Capitol Hill Tackles Complexity

In hearings Wednesday, Congress sought advice on ways to improve accuracy and reduce the complexity of financial reporting.
Tim ReasonMarch 30, 2006

What would make financial reporting simpler? A host of regulators, business groups, and investor advisory firms converged on Capitol Hill yesterday to debate that question. The hearings are the latest in what appears to be an organized push — led by the Financial Accounting Standards Board — to turn the long-running debate over “principles vs. rules-based accounting” into concrete action.

Held by the Capital Markets subcommittee of the House Financial Services Committee, the hearings featured testimony from the PCAOB, FASB, SEC, U.S. Chamber of Commerce, the Securities Industry Association, FEI, AICPA, CFA Institute, Merrill Lynch & Co, and the Investment Company Institute.

The hearings appear to be a response to a push by FASB Chairman Robert Herz, who first took aim at the “complexity” issue in a December speech before the AICPA. Herz, whose previous appearances on Capitol Hill were marked by hostile questioning from congressmen about stock option expensing, has now emerged as the de facto leader of a plan to “bring about broad-based improvements to the U.S. financial reporting system.” This effort, he noted, “would not be easy and would take time, [but] we believe it is one of national importance.”

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Several issues dominated the debate, including the elimination of earnings guidance, the adoption of a principles-based accounting system, the need for tort reform, FASB’s push for fair value accounting, and the use of technology to create “real-time” financial disclosures. Several participants repeatedly stressed that any effort to reduce complexity would require public companies, auditors, and lawyers to actively support such an effort — apparently suggesting that those groups would be most resistant to relying more on judgment than bright-line rules.

Colleen Cunningham, president of Financial Executives International, responded that regulators often second-guess reasonable interpretations and pleaded with Congress for help in reducing litigation over financial reporting. She also tweaked FASB, noting that the standard setter needed to finalize the “conceptual framework” upon which accounting standards are based. “Recently issued accounting standards are not always reflective of the current conceptual framework, but rather rely on changes to the conceptual framework that have not yet been proposed, let alone finalized as ‘generally accepted,’” she testified. “FEI has voiced its concern about this ‘cart-before-the-horse’ approach of standard-setting numerous times.”

Another frequently raised topic was the use of extensible business reporting language (XBRL), a method of tagging financial data so it can easily be compared. SEC Chairman Christopher Cox has adopted “interactive data” as a key initiative during his tenure. The SEC is working to update its existing electronic filing system and has also offered public companies incentives if they file their financial reports in XBRL format. Rep. Michael Oxley (R-Ohio), chairman of the House Financial Services Committee, commended Cox for his efforts in his opening statements, noting that he looked forward to hearing from witnesses about how “they believe XBRL will revolutionize the reporting and analysis of financial information.”

In fact, witnesses had mixed response. FEI’s Cunningham warned that “interactive data is not a ‘panacea’” and that it “will not reduce the ‘operational’ complexity imposed on preparers and auditors to develop the numbers provided in financial reports, nor will such transparency improve the understandability of the underlying numbers to investors.” U.S. Chamber of Commerce vice president David Hirschmannn echoed that sentiment, noting that “while numbers are important,” XBRL was no substitute for investor understanding of industry factors and corporate strategy.

By contrast, Barry Melancon, CEO of the AICPA, heavily emphasized the use of XBRL as part of a program of “enhanced business reporting,” arguing that the technology is “essential to the future of the U.S. economy, the proper functioning of capital markets, and investor confidence. Its promise is extraordinary.”

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