The not-so-mysterious ways of the FASB.

To many, the process and procedures of the Financial Accounting Standards Board appear to be a mysterious labyrinth--and mystery often leads to misunderstanding. Compounding the difficulty is the fact that several of the most prevalent questions about the FASB relate not merely to the board's own structure and operations but also to the nature of standard setting itself, regardless of the organization performing that function.

When Shaun O'Malley, chairman and senior partner of Price Waterhouse, took over at the beginning of 1991 as president of the FASB's parent, the Financial Accounting Foundation (FAF), he asked us to identify three or four aspects of the FASB that are most frequently misunderstood. Very quickly, we identified eight, and about half illustrate the point that, generically, the standard-setting process has subtleties and peculiarities that sometimes make the FASB's operations difficult to comprehend and accept. This article attempts to address that problem by describing some of the realities of how the board does its job.

LISTENING TO CONSTITUENTS

One of the labyrinthine aspects of our process is the lengths to which we go to elicit constituents' input in the form of comment letters, public hearing testimony and other documentation on technical projects. Some people maintain the board ignores this input and doesn't listen to constituents.

Nothing could be further from the truth. Newcomers to the board and staff invariably are impressed, if not intimidated, by the mountain of input, from internal and external sources, that must be read and understood before each week's board meeting. A large part of the reading is comment letters from constituents, some of which run to 30 or 40 pages. On major projects we generally receive 300 to 400 letters, but sometimes more than 1,000 come in. And board members read them all, as do all staff members assigned to the project.

Comment letters frequently have an impact, generally as modifications in a final statement to proposals made in an exposure draft or a change in the effective date. Substantive changes in the exposure draft on other postemployment benefits and a deferral of the effective date of Statement no. 93, Recognition of Depreciation by Not-for-Profit Organizations, illustrate this point. And certainly the current reconsideration of Statement no. 96, Accounting for Income Taxes, is a result of paying attention to constituent concerns.

The trouble is, however, that no matter what adjustments are made in response to constituent input, not all constituents agree with them. Hence, some observers believe the board doesn't listen.

The FASB is committed in its mission statement and its rules of procedure "to weight carefully the views of its constituents," but there is no presumption that the board must accept the views of a majority of constituents. To the contrary, the mission statement and rules also state that "the ultimate determinant of concepts and statements . . . must be the FASB's judgment, based on research, public input, and careful deliberation, about the usefulness of the resulting information."

COSTS, BENEFITS AND CONSEQUENCES

The FASB frequently is challenged to measure a proposed standard's expected benefits against the costs of providing and applying the resulting information and to consider a standard's economic and social consequences. Many of the best minds in business and accounting have examined the cost-benefit question and concluded there is no way to develop formulas or techniques for measuring costs and benefits with an acceptable level of precision--but that the standard setters should make conscientious judgments of costs and benefits in their decision making.

The FASB is committed in its mission statement and conceptual framework to make such assessments on all projects. (See the recent FASB Special Report, "Benefits, Costs, and Consequences of Financial Accounting Standards," November 1991.) Unfortunately, a large portion of the costs are incurred by a community of financial statement prepares that is relatively homogeneous, well organized and articulate, but the benefits accrue to a very large, heterogeneous and unorganized universe of financial statement users. In fact, one can argue that many of the benefits are enjoyed by society at large.

This is often a point of friction between the board and many constituents who are well aware of the costs to themselves of accounting changes but find it difficult to relate to societal benefits because the latter are so diffuse and difficult to assess. On the other hand, the FASB often is urged to give economic and social consequences paramount consideration in standard setting. However, the board has no unique ability or power to make decisions about what is best for society.

The objective of full and fair disclosure expressed in the Securities Act of 1933 arose out of a consensus, which continues to this day, that capital market efficiency is enhanced by a free flow of credible financial information. The history of financial reporting since the 1930s is based on widespread conviction that credible information leads to broader market participation, thereby strengthening competition, and to better investment and credit decisions, thereby improving resource allocation. The strenth and reputation of U.S. capital markets are a testimonial to the long-range commitment to provide prompt, fair and full disclosure.

LENGTH AND COMPLEXITY OF STANDARDS

The plea of "standards overload" has taken a different form in recent years, when the pace of issuance has slowed from early in the last decade. We now hear more about complexity, and the tendency is to equate the number of pages in one of our "brown books" with the density of its contents.

In commenting on one such criticism in a letter to an SEC commissioner, we pointed out that a lot more than the standard itself is included in a FASB statement. In fact, the actual standard, that is, the paragraphs setting forth the procedures preparers are expected to follow, is only a small part of the full package contained in a brown book. Many more pages are taken up by the basis for conclusions, illustrations and dissents--all elements intended to help constituents understand and implement the standards.

For example, Statement no. 106, Employers' Accounting for Postretirement Benefits Other than Pensions (known as OPEB), is 205 pages long, but only 36 pages are devoted to the standard itself; Statement no. 87, Employers' Accounting for Pensions, contains 68 pages, but the standard is only 10 pages. Statement no. 95, Statement of Cash Flows, is 43 pages, but the standard itself is only 5; similarly, Statement no. 94, Consolidation of All Majority-Owned Subsidiaries, is 13 pages, but the standard itself is only 4. In other words, less than 17% of the total pages in these four statements is devoted to the actual standards.

Complexity, like costs and benefits, often is in the eye of the beholder. Vice-Chairman Jim Leisenring has remarked that "an awful lot of the complexities in a good many of our standards are amortization devices, corridors and the like, that we have put in because people perceive these as benefits in mitigating volatility." Several FASB observers have called this "good complexity."

Among the examples of this are Statements nos. 87 and 106. Much of Statements nos. 87 and 106. Much of Statement no. 87's complexity is due to efforts to reduce volatility of earnings. Much of the spreading of OPEB transition amounts and gains and losses was to accommodate preparers' and users' wishes for a more level and predictable earnings patter--in spite of more costly recordkeeping. The board's decision to allow anticipation of certain plan changes for OPEB adds complexity but at the same time produces more satisfactory reported amounts.

FIELD TESTING AS A CURE-ALL

Many have suggested field testing of FASB proposals should be considered formally as part of every major project before a standard is adopted. The subject was discussed by the Financial Accounting Standards Advisory Council (FASAC), a representative body of prominent people from all segments of the board's constituency.

Several definitions of what would constitute a field test were considered, ranging from explicitly solicited responses to an exposure draft on the costs and consequences of implementation to statistically valid sampling to determine a proposal's impact on affected organizations. Since there was no general agreement on a definition, the discussion tended to compare various notions of testing with the kinds of research the FASB staff normally conducts. Ray Lauver, who was then a member of the board, said field testing is "one of the ingredients of the due process procedure" and is equivalent to the disciplined fact-gathering effort the board seeks to carry out on all projects.

While some expressed concern that the more elaborate field testing would delay project completion, several FASAC members said it should be considered but not required for every project. In this vein, one member said it should be recognized as one of the tools available to the board in gathering information but not applied as a rigid procedure to be followed on all projects. No sentiment was expressed in favor of changes in the rules of procedure to require greater formality of consideration than now exists. As with comment letters and other steps in due process, it was recognized the board should carefully consider--but need not be bound by--field test results.

At various times, the FASB has conducted, sponsored or encouraged research that meets most field testing definitions. Most comprehensive and probably best known were the published field tests conducted, with the cooperation of the Financial Executives Institute (FEI), on the pensions and OPEB projects. Beginning in 1981, the FEI, with the board's encouragement, sponsored a cash flow reporting initiative that, in effect, field tested some ideas developed during a conceptual framework project. That initiative provided substantial information for the cash flow project that led to Statement no. 95. Recently we did limited field testing on the fair value disclosures exposure draft and proposed changes to Statement no. 96.

Whatever research techniques are used, the board does take pains to inform itself of implementation problems before adopting a standard.

IMPLEMENTATION PROBLEMS

AND PROSTENACTMENT REVIEW

We are sometimes asked why the FASB doesn't have an established procedure for reviewing standards after they have been in effect for a while to make sure there are no serious implementation problems. We have so many formal procedures--the labyrinth we alluded to earlier--that outside observers tend to overlook our day-to-day routine. In fact, the FASB pays close attention to implementation problems and to whether a standard is producing the intended result.

Staff and board members routinely respond to numerous letters and telephone inquiries and participate in many speeches, panel discussions and workshops as followup to issuance of major standards. On certain complex topics, the FASB has published question-and-answer implementation guides. In some cases, the board undertakes specific research projects, but in general it promptly becomes aware of any problems that may exist through normal communication channels with a wide variety of constituent organizations, the FASAC, the emerging issues task force, the Securities and Exchange Commission and others. This is a rather intense exercise in identifying implementation problems, and it is an important part of assessing a standard's effectiveness.

Of course, early identification of implementation problems is desirable, and in some cases the board is able to do this. But as a practical matter, many implementation questions don't arise until after a final pronouncement has been issued, when various parties focus directly on the specifics.

Finally, a provision in the FASB's rules of procedure requires the board to consider a written request from any individual or organization to reexamine any existing pronouncement. The board must determine two factors: whether the information and reasoning presented had been addressed adequately before issuance and whether events arising since issuance warrant review or reexamination. Responses to such requests are part of the public file, so the board's reasoning is available to all who are interested.

For example, the board decided to amend Statement no. 95 as a result of this process and now is reexamining Statement no. 96. The board has handled many such requests over the years, although most have been denied--either because the board believed it had addressed the arguments adequately during the initial deliberations or because of cost-benefit or relative priority considerations. Even when denied, the requests serve as indicators of potential problems that deserve further monitoring.

In October 1991, the FAF oversight committee recommended that the FASB ". . . consider establishing an annual post-issuance review process to consider collectively the requests for review or reexamination received during the year. . . ." We view this suggestion primarily as a way of better documenting the present continuous review of existing documents. A more formal approach, for example, one based on review after a specified period of time, might suggest the board regards statements as tentative rather than definitive, which, of course, is not the case.

THE STAFF'S ROLE IN DECISION MAKING

There is a widespread misapprehension that the staff exercises undue influence over the board's decision making. It is important to understand the relationship of board and staff. Board members determine the general direction of research. Staff members do the research, report their findings and make recommendations. The board considers those recommendations and very often asks staff for additional research or to explore other directions.

For board discussion in public meetings to be meaningful, there must be (a) a carefully thought-out staff memorandum to provide a basis for discussion and (b) educational meetings between staff and up to three board members. (The Rules of Procedure do not permit private discussion of technical issues among more than three board members.) This ensures board members enter a decision-making public meeting with a full understanding of the background and nuances of the matters to be discussed.

For most staff members who have had proposals rejected by the board and have been "sent back to the drawing board" not once, but many times, the perception of staff domination is a subject of wry humor. Staff recommendations are challenged rigorously by board members in public board meetings, in individual sessions and in internal memorandums. Staff members find such interchanges a valuable part of their experience at the FASB.

The FAST has been operating with basically the same staff structure and size for more than a dozen years. Experience has demonstrated that on major projects, the interplay between a seven-member board and a regularly assigned project team of two to five staff members yields the best results. The board is always looking for ways to improve this equation, but it's undeniable that seven decision makers, determined to attack every issue with conscientious understanding, require a reasonable amount of time to satisfy themselves that they are prepared to make the best possible decision.

The FASB staff members include a handful of key individuals who have been with the board since its inception, but most make their contribution to the standard-setting process within a few years and gain an understanding of that process that they carry with them to other activities. Turnover in the technical staff also is institutionalized in the programs for practice, industry and faculty fellows who come to the board for limited terms of service, generally two years, with the understanding they will return to their former employers. While the fellows acquire valuable experience and knowledge of financial accounting standards during their terms of service, the FASB gains from them current knowledge of accounting problems and practices and fresh insights into possible solutions.

ACADEMIC INFLUENCE ON THE STAFF

Some are under the impression the FASB's technical staff members are mainly academics, augmented by some junior staff fresh out of school. The facts are radically different from the perception. The current technical staff number 40: 29 permanent employees; 7 practice or industry fellows on two-year assignments with the board, committed to return to their previous employers; and 4 postgraduate interns spending one year with the board assisting on certain preparatory aspects of projects before pursuing careers elsewhere.

At the heart of the permanent staff are 16 project managers who direct work on major projects such as financial instruments and consolidation. On average, they have been at the FASB for nearly 6 years. Generally, they have spent a minimum of 10 years in public accounting or industry before coming here and several have significantly more experience. Only 1 of the 16 is from academia.

The practice and industry fellows, though their service to the board is limited to 2 years, function as project managers on implementation and practice problems and as consultants on major projects. At present, there are 7 practice fellows and 1 industry fellow. The fellows generally have had 10 years or more of experience in public accounting or industry before coming to the FASB. The board also has a faculty fellow program but has non on staff at present.

Far from being overloaded with academicians, the staff now is short-handed in that category and would welcome candidates from academia. The objective is not to achieve proportional representation from the various constituencies but, rather, to maintain the best mix of backgrounds, experience and the talent that will contribute to the FASB's technical capability.

IS THE BOARD LOOKING FOR WORK?

No. In fact, the board doesn't have nearly the resources needed to tackle all the accounting problems it is asked to address. Thus, it is compelled to reject many more agenda proposals than it accepts. This being the case, board members feel a responsibility to weigh their agenda decisions for major projects with extreme care and to undertake only those that are most urgent and pervasive and most likely to provide a significant opportunity to improve financial reporting. (Of course, there always will be some of what the board members call "repair and maintenance" projects, such as Statment no. 102, Statement of Cash Flows--Exemption of Certain Enterprises and Classification of Cash Flows from Certain Securities Acquired for Resale.)

Potential agenda topics are brought to the board's attention from many sources--users, auditors, regulators and financial statement prepares. A few years ago, when we again received several requests to work on certain projects, the board took a "fresh start" approach. It began with a list of nearly 100 subjects suggested in recent years by various parties. After extensive research by the staff and consideration by the board members, this list was narrowed to 26 topics for further consideration and ultimately reduced to the 2 that were added to the agenda--impairment of assets and interest methods.

The process shows how wide a net the board casts in seeking the counsel of others about agenda decisions. From the beginning, the FASAC has provided significant input and the circle has widened over the years. The last go-around also included consultation with the FEI committee on corporate reporting, the Institute of Management Accountants (formerly the National Association of Accountants) management accounting practices committee, the American Institute of CPAs accounting standards executive committee, the Association for Investment Management and Research, Robert Morris Associates and other relevant groups. This was a broader outreach for comments on potential agenda projects than had ever occurred before.

With much greater interest in the board's agenda, it is fair to assume the trend toward increased consultation on agenda decisions will continue.

THE MYSTERY UNRAVELED

Carrying out a public responsibility in a field characterized by subtlety, complexity and absence of clear-cut answers, the FASB works hard to develop solutions that can be defended in terms of facts and circumstances, logic and the fairness of the process that produces them. It is an elaborate process, but the objectives and principles on which it is based are no mystery at all.

DENNIS R. BERESFORD, CPA, is chairman of the Financial Accounting Standards Board, Norwalk, Conneticut. ROBERT VAN RIPER was public relations counsel to the board from its founding until his recent retirement.