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U.S. Securities and Exchange Commission

Speech by SEC Staff:
Remarks before the 2010 AICPA National Conference on Current SEC and PCAOB Developments


Nilima Shah

Associate Chief Accountant, Office of the Chief Accountant
U.S. Securities and Exchange Commission

Washington, D.C.
December 6, 2010

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 the author and do not necessarily reflect the views of the Commission or of the author's colleagues upon the staff of the Commission.

I. Introduction

Good afternoon.

As many of you know, one of OCA’s most significant responsibilities is supporting the Commission in overseeing the accounting standard-setting process. This oversight involves several aspects, including monitoring whether the FASB is operating in the public interest, that its results are credible and the product of an independent and unbiased process, and that each standard adopted by the FASB is within an acceptable range of alternatives that serve the public interest and benefit investors. In addition, as part of the Commission’s membership of IOSCO, our office collaborates with regulators around the world to consider IASB exposure drafts and issue joint comment letters in response. In light of the tremendous level of standard setting in the past year, these efforts have become an even greater part of our daily activities. It is from this perspective that I’d like to share a few observations.

Over the past several years, I have developed a profound respect for the members of the FASB, the IASB, and their respective staff. These individuals seem to be subject to nearly constant criticism regarding their priorities, timing, constituent outreach, due process, and technical views in a number of very complex areas. Add to that the myriad pressures to which they are subject because of the importance of their results. With this backdrop, these individuals must do their jobs: issue standards designed to improve financial reporting for a diverse group of users, while considering the needs and concerns of preparers and auditors — standards which may be used in a variety of jurisdictions with differing levels of economic development and market sophistication, legal frameworks, and languages. Truly, the task is a challenging one.

In some respects, however, I believe that constituents may hold the Boards to unrealistic expectations and that they may be able to more meaningfully contribute to the financial reporting process. Said differently, I believe that improved compliance with and enforcement of both the letter and the spirit of accounting requirements would help the Boards more effectively pursue their mission and focus their efforts.

In this regard, when GAAP includes explicit guidance, it must be respected. However, when GAAP provides only minimum requirements or examples, or where it is silent, there is a need to better consider the spirit of financial reporting, the most basic premise of which is that its purpose “is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.”1 Doing so, I believe, may lessen the need for certain aspects of detailed standard setting.

II. Compliance with the Letter of the Standard

I’ll start by discussing compliance with the letter — that is, the explicit requirements — of accounting standards. The FASB’s project on disclosures of certain loss contingencies comes to mind as a recent example of compliance and its effect on the standard-setting process. This project has been ongoing for a number of years, but recent feedback has suggested that the concerns over inadequate loss contingency disclosures may be driven more by a lack of full compliance rather than insufficient guidance. In response, the Board recently agreed to defer further deliberation on this project in order to determine whether improved compliance with existing requirements would better meet user needs.

In reading through comment letters on the exposure draft, I have found feedback on the Board’s proposal regarding “range of loss” disclosures to be particularly interesting. As you may know, the exposure draft proposes, for all contingencies that are at least reasonably possible, disclosure of the possible loss or range of loss if it can be estimated, and if not, a statement that such an estimate cannot be made.2 Some commenters have expressed concern over this proposal, without, oddly, acknowledging that ASC Topic 450 currently requires very similar disclosure or commenting on how companies currently comply with the existing requirements.3 My colleagues in the Division of Corporation Finance have been working hard to improve the quality of loss contingency disclosures under existing requirements, as you will hear more about later today and tomorrow.

III. Compliance with the Spirit of Financial Reporting

The need to comply with the letter of the standard is, of course, a given — but I believe that we also may be able to contribute more to the financial reporting process, and thus alleviate some of the more unrealistic expectations of standard setters, by better following the spirit of existing guidance.

For example, there are a number of areas in which accounting standards provide minimum lists or examples, such as factors that may trigger impairment testing, lines to be presented in the financial statements, and information to be disclosed. These minimum lists or examples are not intended to be all-inclusive, yet practice sometimes appears to take that interpretation, resulting in the need for additional standard setting. The original requirements in FAS 132R provide an example of this point. FAS 132R originally required disclosure of a variety of information for a minimum of three pension plan asset categories and an “other” category. In addition, FAS 132R encouraged disclosure of additional asset categories if it would “be useful in understanding both the risks associated with each asset category and the overall expected long-term rate of return on assets.”4

Five years later, in 2008, the FASB issued FSP FAS 132R-1 (“FSP”). Not only had the Board’s research indicated that many employers did not provide information beyond the four required categories of plan assets, but users had indicated that disclosures pertaining to the four required categories were not sufficient to evaluate the nature and risks of plan assets because the “other” category had increased to a significant percentage of total plan assets.5 Accordingly, the FSP provides a principle for disclosure, provides a number of examples of plan asset categories, and eliminates the list of minimum plan asset categories required for disclosure.6 Although I prefer the revised approach of examples over minimum requirements (and I commend the IASB for reaching a similar decision in its recent re-deliberations on IAS 19), I question whether the FASB’s revisions would have even been necessary, had compliance with the spirit of the original standard been better.

IV. Compliance with the Spirit of Financial Reporting in the Absence of Standard Setting

Compliance with the spirit of financial reporting, I believe, is particularly important in the absence of standards. For example, in reading comment letters on the loss contingency disclosure exposure draft, I have observed some resistance to the proposal that the possibility of recoveries from insurance or other indemnification arrangements should not be a factor in determining the materiality of loss contingencies for which disclosure is required.7 However, even today, nothing prohibits a company from taking this same approach. In fact, it would be consistent with GAAP’s current presentation model in which the netting of indemnification receivables and contingent liabilities is permitted only in very limited circumstances.8 It would also be consistent with the spirit of financial reporting by providing investors with a full population of reasonably possible and probable loss contingencies, particularly because third-party recoveries are often subject to their own uncertainties. In some situations, the failure to provide this more robust disclosure could raise concerns about a company’s financial statements.

The use of IFRS by foreign private issuers provides additional examples of this point. We acknowledge that there may be differing interpretations in some areas, resulting in very different accounting outcomes. For example, there are split views in practice over the permissibility of push down accounting under IFRS. Similarly, there are differing views regarding aspects of accounting for combinations under common control, such as what constitutes a control group and whether restatement of periods prior to the combination is required or permitted.

While it would be ideal for the IASB to address these questions at some point, their plate is obviously quite full right now. In the meantime, disclosures, even when not explicitly required by a standard, would likely facilitate better comparability and user understanding of financial statements, particularly where IFRS may be subject to multiple interpretations. I do not mean to suggest, however, that anything goes under IFRS or that good disclosure may make up for bad accounting — when an interpretation is objectionable, we will object. I should also clarify that, where IFRS contains limited guidance, I am not suggesting that “compliance with the spirit of financial reporting” means “compliance with U.S. GAAP.” It is not our objective to force U.S. GAAP application in the absence of IFRS guidance solely because that is the guidance with which we are most familiar.

In short, I believe, as many have said before me, that we need to continue to view disclosure as a communication, rather than a “check-the-box” exercise. The onus is not just on preparers to consider the spirit of a requirement, but on auditors and regulators to seek disclosure, if it would provide additional transparency and facilitate a user’s understanding of material events, their effects on an entity’s financial statements, and the related uncertainties. This approach, I believe, may create an environment that would better support the notion of objectives-based disclosure guidance and the FASB’s disclosure framework project. Without such a cultural change, I am concerned that we will continue to see standards with long lists of prescriptive disclosure requirements that cannot fully contemplate every unique situation a company may encounter. This may contribute to continued disclosure overload in which the benefit of a particular disclosure requirement to a user is not readily apparent, and could lead to nondisclosure of information that users would find useful, because the relevant disclosure is not part of the required list.

V. Abuse Prevention in Standard Setting

Thus far, I have spoken about the impact of improved compliance on the standard-setting process primarily in the context of disclosure requirements. However, these points apply equally to recognition and measurement. In this regard, we sometimes see a cycle in which failure to achieve the objectives of a standard leads to standard setting for purposes of abuse prevention. This may then lead to seemingly uneconomic accounting results in some fact patterns, which, in turn, may lead to new standard setting. We have seen this cycle, for example, with revenue recognition, in which recognition may be deferred even though performance may have already occurred. I am hopeful, however, that the standard-setting projects underway, coupled with concerted compliance and enforcement efforts, will help break this cycle.

VI. Closing

That concludes my prepared remarks. Thank you for your attention.

1 FASB, Statement of Financial Accounting Concepts No. 8 (September 2010), paragraph OB2.

2 See FASB Proposed Accounting Standards Update, Disclosure of Certain Loss Contingencies (July 20, 2010), proposed paragraph 450-20-50-1F(e).

3 See ASC 450-20-50-4.

4 FAS 132R, paragraph 5(d).

5 See FSP FAS 132R-1, paragraph A6.

6 See FSP FAS 132R-1, paragraph 9.

7 See FASB Proposed Accounting Standards Update, Disclosure of Certain Loss Contingencies (July 20, 2010), proposed paragraph 450-20-50-1E.

8 See, e.g., ASC 210-20.



Modified: 12/07/2010