Peeling away financial reporting issues one layer at a time

Disclosure Framework Dysfunction

It recently occurred to me that the ongoing Disclosure Framework project and the comatose Financial Statement Presentation project have three things in common:

  1. Neither current disclosure nor presentation standards promote high quality financial reporting (perhaps one of the few things the Board and I lately agree on); YET
  2. There is an abundance of simple, principled and highly effective solutions from which the FASB could choose; BUT
  3. Nothing will change.

The FASB’s stated objectives for undertaking the Disclosure Framework project are, as has become typical, expressed so blandly that it is difficult to argue against them ex ante.  Who can be against “improving” any aspect of financial reporting?  But history tells us that much more often than not, despite a decade and more of machinating, the actual “improvements” don’t nearly justify the time and effort; yet a modicum of closure to a project guarantees that the topic will remain taboo among Board members for at least a generation.

To be fair, however, the FASB does on occasion venture to accomplish something significant. For example, a bare majority of members momentarily proffered, until all hell broke loose at the Financial Accounting Foundation, that loans should be measured at fair value.  They also have tried to make revenue recognition principles follow an asset/liability approach, just like expenses; and complex lease terms should be fully reflected as assets and liabilities.  But, decade’s worth of machinating have whittled down each one of those projects to veritable stumps.

With respect to the Disclosure Framework project, it appears that the FASB has taken those recent beatdowns to heart; the “improvement” bar is set about six inches off the ground:

“Consideration of the appropriate content of notes to financial statements starts with considerations of their intended purposes [so far, so good], which is derived from the purpose of financial reporting in general.  The objective of financial reporting is to provide financial information that is useful for making investment and credit decisions.” [DP para. 1.9, footnote omitted].

The DP and Statement of Financial Accounting Concepts No. 8, from which this ridiculous premise is taken, wax eloquently on the lessons learned from a sophomore-level finance course about future prospects being what equity investment and credit decisions are all about.  But anyone familiar with SEC rules and regulations must know this is not what financial reporting is all about.

Let’s start with two incontrovertible facts.  First, the FASB owes its status as the U.S. GAAP standard setter to the SEC’s patronage.  Second, the SEC’s activities in serving the public for which financial reporting is an integral part extends far beyond merely “providing information…”  The SEC doesn’t have a conceptual framework, but it does have a website:

“The mission of the U.S. Securities and Exchange Commission is to protect investors, maintain fair, orderly, and efficient markets, and facilitate capital formation.” [emphasis added]

For example, financial reporting has a firmly entrenched role in corporate governance.  Taking a cue from the Securities Exchange Act of 1934, the SEC quickly recognized that financial statements were essential for shareholders to have in their possession before any vote to elect directors, and for various other matters – most recently, shareholder approval of executive pay.

It is also clear from the SEC’s policy statements and activities that an integral part of its investor protection role is discouraging issuers from making misleading statements and issuing false financial statements; hence, financial reporting control, note disclosure and MD&A requirements have served as an integral part of a regulatory control system designed to do much more than merely inform.

Evasion versus Simple Solutions

As I have stated on more than one occasion, the cure to any and all current limitations of note disclosures, be they rooted in excess bloat or too little information, is extremely simple:  for every balance sheet account, the FASB should require a reconciliation of the beginning and ending balance.  

For whatever purpose financial statements are being used, they are part of a process of trying to learn what has happened, and why it happened.  That’s not just me saying that, but it is also the explicit message in the SEC’s Financial Reporting Release No. 72.  That makes it law, and it’s also common sense.

Imagine a disclosure framework whose core principle is that the beginning and ending balances of each balance sheet account should be reconciled (just as the SEC already requires a reconciliation of equity accounts [see Regulation S-X, Rule 3-04]) along with XBRL data analysis tools. Service providers would be competing fiercely against each other to create the very best ‘out of the box’ analytics derived from the financial statements plus the quantitative reconciliations.  Given the stringent requirements already in place for MD&A, this would make many of the narrative disclosures that are now required in the notes, and that engender so much gibberish and boilerplate, useless and redundant.

Now, wake up to the reality that the existence of XBRL and its potential to “improve” disclosures is not even acknowledged by the FASB in its DP.  Nor are account reconciliations, save for one example of how they can be shortened under a new and “improved” disclosure framework.

Imagine that.

Commence Evasive Actions

Managers despise the clarity and transparency of reconciliations, and auditors even more so.

The subject won’t even be broached during the Disclosure Framework project, because the corporate oligarchs that appoint board members through their control of the Financial Accounting Foundation must continue to wield the awesome power to make value-destroying choices — if only for the sake of the accounting results that feed into their compensation schemes.

As for the auditors, even though S-OX essentially requires that these reconciliations must reside somewhere in each issuers’ system of financial reporting controls, they could not abide the prospect of providing each and every investor with the opportunity to perform its own ‘analytical review’ from which its own “independent” conclusions could be second-guessed.

Do you remember when Tiger Woods was penalized for a violation that he failed to self-report, but one nerdy television viewer called him out on? Balance sheet account reconciliations would make financial statements like the high-definition cameras with telescopic lenses used at the Masters, except 1000 times worse – or better, if you are one of those investors that the FASB is supposed to serve.

* * * * * *

The Disclosure Framework project is an elaborate hoax.  The FASB seems to think that by putting blinders on itself it can get away with fooling the public into believing that their accounting standards play no role in corporate governance, and that XBRL does not exist. The irony is that the oligarchs who pull the strings and who exemplify the economic axiom that “more is [always] preferred to less” want everyone else to believe that “less is more” when it comes down to examining their own accountability.

If SEC chair Mary Jo White truly has investor protection as her top priority, then she should tell the FASB to reboot the Disclosure Framework project under a premise that is consistent with the SEC’s view of the role of financial reporting in the 21st century.


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