A high-profile committee established to find ways to simplify financial reporting and make it more useful to investors has put the last spit and polish on its ideas.
The Advisory Committee on Improvements to Financial Reporting will present its final recommendations to the Securities and Exchange Commission on Aug. 1, but the committee has already published a draft of its final report, and the public comment period for that document closes today. CIFR will hold one final vote to ratify the report on July 31.
The committee’s doings have been closely watched since it was formed last year, since the SEC has given much weight to similar committees formed in the past to address other issues. CIFR’s purview covered five areas: increasing the usefulness of information in SEC reports; enhancing the accounting standards-setting process; improving the substantive design of new accounting standards; delineating authoritative guidance from non-authoritative interpretive guidance; and clarifying guidance on financial restatements and accounting judgments.
The SEC has also already embraced one of CIFR’s early proposals: to adopt XBRL technology for financial reporting. At the start of the year, CIFR offered an interim recommendation that XBRL would be a good idea if phased in over several years and not requiring auditor attestation of a company’s XBRL efforts. The Commission then proposed a rule in May to mandate XBRL, largely along those lines. That proposal is still out for public comment, but most people expect the SEC to approve a final mandate later this year.
Cox
To increase the chance that the SEC would act on its proposals, CIFR has avoided any recommendations that would require new laws or other legislative changes. That strategy seems to be paying off. At CIFR’s final meeting on July 11, SEC Chairman Christopher Cox said the Commission is “close to doing something” on the committee’s recommendation for more guidance on how companies can use corporate Websites for disclosure of required information. Cox added: “We’ve got a handful of others, including one on judgment, that we hope to move forward on.”
Use of judgment is a contentious issue in financial reporting, since auditors and others often fear they may be sued for exercising judgment that later turns out to be wrong. CIFR’s recommendation on judgment says the SEC should issue a policy statement articulating how it evaluates the reasonableness of accounting judgment and include factors that it considers when making that evaluation. The group says the Public Company Accounting Oversight Board should adopt a similar approach on auditing judgments.
Cook
The call for a policy statement is a departure from the group’s initial plan to call for a judgment framework. “This is now an evaluative process for regulators” as opposed to a framework, said Michael Cook, a former chairman of Deloitte & Touche and chairman of the CIFR sub-committee that wrote the judgment recommendation. “There is no safe harbor. This is strictly a recommendation for statement of policy.”
FINAL DETAILS
Below are some excerpts of CIFR's draft final report on improving financial reporting.
Delineating Authoritative Interpretive Guidance
[We believe] that there should be a single standards-setter for all authoritative accounting
standards and interpretive implementation guidance of general significance. The FASB
should perform this function for U.S. GAAP, while the SEC should focus on registrant-
specific guidance as explained below. If the SEC staff identifies accounting issues of
relatively broad significance in the process of reviewing filings by registrants, the SEC
publish its comment letters on financial reports filed by registrants. However, [we urge]
the SEC staff to re-emphasize that those comment letters are registrant-specific and do
not represent binding precedent on other registrants. Similarly, [we urge] the Division of
Corporation Finance and the Office of the Chief Accountant to emphasize that their “pre
clearance” processes are registrant-specific and are not binding on other registrants. [We
also support] a number of steps that we understand the SEC staff is planning to take to
increase the consistency of its accounting guidance to registrants.
one document, which would clearly delineate authoritative from non-authoritative
literature. Further, the SEC should codify its guidance on accounting matters in a format
staff should refer such issues to the FASB through the proposed FRF. In those rare
instances when the SEC believes it is necessary to quickly announce an accounting
interpretation of broad significance, [we strongly encourage] the SEC to consult in
advance with the FASB and the FRF.
[We support] the efforts of the SEC staff in its Division of Corporation Finance to
publish its comment letters on financial reports filed by registrants. However, [we urge]
the SEC staff to re-emphasize that those comment letters are registrant-specific and do
not represent binding precedent on other registrants. Similarly, [we urge] the Division of
Corporation Finance and the Office of the Chief Accountant to emphasize that their “pre
clearance” processes are registrant-specific and are not binding on other registrants. [We
also support] a number of steps that we understand the SEC staff is planning to take to
increase the consistency of its accounting guidance to registrants.
Clarifying Guidance on Financial Restatements and Accounting
Judgment
The preparation and audit of financial statements have always required the exercise of
judgment. The recent trend in accounting entails a move away from prescriptive
guidance toward greater use of judgment – for example, the more frequent use of fair
value involves estimates of value that may be less objectively determined than historical
cost measures. Similarly, the revised auditing standards recently issued by the PCAOB
emphasize the need for professional judgment in taking a risk-based approach to
performing internal control audits. Moreover, international accounting standards
the reasonableness of a judgment. [We have offered] factors that [we believe] are
important in this evaluation process, including the available alternatives a company
identified; the robustness of a company’s analysis of the relevant literature and review of
the pertinent facts; and how a company’s conclusions meet investors’ information needs.
[We also believe] that the statement of policy should emphasize that judgments be
documented contemporaneously to ensure that the evaluation of the judgment is based on
the same facts that were reasonably available at the time the judgment was made. [We
generally contain less prescriptive guidance and more reliance on general principles than
U.S. GAAP.
In recognition of the increasing exercise of accounting and audit judgments, [we
recommend] that the SEC and PCAOB adopt policy statements on this subject. These
policy statements would provide more transparency into how these regulators evaluate
believe] adoption of these policy statements would not only provide more transparency
into how the SEC and the PCAOB evaluate the reasonableness of a judgment, but also
encourage preparers and auditors to follow a disciplined process in making judgments.
As a result, investors should have more confidence in the ways in which accounting and
auditing judgments are being exercised.
Source
CIFR Draft Final Report (July 2008).
CIFR hopes such a policy statement by the SEC would help end second-guessing. Cook noted, however, that the process wouldn’t preclude auditors or regulators from challenging a judgment. Regulators will “have the same prerogative they have today to challenge judgments,” he said.
Among its recommendations to improve the delivery of financial information, CIFR wants companies to include a short summary in their annual and quarterly reports that would describe their main business units, key metrics for past performance, and an outline of their business outlook, as well as an index showing where investors can find more information on particular subjects. The group is encouraging the private sector to develop key performance indicators to facilitate comparisons across companies and over time.
One topic CIFR avoided: International Financial Reporting Standards. The SEC is already wrestling with whether to let U.S. companies file financial statements according to IFRS, and since the topic is so fluid and controversial, CIFR left it alone.
In all, the committee’s 180-page report includes 25 recommendations. Among them is a controversial proposal that would require companies to disclose and correct all errors promptly, but not always restate their financials.
The report calls for the SEC to supplement existing guidance on evaluating the materiality of errors and to issue new guidance on correcting material errors based on the needs of investors making current investment decisions. While CIFR says companies should promptly correct and disclose any accounting error, the group stresses that the correction and disclosure of an error shouldn’t automatically result in a restatement. Rather, past financials should be restated only if the error would be material to investors making current investment decisions.
Will This Work?
Greg Jonas, managing director of Moody’s accounting specialists group, says the recommendations—particularly about error correction—would benefit users of financial statements. “If we can reduce unnecessary restatements, I think it will significantly speed the timeliness with which companies can deal with errors through disclosure,” he says.
CIFR also wants the SEC to issue guidance for companies on disclosing information while they’re preparing restatements. A chronic complaint among investors today is that a company announces an error, promises a restatement, and then says nothing for quarter upon quarter as it tries to verify the extent and cost of the error.
Jonas
“Companies go into restatement mode and don’t come out for long time,” Jonas said. “That dark period is a tragedy for users. It’s a big black hole.”
Another recommendation calls for FASB to be “judicious” in issuing new standards and interpretations that expand the use of fair value, at least until FASB finishes a measurement framework and standard setters implement a plan to strengthen the infrastructure that supports fair value reporting.
The recommendations also call for FASB to avoid the use of bright lines in new projects in favor of proportionate recognition, in consideration of qualitative factors and enhanced disclosure, and to eliminate existing bright lines where possible. Yet another suggestion: minimize industry-specific guidance, alternative accounting policies, scope exceptions, and competing accounting models.
Moreover, the committee says the SEC and FASB should establish a process to coordinate their efforts so that the SEC would regularly update and, as appropriate, remove portions of its disclosure requirements as new FASB standards are issued.
CIFR also urged the creation of a “Financial Reporting Forum,” which would represent groups from across the regulatory and financial reporting spectrum: the SEC, the PCAOB, FASB, auditors, investors, and others. The forum would meet regularly to evaluate pressures on financial reporting and help set priorities of what fixes and improvements should be made.
The committee also says investor perspectives should be given “pre-eminence” in the standards-setting process, with more investor representation on the Financial Accounting Foundation, FASB and the FASB staff, and calls for post-adoption reviews of new standards and periodic assessments of existing standards. In addition, the committee says FASB should be the sole issuer of authoritative guidance for U.S. Generally Accepted Accounting Principles.
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