FASB Chairman Herz reviews key issues.

Financial Accounting Standards Board Chairman Robert Herz spoke candidly with Financial Executive's Managing Editor Ellen M. Heffes about some of today's key issues in financial accounting and reporting. For the full interview, including Herz' comments on the process and timing for important current standards, see the Web site at: www.fei.org/mag/articles/62004_fr.cfm.

What would you say is the biggest success so far related to international convergence?

HERZ: The biggest success so far is that we were able to get together, agree upon and start executing a strategy on convergence. In addition, [there] is the fact that [while] the International Accounting Standards Board (IASB) has done a lot--they had to fill in their book of standards; they had holes, and still have some--some of that has been looking at what we do in the U.S., and concluding that it would be okay for them. So there has been a lot of movement on their part. We've also made some movement in their direction.

I think the biggest thing is for us to stick to the overall strategy on convergence, and to do it in a thorough way--touching base with all of our constituents--in order to get to higher-quality reporting that is common across the capital markets.

Do you have in mind a goal for completion of the convergence project?

HERZ: "Complete" would mean that there would be only one set of standards. I could see that happening, perhaps, in 7 to 10 years from now, but there are degrees of completion. Could there come a day when the Securities and Exchange Commission (SEC) says foreign registrants can use international standards, and not reconcile to U.S. generally accepted accounting principles (GAAP)? That could happen in say two or three years.

Could there be a time when the SEC says for U.S. public companies, "All right, you've got a choice. We now think the international standards are good enough, complete enough and similar enough to what you are already using. You can choose." That could be five or so years.

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It'll depend on a lot of factors, not just how we progress, but, importantly, it will [also] depend near-term on whether or not the broad-scale implementation of international standards in Europe starting next year is a success. They are having some issues, but I think the biggest challenge relates to the fact that there will 7,000-plus companies moving [to new standards]--this is like the D-Day of accounting and financial reporting.

I hear the pain of some of our [U.S.] companies--preparers, with [Sarbanes-Oxley Section] 404, faster reporting deadlines and other things that they need to do now--and that certainly is a challenge. But imagine you are a company, in Italy or Greece or any part of Europe, and you are changing from national standards to a completely different set of standards.

In late March, FASB released an exposure draft on share-based payments, which is not without controversy. What do you believe is the likelihood of Congressional involvement--is it another 1995, or will it be different this time?

HERZ: There already has been extensive Congressional involvement; right at the point where we put it on the agenda a year ago, some folks immediately called hearings. There have been a number of hearings since that time, and there will be more hearings. It's a topic where different people have different views and different interests.

Our mission is quite clear: it is to improve accounting and financial reporting standards. We put stock compensation on the agenda because after an invitation to comment, we heard from many constituencies--investors, analysts, people who run pension funds, trade unions, the major accounting firms, some people in Congress, a report from The Conference Board--and all of them said, "You have to do something about this."

The current accounting is a real problem, and not just in view of excessive executive compensation; it's not good accounting. So we put it on the agenda a year ago; we went thoroughly through it, and came up with this proposal, which we think is a good proposal. We put it out for public comment [as an Exposure Draft]. We will hold several roundtables, and we'll take it from there.

I don't view this as an issue of backing down, winning or losing. It's about carrying out our mission of improving financial reporting, and doing it in the way that we normally do things--in a thorough, objective way.

Bottom line, do you expect it will culminate in a new standard by year-end, including the valuation issues?

HERZ: As for valuation, we talk extensively in the document about different approaches, although they are all based on the same financial economic theory. People say, "How can that be, Black-Scholes, or lattice or binomial model?" Well, [using] lattice is just like opening up and peering into the Black-Scholes [model]. It's based on the same financial economic theory. It's just a more flexible version, where you can put a lot more inputs into it.

The exposure period ends June 30th, and that gives us time to carefully redeliberate. So, our current target is to get something out in the fall time frame.

Just generally, talk about your perspectives regarding Congressional involvement in the private-sector standard-setter, FASB.

HERZ: I've spent a fair amount of time on Capitol Hill, and know that being a Congressman or Senator is extremely challenging. The range of things that you have to deal with is just mind-boggling. I believe most of them are really trying to serve their constituents in the public interest. They may have different views about that; they come from different political persuasions and philosophic persuasions, but I think they are trying to serve the public interest. We, too, serve the public interest. As I said before, our mandate is quite clear about how we're supposed to be serving the public interest.

I think Congress has a natural interest in what we are doing, but I think that interest is best channeled into ensuring that our process is thorough and objective--rather than catering to particular special interests, either trying to say, "I think this accounting is better," or, "My constituents are not happy with this answer, so we'll call a hearing." So, again, I welcome their interest, but I think that interest should focus on helping ensure that our process is independent, objective and thorough.

FASB has launched a small business advisory committee to study the accounting needs of these companies. Why now, and what do you expect will come of this?

HERZ: We set accounting standards for not just public companies, but for private companies and not-for-profits, as well. Thus, I think there is a valid concern that with all the focus at the top level on the public-company reporting problems and with the movement towards international convergence, that we don't lose sight of the accounting and financial reporting for the many hundreds of thousands of private and smaller businesses.

The issue of "differential reporting" has been looked at many times in the past, and it's known as "Big GAAP, Little GAAP." Lots of work has been done, and every time the answers come back that while it makes sense to maybe have different levels of disclosures, or some different disclosures and it certainly makes sense to have longer effective dates for smaller companies, but that it does not make sense to have a whole different set of GAAP.

In fact, if the companies wanted to do a different GAAP, there are different comprehensive bases of accounting that are not GAAP that they could choose to use. But often it is the users of that information--usually the banks or other people--who say they want GAAP. So, it's a product choice.

We want to hear in a focused way from people in small business, and the users of small business financial information and the auditors of small businesses, to understand exactly how they see things, to what extent there should be at the least differential disclosures and the like. Should there be some short-cut methods in some places? I don't know.

The U.S. answer has generally been kind of "one-size-fits-all," except [for] disclosures and effective dates. Not so in other parts of the world; I am also an English Chartered Accountant, and the U.K. has a thing called "financial reporting for small enterprises," FRSE. Canada has some differences, and IASB is going through some thinking on this subject. I've got an open mind on it.

But where I feel fairly strongly is that financial reporting is a product that is there for the customer, and the main customers are the people who use the information to make lending or investment decisions. So ensuring that their information needs are met must be the primary goal, while also being cost-effective.