The CPA exam's financial accounting and reporting (FAR) section tests you on the reporting requirements that are set by regulators in the accounting industry. Most of these regulators ask for and consider information from the general public regarding regulatory matters, and companies and individuals are often asked to provide comments about proposed regulations. Here’s an overview of the regulators you should know:
Securities and Exchange Commission (SEC): According to the SEC website, this organization exists to “protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.” One way to protect investors is to ensure that companies provide sufficient financial information to the public. If investors can review adequate financial information, they can make informed decisions about investing in a company’s stock or bond offering.
The SEC was created in response to the stock market crash of 1929. After the crash, legislators and securities industry officials determined that many investors had bought securities based on little or no accurate financial information. As a result, many investors were unaware of the financial risk they were taking. To address this concern, Congress passed the Securities Act of 1933, which requires that companies selling securities to the public disclose accurate financial information.
The SEC’s Division of Corporate Finance oversees the financial disclosure process. Companies must disclose financial data when they issue stock to the public for the first time — at the initial public offering, or IPO. After the IPO, businesses must report financial information on a periodic basis. Financial reporting for a security trading in the marketplace is regulated based on the Securities Act of 1934.
Financial Accounting Standards Board (FASB): This private-sector organization establishes financial reporting standards for nongovernmental entities, whether they’re private (for-profit) businesses or not-for-profits. As long as FASB’s standards operate in the best interests of the public, the SEC relies on FASB to create financial reporting standards.
Governmental Accounting Standards Board (GASB): The GASB regulates accounting for public-sector entities: federal, state, city, and other governments. Their website explains that GASB exists to ensure accountability and to help financial-statement readers make well-informed decisions.
International Financial Reporting Standards (IFRS) Foundation: A CPA’s work may involve companies that operate outside the U.S. The IFRS Foundation is a private-sector organization that works on international accounting issues. One of the foundation’s objectives is to create a single set of international accounting standards, or International Financial Reporting Standards (IFRS). Those standards are developed by the International Accounting Standards Board (IASB).
Here are the three types of regulated entities and how they relate to their regulators:
For-profit (business) entities: For-profit businesses exist to generate a profit and produce a return for the owners or shareholders (if the company issues stock). FASB has oversight over for-profit businesses. If a for-profit company issues stock to the public, the SEC has oversight when the stock is issued and for as long as the public owns stock.
Not-for-profit (nongovernmental) entities: Charitable organizations are nongovernmental entities. You can think of these entities as “mission-driven businesses.” The goal is not to generate a profit but to fulfill a mission (helping the poor, feeding the hungry, and so on).
FASB regulates not-for-profit businesses, which must answer to contributors, such as donors and grantors. Governments as well as private foundations and individuals provide grants for not-for-profits, and the contributors need information on how their dollars are spent.
Not-for-profits have some of the same accounting issues as for-profits. For example, both types of entities must account for employee retirement plans and other worker benefits.
Governmental entities: Governmental entities (federal, state, city, and local governments) are regulated by GASB. The main source of income for these entities is tax dollars. Those taxes may include income tax, sales tax, or estate taxes. A government focuses on proper approval of spending, budgeting, and documentation of spending results. All this activity is important to taxpayers.
Understanding these entities and how they’re regulated will help you keep the regulatory bodies straight in your mind.