Experts Discuss the Adequacy of GAAP and the Future of Corporate Reporting

Experts Discuss the Adequacy of GAAP and the Future of Corporate Reporting

By Tom Morris, Managing Editor, The CPA Journal

Are generally accepted accounting principles (GAAP) sufficient to yield financial reports that satisfactorily meet the needs and considerations of their users?

Such was the central issue of a June 29 panel discussion at Baruch College in Manhattan that included representatives from the investor community, the corporate sector, academia, public policy institutions and accounting standard setting bodies. Their goal was to examine whether companies are issuing corporate reports that provide a comprehensive, reliable account of their value drivers and why they may or may not be suitable for long-term investment.

Sorting Out the Brass Tacks

Baruch Lev, professor of Accounting and Finance at New York University’s Stern School of Business, noted that the original idea of projections and estimates, such as debt and cash flow, was good but has led to two significant developments: projections of the stock market and “massaging, managing estimates” by managers. Lev and other panelists indicated that they support a distinction in financial reports between facts and estimates, or “guesses,” as one panelist characterized them, so that users can assess the plausibility of the numbers. This separation, or other disclosure, would be helpful because people believe that financial statements and other reports are based solely on fact and are surprised to learn otherwise, Lev said. The solution, he said, is to “disclose.”

Along those same lines, moderator Peter J. Wallison, resident fellow of the American Enterprise Institute, noted that the American Assembly, a national, nonpartisan public affairs forum, has concluded that the standard auditor certification should be modified to better separate what the auditor actually determines from what the auditor may have reviewed but cannot certify as to accuracy.

Suzanne Bielstein, director of major projects and technical activities for the Financial Accounting Standards Board (FASB), said FASB is working on projects she described as “fundamental architecture.” She also said FASB is working jointly with the International Accounting Standards Board (IASB) on a project involving the display of information on the corporate balance sheet and income statement, and reviewing whether financial statements should separate facts from estimates, including fair-value estimates and the underlying volatility of the business.

James Ryan, vice president of investor relations for Lockheed Martin Corporation, said that the management’s discussion and analysis (MD&A) part of a company’s financial statement is key and can be a better disclosure device for explaining various items. Steven B. Lilien, chair of Baruch College’s Department of Accountancy, noted that he has been sitting on meetings of the American Institute of CPAs’ Accounting Standards Executive Committee (AcSEC), which he said has projections and estimates directly on its radar screen.

The Intangibles That Matter

“I have a conspiracy theory,” Lev said. “First, managers know that earnings (per share) are easier to manipulate than cash flow. Second, financial analysts are happy to get a ‘smooth’ number or a number that can be smoothed for their customers.”

Jane Adams, managing director of Maverick Capital, a manager of private investment funds, countered that one number, such as earnings, should not serve as the sole basis for any decision-making, adding that she doesn’t believe any user group wants to place that much reliance on one item either.

This discussion prompted a brief examination of the impact of intangibles on earnings. According to Lev, intangibles constitute two-thirds to three-fourths of the value of many companies, and, as such, he doesn’t understand why they have been at the bottom of FASB’s agenda for years. Bielstein responded that at the time FASB was working on intangibles, a financial reporting crisis overtook its agenda. Because it was then funded through voluntary contributions and operating at a deficit, FASB had to make difficult priority decisions. She noted that the board is now working with the IASB and the Australian Auditing Standards Board on studying intangibles.

Enhanced Business Reporting

Mike Starr, worldwide director of risk and regulatory matters for Grant Thornton International, said that his firm wants to see a reporting model based on global GAAP. Starr said that Grant Thornton has begun to create a framework that identifies key performance drivers and indicators, but there are still kinks to work out. For example, he said, determining retail sales per square foot is complicated because of the varying definitions of square foot. Industry-specific guidelines, he believes, would help resolve this type of issue.

Lev noted, though, that companies don’t always use available guidance, sometimes because of “sheer ignorance,” and sometimes because they don’t gather the necessary information.

“We ask companies for lots of information, and often get only a little,” said Rebecca McEnally, director of the capital markets policy group for the CFA Institute’s Centre for Financial Market Integrity.

Rather than waiting to be asked, however, Lou Thompson, president and CEO of the National Investor Relations Institute, said companies should incorporate information, especially on earnings and corporate strategy, into their presentations to analysts.

According to Adams, part of a company’s overall strategy should include how it measures success. Consequently, companies should educate analysts about which performance measurements they believe are important.

The Role of XBRL

Mike Willis, a partner of Pricewater-houseCoopers and founding chairman of XBRL International, talked about the role of extensible business reporting language (XBRL) as a “tagging” language specifically designed for all financial reporting that companies express to the marketplace. XBRL can reduce a company’s financial reporting compliance costs by an estimated 33 percent, he said. Among its benefits, XBRL uses the Internet’s language standards, which include “tags” that more easily define content. Through its use, data can be translated into Microsoft Excel from other formats and document can be seen in different languages.

“Populating the MD&A with more information on strategy, plans and performance indicators can lead us to a new financial reporting template. There’s also a significant opportunity through XBRL to capture and tag information so different users can extract what they see as important and what they need in order to make decisions at hand,” Lilien said in an interview after the discussion. “What also came across to me at the forum was that some feel, and rightly so, that we have a system that’s stood test of time and there’s no need to dump it. We can populate the current information with new information to improve its quality and transparency.”

The National Investor Relations Institute, the Chartered Financial Analyst Institute’s Centre for Financial Market Integrity, and Baruch College sponsored the forum. An audiocast of the discussion is available at
www.baruch.cuny.edu/cci/thefutureofcorporatereporting.htm.