Q&A.

Q&A SOUTHERN: In the Seattle marketplace, we have a few very large corporations and many small- to medium-sized corporations. Rick, when you hand the CEO of one of your clients those financial statements, with two-page footnotes, does he or she understand them?

FOX: Sometimes present accounting requirements are difficult to explain. for example, to explain the reasons why an intangible asset is recorded as an offset to a liability for pensions is very difficult.

And, going on to income taxes, Statement 96 requires companies to invest money in systems and outside assistance to get answers that in many cases are not relevant to day-to-day operations. It is extremely difficult to explain why the implementation costs relating to these new standards are justifiable.

SOUTHERN: But what about fraudulent and misleading financial reporting?

FOX: Clearly, fraudulent financial reporting is a real concern. The Emerging Issues Task Force is doing a good job of dealing with many of the day-to-day issues.

MEAD: FEI is trying to bring the FASB together with business representatives before a statement is published that traps the FASB, like it is right now on the statement on income taxes.

Let's take another example--postemployment benefits. FEI agrees with the FASB that there is a need for an accrual. But the issue is how you go about it. The exposure draft contains some tough assumptions on how these benefits should be accrued. This comes back to the credibility issue and whether the FASB really is listening to people.

There was an excellent article in the January/February 1990 issue of Financial Executive on this very issue. The author presents three or four points that, if adopted by the FASB, would "gain renewed confidence for the Board and support from its broad constituencies." [Mr. Mead refers to Michael F. Sullivan's "The OPEB Exposure Draft: A 'Golden Opportunity' for the FASB."]

HEATH: Ron, I think the FASB is listening to you. what the Board members are saying is, "We have listened to you. We have heard you. We even understand you--but we disagree with you."

SOUTHERN: One of the basic issues of disagreement is that, in order for GAAP to improve, the principles must change. But I remember opinions I could read in half an hour. There aren't many of those anymore. Are we digging too deeply into these issues and that's why nobody understands them, everybody loses interest in them, and we can't even explain them to our CEOs? If we're going to improve, must we change? And is there any way we can move back toward simplicity from the way it seems to be going, which is thicker and thicker rule books? You know, the checklist to start, taxi, and fly a Boeing 747 is only four 5" x 8" pages long!

MEAD: That's called the cookbook approach. some say the kind of system we are moving toward resembles the Internal Revenue Code. If we try to solve every problem, business accounting will become buried in detail. We've got to have basic principles, and then let people make decisions based on them.

HEATH: I don't think the FASB is trying to make financial statements all things to all people. But I do think that's what you're trying to do when you say accounting principles should be simple. The FASB has gone on record as saying that it's trying to provide information to sophisticated users.

I agree that financial statements are very complex, but the underlying transactions are very complex.

SOUTHERN: What happened to the FASB's conceptual framework project? How did the FASB get off that approach to the current approach of dealing with very specific issues?

HEATH: There's no simple answer to taht question. The conceptual framework has been a disappointment. When it was started, there were unrealistic expectations about what it would do. it was felt that if we could agree on the basic concepts, all of the specific issues would fall neatly into place. But this was naive. It is like saying that if a legislature or court were to sit down and agree on the meaning of truth, justice, fairness, and equity, all of the issues society now faces, like capital punishment, abortion, and flag burning, would fall neatly into place. that just won't happen.

Although the conceptual framework has been a disappointment, it hasn't been a failure. Comment letters received by the Board are now of much higher quality than they were a number of years ago. Much of that, i believe, is due to the conceptual framework. It has helped focus the issues.

MEAD: I think the conceptual approach has gotten the Board into trouble at times. That's what happened on the statement on income taxes. The Board tried to come up with an answer that complies with the theory and that also satisfies income taxes. The answer doesn't make sense.

HEATH: Ron, if you're saying that the FASB ought to pay attention to the costs of implementing these standards, obviously that's true. No one disagrees with it. But I don't know what you and others mean when you say that standard setting is too theoretical or too conceptual.

Your comment brings to mind something in the FERF funds flow study ("The Funds Statement: Structure and Use," by Alan Seed, III). Author Seed dismisses the direct method of reporting cash flows from operations on the grounds that it is "too theoretical." But when he made that argument at an FASB cash flow task force meeting, the SEC representative countered with, "What do you mean it's theoretical? It's plain old checkbook accounting." I agree. Arguing that something is "too theoretical" is meaningless.

MEAD: But FEI encouraged its members to take the lead in voluntarily reporting cash flows in funds statements.

HEATH: FEI didn't encourage them to report cash flows. it said use the cash method or preparing your statement of changes in financial position. Start with income, which isn't cash, and add back depreciation, which isn't cash, and that will get you cash on the bottom line. That's confusing method of presenting.

FOX: That's the way most of my clients prepare their cash flow statements for internal use. They must find them useful or they'd go to a direct method.

SOUTHERN: Let's go back to the issue of the levers and switches. Who should control the standard-setting process, and why? What makes you think that the current controllers of the levers and switches are appropriate?

HEATH: The various organizations that set up the FASB and the FASB itself have recognized that the Board's responsibility is to the public. That's why Congressman Dingell has been its supporter lately. I think that the FASB should be responsible to the public, but you've got to recognize that the FASB is trying to regulate financial statement preparers. Financial statements are a report on management. Earnings per share are to management what grade point averages are to students. They are performance indicators.

FOX: I disagree. In my view, management should be permitted to prepare financial statements in a way that best communicates the financial condition of the company. Accordingly, I feel that broad accounting standards should be issued, not standards that are so narrow that companies do not have the opportunity to communicate their financial results in a manner that management believes is fair.

SOUTHERN: You said that it's appropriate that the FASB makes its own judgments about whether it's serving the public good. But who passes judgment on the FASB?

MEAD: Under the new procedure, the Foundation trustees are going to review the FASB, not on technical considerations, but on its performance and on the performance of each board member against the FASB's mission. We think this is the right way to go. But it's not going to happen overnight.

HEATH: Art Wyatt, as many of you know, resigned from the FASB in protest of what he called the undue dominance of the Board by the financial statement preparers. One of his criticisms was that the trustees, who are really responsible for the FASB, had not been exercising their influence. And now we have the Trustees' Oversight Committee, which is, I think, a healthy influence. But then, you might ask, to whom is the Financial Accounting Foundation responsible? I guess it's responsible to the SEC and ultimately to Congress.

SOUTHERN: I'd like to conclude by asking each panelist where we are going to be in five years. Will we be having the same discussion then?

MEAD: I would say that in five years we will be pleased with the establishment of the Oversight Committee of FAF and how it has refocused the FASB on its mission statement. I am hopeful that the FASB will seek a balance between the theoretical and the practical, even though we are getting mixed signals at this time. I predict that the standard-setting process will remain in the private sector. I also predict that international standard setting will become a major factor and will influence standard setting in the United States.

HEATH: I think the situation will be about the same in five years as it is now. My concern is that if financial statement prepares have gained control of the process, or if Congress believes that they have, it will step in and move standard setting to the government. That is a threat that has been with us for years and is something that may well occur at some time.

FOX: I agree that the standard-settinng process should remain in the private sector. While we may disagree with the conclusions from time to time, that process generally has worked well. Many of the criticisms that were leveled at the FASB's predecessor, the Accounting Principles Board, have been addressed. This is not to say, however, that there is not room for improvement. In my view, the Board should focus its attention on the major accounting issues, such as its current projects on financial instruments and postemployment benefits. With respect to the day-to-day issues and questions of implementation, the emerging Issues Task Force is doing a good job and I believe that process should continue.

I look forward five years and see a very active and very structured EITF seeking out and dealing with the day-to-day issues. This is very important for all of us. We need to reserve for the Board's deliberation process the major issues, such as postemployment benefits and financial instruments. If the FASB deals with the major issues with a practical approach that meets cost/benefit criteria, it can become more efficient and more effective.