U.S. Securities & Exchange Commission
SEC Seal
Home | Previous Page
U.S. Securities and Exchange Commission

Speech by SEC Staff:
Charting a Course for
High Quality Financial Reporting

Remarks by

Lynn E. Turner

Chief Accountant
U.S. Securities & Exchange Commission

At the European FASB-SEC Financial Reporting Conference
Frankfurt, Germany

March 23, 2000

The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of Mr. Turner and do not necessarily reflect the views of the Commission, the Commissioners, or other members of the Commission's staff.

I want to thank Professor Guenther Gebhardt for graciously hosting this conference again this year. This conference provides a venue to continue our dialog on accounting and auditing issues. Through our discussions, we can identify methods to maintain and enhance high quality financial reporting worldwide. In this way, our efforts today and tomorrow can benefit investors worldwide.

At the outset, I must inform you that the Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views that I express are my own and do not necessarily reflect the views of the Commission or of other members of the Commission's staff.

We are living in very dynamic times – the pace of technological change is without precedent. Market capitalization and trading volumes are setting new records. Just last Thursday, the New York Stock Exchange set two records. It recorded the largest single-day point gain in history. And trading volume reached an all-time high. Record numbers of people are becoming investors, and the increase in wealth is having a dramatic impact on our economy. We're seeing evidence of these dramatic increases in securities prices affecting the broader economy. A recent report by the Federal Reserve stated that Americans' investment in stock increased from $10.57 trillion at the end of 1998 to $13.33 trillion at the end of 1999. According to the report, almost one-third of household wealth is in stocks.

Some may say that this prosperity means that we have done our jobs well. We can all relax. While I think that we are doing a good job for the most part, we must be careful. A recent news account signaled what should be an alarm – because consumers have a large portion of their wealth in stocks, a market correction could have a significant impact on consumer behavior. So now is a good time to take a careful look at what we can do to assure that investors are protected in both good times and bad times.

In the United States, we use a market-oriented approach to securities regulation. The Securities and Exchange Commission ("SEC") does not regulate by passing on the merits of securities offerings. Rather, SEC regulation aims to maintain fair and orderly markets and to protect investors by requiring securities issuers to make full and fair disclosure of all material information, so that investors have a basis for making informed decisions. We also look to the private sector for guidance in setting accounting standards. The Financial Accounting Standards Board ("FASB") plays a prominent role in developing accounting principles. And other private sector organizations, including the Public Oversight Board ("POB"), the Auditing Standards Board ("ASB"), the Independence Standards Board ("ISB"), and the American Institute of Certified Public Accountants' ("AICPA") SEC Practice Section ("SECPS"), all play important roles in developing and monitoring the auditing environment to assure that audits are of high quality. Indeed, all of these organizations must function effectively for investors to receive financial statements that are of high quality for every company, each fiscal period.

This afternoon, I want to talk to you about the principles that I think contribute to high quality financial reporting and opportunities to enhance our reporting environment as we begin the new millennium.

Transparency – So Investors Can Chart a Voyage

Let me begin by discussing one fundamental problem that all investors face. Every investor confronts two questions when making an investment decision – what return can I expect to receive from this investment, and how risky is this investment? Investors like higher returns, but don't like risk. By reducing an investor's risk, a company can attract capital at a lower cost. But business is fundamentally risky. So how can risk be reduced for an investor? One approach is to create different types of investment securities – debt, preferred stock, and common stock, for example. But these securities don't eliminate business risk – they just reallocate it.

When evaluating business risk and expected return, investors confront another type of risk – risk of the unknown. In the business world, risk of the unknown arises when an investor is not able to assess business risk or expected return, or both, with confidence. This risk is very real. Just as sailors approach uncharted waters cautiously, investors proceed with caution by demanding higher returns. In much the same way that charts aid sailors, financial statements aid investors by reducing risk of the unknown.

Recently, I had the opportunity to visit the U.S. Library of Congress. It's a magnificent library and it is only a few blocks from my office. The library had an exhibit that included some books with great historical significance to the United States. One of the books was an updated edition of Ptolemy's geography book. This edition was updated in the sixteenth century to include a newly discovered land – America! The map was not very precise, however. Indeed, I don't think that any sailor today would want to rely on that map at all. But it got me thinking – what makes one map better than another? What features would a sailor look for in choosing a map? And how would a mapmaker go about making a map that a sailor could rely on?

Well, if I were a sailor, the first thing I'd look for is a map that shows the waters and the coastline where I planned to sail. That is, the map has to be relevant. Then I'd want a map that presents the information accurately. It has to faithfully represent the coastline. The distances shown must be reliable. You might think – well, just take a picture from a satellite. But that's not good enough. The surface of the water would obscure the features of the ocean's floor. I would want information about what's under the surface of the water too. That is, I would want a transparent view to allow me to see under the surface to the details below. Then I could chart my trip knowing the nature and the location of the shoals, the reefs, and other features that would pose risks to my voyage.

As an investor, I want a financial statement – a map, if you will – that has the same characteristics. It must be relevant. It must be reliable. And it must have transparency – that is, it must permit me to see clearly what's under the surface and what risks I might face.

Just like a sailor's map, the financial statement can't tell the future. But it can document past travels, and offer me information about what lies ahead. Of course, we know that no map can tell a sailor the weather or how the changing environment will affect the journey. But a high quality map is an important tool, to be used in conjunction with other tools. When used by a skilled sailor, they permit a sailor to reach a safe harbor at the end of the journey.

High quality, transparent financial statements facilitate investing in the same way that maps facilitate sailing – by clarifying the environment and therefore reducing risk of the unknown. In my travels when I go fly-fishing, I've found that good maps make a big difference. In the United States, we've found that investors are willing to reduce the price they charge to bear business risks if they can chart them.

Characteristics of High Quality Financial Reporting

I want to comment for the next few minutes on several of the criteria that are critical for producing high quality, transparent financial statements. These criteria include:

  • Relevance
  • Reliability
  • Representational faithfulness
  • Verifiability
  • Neutrality
  • Comparability and consistency
  • Operationality

Let me describe each of these criteria:


A high quality accounting standard requires relevant accounting information. The information is relevant if investors can use it when they make investment decisions. The information should permit investors to evaluate past performance and to predict future performance. The information should also enable investors to estimate the risk of an investment.


High quality financial statements must convey reliable information. Information is reliable to the extent that investors can depend on it to represent the economic conditions or events that it purports to represent. Reliable information has three ingredients: representational faithfulness, verifiability, and neutrality.

Representational Faithfulness

High quality financial statements should reflect the real economics of the transaction being reported. In the U.S., we refer to this concept as representational faithfulness. A map's representational faithfulness may be determined by how well the map describes the coastline. In the same way, a financial statement's representational faithfulness may be evaluated by how well it represents the economic resources and obligations of the company, and by how well the transactions and events that change those resources and obligations are described. For example, suppose that a company reflects future costs in its income statement by setting up reserves in a profitable year and then reducing those reserves in a bad year when the costs are actually incurred. Investors are unable to see the real economic results of the business. Accounting standards that permit this practice lack high quality because they don't exhibit representational faithfulness.


Verifiability means the degree to which different people, when asked to measure something using the same approach, arrive at the same amount. Cash held by a company will possess a high degree of verifiability if several people can count the cash and arrive at the same amount.


Information should be free from bias towards a predetermined result. This quality is referred to as neutrality. For example, in determining income for a period, high quality financial reporting should not bias income to be a high amount or a low amount. Instead, high quality accounting standards should lead to reporting an amount that reports economic activity as faithfully as possible.

Comparability and Consistency

Information about a particular company is more useful if an investor can compare it with similar information about other companies with similar information about the same company for some other time period. The purpose of comparison is to detect and explain both similarities and differences. High quality accounting requires accounting for similar transactions and circumstances similarly and accounting for different transactions and circumstances differently.

These criteria are important to consider when financial accounting standards are being evaluated. Based on my experiences as an audit partner for a Big 5 public accounting firm, as a chief financial officer for a high-tech manufacturing company, and now as the Chief Accountant at the SEC, I would add one more – operationality.


High quality accounting standards must be practical and operational. That is, we must be able to apply accounting standards in the real world. The "litmus test" I would apply to any accounting standard is whether the standard is operational at all levels: from the CFO, controller and accounting staff who have to implement the standards in practice; to the auditors who have to give an opinion on whether the company has correctly applied the standards; to enforcement bodies such as the SEC and similar securities regulators around the globe, who have to review financial filings and judge whether such filings follow the standard.

The need for accounting standards to be practical in application applies across all industries, so that the CFO of a bank, the controller of airline, and the front-line accountant at a retailer all could understand and apply the accounting standard in a correct and consistent manner.

Let's look at how the FASB treated the issue of practicality in its report titled, International Accounting Standard Setting: A Vision for the Future. This report described the importance of two goals for the FASB: helping to assist the process of the development of the highest quality accounting standards possible in the international arena, and to assist in the process of convergence.

One thing noted as particularly important in the FASB's report was that:

Accounting standards that specifically allow alternatives are counterproductive in meeting the goal of enhancing comparability Explicit accounting alternatives create noncomparability. Financial statement users who try to adjust for noncomparability have varying degrees of success. Implicit accounting alternatives that result from accounting standards that have imprecise or ambiguous requirements or that provide inadequate guidance are even more troublesome. Financial statement users cannot even attempt to adjust for noncomparability of which they are unaware.

And the report went on to stress the importance of unambiguous standards.

Accounting standards cannot help to meet the objectives of financial reporting if those standards are not understandable. An accounting standard should not be subject to multiple interpretations or to avoidance through misunderstanding or misinterpretation. A so-called "cookbook" full of "bright line" rules may in some instances be counterproductive.

I wholeheartedly concur with the Report's summary, which stated:

Vague, imprecise, or cursory language inevitably produces implicit accounting alternatives . Clarity is particularly critical for international accounting standards, which must overcome language and cultural barriers to be applied in many different countries.

At the SEC, we embarked on a "plain English" initiative. And of course, I do not mean to be parochial here, the point is that in whatever country and whatever language a standard is written, it should be written in plain, straightforward language that should be understandable by those who read it.

The above criteria are important as they form a model for the determination of high quality financial reporting. Such a model is beneficial in two ways. First, as described in a concept release issued by the Commission on February 16, the SEC staff is considering the quality of International Accounting Standards. The criteria and model that I just described will provide a useful tool in measuring the quality of each of the standards. I might note that the model is useful in assessing the standards we develop in the United States as well. Second, we frequently receive requests from foreign registrants related to application or implementation of both U.S. and International Accounting Standards. When such questions arise, we consider the standard itself, and when existing guidance is not clear, we also give careful consideration to the criteria that form the foundation of high quality financial reporting.

So what does it take to produce high quality financial statements? It takes accounting standards that produce relevant, reliable information. The accounting information must possess representational faithfulness, verifiability, and neutrality. Investors must be able to compare performance or financial condition across firms or over time. But it's not enough that the standards work "in theory" – they must work in practice. Only then will investors be able to read the "map" and understand the geography – that is, to look at the financial statements and see the company's financial condition. When financial statements are as transparent as a map, investors will be able to chart their investing course with confidence.

The Auditor's Role

Once you have high quality accounting standards that can be readily applied in practice, you need an auditing profession that is independent and qualified. In its International Concept Release, the Commission noted the importance of auditor independence in giving investors, creditors, and others who rely on financial reporting enough confidence in the numbers to trust and participate in efficient capital markets. In that release, the Commission also identified a number of issues related to ensuring the implementation of the International Accounting Standards and the quality of audits including:

  • an effective, independent and high quality accounting and auditing standards setter;

  • high quality auditing standards;

  • audit firms with effective quality controls worldwide;

  • profession-wide quality assurance; and

  • active regulatory oversight.

I think that it is also time to re-examine the self-regulatory structure for auditing in the global marketplace. In the U.S., such a review has not taken place in over twenty-five years. I have been quite interested in the United Kingdom's new framework of independent regulation for the accountancy profession. This model appears to be quite innovative. A copy of that framework is available on the UK Department of Trade and Industry's web site. The URL is www.dti.gov.uk/cld/framework.

Key components of that framework include:

  • A newly formed independent foundation which will have a Review Board, Auditing Practices Board ("APB"), Ethics Standards Board ("ESB"), and Investigation and Discipline Board reporting to it. The role of the foundation is to safeguard the independence of its various boards and to ensure that the system is providing an effective way of representing the public interest in relation to the setting of standards, discipline, and the regulatory responsibilities of the bodies.

  • The foundation members are from institutions and representative bodies who have an interest in the accounting profession.

  • The Review Board, which is empowered to investigate; the APB, which sets auditing standards; and the ESB, which will set ethical guidelines; all have a majority of their membership independent of the accounting profession.

I suggest that this is a useful framework that should receive careful consideration by all of us who participate in and regulate the global capital markets.


Our common interests – to protect investors without impeding the proper functioning of capital markets – bring us together today. I want to thank Professor Gunther Gebhardt and all of the others who have made this conference possible. I hope that our discussions today and tomorrow will enhance high quality transparent financial reporting practices globally. Investors everywhere will benefit.

Thank you.


Modified: 03/24/2000