9. Measurement Uncertainties
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 . . . the needs of users. [FASOversight, p. 1]
Additional disclosure of risks and uncertainties, commitments, and off-balance-sheet transactions should be made in the financial statements. [Also included in 10 and 19] [FASOversight, p. 2]
__________
Another aspect of verifiability is knowledge of its absence. Most accounting numbers have an appearance of precision. But, other than contemporaneous exchanges involving cash, accounting numbers are determined by estimates of various degrees of inexactitude. Analysts need to know how indefinite those numbers are and they need to know the degree to which the same economic event or condition could have been reported differently using alternative measurement methods. More information of that sort incorporated in financial reports would be exceedingly welcome. [Also included in 2(b)] [AIMR/FAPC92, p. 21]
__________
[Context] Meeting of the Investor Discussion Group on December 9, 1992. Part of the meeting was devoted to the topic of alternative accounting procedures. During the discussion, a comment was made on measurement uncertainties.
Participant I-12
The accounting profession seems to have decided that discounted cash flow is the appropriate accounting disclosure. My difficulty with that is that when you use a discounted cash flow approach, you have to make certain interest rate assumptions and other assumptions. We don't know what assumptions are used nor the amounts to which they were applied. When you have a big change in interest rate, it suddenly changes the value of those cash flows. Another example is the present value of retirement obligations; there are a few companies that are using 9%-10% interest rate assumptions in today's environment and there is a risk there that is not very obvious. [TI 12/9, p. 45]
[Context] Meeting of the Investor Discussion Group on December 9, 1992. Part of the meeting was devoted to the topic of measurement uncertainties.
Committee/Staff/Observer
Question 10(d) relates to measurement uncertainties. Some of the amounts of the assets and liabilities at the reporting date are uncertain, and whether their amounts are materially correct will be confirmed by future events. The estimates involved in asset and liability measurements are referred to as measurement uncertainties. Some members of the Special Committee believe that investors too often are unaware of, or tend to forget, the extent to which amounts in financial statements are the results of estimates, assumptions and judgments. They believe the usefulness of financial reporting can be improved by requiring companies to disclose that uncertainties are inherent in measuring many financial statement items because measuring their reported amounts requires estimates, assumptions, judgments, and the application of various allocation procedures. Our question is: do you agree that a disclosure that would remind investors about the existence of measurement uncertainties would be a meaningful improvement in financial reporting? [TI 12/9, p. 59-60]
Participant I-12
Amen. [TI 12/9, p. 60]
Participant I-8
What do you mean? Just a paragraph that says that these are approximations? [TI 12/9, p. 60]
Committee/Staff/Observer
Let's get into detail. There are two different things; the first is a boilerplate type of disclosure (like on a cigarette pack) to tell people that the accounting numbers are not as precise as they appear. Would such a disclosure be helpful? But more importantly (the second thing), would you want disclosure of the assumptions made when it's not a definitive number? [TI 12/9, p. 60]
Participant I-4
Doesn't a company need that for its own liability? [TI 12/9, p. 60]
Participant I-7
I'll accept a boilerplate disclosure to the extent that there is specific disclosure for material information. [TI 12/9, p. 60]
Participant I-11
I think it's true that many people don't realize and people who do realize forget about the uncertainties going into the creation of financial statements. But there is so much boilerplate on everything anymore that it seems worthless to add one more piece of metal. In terms of the disclosure of each individual assumption, that strikes me as a logistic monstrosity. I suppose there could be some exception to my comment, for example stage of completion on construction projects. But by and large, I don't think we need it. [TI 12/9, p. 61]
Participant I-8
Stage of completion on construction projects is an area of abuse that I've seen in the past. I would agree with [participant I-11] on that. [TI 12/9, p. 61]
Participant I-11
That's one where I can see a reason for the disclosure. [TI 12/9, p. 61]
Participant I-7
A lot of this information is already provided in the 10-K: receivable reserves and inventory reserves. Also, in the annual report, when you break out the tax line, very often you can see things like warranty reserves as one example. So there is a lot of information already for material items. [TI 12/9, p. 61]
Participant I-4
I think a boilerplate disclosure is redundant if you believe that the market you're serving is the professional investment community. Hopefully, people in our profession know that these kinds of balances and reserves exist. [TI 12/9, p. 61]
Committee/Staff/Observer
Let's leave the boilerplate disclosure off the table. What about unique assumptions or measurements on the liability side; would you want disclosure of how the company arrive at them? [TI 12/9, p. 61]
Committee/Staff/Observer
For example, the company has a tax contingency; the IRS claims $200 million and the company is taking it to court. [TI 12/9, p. 62]
Participant I-7
That's material and that's disclosed. [TI 12/9, p. 62]
Committee/Staff/Observer
Another example is the assumptions that a company uses in establishing warranty reserves? Or factors that go into the computation of the present value of an item that is reflected on the balance sheet at present value? [TI 12/9, p. 62]
Participant I-8
There is a lot of examples. Companies have different inventory obsolescence policies. I'd love to know about that. [TI 12/9, p. 62]
Committee/Staff/Observer
Again if it were material? [TI 12/9, p. 62]
Participant I-8
Yes. [TI 12/9, p. 62]
Committee/Staff/Observer
Those are the kinds of things we're thinking about. Not just a boilerplate statement with respect to each balance sheet item, but disclosure about the major assumptions that go into the measurement of those items. [TI 12/9, p. 62]
Committee/Staff/Observer
Isn't the kind of information that [committee/staff/observer] is describing the kind of information you would obtain by probing on your own? [TI 12/9, p. 63]
Participant I-8
You try. [TI 12/9, p. 63]
Committee/Staff/Observer
If that's the case and it's pertinent to you, it seems that it should be in the financial statements. [TI 12/9, p. 63]
Participant I-8
We're all in favor of that. [TI 12/9, p. 63]
Participant I-5
Generally speaking, why wouldn't it already be disclosed in your accounting principle statement? [TI 12/9, p. 63]
Participant I-12
I would like once again to make my point about present value accounting. Everyone of us has gone to the retirement footnote and seen what kind of interest rate assumptions people are using. There's a lot of companies that we can see go bankrupt over the next 3 years because they're using very high projected returns (9-10%) and they're not getting those kinds of return in this environment. Those are adjustments that will have to be made at some point, I suspect. In the industries that I cover, you have a whole range of assets and liabilities that are valued on a present value basis. For mortgage banks, there is a form of discounted cash flows that is being applied as a required accounting convention, and I don't know what interest rates those are put on the books at. [TI 12/9, p. 63]
Participant I-7
There is only one company that I follow that is making an estimate in terms of environmental exposure. In the manufacturing industry, for an increasing number of companies, the environmental risk is rather extraordinary, and I have only one company that makes an attempt at telling you what they spent and forecast expected costs for 1 to 3 years. [TI 12/9, p. 64]
Committee/Staff/Observer
I'd like to ask [participant I-5] a follow-up question. Right now in the financial statements, footnote 1 tells you how the accountants grind on the numbers in a particular case. This issue deals with whether you want more disclosure in the financial statements that talk about management's subjective decisions that were added to that grinding? Or in some cases used in lieu of grinding? [TI 12/9, p. 64]
Participant I-5
I think that the accounting policy statement is not complete without that. [TI 12/9, p. 64]
Committee/Staff/Observer
No, the statement is a statement of accounting principles. What we're talking about here is something in addition to that. [TI 12/9, p. 64]
Committee/Staff/Observer
It's information about the method of applying a principle. [TI 12/9, p. 64]
Committee/Staff/Observer
You're going to read about what management thought about in arriving at an estimate. [TI 12/9, p. 64]
Participant I-5
Give us an example. [TI 12/9, p. 64]
Committee/Staff/Observer
With respect to the warranty, maybe it's not simply a mechanical process of looking at the current month's sales; instead, management makes some kind of judgment based on how it reads its current quality control information, and then they determine that the estimates should be based on certain specific factors. The information you would be getting is the factors they took into account, without getting any numerical calculations as a result of that. [TI 12/9, p. 64-65]
Participant I-5
If that was a big deal, wouldn't that be in an individual note about those numbers? [TI 12/9, p. 65]
Committee/Staff/Observer
No. What we're saying is management has complied with generally accepted accounting principles in arriving at its determination of liability under product warranties. All you have is a number. What we're asking is whether you want to know about the assumptions used by management to arrive at that number? [TI 12/9, p. 65]
Participant I-7
If we're not talking about a case of fraud, management is in a better position to do that than I am. So the only time I would want the information is if we're talking about like product and there is a material change in the warranty. [TI 12/9, p. 65]
Committee/Staff/Observer
Let's assume that management legitimately came up with $1,000 for that warranty liability. Something happens and the next year, instead of $1,000, it's $1 million and the company's stock goes down by half and somebody asks the auditor how he could have passed on those financial statements when there is no disclosure about how they arrive at $1 million. [TI 12/9, p. 65]
Participant I-12
We have a real-world example: the S&Ls and their loan loss reserves. [TI 12/9, p. 65]
Participant I-9
I don't think you can ask the companies to do this. This prejudices their negotiating of settlement of claims. A company can't put a number in there that they would be happy to settle for without costing the shareholders value over time because that's a blank check. The two areas in which I find information would be most helpful on are real estate (fair value that could be realized in an orderly liquidation over time) and the health care benefits assumptions. On the latter, companies like [names deleted] are not using numbers that are relevant to past history because if they did they would be insolvent. We want the accounting profession to at least put us on notice that the inflation rate in health care that they're using doesn't bear any relationship to what's going on over the last 20 years. We can't do that ourselves. [Also included in 4] [TI 12/9, p. 65-66]
Participant I-5
If there's materiality in the outcome, then we should know what those assumptions are and I think that this is the general rule now, isn't it? [TI 12/9, p. 66]
Committee/Staff/Observer
No. I think you're mixing up disclosure in accounting principles versus how management arrives at its estimate of a number. [TI 12/9, p. 66]
[Context] Meeting of the Investor Discussion Group on January 13, 1993. Part of the meeting was devoted to the topic of value information. During the discussion, comments were made on measurement uncertainties.
Committee/Staff/Observer
There is no interest for running value changes through the income statement. I'm wondering what your reaction is to the accounting in the pension arena when value changes are in effect spread to eliminate volatility. That's kind of a compromise in the market value arena; is that good or bad? [Also included in 2(b) and 4] [TI 1/13, p. 23]
Participant I-8
I think it's good; it reflects the realities of the world and to that extent it's good. The real question is whether the actuarial assumptions are valid or not, not the interim fluctuations in the assets that happen to be held at that moment. [Also included in 2(b) and 4] [TI 1/13, p. 24]
Participant I-12
I have a problem with the actuarial assumptions. We all know of companies that are still using 7-10% accumulation rates. This comes back to the notion of reliability. I don't have a problem in trying to reflect in some manner the cost of employee health care benefits; on the other hand, what happens if we socialize medicine and get deflation? [Also included in 2(b) and 4] [TI 1/13, p. 24]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of auditor involvement. During the discussion, comments were made on measurement uncertainties.
Participant I-7
We have discussed in previous meetings that in going through your procedures, estimates were made so that not everything is specific to the dollar. Estimates are made in your audit procedures that are of such significance that, if a different route had been chosen, there may have been a material change in the end result. We'd like to know about that. [Also included in 17(a) and 17(c)] [TI 3/17, p. 5]
Participant I-12
Where the greatest problems have come up is when the auditors have to rely on assertions and opinions of management. In a world that is changing as rapidly as ours, managements are highly capable of misleading themselves. I'm not sure if this is really the arena in which auditors should work, but it seems to be where I've seen the biggest issues come up. For example, everyone is sort of going along business as usual, then there's a major change in the environment, and nobody catches the fact that this will have a material effect in terms of the financial statements. [Also included in 17(a)] [TI 3/17, p. 5]
I'm not even sure that that's the arena of the auditors. I harked back to the change in tax law in 1986 which had enormous implications on the future of real estate partnerships. One would think that perhaps such things should be given more prominence in the financial statements or audit reports. Things of that nature should somehow be highlighted. [Also included in 17(a) and 17(c)] [TI 3/17, p. 5-6]
Committee/Staff/Observer
[Participant I-12], is it an audit issue or an accounting issue? To the extent that the accounting is driven by management judgements or decisions, is that maybe where your concern is? Or is your concern with respect to auditors auditing the subjective and the intangible? [Also included in 17(a)] [TI 3/17, p. 6]
Participant I-12
It seems to me that it's all wrapped up together. The accounting profession is accounting for various transactions and that gets colored by whatever the current rules are; if you change the rules, the accounting will change. So it is an accounting issue. There is also an auditing element in that the auditors ought to be caught up with those changes and changes in the environment, and they should have a role to play in the reporting process. But I don't know what that role is. [Also included in 17(a)] [TI 3/17, p. 6]
Committee/Staff/Observer
It sounds like what you and [participant I-16] are saying is the same. Our audit report now is kind of a one-size-fits-all report, very standardized. But the world is becoming more and more subjective, decisions have to be made more rapidly, and the impact on longer term assets is more and more uncertain; so it would be useful if the audit report could reflect that environment. [Also included in 17(a) and 17(c)] [TI 3/17, p. 6]
Participant I-16
When I first became a financial analyst 20 years ago, the major concern one had was the choice of accounting principles of management and how they could affect the numbers. Over the last 5 years, we know that what's really important are the estimates. When you see the enormous write-offs that companies have made in the last few years, they're basically saying that for years they have overstated their earnings by making bad estimates. Yet, auditors have not acknowledged that problem in their report. They also do not acknowledge when a company, every year for 5 straight years, has a huge write-off of assets in the fourth quarter, which says that they have been misleading people for eternity by capitalizing expenses. [Also included in 17(a) and 17(c)] [TI 3/17, p. 6-7]
Participant I-12
I'm not sure that management is deliberately misleading people. One of my issues with accounting and auditing is the use of assumptions and estimates and making those transparent. Because they're not always transparent to an analyst. There is a lot of room to change the appearance of financial statements based on the assumptions and estimates. [Also included in 17(a)] [TI 3/17, p. 7]
__________
Participant I-12
The MD&A may also be an area that would be more appropriately handled by the SEC, in terms of what kinds of things belong there. I agree with the notion of having an independent opinion of internal control and information systems because that leads back to the reliability of the information that we're getting. Also, the auditor could play a role in the MD&A in terms of bringing out environmental changes and the company's exposure to those changes. And perhaps greater discussion of assumptions that underlie all the numbers. [Also included in 2(b) and 17(b)] [TI 3/17, p. 10]
Participant I-11
A central issue to these discussions is what the role of the auditor is or should be. I think that we may be looking at auditors to do more than they should be doing, using that as an excuse not to do it ourselves. The broad issue is that the financial statements of a company are supposed to accurately reflect the operating performance of that company. The proper role of the auditor is to provide independent judgement that the financial statements do provide an accurate reflection of the operating results. If you think of the role of the auditor in those terms, then expecting of the auditor to get involved in things like the MD&A or the company's forecasts are not appropriate functions for the auditor. On the other hand, issues relating to uncertainty of estimates are related to the auditor's role. To the extent that it is economically feasible, we ought to have a lot more information in that area. There is some limit based on cost-effectiveness. For example, I'm not sure that it is cost-effective to have a quarterly audit. [Also included in 17(b) and 17(d)] [TI 3/17, p. 11]
Participant I-12
I would agree with that. I know that a lot of companies that I cover have their statements audited not only quarterly but before they report, which I find astounding for companies who report 10 days after the end of the quarter. I don't see any need to have an audit done more than annually. I also think that there are areas where the auditor might become involved; measurement uncertainties, for example. Another area for auditors would be looking at transactions with related parties (including major suppliers and major customers). In close relationships like that, that's where a company has the greatest potential for trying to cook the books. An auditor could look at those transactions and determine whether they're being accounted for on an arm's length basis. [Also included in 17(b) and 17(d)] [TI 3/17, p. 11-12]
Participant I-7
I'm not sure whether I can ask an auditor to measure one company's reporting against another. In the course of an audit, the auditor comes across certain paths in which estimates and assumptions are made; if those estimates and assumptions are continuously made in favor of the company and they are material relative to the bottom line, I'd like to know that on a qualitative basis. [Also included in 17(c)] [TI 3/17, p. 13]
Committee/Staff/Observer
How would you deal with the fact that auditors very often cannot deal with competitors? So in major industries, each company is audited by a different auditor. How do you get a meaningful comparison of a peer group by the auditor? [Also included in 17(c)] [TI 3/17, p. 13]
Participant I-7
It would be extremely difficult to ask the auditor to know what's going on elsewhere in the industry. But in the course of the audit, you know that certain assumptions and estimates are made, and you know enough about the particular business that making different estimates would have a material effect; that could be disclosed. [Also included in 17(c)] [TI 3/17, p. 14]
Participant I-12
It would be very helpful to learn about all those things, to get some viewpoint from someone who sees things far more closely than we do; the management information systems, management's assumptions, range of accounting principles that they are using. All of those things would be extremely useful. [Also included in 17(c)] [TI 3/17, p. 15]
Participant I-16
Financial analysis is about making forecasts on future trends and performance of a business and then putting a value on the securities relating to that business. The financial analyst starts with the financial statements, which are very important. We're not suggesting that the auditor do financial analysis work; I don't presume that the auditor should make a statement on the future trends of a business but rather statements on the role of estimates in the financial numbers that purport to represent past transactions. Secondly, about the adequacy of control systems, I'm less convinced that it could be done; I'm not sure it is essential because that's something that a financial analyst should be able to do. It might be more important to the lay shareholder as opposed to the professional financial analyst. [Also included in 1(d) and 17(c)] [TI 3/17, p. 16]
Committee/Staff/Observer
I'd like to challenge that. Management makes a projection which is based upon estimates and assumptions. You said you want us to be involved in historical financial statements, in either expanding in a note or in an AD&A, by having standards to disclose more about measurement uncertainties. Those same uncertainties enter into a projection. As a starting point, couldn't the auditor be properly involved in a projection by expressing an opinion about whether management's assumptions are realistic (based on x dollars, x volume, x units)? [Also included in 12 and 17(c)] [TI 3/17, p. 18]
Participant I-12
That's our business, that's what we do. There's no need for us if the auditor is going to do it. [Also included in 12 and 17(c)] [TI 3/17, p. 18]
Committee/Staff/Observer
Let's suppose you have the financial statements of an institution that has a large portfolio of real estate loans. This group and others have told us that they would expect the auditor to evaluate management's assumptions about whether those real estate properties are going to be profitable or not, and to make judgements about whether the carrying values of the assets are appropriate or not, whether they should be reserved, and you expect the financial reporting to reflect the appropriate adjustments. How is that different from other kinds of projections? [Also included in 17(b) and 17(c)] [TI 3/17, p. 18]
Participant I-12
For real estate properties, there are current appraisals on most of these properties. Theoretically, banks and other financial institutions have set aside reserves to appropriately reduce the value of the assets to reflect the current situation. I don't know if real estate prices are going to go up or down; I will look at all of that and I'll make an estimate of my own. What I would like the accounting profession to do is to make it clear to me what the basis of all of that is. A question analysts ask a lot is: what percentage of original value have your nonperforming real estate loans be written down? If we know how much has already been written down, we then have some information that will help us make estimates about how much more write-downs should be made given our general outlook. I would like to know what has already been done and what the status is. Managements are always making estimates; analysts try to know what the assumptions are and make their own estimates that can be radically different. I'm not sure the accounting profession needs to get involved in future estimates; the most important function of financial statements is clarity. [Also included in 12, 17(b), and 17(c)] [TI 3/17, p. 18-19]
[Context] Meeting of the Investor Discussion Group on March 17, 1993. Part of the meeting was devoted to the topic of priority of improvements needed in external reporting. During the discussion, a comment was made on measurement uncertainties.
Participant I-16
I would agree with numbers 3 (unconsolidated entities) and 12 (interim reporting). I would add numbers 5 (business combination practices), 8 (disclosure of measurement uncertainties), and 16 (impairment); for number 16, I'm more concerned about long-lived assets than receivables. For number 8, I'm concerned with getting more explanations about where things are and come from. Business combination practices is an area where we don't understand how companies account for acquisitions; they don't explain that and you can't follow it. [Also included in 8(b) and 15] [TI 3/17, p. 66]
[Context] Meeting of the Creditor Discussion Group on December 8, 1992. Part of the meeting was devoted to the topic of creditors' objectives and approaches. During the discussion, a comment was made on measurement uncertainties.
Participant C-14
I perceive a lot of the overload to be in the footnotes, but I also find the footnotes to be the most useful part of the financial statements. And I tried to think of how to enhance the understandability of that information, and I think we started to touch on it when we said well, in the footnotes you find the nominal amount of the swaps, but you really don't know what the impact could be. We also need information on the assumptions used by a company or the reasoning for the assumptions they chose in their accounting methods. For instance, why did [one company] pick a 12% return on plant assets, it's 11 or 12%, when inflation is you know, 3 or 4%? Or why did [another company] depreciate its video over 36 months when the economic life is only four months? I'd like to know more about why they choose those kind of things. Or other examples would be why they've changed accounting standards. [Also included in 1(b), 2(a), 2(c), and 19] [TC 12/8, p. 41]
[Context] Meeting of the Creditor Discussion Group on February 2, 1993. Part of the meeting was devoted to the topic of value information. During the discussion, a comment was made on measurement uncertainties.
Participant C-5
Historical cost may be one reference to what actual value is. Current price is your supposed fair market value in a non-distressed situation. In making decisions, you have to understand the likelihood that market value will return to some reference point. One of the problems with market value is many markets are inefficient--the real estate property market being the most inefficient, just because of the way it's driven by tax incentives and the like. It takes a while for these markets to find equilibrium but we have to understand that underlying all that, there is a real value. As a lender, it is true we don't take into account market value, not just because we don't necessarily believe the approach that's been used, but also because we don't get the detail of all the assumptions that went into the estimates. Without knowing all those assumptions, and you could never give us all those assumptions in a set of disclosures, we would have to go in and make our own set of assumptions and revisit the estimates anyway. Large corporations, particularly, is the one area where we would advance funds without knowing market values. And in secured lending situations, non-investment grade, it really adds no value to us. [Also included in 4] [TC 2/2, p. 6]
[Context] Meeting of the Creditor Discussion Group on February 2, 1993. Part of the meeting was devoted to the topic of disclosure about measurement uncertainties.
Committee/Staff/Observer
I'd like to deal with one last topic on my list, which has to do with the measurement uncertainties inherent in accounting information. Risks and uncertainties are in two different forms, both with respect to reported assets and the contingent liabilities. This has to do with the inherent imprecision of estimates inside the balance sheet. Without necessarily identifying all the items that fall under that canopy, but just acknowledging in a greater way that there are these kinds of uncertainties, reminding people that estimates are, therefore, subject to change from time to time, would that improve financial reporting and help users? [TC 2/2, p. 49]
Participant C-11
The way you just described this, I would call it boilerplate, and I would totally ignore the whole thing. I would expect to find the same kind of statement in every annual report I picked up. [TC 2/2, p. 49]
Participant C-13
I agree. I think people disregard it. [TC 2/2, p. 49]
Participant C-15
I think that the things we talked about earlier such as the aging of receivables, are much better ways to get at answers. Maybe the one area where it might benefit would be for some non-sophisticated users. I think that we're all aware of the differences or potential differences. But someone who's not used to dealing with financial statements, not a sophisticated user of financial statements, tends to take numbers at their face value. So for non-sophisticated users, I think to point out, even if we would consider it boilerplate or a disclaimer, it might raise someone's level of awareness. That what you see may not be exactly what's there. [TC 2/2, p. 49-50]
Committee/Staff/Observer
I understand that one type of disclosure would be boilerplate, the acknowledgment that it's inherently risky. The second type of disclosure could deal with how much do you want to know about these estimates. If we go to page 24, it proposes that there could be a variety of approaches to telling users more about things that underlie assumptions. Sometimes it could be something as simple as the aging of accounts receivable to show a little bit more about how the bad debt reserve might relate to it. In other cases, it might be much more complicated to talk about, for example, warranty experience and quality controls inherent in manufacturing process, and some other fairly in-depth discussions. Is this useful information? Is the financial report the correct place to put it? What is your feeling as a user, if that is what you want? How do you deal with it? How would you expect the package to look to make it useful? [Also included in 17(b)] [TC 2/2, p. 50]
Participant C-5
I don't know if I would have an auditor provide that. [Also included in 17(b)] [TC 2/2, p. 50]
Participant C-4
I think some information that might be helpful is hindsight review: estimated cost of completion on long-term contracts are obviously a huge estimate that significantly impacts earnings. If there were some comment made that at the prior year end the estimate for cost to complete was within a certain range of what the actual final costs were. Using that as a basis for the current estimated cost, is giving us some historical information which is not readily available. It may just be about allowances for doubtful accounts and what actually that expense was. That type of information. It may be just a footnote disclosure. [TC 2/2, p. 50]
Participant C-13
I think that, basically, it's hard to argue with the usefulness and even importance of most of these disclosures. Obviously, some are relevant. [TC 2/2, p. 50]
[Context] Responses to the postmeeting questionnaire to the February 2, 1993 Creditor Discussion Group meeting.
QUESTION 12
a. While some have proposed a general disclosure stating that "financial statements reflect the results of estimates, assumptions, judgments, and allocations that are inherently uncertain", the disclosure would be considered "boilerplate" and would have little or no value to investors, analysts, and other users of financial statements.
Do you _ AGREE? 12 _ DISAGREE? 2
Comments:
Participant C-17: Basis of disclosures is always important and may not be boilerplate if there are basis modifications from company or industry to industry.
Participant C-18: Complete waste of paper. CYA statement only.
Participant C-2: But the statement still has value for novice or infrequent statement users.
Participant C-12: If management goes further to state which specific estimates, etc. are the most uncertain and which have the most impact on financial statements, then we might have something.
Participant C-14: How does this statement help?
Participant C-15: In general, I agree for sophisticated users. This might be helpful for non-sophisticated users.
b. Do you think that some of the amounts in financial statements should be subject to more detailed disclosure of how the uncertain amounts were derived and the nature of the estimates, assumptions, judgments, and allocation procedures used in measuring them?
13 _ Yes 1 _ No
Comments
Participant C-18: Only if meet materiality test.
Participant C-13: If there are significant uncertainties, it is mandatory - I would have thought - to disclose them in MD&A.
Participant C-5: Information sufficient to allow users to make their own estimates should be required.
Participant C-4: Should disclose how estimates for doubtful accounts, cost to complete, etc. compare to actual historic results.
Participant C-14: Maybe if material.
If YES, do you think (please check the appropriate box)
_ 6 The information to be disclosed should be specifically mandated by accounting standards setters (creating a uniform, mandated disclosure requirement )? or
_ 7 The information to be disclosed should be selected by management and auditors based on the specific circumstances of each company (leaving disclosure significantly subject to professional judgment)?
[PMQC 2/2, p. 21-22]
[Context] Meeting of the Creditor Discussion Group on March 11, 1993. Part of the meeting was devoted to the topic of auditor involvement. During the discussion, comments were made on disclosure about measurement uncertainties.
Committee/Staff/Observer
Would it be more beneficial to the user community to have information that may make you able to better assess the need for surprise adjustments, say in receivables or inventories? [Also included in 5(b) and 17(a)] [TC 3/11, p. 14]
Participant C-17
Yes. I went back and looked at a spreadsheet that I used to use in 1972, when I started. And it has all kind of little captions that I used to be able to fill out, like aging of receivables. I could go through the receivables and I saw what was actually written off. I can't always do that today. In my mind it's a question of more disclosure and consistency. It's like when you get a fraud, for instance, the apparel manufacturer, [name deleted]; you get those kinds of situations, and they begin to pop up in groups and it shakes people's confidence. You wonder what actually happened. And how did they reach the size that they did? And how did it go on for the amount of time that it did? Some of these frauds are absurd in terms of their lack of sophistication. And yet it wasn't caught. And that's the thing that's most disturbing. You begin to wonder, was the auditor truly independent? Was he caught up in a battle between his peers in terms of staying on the account? I don't know, I'm just saying that it is disturbing. [Also included in 5(b) and 17(a)] [TC 3/11, p. 14]
__________
Participant C-8
In the construction industry, GAAP rules often don't reflect the reality of the business. The ability of a contractor to book and carry construction claims, to carry contract costs in excess of contract billings, and things like that; GAAP generally don't reflect just how questionable and volatile those assets are. That's probably the case in a lot of other industries as well. [TC 3/11, p. 17]
__________
Participant C-4
We're hitting at what the role of the auditor is. And if we're asking the auditor to make assessments about what the business risks are, I think that's really beyond the scope of what we want. I would be more interested in the auditor disclosing at what level they've audited from a materiality standpoint, and what has taken place from a statistics standpoint. What were the basis for their estimates for doubtful accounts? And on a hindsight basis, how do these current estimates compared to the prior year results? So some format of factual presentation as opposed to their doing the assessment. We'll do the assessment but we would like more information about how estimates were arrived at. [Also included in 17(b) and 17(c)] [TC 3/11, p. 33]
[Context] Responses to the postmeeting questionnaire of the December 9, 1992 and January 13, 1993 Investor Discussion Group meetings.
QUESTION 18
Current financial reporting standards require neither (a) disclosure of the fact that uncertainties resulting from estimates, assumptions, and judgments or from allocations (or both) are inherent in measuring most of the amounts in financial statements nor (b) disclosure of the significant uncertainties underlying those amounts.
a. While some have proposed a general requirement to disclose that financial statements reflect the results of estimates, assumptions, judgments, and allocations that are inherently uncertain, disclosure of information of that kind would be considered "boilerplate" and would have little or no value to investors, analysts, and other users of financial statements.
Do you agree? 7 disagree?
Comments
Participant I-8: Nevertheless such a statement might be of some benefit to the less sophisticated.
Participant I-11: Such a disclosure would do no harm, but it contributes no information to a sophisticated user (and probably no real information to an unsophisticated user, for that matter).
Participant I-12: A simple "hedge clause" would simply provide management with some legal protection. More detail is needed.
b. Do you think that some of the amounts in financial statements should be subject to more detailed disclosure of how the uncertain amounts were derived and the nature of the estimates, assumptions, judgments, and allocation procedures used in measuring them?
Yes 6 No 1
If you think that more detailed disclosure of information is needed, do you think (please check the appropriate box)
The information to be disclosed 1 should be specifically mandated by accounting standards setters (consequently creating a uniform, mandated requirement to disclose the information)? Participant I-12: Focus on materiality. The information to be disclosed 5 should be selected by management and auditors based on the specific circumstances of each company (consequently leaving disclosure significantly subject to professional judgment)?
[PMQI 12/9 and 1/13, p. 35-36]
__________
Objective 4 [Improve the common understanding of the nature and purposes of information contained in financial reports]. None of the FASB's objectives are easily attained. Objective 4 is one of the more elusive. This is in part true because "improving the common understanding" of anything is difficult given the static inherent in the era's dependence on the media as a communications tool. The media fastened on Statements 87 and 106 during their gestation periods, as well as following their release. We hope that such attention may have helped to communicate some of the benefit that such accounting standards provide. We also hope that it encourages comprehension that "the basic objective of financial statements is to provide information useful for making economic decisions."6 [AIMR/FAF91, p. 17-18]
__________
From what has briefly been described of the [foreign] financial analysts' work, there results a series of requirements with regard to accounting data, which are but insufficiently met at present. We have broken them down into . . . major categories. [Also included in 1(b), 2(c), 2(d), 3(c) 4, 5(a), 5(c), 6, 11(b), 11(c), and 15] [BETRIOU, p. 1]
It is likely that the objectives of all accounting data users do not coincide. As far as they are concerned, [foreign] financial analysts essentially need data which reflects the economic reality of entities they examine (groups or companies). Further progress is still required and we have broken this down into . . . categories: [Also included in 1(b), 4, 5(a), 6, and 15] [BETRIOU, p. 3]
Undervaluation of asset items. The differences between accounting valuations and the "economic reality" results notably from:
[1] the "conservative rule", indeed useful to protect creditors, but which plans for immediate entering of potential loss and does not take into account latent gains. [Also included in 1(b), 4, and 15] [BETRIOU, p. 3]
More particularly, the historic cost method does not allow showing the potential revaluation of assets. This data would be necessary for investment securities, because of the development of money market funds: part of the financial products are released only when mutual fund shares are sold, distorting the meaning of net financial expenses. [Also included in 1(b), 4, and 15] [BETRIOU, p. 3]
Data on market values included at least in the appendix would give a more precise view of reality. It could concern in priority current assets (investment securities and raw material notably). [Also included in 1(b), 4, and 15] [BETRIOU, p. 3]
[2] of the too large latitude (allowed by the Fourth Directive) in the determination of provisions which may sometimes be profit. It would be preferable to have stricter allowance criteria. [Also included in 1(b), 4, and 15] [BETRIOU, p. 3]
[3] of the too large liberty to capitalize research and development expenditures which could lead to overestimating profit over a period. [Also included in 1(b), 4, and 15] [BETRIOU, p. 3]