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Speech by SEC Staff:
American Accounting Association: 2004 Annual Meeting: The Future of Standards Setting for Public Companies


Donald T. Nicolaisen

Chief Accountant
US Securities & Exchange Commission

Orlando, FL
August 10, 2004

It's a real privilege for me to be here today and to participate in a discussion on this critical issue. I can tell you that I have given considerable thought to this subject. But I certainly don't have all the answers, nor for that matter have I considered all of the potential questions. So it's a particular pleasure for me to be with this group of panelists - all leaders whom I deeply respect - and, importantly, to have the opportunity to interact with this audience whose members do what I've always wanted to do. Working with students and young professionals and getting their fresh perspective on issues has always been fulfilling for me, and I truly envy you. I can't imagine a more exciting time for young people to enter the profession. I also want to acknowledge the importance of the research work that academic professionals do on financial reporting matters. Good, solid academic research provides valuable insights on improvements needed in global financial reporting.

Before I continue, let me make the usual SEC disclaimer. The remarks I make today are my own and do not necessarily represent the views of the Commission or its staff. But, Chairman Donaldson does send his greetings and wishes that he could be here. From personal experience, I can assure you that he has a deep interest in matters of accounting, auditing and education.

Bill has limited us to 15 minutes for opening remarks, so I'm going to very briefly describe certain initiatives we are working on at the SEC. I will also identify some of those environmental factors that I believe are likely to influence the future direction of financial reporting, and offer a glimpse of my own views. Don't try to read any importance into the order of my comments. There isn't any. I simply want to tee up at least some of the issues. What is important, though, is to understand my bias. It's to ensure that the millions of investors in our capital markets, young and old, can make their investment decisions on the basis of the best information available. And, that information must be reliable.

So, here goes:

  1. When I speak about financial reporting, what I mean is broader than just the financial statements and the footnotes required by GAAP. My reference includes the various disclosures in filings with the SEC, including MD&A, key performance indicators and other non GAAP measures and disclosures. I believe disclosures are essential to an understanding of financial performance, especially as we struggle with a mixed attribute model that uses historical costs, lower of cost and market, and fair values. One of my predecessors at the SEC, Walter Schuetze, suggested that financial statements should clearly distinguish between historical costs, opined on by auditors, and fair values, which may require other skills to verify. Walter's intent is to improve investor understanding. I appreciate his willingness to make suggestions, and I equally welcome your views.

  2. I realize that we are doing a lot in the standards-setting and rulemaking arenas, and I know that there is a concern with overload. But, I believe we must improve investors' access to, understanding of, and trust in financial information. Every one of us in the financial reporting chain - standard setters, auditors, regulators, preparers, users, analysts, the press and those of you in the academic world - all of us can and must do better. I should also mention here that I believe that the AICPA with its more than 300,000 members has an important role in restoring investor trust as well.

  3. Sarbanes Oxley required major reform in many areas in response to the financial failures of recent years. It sets the right perspective and establishes an appropriate foundation upon which to improve financial reporting. This drive to improve financial reporting is one of the main reasons I joined the Commission. Among other reforms, the Act called for strengthened corporate governance, it created the PCAOB's oversight authority over the profession, it requires CEOs and CFOs to certify the fairness of their financial statements, and it requires that both management and the company's auditors report on the existence and effectiveness of internal controls over financial reporting.

  4. In June, the Commission approved the PCAOB's standard on audits of company internal control over financial reporting. The requirement to provide management's assessment of the effectiveness of internal control over financial reporting and the accompanying attestation under the PCAOB's standard will be required for the first time for fiscal years ended after November 15, 2004 for accelerated filers and for fiscal years ended after July 15, 2005 for smaller issuers and foreign private issuers. This is a major change in practice.

    Of all of the reforms in the Act, I believe that the internal control requirements may have the largest effect on improving the reliability of financial reporting. It is for that reason that it is absolutely critical that we get the internal control requirements right. In fact, it's so important that the SEC staff is considering whether to recommend that the implementation of other initiatives be delayed, at least temporarily, because we want management and their auditors to put the appropriate emphasis on these requirements and to get them right the first time around. At the end of my remarks, I will make some observations about small business. Without preempting that discussion, I would like to mention here that I encourage the private sector to consider developing an internal control framework designed specifically to address small business needs.

  5. I believe that the current process of accounting standard-setting could be improved by focusing more on the underlying objective of the accounting that is being addressed. Similar transactions should receive similar accounting. The IASB and FASB have begun this process. However, further work is needed to clearly identify and articulate the principles or objectives underlying each standard.

    Objectives-oriented standards do not stop with the articulation of objectives. Other important attributes of objectives-oriented standards include:

    • A clearly-defined scope;

    • Avoidance of scope exceptions;

    • Avoidance of bright-line tests; and

    • Sufficiently detailed implementation guidance (including real-world examples as much as possible).

  6. The FASB and IASB support moving toward a single conceptual framework that would be used by both Boards. The work of these two Boards, and other national standards setters involved in the IASB process, is an important part of building and maintaining an effective global financial reporting infrastructure. I support global convergence. It's in the best interest of investors.

  7. I would encourage you to consider discussing the economic substance of transactions with your students. Ask them to think about whether or not the accounting faithfully represents and portrays that substance. Challenge them with real life examples of transactions in which the form of the transaction was specifically selected to achieve a particular accounting result, even though the economics of the transaction would indicate that a different accounting result is more representative.

    I should also mention here that I still hear some accountants focusing on conservatism and the matching principle. While one or both of those ideas underlie certain accounting standards that are still in place today (e.g., FAS 5), those ideas should not be the focal point or end point of discussion. Much of the focus of standard setters is on assets and liabilities.

  8. We have all become familiar with HTML, the Hypertext Mark-up Language that lies behind our personal and business homepages. More general mark languages are available to support structured data bases (e.g., XML and XBRL). The Commission recently issued a press release indicating that it is assessing the benefits of tagged data and its potential for improving the timeliness and accuracy of financial disclosure and analysis of Commission filings. In addition, the staff is considering whether to propose that the Commission accept voluntary supplementary filings of financial data using data gathering and analysis tools such as eXtensible Business Reporting Language (XBRL). This includes a possible voluntary program, beginning with the 2004 calendar year-end reporting season, which would enable the Commission staff to further investigate the types of data tagging currently available in the marketplace.

    There is an inherent need for registrants to follow a consistent mapping of data in the tagging process in order to utilize XBRL. However, the prescriptive nature of the process may strike some as contrary to the view of some that disclosure requirements should allow reporting firms some flexibility to present information based on the way the firm is managed. Further study in this area clearly is needed.

    These tools including XBRL have the possibility to provide investors and analysts with information more quickly and at a lower cost.

  9. The Sarbanes-Oxley Act requires that we provide Congress with a report later this year regarding off balance sheet transactions. The study is well underway, and I suspect that our findings will be of interest. Stay tuned.

  10. Small business is an area that you will hear me speak about much more in the future. Small business plays a vital role and has long been a growth engine for our economy. During the Commission's Sarbanes-Oxley rulemaking initiatives, we received many comments focusing on the increased burden that the proposed rules would place on smaller-sized public companies. I have heard similar concerns expressed about the impact of some of the FASB's proposed standards, such as its exposure draft on accounting for stock options. As a general matter, I believe that small business should be expected to adhere to those same standards to the extent that they have like transactions. However, the burden to smaller companies can be disproportionate and needs to be appropriately weighed against the protection of investors. This balancing act is something that I will continue to closely monitor, and it is also an important consideration for the FASB and the PCAOB. Clearly, we all need to strike the right balance.

I said earlier that I believe we can do better. Other professions and industries have embraced an impressive number of diagnostic test tools and measures, use of technology, and a willingness to push traditional boundaries. We can do the same. We have to improve standard setting. We have to more broadly embrace technology. We have to adopt a less critical attitude toward change and embrace new ideas and concepts. We have to have a global view. My goal is to improve the quality, timeliness and cost effectiveness of information available to investors. Improvement is not perfection so, as we continue down this path, I don't want us to get bogged down. We've all heard the saying: the search for perfection is the enemy of good.

Thank you. I look forward to the upcoming question and answer session. This should be a lively discussion.



Modified: 08/10/2004