Updated January 4, 2021
Introduction to Financial Services: Accounting and Auditing
Regulatory Structure, U.S. and International
This In Focus provides an overview of how accounting and
auditing standards are created and regulated in the private
Material misstatement in financial reporting can be
sector, the federal government, and state and local
defined as misleading information on a financial
governments. Different accounting and auditing standards
statement that could potential y af ect a reader’s
evolved in the private and public sector to address the
investment decisions or conclusions about the financial
specific needs of their respective stakeholders. This In
status of a firm.
Focus also discusses two policy issues that might be of
interest to Congress and investors.

Private Sector
Federal Government
The private sector includes public and private companies as
The financial statements of the U.S. government and its
well as not-for-profit organizations. The accounting and
agencies provide taxpayers and Congress a comprehensive
auditing standards created for publicly traded firms are
view of how the government manages tax revenue and how
subject to the Securities and Exchange Commission’s
effective the federal government is at providing services.
(SEC’s) oversight.
The Financial Report of the United States Government
Federal securities laws require public companies, both
serves the same basic purpose as the annual report issued by
domestic and foreign, to share critical information about
a publicly traded company to its investors.
their performance on an ongoing basis with investors,
Accounting. The accounting standards established by the
regulators, and other stakeholders. The companies are
Federal Accounting Standards Advisory Board (FASAB)
required to submit annual reports providing a
are considered GAAP for federal financial reporting
comprehensive overview of their performance, including
entities. FASAB was created by the Government
their audited financial statements.
Accountability Office (GAO, an independent, nonpartisan
agency of Congress), Department of the Treasury, and the
Accounting. Throughout its history, the SEC has relied on
the private sector to establish and develop Generally
Office of Management and Budget.
Accepted Accounting Principles (GAAP) in the United
Auditing. The financial statements of federal agencies and
States. GAAP are a common set of principles and practices
the U.S. government are audited by inspectors general,
to measure and report the economic activities of an
independent accounting firms, or GAO. GAO issues the
organization. Currently, the SEC recognizes the Financial
Generally Accepted Government Auditing Standards
Accounting Standards Board (FASB) as the designated
(GAGAS), also commonly known as the “Yellow Book,”
organization for establishing GAAP for the private s ector.
which provide a framework for conducting audits. Some
audit organizations within the federal government use a
Auditing. Private- and public-sector stakeholders need to
have reasonable assurance that an entity’s financial
hybrid method of external and internal auditors.
statements are free of material misstatement, whether
State and Local Governments
caused by error or fraud. In the private sector, independent
The Comprehensive Annual Financial Report (CAFR)
assurance to shareholders and other stakeholders is
provided by a qualified external party—an auditor. The
issued by a state or local jurisdiction serves the same
auditor is engaged to give an unbiased professional opinion
purpose as the annual report issued by a publicly traded
company to its investors. States and territories have the
on whether the financial statements and related disclosures
flexibility to choose the accounting and auditing standards
are fairly stated in all material respects for a given period of
time in accordance with GAAP. Generally Accepted
that suit their needs.
Auditing Standards (GAAS) provide standards of practice
Accounting. The voluntary standard-setting body for state
on how an audit should be conducted.
and local governments’ accounting standards is the
Governmental Accounting Standards Board (GASB).
The Sarbanes-Oxley Act of 2002 (P.L. 107-204) created the
Public Company Accounting Oversight Board (PCAOB) as
Although the SEC requires publicly traded companies to
a self-regulatory organization to provide independent
follow the accounting standards created by FASB, state and
municipal governments are not required to follow
oversight of audits of public companies. The PCAOB also
oversees the brokers’ and dealers’
accounting standards promulgated by GASB. States and
audits, including
compliance reports. The SEC has oversight authority over
municipalities can voluntarily adopt GASB accounting
the PCAOB and approves the board’s rules, standards, and
standards without any changes, choose not to adopt a
budget.
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Introduction to Financial Services: Accounting and Auditing Regulatory Structure, U.S. and International
specific standard, or modify a standard to meet their
ESG Disclosures
specific needs.
The investing community and various stakeholders—
institutional and individual investors, academics, and
Auditing. State and municipal government audits are
advocacy groups—continue to engage in a long-running
conducted by either an elected or appointed auditor. Elected
debate about what should be disclosed by public firms.
auditors conduct their work at all levels of government,
Issues related to sustainability accounting standards have
from states to cities and towns. Appointed auditors are often
been at the forefront of that debate. Shareholder
appointed by the legislature or by the chief executive of the
expectations for corporations to address material ESG
respective municipal organization with the consent of the
issues have continued to increase. In alignment with these
legislature. State and municipal auditors might follow
increasing shareholder expectations, firms with nearly $80
GAGAS or other audit standards that meet their specific
trillion in collective assets under management have
needs.
indicated they will consider ESG issues, such as political
Policy Issues
spending, climate change, leadership diversity, and human
rights, in the investment management decisionmaking
Two policy issues might be of particular interest to
process.
Congress and investors. The first is the limits encountered
by PCAOB to inspect the work of foreign accounting
The Sustainability Accounting Standards Board (SASB), a
(audit) firms that audit the foreign firms listed on the U.S.
U.S.-based nonprofit has created a set of standards to help
exchanges. The second is the newly emerging sustainability
corporations address increased shareholder interest in ESG
accounting standards for businesses, which encompass
issues. Currently, corporate filers with the SEC are not
environmental, social, and governance (ESG) issues.
required to follow standards as recommended by SASB.
Publicly traded firms are subject to certain other ESG-
PCAOB Inspection Limits
related disclosure requirements (e.g., GAAP disclosure
Foreign firms accessing U.S. capital markets use foreign
requirements), though these disclosure requirements might
auditors from their home countries to audit their financial
not be as relevant for investors’ decisions as compared with
records. Over the past decade, the SEC and the PCAOB
those proposed by SASB or other standards developers.
have entered into various agreements either multilaterally
or bilaterally with various foreign regulators, but they face
Congress could continue to allow companies to voluntarily
limitations with regulators in certain countries.
choose to disclose ESG issues, require companies to
disclose ESG issues, or make it harder for institutional
For example, the PCAOB is restricted from inspecting the
investors to call for ESG disclosures. To address certain
audit work and practices of PCAOB-registered accounting
ESG issues in the 116th Congress, Members introduced
firms in China, including Hong Kong, to the extent their
H.R. 1018, H.R. 3279, H.R. 4329, and S. 592.
audit clients have operations in China. U.S. exchanges list
217 Chinese companies with $2.2 trillion in combined
Proponents of ESG disclosures suggest that investments in
market capitalization. Of these Chinese listed companies,
material issues can increase shareholder value by
13 are national-level state-owned enterprises. Although
differentiating among competitors within each industry,
other major U.S. exchanges continue to provide information
fostering investor confidence, increasing employee trust
identifying foreign-headquartered companies, NASDAQ
and loyalty, and increasing access to capital, among other
stopped providing such information as of February 25,
things.
2019.
Critics argue that existing regulations address many of the
In the 116th Congress, the Senate passed S. 945, the
ESG issues or allow issuers to voluntarily disclose.
Holding Foreign Companies Accountable Act, and a
Additional disclosures and reporting requirements, they say,
companion bill, H.R. 7000, was introduced in the House but
could be an unnecessary regulatory burden for firms and
not acted on. These bills would have required that foreign
distract firms from increasing shareholder value.
companies listed in U.S. stock exchanges be subject to the
CRS Resources
same accounting and audit oversight as listed domestic
companies. These proposals would require increased
CRS Report R44894, Accounting and Auditing Regulatory
disclosure about noncompliance by the foreign firms listed
Structure: U.S. and International, by Raj Gnanarajah
on U.S. exchanges and eventual delisting. Other similar
CRS In Focus IF11221, Introduction to Financial Services:
proposals—such as S. 1731, H.R. 3124, and H.R. 7181—
Corporate Governance, by Raj Gnanarajah and Gary
were also introduced.
Shorter
In the 116th Congress, Members also introduced S. 2791,
CRS In Focus IF11256, SEC Securities Disclosure:
H.R. 5018, and H.R. 6614, which would have required the
Back ground and Policy Issues, by Eva Su
federal Thrift Savings Plan to divest from foreign
companies listed in the United States if PCAOB were
Raj Gnanarajah, Analyst in Financial Economics
unable to inspect the audit work papers of their foreign
accounting firms. Some Members have also expressed
IF10701
concerns about the SEC’s oversight of the PCAOB and the
culture within the board.


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Introduction to Financial Services: Accounting and Auditing Regulatory Structure, U.S. and International


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