according to the sec, what is the optimal system setting standard?
Testimony:
Are Electric current Financial Accounting Standards Protecting Investors?
by Robert Chiliad. Herdman
Primary Accountant, U.S. Securities and Exchange Committee
Before the Subcommittee on Commerce, Merchandise and Consumer Protection, Committee on Energy and Commerce, U.S. House of Representatives
February 14, 2002
Chairman Stearns, Ranking Member Towns, and members of the Subcommittee:
I am pleased to appear earlier yous on behalf of the Securities and Exchange Commission ("SEC" or "Commission") to prove on the importance of responsive and transparent fiscal reporting to investors and our upper-case letter markets. The specific question this panel was asked to address is "Are current fiscal accounting standards protecting investors?"
Our financial reporting system has long been considered the best in the world and is one of the underpinnings of our capital letter markets, which are the deepest and about liquid in the world. However, certain aspects of the system can and should be improved and so changes to accounting standards can be implemented more quickly, be more than responsive to market changes, and provide more than transparent information to investors. Our current system's weaknesses are more visible as a issue of Enron's failure.1 However, these weaknesses did not arise overnight, rather they evolved over many years. Investors expect our system to exist the finest in the earth. Nosotros intend to see that information technology remains the finest. Today I will talk over what should be done.
Concerns about our financial reporting system precede the bankruptcy of Enron Corporation and my testimony reflects that. The Commission is investigating events associated with Enron'southward collapse; and, consistent with the Commission'southward rules and practice, I am unable to discuss the specifics of that ongoing investigation. The Committee requests that the Subcommittee respect the confidential nature of the Commission'south investigation and our reluctance to address specific issues related to Enron's compliance with federal securities laws in this public forum.
Overview of U.s.a. Standard-Setting Process
The SEC relies on an independent, private sector standards-setting procedure that is thorough, open up, and deliberate. While the Committee has the statutory potency to set up accounting principles,2 for over 60 years information technology has looked to the private sector for leadership in establishing and improving accounting standards.3 The quality of our accounting standards and our capital markets can be attributed in large office to the private sector standards-setting procedure, as overseen by the SEC.
The master private sector standards-setter is the Financial Bookkeeping Standards Board (the "FASB"), which was established in 1972. An oversight body appoints the members of the FASB. This oversight trunk, the Financial Accounting Foundation, is comprised of investors, business people, and accountants. The FASB's standards are designated every bit the main level of by and large accepted accounting principles ("GAAP"), which is the framework for bookkeeping. The FASB's standards set forth recognition, measurement, and disclosure principles to be used in preparing financial statements.
The secondary standard setter is the Bookkeeping Standards Executive Committee (AcSEC), which provides guidance in the form of Statements of Position (SOPs), subject to the affirmative concurrence past the FASB at every step in the procedure. The main purpose of AcSEC, which is a commission of the American Institute of Certified Public Accountants (AICPA), is to develop standards for specialized industries.
The interpretative trunk of the FASB is the Emerging Issues Task Force (EITF). It meets every other month to provide interpretative guidance, or develop new guidance, on narrow, new or emerging issues that arise under existing GAAP and when GAAP does non exist.
Criticisms of U.S. Accounting Standards and Standard Setting
Even earlier Enron's collapse, we chosen upon the FASB to work with us to address concerns about timeliness, transparency, and complexity. Specifically, nosotros asked the FASB to address criticisms that:
- The electric current standard-setting process is too cumbersome and slow.
- Much of the recent FASB guidance is rule based and focuses on a check-the-box mentality that inhibits transparency.
- Much of the recent FASB guidance is likewise complex.
Recently, some people have suggested that the FASB should exist federalized instead of remaining in the private sector. Those who advise this apparently have lost confidence in the FASB's procedure. In that location is no assurance that simply placing the structure within the federal government would result in better accounting standards. For example, many question whether the FASB's proposal to expense stock compensation, before the Congress intervened, would have been better for investors.
Federalization of the FASB not only would require increases to the federal budget, only as well might disenfranchise those who are best qualified to address the highly complex business organization and accounting issues that must be resolved. I believe that with the Committee's leadership and cooperation by the FASB, the FASB tin exist constructive, and confidence in the procedure tin can be restored. Private-sector standard setting can piece of work in our current business surround, even as fiscal transactions become more circuitous. In spite of recent events, nosotros still have the all-time financial reporting organization in the world, and the Commission is intent on making it even better.
When done properly, standard setting in the private sector is the best alternative for our capital markets as it provides a number of advantages over federalized standard setting. Private sector standard setting has greater flexibility to complete rules more speedily than accounting standards set past the government. The FASB is comprised well-nigh entirely of accounting experts and has a greater ability to attract and retain qualified personnel. Similarly, AcSEC and the EITF are composed of members with accounting expertise.
Evolution of Standard Setting
It is important to understand how the current system of standard setting evolved. Every bit we contemplate reform, nosotros need to consider how nosotros got here. In the late 1970s and early 1980s, the FASB undertook a serial of projects to drastically change how financial information is reported to investors and other financial users. These projects, which include consolidation of financial statements and accounting for fiscal instruments, represent major conceptual changes in financial reporting. Equally you might wait, such sweeping change has been very controversial and sapped the resources of the FASB.
Equally a result, issues such as acquirement recognition (which is a gene in approximately one-half of all restatements and financial reporting enforcement cases) and consolidation of SPEs have not been adequately addressed by the FASB. The EITF and the SEC staff have attempted to address some of the problems, merely without an underlying principle the outcome has been disappointing.
In other cases, the FASB has delegated wide issues such as accounting for partnerships; belongings, plant and equipment; and the bookkeeping for environmental liabilities to AcSEC. AcSEC is comprised of part-fourth dimension volunteers from the preparer, auditor, and user communities and is subject to affirmative review by the FASB each step of the way. As a result, AcSEC is sick equipped to bargain with broad issues in a timely style. While AcSEC's guidance has been of high quality, it often takes years to result because of its infrastructure constraints.
Another criticism that has arisen over time is the trend to complex, rule-based accounting standards. This trend tin be attributed to a number of factors including (1) changes in how companies do business organization; (2) granting exceptions to new controversial standards; (3) internal conflicts in the accounting literature as the conceptual underpinnings change; and (4) demands for a single answer to every question. FASB Argument No. 133 on accounting for derivatives and hedging and Statement No. 140 on transfers of financial assets and extinguishments of financial liabilities are 2 prominent standards that have been subject to such criticism.
Improving Timeliness
Now I would like to review with the Subcommittee actions that should be taken to go along to ensure that our financial reporting arrangement remains the premier system in the world. Let's begin with the FASB. The FASB must modify the telescopic of many of its technical projects and the style in which information technology carries out its activities.
The FASB uses a building-block arroyo when developing standards. That is, the Board addresses a scattering of issues at any given meeting instead of all of the issues that comprise a single proposal. This arroyo tends to expand the fourth dimension it takes to resolve reporting issues. In contrast, the SEC staff generally will present an entire proposal to the Commission for consideration. The FASB needs to reconsider its approach.
The Board's major projects tend to be very broad. For instance, the FASB currently has on its agenda a liabilities and disinterestedness project that raises six or seven important problems. I believe this project has also broad a scope. Information technology attempts to weave too many issues into a conceptual framework everyone tin can agree on. Virtually people agree that more guidance is needed on disinterestedness derivatives and redeemable preferred stock. Why not separate out these issues and provide timely guidance on them? The remaining issues, where many believe no boosted guidance is necessary, can be addressed at later dates. Narrowing the scope to its critical elements allows the procedure to move forward in a timely manner.
Some are calling for a limitation on the time a project tin exist on the FASB's agenda. I share their concerns about timeliness. It is articulate that the FASB must work more rapidly and be more responsive to market needs. For instance, how it deals with the issue of when to consolidate SPEs is important. This projection must be finished then information technology can be both effective for, and implemented by, the cease of this twelvemonth. If the FASB is not able to make progress on such important issues every bit they ascend, the SEC should take action. We must improve our oversight of the standard-setting agenda.
Principle-Based Accounting Standards
As I mentioned in my introduction, over the last few years many of the FASB standards have been dominion based, every bit opposed to principle based. Rule-based accounting standards provide extremely detailed rules that try to contemplate virtually every application of the standard. This encourages a cheque-the-box mentality to fiscal reporting that eliminates judgments from the application of the reporting. Examples of rule-based accounting guidance include the accounting for derivatives, employee stock options, and leasing. And, of form, questions keep coming. Rule-based standards arrive more difficult for preparers and auditors to step back and evaluate whether the overall impact is consequent with the objectives of the standard.
An ideal accounting standard is one that is principle-based and requires financial reporting to reflect the economic substance, non the class, of the transaction. FASB Statement Nos. 141, Business Combinations, and 142, Goodwill and Other Intangible Assets, which were issued in 2001, appear to be steps in the right management. These standards will serve as a test of the level of specificity needed to strike a balance between rules and principles. Principle-based standards will yield a less complex financial reporting paradigm that is more than responsive to emerging problems.
Furthermore, a byproduct of rule-based bookkeeping standards has been an increase in the number of "SAS fifty" letters issued to investment banks providing opinions as to whether hypothetical transactions follow accounting standards. SAS 50 messages may exist used as the basis to construction complex transactions that technically comply with bookkeeping standards, but practise not accurately reverberate the objectives of the standards. I believe it is in the public interest that the Auditing Standards Board ban those types of letters, and yesterday I sent a letter to the Auditing Standards Lath urging that information technology do and so.
A motility to principle-based standards volition require greater field of study by the corporate community, the accounting profession, private-sector standard-setting bodies, and the SEC staff. A motility abroad from a check-the-box arroyo to fiscal reporting means that all constituencies must make concerted efforts to report transactions consistent with the objectives of the standards. While this may hateful that not all transactions are recorded in exactly the same manner, it is my conventionalities that similar transactions in this organization of principle-based standards will non be reported in materially different ways, preserving comparability.
While the FASB addresses problems of timeliness, transparency and complexity information technology must remain nimble to deal with changes in the market. Looking ahead, it must accelerate its efforts to achieve short-term convergence with the International Accounting Standards Board and coordinate with the SEC's fiscal reporting and disclosure reform initiatives so our upper-case letter markets can proceed to be the deepest and most liquid in the earth.
Resource Management
At present I would like to hash out how better resource direction should improve timeliness of standard setting. This is where the leadership of the SEC is important. Every bit I stated at the beginning, the FASB is bailiwick to the oversight of the SEC.
Allow me to draw how I believe that oversight should work. In lite of its enforcement and review activities, the SEC is in a unique position to provide input into the FASB's agenda. We have a responsibility to do that, and the FASB has a responsibility to accost the problems we refer to them in the fourth dimension frame that we request, even if information technology is 180 days. I believe that nosotros can and should stay out of their style once we ask them to take on a project. However, we should meet with the FASB often to monitor the status of their projects. If projects are languishing, we must decide why.
By and large, there are two reasons that topics remain on FASB'southward calendar for extended periods. First, there may not be a problem with existing guidance, equally many believe is the case with the basic consolidations model. Using resources to revisit this model slows the process and detracts from the Board's power to accost the more important problems such as SPEs.
2nd, a topic may remain on the agenda for an extended period because it is too wide. This is a principal reason why the Board has had to spend much fourth dimension on its liability and equity project. Instead of focusing solely on the pressing bug of accounting for redeemable preferred stock and disinterestedness derivatives, the FASB has decided to utilise the projection to make conceptual changes to minority involvement and require separate accounting for elements of sure debt instruments, delaying projection completion.
The changes I take discussed in my testimony should allow the FASB fourth dimension to address important issues as they arise, and eliminate the demand to refer wide problems to AcSEC and the EITF, so they can focus on developing manufacture and interpretative guidance, respectively, as they were designed to do.
Conclusions
In summary, let me reiterate that we have the deepest and most liquid capital markets in the world largely because of the loftier quality of our financial reporting system. While information technology is imperative that the issues of standard-setting timeliness, transparency, and simplification of accounting standards be addressed, we should non abandon the arrangement that has allowed us to accomplish what we have to date. Instead let united states of america have the opportunity to make cardinal changes to standard setting and SEC oversight.
Endnotes
ane In a Grade 8-K dated Nov viii, 2001, Enron Corporation stated that it would restate its fiscal statements for the years ended December 31, 1997 through 2000 and quarters ended March 31 and June 30 2001 because it did not follow GAAP. On Dec 2, 2001 Enron filed for bankruptcy.
2 Run across, due east.g., department 19(a) of the Securities Act of 1933, 15USC 77s(a), and section xiii(b)(1) of the Securities Exchange Act of 1934, 15 USC 78m(b)(1).
iii Bookkeeping Series Release (ASR) No. 4 (April 1938) and ASR No. 150 (Dec 1972).
http://www.sec.gov/news/testimony/021402tsrkh.htm
Source: https://www.sec.gov/news/testimony/021402tsrkh.htm
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