A businessman's view of the standard-setting process.

A businessman's view of the standard-setting process Let me start by saying that I do believe in the standard-setting process and I believe in the need for the FASB. And while much of what I offer here may seem highly critical, particularly of the FASB--and it is--I offer it out of concern for Corporate America and with considerable respect for the Board.

Why do I, as a CEO, have such an active interest in standard-setting?

Because financial reporting has an impact on our company beyond how our statements are interpreted by investors. True, financial reporting is the primary way to communicate the financial health and performance of a company, but it also provides the framework for measuring financial results internally and it provides the information for credit evaluation and investment decisions both externally and internally. As a result, businesses are not only the primary preparers of financial reports, but also the primary users, even though the emphasis is always placed on the needs of analysts and outside investors.

It is only natural that CEOs are giving attention to the standard-setting process. We are the ones who ultimately will be held accountable for our companies' fortunes and misfortunes. Therefore, it is critical that we view financial reporting not simply as an important area, but as one in which we should become actively involved.

Indeed, that is why I support the recommendations of the Treadway Commission that ask for an appropriate "tone at the top." The tone set by top management is an important factor contributing to the integrity of the financial reporting process. Our trumpets can give no uncertain sound. No matter how many impressive edicts or written procedures a company promulgates, if the tone set by management is lax or unclear, fraudulent financial reporting is more likely to occur.

We need to include everyone at all levels of the company: operating management, attorneys, financial managers, internal auditors, and top-level corporate management. Heightened awareness and sensitivity from all of these individuals are key.

But we also could use some heightened awareness and sensitivity from the FASB. In my opinion, the original reason the SEC believed it appropriate to rely on the private sector for standard-setting remains valid today: we need a standard-setting organization, like the FASB, to be independent of political pressures.

But we also need our standard-setting body to take better advantage of the knowledge of the financial people in the private sector who have the primary responsibility for fairly presenting financials. Yes, the FASB should be independent, but it should not be insensitive to the operational needs of business. That, quite frankly, is what I fear it has become.

At best, it is an ivory tower that offers a nice overview of the business world. But such a lofty perspective often makes it difficult to decipher what is actually happening in the street--Wall Street, Main Street, or otherwise. At worst, it is a quasi-governmental entity promulgating rules, regulations, and mountains of paperwork with little accountability to anyone.

I have no quarrel with the Board's appointed mission. Among the many things its mission statement says is that the FASB is "to establish and improve standards of financial accounting and reporting for the guidance and education of the public, including issuers; auditors, and users."

I have no problem with that. And I certainly have no problem with that portion of the FASB's mission statement that declares standards should be promulgated "only when the expected benefits exceed the perceived costs."

It also is difficult to argue with the Board's comments on the importance of "developing neutral standards." The Board's neutrality is paramount, because it ensures objective reporting. But neutrality also should result in more broadly stated standards, which, in turn, permit accounting and financial reporting staffs to accurately report the results of management decisions to the public.

Where the problem lies

So my problem is not with the FASB's mission. My problem is with how the Board carries out that mission. Here, in a nutshell, is my criticism: FASB rules have become too complex, too theoretical, and too expensive.

The rush to write mind-numbing detail into rules and regulations is unrealistic. Given the complexity of today's corporations and the complexity of their financial dealings, the FASB should not even try to detail each and every situation, because it cannot.

Sure, the Board has its due process system to address specific concerns and to make sure that its attempts at clarity do not confuse. But having such a system in place does not guarantee responsiveness.

Even when there has been overwhelming criticism on certain issues--for instance, Statement 96 on deferred income taxes--the FASB has steadfastly refused to tamper with the theoretical purity of its models, even in the face of serious practical considerations.

If larger corporations like Kodak are troubled by this system, imagine how smaller corporations feel.

While the FASB is no doubt considering hundreds of other topics, it might be useful for it to consider just one more: at what point does theoretical purity obscure economic reality?

In the last several years, we have not only witnessed a sacrificing of the real for the theoretical, but we have seen enormous change in a relatively short period of time, leading some to conclude that change has begotten only chaos. For instance, a 50-page lease accounting standard issued in 1976 has subsequently been amended by nine additional regulations and 10 FASB technical bulletins.

I do not know about you, but I am more than a little concerned about the amount of mail I am getting in my in-box announcing new seminars to explain yet another new accounting process or rule. I know someone is making money off that proposition, and it is not the Eastman Kodak Company.

There is also a growing concern about standards that force some to focus on short-term accounting results at the risk of long-term profitability. I know that FASB Chairman Dennis Beresford argues that "measurable costs are borne by the preparers of financial information . . . while the unmeasurable benefits accrue to the economic system as a whole." One would hope it works that way, but there is reason to doubt that it does.

Jim Parks, of the Federal National Mortgage Association (or Fannie Mae), noted in an article in the Journal of Accountancy last November that FASB Statement 91, as well as Technical Bulletin 87-3, on mortgage servicing fees and rights has prompted structural changes in the home mortgage industry.

Prior to Statement 91, many lenders recognized certain up-front commitment and origination fees in income immediately. As Parks notes, the standard has caused lenders to increase the sale and securitization of more loans to offset the decrease in profits caused by deferring the up-front fees.

Parks argues that this has created a whole new administrative layer in the loan business, and that additional transactions may actually lead to higher mortgage rates for consumers.

Maybe I have been operating under some misunderstanding but I thought that one of the underlying assumptions of financial accounting standards was that they should report economic events, not cause them. Even relatively non-controversial changes have their costs. They can take an enormous amount of time, effort, and resources for our companies to meet or adjust to.

For instance, Statement 96 has a number of implications that disturb me. It is unclear how the income to be reported under 96, as it has been proposed, will result in a more understandable or more reliable income figure than what we are reporting today. Nor is it clear how shareowners and investors will be better served.

I have heard from Tom Jones, executive vice president of Citicorp, that his firm has spent several million dollars just to plan the implementation of Statement 96, and they have not implemented the standard yet.

Why should we make changes to fit theoretical structures, when the result is no more enlightening and the cost to business is substantial? To my way of thinking, costs borne by business through additional disclosure should not exceed the value of that information to investors and other users.

We hear a lot, especially in manufacturing circles, about the need to be more competitive in America. But here we have an industry-supported, rule-making body that in some cases makes competing just that much more difficult.

If we are to be competitive, we cannot afford to expend marginal dollars on new accounting systems solely to provide data that does not add significantly to the reliability or relevance of reported information--and that is not used in running the company. We need to spend our precious time, energies, and resources elsewhere. You can bet our overseas competitors are doing that.

I say this with some understanding of standard-setting in other countries that have highly developed accounting systems, like the United Kingdom and Canada. They simply do not face the same problem we do. Their standards are in many respects much more practical.

The corporate crystal ball

Even when there is something to be gained through additional reporting, the FASB does not always take the most practical tack. Indeed, the Board often assumes that requiring more data is equivalent to providing useful information.

The FASB's proposal for requiring additional disclosure of financial instruments is a case in point. Its objective is to provide adequate disclosure and uniform accounting applications for the plethora of new financial instruments now being used. This is an admirable objective, but what the FASB has focused on is quantitative data about, rather than qualitative discussion of, the newer derivative instruments.

Almost two years after the proposal, we still do not have guidelines. However, following the intense criticism by industry, the FASB is finally proposing more reasonable rules that will require an explanation of the products, with selected quantification.

While additional disclosure is needed under certain circumstances and as business evolves, I caution against the overuse of the management's discussion and analysis (MD&A) section as a vehicle for disclosure. For some time, former SEC Chief Accountant Sandy Burton and others have discussed putting more "forward-looking" information in the MD&A. Indeed, the FASB Concepts Statement 1 states that providing information that will assist investors in predicting the amount, timing, and uncertainty of future cash flows is a major objective of financial statements.

There are, of course, a number of problems with changing the emphasis of disclosure from corporate reporting to corporate forecasting, not the least of which is the obvious problem of liability. While internally we make educated guesses about the future, we do not control all of the variables. And I would not like to give investors the impression that we do.

I am also concerned about what such a requirement will do to us competitively. Like a football quarterback, the last thing I want to do as a CEO is start telegraphing each and every move to the competition, especially in this international environment where reporting requirements are not the same. Not only might it inhibit our ability to win, it may be difficult to gain any first downs.

Finally, because of the subjectivity involved, I think it would put undue pressure on preparers and auditors. What are we going to do? Change them from recorders of fact to readers of fortunes?

Inching forward

Despite my criticisms, I am hopeful. For one, the business community has become more engaged in reviewing the standard-setting process. While the recommendation put forward by the Business Roundtable's Accounting Principles Task Force, of which I am a member, to create a new private-sector committee to oversee FASB activities has not been embraced by the FASB or the SEC, I hope it encourages the FASB to be more sensitive to private-sector concerns.

Last year the Financial Accounting Foundation's board of trustees adopted several recommendations that head us in the right direction. They include the following three:

* Formation of a committee of trustees to help monitor FASB standard-setting activities.

* Inclusion of a commentary in the FAF annual report on its oversight activities.

* Reevaluation by the trustees of the FASB's voting requirements for the adoption of new standards and the issuance of exposure drafts. Currently, a simple majority is required. But some have argued that a five-to-two majority might better assure policy stability.

FASB Chairman Beresford agreed last year to enhance business involvement in FASB task forces and to try to conduct more field testing. So, I feel good that we are making some headway. But as we get more involved, we need to be asking ourselves: where should financial reporting be heading?

One, financial reporting needs to be moving toward more general-purpose financial statements that can be easily understood by preparers and investors alike.

Two, our focus needs to be on disclosure, not just on form. We still need to stress audited financial statements and related footnotes as the cornerstone of financial reporting. But financial reporting should be flexible enough to allow management to communicate to investors, managers, and creditors the basic dynamics and risks of the business enterprise.

Three, there should be greater cooperation by standard-setting bodies to produce accounting rules more understanding of business realities, and those rules should be properly field tested before issuance.

And, four, given the international nature of business these days, we should be seeking greater harmony among various international standards in order to speed the globalization of financial markets. Like many, I am very interested to see what happens with the International Accounting Standards Committee's project on the comparability of international accounting standards.

Reaching these four goals will require greater involvement from all of us in the private sector. I think Financial Executives Institute understands this better than most, and I appreciate FEI's efforts over the years to increase business membership on the FAF and to push candidates for FASB vacancies who have strong business management backgrounds.

It is incumbent upon us, as the preparers and most active users of financial reports, to get more involved in the standard-setting process. We need to participate on FASB task forces. We need to prepare well-thought out comment letters. And we need to participate through such industry groups as the Business Roundtable and FEI to effect change in this critical area of standard-setting.

And, by all means, we need to engage not only our financial people but our CEOs and top managers. The tone at the top is as critical in this effort as it is within our companies.

Only through involvement will we make standard-setting more responsive to the needs of the business community and investors alike. Only through involvement can we change the focus of standard-setting from theoretical purity to economic reality. And only through involvement will we build a balance between costs and benefits.

Mr. Chandler's remarks have been edited from a speech he delivered at FEI's Current Financial Reporting Issues Conference.

Colby H. Chandler Chairman and Chief Executive Officer Eastman Kodak Company