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U.S. Securities and Exchange Commission

Speech by SEC Staff:
A QT Report Card for
High Quality Financial Reporting

Remarks by

Lynn E. Turner

Chief Accountant
U.S. Securities & Exchange Commission

Hylton Lecture Series in Accountancy
Critical Issues in Accounting Forum
Wake Forest University, Winston-Salem, N.C.

April 25, 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.

Thank you very much, Dean Wilkerson.

Before I go any further, allow me to recite the required proviso that anything I have said, and anything I am going to say here today represents my views only, and are not necessarily those of the Commission, the Commissioners, or the SEC staff.

I am honored to have been invited as the Hylton Lecturer today, and to be part of a long line of impressive and important people who have spoken from this podium in the past.

Let me start today by congratulating those of you who are studying for a degree in accounting. Accounting is a profession with an honored past of several hundred years. Investors and the public have come to rely on accountants, including those preparing as well as those auditing financial statements, to generate reliable and high quality information that will provide for a more efficient allocation of resources.

For those of you who choose to join public accounting firms, you will be committing yourself to maintaining and enhancing the confidence of the public in our profession. This is a daunting, sometimes difficult, but very rewarding task. The training you receive is exceptional. You will, no doubt, have the opportunity to serve companies with a wide range of success from the worst to the best managed, hopefully learning and developing your own base of knowledge of what works, and what doesn't. You also will be assigned exciting and challenging tasks that will draw on everything you learn in the classroom as well as on the job, as you dig deep into every aspect of your client's business when preparing your findings and reports.

As for those of you who choose to join the ranks of accountants in industry, I can only say that my time spent as a Chief Financial Officer was just as rewarding as being a partner in one of the then Big Six accounting firms. No doubt, experience in industry can enhance one's abilities as an auditor. Perhaps the best way to say it, is that in industry, you are on the front line actually doing what it takes to build a successful business. Just as you learn things in public accounting that you would not learn in industry, there will be things you learn in industry that you would not learn in public accounting. I suspect that many of you here today will have the good fortune in the future to experience a variety of opportunities that an accounting career provides. The growing ranks of CPAs who have become Chief Executive Officers (CEOs) is perhaps the best evidence of these opportunities.

One reason accountants have been successful in business, auditing, consulting and in management is due to our commitment to quality. We have strived to improve the quality of financial reporting for investors. From the Committee on Accounting Procedure to the Accounting Principles Board ("APB") to the Financial Accounting Standards Board ("FASB"), we have made improvements to the quality of our standards and the standard-setting process. For example, in the early 60s, we began to require companies and their auditors to follow the standards being set, so as to improve the comparability of reporting for comparable transactions by companies. With the establishment of the FASB in the early 70s, we moved from a part-time standard setter with potential conflicts of interest, to independent full-time standard setters, chosen for their technical competence.

The Need for Quality Financial Reporting

High quality, transparent financial reporting is an idea that is taking hold and gaining acceptance. The Chairman of the SEC, the Federal Reserve and the Secretary of Treasury, as well as the World Bank, have all boldly and correctly called for improvements and enhancements in our financial infrastructure and reporting, both domestically and worldwide. And at the SEC, we take the quality of financial reporting very seriously.

You see, we do not regulate the merits of a public offering. Rather, pursuant to the securities laws, we look to see that full and fair disclosure is made to investors about the various aspects of a business, including its financial disclosures. Investors use this financial information as a basis for modeling their expectations for the future of the business. In essence, the historical financial information serves as a foundation upon which investors build their decisions as to how, when and where they will allocate their capital.

It has been with interest that I have noted others in the financial community focusing a keener eye on the quality of financial reporting during the past two years. I have noted business shows such as CNBC, reports of leading analysts, and investors all talking about the quality of earnings. Recently, two people have come up to me and noted their pastor or minister included in their Sunday Sermon the lack of ethics and morals when the numbers game is played. Perhaps current press reports expressing concern about the quality of earnings and reported revenues of some dot.com companies, highlight the price one can pay when reported numbers are challenged. Unfortunately, as we have also learned from the Asian, Russian, and South American markets, as well as with some limited companies we have all read about in the financial press, a lack of transparency has a tremendous cost attached for all of us. We now clearly know that financial reporting that does not reflect economic reality will result in inefficient pricing of stocks in the capital markets, higher costs of capital to companies, and a flight of capital to safer investments. In the worst cases, investors may lose billions of dollars.

There has always been a need for high quality, transparent financial reporting, to facilitate the fair flow of information to investors in assessing the potential risks and rewards associated with a particular investment. But this is especially so today, with instant access to information via the Internet, and the vastly increased propensity of Americans to purchase stock for their portfolios. Keep in mind that one-third of American's wealth is tied up in the stock market.

About a month ago, before the recent "correction", Nobel prize winning economist Franco Modigliani wrote that there seem to be two ways to value a stock in the present economy, the first being the fundamentals, which was still his personal choice, and the second being the herd mentality, which was saying by inference that what goes up will continue to go up. But how do we explain our ability to overcome the laws of physics? If, like the astronauts, we are to be comfortable in overcoming Newton's law of gravity then we have to have a way of valuing the engine, fuel, and navigational ability of the forces and resources that are driving the market, on both a macro and micro level.

Once again, it is the information provided by financial reporting and related disclosures, which is important in making assessments of potential future risk and reward.

Quality Financial Reporting Meets Standard Setting

At the same time as we are seeing a need for greater transparency in financial reporting, we continue to see public and political debates about the standard-setting process and resulting standards in the U.S. I remember one of the leading members of business who facilitated the establishment of the FASB noting it would be without controversy only until someone's ox got gored. What an accurate prediction that has turned out to be!

Too often today, we debate the merits of a particular accounting standard based on individual agendas, as opposed to transparency and quality of financial reporting that would result from the standard. The debate on a standard being developed should be based on whether it improves the transparency to investors, regarding the economics of a business. That is, does it increase the representational faithfulness, comparability, consistency and just as important, the verifiability of financial information. If a new standard achieves these criteria, thereby enhancing transparency, it is difficult to understand why it should not be adopted.

Despite the ongoing debates, I want to make sure we deal with the facts:

  • First, as I travel abroad, I often hear the FASB referred to as simply the world's best standard-setter with the best process. No doubt, that is why other countries often meet with the FASB to learn about the Board's processes and procedures.

  • Second, the quality of our financial reporting system is what other countries benchmark against. In fact, I have spoken to a number of large international companies who have said that their adoption of U.S. GAAP has resulted in better management information.

  • Third, at the SEC, we continue to strongly support the FASB as an independent, private sector standard setter, that undertakes extensive due process in the sunlight, and gives careful consideration to all of its constituents' viewpoints, while weighing the interests of the public.

New Ideas for Quality

Yet, we should always strive for continuous improvement. We should look for ways to improve the transparency and quality of our financial reporting, much like businesses search for ways to improve their products, or marketing or manufacturing. And, we must be able to think out of the box. I am reminded of Albert Einstein who once said imagination is more important than knowledge.

I'd like to put forth a few ideas on how we can improve the quality of our financial reporting in the U.S. My ideas are drawn from my experience in business where we studied the processes and successes of companies, including those who operated in other industries. We would often study and gain knowledge about those processes and business practices that seemed to be best in class, and then try to improve on them.

Similarly, I think it would be helpful if we developed a further model of what is "high quality" financial reporting. Such a model should result in financial statements that reflect the underlying economics of the business and the transactions it enters into, in a comparable, consistent fashion.

Recently, the Blue Ribbon Committee on Improving the Effectiveness of Audit Committees, the Auditing Standards Board ("ASB") and the SEC have advanced this topic by adopting guidelines for a discussion about the quality of financial reporting between audit committees, management and their auditors. I think this should be a useful discussion that will no doubt also serve the interests of investors.

Developing a model for what constitutes high quality financial reporting could enhance and assist the participants in these discussions. To that end the ASB recently has sent a letter to the FASB requesting that they undertake a project to further develop the qualitative characteristics set forth in FASB Concepts Statement No. 2 ("SFAC 2"). SFAC 2 provides a set of basic criteria for assessing quality in financial reporting.

I think that developing further guidance on what constitutes quality financial reporting, as well as an assessment process, can also serve as an important framework and benchmark. This guidance could be developed into a Quality/Transparency (or "QT") Report Card on the development of standards. As each new standard is developed, be it by the FASB, Accounting Standards Executive Committee, Emerging Issues Task Force or International Accounting Standards Committee, it could be graded. The grade would be indicative of how well the new standard will advance the ball in improving the quality and transparency of financial reporting and the related standards. In essence, the Q/T Report Card would measure the success of the standard-setting product, just as grades are used to measure the success of a student in learning.

Standards should also be remeasured after a period of implementation to see if the product continues to make the grade. Continuous assessment of the quality of one's product is important to business, and to the credibility of financial reporting.

Characteristics of High Quality Financial Reporting

So, let me provide you some of my thoughts on what constitutes some of the criterion for high quality financial reporting.

Let's start with the 3 R's of Quality. Not Reading, (W)riting, and (A)rithmetic, but Relevance, Reliability, and Representational Faithfulness.


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.

  • Relevance requires sufficient and appropriate information as to:

    • recurring/continuing events/transactions/cash flows

    • non-recurring and unusual events/transactions/cash flows

    • aggregate information, and whether it is put together in a sensible and complete way

    • disaggregated information, and whether it is provided in sufficient and appropriate ways, showing the major risks and rewards associated with components of the business to allow the reasonable investor to make reasonable decisions about the business as a whole as affected by its component parts.

    • timeliness: information should be provided to investors on a timely basis, before it becomes irrelevant. If it would make a difference to investors, they want to be able to incorporate the information into their assessment of the entity's past and predicted future performance

  • Relevant information is that which investors need to assess trends over time and the likelihood of continuation of or changes in those trends.

  • Relevant information provides feedback value about past performance.

There should be sufficient information about unusual transactions versus recurring transactions without burying or offsetting the results of unusual transactions.

Further, the level of aggregation/disaggregation of data must serve to enable investors to understand the major risks and rewards associated with the business.


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.

The bottom line in Representational Faithfulness is that transactions need to be accounted for based on their true economics rather than just their form. And we need companies, their auditors, financial analysts and investors to focus on this as an integral objective of high quality, transparent reporting, rather than trying to add bells and whistles to a transaction purely to achieve a different accounting treatment. If you try to paint stripes on a horse just so you can call it a zebra, watch out when the rain falls! And you better make sure that horse doesn't come back and kick you for trying to portray it as something that its not.

Let me add just a footnote to this discussion on representational faithfulness. I believe that companies, their auditors and investors are best served when financial management asks for and receives, sound financial advice on how to implement or apply a particular accounting standard. Auditors can play a significant role in improving the quality of reported numbers when they give sound, unbiased and objective advice on how a transaction should be properly accounted for.

However, I am deeply concerned when an accounting firm that has a primary duty to investors is involved with structuring transactions that reduce the quality and transparency of financial reporting. I encourage audit committees to inquire of their auditors what role they have played in structuring transactions and the impact the accounting treatment chosen for those transactions has on the quality of the company's financial reporting.


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.

One of the trends in financial reporting in the latter half of the 1900's, was a move towards more fair value information. Research studies of the APB, the Trueblood Study Group and now the efforts of the FASB have all pointed in that direction. Examples of the use of fair values today include the measurement of acquired businesses and assets pursuant to APB Opinion No. 16 as well as the tax code, valuing the issuance of equity instruments, exchanges of certain nonmonetary assets, determining the value of financial instruments in accordance with Statement of Financial Accounting Standard No. 107, recording marketable securities at their fair value and my favorite, In-Process Research and Development ("IPR&D).

Businesses also manage their operations by managing risks. Risks are managed by managing changes in value. A risk management process often requires measurement of fair values of contracts, financial instruments and risk positions that have been taken. I believe if these measures of fair value are reasonable enough to be used for business purposes, then they should be given serious consideration for financial reporting.

Some have argued that companies have already developed models for determining fair values to effectively manage their businesses. As such, they believe there is already a basis for developing guidance to ensure reliable and verifiable fair value information that can be reported on a consistent and comparable basis.

The bottom line to all of this is that we use fair values quite frequently. As a result, we need to be sure those values are verifiable for financial reporting purposes. To achieve a level of verifiability that ensures consistency and comparability among registrants, accounting and auditing standard setters need to provide adequate guidance on the determination of fair values. For example, the American Institute of Certified Public Accountants (AICPA) has provided guidance on determination of the values of businesses for consulting purposes. I would hope that in the future such guidance could be developed for preparers and auditors.

I note that the ASB is providing additional guidance on the auditing of fair values of financial instruments, and the AICPA SEC Regulations Committee is providing guidance on the valuation of IPR&D. Both the ASB and SEC Regs Committee are to be commended for undertaking these projects. I look forward to their successful completion in the near future. I also hope further guidance on the determination of fair values will be forthcoming in other areas.


Information should be free from bias towards a predetermined result. 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.

Neutrality must remain a key concept of our mission, just as it is incorporated into the FASB's Mission Statement and a key component of SFAC 2, Qualitative Characteristics of Accounting Information, which states:

Neutrality in accounting has a greater significance for those who set accounting standards than for those who have to apply those standards in preparing financial reports, but the concept has substantially the same meaning for the two groups, and both will maintain neutrality in the same way. Neutrality means that either in formulating or implementing standards, the primary concern should be the relevance and reliability of the information that results, not the effect that the new rule may have on a particular interest.

The Board's responsibility is to the integrity of the financial reporting system, which it regards as its paramount concern.1

In putting neutrality into practice, former FASB Board Chairman Donald Kirk has stated:

[N] eutrality of information keeps financial reporting standards as a part of a measurement process, rather than a purposeful resource allocation process It is the emphasis on neutrality of information, as well as the independence of the standard setters from undue influence, that ensures the continued success of private sector standard setting.2

The SEC has historically, and continues, to share this view. Former SEC Chairman Harold Williams made the following statement in 1978, which holds equally true today:

"If it becomes accepted or expected that accounting principles are determined or modified in order to secure purposes other than economic measurement we assume a grave risk that confidence in the credibility of our financial information system will be undermined."3

Now, on to the "4 C's" of Quality: Comparability, Consistency, Completeness and Clarity.

Comparability and Consistency

Information about a particular company is more useful if an investor can compare it with similar information about other companies and with similar information about the same company for some other time period. We used to call this comparing Apples to Apples (that is, before Apples became Computers!) The purpose of comparison is to detect and explain both similarities and differences. High quality accounting requires accounting for similar transactions similarly and accounting for different transactions and circumstances differently.

High quality accounting also means accounting principles are consistently applied over time. A change in principle or its application is reasonable if it increases transparency, not if it clouds over reality.


Sufficient information about major events and transactions must be provided to give a complete picture to enable investors to understand past events and predict future performance. Providing high quality, transparent reporting to half the story and holding back the other half is not in the best interests of investors. Information about the timing of significant items is also important to provide.

We issued a SAB, or Staff Accounting Bulletin, on Materiality last year. That SAB puts people on notice that the use of simple quantitative cutoffs like 5%, or any other percent, as determining whether or not an item needed to be included or corrected, are unacceptable. The real test is whether the information would make a difference when considered by a reasonable person in terms of his or her investment decisions with respect to that company. So, remember to tell the truth, the whole truth, and nothing but the truth!


High quality, transparent financial reporting must provide sufficient information in a "plain English" form so as to promote the understanding of a reasonable person. Presentation of information should be organized and displayed in a way that assists in the reader's understanding. Amplification through footnotes and Management's Discussion and Analysis ("MD&A") should use "plain English" and assist in presenting a useful, understandable, and comprehensive picture of the company that enables assessment of past performance and prediction of future performance as well.

MD&A can be a powerful tool. But we need to explore how it or other disclosures can advance transparency in the capital markets. For example, when I read MD&A's today, I can't help but notice many of the numbers come directly from the financial statements. Often, there is very little new financial data that has not been calculated or taken directly from the financial statements that really allows the investors to really see the company through the "eyes of management". I am concerned we may be backsliding some into practices that existed prior to the Commission's 1989 MD&A release. I also wonder why it isn't time for companies to consider providing non-GAAP performance measures, such as key performance indicators ("KPIs").

All of the criteria I have just discussed are important to consider when financial accounting standards are being evaluated and put into practice. But based on my experiences as an audit partner, a chief financial officer, and 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 an 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.

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.

The FASB has used field tests, solicited input as to the application of proposed standards to sample transactions, and used other methods to determine potential outcomes of standards. I support and encourage the use of such tools, to ensure that new standards will result in consistent and comparable interpretations by preparers and their auditors.

Everyone Has a Role in High Quality Financial Reporting

Everyone has a role in high quality, transparent financial reporting, and the responsibility for its continuous quality improvement. Many of you are familiar with or have heard of the new rules of the stock exchanges, SEC and AICPA requiring auditors, the audit committee and management to discuss audit quality, and other initiatives to improve quality. These initiatives are based on the audit committee, financial management and outside auditors forming a "three-legged stool" to support responsible financial disclosure and active and participatory oversight.

SEC Rule on Audit Committee Disclosure

The SEC's new rule on Audit Committee Disclosure, issued in December, requires disclosure that the Audit Committee has done the following things:

  • Reviewed and discussed the audited financial statements with management, and

  • Discussed with the auditors items required by AICPA auditing standards. These include a discussion of any audit adjustments, including uncorrected misstatements determined to be immaterial by management, both individually and in the aggregate.

Other new requirements include proxy disclosures relating to the Audit Committee's charter, whether the audit committee has recommended to the board that the financial statements be included in the Annual Report and Form 10-K, and whether the audit committee has received a report from its auditors as to their independence, as required by Independence Standards Board (or ISB) Standard No.1. In addition, this new rule requires that interim (or quarterly) financial statements be reviewed by auditors on a pre-filing basis, to provide more timely and accurate information.

For further details on this rule, I refer you to the SEC's website, www.sec.gov.

AICPA's SAS 89 and 90

The AICPA has also issued two important new rules on this topic, Statement on Auditing Standards ("SAS") 89 on Audit Adjustments, which I touched on a moment ago as it relates to discussing audit adjustments, and SAS 90 on Audit Committee Communications,

  • The AICPA's SAS 90 requires the auditor to discuss with the audit committee the QUALITY, not just the acceptability, of the accounting principles used by an entity.

  • This Quality discussion should include not only the audit committee and the auditor, but also management, since management has primary responsibility for the entity's financial reporting.

  • The Quality discussion should encompass:

    1. consistency of the entity's accounting policies and their application,
    2. the consistency, clarity and completeness of the financial statements and related disclosures, and
    3. items having a significant impact on the representational faithfulness, verifiability, and neutrality of the accounting information.

Warren Buffet, perhaps the most widely recognized investor of our time, also weighed in during the development of the Blue Ribbon Committee's recommendations. He suggested an approach based on audit committees asking auditors three intriguing questions:

1. If the auditor were solely responsible for preparation of the company's financial statements, would they have been prepared in any way differently than the manner selected by management? They should inquire as to both material and nonmaterial differences. If the auditor would have done anything differently than management, an explanation should be made of management's argument and the auditor's response.
2. If the auditor were an investor, would he have received the information essential to a proper understanding of the company's financial performance during the reporting period?
3. Is the company following the same internal audit procedure that would be followed if the auditor himself were CEO? If not, what are the differences and why?

No doubt, these are the type of questions being raised in the Board Room today by audit committees.

Framework for the Discussion of the Quality of Financial Reporting

I have seen an outstanding publication by Arthur Andersen, which takes the audit committee and management through the discussion on quality. This publication, "New responsibilities and requirements for audit committees," is an exceptional publication and lists sample questions to guide the discussion. Here are some sample questions that follow their book.

Relevance/Predictive Value/Earnings Persistence

  • When identifying unusual or nonrecurring items for disclosure, are both gains and losses given equal importance?

  • To what extent was the timing of transactions managed in order to occur (or not occur) in the reported period? What was the purpose of managing the timing? How did that affect the predictive value of the reported results?

Relevance/Predictive Value/Disaggregated Information

  • What specific aspects of the company's disaggregated information, taken as a whole, lead you to believe that the company has communicated a sufficiently complete understanding of its various business opportunities and risks?

  • How does the discussion of the company's business segments in MD&A and other non-financial statement reports (Including discussions with analysts or reporters) complement the segment information presented in the financial statements? What specific examples illustrate how the respective disclosures complement each other?

Relevance/Feedback Value

  • How much information is provided about management's previous expectations, results that confirm such expectations, and reasons for expectations not being met?

  • Do the reported results (including the company's financial position) provide feedback to investors as to how various market events and significant transactions affected the company?


  • In what way does the company go beyond merely complying with SEC filing requirements in terms of timeliness?

  • What new ways of communicating financial information (e.g., internet communications, etc.) has the company used or begun to consider?

  • How does the company ensure that it provides the same information to all interested users at the same time?


  • What are the most judgmental aspects of the company's financial reporting from a measurement perspective? How does the information in the financial statements allow a reader to understand what those aspects are?

  • What information in the financial statements (and MD&A) communicates the significant estimates and assumptions used to develop financial information? Where there is a range of possible outcomes, how does the company communicate that range to investors?

  • How does the company assess whether its significant estimates and assumptions are based on the best information available/ Does the company use independent specialists or sophisticated quantitative techniques to validate or develop key estimates and assumptions?

  • What materiality thresholds does the company use for recording transactions and preparing its financial statements? How are these thresholds communicated to accounting, sales, purchasing and other appropriate personnel?


  • What are the most significant events of the past year and how are those communicated to investors? Is the information presented in an even-handed manner?

  • How are both negative and positive events presented in the financial statements and MD&A? What process did management follow to ensure the story was told fairly and impartially? Is the weight placed on these events appropriately balanced with other events?

Reliability/Substance/"Representational Faithfulness"

  • How does the company assess whether the accounting principles it has selected will appropriately convey the underlying economics of the transactions? What accounting principles changed during the year and how were they assessed?

  • When the company enters into significant or complex transactions for which the accounting literature is not black and white, how does the company assess whether its accounting is appropriate?

  • To what extent does the company enter into (or modify) transactions in order to achieve a specific accounting result? In those situations, how does management ensure that the accounting is an honest and clear portrayal of the substance and purpose of the transaction?

  • To the extent that the accounting literature precludes the company from portraying the transaction according to its substance, what information does the company provide (in the footnotes and the MD&A) to supplement the investor's understanding?


  • Looking at significant judgments made, how neutral was management's assessment of the likely outcome? What specific examples illustrate this?

  • Although characteristics such as "aggressiveness" or "conservatism" mean different things to different people, one way or another, they suggest some type of bias. Thinking about those two terms, how close to "neutral" is the company's accounting for and disclosure of significant events and transactions?

  • How does neutrality factor into management's selection of accounting principles? Will the selected accounting principles present a balanced view?


  • What changes, if any, have there been in the company's accounting policies or in management's application of the policies and the use of estimates and judgments? In what way are those changes an improvement over past practices? What specific disclosures can you point to, to demonstrate that the effect of the changes on all periods has been appropriately disclosed?

  • What indication, if any, is there that changes in the company's accounting policies, in the application of those policies, or in the use of estimates and judgments are motivated by management's desire to achieve a specific accounting result?


  • In what way do the company's disclosures go beyond complying with the absolute minimum requirements of GAAP?

  • How well organized and easy to follow is the company's presentation of its information?

  • Is the language used in the financial reports easily understandable by nonaccountants? How has the company applied "plain English" concepts to its financial information?

  • How has the company made use, in its financial reports, of simple, clear graphs and charts to enhance the understandability of the financial information?

  • Do the financial statements and other disclosures (e.g., MD&A) form a comprehensive, cohesive, and coherent set of financial information that "tell the whole story"?

In addition to the use of these or similar questions, I suggest companies and their audit committees could develop their own Q/T Report Card as a specific scoring mechanism to more fully assess the quality of their financial reporting.


I believe regulators and the private sector can work toward developing a common, useful framework to aid in the creation, assessment, and practical application of high quality financial reporting standards and practices.

I invite all of you to join us on this journey along the road to quality. Just bring along some strong hiking shoes, a pocketful of ideas, and an open mind!

Thank you very much!

1 FASB Concepts Statement No. 2, paragraphs 98 and 110
2Donald J. Kirk, "Looking Back on Fourteen Years at the FASB: The Education of a Standard Setter," page 13.
3 The Framework of Financial Accounting Concepts and Standards by Reed K. Storey and Sylvia Storey, published by FASB, pg. 113 & fn.138; which quotes from "Reflections on a Reconceptualization of Accounting' " by Donald J. Kirk