Is there a direct link between the complexity of the U.S. financial reporting system and the rising number of restatements among public companies here?
That was the major question hovering over the first meeting of a committee charged with figuring out how to simplify financial reporting. But the group also faces a more practical problem: how to keep its job simple enough so that its members can make realistic recommendations to the Securities and Exchange Commission by next August.
Considering the myriad numbers on their plate, the task won’t be easy. At the Thursday meeting, the members — made up of current and former CFOs, professors, securities lawyers, investor advocates, and audit-firm executives — laid them all out. Included in their agenda is scrutiny of how the Financial Accounting Standards Board and the Public Company Accounting Oversight Board work; the debate over principles-based versus rules-based accounting; and the consequences of giving auditors more professional judgment.
The Advisory Committee on Improvements to Financial Reporting, as the group is called, will try to present about 12 recommendations for reducing complexity in financial reporting to the SEC. Acknowledging how tough it will be to limit the committee’s focus, chairman Robert Pozen offered an end goal: “One of the measures of the success of this committee will be if five years later, the number of restatements have been reduced because people will have better guidance [to do their financial reporting].”
Indeed, many members blame the growing number of restatements — 10 percent of public companies restated their financials in 2006, a number of them said — on the complexity in the current U.S. financial reporting system. Pozen, chairman of MFS Investment Management, recommended that a subcommittee be formed to mull whether the increase stems from an on overly broad definition of materiality, increasingly detailed accounting standards, or some other issue. Less than 25 percent of restatements are indeed material to a company’s financial standing, according to committee member James Quigley, CEO of Deloitte Touche Tohmatsu.
The committee will likely wait to address the restatement issue until a U.S. Treasury-formed commission releases its own report on why the number of restatements has risen so dramatically. That report is expected to be released in the first quarter of 2008.
Still, members theorized that restatements with no material impact could be spurred by burgeoning management fears of being second-guessed by auditors and regulators. They could also stem from companies’ confusion over which rule to follow when so many interpretations exist: FASB rules, guidance from the board’s Emerging Issues Task Force, SEC staff bulletins, and regulators’ speeches and comment letters.
Add to that rule interpretations by the American Institute of Certified Public Accountants and the large accounting firms. Such readings often carry as much weight as the generally accepted accounting principles mandated by FASB. “We have too much GAAP running around,” Pozen said. “We need to figure out what is and isn’t GAAP and grab hold of it.”
To be sure, committee members also slammed the actual accounting standards themselves for needing added guidance in the first place. In particular, FASB’s rules on hedge accounting and fair-value accounting have caused widespread misunderstanding.
In the case of FAS 159, a principles-based standard that gives companies the choice of irrevocably applying fair-value accounting to certain assets and liabilities, early adopters “failed to understand the principles when they tried to implement it, and perhaps that failure was due to the difficulty of articulating a principles-based standard,” said Linda Griggs, a partner at Morgan Lewis, a law firm.
The members also want to find out if MD&A disclosures should be improved and if earnings releases, which often include non-GAAP financials, should be included in regulatory filings. Other topics included how the ongoing FASB-International Accounting Standards Board convergence project might affect complexity and how to better promote the use of data-tagging technology in financial reporting.
In the free-wheeling discussion on Thursday, members agreed with SEC chief accountant Conrad Hewitt’s recommendation that they keep an open mind. Joseph Grundfest, a professor at Stanford Law School, even suggested that the group consider the notion that some complexity is desirable. “Sometimes to describe a complicated transaction you have to give a complicated answer,” he said. If you force everyone to give “a simple, yes-or-no answer to a complicated question, then you can end up forcing someone to lie.”