(Note to readers — I have deleted the reference to Worldcom in a previous version of this post. A dialogue with one reader caused me to re-consider my statement that account roll forwards could have saved an audit process that was deeply flawed in a great many respects. )
Now that I’m back from an exhausting week of summer vacation (rode across Iowa on my bike – see www.ragbrai.org), it’s time to catch up on blogging. This post is probably the first of two on the same subject. After that, I’m going to weigh in one more time on the AICPA’s FRF for SMEs; and then I think I’ll discuss the recent appointment of James Kroeker to the FASB.
As for today’s topic, two speeches concerning the FASB’s disclosure framework project came to my attention since I wrote about it last month:
- On December 3, 2012, the acting and now permanent SEC chief accountant Paul Beswick announced that the staff would organize a roundtable to discuss disclosure issues “in the coming months.” As a native English speaker, it seems to me that the time for the roundtable has come and gone. But, since Mr. Beswick is new at his job, let’s cut him some slack and pretending that he’s just running about nine months behind schedule. The other likely scenario is less pleasant to contemplate: that he was ‘persuaded’ to dial back his enthusiasm, and to make way for the FASB to go through its merry motions – even though it’s quite obvious that the disclosure framework topic should be right in the SEC’s wheelhouse.
- On June 27th of this year, IASB chair Hans Hoogervorst gave a speech entitled “Breaking the Boilerplate” in which he announced that the IASB would soon undertake its very own disclosure framework project to replace IAS 1 (presentation), IAS 7 (cash flows) and IAS 8 (accounting policies). I’m ecstatic that the IASB is going it alone, rather than gumming up with works in the U.S. with a joint project. As an indication of the problems that would have caused, Mr. Hoogervorst provided ten mostly ludicrous suggestions for improving disclosures, which it seems would form the basis of the IASB’s framework. More on that in my next post.
As for Mr. Beswick, his remarks weren’t especially inspiring, either. Nearly all of his words were wasted on an admittedly superficial but also entirely gratuitous recitation of the history of the MD&A requirements presently set forth in Regulation S-K and in various interpretive releases issued by the Commission over the past two decades. By his logic came the following questions he would like to see addressed at the roundtable (that should have already been, and may not ever happen):
“…We plan initially to focus on  whether this issue should be further explored (including, for example, whether there any perceived disclosure gaps today), and  what are the critical decision points regarding this issue of the dividing line between what should appear in financial statements versus the broader financial reporting package…” [Numbers in brackets added]
For someone who clearly wants us to know that he is a certified accounting wonk, his vision for the roundtable is awfully shallow: whether there is a problem that needs to be fixed; and which disclosure should be in the notes covered by the auditor’s report.
I know little about Mr. Beswick’s background and qualifications to be chief accountant, other than that he was a good soldier under good soldier James Kroeker. For playing his part in the 10-year long IFRS adoption charade, Mr. Beswick got a promotion. Yet, despite the fact that he knows how to play dumb he must surely realize that the pertinent disclosure history lessons are to be found the lengthy list of enforcement actions beginning in the 1990’s against some very significant companies like Caterpillar, Sony and America West Airlines [SEC AAER No. 561, which I can’t find online].
In a nutshell, despite the principles-based requirements and pointed interpretive releases from the Commission, these companies and many others were caught attempting to cover up their problems with incomplete and misleading narrative discussions of trends, events and uncertainties. (Of course, not a single one of the companies found by the Commission to have violated the MD&A rules ever admitted their liability or were determined to be liable in a legal proceeding.) Years after that spate of enforcement, an extensive 2003 staff analysis based on reviews of the filings of the Fortune 500 reported that the most frequent area of deficiency in financial reporting was still MD&A.
Unless a miracle has since occurred, getting companies to comply with narrative disclosure requirements has been an effort that has had dubious success. The pertinent history clearly indicates that it would be a mistake to expect that new rules or principles will enhance the quality of narrative disclosures, no matter where they are located in the filing. (Location of a narrative disclosure in a filing may be important to an auditor for the sake of exposure to liability, but I doubt if anyone else actually gives two hoots.)
Any disclosure framework, in order to be useful to investors for the many ways that they use financial reports, must comprehend the entirety of a public filing. Even though the FASB seems to want to have the disclosure framework for itself (and to needlessly restrict its scope), there is no getting around the fact that the FASB’s participation should be just one part of a project led by the SEC.
In that spirit, I want to suggest to Mr. Beswick a roundtable agenda that could actually advance investor interests.
As Louis D. Brandeis famously stated, “Sunlight is said to be the best of disinfectants…” Financial statement disclosures can, and should, contribute a whole bunch of lumens, but that’s mainly because the brightest beams of light are quantitative and not merely narrative.
Any SEC staff reviewer can tell Mr. Beswick that the foundation for discussion in MD&A of past trends and events are the numbers reported in the financial statements and accompanying notes. I would simply propose to discuss what could happen to narrative disclosures if the quantitative foundation upon which narrative disclosures are built is broadened; ultimately, to include detailed reconciliations of all balance sheet categories. We already have two such reconciliations: the statement of cash flows as set forth in GAAP, and the reconciliation of stockholders’ equity as set forth in Rule 3-04 of Regulation S-X. So, why can’t there be more?
To an intelligent person who truly has investor interests at heart, the case for reconciliations is painfully obvious, and the excuses from issuers about the costs of providing them are pure dross. In a brief fit of idealism, comprehensive reconciliations was even jointly proposed by the IASB and FASB in their financial statement presentation project, which has been buried for reasons we can only imagine.
The SEC roundtable should not be asking whether reconciliations, but why not reconciliations:
- I have argued in the past that XBRL adds capabilities to information processing that would make reconciliations even more valuable, and that S-OX essentially mandates that reconciliations (accountants often call them roll forwards) of accounts are a seemingly integral part of ICFR.
- If roll forwards were provided in sufficient detail in the notes, auditors would be more compelled to test them. Thanks to double-entry accounting, financial statement fraud is like squeezing a balloon filled with water: fraud that would squeeze the balloon to make the trend in one account look normal has to pop up somewhere else; one only needs to look close enough for the bulge. Even better, if the auditors misses seeing the bulge, some enterprising analyst is likely to show it to them after the fact.
But if all of those considerations were not enough to at least discuss the issue, then Mr. Beswick should put himself in the shoes of a staff accountant in the Division of Corporation Finance. Imagine how easy it would be to enforce compliance with the narrative elements of MD&A if a staff reviewer could see the significant trends to the components of each balance sheet line item for herself!
To me, all of the above are no-brainers. The really interesting discussion at a roundtable would occur when we consider how adding quantitative disclosures in the form of reconciliations can reduce the need for narrative in the notes to the financial statements. This is important for at least two reasons. First, auditors are better at examining numbers instead of words. Second, words invite obfuscation through boilerplate; but numbers defeat boilerplate.**
* * * * *
Will, after months of silence on the subject, there eventually be a disclosure roundtable?
Methinks not, for the right answers — as opposed to the answers the FASB is ginning up — will be too hard to ignore.
*Looking ahead to the case of Mr. Kroeker, I can give you a pretty good indication of my thinking by asking you to ponder just one question: What, during his numerous years in a position of leadership (circa 2007 – July 2012) did this person actually accomplish (or maybe just do) to merit appointment to the FASB? If someone can provide actual examples (the excuse that he was merely a tool of the SEC chair is not acceptable) please send them to me, and I’ll include them in my post.
**While I may not have the time to write an in-depth critique of Mr. Hoogervorst’s remarks, this sentence is the essence of my suggestion to him as well. To reduce the boilerplate disclosures that are the focus of his ire, the IASB could replace existing many existing narrative disclosure requirements with numbers.