August 2008 was a hopeful time for advocates of principles-based accounting. The United States had a new plan to adopt global accounting standards, which are considered to allow for more judgment than U.S. generally accepted accounting principles. And an advisory group to the Securities and Exchange Commission unveiled a 170-page report recommending ways financial reporting could be simplified, including the belief that bright lines should not exist.
A year later, there has been no movement toward adopting International Financial Reporting Standards in the United States since then–SEC chairman Christopher Cox introduced a roadmap for the conversion last August. And while some recommendations of the Committee on Improvements to Financial Reporting were taken up by standard-setters and regulators during the year the CIFR convened, the SEC has procrastinated on addressing the meatier, more-controversial suggestions that could substantially reduce reporting complexity.
Those suggestions included having the SEC develop a policy statement on the reasonableness of judgment, in order to reduce second-guessing among companies, regulators, and auditors. The CIFR also recommended that the commission issue additional guidance on how companies should view materiality when considering a financial restatement. And, the committee offered, the SEC could require companies to write executive summaries of their 10-Ks, briefly explaining their business, financial condition, and operations.
To be sure, the SEC has been wrapped up in repairing its reputation following the Madoff scandal and the collapse of investment banks. The announcements coming out of the commission this year have focused largely on short-selling rules; executive compensation; proxy access; and enforcement actions against or settlements with financial institutions, a corporate behemoth (General Electric), and several Ponzi schemes.
Indeed, nearly seven months into her job as SEC chairman, Mary Schapiro has for the most part — at least publicly — stayed away from talking about corporate finance and accounting policies. In fact, Schapiro has yet to name a permanent chief accountant since Conrad Hewitt left in January.
“We have focused our efforts on matters directly related to the economic crisis, financial regulatory reform, and improvements to the agency’s processes and programs, and we expect to continue to do so in the coming months,” Schapiro wrote last month in a letter to CIFR chairman Robert Pozen, who also chairs MFS Investment Management.
In 2007 Pozen’s group was tasked with the lofty goal of spending a year coming up with tips for how regulators and standard-setters could simplify financial reporting. The members — current and former CFOs, professors, securities lawyers, investor advocates, and audit-firm executives — avoided recommending any changes that would require legislation and did not weigh in on the debate over whether the United States should adopt IFRS.
Some of the committee’s advice regarded changes that were already in process and are now completed or nearly done. For example, the SEC has clarified how companies can use their Websites to disseminate financial information. Also, the Financial Accounting Standards Board has been working on getting investor representatives more involved (for example, Vanguard chairman John Brennan now chairs FASB’s board of trustees). FASB has also completed its codification project, creating a one-stop, authoritative location for all GAAP literature in a bid to clear up confusion resulting from quasi-GAAP issued by regulators and accounting organizations that has piled up over the years.
“Given the context of where we’ve been in the last year in terms of the financial crisis, I’m quite pleased by the amount of work that has been done,” says Pozen, who estimates that about two-thirds of his committee’s recommendations have been addressed. Still, he tells CFO.com, he felt the need to recently “prod” the SEC and FASB on the status of committee recommendations that haven’t received recent attention.
One tricky recommendation that SEC staffers may continue to ignore involves materiality. The CIFR wanted the commission to tell companies to consider both qualitative and quantitative factors when determining an error’s materiality, and make their decision based on “the perspective of a reasonable investor.” In addition, the committee wanted more guidance on how companies should address an old error. But while the SEC has not issued any new guidance on materiality since the CIFR report came out, Pozen says companies are gradually reevaluating what is considered material on their own.
Another CIFR suggestion may be dead for now. Many accounting observers believe a more principles-based approach to financial reporting, putting more trust in professional judgment, would clear up the muddy water created by decades of rules proliferation. In that spirit, the CIFR asked that standard-setters eliminate percentage tests, strict thresholds, and numerical parameters in rules.
However, FASB believes that pleas for more detailed guidance won’t abate. “Although the Board is committed to eliminating or reducing the use of bright lines and exceptions, we do not perceive any significant change in the demand for such guidance,” FASB wrote in a 17-page response to Pozen.
The board took a defensive tone, noting that “the SEC, the FASB, and others have been understandably devoting significant time and attention to addressing the issues brought to light by the current economic crisis.”
As for the CIFR’s suggestion to address the reasonableness of judgment calls, the regulators are mum. The CIFR had wanted input from both the SEC and the Public Company Accounting Oversight Board; however, while the issue is on the board’s radar screen, it’s waiting for guidance from the SEC on how to proceed, says PCAOB communications director Mary Sjoquist.
Pozen says the two agencies should coordinate their efforts, and suggests that “if the SEC is so overwhelmed with other things, it may be the case that the PCAOB should take the lead.”
In her letter to Pozen, Schapiro said the SEC will “hopefully” take up more of the CIFR’s recommendations later this year. “As the regulatory agenda continues to unfold, I am confident that we will consider further specific action related to the many thoughtful recommendations that CIFR developed,” she wrote.
In the meantime, Pozen believes financial reporting will get easier over time, and actually has somewhat over the past year. But because improvements will be so gradual, preparers may not even take notice. “A CFO is not going to wake up one day and say, ‘Today is the day when things change,’” he says.