FASB Guidance; SOX at 5; PCAOB Work

The Financial Accounting Standards Board has decided to shelve planned guidance on a narrow aspect of materiality, awaiting the outcome of action by the Securities and Exchange Commission and other bodies that are studying materiality and financial reporting in a broader sense.

The Board issued a proposed staff position in late April mirroring earlier guidance by the SEC staff contained in Staff Accounting Bulletin No. 108 regarding how to correct accumulated errors in financial reports. SAB 108 required—and the proposed FASB guidance followed suit—that companies should use not one or the other of two common approaches to correct errors, but instead should use both methods to provide a more comprehensive correction of the error.

At its meeting last week, FASB considered comments contained in a dozen comment letters and decided it should wait on the narrow materiality question for now, while other bodies—including the SEC—wrestle with more conceptual issues about materiality. The SEC has indicated it may take a fresh look at its most recent, principles-based guidance on materiality contained in Staff Accounting Bulletin No. 99. The SEC also has formed an Advisory Committee on Improvements to Financial Reporting, which is expected to consider materiality among other topics.

FASB members agreed they should await the outcome of such initiatives before proceeding on any narrow materiality question, but the discussion touched a nerve among board members on the broader question of whether FASB should be in the business of offering materiality guidance at all.

Crooch

“I don’t believe materiality is an accounting standards issue,” FASB member Michael Crooch said, contending that it is an audit concern best left to the professional judgment of preparers of financial statements and their auditors.

Smith

Larry Smith, FASB’s newest member, disagreed. “We’re the ones who put the materiality box in the accounting standards,” he said, referring to boilerplate language in many accounting standards that says the standard does not apply to immaterial items. “We should put some parameters around how materiality should be considered, what things people ought to consider, and how people should approach materiality.”

Five Years on, Companies Still Unenthused by SOX

Five years on the books, Sarbanes-Oxley is still seen more favorably by investors and regulators than by companies caught up in the compliance exercise, according to speakers at a recent Center for Audit Quality forum.

Fornelli

Reflecting on SOX and its fifth anniversary last week, Cindy Fornelli, executive director of the Center for Audit Quality, said a recent poll found some 84 percent of investors have confidence in the U.S. capital markets, and 62 percent say Sarbanes-Oxley rules should remain in force essentially unchanged. In fact, two-thirds of investors polled said they would be concerned about any easing up on SOX-related rules.

“Corporate executives, however, have a different view of the impact of SOX,” Fornelli continued. “They’re a little less enthusiastic.” In a separate poll of executives of companies that had recently gone public, 73 percent of executives said regulations under SOX were “at times, excessive,” she said.

Christopher Cox, chairman of the Securities and Exchange Commission, said the scandals and corporate collapses that brought Sarbanes-Oxley into place led to a “remarkable startup” to calm public fears. “Congress was after regulators to do something in a hurry,” Cox said at the forum.

Cox

Recent measures by the SEC and the Public Company Accounting Oversight Board to redirect Sarbanes-Oxley implementation, especially the reporting on and auditing of internal controls over financial reporting, should address executive concerns about the costs and benefits of compliance, Cox said. “Now that we have a lot of experience, we were able in a much more relaxed environment to go through it one more time,” he said. “The intent right now at the SEC is on making sure we continue to adjust that cost and benefit to get ever more benefits as we get ever more reasonable cost.”

Despite intense pressure to continue to defer internal control reporting requirements for smaller public companies, including Congressional measures to override the SEC’s current timeline, Cox said he doesn’t foresee any further delay for smaller companies.

Regulators will watch carefully as larger companies implement the new Auditing Standard No. 5, recently rewritten by the PCAOB and approved by the SEC, to determine whether any further delay is warranted for smaller companies, Cox said. “We will find out in a real-world way whether the new auditing standard that the SEC and the PCAOB have approved will result in cost reductions we have hoped for, and improvements, when those who are required to comply now have to do so,” Cox said.

He conceded, however, that the window of time to examine implementation will be short before current requirements kick in for smaller companies. As such, he warned smaller companies not to defer their work in hopes of another implementation delay. “It’s still in the cards for us to consider whether another deferral is possible for smaller companies, but it’s not our plan at the moment, so we want to make sure everyone is ready for this,” he said.

FASB Offers Approach to Repurchase Financing

As promised, FASB has proposed a new approach to accounting for transfer of financial assets and subsequent repurchase financing to weed out structured transactions that have no economic substance.

The Board issued a proposed staff position that focuses on the circumstances that would allow a buyer and seller of a financial asset to evaluate the accounting for such a transfer and repurchase separately under Financial Accounting Standard No. 140, Transfers and Servicing of Financial Assets and Extinguishments of Liabilities.

The proposed FSP says that a transfer of a financial asset and a repurchase agreement involving that same asset should be considered part of the same arrangement when the buyer and the seller are the same in both transactions, unless certain criteria are met. The criteria are intended to assure there is a valid business purpose and economic substance to the transaction, as well as to assure that the repurchase financing does not result in a change of control over the financial assets.

FASB said the goal of the staff position is to limit diversity of practice in accounting for these situations, resulting in more consistent financial reporting. The Board is seeking written comments by Sept. 14, 2007.

Inspect Thyself! PCAOB Internal Review Finds Flaws

A Public Company Accounting Oversight Board review of its own inspection process has revealed that the PCAOB is not getting the full benefit of a $1.3 million document management system, because staff find it too cumbersome to use and routinely bypass it.

The review focused on 2006 inspections of the eight largest U.S. audit firms that are subject to annual PCAOB inspection. The Board wanted to determine whether inspections of those eight firms were supported by documentation as required by PCAOB inspection rules. The review found inspection teams generally documented the results of their inspections in accordance with PCAOB guidelines, but used work-arounds to bypass the document management system because they found using it too much of a chore.

Among the problems staff cited: inconsistent network connections, slow response times, and duplicative or burdensome processes for certain tasks. The internal review says the work-arounds have left the PCAOB inspection system void of information that could facilitate later analysis or data mining.

Olson

The PCAOB has been criticized for the long lag between completion of inspections and the publishing of completed inspection reports. PCAOB Chairman Mark Olson has said since the beginning of his tenure that improving reporting and speeding up the process is one of his top priorities.