FASB Calls for a Cultural Change

Executives who use accounting-motivated transactions to prop up financial results are among the obstacles to a principles-based approach, says Robert Herz, the board's chairman.

The Financial Accounting Standards Board is conceding that its push for a principles-based accounting system could run smack into some powerfully entrenched interests.

FASB laid out the challenges it faces in a February 16 reply to a Securities and Exchange Commission report on improving the transparency of off-balance-sheet arrangements, which was issued eight months ago. Largely agreeing with the SEC, the board threw down the gauntlet against complexity, essentially calling for the U.S. accounting industry to move away from its traditional rules-based model to a more principles-based system.

In its letter, FASB agreed to revisit everything the SEC suggested: the accounting treatment of leases, defined-benefit pensions, and financial instruments, as well as consolidation policies. But the standards board also issued a broader critique, noting that form was surpassing function in financial reporting and that complexity was clouding transparency.

The response, however, reiterated the obstacles to change that FASB chairman Robert Herz hit on in a December speech to the American Institute of Certified Public Accountants (AICPA). “Fundamental structural, institutional, cultural, and behavioral forces have caused, and continue to cause, complexity in the system and impede transparent financial reporting,” he said then.

One of the forces is inertia, notes Jack Ciesielski of R.G. Associates Inc. and editor of the Analyst’s Accounting Observer newsletter. “People don’t want to change because the status quo is easier,” he says. Indeed, exorcising complexity from an accounting system that has added hundreds of bright-line rules and guidelines in the past 30 years won’t be easy.

For its part, FASB has already begun to systematically identify standards that need simplifying, such as those that are overly complex (like leasing and pension accounting) or those it deems outdated (using cost accounting for options valuation). Further, the board would like new standards to be more consistent with a principles-based system, and may borrow some ideas currently used by the International Accounting Standards Board.

But those efforts are a mere drop in a very big bucket. Herz acknowledged that the only way to move toward a simpler system is to get all the constituents to iron out their conflicting views. Taken together, the scope of their agendas is wide, since the stakeholders vary, and include FASB, the SEC, the Public Company Accounting Oversight Board, corporations, and auditors.

Indeed, Herz expects a good deal of pushback. In his AICPA speech, he identified some of the forces blocking the board’s anticomplexity campaign, including an excessive focus on short-term earnings and a fear of being second-guessed — and punished — by regulators.

Among the recalcitrants are executives bent on improving short-term earnings who use accounting-motivated transactions to prop up financial results, according to Herz. Other proponents of the status quo are auditors and corporate accountants who rely heavily on bright-line rules, worrying that the use of professional judgment could leave them open to shareholder litigation or regulatory reprimand.

The fear of second-guessing is especially prevalent in a post-Sarbanes-Oxley Act environment, where auditors constantly weigh “subjectivity and liability,” says attorney Matt Dyckman of Thacher Proffitt and Wood. “Sarbanes-Oxley made it a higher-stakes game,” he adds, noting that companies and auditors now take on “greater risk for participating in the capital markets.”

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