Financial Reporting Standards: Standard Setting Bodies | CFA Level I FSA

In this lesson, we’ll learn about the main global standard-setting bodies, the objectives of financial reporting, and the relevant regulatory bodies that enforce compliance with these standards.

Importance of Standardization

Due to the variety and complexity of transactions, estimates, and assumptions a firm must make when presenting its performance, standardization of financial reports is essential. This ensures consistency and comparability between firms.

International Accounting Standards Board (IASB)

The IASB sets financial reporting standards that have been adopted in many countries. According to the IASB, the objective of financial reporting is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity. This includes decisions about buying, selling or holding equity and debt instruments, and providing or settling loans and other forms of credit.

Financial reporting is not designed solely for valuation purposes but has a multipurpose nature, providing information to investors, creditors, employees, customers, and others.

International Financial Reporting Standards (IFRS) and Generally Accepted Accounting Principles (US GAAP)

The IASB establishes the IFRS, a standard widely followed by firms outside of the US. In the US, the major standard-setting body is the Financial Accounting Standards Board (FASB), which establishes the Generally Accepted Accounting Principles (US GAAP).

Attributes of Standard-Setting Bodies

Standard-setting bodies like the IASB and FASB are professional not-for-profit organizations that establish financial reporting standards. They typically share certain desirable attributes:

• High professional standards, including standards of ethics and confidentiality
• Adequate authority, resources, and competencies to fulfill their responsibilities
• Clear and consistent processes guiding organization and formation of standards
• Guided by a well-articulated framework with a clearly stated objective
• Operate independently, seeking input from stakeholders but making decisions consistent with the stated objective of the framework
• Uncompromised by external pressure or self/special interests
• Decisions and resulting standards made in the public interest

Regulatory Authorities

Standard-setting bodies like the IASB and FASB are responsible for establishing financial reporting standards, but the requirement to prepare financial reports in accordance with these standards is the responsibility of authorities like the SEC and ESMA. These governmental entities have the legal authority to enforce financial reporting requirements and exert other controls over entities participating in the capital markets within their jurisdiction.

The SEC and ESMA are members of the International Organization of Securities Commissions (IOSCO). While not a regulatory authority itself, IOSCO members regulate a significant portion of the world’s financial capital markets. Its objectives are to protect investors, ensure fairness, efficiency, and transparency of markets, and reduce systematic risk. IOSCO aims to achieve uniform financial regulations across countries.

Key Relationships and Filings

The IASB and FASB are standard-setting bodies, establishing widely followed IFRS and US GAAP financial reporting standards. The SEC and various regulatory authorities ensure that these reporting standards are adhered to in their respective markets. Many of these regulatory authorities are members of IOSCO, working towards uniform financial regulations across countries.

The US Securities and Exchange Commission (SEC) is an ordinary member of IOSCO. Publicly listed US companies are regulated under the SEC, which requires companies to file standardized forms regularly. These include:

• Form S-1: A registration statement filed before the sale of new securities to the public.
• Form 10-K: A required annual filing, similar to what a firm typically provides in its annual report to shareholders. Form 40-F and 20-F are the equivalent for Canadian and other foreign issuers, respectively.
• Form 10-Q: US firms are required to file this quarterly, with updated financial statements that need not be audited. Non-US companies are typically required to file the equivalent Form 6-K semiannually.
• Form DEF 14A: Filed when a company prepares a proxy statement for its shareholders before the annual meeting or other shareholder vote.
• Form 8-K: Filed to disclose material events like significant asset acquisition or disposal, changes in management.
• Form 144: A notification to the SEC when a company issues securities to certain qualified buyers.
• Forms 3, 4, and 5: Involve the beneficial ownership of securities by a company’s officers and directors.

Most of these filings can be retrieved from the SEC’s website.