the "due process" procedures followed by the FASB in developing a financial reporting standard.

(b) What is meant by the term "economic consequences" in accounting standard-setting?

(c) What economic consequences arguments are used in this letter?

(d) What do you believe is the main point of the letter?

(e) Why do you believe a copy of this letter was sent by the business community to influential members of the U.S. Congress?

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