Herz assumed his responsibilities as FASB chair
in July 2002 and began his second five-year term on July 1, 2007.
Prior to accepting his appointment to FASB, Herz was a senior
partner with PricewaterhouseCoopers and a member of its global
and U.S. boards. He was also a part-time member of the International
Accounting Standards Board (IASB). He is both a CPA and a chartered
The CPA Journal: Principles-based
accounting has been touted as the way to go for accounting standards.
Yet some believe that we will always revert to rules-based standards.
Can you explain your understanding of principles-based accounting
and how FASB plans to achieve that goal?
Robert H. Herz: To understand
my perspective, I should explain my background. I went to college
in England and started working as a chartered accountant there.
The accounting system there is more principles-based and the corporate
governance system is different. Its legal system is also different
from the U.S.’s. The capital markets are smaller, and in
some ways more transparent. Overall, the U.K. accounting system
probably works better there than it might work here.
I believe that the U.S. system has too many rules
and bright lines, too much detail, and too much attention paid
to providing specific answers to detailed fact patterns. That
has come not only from us and the Emerging Issues Task Force (EITF),
but also from the SEC and its staff and from the AICPA in various
forms. I think that can, and does, undermine professionalism,
both in the preparation of financial statements and in auditing.
I also think it can make it harder for readers of a company’s
financial statements to figure out what was actually done, and
it leads to inconsistencies. So I am in favor of what the SEC
outlined in its July 2003 report to Congress on a principles-based
system, what they termed “objectives-oriented” standards.
I think the SEC also made the point, as FASB has,
that you can’t achieve that kind of system just by writing
accounting standards. The fact is that accounting standards are
part of a larger financial reporting system; therefore, a financial
reporting system that works properly involves many elements working
together. I think we are trying to articulate broader principles
or objectives, explain them, and then, where possible, relate
them to real-world examples. We don’t want to get into every
possible fact pattern or create unnecessary exceptions. We’re
also trying to stay away from bright lines. However, over the
past 15 or 20 years, counter to that, many companies and auditors
have said, “Just tell me what to do.”
CPAJ: Is that a consequence of the
basic nature of our society?
Herz: For good or for bad, a significant degree
of second-guessing goes on in financial reporting. Many preparers
and auditors therefore say, “Rather than having to think
about it, to use my professional judgment, I just want to go home
at night and be able to sleep without worrying about everything
I did that day.” I think FASB’s effort to move financial
reporting toward a more principles-based system is important because
many of us believe it will achieve better financial reporting,
but it will also take changes by others in the system to make
it a reality.
Principles-based reporting is also important from
a convergence perspective because many parts of the world don’t
use a rules-based approach. Over the last two years I’ve
pushed for a national effort to look at the complexity of our
financial reporting system. It is not clear from a cost–benefit
perspective that we couldn’t have a better system that actually
provides more useful and transparent reporting without killing
the crew in the process, so to speak. I believe we can do that,
but as I said, getting there would involve more than FASB just
saying that we’re going to write more principles-based standards.
FASB receives many inquiries on specific fact patterns for the
principles-based standards we’ve written. So it may take
institutional, behavioral, and cultural changes by other parties
to make it work.
[In June 2007, the SEC announced the establishment
of an advisory committee to explore ways to improve financial
reporting by reducing the complexity and increasing the usefulness
of reported financial information. In addition to its 17 appointed
members, five others, including Herz, will serve as official observers
of the advisory committee.]
CPAJ: Perhaps that’s because
principles-based accounting requires auditors to exercise their
professional judgment, which exposes them to greater risks?
Herz: Yes, auditors have that concern. But I think
the PCAOB and the SEC staff have indicated that they will respect
judgments that are made with proper due diligence and proper documentation.
However, I don’t think that auditors believe that completely
CPAJ: Why not?
Herz: I hear lots of descriptions of situations
from both companies and auditors. The companies or the auditors
will contend that a ruling or other decision by the SEC or the
PCAOB regarding the application of a standard was unfair; yet
when one asks questions about the specific facts of a situation
that may have been the subject of a SEC or PCAOB action, you find
that it was quite fair.
CPAJ: In light of the recent issues regarding
stock options, such as “spring-loading,” which entails
setting the grant date and exercise price of an option shortly
before the company expects to announce positive corporate news,
or “backdating” executive stock options after the
price has risen—what can FASB do to mitigate this problem
Herz: Those are problems of corporate governance and basic
CPAJ: But the SEC has said that it
doesn’t perceive spring-loading to be fraudulent.
Herz: I’m not an attorney, so I can’t
make judgments on whether spring-loading is fraudulent. Probably,
disclosures should have been made by the companies involved. As
an investor, I’d like to know whether company executives
are taking advantage of inside information for their own benefit.
FASB passed SFAS 123(R) [Share-Based Payment], and we
fought hard for that standard because it establishes the accounting
for compensation that needs to be reported. From what I’ve
heard, SFAS 123(R) has been effective in increasing disclosures.
The SEC has also increased its disclosure requirements involving
CPAJ: To expand on that, the NYSSCPA’s
Auditing Standards and Procedures Committee has discussed whether
there should be internal control requirements for a corporation’s
board of directors, because it serves as the head of the corporate
governance structure. What do you think of that?
Herz: I’m not a corporate governance expert.
But a company’s directors represent the shareholders, and
if I’m a shareholder and I find out, after the fact, that
without disclosure or due consideration, executives have been
loading themselves up with equity awards and backdating them or
just timing the awards to maximize their personal profit, that
would be problematic. The real issue is the need for corporate
boards to function properly. Whether a board’s conduct ought
to be monitored, I can’t judge. But if you’re a director,
you have responsibilities to the shareholders.
CPAJ: Fair value has presented some
confusion and controversy within the accounting community. Do
you foresee any additional guidance or changes with regard to
the new standard, enacted in September 2006?
Herz: First, SFAS 157 [Fair Value Measurements]
did not introduce the concept of fair value. The words “fair
value” were already in many standards that go back 40 or
50 years. Some of those standards provided a definition of fair
value and explained how to arrive at it, but each standard was
different. Some standards gave no definition or explanation—they
just used the words “fair value” as if everyone had
the same understanding of what that meant.
In some cases fair value became almost a synonym
for “not historical cost.” We felt it was important
for consistency and from an educational perspective to create
a new kind of standard—a reference standard—that said,
“When we say ‘fair value’ in existing and future
standards, here’s what we mean.” The standard provides
a consistent definition and provides a framework for those measurements.
The extent to which FASB requires or permits the use of fair value
in the future is a different issue and will be addressed standard
by standard when we look at a particular topic. Therefore, SFAS
157 is not introducing new fair value measurements—it’s
just aimed at consistency, education, and providing a framework
for what we mean and how to approach it. FASB has been dealing
with implementation questions, and we have recently established
a valuation resource group to help us provide further guidance
in this area.
SFAS 157 also introduced disclosures intended
to tell people when fair value was used and its impact on the
balance sheet and the income statement. These disclosures also
describe how the fair value measures were developed, such as stock-market
price quotations from the newspaper, or measurements that involve
more complex information, input, and valuation approaches.
CPAJ: Some would ask, “Why remove
historical costs from the financial statements and not just supplement
the historical financials with needed disclosures or a supplementary
schedule that shows fair value?” That way users could find
the information that is most helpful to them without being misled
by unscrupulous executives who might use fair value accounting
to manipulate a company’s financial picture. Why not say,
“This is the standard. If you’d like to provide additional
Herz: Of course, the emphasis should be on providing
useful information to those who read financial statements, including
those who use them to make investment and credit decisions. The
debate about fair value versus historical costs has, in my view,
been somewhat misplaced because it’s not necessarily an
“either/or.” One approach, which you suggested, is
supplementary. Other approaches, which are based on economic theory
and our conceptual framework, tell you that both fair value and
historical costs can be accommodated within one accounting model.
Among other goals, our very important project on financial statement
presentation with the International Accounting Standards Board
(IASB) is looking at that.
You might also want to look at the CFA Institute’s
comprehensive business reporting model report [
In today’s “mixed attribute” accounting, people
are asked to make many estimates that are highly subjective, like
depreciable lives of fixed assets, or impairment charges or loan-loss
reserves. When you use a value-based approach, some other questions
arise. For example, how to disaggregate and display the components
of the changes in value. You could, for example, separately show
the cash component, any working-capital accrual adjustments, and
other elements of the change in value, so that users would be
able to understand the various economic aspects that contributed
to the change in value.
CPAJ: Why do you think there has been
so much resistance to moving away from historical cost for accounting
Herz: In traditional accounting, historical cost
is the starting point, but then we have other highly subjective
estimates, such as percentage of completion, loan-loss reserves,
and deferred-tax assets. The SEC has something called critical
accounting estimates that companies disclose. While one of those
might be related to fair-value items, the rest are related to
traditional historical cost accounting. I’m not necessarily
plugging fair value, but I would like an objective and thorough
discussion about its pros and cons as compared to other measurement
In that regard, an important part of our conceptual
framework project with the IASB relates to measurement. We started
open discussions on the subject by holding public roundtables
earlier this year in Hong Kong, London, and the United States.
The objective was to discuss the issue in general: why different
measurement attributes, including historical cost and fair value
approaches, are used.
Earlier you mentioned manipulation. People who
don’t like fair value accounting usually cite Enron as a
reason. Enron is an example of what I’ll call “unfair
value,” using “mark-to-model” accounting without
further adjustments to properly reflect fair value. When we were
developing Statement 157, we asked investment portfolio managers
and financial analysts—who follow derivatives dealers and
companies that handle energy trading—if they preferred to
know the historical costs or the fair value, with disclosures.
They overwhelmingly chose the latter—fair value with additional
Communicating with Users
CPAJ: Does SFAS 158 [Employers’
Accounting for Defined Benefit Pension and Other Postretirement
Plans] “improve” information provided to financial
Herz: I hope so. SFAS 158 puts the plan sponsor’s
position with regard to underfunding, or overfunding, squarely
on the face of the balance sheet. When we asked users about this,
they said they view underfunded plans as a liability. They also
say they found the existing footnotes hard to decipher. A lot
of users also told us the smoothing approaches under current pension
and OPEB accounting in the income statement is, to quote one user,
“public enemy No. 1.”
There are other big issues regarding cash balance
plans because the traditional defined-benefit plan increasingly
has been phased out or replaced by cash balance plans that offer
lump-sum payments. From the participants’ perspective they
resemble a defined contribution account or a 401(k), but under
the law, they work more like a defined-benefit plan. Some believe
that the measurement of these plans has been problematic, so that’s
something we may also address.
CPAJ: How is FASB communicating its
financial reporting initiatives to users, preparers, and auditors?
Herz: We have many formal and informal advisory
and liaison groups whom we meet with and communicate with regularly.
We also communicate with constituents through our documents, asking
for and receiving comment letters, and by hosting public roundtables.
We also do this through our website and written alerts and publications.
Furthermore, because the financial reporting arena has become
so high-profile, FASB receives endless requests for public speaking,
and we accommodate as many as we can. Within the last year, I
estimate that board members and senior staff spoke at more than
CPAJ: Does that place even greater
demands on FASB board members and staff?
Herz: It’s a balancing act. We view speaking
events as an opportunity to inform people about what we are doing
and to receive valuable input from constituents. Yes, the demands
on the board are probably greater than they’ve ever been,
but the demands on the reporting system are greater too.
CPAJ: There seems to be an insatiable
quest for more input from stakeholders. FASB formed a new committee—the
Investors Technical Advisory Committee (ITAC). How does its charge
differ from the User Advisory Council (UAC), which FASB established
Herz: The UAC, which consists of senior representatives
of the investment community, operates at a high level in terms
of providing advice to us on our overall priorities, direction,
and dealing with major GAAP issues. Although we hope the ITAC
group will also address some of those areas, the ITAC members
were selected from people who satisfy two specific criteria: 1)
they work in the investment arena full-time, which is true of
the UAC too; and 2) they have significant experience, expertise,
and focus on financial reporting, so their charge is to provide
us with input and help at a more technical level.
CPAJ: Is that “hands-on”
Herz: Yes, and I think the view was that we needed
a group on the investor side like that. FASB hears from and meets
with audit firms, state CPA societies, and the AICPA. At a technical
level, we also hear from individual companies through their CFOs,
controllers, and directors of financial reporting—both individually
and through their industry organizations. We hear from accounting
committees with Financial Executives International (FEI) and the
Institute of Management Accountants (IMA), and we meet individually
with many industry accounting committees. We felt that it was
important to hear from the user community at a technical level
as well. The best way to do that was to create a group like the
CPAJ: What role do you think professional
societies can or should play in the accounting environment today?
Herz: Professional organizations are absolutely
essential. We are certified public accountants, and our responsibility
goes beyond figuring how to make more money for ourselves. Making
more money is a good thing, but our primary responsibility is
to the public. In my view, that needs to be a hallmark of our
profession. The public believes that we provide a public service.
We must live up to that expectation. The state societies and the
AICPA provide important, knowledgeable input about the profession
to the public and to agencies like the SEC and the PCAOB.
CPAJ: What are your thoughts on mobility
within the profession—the ability for licensed CPAs to practice
across state lines?
Herz: I’ve long thought that there should
be a uniform national licensing, at least for activities like
auditing public companies. I think the fact that we have a uniform
CPA exam is very important. I remember the licensing issues from
my days with the New York City office of Pricewater-houseCoopers,
when we had clients in New Jersey, New York, and Connecticut,
which meant our auditors needed licenses in all three states.
I’m not sure different state rules and regulations are necessary.
I think a uniform set of licensing rules should be worked out
and applied at least to those activities that are clearly cross-state
Convergence and Codification
CPAJ: In 2003, The
CPA Journal published your interview with
then–editor-in-chief Bob Colson about many of your plans
at FASB. What accomplishments since then have presented the greatest
Herz: The change-management issues involved in things
like trying to develop standards that are more principles-based,
and a financial reporting system that is less complicated in general.
The second-guessing environment that we talked about earlier may
not be conducive to more principles-based standards and to different
approaches to reporting information that better reflect economics
and finance, which a lot of investors want. Because these counter-forces
are at work, we have to temper the degree to which we introduce
change into the system. We have held back on implementing some
needed improvements because people can do only so much at a time
and have a limited amount of resources available.
CPAJ: What are FASB’s timetables
for comment periods?
Herz: The timetable depends on the issue involved.
If the issue is a narrow one that affects only a limited group
of people, it can be as short as 30 days. For a major, global
topic, the comment period is often 90 to 120 days. We prefer to
err on the side of setting longer comment periods, because both
those who wish to comment and those of us at FASB have other things
on which to focus at the same time.
CPAJ: FASB’s codification project
will create a single, authoritative body of U.S. GAAP. The stated
objective is to integrate and topically organize all relevant
accounting guidance issued by U.S. standards setters (FASB, including
the EITF; the SEC; and the AICPA). Will this codification supersede
all existing standards?
Herz: Yes, FASB has undertaken to simplify standards
in four ways: 1) to take greater ownership for standards-setting
so we don’t have multiple groups promulgating standards
that may conflict with or contradict each other; 2) to integrate
this mass of accounting literature by subject into a single codification;
3) to address how standards are written, which gets back to the
broader issue of the complexity of the whole system; and 4) to
develop new standards, in conjunction with the IASB, that are
both better and less complex in areas such as revenue recognition
and lease accounting. We are also looking at ways to try to simplify
the current complex set of rules on derivatives and hedging and
on transfers of financial assets.
We’re attempting to do our part. I have
been pushing for a high-level commission or panel to address what
can be done to create a system that both provides more useful,
transparent information and does it in a way that isn’t
as complicated as what we have now.
In the meantime, we continue with our codification
efforts and to write standards in a more principles-based, understandable
way. The codification project is massive. We brought in 25 outside
experts to work on it. When it’s done and as people use
it for a year or so, the “real world” will tell us
how well it works. After that input is incorporated, it will then
be officially adopted to replace the original pronouncements.
Our standards-setting process, going forward, will follow that
new codified body of literature by amending, adding, or deleting
sections of the codification. We hope that new body of literature
will be much more usable for everyone.
CPAJ: What else would you like our
readers to know about FASB’s efforts?
Herz: I want to re-emphasize FASB’s awareness
of the importance of the pace of change; the openness, thoroughness,
and deliberateness of FASB’s process, and how important
the engagement of all points of view is to FASB’s work.
FASB not only develops proposals and puts them out for public
comment; it engages many different groups and viewpoints, using
roundtables and visits to companies and constituents. When we
give people the opportunity to comment, we learn. We deliberate
using all of that input. It can be frustrating at points because
the process is so involved, but it’s also very rich. We
work hard to maintain a certain balance between timeliness and
Another point that I would like to make is that
during my tenure, FASB has tried to rationalize the accounting
standard structure, to establish a structure that includes more
direct responsibility for, and ownership of, standards setting.
CPAJ: If you were to create a map
for the future, what’s your vision for FASB?
Herz: I believe strongly in international accounting-standards
convergence, and I believe that creating common international
standards in at least the public-company arena is very important.
We are working hard and systematically with the IASB and others
to bring about convergence, but it will take a number of years
and I’m not sure we will fully get to the “promised
land” during my tenure. However, I’ve been to the
mountain, so to speak, and I can see convergence becoming a reality.
In such a world, FASB’s role would change, but exactly how
remains to be seen.