Last year the Emerging Issues Task Force at the Financial Accounting Standars Board turned 30. Consistent with prior practice, FASB has been conducting a 10-year review of the EITF. Such reviews were done in 1995 and 2005, and resulted in various changes intended to improve the EITF’s processes and overall effectiveness. FASB is taking another turn at the wheel this year.
The EITF was established in 1984 to assist FASB in the timely identification, discussion, and resolution of accounting and financial issues encountered in practice, including those resulting from new types of transactions and arrangements as well as issues of diversity in practice. In this way, the EITF has become an important part of U.S. accounting standard setting. Indeed, if imitation is the sincerest form of flattery, then the EITF has clearly been a positive part of accounting standard setting, as EITF-like bodies have subsequently been created by other major national standard setters and by the International Accounting Standards Board in the form of the IFRS Interpretations Committee (IFRIC).
The EITF consists of 12-15 voting members drawn from a cross section of stakeholders in the U.S. financial reporting system, including preparers, auditors, and users of financial statements. The FASB technical director serves as the non-voting chairman of the EITF (but can vote in the event of a tie). Representatives of the SEC’s Office of the Chief Accountant and the AICPA’s Financial Reporting Executive Committee act as non-voting observers but do have the privilege of the floor at EITF meetings.
Crucially, FASB board members also attend and participate in the meetings. While they do not vote on the issues, FASB must ratify a proposed EITF consensus before it is exposed for public comment. The same must happen for the consensus to become part of Generally Accepted Accounting Principles through the issuance by FASB of an Accounting Standards Update (ASU) amending the Accounting Standards Codification (“the Codification”).
Consistent with the goal of trying to reduce diversity in practice, a consensus is reached if no more than three voting members of the EITF object to a proposed position on an issue. Over its 30-year history, the EITF has addressed more than 530 issues, contributing significantly to the development of U.S. GAAP. And over those years, many EITF members subsequently became FASB board members, including yours truly and several other FASB chairs. Current FASB Chairman Russell Golden chaired the EITF from 2007 to 2010 when he was FASB technical director, as did current FASB board member Lawrence Smith from 2002 to 2007.
There have been many enhancements to the EITF’s processes and procedures over the years. For example, the 10-year review from 1995 resulted in the creation of a formal agenda committee to improve the EITF’s agenda-setting process. While I was FASB chairman, we made a number of important changes: adding financial statement users to the EITF, instituting the requirements for FASB ratification of proposed and final EITF consensuses and making EITF discussion materials available free of charge, among many others.
If imitation is the sincerest form of flattery, then the EITF has clearly been a positive part of accounting standard setting, as EITF-like bodies have subsequently been created by other major national standard setters and by the International Accounting Standards Board in the form of the IFRS Interpretations Committee
My own view is that the EITF functions quite well. Nevertheless, the current 10-year review may find additional ways to enhance the overall effectiveness of the EITF. In that regard, readers of this column will not be surprised that I have some thoughts on the subject.
A critical issue being addressed in the current 10-year review (and that has been the subject of prior reviews of the EITF’s operations) relates to whether the EITF’s role should be focused on interpreting the existing authoritative literature or creating guidance that goes beyond the existing requirements—thus effectively creating new GAAP.
Before the Codification came into being, GAAP had four levels (or “categories”) of guidance. The highest level of authority was accorded to Statements of Financial Accounting Standards, issued by FASB at the top of the hierarchy as “Level A” GAAP. Next were certain pronouncements issued by the American Institute of Certified Public Accountants at “Level B.” Then followed various other pronouncements and sources of guidance as “Level C” or “Level D.”
EITF pronouncements were categorized in Level D until 1992, and thereafter in Level C. Under that system, it became important to try to ensure that the work of the EITF was more interpretative in nature, to help narrow diversity in practice on specific issues under current GAAP and to provide guidance under existing GAAP on emerging issues.
Adhering to this intended limitation, however, sometimes proved challenging. Over the years some of the issues addressed by the EITF were quite broad in scope, and the resulting consensuses had a significant effect on accounting and reporting practices. That raised questions and concerns from time to time that FASB had allowed the EITF to exceed its authority.
In my view, the situation nowadays is different, since the GAAP hierarchy was eliminated with the issuance of the Codification in 2009. The Codification is now the single, authoritative source of U.S. GAAP. Moreover, since consensuses of the EITF require ratification by FASB (and effectively go through the same due process as other ASUs issued by FASB before becoming part of the Codification), the prior issues and concerns relating to the scope of the EITF’s authority now seem moot to me.
Instead, it seems to me that the key issue for FASB is how best to use the EITF in addressing emerging issues and areas of diversity in practice—that is, which issues would best benefit from examination, deliberation, and proposed resolution by the EITF. I think this is best left to the judgment of FASB using some broad criteria that help it decide which emerging and practice issues should be addressed through the EITF process, and which ones are better dealt with directly by FASB.
In that regard, FASB should try to avoid using the EITF to address issues that are industry-specific but that have potentially broad impact on the affected industry. Because EITF members may not be experts in the particular industry issue being addressed, a working group of knowledgeable industry participants is often formed to examine the issue and develop proposed solutions for consideration by the EITF. In my view, in such cases it would be more efficient and probably just as effective for FASB and its staff to work directly with the industry to address and resolve the issues.
The voting procedures of the EITF are another area that may warrant consideration in the 10-year review. The current process is interesting and somewhat unique. As noted above, reaching a proposed or final consensus requires that no more than three EITF members object to it. This approach was designed to promote reaching consensus, to provide timely guidance and to reduce diversity in practice. It can also produce some odd results. Let me explain by using a hypothetical, but not completely atypical, example of how the process sometimes works.
Let’s say that three alternatives, A, B, and C, are proposed as potential solutions to a particular issue the EITF is addressing. After discussion by EITF members, the EITF chair conducts a straw poll of the members on their preferred alternative. Let’s say seven vote for alternative A, three for B, and two for C.
The chair then asks “who would object to alternative A?” Four hands go up, preventing a consensus on alternative A. Next the chair asks “who would object to alternative B?” Only three hands go up, and a consensus is reached—despite a majority of EITF members presumably believing that alternative A was the best solution.
From my many years of participating in or observing EITF meetings, I can say this lowest common denominator outcome is not what happens in most cases. Still, it does happen occasionally, thus potentially producing “least objectionable accounting” rather than better accounting.
To be fair, because FASB must now ratify the EITF consensuses, it has the ability to prevent those “least objectionable” consensuses from becoming part of GAAP. In, practice that rarely (if ever) occurs. So I believe it would be useful to consider whether the EITF’s voting requirements and procedures should be changed. For example, the EITF could require a majority positive voting outcome (which is how FASB itself operates), or a supermajority positive vote, which is how some other standard-setting bodies operate. Pros and cons exist to each approach, but I feel now is an appropriate time for FASB to assess whether the current EITF voting requirements should be changed.
Notwithstanding these suggestions, I reiterate and emphasize my strong belief that the EITF serves as an important and valuable part of the U.S. accounting standard-setting system. Over the years, its processes have periodically been improved and updated. The current 10-year review provides another opportunity to further enhance the overall effectiveness of the EITF process.