Actuarial Notes

Accounting Rule Hierarchy

Study guide: Exam DISC-IA

An Accounting Rule Hierarchy ranks the sources of accounting guidance within one framework, so a preparer knows which source governs when two of them disagree and where to look when none of them addresses a transaction. U.S. GAAP has two levels, authoritative and nonauthoritative, with the FASB Accounting Standards Codification as its single authoritative source. U.S. statutory accounting rests on state law, then the NAIC's five-level statutory hierarchy.

\text{GAAP:}\quad \text{Codification (+ SEC rules)} \succ \text{Nonauthoritative}

\begin{aligned} \text{SAP:}\quad & \text{State law, prescribed or permitted} \\ & \succ \text{Level 1} \succ \text{Level 2} \succ \cdots \succ \text{Level 5} \end{aligned}

  • Symbols: A \succ B means guidance in A governs where it conflicts with B. The SAP levels are listed below.
  • GAAP, authoritative: FASB Statement No. 168 made the Codification the source of authoritative U.S. GAAP for nongovernmental entities, for periods ending after September 15, 2009; it is now Topic 105 of the Codification. All content in the Codification carries the same level of authority, which replaced the earlier multi-level GAAP hierarchy of Statement No. 162. The SEC's rules and interpretive releases under the federal securities laws are also authoritative GAAP, but only for SEC registrants. The FASB now issues Accounting Standards Updates, which are not authoritative in their own right; they only update the Codification and explain the change.
  • GAAP, nonauthoritative: Other sources include practices widely recognized in the industry, FASB Concepts Statements, AICPA Issues Papers, IFRS, pronouncements of professional associations or regulatory agencies, AICPA Technical Practice Aids, and accounting textbooks, handbooks and articles. When authoritative GAAP does not address a transaction, an entity first considers authoritative guidance for similar transactions, and only then nonauthoritative sources, weighed by their relevance, specificity, the author's standing and how widely they are used.
  • SAP, state law first: Statutory accounting is the accounting prescribed or permitted by the insurer's domiciliary state. The NAIC Accounting Practices and Procedures Manual is not intended to preempt state legislative and regulatory authority. It applies where it does not conflict with state statutes or regulations, or where they are silent. A prescribed practice is incorporated directly or by reference in a state's laws, regulations and general administrative rules for all insurers domiciled or licensed there. A permitted practice is one an individual insurer asks for that departs from NAIC SAP and the state's prescribed practices, and that its domiciliary regulator approves.
  • SAP, the five levels: As the Preamble sets them in the March 2025 Manual:
    • Level 1: the SSAPs, including U.S. GAAP guidance to the extent the NAIC has adopted it;
    • Level 2: interpretations of existing SSAPs (INTs) adopted by the NAIC's working groups;
    • Level 3: the NAIC Annual Statement Instructions and the Purposes and Procedures Manual of the NAIC Investment Analysis Office;
    • Level 4: the Statutory Accounting Principles Preamble and Statement of Concepts;
    • Level 5: nonauthoritative GAAP sources, the same kinds of literature listed above, including FASB Concepts Statements and IFRS.
  • Resolving a gap or conflict in SAP: If the SSAPs do not specify a treatment, the preparer applies a relevant principle from Level 2 or 3, and if those conflict, follows the higher level. If no established statutory principle applies, a principle for an analogous transaction may be used, and after that other literature, of which the Statement of Concepts is the most authoritative. GAAP guidance does not become part of SAP until the NAIC adopts it.
  • Disclosure of departures: An insurer using a prescribed or permitted practice that affects surplus or risk-based capital must describe it, state that it differs from NAIC SAP, give its monetary effect on net income and surplus, and say whether risk-based capital would have triggered a regulatory event without it (SSAP No. 1). These disclosures are in Note 1 of the notes, and Accounting Standards works an example.

Ranking Statutory Guidance A statutory accountant finds that an SSAP is silent on a transaction. The Annual Statement Instructions describe one treatment, an INT adopted by the NAIC working group addresses a closely similar question with a different treatment, and a widely used accounting textbook suggests a third. The insurer's domiciliary state has no prescribed practice on the point. Which treatment should be used, and what would change the answer?

Answer With the SSAP silent, the preparer turns to Levels 2 and 3. The INT is Level 2 and the Annual Statement Instructions are Level 3, so where they conflict the INT's treatment governs. The textbook is Level 5, used only when no established statutory principle applies.

Two things would change the answer. A practice prescribed by the domiciliary state would govern over every NAIC level, because the Manual does not preempt state authority. Or the insurer could ask its regulator for a permitted practice, which it would then disclose in Note 1 with its effect on income and surplus.

Reading a GAAP Question A privately held insurer preparing GAAP statements finds no guidance in the Codification for an unusual transaction. One adviser points to an IFRS standard, another to guidance in the Codification for a similar transaction, a third to a recent Accounting Standards Update's basis for conclusions. In what order should these be considered?

Answer First, the Codification's guidance for a similar transaction, because authoritative GAAP for an analogous transaction comes before any nonauthoritative source, unless that guidance prohibits its use by analogy. Then nonauthoritative sources such as IFRS, weighed by their relevance and specificity. The update's basis for conclusions is not authoritative in its own right; it explains a change to the Codification. As a private company the insurer is not bound by the SEC's rules, which are authoritative only for registrants.

How it appears on the exam

  • DISC-IA: The objective pairs accounting frameworks with rule hierarchies. Expect a question that names several sources of guidance and asks which governs, or asks what makes a source authoritative under GAAP or SAP.
  • Prescribed versus permitted: A short scenario, such as a state law that applies to every domestic insurer or one insurer's approved exception, asks which kind of practice it is and how it is disclosed.
  • SAP and GAAP together: A question can ask how a new GAAP standard enters statutory accounting, which happens only when the NAIC adopts it or adopts it with modification.

Exam traps

  • The Manual does not outrank state law: Statutory statements follow the domiciliary state's prescribed and permitted practices. The Manual provides the common standard against which departures are measured and disclosed.
  • Concepts statements are low in both hierarchies: FASB Concepts Statements are nonauthoritative under GAAP and Level 5 under SAP. The NAIC's own Preamble and Statement of Concepts are Level 4, below the Annual Statement Instructions.
  • Updates are not standards: After the Codification, an Accounting Standards Update only amends the Codification; citing an update rather than the Codification topic it changed cites the wrong source.
  • Prescribed is not permitted: A prescribed practice applies to every insurer under the state's rules; a permitted practice is approved for one insurer at its request.