Here’s How to Fix Accounting’s Complexity

Tips for a new SEC committee tasked with simplifying financial reporting.
Sarah JohnsonOctober 26, 2007

A Securities and Exchange Commission group charged with simplifying the U.S. financial-reporting system in one year will consider several recommendations during its second open meeting next Friday.

One of the topics on the table is whether the group’s 17 members can actually address the weighty job of figuring out how to whittle down the complexities inherent in accounting by next August, when they are mandated to turn over their recommendations to the SEC. “We believe that the advisory committee in its limited life cannot address all of the issues raised in [its] discussion paper,” wrote midtier accounting firm BDO Seidman in its comment letter to the Advisory Committee on Improvements to Financial Reporting (CIFR).

Indeed, many of the group’s agenda items could easily take a year to debate on their own, such as whether principles-based accounting standards are better to use than rules-based standards. Nevertheless, the committee’s agenda for its November 2 meeting includes considering its subcommittees’ recommendations and those that came out of the public comment period for the discussion paper that CIFR chairman Robert Pozen presented during the summer.

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In that paper, Pozen suggested that the committee examine the inner workings of the Financial Accounting Standards Board and the Public Company Accounting Oversight Board, and the consequences of giving auditors more professional judgment, among other issues. He hopes the group — made up of current and former CFOs, professors, securities lawyers, investor advocates, and audit-firm executives — will eventually come up with about 12 recommendations for reducing complexity in financial reporting.

The group blames the complexity build-up on the wealth and length of accounting standards from FASB in the past several years, and on the mounting interpretations of those rules coming from regulators and the accounting firms. “We have too much GAAP running around,” Pozen said during the CIFR’s first meeting. “We need to figure out what is and isn’t GAAP and grab hold of it.”

That sentiment was echoed in at least one of the 19 letters the CIFR received during the public-comment period for its discussion paper. The Big Four accounting firms have added to the confusion by publishing different interpretations of standards, particularly those that are considered principles-based, according to Kenneth Bentsen, president of the Equipment Leasing and Finance Association. “These interpretations are, in effect, establishing GAAP,” he wrote.

ELFA recommended that the Big Four’s interpretations undergo regulatory review, perhaps by FASB staff members. The trade association also suggested that this type of guidance should be made consistent and widely available through a public Website with a Q&A-type format from FASB and SEC staff, creating a “case law” for GAAP.

Like others who wrote in to the CIFR, the trade association also shared its own problems with certain accounting standards. In its case, the group anticipates being deeply affected by the impending changes to the lease-accounting standards, a joint project by FASB and the International Accounting Standards Board that will require companies to capitalize more lease agreements on their balance sheets.

Another accounting standard frequently mentioned in the comment letters is the new fair-value rules, which go into effect for most companies next month. Critics are calling them unreliable for allowing estimated values of assets and liabilities to be marked to markets that are thinly traded or not traded at all.

However, the CIFR isn’t charged with revising current standards: it is limited to suggesting broad ways the financial-reporting system can be changed. One particular area the group will surely look at is the issues surrounding professional judgment.

As recent waves of standards and revised regulations have promoted taking a more principles-based approach, companies are left with having to believe their professional judgment will be trusted when they are under review by their auditors and regulators. But observers say the all-too-human tendency to question another person’s decision has led to the influx of restatements in recent years by companies afraid of auditors’ and regulators’ second-guessing.

To ease the confusion, the Canadian Public Accountability Board, which oversees auditors of Canadian public companies, suggests that the term “professional judgment” be defined. Neither the SEC nor standard-setters have such a definition but include the term in their literature, according to the CPAB. The board is also hoping that the CIFR will “stress that preparers and auditors of financial statements cannot avoid making professional judgments, regardless of the type of standards being applied,” wrote CPAB chief executive Keith Boocock.

Furthering that idea, BDO Seidman suggested that the SEC and Congress let the concept of “reasonable judgment” be used as a defense in lawsuits.

The following are among the other recommendations the CIFR may consider next Friday:

• The Institute of Management Accountants brought up the idea of creating an “accounting court” for companies and auditors to resolve their disagreements over the interpretations of accounting rules with the SEC. The IMA compared this idea to “tax courts” where taxpayers and the Internal Revenue Service can resolve their disputes.

• BDO blamed complexity partly on the fast pace of change that has been put on companies and their accounting firms in recent years following the implementation of new standards. To create “stability” between changes, BDO suggested that implementation dates of standards be “bunched” into one day, every three years. For example, all new rules issued from 2008 through 2010 would be effective for fiscal years beginning after December 15, 2011.

• In another suggestion, BDO asked the CIFR to consider whether changing the makeup of FASB could result in simplification down the road. “A mix of full-time and part-time board members and staff might contribute a better appreciation of the burdens of complexity and, as a result, lead to less complex standards,” the firm wrote. As it is, the board’s members do not have to apply the standards they create and may tend to think more in theories than practicalities, according to BDO.