Harmonization and Financial Reporting - Coursework Example

Running Head: Harmonisation and Financial Reporting Harmonization and Financial Reporting f the f the Harmonization and Financial Reporting Worried about ever-expanding financial reporting requirements Well, you can relax--a little. The long ball hit by the American Institute f Certified Public Accountants (AICPA) in late 1994 in the form f its far-reaching proposal for a new financial reporting model appears to be dropping inside the fence. It was not, after all, a game-ending home run. As a result, financial executives won't face the most sweeping expansion f financial reporting requirements since 1933. Instead, the long-running contest between preparers f financial statements, who almost universally want to streamline disclosure, and the auditors and regulators, who have pushed for expanded standards piece by excruciating piece, appears certain to go. That seemed far from a sure thing last spring, w. hen the Financial Accounting Standards Board (FASB) solicited comments on the AICPA's new "comprehensive "model f business reporting" and so endowed it with a faint whiff f reality. The timing seemed right. At the Securities and Exchange Commission (SEC), commissioner Steven M.H. Wallman was already lending tacit support to the concept by publishing articles and hosting conferences on his own ideas for an expanded system that would include improved disclosure f intangible assets. Meanwhile, SEC chairman Arthur Levitt had just successfully lobbied the Financial Accounting Foundation (FAF) to give one f the seats held by the Financial Executives Institute (FEI) to a public-sector trustee. The FAF oversees FASB, f course, and what small voice preparers had in directing the views f FASB was further diminished. Finally, many preparers had concluded that FASB, as demonstrated by the onslaught f new standards it had issued in recent years, was hardly worried about complaints that financial executives were overburdened. And yet, like a baseball team that has just captured a wild-card ticket to the playoffs, the preparer community appears to have enjoyed a turn f luck. After reviewing the AICPA's arguments for a new reporting model and listening to comments from users and preparers f financial statements, both in written and oral testimony, FASB chairman Dennis Beresford has concluded that, for now anyway, it's just too much. "While it is dangerous to generalize about such letters and meetings," Beresford says, "my feeling is that most f our constituents aren't interested in wholesale changes to our current financial reporting system." And FASB, it seems, is not interested in tackling any major overhaul f the status quo. "My prediction," says Beresford, "is that FASB is going to be quite cautious about expanding its role beyond traditional financial statement matters." The Complicating Factors FASB has good reasons for tabling the issue. For one thing, Beresford's second five-year term expires in June, and many observers think the Board will be reluctant to take on any major new projects until a new chairman is installed. In addition, FASB's current agenda is jam-packed with such projects as derivatives disclosure, segment reporting, and comprehensive income. While FASB agreed to review the future f financial reporting as part f its first strategic plan, adopted last April, so far it has been reluctant to for-realize the creation f a new financial reporting model as a working project. And whatever decision is made about the future f reporting has to be made with an eye toward possible U.S. acceptance f new international accounting standards--which isn't expected for at least several more years. All in all, this is not what the AICPA had in mind when its Special Committee on Financial Reporting, chaired by Edmund Jenkins, issued its voluminous report a little over two years ago. The committee said then that current financial statements were no longer providing users with the information they needed to make smart credit and investment decisions, and were therefore becoming less relevant. If those problems were not addressed, the committee warned, nothing less than American competitiveness in a global economy might be at stake as U.S. companies came to be penalized for their reporting shortcomings through a higher cost f capital. "For the economy as a whole," explains Jenkins, "there's a cost f capital added to everything because there is something less than complete information available." To correct the problem, the AICPA recommended that financial statements be expanded to include both nonfinancial information, such as customer satisfaction ratings, and forward-looking information, which could include discussion f management's business strategies and any risks and opportunities it had identified. (Sobcry 1983, 2-4; Mueller 1997, 1-10) The response from the preparer community was both swift and pointed. "We thought it was much too broad," says Frank Borelli, senior vice president and chief financial officer f $4 billion Marsh & McLennan Cos. and FEI chairman. In a letter to Jenkins on behalf f the FEI's CFO Advisory Council in the New York metropolitan area, Borelli warned that mandated disclosure f nonfinancial performance data, for-ward-looking information, and detailed business segment results could saddle CFOs and their employers with shareholder lawsuits and competitive disadvantages, not to mention increased costs. Borelli's letter also voiced suspicion that the Jenkins Committee Report might have been designed more to drum up business for auditors than for the benefit f investors. (The report didn't recommend unilaterally that all parts f the model be subject to audit; rather, it suggested that auditors be involved with information contained in the model to the extent that companies and users deem it necessary.) "Our principal concern going into the special committee's work was not to expand our scope f auditor involvement, and we again did not make any specific recommendations that we do so," Jenkins says. Curiously, he then adds, "Rather, we had a concern that the principal product we were associated with--financial statements--seemed to be becoming a smaller and smaller piece f the totality f information investors were using to make decisions, and therefore our [auditors'] relevance and involvement in the whole capital-allocation process seemed to be diminished and threatened." Some Good Ideas Whatever the AICPA's motives in sponsoring the work f the Jenkins Committee, it is becoming increasingly clear that regulators aren't prepared to tackle anything so radical as the reporting model it has put forward. Not that this is surprising. For all the complaints from preparers about how much additional work FASB has saddled them with, the standard-setting body has always moved with deliberate (some call it unconscionably slow) speed in resolving even single-issue matters f accounting practice. Nothing in its history suggests that FASB would move quickly on something so broad as the comprehensive model. "Many people do believe that nonfinancial statement information can be very useful," Beresford says. "But most f those people would strongly oppose our requiring those disclosures or making them subject to standardized formats--at least at this time." (McGee 1984b, 1-10; Wolk 1997, 10-15) Yet, the ideas promulgated by the Jenkins Committee aren't entirely dead. Users, auditors, and even pre-parers f financial statements generally agree that nonfinancial performance measures and forward-looking information are important to making investment and credit decisions. When the accounting firm f Ernst & Young LLP surveyed 2,000 portfolio managers on the topic, for example, the 275 who responded said rather uniformly that they base about a third f their allocation decisions on nonfinancial measures, excluding the value f brand names. When brands are included in the equation, they said, nonfinancial measures account for two-thirds f their investment decisions. The problem with translating that appetite for information, worry preparers and even some auditors and users, is that it would probably be too difficult to issue standards that would meet the needs f all companies. Relevant information, they say, would vary tremendously from industry to industry and even from company to company. (Miller 1997, 3-6) "My bank might have a very fast response time when it comes to answering telephone calls from customers," notes Bob Wells, executive vice president and chief financial officer f Bank f Montreal, and one f the few CFOs to speak out in favor f expanding financial reports. "But if virtually all f my customers are doing their business in our branch offices, that statistic is not very relevant. On the other hand, if the majority f our customers' queries happen over the phone, it might be absolutely critical." Despite such problems, Bank f Montreal does try to give its investors more' information than is required by regulators in Canada or the United States (where the bank's shares also trade), providing, for example, a three-page discussion f the company's risk management practices in its latest annual report. If one were to mandate reporting f such nonfinancial measures, Wells says, the trick would be to do so only at a very high, broad level that would leave plenty f room for corporations to decide exactly what they were going to report and how. (Hendriksen 1992, 1-5) Even Jenkins himself could live with something like that. "I, for one, would be happy if, as a start, the standards were simply to say something like, 'Companies should disclose the most important nonfinancial measures they use internally to assess opportunities and risk for each segment f their business,'" says Jenkins, who is now retired from his job as partner in charge f professional standards at Arthur Andersen LLP. A Market Mentality Yet even that wording would be troubling to many CFOs because it would require that they report the same measures they use internally to manage their business, regardless f how that information could be used against them by their competitors. "Companies already make decisions about disclosure relative to their cost f capital and their competitiveness," says Lonnie Arnett, vice president and controller f Bethlehem Steel Corp. and one f only two pre-parers on the Jenkins Committee. Companies should retain that freedom, Arnett suggests. And the only way to do that, say many f his fellow preparers, is to let the market, not regulators, dictate which increases in financial reporting are necessary. (Sunder 1997, 5-6) "Companies realize that to drive down the cost f capital they need to do a better job f communicating their business case to the financial world, and they have done so," Arnett says. "If you look at what's happened over the past 10 years, you'll see companies issuing fact books, making more executive presentations, and generally providing more information about their businesses." (Goeltz 1991, 85-88) "If information is important and extremely useful to users f financial statements, it will be conveyed," agrees Michael Mathieson, vice president and controller for $4.5 billion Avon Products Inc. "If not, companies will pay the price in their cost f capital. So, I believe the market will prevail if allowed to do so. I don't know if in a regulatory environment the market would prevail in the same way." Fix What's Broken If FASB does leave decisions about reporting on nonfinancial and for-ward-looking information to the market, finance executives say, it might have more time to refine its existing standards. Good targets, they say, would be footnote disclosures for pension plans and other post-retirement benefits, and for income taxes and stock options. "Our reporting system over the years has become one in which every change has been additive," says Frank Gatti, vice president f financial management at The New York Times Co. Gatti, in fact, estimates that his own company could provide all f the footnote information investors really need about pensions on a fraction f a page, rather than the two full pages it takes now, if FASB would streamline its requirements. (Scott 1997, 15-16; Mautz 1989, 21-27) Elsewhere, says Gatti, ease f understanding doesn't translate into usefulness. There is, he says by way f example, little to be gained for any creditor or investor by knowing what the average price was for employee stock options exercised over the past three years. "My department never get questions on these types f things," agrees Avon's Mathieson, referring to the details he has to supply in footnotes on pensions and taxes. "Either we've done a great job explaining it, or it's just not that useful to users." Like many f his peers, Mathieson supports the idea f disclosing more relevant information (he values non-financial performance measures but is leery f imposing standards on the disclosure process), but thinks it pander to the lowest common denominator among financial statement users," he says. (Holthausen 1983, 77-117) The Future is Later For all the confusion over just where the future f financial reporting lies--and who will lead the way there--it would be a mistake to think that the status quo won't change. Regardless f what FASB decides to do about the Jenkins Committee Report (and Beresford has said that a decision on whether to pursue its recommendations should be made within the next few months), the standard-setting board already has a host f projects on its agenda that are scheduled to be resolved by the second quarter f 1997, including equally important that existing standards be streamlined to eliminate the overwhelming amount f information in pension and tax footnotes and much boilerplate language (such as that which says consolidated financial statements eliminate intercompany transactions). Not everybody buys that assessment, f course, and it is unlikely that users--at least the institutional investors and professional analysts who bother to make their views known to FASB and the SEC--will back many calls to eliminate existing information. The Jenkins Committee, for example, failed to recommend a single disclosure requirement for elimination. And Peter H. Knutson, associate professor emeritus f accounting at the Wharton School f the University f Pennsylvania, and principal author f the Association f Investment Management and Research's 1993 position paper entitled "Financial Reporting in the 1990s and Beyond," freely admits, "It would be a real sacrifice for any analyst to say he or she would give up information." Part f the problem is that one user's overly technical footnote is another's unique insight into a company's health. And, says Jack Ciesielski, publisher f The Analyst's Accounting Observer newsletter, some analysts are simply better equipped than others to use the information found in financial statements. "It would be a mistake to accounting for derivatives and hedging activities, and several projects related to accounting for business consolidations, including one entitled "Disaggregated Disclosures." The latter, which would require that public companies provide financial and descriptive information about their operating segments, addresses one f the proposals contained in the Jenkins Committee Report. In addition, FASB has other projects slated, without definitive timetables, that cover impairment issues, liabilities for closure or removal f long-lived assets, and stock compensation. Meanwhile, the SEC is pressing forward with its experiment on requiring more readable filings--so-called plain English documents. And both bodies are trying to figure out how to respond to pending international accounting standards. As for the Jenkins Committee Report, Borelli says he doesn't think it will just fade away. "But it's not so important that there's going to be a big rush to implement it. Some parts that make the most sense and will be helpful in improving disclosures will be extracted. [He cites recommendations for improved reporting on segment operations and key trends that affect a company's business.] But there will be a whole lot f other items that will go no place, because they're too controversial." The AICPA's recommendation on disclosing for-ward-looking information might be one f the latter, given that preparers are certain to vigorously oppose any requirements in that area until they can be assured they won't be subjected to frivolous lawsuits when their projections don't pan out. Although the Private Securities Litigation Reform Act f 1995 provides some safeguards against those types f suits, most financial executives have concluded that it doesn't provide the sort f protection they really need. In the meantime, Jerry Weygandt, Arthur Andersen Alumni Professor f Accounting at the University f Wisconsin, and chairman f the AICPA committee formed to follow up on the recommendations f the Jenkins Committee, suggests that until regulators are more comfortable with the ideas in the Jenkins report, it may be helpful to form a coalition f preparers, users, and standard-setters that could identify best practices already being employed and help to spread the word. "There are some large companies out there today that are doing a good job, and there are thousands and thousands f companies that could really use some information and some examples," says Weygandt, who also chaired the AICPA's "Business Reporting Symposium" last October. If history has any lesson in this matter, it is that as time goes by, finance executives will almost certainly find themselves preparing ever more information. The SEC's Wall-man, for one, doesn't think that's all bad. (Boettke 1994, 1-7; Cowen 1988, 10-11) "The long-term question," says Wallman, "is whether we want a world where much f the useful and reliable information people are seeking is going through channels that are not standardized, or one where there is a common language. We had a world where people provided whatever information they thought investors wanted, and it was called the world f pre-1933. In that world, a lot f companies issued stock and did quite well, and others issued stock and turned out to be frauds. "Over time, there was an outcry to standardize the system. We did, and created one f the best markets for raising capital the world has ever seen." References Boettke, Peter J. (Ed.) (1994). The Collapse f Development Planning. New York: New York University Press. Cowen, Tyler. (Ed.) (1988). The Theory s. f Market Failure: A Critical Examination. Fairfax, VA: George Mason University Press. FASB, IASC Finalize Earnings per Share (1997). Journal f Accountancy, March, 14-15. Financial Accounting Standards Board (1982). Determining Whether a Convertible Security Is a Common Stock Equivalent -- An Amendment f APB Opinion No. 15. Statement f Financial Accounting Standards No. 55. Stamford, CT: Financial Accounting Standards Board. Financial Accounting Standards Board (1997). Earnings per Share, Statement f Financial Accounting Standards No. 128, February. Norwalk, CT: Financial Accounting Standards Board. Goeltz, Richard Karl (1991). International Accounting Harmonization: The Impossible (and Unnecessary) Dream. Accounting Horizons, March, 85-88. Hendriksen, Eldon S. and Michael F. van Breda (1992). Accounting Theory, fifth edition. Burr Ridge, IL: Gavin. Holthausen, Robert W. and Richard W. Leftwich (1983). The Economic Consequences f Accounting Choice: Implications f Costly Contracting and Monitoring. Journal f Accounting and Economics, August, 77- 117. Mautz, R. David, Jr. and Thomas Jeffcry Hogan (1989). Earnings Per Share Reporting: Time for an Overhaul Accounting Horizons, September, 21-27, reprinted in Zeff-Dharan, Readings & Notes on Financial Accounting: Issues & Controversies, New York: McGraw-Hill, 1994. McGee, Robert W. (1984b). Accounting for Income Taxes. New York: National Association f Accountants (now the Institute f Management Accounting in Montvale, N J). Miller, Roger LeRoy (1997). Economics Today.' The Micro View. Reading, MA: AddisonWesley. Mueller, Gerhard G.; Helen Gemon and Gary K. Meek (1997). Accounting.' An International Perspective. Chicago: Richard D. Irwin. Scott, William R. (1997). Financial Accounting Theory. Upper Saddle River, N J: Prentice Hall. Sobcry, Julie S. (1983). An Empirical Evaluation f SPAS No. 55. Journal f Accounting Research, Autumn, 21:2, 623-628, reprinted in Zeff-Dharan: Readings & Notes on Financial Accounting.' Issues & Controversies. New York: McGraw-Hill, 1994. Software Accounting Policies on Bank Lending Decisions and Stock Price. New York: National Association f Accountants (now the Institute f Management Accounting in Montvale, N J). Sunder, Shyam (1997). Theory f Accounting and Control. Cincinnati: South-Western Publishing. Wolk, Harry I. and Michael G. Tearney (1997). Accounting Theory: A Conceptual and Institutional Approach. Cincinnati: SouthWestern Publishing Company. Read More