July 19, 2002
Jonathan G. Katz, Secretary
U.S. Securities and Exchange Commission
450 Fifth Street, NW
Washington, DC 20549-0609
RE: File No. S7-16-02
Dear Mr. Katz,
The Williams Companies, Inc. appreciates the opportunity to provide comments on the proposed rule for "Disclosure in Management's Discussion and Analysis about the Application of Critical Accounting Policies." We support the Commission's objective of enhancing investors' understanding of the application of companies' critical accounting policies. We generally believe the qualitative disclosures being proposed would provide the reader valuable information regarding the assumptions used and estimates made, and for that reason we support this aspect of the proposed rules. However, we feel that quantifying the sensitivity of estimates/assumptions to change and disclosing historical changes to estimates are not meaningful and would add additional complexity to the financial statements disclosures. We believe that management's assumptions as reviewed by the external auditors are the most appropriate assumptions to be used, and providing detailed quantification of information about management's assumptions to the reader may lead to possible misapplication of the relevant information to the particular situation. These concerns are addressed more fully below and we would appreciate them being considered before issuance of final rules.
Disclosures Regarding Use of Different Estimates
One required disclosure, if applicable, is to describe why different estimates could have been used in the current period. We disagree with this disclosure as currently proposed. Current authoritative literature provides guidelines for making estimates in various situations. Those guidelines have a consistent theme - they require the estimate be based on the best information available at the time. For example, Concepts Statement No. 7 provides guidance for incorporating different assumptions and their relative probability of occurrence along with various risk factors in calculating fair value using discounted present values. Requiring disclosure of "why different estimates ... could have been used" implies that management had its choice of various equally appropriate estimates. Using the best information available in making an estimate in accordance with generally accepted accounting principles (GAAP) does not result in a choice among various equally appropriate estimates. It leads to one estimate calculated in accordance with GAAP that is used by management to recognize the transaction in the financial statements. This proposed disclosure would increase investor confusion, lead to "second guessing" of management and decrease the integrity of the financial statements.
An alternative approach to this disclosure would be a qualitative discussion that provides insight into the decision process that management went through to apply an accounting principle while not implying that management had a choice among various estimates.
Quantifying Sensitivity of Estimates to Change
We disagree with the requirement to quantify changes that would result if certain revisions relating to a critical accounting estimate were assumed to occur. We feel that this requirement would introduce an additional element of subjectivity, increase investor confusion, lead to "second guessing" of management and potentially decrease the integrity of the financial statements. In many situations, multiple material assumptions work together to produce the resulting estimate. And within a single line of the financial statements there may be multiple transactions that required estimates, each involving multiple assumptions. The proposed rules would require that each material assumption for each estimate be addressed. This would be complex, cumbersome, and difficult for an average reader to fully comprehend particularly when those assumptions are interrelated and, thus, misleading if addressed in isolation.
If this requirement is retained in the final rules, we believe providing only two approaches for making that quantification is not appropriate. The method of quantification should not be dictated. Because the complexity and meaningfulness of quantifying the impacts of changes in accounting estimates is different for each situation, management should be allowed to assess their individual situation and develop the most appropriate quantification under the circumstances. In some cases, there already exist standard methodologies used for existing disclosure purposes that differ from the proposed approaches. In addition, there may be standard industry measures or other methodologies that are very meaningful but do not fit within the two approaches specified in the proposed rule. Therefore, we believe the method used to quantify sensitivity should be management's decision and should not be set forth in the final rules.
Disclosure of Historical Changes in Estimates
As pointed out in the proposed rules, current MD&A disclosures are required to include historical and prospective analysis of the financial statements, and identify the cause of material changes from prior periods in the line items of the financial statements where those changes are reflected. A company must analyze significant components of revenues or expenses needed to understand the results of operations. It also must discuss significant or unusual economic events or transactions that materially affected results of operations. Although the format, placement and specificity of the current disclosures may not be what the Commission is currently envisioning, the proposed disclosure of material changes made to accounting estimates in the past three years is basically the same requirement. Requiring it again in a separate section of MD&A would be redundant and unnecessary.
It appears that one of the Commission's objectives for requiring specific disclosure regarding past changes in critical accounting estimates is to enable investors to evaluate management's formulation of critical accounting estimates over time. We believe the requirement as currently proposed will lead instead to "second-guessing" and a lack of confidence in management. Estimates, by their nature, will change. Many changes in estimates occur because circumstances change, new information becomes available or new events occur - not necessarily because management estimated incorrectly. The proposed disclosures may lead investors to question management's ability to make estimates. This does not mean that management's estimate was not appropriate given the circumstances and facts available at the time the estimate was made. Alternatively, we believe information for investors' evaluation of management's formulation of critical accounting estimates would be better accomplished through a qualitative discussion of the decision process that surrounded the assumptions that were utilized at the time the estimate was made. Hence, we recommend the elimination of the requirement for specific identification and quantification of historical changes to accounting estimates.
The proposed rules point out that the possible competitive harm resulting from these disclosures would diminish to the extent that all companies make the proposed disclosures. Although this may be true to a limited extent, the inherent inconsistencies in types and quantity of disclosures made by different companies and inconsistencies introduced as companies attempt to balance disclosure with potential competitive harm will not be eliminated with these proposed rules. For example, quantification of different assumptions used to estimate the impairment of an asset held for sale would provide the potential buyer with confidential information that could impact the ultimate purchase price.
In addition, this proposal has not addressed the competitive harm relative to litigation, environmental issues, contract disputes or similar-type estimates where counterparties would now have access to a company's underlying assumptions and reasonably likely changes to those estimates. The counterparties could use that information to a company's detriment in litigation or negotiations. This would ultimately be harmful to investors. One possible solution would be to limit the required disclosures as they relate to litigation, settlement discussions, contract disputes, etc.
Disclosure of Discussion With the Audit Committee
We concur that senior management should discuss the company's critical accounting estimates with the audit committee of its board of directors. However, instead of requiring a statement to that effect in the MD&A, we feel that a more appropriate approach would be to amend Item 306 of Regulation S-K and Regulation S-B to require that the audit committee report included in the proxy statement also disclose whether the audit committee has reviewed and discussed with senior management the development, selection and disclosure regarding critical accounting estimates. This location of such a disclosure is more consistent with the current requirements about auditor discussions with the audit committee regarding the audited financial statements. In connection with this, we also believe that the following amendments to Item 306 be included in the final rule:
Auditor Examination of MD&A
We do not believe that examination of the proposed critical accounting estimate disclosures within MD&A by the external auditors is necessary. We feel that the current requirements for the independent auditor to read the information in the entire filed document, including the MD&A, and consider whether such information is materially inconsistent with information appearing in the financial statements remain appropriate for these new proposed disclosures. Requiring examination of the critical accounting estimates disclosure in the MD&A by external auditors would add to the time, effort and cost of the annual audit, and in light of the Commission's proposed accelerated filing dates, would make timely completion of the quarterly and annual reports more difficult for the company and independent auditor.
We appreciate the opportunity to comment and would be pleased to discuss our views with the SEC staff.
Controller and Chief Accounting Officer
The Williams Companies, Inc.