The Redneck tries to present information for the reader of these rants so as to let the reader draw their own conclusions about the financial markets. There are factors that most private investors simply don’t know. Those factors relate to little known accounting standards that all public traded companies are required to use in presenting their financial statements. The financial statement of any entity will include a balance sheet that shows the assets owned by the entity, any liability incurred by the entity, and the net worth or capital contributed or earned by the entity. The financial statements will include an income statement that details the way the company operates and the amount of net income earned from operations. And finally, the financial statements will show cash flow of the entity. The financial statements will also have “notes” that describe certain important information about the entity like the method of accounting used by the entity to report its balance sheet, income statement and statement of cash flows.
The Redneck is concerned about that the right hand doesn’t know what the left hand is doing. In the United States economy we have more than one organization that make critical decisions that impact our financial system and markets. The Federal Reserve Board and the FOMC (discussed in previous rants); the Federal Securities and Exchange Commission; the United States Congress; and an entity called The Financial Accounting Standards Board. There are others, but I want to focus on The Financial Accounting Standards Board here.
The Financial Accounting Standards Board (FASB) is a private, not-for-profit organization whose primary purpose is to develop generally accepted accounting principles (GAAP) within the United States in the public’s interest. The Securities and Exchange Commission (SEC) designated the FASB as the organization responsible for setting accounting standards for public companies in the U.S. It was created in 1973, replacing the Committee on Accounting Procedure (CAP) and the Accounting Principles (APB) of the American Institute of Certified Public Accounting (AICPA).
“The FASB’s mission is “to establish and improve standards of financial accounting and reporting that foster financial reporting by nongovernmental entities that provides decision-useful information to investors and other users of financial reports.
The FASB accomplishes its mission “through a comprehensive and independent process that encourages broad participation, objectively considers all stakeholder views, and is subject to oversight by the Financial Accounting Foundation’s Board of Trustees.” (FASB website.)
The FASB is not a governmental body. The SEC has legal authority to establish financial accounting and reporting standards for publicly held companies under the Securities and Exchange Act of 1934. Throughout its history, however, Commission policy has been to rely on the private sector for this function to the extent that the private sector demonstrates ability to fulfill the responsibility in the public interest.
The FASB is part of a structure that is independent of all other business and professional organizations. Before the present structure was created, financial accounting and reporting standards were established first by the Committee on Accounting Procedure of the American Institute of Certified Public Accountants (1936–1959) and then by the Accounting Principles Board also a part of the AICPA (1959–73). Pronouncements of those predecessor bodies remain in force unless amended or superseded by the FASB.
The FASB is subject to oversight by the Financial Accounting Foundation (FAF), which selects the members of the FASB and the Governmental Accounting Standards Board and funds both organizations. The Board of Trustees of the FAF, in turn, is selected in part by a group of organizations that have expertise related to accounting issues. (See the Wikipedia link at the right.)
An accounting standard dictates the methods to be used to record certain types of financial transactions. One of the accounting standards primarily for recording the value and income from negotiable instruments is known as the “mark-to-market” standard. This standard recognizes that the value of long-term contracts and negotiable instruments changes when the market rate of interest changes. An example would be ‘if a $10,000 mortgage is made to a borrower at an annual rate of interest of 5% and the market rate of interest decreaces to 4% the value of mortgage increases to approximately $12,000. If the market rate increases to 6%, the value of the mortgage would decrease to approximately $8,500.” The holder of the mortgage would be required to adjust the value of mortgage on the books of the holder and the books of borrower to reflect the variances. The increases or decreases are recorded and income or expense of the entities.