Proposals Adopted At SEC CIFR Meeting
January 11, 2008
FEI Summary
The numbering of proposals shown below conforms to that shown in the Draft Decision Memo (DDM) of the U.S. Securities and Exchange Commission (SEC) Advisory Committee on Improvements to Financial Reporting (CIFR), dated January 11, 2008.
The proposals, formally described as “developed proposals’ in CIFR’s DDM, were adopted unanimously by CIFR at its meeting on January 11, except for proposal 5.1 for mandating XBRL, on which there was one dissenting vote.
Chapter 1: Introduction
- The introductory chapter contained a definition of complexity that was not formally voted on by the committee, but used as a working definition, and other background materials.
- The remaining chapters related to CIFR’s four subcommittees, and their respective proposals.
Chapter 2: Substantive Complexity
2.1: GAAP should be based on activities, rather than industries.
o Any new projects undertaken separately by the FASB or IASB should be scoped on the basis of activities rather than industries.
o Any new joint projects between the FASB and the IASB should be scoped on the basis of activities rather than industries, and should include the elimination of existing industry-specific guidance in relevant areas as a specific objective of those projects, unless in rare circumstances, retaining such guidance can be justified.
o In conjunction with its current codification effort, the FASB should add a project to its agenda to remove or minimize existing industry-specific guidance that conflicts with generalized GAAP prior to achieving full convergence.
2.2: GAAP should be based on a presumption that formally promulgated alternative accounting policies should not exist.
o Any new projects undertaken separately by the FASB or IASB should not provide additional optionality, unless in rare circumstances, it can be justified.
o Any new joint projects between the FASB and the IASB should not provide additional optionality, but should include the elimination of existing alternative accounting policies in relevant areas as a specific objective of those projects, unless in rare circumstances, the optionality can be justified.
Chapter 3: Standard-setting process
3.1: Additional user/investor involvement in the standard-setting process is central to improving financial reporting. Only if user/investor perspectives are properly considered will the output of the financial reporting process meet the needs of those for which it is primarily intended to serve. The SEC should formally encourage the following improvements:
o Additional users/investors should be added to the FAF to ensure that additional views of users/investors are brought to bear in the governance process.
o Experienced users/investors who regularly use financial statements to make investment decisions should be better represented on both the FASB Board and its staff to ensure that the standard-setting process and the process of issuing interpretive implementation guidance better consider the usefulness of the resulting information.
o As more fully described in developed proposal 3.4, consideration of user/investor views in the agenda-setting process should be increased as part of a formal Agenda Advisory Group.
o The FASB should solicit comments from a diverse panel of experienced users/investors on whether the proposed changes improve the current approach prior to exposing new accounting standards or interpretive implementation guidance for public comment.
o The FASB should consider other measures designed to ensure that the user/investor perspective is given preeminence when balancing the perspectives of constituents during the standard-setting process.
3.2: The SEC should assist the FAF in enhancing its governance over the FASB, as follows:
- By formally supporting the FAF’s proposals outlined in the “Request for Comments on Proposed Changes to Oversight, Structure and Operations of the FAF, FASB and GASB”, particularly the decision to end the constituent-based approach to selecting trustees.
- By encouraging the FAF to amend the FASB’s mission statement, stated objectives or precepts to highlight that an additional goal should be to minimize avoidable complexity
- By encouraging the FAF to consider developing performance metrics to monitor the FASB’s compliance against its stated goals over time.
3.3: The SEC should formally encourage the FASB to further refine its standard-setting process by performing the following:
- Creating a formal Agenda Advisory Group that includes strong representation from users/investors, the SEC and the PCAOB to actively recommend priorities for managing standard-setting priorities in the U.S.
- Improving its procedures for field testing, field visits and cost-benefit analyses, by:
- Requiring that scalable field tests, field visits, and cost-benefit analyses be performed for new standards that would better leverage resources in the preparer, auditor, and user/investor communities; and
- Implementing certain cost-benefit process improvements.
3.4: The number of parties both formally and informally interpreting U.S. GAAP should be reduced. The SEC should coordinate with the FASB to clarify roles and responsibilities regarding the issuance of interpretive implementation guidance, which would further reduce uncertainty in the U.S. financial reporting community. Specifically, the following steps should be taken:
o The first phase of the FASB’s codification should be verified, issued and implemented in a timely manner.
o So that the benefits of the FASB’s codification efforts may be fully realized, the SEC should ensure that the literature it deems to be authoritative is able to be integrated into the FASB codification to the extent practicable, including through a re-codification of such literature if necessary.
o Going forward, there should be a single private-sector standard-setter for all authoritative accounting standards and interpretive implementation guidance applicable to a particular set of accounting standards (e.g., U.S. GAAP, IFRS). For U.S. GAAP, the FASB should continue to serve this function. The SEC and the FASB should also continue to be judicious when determining when to issue interpretive implementation guidance.
o In instances when the SEC identifies accounting matters that it believes may apply or should be applied broadly, the SEC should refer those items to the FASB as part of the formalization of the informal feedback loop that is currently in place.
o All other sources of interpretive implementation guidance should be considered non-authoritative and should not be given more credence than any other non-authoritative sources that are evaluated using well-reasoned, documented professional judgments applied in good faith.
3.5: The SEC should formally encourage an objectives-based approach to the way standards are designed and implemented, which would allow a reasonable amount of diversity in practice, as follows:
o By encouraging standard-setters to refine transition guidance in new standards to make clear that a reasonable amount of diversity may exist following initial adoption of standards, which may allow the SEC to regulate compliance with new standards without forcing restatements that may not be material to users/investors, so long as the basic principles in U.S. GAAP are followed, including the importance of promoting comparability amongst preparers. Such implementation and transition guidance would continue to have a stated, required implementation date, but should acknowledge that diversity in practice post-implementation will be monitored and addressed by the standard-setter in the form of post-adoption effectiveness reviews to maintain an appropriate amount of comparability.
o By encouraging post-adoption effectiveness reviews of new standards to be conducted by the standard-setter within a reasonable timeframe after adoption of new standards, as determined by the standard-setter based upon the scale of the standards themselves. By identifying diversity that develops during the review period that is perceived to undermine comparability, the standard-setters should take immediate action to reduce diversity through the standard-setting process, with appropriate transition provided to avoid restatements that may not be perceived as material to users/investors.
Chapter 4: Audit Process and Compliance
4.1: Materiality. The Commission or its staff should issue guidance reinforcing the following concepts:
o Those who evaluate the materiality of an error should make the decision based upon the perspective of a reasonable investor.
o Materiality should be judged based on how an error impacts the total mix of information available to a reasonable investor.
o Just as qualitative factors can lead to a conclusion that a quantitatively small error is material, qualitative factors also can lead to a conclusion that a quantitatively significant error may not be material. The evaluation of errors should be on a “sliding scale.”
The Commission should also direct its staff to conduct both education sessions internally and outreach efforts to auditors and financial statement preparers to raise awareness of these issues and to promote more consistent application of the concept of materiality.
4.2: Correction and Disclosure of an Error. The Commission or its staff should issue guidance on how to correct an error consistent with the principles outlined below:
o Prior period financial statements should only be restated for errors that are material to those prior periods.
o The determination of how to correct a material error should be based on the needs of current investors. For example, a material error that has no relevance to a current investor’s assessment of the annual financial statements would not require restatement of the annual financial statements in which the error occurred but may need to be disclosed and/or corrected in the current period.
o There may be no need for the filing of amendments to previously filed annual or interim reports to reflect restated financial statements if the next annual or interim period report is being filed in the near future and that report will contain all of the relevant information.
o Restatements of interim periods do not necessarily need to result in a restatement of an annual period.
o All errors, other than clearly insignificant errors, should be corrected no later than in the financial statements of the period in which the error is discovered.
o The current disclosure about the need for a restatement, during the period when the restatement is being prepared and about the restatement itself is not consistently adequate for the needs of investors and needs to be enhanced.
4.3: Errors related to interim periods. The Commission or its staff should develop and issue guidance on applying materiality to errors identified in prior interim periods and how to correct these errors. This guidance should reflect the following principles:
o Materiality in interim period financial statements must be assessed based on the perspective of the reasonable investor.
o When there is a material error in an interim period, the guidance on how to correct that error should be consistent with the principles outlined in developed proposal 4.2.
4.4: The Commission should issue a policy statement or adopt a safe harbor on a professional judgment framework consistent with the concepts outlined below [linked here]. The Commission should also encourage the PCAOB to consider similar action. Careful consideration should be made in implementing any framework to ensure that the framework does not limit the ability of auditors and regulators to ask appropriate questions regarding judgments and take actions to require correction of unreasonable judgments.
The proposed framework would be applicable to accounting related judgments, including the choice and application of accounting principles, as well as the estimates and evaluation of evidence related to the application of an accounting principle. The Committee believes that a framework that is consistent with the principles outlined in this framework to cover judgments made by auditors based on the application of PCAOB auditing standards is very important and would be beneficial to preparers, investors and auditors. Therefore, the Committee recommends that the PCAOB develop a professional judgment framework for the application of and evaluations of judgments made based upon PCAOB auditing standards.
Chapter 5: Delivering Financial Information
5.1: The SEC should mandate the filing of XBRL-tagged financial statements within a defined time frame after certain preconditions relating to successful taxonomy testing and capacity of reporting companies to file XBRL tagged financial statements using the new U.S. GAAP taxonomy on the SEC’s EDGAR system and for the EDGAR system to provide an accurate rendered version of all such tagged information. The SEC should phase-in XBRL tagged financial statements as follows:
o The largest 500 domestic public reporting companies based on unaffiliated market capitalization (public float) should be required to:
· Furnish to the SEC, as is the case with the voluntary program today, a document prepared separately from the reporting company’s financial statements filed as part of their periodic Exchange Act reports that contains the following:
· XBRL tagged face of the financial statements;29 [footnote 29: To allow this first phase, the SEC EDGAR system must permit submissions using the new U.S. GAAP taxonomies.] and
· Block tagged footnotes to the financial statements;30 [footnote 30: The Committee understands that tagging beyond the face of the financial statements and block tagging of footnotes, such as granular tagging of footnotes and non-financial data, may require significant effort and would involve a significant number of tags.]
o Domestic large accelerated filers (as defined in SEC rules, which would include the initial 500 domestic public reporting companies) should be added to the category of companies, beginning one year after the start of the first phase, required to furnish XBRL tagged financial statements to the SEC; and
o Once the preconditions noted above have been satisfied and the second phase-in period has been implemented, the SEC should evaluate whether and when to move from furnishing to the official filing of XBRL tagged financial statements for the domestic large accelerated filers, as well as the inclusion of all other reporting companies, as part of a company’s Exchange Act periodic reports.
5.2: The SEC should issue a new comprehensive interpretive release regarding the use of corporate websites for disclosures of corporate information addressing such issues as liability for information presented in a summary format, treatment of hyperlinked information from within or outside a company’s website, and clarification of the public availability of information disclosed on a reporting company website.
Prepared January 11, 2008 by Edith Orenstein, Director, Technical Policy Analysis, Financial Executives International (FEI). This summary does not reflect FEI opinion unless specifically noted above.