18(e). FASB
As part of its oversight activities, the Oversight Committee of the Financial Accounting Foundation interviewed and requested written comments (collectively, "the interviews") from thought leaders among the FASB's constituencies. There were 107 interviews in total, including 12 with representatives of financial statement users and 17 with regulators (a special class of financial statement users). [FASOversight, p. 1]
While the interviews were not designed to elicit criticisms of financial reporting, in general, or to identify the needs of users of financial information, interviewees did comment on those matters. [FASOversight, p. 1]
Following is a summary of the principal comments received [on the subject] from users and regulators relating to criticisms of financial reporting. . . . [FASOversight, p. 1]
Financial statements and the related disclosures are too complex for most users (including analysts) to understand. As a result, there is a high cost to the preparer to produce financial information and a high cost to the user to analyze and understand the information. [FASOversight, p. 1]
Business practices and transactions have become so complex that it is almost impossible to capture everything in the financial statements. [FASOversight, p. 1]
There is inconsistency among industries and enterprises in the methodology for calculating reserves, allowances and other valuation adjustments. [FASOversight, p. 1]
Financial reporting has not kept pace with the economics of business; for example, financial statements do not reflect the evolution from a manufacturing to a service economy. [FASOversight, p. 1]
From an acquisition perspective, the financial statements do not reflect the value of an enterprise; the financial statements are of little value in evaluating acquisition opportunities. [FASOversight, p. 1]
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Over the years RMA's Accounting Policy Committee (APC) has reached many important conclusions on accounting and auditing matters that reflect the viewpoints of lenders. These conclusions, reflecting as they do the views of financial statement users, are not all in agreement with current accounting and auditing standards. They are used to guide the APC in forming its comments and other responses to initiatives of the Financial Accounting Standards Board (FASB), Governmental Accounting Standards Board (GASB), American Institute of Certified Public Accountants (AICPA), Securities and Exchange Commission (SEC), International Accounting Standards Committee (IASC), and other designated standard-setting bodies. [RMA90, p. 1-2]
Understandability is an important characteristic of accounting data. The [following item] listed below [is] vital to understandability. [RMA90, p. 3]
Standards, not rules: Financial accounting standards should address issues of broad principles. They should be less concerned with setting detailed rules, although interpretive guidance and examples illustrating implementation are desirable. [RMA90, p. 3]
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[Context] The following brief summary of the topic "The Standard-Setting Process," is from the "Executive Summary" of the report the AIMR's Financial Accounting Policy Committee (FAPC):
Several topics are covered in this section. First is our assertion of support for the continued development of globally acceptable accounting standards. That support is accompanied by a discussion of the problems that we expect will be encountered in the quest for worldwide standards. [Also included in 18 (a) and 18(d)] [AIMR/FAPC92, p. x]
Second, we express our support for the standard-setting process in the United States and for the FASB as an institution. We provide refutation to many of the criticisms directed against it. We do not believe the FASB is to blame for many of the complications in financial statements today, nor do we believe that it has issued too many standards too quickly. We disagree with those who say its standards are too theoretical, that the cost of implementing them is too great, or that the FASB is inimical to the interests of financial statement preparers. Rather than following due process too little, we believe the FASB follows it too much. The reasons supporting these beliefs are set forth in the report. [Also included in 18 (a) and 18(d)] [AIMR/FAPC92, p. x]
Finally, we emphasize the needs of financial statement users in the standards-setting process. We argue that users of financial statements are also the owners of the enterprises being reported upon, and it is the users who, in addition to receiving the benefits, ultimately bear the cost of providing financial reports. We suggest that user viewpoints be incorporated in the standard-setting process through their direct participation as members of the FASB, in addition to the current practice of their providing written comments and oral testimony. [Also included in 18 (a) and 18(d)] [AIMR/FAPC92, p. x]
[Context] It indicates the scope of the discussion of the topic and lists the report's major recommendations, providing an introduction to the following excerpts from the report.
The Role of the FASB
We do not know what the future role of the FASB will be, but at the moment it certainly is the paramount standard-setting organization affecting financial analysis in the United States. Over the years we have had differences with the FASB and we have discussed many of them and noted others at various places in this report. Those differences are inevitable given our single-mindedness in seeking information useful in the workings of investment analysis. They in no way subvert our total support of the FASB as an institution. We are on the record22 in that regard. All of our comments herein are made with the hope of improving its operations, strengthening its perseverance, and raising its stature. [AIMR/FAPC92, p. 54]
From time to time the FASB is criticized, disparaged, assailed, censured, and even castigated by various individuals and organizations. Much of that criticism seems to us unwarranted, as we discuss in greater detail below. It seems to be as much an expression of disappointment and disagreement, ie. unhappiness, as anything else. In fact, the more we hear of it the more convinced we are that the FASB is accomplishing its mission. It has undertaken some of the most daunting projects imaginable: financial instruments, post-retirement benefits of all sorts, reporting income taxes, among others. It has been lobbied incessantly by, among others, the Business Roundtable, various competing government agencies, a variety of financial institution trade associations, and various trade associations and similar groups. [AIMR/FAPC92, p. 54]
Perhaps the best way to appreciate the virtue of the FASB is to ask who or what could do a better job. The answer is clear. There is no alternate arrangement that would come close to achieving the integrity of the FASB and its ability, by promulgating accounting standards, to compel the propagation of unpopular truth through financial reports. We, in common with others, could hope for standards more beneficial to our needs. Unlike many others, we also encourage the FASB to act more rapidly in considering and issuing standards. We have consistently opposed changes in the Board's operating procedures that act to slow its tempo. We hope it is clear that our position is one of thorough support for the institution, without endorsement of all its actions or conduct. [AIMR/FAPC92, p. 54]
Recent Criticism of the FASB
The issuance inate 1987 by the FASB of three majopronouncements € marked the escalation of previously scattered protests into more serious dissention. "FASB bashing" became close to sport in some quarters. We agree with some of the opposition, but we differ with the passion (and sometimes vitriol) with which a good deal of it has been expressed. In most cases however, we believe that the FASB's critics either are mistaken or else are acting in a self-interested manner. Some of the criticisms we have heard and our answers to them are summarized in the list that follows. [AIMR/FAPC92, p. 55-56]
Financial reports have become difficult to understand. We agree, but for quite different reasons. First, business activity has become more complex. Second, the FASB has had the fortitude to confront difficult problems that are not amenable to simplistic answers. We do not expect the financial affairs of multifarious economic organisms to be reducible to a few simple comprehensive easy-to-read numbers. It just is not possible. [AIMR/FAPC92, p. 56]
However, we could and do expect a better effort on the part of enterprises issuing financial reports to make their affairs more understandable to the investment analysts and advisors who simply are unable to devote major portions of their time to digesting imposing new pronouncements on abstruse accounting topics. Financial reports more and more have taken on the appearance of compliance documents rather than communication tools. There is no need for that. Some investment analysts have even begun to question whether those who prepare financial reports understand the purpose for which a particular standard was issued. The FASB and the SEC set minimum disclosure requirements. There is no proscription on relating more or explaining that which is disclosed. We should not blame the FASB because it cannot mandate a willingness on the part of managements to decipher and illuminate their affairs. [AIMR/FAPC92, p. 56]
The FASB has issued too many standards too quickly. The FASB commenced operations in 1973, nineteen years before this report was written. In that interval, it has issued 109 standards and substantially fewer interpretations. The rate is fewer than six standards per year. But, the rate of issuance of major new standards with broad impact across all industries is between one and two a year. The vast majority of the FASB's new standards are modifications of existing pronouncements, adoption as standards of existing AICPA literature, or matters that affect specific industries, including not-for-profit enterprises. Not only that, the standards themselves are relatively brief. Most of the bulk is supplied by the included illustrations and practice guides requested by financial statement preparers and their auditors. [AIMR/FAPC92, p. 56]
Nor can the pace at which major new broad-based standards are issued be characterized as swift. In our comments on transition we remark on the number of years it takes before a new standard is fully implemented. In addition, many new standards take numerous years from the time they are placed on the FASB's agenda until a final standard is approved by a minimum 5-2 vote, the so-called "super majority." The change a few years ago from a simple majority vote for approval of a new standard to the "super majority" was designed to slow further the board's already glacial pace. [AIMR/FAPC92, p. 56]
Complaints about too many standards, too quick standards, or too-complex standards seem to be mistaken, but may actually be misdirected. Major new standards are infrequent and, shorn of accompanying material, relatively succinct. However, the numbers and size of the new reading material emanating from the FASB is overwhelming. Most of it pertains to matters in progress. Perhaps if the process were to be speeded up, fewer interim reports of various sorts would be produced, thus lessening the seemingly endless pondering by all of unfinished agenda matters. [AIMR/FAPC92, p. 56]
The FASB is too theoretical. This argument is heard frequently, but simply is not true. In fact, in many cases the FASB has issued standards that are obviously contrary to good accounting theory. For example: [AIMR/FAPC92, p. 57]
FAS 87 and FAS 106 on employers' accounting for pensions and other postretirement benefits, respectively, contain a variety of procedures and choices that allow smoothing of transition balances, actuarial and experience gains and losses, and the cost (benefit) of plan amendments over many accounting periods, thus smoothing the annual pension costs in ways totally unsupported by accounting theory. [AIMR/FAPC92, p. 57]
FAS 15 specifies accounting for restructured debt using methods that ignore the time value of money. FAS 15 directly conflicts with APBO 21 "Interest on Receivables and Payables." One of its effects was to allow financial institutions in the U.S. two different accounting results for optional alternative settlements of the Mexican debt, even though the alternatives were identical in substance. [AIMR/FAPC92, p. 57]
FAS 52 provides that assets and liabilities expressed in foreign currency, where the local currency is the functional currency, shall be translated at the exchange rate at the balance sheet date. The result is that real assets (property, inventories, etc.) are treated as if they are money. In order to prevent obviously absurd results, FAS 52 prohibits application of that method to currencies of highly-inflationary24 economies. [AIMR/FAPC92, p. 57]
In our opinion, a more accurate accusation would be that the FASB is not sufficiently theoretical in its pronouncements. We often are disappointed by the issuance of a standard that incorporates one or more flagrant departures from theory in order seemingly to make it more palatable to other members of the business community. Each departure from theory makes the data contained in financial statements less interpretable, or comprehendible only with additional analytic effort. [AIMR/FAPC92, p. 57]
It is quite possible that those who denounce the FASB for being too theoretical are in actuality complaining less about the standards issued than about the succession of documents that antedate issuance of a standard. Commentators are forced by discussion memoranda, invitations to comment, exposure drafts and the like, to provide conceptually valid support for the positions they take. Respondents therefore are required to be more than familiar with the FASB's conceptual framework project as well as with the greater body of "common law" accounting and economic theory. In addition, they are called upon to be up-to-date on new and seminal conceptual and empirical work, not only in accounting, but also in finance and economics. Although their grievances are filed with the FASB, they might be more accurately directed to persons who are pushing back the frontiers of knowledge. [AIMR/FAPC92, p. 57]
The cost of applying new standards is excessive. The dictionary definition of excessive is "characterized by excess; being too much or too great; immoderate; inordinate." For something to be excessive, it must exceed the right, proper or correct amount. Yet, there is no reference amount of cost that one can characterize or measure out as being correct. In short, excessiveness is a value judgement. Assertions that it exists do not make it true. [AIMR/FAPC92, p. 58]
In particular, it is the providers of financial statements from whom the claim of excessive cost is heard. We can respond by asserting that the cost to them, high as it may seem, is still less than the benefit to financial statement users of: (a) minimizing the cost of providing the data by having the firm do it once and provide it to multitudes of users who otherwise would individually have to replicate the firm's effort; (b) having the firm as the source of information, thus obviating the need for analysts to scavenge for less reliable data from secondary sources; and (c) making available an additional source of information which confirms or denies other sources. One of the charges to the FASB in its mission statement is: "To promulgate standards only when the expected benefits exceed the perceived costs." We wish them well in trying to implement a notion for which there is a paucity of guidance in the literature of welfare economics. We hope they will not succumb to judging the issue based on the quantity and loudness of the voices they hear. [AIMR/FAPC92, p. 58]
Finally, we need to consider who bears the cost of providing the information that appears in financial reports. In one very real sense there is no added compliance cost to financial statement preparers. Their salaries remain unchanged, and may even be enhanced as the scope of their responsibilities is enlarged. The costs are paid out of general corporate funds and, ultimately, are borne by the firm's investors, the users of financial statements. The cost of information is one of the prices we pay for efficient financial markets. But the benefit of rational capital allocation can be far in excess of the relatively small amounts paid to make financial markets efficient. Investors are the ones who suffer both the cost and reap the benefits of improved financial reports. We would hope that company managers, who are their agents, should not confuse their own personal interests with those of their principals. [AIMR/FAPC92, p. 58]
The FASB is inimical to the interests of financial statement preparers. This is a variation on the criticisms already discussed above. It can be addressed briefly. We have seen much concerted action of the part of financial statement preparers, in particular the Business Roundtable, to attempt to stifle the work of the FASB. We view these actions with much trepidation, our concern being that the size of the forces deployed by the critics of FASB might be construed as measuring the justness of their cause. [AIMR/FAPC92, p. 58]
The cause needs to be examined on its own merits. The discussion of specific complaints immediately above indicates that they have little or no substance. We believe that any declaration to the effect that the FASB does not serve the interests of financial statement preparers is not only wrong, it is self-serving. First, some financial analysts hold the exact opposite view; they feel that the FASB favors preparers. We also find that view self-serving. The fact is that the FASB is not to serve any specific constituent group. It is to serve equally and even-handedly everyone with an interest in financial reporting. That is why the members of the board must sever all ties with their previous employers. As long as everyone, financial analysts included, believes that their interests could be better served, the FASB must be doing a rather good job of balancing competing interests for the good of the whole. [AIMR/FAPC92, p. 58-59]
Does the FASB follow due process? Some commentators have taken the FASB to task for not following due process. Their view seems to be that the FASB should be following the popular view as expressed by the majority of the comments directed to it. In that view, the setting of accounting standards is (almost) entirely a political process in which lobbying is seen as a productive activity. Our view is quite to the contrary. [AIMR/FAPC92, p. 59]
First, we believe that the politicization of accounting should be kept to a minimum. It should not be used to serve special interests. The FASB needs information from its various constituencies that will aid it in seeing that important information is provided to financial statement users without causing undue turmoil on the part of preparers. Lobbying is an extreme form of information transmittal that has negligible legitimacy in the standard-setting process. After all, we are speaking of the measurement of economic phenomena; no matter how fine the sentiments expressed, the laws of economics defy change. [AIMR/FAPC92, p. 59]
Second, we are convinced that, if anything, the FASB is too concerned with due process and sunshine. In many cases, the system has acted to slow almost to a halt the pace at which new standards are issued. The stages seem excruciatingly slow on occasion. Now the FASB has gone to extended comment periods on two recent discussion memoranda.25 We also suggest that the prohibition on a majority of the board members meeting in private or without advance public notice is unnecessary. In fact, we believe that the quality and quantity of the board's work could improve if some of it at least were sheltered from continual scrutiny. [AIMR/FAPC92, p. 59]
The Charge to the Oversight Committee
In its response to a request for comment on the report of the Special Advisory Group to the Board of Trustees of the Financial Accounting Foundation, the Financial Analysts Federation, one of two organizations that combined January 1, 1990 to form AIMR, disagreed with the statement that the Foundation's role is "to offer the FASB greater support in terms of advice and counsel regarding standard-setting activities."2 We also disagreed with the notion that the trustees should consider such matters as agenda-setting, implementation matters, and relations with constituents when monitoring the standard-setting process. [AIMR/FAF91, p. 3]
In particular we disagreed with Recommendations (8) and (9) in the Special Advisory Group Report proposing establishment of an oversight committee with part-time paid Chairman and staff. We wrote that in our view:
Such a proposal. . . would add an unnecessary additional layer of expense, bureaucracy, and paperwork. We view this as an attempt by the business community to gain greater control of the standard-setting process. In the event that the Foundation should pursue these recommendations, we believe that any person selected as Chairman of the Oversight Committee should have few ties to the preparer community and have a known reputation for independence and objectivity.
[AIMR/FAF91, p. 3]
In responding to the specific questions below, we have to state our hope that the Oversight Committee's interview guide and process does not set a precedent for an annual review of FASB activities for each previous five-year period. [AIMR/FAF91, p. 4]
Purpose of the Project
A reading of the interview guide leads us to offer the following additional comments about the purpose of the project. In the main these comments repeat material submitted previously to the Securities and Exchange Commission (SEC) during the past five years.3 [AIMR/FAF91, p. 4]
Since the SEC holds ultimate authority over the standard-setting activities of the FASB, including the consistency of FASB actions with its mission statement, the Foundation's Oversight Committee appears to us to be performing a redundant, unnecessary, and costly function during a period in which resources are tight. [AIMR/FAF91, p. 4]
The repeated comment in the interview guide that the Oversight Committee "will not impair, in fact or perception, the independence of the FASB with regard to the technical content of standards" is reassuring. We would welcome an equally strong statement that both the Oversight Committee and the Financial Accounting Foundation will not impair, in fact or perception, the independence of the FASB with regard to standard-setting activities, including agenda-setting, implementation and transition matters, and relations with sponsoring organizations and the public. [AIMR/FAF91, p. 4-5]
Confidentiality
We note that responses to the Oversight Committee's request for comment will be held in confidence. We have no objection to dissemination of our response; in fact, we welcome it. [AIMR/FAF91, p. 5]
In response to the Oversight Committee's questions, we will summarize below many of the comments submitted within the past five years by our Financial Accounting Policy Committee (FAPC) about specific standards and the standard-setting process. It is the function of the FAPC to comment to the FASB (and other standard-setting bodies) about proposed accounting standards. Committee representatives testify at FASB hearings related to proposed standards and participate in FASAC and task forces. The committee also meets periodically with individual members of the FASB and/or its staff in response to FASB requests for input. The committee also schedules an annual public meeting with the full board and representatives of its staff. These discussions lead us to believe that the members of the FASB--and its staff--know and understand our point of view. That they do not necessarily heed it or adopt it is entirely another matter. [AIMR/FAF91, p. 5-6]
Our submission to the FASB are, of course, public documents. In addition to FASB's disclosure of written comments and testimony, we have a relatively extensive dissemination list of our own. We are questioned sufficiently often by the press and, at times, by representatives of publicly listed companies and accounting firms, to believe that our comment letters are read. [AIMR/FAF91, p. 6]
The members of the FASB and its staff also know that we feel very strongly that FASB efforts to placate some issuers have led to specific provisions within individual standards with which our committee finds fault. Despite this, by and large, we feel that the FASB is meeting its own objective that "Financial reporting should provide information that is useful to present and potential investors and creditors and other users in making rational investment, credit, and similar decisions."4 [AIMR/FAF91, p. 6]
How Well is the FASB Accomplishing Its Mission?
Overall, we believe that the FASB is doing a good job. We do, however, have three major concerns:
1. The inconsistency, standard-to-standard, and alternatives within standards, of effective date and transition provisions for new pronouncements;
2. Destruction of financial data without commensurate improvement in the financial information provided; and
3. Pronouncements concerned with balance sheet presentation with little attention to how the results are reported in the income statement.
[Also partly included in 2(c)] [AIMR/FAF91, p. 7]
These concerns have been communicated to the FASB in a public meeting, by summary letter, and in individual comments on individual standards [and are the subject of the following pages, which are included in several of the categories of the database - 1(b), 2(c), 3(c), 5(a), and 5(c)].
[AIMR/FAF91, p. 7]
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Factors contributing to the FASB's Success or Lack of It. When the FASB focuses on the Objectives of Financial Statements that were its inheritance from the Trueblood Study Group, and its own Statement of Financial Accounting Concepts No. 1 (Objectives of Financial Reporting by Business Enterprises), it appears most successful to us. Where it is deflected by attempts to accommodate "constituents," it appears to us to be least successful. [AIMR/FAF91, p. 14]
The inconsistency of provisions for the date of compliance with new standards and the alternatives permitted during transition periods appear to us to be accommodations to some issuers who argue for time to rewrite computer programs, gather data, or otherwise prepare for compliance. Such needs are perfectly understandable, but elasticity in effective date and terms of transition reporting defeats the needs of users. [AIMR/FAF91, p. 14]
In addition the concept of "constituents" in the context of conceptually sound standards, Precept 2, is one that troubles us. We tend to believe that the root of much of the criticism received by the FASB is in the use of the word "constituent." The word implies the relationship of the elected representative, who continually must balance the needs and benefits expected by electors with that of the general welfare. That is not, and should not be, the role of the FASB. [AIMR/FAF91, p. 14-15]
Overall FASB's role was spelled out in the Objectives of Financial Statements developed by the Trueblood Study Group, which concluded "that the development of objectives should not be based on the operating needs of the managers of businesses, but rather on the needs of users of financial information outside enterprises or organizations."5 [AIMR/FAF91, p. 15]
Objective 3 [Consider promptly any significant areas of deficiency in financial reporting that might be improved through the standard-setting process]. Two of the FASB's most cherished traditions, careful attention to the views of "constituents" and its elaborate and time-consuming due process procedures, are in direct conflict with the objective of prompt consideration of significant areas of deficiency in financial reporting. Our experience has been that through the Emerging Issues Task Force, FASAC, and the normal give and take of discussions, meetings, and correspondence with accountants, preparers, academics, users, and others, the FASB has developed the "screens" necessary to highlight significant areas of deficiency. [AIMR/FAF91, p. 16]
Except in one or two exceptional instances (delaying the FAS No. 96 implementation date for one and FAS No. 104 amending No. 95 and the occasional provision of technical bulletins), and despite its knowledge that standards are necessary and overdue, the FASB process allows for slow and tortuous decision-making. Standards that were overdue include FAS Nos. 105 and 106 (Postretirement Benefits Other than Pensions). Users found problems with applications of FAS No. 14 early on and have called attention to them for more than a decade. Users applauded the announcement that there would be research in the segment area, albeit occasioned by implementation of FAS No. 94, but no result is expected for years to come. In the user's order of priorities such action has been on the top of the list for much too long. [AIMR/FAF91, p. 17]
Precept 2 [To weigh carefully the views of its constituents in developing concepts and standards]. We believe wholeheartedly in the FASB's system of due process. The major problem we perceive is that the way the system is employed handicaps any effort to provide statements on a more timely basis. That is, it takes too long for a standard to find its way between the initiation date and the implementation date. The technology driven age in which we live is formulating new equations between relevance and timeliness that the FASB needs to address. Our concerns in the area the interview guide explores here were discussed earlier in this response. [AIMR/FAF91, p. 21]
Frustrations continue in the task force process. We continue to hope that having a member of the FASB as chairman will have beneficial results for both the board and the members of task forces. [AIMR/FAF91, p. 21]
The FASB can always do more to communicate that it has considered the views of all parties. We hear major complaints from some issuers that its views are not heard. We could echo those complaints in equal volume but we do not have the time, funds, or inclination to do so. It is perhaps a sign that the system works that both communities can voice the same complaint. [AIMR/FAF91, p. 21]
Precept 3 [To promulgate standards only when the expected benefits exceed the perceived costs]. When the various arguments related to the cost/benefit equation are applied to accounting standards, it seems that the only inarguable conclusion can be that a standard that helps enterprises report economic reality is the ultimate benefit that outweighs the costs to both preparers and users. Unfortunately, the way the cost benefit rule is formulated, it appears to place the burden of proof on the user of financial statements. Since it is almost always the user that is seeking change, it appears that the user must demonstrate that the benefits outweigh the costs. [AIMR/FAF91, p. 21-22]
We repeat here comments on the cost of accounting standards and disclosure vs. their benefits previously conveyed to SEC Commissioner Philip R. Lochner, Jr. [AIMR/FAF91, p. 22]
The cost of not applying appropriate accounting and disclosure principles is most vividly and currently evident in the meltdown of shareholder and debt holder investments in savings and loan institutions. Two elements are necessary in any comparison of that cost with the cost of developing and implementing an accounting and disclosure system that would reveal the "underlying reality"8 and economic integrity of the institutions:
1. The equity holder is an owner of a business and bears a pro rata share in every cost of doing business. Disclosure to the stock holder is not a corporate frill provided by benevolent management but an obligation of those retained to manage an enterprise to those who participate in the ownership and carry their fair share of risk and reward of the business. If there is no reward, the stock holder simply loses income on the investment. If the risk is extreme, the stock holder loses the investment.
The debt holder also has a monetary stake in the enterprise but is in a more advantaged position than the equity owner and may recoup some, if not all, of an investment even if the agreed upon return is lost.
2. The cost to investors of a financial debacle, whether industry-wide as with the S&L failures, or isolated to one company, as is the case of Caterpillar's failure to disclose its dependence on its Brazilian operations, outweighs the cost of adequate accounting and disclosure. The minimum costs of nondisclosure to the enterprises in both instances include major stock price declines as well as diminished corporate credibility.
The interaction of reality-related accounting and disclosure with the analysis of securities professionals yields the ultimate benefit--a fair and efficient market. Bevis Longstreth, a former SEC Commissioner, described this result in a relatively recent book:
Today, the efficiency of our capital markets is much more a product of rapid dissemination of information, its analysis by professionals, and the investment decisions of institutional investors relying on that analysis than of the trading by insiders and those with special access to insiders. Over the years the security analyst has replaced the inside source as the key to sound investment choice within an actively managed portfolio.9
John C. Coffee, Jr. of Columbia University Law School offered four major arguments in favor of a mandatory disclosure system in a Virginia Law Review article.10
1. Because information has many characteristics of a public good, securities research tends to be underprovided. . . . A mandatory disclosure system can thus be seen as a desirable cost reduction strategy through which society, in effect, subsidizes search costs to secure both a greater quantity of information and a better testing of its accuracy. . . . It [improves] the allocative efficiency of the capital market--and this improvement in turn implies a more productive economy.
2. Greater inefficiency would exist without a mandatory disclosure system because excess social costs would be incurred by investors pursuing trading gains.
3. The theory of self-induced disclosure. . . . has only a limited validity. A particular flaw in this theory is that it overlooks the significance of corporate control transactions and assumes much too facilely that manager and shareholder interests can be perfectly aligned. . . . Instances will arise in which management can profit by giving a false signal to the market.
4. Even in an efficient capital market, there remains information that the rational investor needs to optimize his securities portfolio. Such information seems best provided through a mandatory disclosure system.
From time to time analysts have been asked for a cost/benefit analysis of one disclosure requirement or another. AIMR's accounting committee made a fairly wide search several years ago for a model that might be used for such analysis. We discussed the matter with several academics as well as statistics experts. Those discussions convinced us that there is neither a commonly accepted model nor a convincingly workable one to compare costs that may be quantifiable in terms of such expenses as personnel, computer time, and printing and distribution with the benefits of rapid dissemination of information in the marketplace and such savings as may be achieved in the research time of professional and individual investors. We know that investors ask many questions of management. We would expect them to ask many more questions should timely, relevant information not be available.
[AIMR/FAF91, p. 22-24]
Several of the standards issued during the past five years have provided less in terms of benefits to users than they cost in terms of destruction of data and loss of comparability and consistency. We would not, however, except in the case of FAS No. 96, agree that the standards failed to provide benefits that exceed the costs of providing information necessary to reflect the economic reality of an enterprise. [AIMR/FAF91, p. 24]
Field tests. We stated our belief earlier in this response that analyst participation in a cash flows field test might have prevented the disenchantment that has replaced initial support for the indirect method adopted in FAS No. 95. [AIMR/FAF91, p. 24]
In one of its annual meetings with the FASB, AIMR's Financial Accounting Policy Committee suggested that users be included in field tests. Fear that inside information would be made available made the FASB cautious about pursuing analyst interest here. The committee also made the same suggestion to representatives of the Committee on Corporate Reporting of the Financial Executives Institute. It was agreed, we believe, that, at a minimum, user review of proposed field test questions would be helpful. [AIMR/FAF91, p. 25]
Analysts continue to believe that ways can be found to erect a Chinese Wall to prevent use of any nonpublic information that might be obtained through a field test relationship. Many analysts are academics who do not manage money. Others are specialists whose interests are confined to one industry or industry sector but whose skills could be transferred to another industry involving companies they do not follow. [AIMR/FAF91, p. 25]
Precept 4 [To bring about needed changes in ways that minimize disruption to the continuity of reporting practice]. To minimize disruption to the continuity of reporting practice, we believe that the FASB should eliminate alternatives and establish one effective date for implementation. We discussed the problems inherent in the disruption of the continuity of reporting practice earlier in this response. [Also included in 2(c)] [AIMR/FAF91, p. 25]
Precept 5 [To review the effects of past decisions and interpret, amend, or replace standards in a timely fashion when such action is needed]. As we stated earlier in this response, we believe that the FASB's informal and formal interactions with the bodies concerned with accounting standards provides adequate information about problems associated with individual standards, their timeliness, and the necessity for amended or new standards. [AIMR/FAF91, p. 25-26]
General Questions
FASAC--We believe that FASB's relationship with FASAC is satisfactory.
Technical Staff--By and large we find FASB's technical staff satisfactory but sorely lacking exposure to, and experience with, financial statements from the user point of view. Since the pool of analytical talent is relatively small, and since analysts are not accountants and so are not likely to be of as much assistance as a staff member who can deal with the technical aspects of accounting, we wonder whether the sensitivity of the FASB's technical staff to user needs and methodologies would be enhanced by experience as interns in the research departments of broker-dealers, investment advisory firms, banks, insurance companies, or pension funds. [AIMR/FAF91, p. 26]
Functioning of trustee or board member--More time spent with representatives of the users of financial statements and more representation of users on the trustees and the board seem to us essential. [AIMR/FAF91, p. 26]
The FASB's Mission, Objectives and Precepts
With the exception of Precept 2, discussed above, we believe that the Objectives and Precepts are appropriate. [AIMR/FAF91, p. 27]
There is a gap in the Objectives and Precepts relating to the Concepts Statement of the Objectives of Financial Statements. If the desired result is as stated--that is, to provide information useful to present and potential investors and creditors, and other users in making rational decisions, it appears to us that a new Objective 1 should be added to state that goal. By and large the user has been the invisible guest at the accounting standards-setting table. [AIMR/FAF91, p. 27]
The FAF's Oversight Responsibilities and Process
We firmly believe that the Foundation's oversight activities should be restricted to those stated in the initial incorporation documents, i.e. financing and budget without power to omit or undertake any particular projects or activities or otherwise affect FASB functions and powers relating to standards of financial accounting and reporting; review of bylaws and structure; and election of members of the FASB. [AIMR/FAF91, p. 27]
Oversight for such a foundation should be a relatively simple process. [AIMR/FAF91, p. 27]
Since we believe that the function of the Oversight Committee is redundant, we do not think it necessary that the committee publish any report but that any matters necessary for comment come through the annual report of the Trustees. [AIMR/FAF91, p. 28]
Other issues that we believe the Trustees (or the SEC) should consider:
a. The perception that the FASB is under undue political pressure from some issuers to favor managements' accounting goals.
b. The perception that most if not all accounting firms have lost their ability to maintain an independent attitude.
c. That the contribution of funds, or the lack thereof, gives special status or voice to the contributor.
d. The continuing dearth of bona fide user representatives on the FASB.
[AIMR/FAF91, p. 28]
[Context] The papers are a summary of a committee and staff members' discussions with selected sell-side analysts from Goldman Sachs.
[One analyst] believes that management is responsible for the integrity of financial statements, but that the profession has not carried this message to the public. She also believes that the profession should take a more public and positive stand on issues that affect it. [Also included in 2(d)] [GOLDMAN, p. 2]
[Context] Letter sent to the FASB Chairman by an analyst.
[Agenda setting] is one of the single most important activities of the Board; it determines how effectively Board time will be spent over the next several years. Any [investment] professional should be able to appreciate the significance of that effort. As [has been pointed] out, this activity is nearly invisible to the user community at large. [R.G. ASSOCIATES, p. 1]
How to make it visible? I think that the Board may be on the right track with its "prospectus" approach on a mortgage servicing rights project, but I don't know how effective it has been so far. To make the agenda setting process more visible in the analyst community, I would again suggest getting some of the technical staff members on the analyst society luncheon circuit. They could easily discuss current and potential agenda projects; if done properly, they could provide relevant first-hand intelligence to the Board for defying the agenda while bringing some appreciation of the process to the constituency. [R.G. ASSOCIATES, p. 1]
I believe that analysts would immediately understand the problems in agenda-setting; however, I think we have short memories. I'm not certain that any long-lasting communication benefit would be gained from this, but I still believe that the input aspect of this exercise would make it justifiable. [R.G. ASSOCIATES, p. 1]