SEC commissioner proposes new multilayer reporting model.

Steven M. H. Wallman, commissioner of the Securities and Exchange Commission, unveiled his proposal for an alternative reporting model in which financial statements and related disclosures would be viewed in different layers. Wallman told members attending the American Institute of CPAs 23rd annual conference on current SEC developments that the model focuses on providing relevant information by de-emphasizing black-and-white recognition criteria, the basis of the current core financial statements. "My goal in proposing a model is to stimulate creative thinking to address the challenges facing accounting and financial reporting in the next century," said Wallman.

"The most relevant and reliably measured items would represent the core of the financial reports," he continued. "Successive outer layers would consist of information that meets the requirements of recognition but that is not as susceptible to verification procedures." The commissioner said the additional layers outside the core financial statements and levels of attestation for each layer would have to be determined.

Uncovering the layers

The first layer would include items that satisfy recognition criteria and could resemble the current core financial statements. The commissioner suggested re-examining what would satisfy the core financial recognition criteria. "For example, does it really make sense to recognize one parcel of real estate acquired 100 years ago in 1896 dollars in a manner identical to another piece of real estate acquired yesterday?"

The second layer would include items that satisfy recognition criteria but that are not included in the core financial statement because of reliability concerns, such as research and development, advertising and similar expenditures. Other currently unrecognized elements could be included, such as the value of brands and deposit intangibles. "Establishing this additional layer of reporting outside the core allows for the reporting of relevant but perhaps less reliable information," said Wallman.

The third layer would consist of items that raise both reliability and definition concerns, such as measures of customer satisfaction. He said these measures contribute to earnings capacity in a tangible manner. "Customer satisfaction may sometimes meet the definition of an asset, such as when it is associated with a brand name.

"A fourth layer in the reporting model could be specified for items that satisfy measurement, reliability and relevance criteria but do not meet the definitions of financial statement elements." The commissioner said that risk sensitivity metrics were a good example of information that would fall within this layer.

Finally, a fifth layer of the model would contain relevant items that do not meet the definition of elements and cannot yet be reliably measured, according to Wallman. "For example, the going concern value of a company, intellectual capital or the value of a trained workforce may not meet the definition of an asset because the employees to which these investments relate are not controlled by the company" said Wallman. Instead of not reporting these items at all, the preparer could disclose them in the fifth layer along with a description of the limitations associated with any valuation.

Measuring the difference

Under the commissioner's model, recognition becomes the concept for one layer of presentation, not the objective for financial reporting. Wallman said there were important issues to be resolved before changing the system, such as

* Determining the degree of comparability in the new model.

* Assessing the costs to preparers, litigation exposure and the need for safe harbor.

* Concerns about litigation exposure and the need for a safe harbor.

* Uncertainty about how traditional accounting measures such as net income or earnings per share would be calculated.

* Whether the additional layers would create greater confusion.

Wallman said a new multilayered system would provide end-users with a better sense of the quality of the information. "This approach is more aligned with the purposes of financial reporting and more compatible with the dynamic nature of information that is relevant to the end-users of financial reporting."