Updated January 13, 2022
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 potentially affect a reader’s
evolved in the private and public sectors to address the
investment decisions or conclusions about the financial
specific needs of their respective stakeholders. Two policy
status of a firm.
issues that might be of interest to Congress and investors
are also discussed.
Federal Government
Private Sector
The financial statements of the U.S. government and its
The private sector includes publicly traded and private
agencies provide taxpayers and Congress a comprehensive
companies as well as nonprofit organizations. The
view of how the government manages tax and other sources
accounting and auditing standards created for publicly
of revenue and how effective the federal government is at
traded firms are subject to Securities and Exchange
utilizing the resources. The Financial Report of the United
Commission (SEC) oversight.
States Government serves the same essential purpose as the
annual report issued by a publicly traded company.
Federal securities laws require public companies, both
domestic and foreign, to share critical information about
Accounting. The accounting standards established by the
their performance on an ongoing basis with investors,
Federal Accounting Standards Advisory Board (FASAB)
regulators, and other stakeholders. The companies are
are considered GAAP for federal financial reporting
required to submit annual reports providing a
entities. FASAB was created by the Government
comprehensive overview of their performance, including
Accountability Office (GAO), the Department of the
their audited financial statements.
Treasury, and the Office of Management and Budget.
Accounting. The SEC has relied on the private sector to
Auditing. The financial statements of federal agencies and
establish and develop Generally Accepted Accounting
the U.S. government are audited by agency inspectors
Principles (GAAP) in the United States throughout its
general, GAO, or independent accounting firms. GAO
history. GAAP are a common set of principles and practices
issues the Generally Accepted Government Auditing
that measure and report an organization’s economic
Standards (GAGAS), also commonly known as the “Yellow
activities. Currently, the SEC recognizes the Financial
Book,” which provide a framework for conducting audits.
Accounting Standards Board (FASB) as the designated
organization for establishing GAAP for the private sector.
State and Local Governments
The Annual Comprehensive Financial Report (ACFR)
Auditing. Private- and public-sector stakeholders need
issued by a state or local jurisdiction serves the same
reasonable assurance that an entity’s financial statements
purpose as the annual report issued by a publicly traded
are free of material misstatement, whether caused by error
company to its investors. States and territories have the
or fraud. In the private sector, independent assurance to
flexibility to choose the accounting and auditing standards
shareholders and other stakeholders is provided by a
that suit their needs.
qualified external party—an auditor. The auditor is engaged
to give an unbiased professional opinion on whether the
Accounting. The voluntary standard-setting body for state
financial statements and related disclosures are fairly stated
and local governments’ accounting standards is the
in all material respects for a given period of time in
Governmental Accounting Standards Board (GASB).
accordance with GAAP. Generally Accepted Auditing
Although the SEC requires publicly traded companies to
Standards (GAAS) provide standards of practice on how an
follow the accounting standards created by FASB, state and
audit should be conducted.
municipal governments are not required to follow
accounting standards promulgated by GASB. States and
The Sarbanes-Oxley Act of 2002 (P.L. 107-204) created the
municipalities can voluntarily adopt GASB accounting
Public Company Accounting Oversight Board (PCAOB) as
standards without any changes, choose not to adopt a
a self-regulatory organization to provide independent
specific standard, or modify a standard as needed.
oversight of audits of public companies. The PCAOB also
oversees the brokers’ and dealers’ audits, including
Auditing. State and municipal government audits are
compliance reports. The SEC has oversight authority over
conducted by either an elected or appointed auditor. Elected
the PCAOB and approves the board’s rules, standards, and
auditors conduct their work at all levels of government
budget.
from states to cities and towns. Appointed auditors are often
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Introduction to Financial Services: Accounting and Auditing Regulatory Structure, U.S. and International
appointed by the legislature or the chief executive of the
ESG Disclosures
respective municipal organization with the legislature’s
Companies, investors, and various stakeholders—including
consent. State and municipal auditors might follow GAGAS
academics and advocacy groups—continually debate
or other audit standards that meet their specific needs.
exactly what should be disclosed by public firms. Recently,
issues related to sustainability accounting standards and
Policy Issues
increasing shareholder expectations for corporations to
Two policy issues might be of particular interest to
address material ESG issues are at the forefront of those
Congress and investors. The first is the limits encountered
debates. For example, demand for “ESG funds”—funds that
by PCAOB to inspect the work of foreign accounting
invest in companies deemed to be especially responsible on
(audit) firms that audit the foreign firms listed on the U.S.
ESG issues—continues to increase. Reportedly, ESG funds’
exchanges. The second is the emerging sustainability
assets have surpassed $2 trillion globally. Meanwhile, the
accounting standards for businesses, which encompass
SEC continues to scrutinize “greenwashing”—labeling
environmental, social, and governance (ESG) issues.
funds or bonds as ESG investments while the criteria used
to make the classification are questionable or not disclosed.
PCAOB Inspection Limits
Foreign firms accessing U.S. capital markets use foreign
The Sustainability Accounting Standards Board (SASB), a
auditors from their home countries to audit their financial
U.S.-based nonprofit, has created a set of standards to help
records. The SEC and the PCAOB have entered into
corporations address increased shareholder interest in ESG
various bilateral or multilateral agreements with various
issues. In 2021, SASB merged with the International
foreign regulators over the past decade. Nevertheless, the
Integrated Reporting Council (IIRC) to form the Value
SEC and the PCAOB still face limitations with regulators in
Reporting Foundation. While SASB Standards and the IIRC
certain countries, including the People’s Republic of China.
framework are considered complimentary, corporate filers
with the SEC are not required to follow either of the
For example, the Chinese government restricts the PCAOB
protocols. Publicly traded firms are subject to certain other
from inspecting the audit work and practices of PCAOB-
ESG-related disclosure requirements (e.g., GAAP
registered accounting firms in China, including Hong Kong.
disclosure requirements). These disclosure requirements
Meanwhile, according to the U.S.-China Economic and
might not be as relevant for ESG investors’ decisions as
Security Review Commission, U.S. exchanges list 248
compared with those proposed by SASB or other standards
Chinese companies with $2.1 trillion in combined market
developers.
capitalization as of May 2021. (Most major U.S. exchanges
provide information identifying foreign-headquartered
One ongoing debate is whether companies should be
companies, although NASDAQ stopped providing this
required to make certain ESG disclosures. Proponents of
information in 2019.)
ESG disclosures suggest that investments in material issues
(e.g., climate change) can increase shareholder value by
Congress passed the Holding Foreign Companies
differentiating among competitors within each industry,
Accountable Act (HFCAA, P.L. 116-222) to address audit
fostering investor confidence, increasing employee trust
limitations faced by the PCAOB. HFCAA requires foreign
and loyalty, and increasing access to capital, among other
companies listed in U.S. stock exchanges to be subject to
things. Critics argue that existing regulations address many
the same accounting and audit oversight as listed domestic
of the ESG issues or allow issuers to disclose voluntarily
companies. The law requires the SEC to identify each
information that is material. Additional disclosures and
foreign firm not in compliance and suspend trading of those
reporting requirements, they say, could be an unnecessary
companies from U.S. exchanges after three years of
regulatory burden for firms and distract firms from
noncompliance. Without any changes to the existing law,
increasing shareholder value. Congress has a range of
these companies would be delisted from U.S. exchanges
legislative options on this issue if it wanted to make
beginning in 2024. In the 117th Congress, the Senate passed
changes to disclosure rules, including explicitly making all
a bill accelerating HFCAA (S. 2184) to shorten the
ESG disclosures strictly optional to requiring certain ESG
noncompliance period to two years and begin delisting
disclosures.
foreign companies not in compliance with the PCAOB
audit requirements beginning in 2023. The House is
CRS Resources
considering a similar proposal.
CRS Report R44894, Accounting and Auditing Regulatory
Structure: U.S. and International, by Raj Gnanarajah.
At least some of the Chinese listed companies would likely
not want to be subject to public audits. For example, eight
CRS In Focus IF11716, Introduction to Financial Services:
of the companies are national state-owned enterprises.
Environmental, Social, and Governance (ESG) Issues, by
Since October 2020, 17 Chinese companies have delisted
Raj Gnanarajah and Gary Shorter.
from U.S. exchanges for various reasons, including material
misstatements. (Four companies delisted after being
CRS In Focus IF11803, U.S. Capital Markets and China:
identified in Executive Orders 13959 and 14032 restricting
Issues for Congress, by Michael D. Sutherland and Karen
certain U.S. investments in certain firms identified as tied to
M. Sutter.
China’s military.)
Raj Gnanarajah, Analyst in Financial Economics
Some Members have also expressed concerns about the
SEC’s oversight of the PCAOB and the culture within the
IF10701
board.
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Introduction to Financial Services: Accounting and Auditing Regulatory Structure, U.S. and International


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