Accounting and Audit Rulemakers Make the Case for Transparency

Beating back political pressure to lighten up on issuers and auditors, the nation's top accounting and audit rulemakers appealed to corporate compliance officers to see the wisdom of adopting tough rules.

During separate keynote addresses at the Compliance Week 2012 conference in Washington D.C. last week, chairmen of the Financial Accounting Standards Board and the Public Company Accounting Oversight Board told compliance, risk, and governance officers they are working on new rules that are intended to produce more relevant and reliable financial statements. And both chairmen acknowledged the opposition each board faces to some of their most aggressive proposals.

Leslie Seidman, chairman of FASB, addressed recent pressure for the board to pay closer attention to the economic impact of the accounting standards it develops. Seidman said cost and benefit analysis is something FASB takes very seriously and has built into the process for making or changing accounting standards. “Finding the right balance between the investor's needs and the preparer's constraints is a recurring issue in our discussions.”

Still, she emphasized the need for transparent accounting, regardless of how it might portray the underlying transactions. For example, Seidman and her FASB colleagues are nearing completion of a second draft of a proposal to dramatically change the way leases are treated in financial statements. Today, leases are treated as normal operating expenses unless they meet some strict, easy-to-navigate criteria for treatment as the acquisitions of capital. The board is working on a proposal to require that all leases be recorded as an asset and a liability on corporate balance sheets.

FASB says it has heard widespread support for bringing leases on the balance sheet, but members of Congress and the U.S. Chamber of Commerce are still calling on FASB to take into account the massive influx of assets and liabilities that will be added to corporate balance sheets as a result of the new standard. The Chamber recently reminded FASB that leases account for hundreds of billions in transactions annually throughout the global economy, and that bringing them on the balance sheet may change corporate decision making and have an adverse economic impact.

The Chamber predicts the standard will lead to “the loss of thousands of jobs and billions of dollars of economic activity.” Congress members also cited concerns about an already fragile real estate sector and the effect on existing debt covenants, given the increase in liabilities companies will have to record.

Seidman appealed to compliance officers to see it another way. “The role of financial reporting in the economy is to provide information that is useful in making business and economic decisions, not to determine what those decisions should be,” she said. “While new accounting standards may change the way companies report their financial condition, the standards do not create or change the underlying condition itself.”

She likened accounting standards to a barometer that measures atmospheric conditions to predict weather. Accounting standards aren't meant to determine economic conditions, but to reflect them, just as a barometer predicts the weather rather than controls it. “Standard setters can't make it sunny or make it rain,” she said. “The best we can do is provide a neutral tool so others can make informed decisions based on the likelihood of sun or rain.”

Acknowledging calls for a broad study of the economic impact of standards, Seidman said it's not within the board's role. “Some think that the potential for adverse consequences is a reason to not improve reporting,” she said. “We do not share that view. We think investors, creditors, donors, and other users, including policy makers, need relevant and unbiased information on which to base their decisions. They need a good barometer, even if it predicts rain.”

Seidman did provide some details, however, on a project underway at FASB that could make life easier for preparers of financial statements. FASB will soon publish a discussion paper to outline its proposed solution for how to address rising concerns about disclosure overload.

The board is working on developing a framework that would help the board establish consistent disclosure requirements focused on what matters most to users of financial statements, she said. In the discussion paper, the board will ask for feedback on the framework, which also will explain how reporting entities should evaluate which disclosures they need to make based on their own circumstances. That might even include helping a company determine when a particular disclosure is unnecessary and can be excluded from financial statements, she said. It could also end up reducing some of the overlap that exists among standards.

Seidman was quick to point out, however, that the purpose of the project wasn't necessarily to reduce disclosure burdens, although that could be the end result. “Let me emphasize that the purpose of this project is to improve disclosure effectiveness, not to single-mindedly reduce disclosure volume,” she said.

PCAOB's Range of Possibilities

PCAOB Chairman James Doty likewise is facing political pressure to back away from a controversial idea to improve auditor skepticism by requiring auditors to limit their terms of engagement with public company clients. After hundreds of comment letters and dozens of roundtable speakers mostly criticized the idea, Doty also faced a testy House Financial Services Committee that instructed him to take a close look at the costs and benefits before proposing a mandatory rotation rule.

“Some think that the potential for adverse consequences is a reason to not improve reporting. We do not share that view,” said Financial Accounting Standards Board Chairman Leslie Seidman during her keynote address at CW 2012.

“Some form of term limits may or may not provide more independence, but I believe we must explore the range of approaches available to free the auditor to think and act independently,” Doty told compliance officers. “The relevance, credibility, and transparency of the financial audit are rooted in the core values of independence, objectivity, and skepticism.”

Auditors have taken it on the chin in the wake of the financial crisis as blue-chip companies collapsed with almost no warning, prompting critics to question the relevance of the audit. Doty assured compliance officers he and his fellow board members are working on a number of ideas to address the concerns. “The PCAOB is deeply engaged in examining ways to enhance the relevance, credibility, and transparency of the audit to better serve investors,” he said.

The board is working on a proposal to require auditors to say more in their audit reports to reflect what they learn about a company's financial statements through the audit process, although the board has explored a wide range of options and given little hint to what it will propose. It also is working on an auditing standard that would require the auditor to give audit committees more information in the hopes it will better equip audit committees with the information they need to adequately oversee external auditors. “The proposal addresses part of what investors found disquieting about the recent financial crisis,” Doty said. “It is not necessarily a question of access to information, or volume, but of relevance and quality.”

James Doty, Chairman of the Public Company Accounting Oversight Board, spoke on improving the audit process. “The PCAOB is deeply engaged in examining ways to enhance the relevance, credibility, and transparency of the audit to better serve investors,” he said.

Answering questions following his speech, Doty also acknowledged the board faces pressure on cost concerns as it writes new auditing standards and gets tough on auditors in inspections. As the board clamps down on auditors and demands they do more work to support their audit opinions, Doty encourages audit committees to toe the line on cost with their audit firms. “We haven't seen spikes in audit fees,” he said.

He pointed out that European regulators are pursuing a controversial mandatory rotation measure in part because they want to make room for smaller firms to grow and create more competition for larger firms. “Competition will drive down costs,” he said. At the same time, he warned companies to be careful not to get too carried away in beating up the auditor over cost. “You don't want the cheapest audit,” he said. “You want a credible audit.”