The institutionalization of the balance sheet approach in standard setting

In 1998, the Financial Accounting Standards Board declared that their conceptual framework drove their adoption of the ‘balance sheet approach.’ We first document that the framework, which was critiqued as ambiguous and internally inconsistent, contains significant elements supporting both the balance sheet approach and the income statement approach. Next, we examine every authoritative reference to the framework in pre-codification standards and find that, during its implementation (1987–2009), the FASB systematically favours its balance-sheet-approach elements. Notably, this result is driven by an exponential increase in the frequency of balance-sheet-approach citations shortly after the FASB’s 1998 declaration, largely arising from standards that apply fair value measurements to non-financial assets and liabilities. We contribute to the standard setting literature by (i) documenting a discrete shift in the FASB’s implementation of fair values around 1998 and (ii) demonstrating that standard setters can change how they use a framework and can strategically co-opt it to justify preferred policies. Importantly, we challenge the accepted notion that the FASB’s conceptual framework endorsed the balance sheet approach ex ante, arguing instead that the FASB constructed this narrative ex post and reinforced it through their use of the framework, thereby institutionalising the balance sheet approach in standard setting.