Peeling away financial reporting issues one layer at a time

Can the Devil in the Details of GAAP be Exorcised?

Rule complexity is not solely the province of accounting in the world of business.  Just trying to list the others–taxes, securities, labor, environmental, trade, etc.–boggles my mind.  But, I do know that accounting rules can, and should, be a lot simpler.  If you want evidence that the post-Enron resurrection of principles-based accounting has crashed and burned, see my earlier posts on EITF 07-3, and the latest revision to IAS 23.  Now, too, it appears that the SEC is once again trying to change the rules of engagement. 

On June 27th, the SEC announced the establishment of The SEC Advisory Committee on Improvements to Financial Reporting to "examine the U.S. financial reporting system with the goals of reducing unnecessary complexity and making information more useful and understandable for investors."

The SEC press release indicates that its new committee is charged with everything but the kitchen sink: how accounting standards are set, compliance with SEC accounting regulations, dissemination of financial information, internationalization, and the factors that drive complexity.  But, how to go about changing the current morass that is U.S. GAAP must surely be its focus. 

The Committee would do well to begin their deliberations with a discussion of the broad ranging implications of fair value accounting.  Two years ago, the CFA Institute published a monograph urging the adoption of a comprehensive fair value model for accounting standards. Walter Schuetze, former SEC Chief Accountant and perhaps the most vocal advocate for simplification and fair value accounting for at least the last 15 years (full disclosure: Walter was my boss when I was at the SEC), has echoed these sentiments in a letter to Robert Pozen, chair of the new committee.  I could not make the case for fair value accounting better than he has:

Why do I suggest fair value reporting for all assets and liabilities?  Because the result will be understood by retail and institutional investors and creditors, by boards of directors, by Congress, and by ordinary people on Main Street, which is not the case today.  Financial reports today may be said to be broadly incomprehensible.

Here is how I think the committee should proceed.  First, it should narrow its scope to recommendations for reforming extant U.S. GAAP.  Second, it should put to rest any notion that historic cost accounting–either the convoluted form we currently live with, or any other version (e.g., IFRS)–provides relevant information to modern investors.  Third, it should specify how they expect a full set of financial statements would be laid out under full fair value accounting (in particular, the geography of the income statement).  Fourth, it should provide the FASB with a rule-making road map toward full fair value accounting.

For its part, the SEC should, through its Office of the Chief Accountant, actively participate in discussions of fair value accounting.  It should also set a timetable for the FASB to implement (not re-deliberate) the recommendations of the advisory committee; and just to show that it means business, the SEC should declare immediately that cash flow statements prepared under the indirect method will no longer be acceptable in filings with the SEC. 

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