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Sarbanes Oxley : Auditing : Continuous Auditing
Effective Simplification Needed to Overcome Complexity
By
Colleen Cunningham
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Colleen Cunningham
President and CEO
Financial Executives International
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The Securities and Exchange Commission (SEC), in its recent study on Off-Balance Sheet Accounting, discussed the critical need to make accounting standards less complex. The Financial Accounting Standards Board (FASB) has stated that it is striving for simplicity.
Many of the material weaknesses noted in the first Sarbanes-Oxley Section 404 reports relate to misapplication of complex accounting standards.
That's not all. The American Institute of Certified Public Accountants' (AICPA) recent task force found that current GAAP is too complex and not necessarily useful to the users of private company financial statements.
FEI's Committee on Corporate Reporting (CCR) has frequently noted that the complexity of accounting standards is simply outpacing our ability to keep up. In fact, both the SEC and FASB have indicated that simplification of accounting standards is a priority, and I commend both for recognizing that.
So, if we all agree the standards are too complex, the solution should be easy, right? Just simplify them! Unfortunately, it isn't that easy. First, we need to make sure that "complexity" means the same thing to all.
In a recent speech, Don Nicolaisen, then the SEC's Chief Accountant, stated:
"Much of what I describe as complexity is the direct result of 1) a desire to reduce volatility in the income statement, 2) the development of numerous exceptions to basic principles or 3) the application of detailed rules.
When I talk about reducing complexity, I am not talking about dumbing down accounting or implying that accounting or auditing will be simple.
"?.Changes - even to reduce complexity - are not simple, and they will take time and, of course, must be subject to appropriate due process. Further? every single change in accounting will, for many companies, require systems changes and testing to ensure that internal controls are effective before the change can be made. It's clear that the FASB has a very difficult job ahead."
When regulators and standard-setters think about "complexity," they understand it to mean the inability to succinctly determine the principle of an accounting standard, due to the myriad of exceptions and interpretations. Many of these are issued at the request of auditors and preparers. I agree that these can add to the complexity, and we should certainly strive for the ability to exercise judgment in applying an understood accounting principle.
This may require some change in mindsets of the preparers and auditors. (More importantly, it may require a change in the current legal environment. The request for more interpretations generally comes from a determination to do the right thing.
No one wants to be second-guessed, least of all by the plaintiffs' bar.)
But when I think about "complexity," I don't just think about the accounting standard itself. I think about implementing accounting standards, whereby the ability to determine the appropriate accounting for a transaction - as well as the ability to estimate the appropriate measurement - is easily understood.
For example, FASB might say that the recently issued Exposure Draft on Business Combinations has a simple principle: account for business acquisitions at fair value. However, the implementation is far from simple.
How do you appropriately estimate the fair value for items such as contingent liabilities? When estimates change (as they certainly will) and adjustments are required, will this "simple" principle be widely understood by investors?
I question how relevant and understandable (not to mention reliable) the accumulation of statistical probabilities of potential outcomes are to users of financial statements (as prescribed by the recent Business Combinations exposure draft).
The usefulness is further called into question, as these statistical probabilities change from period to period. If that isn't complexity, I don't what is. High-quality accounting standards should be understandable and capable of implementation and audit without requiring extensive use of specialized expert assistance.
Investors read the financial statements, not the accounting standards. If the implementation of the accounting standard, even with a "simple" principle, is difficult to follow, we are not appropriately serving the investor. The most important function of financial statements is communication with investors.
Improving financial reporting requires the commitment and support of preparers, auditors and investors, as well as standard-setters. Preparers and auditors must be prepared to exercise professional judgment. Investors need to clearly articulate what is useful to them for decision-making. We can't continue down the path of providing everything to everybody.
FASB may need to "just say no" to constituents' demands for bright lines. The PCAOB and SEC need to enable the use of judgment in their review processes. Second-guessing a judgment made in good faith will certainly kill any simplification effort.
Finally, as FASB moves towards less complex accounting standards, it needs to consider that complexity does not just relate to the accounting standard itself, but to the implementation and the ultimate understandability of financial statements as well.
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