SEC Accountant Lays Out Priorities for 2005
From MD&A to International Standards, It’s All About Less Complexity

By Simon Eskow and Jay Dismukes

The Securities and Exchange Commission’s chief accountant would like to reduce complexity in the financial reporting system, the official said at a recent conference.

That concept underlies much of what Chief Accountant Donald Nicolaisen foresees as his office’s important ongoing projects, from moving toward international standards to improving accounting and auditing standards.

“There is a level of complexity that has crept into our system, into our methods and our jargon,” Nicolaisen said at the Foundation for Accounting Education’s SEC/FASB Conference on Jan. 24. He likened the current accounting system to over-engineered alarm clock radios.

“These have CD players and buttons everywhere and you can do all kinds of things with them except turn off the alarm,” Nicolaisen said. “The accounting system and reporting has that problem.”

Nicolaisen called complexity one of the most important problems for the SEC and the accounting community to confront. Complexity, he said, can be found in MD&A, revenue recognition and derivatives accounting—which requires 800 pages of guidance—that tend to make it difficult for investors to interpret a company’s financial health.

“It’s time for the profession and the SEC to rethink its reporting requirements where complexity is acute,” he said.

Nicolaisen mentioned no official program that specifically addresses complexity, but the concept seemed to underlie the priorities his office has set for 2005, including improving MD&A, adopting international accounting standards, conducting an off–balance sheet study and further implementing Section 404 internal control requirements.

The chief accountant did, however, point out two specific examples of areas that can help reduce complexity: segregating operating income and the wider use of the Extensible Business Reporting Language (XBRL). The XBRL format allows users to read and exchange data regardless of the computer platform or software program they are using.

“I’m a big proponent of XBRL,” Nicolaisen said. “It’s important to the analyst community. It’s cheap technology, it’s uncomplicated, and it helps you to know what you want about a company.”

Nicolaisen also spoke of broader initiatives that, he hopes, will help lead to a reduction of complexity. SEC Deputy Chief Accountant Scott A. Taub is now focusing on accounting matters and standards, taking on specific projects such as the further clarification of materiality. SEC Deputy Chief Accountant Andrew D. Bailey is heading up an effort to improve auditing standards and independence issues in conjunction with the Public Company Accounting Oversight Board (PCAOB).

Finally, Nicolaisen referred to the emergence of international accounting standards that will obviate the need for companies to reconcile foreign standards with U.S. generally accepted accounting principles. Nicolaisen said the need for this has increased as more investors include foreign corporations in their stock portfolios.

“Having one set of accounting standards is the way forward,” Nicolaisen said. “It’s the way of understanding international markets as old barriers are rapidly disappearing.”

Enforcement Side

In a later presentation, Susan Markel, chief accountant of the SEC’s Division of Enforcement, discussed general operations and recent trends in enforcement.

Almost 30 percent of the cases that the division pursues annually have to do with issuer’s financial fraud. Tips on fraud and other kinds of cases come from a variety of sources, including other agencies and the companies themselves, who, not uncommonly, contact the SEC to alert them to possible improprieties in their financial statements. The division also receives 20,000 tips a month through its call center, though many of those lead to “dry holes,” Markel said.

Common frauds in valid cases include premature revenue recognition and excess reserves, changes in estimates, variable length quarters and false certifications, she said.

To deal with the number of cases the division faces, it now has a 1,100-strong staff. The division, in dealing with the many cases that have come up over the last few years involving fraud, has sought to increase penalties and prosecutions, to hold individual executives responsible for corporate fraud, to hold companies accountable for noncooperation while recognizing companies that do cooperate, and to more regularly scrutinize boards of directors and audit committees.

Q & A

Later in the day, Nicolaisen, Markel and Sondra Stokes, associate chief accountant for the SEC’s Division of Corporation Finance, covered a smorgasbord of regulatory and accounting issues when they participated in a question-and-answer session. Conference attendees got an opportunity to ask the SEC officials about everything from the confirmation process to their thoughts about the efficacy of Sarbanes-Oxley more than two years after its passage.

According to Markel, the SEC does have cases where the confirmation process, a standard procedure of the audit, is problematic.

“Confirmations have to be done correctly to be considered sufficient evidence,” she said.

She advised the attendees to make certain they are addressing the confirmation letter to the right people, and to be wary of a client that tries to steer the auditor away from the confirmation process or to a particular party. If the auditor has any suspicions about the confirmation, he should carefully document them in his report, Markel said.

Other “red flags” Nicolaisen said to consider include confirmation letters sent out by the client, not the auditor, and confirmations by faxes that are blotted out or inked over.

Pertaining to Sarbanes-Oxley, Nicolaisen said he thinks the landmark act may be in need of some “fine–tuning,” particularly as it relates to the cost/benefit ratio of compliance. While he would like to see a more workable cost side, he attributes a noticeable improvement in board governance to the legislation. Markel added that Section 404, pertaining to internal controls, and the PCAOB process have significantly helped tighten up financial reporting.

Despite this progress, Nicolaisen noted that continued diligence by the business community will be essential going forward.

“The big concern is that the comfort level increases and this (atmosphere of increased accountability and new financial reporting requirements) becomes a check-the-box (mindset),” he said.

Good Conference

About 140 people attended the day-long conference, held at the Marriott Marquis in New York City. The NYSSCPA’s SEC Practice Committee, chaired by George I. Victor, sponsored the conference. Victor and committe members Mitchell Mertz and Rita Piazza served as conference cochairs.