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The rule-making process: a time for change?

The rule-making process: a time for change?

The FASB is beginning to respond to its critics, the authors write. What is now needed is some give and take from both sides. From industry's perspective, such discussion would begin with the agreement that business is both a preparer and a user of financial information and that the conceptual framework should not drive standard-setting. Rholan Larson and Dennis Beresford are sending some clear signals that the corporate community's concerns may finally be getting some attention. While that is encouraging and the changes seem to be pointing in the right direction, it may take more than mere raging incrementalism to still the legitimate criticisms.

The FASB is clearly a natural target for criticism, and has been almost from the beginning. It has been criticized for issuing "cookbook" accounting standards on the one hand and for being too broadly conceptual on the other. It has been condemned for standards that are too complex and costly to implement, and accused of a preoccupation with "conceptual purity" resulting in standards that are far removed from reality. Most recently, critics have asserted that the Board does not pay enough attention to the "social consequences" of its actions and that it has too much autonomy.

While some of the critics are new, the criticisms are not. The labels get changed, but the underlying discontent is the same. What is new is the recent ground swell of opinion within the corporate community and the public accounting profession that changes need to be made in the standard-setting process. Also new are the remedies that have been recently suggested to accomplish this.

Some in industry have even suggested that accounting standard-setting responsibility be taken away from the private sector and turned over to the Securities and Exchange Commission, or that an oversight committee be established which would have veto power over projects added to the Board's project agenda. Others have suggested less drastic action which they characterize as fine-tuning, such as the more effective use of project task forces and the need to do more field testing of the FASB's tentative conclusions on major projects.

The idea of turning accounting standard-setting over to the Securities and Exchange Commission has no appeal to the authors, nor do we think it has widespread support. Politicizing the standard-setting process would not be helpful. Similarly, establishing an oversight committee with the power to overrule Board project agenda decisions would erode its independence and weaken the credibility of the process. Neither solution is very good. But they are certainly symptomatic of the business community's growing perception that it is not being heard in Norwalk.

So the question is: are these concerns justified? And, if so, how can they be addressed without throwing the baby out with the bath water?

Several years ago, a coalition of members of industry, including some from FEI, argued that what was needed was a shift in the balance of power at the FASB with more industry representation on the board of trustees of the FAF, and more practical experience on the FASB itself. Since that time, the FAF has added a fourth member from industry to its 16-member board of trustees, and the seven-member FASB now includes two members with industry backgrounds.

Those were constructive steps. But they obviously have not decreased the level of criticism and have not been successful in allaying industry's concerns. In retrospect, it was probably unreasonable to expect that they would. While industry representatives bring an industry perspective to the Board, they are independent and objective thinkers fully capable of arriving at their own conclusions, which may or may not reflect the view prevailing amongst their business constituency.

The hard fact is there are fundamentally differing views between the standard-setting and the business community on what accounting standards are supposed to do. These differences get reflected in the consideration of such things as the need for trade-offs between conceptual primacy, complexity, and cost, or whether the focus of standards should be on the income statement or the balance sheet, or on enhancing the usefulness of financial information. And, of course, both sides use the same words to support their views--words such as useful, relevant, and cost effective--but they attach different meanings. These differences in perception have significantly hindered the dialogue. While the standard-setters and the business community may "listen" to one another, there is certainly ample evidence that neither "hears" very well.

The key to improvement may be in a greater willingness to compromise, and by that we do not mean giving in to special interests. What we mean is give and take--listening and hearing, and then reacting to concerns in a tangible way rather than dismissing them as self-serving. The dialogue today is defensive where it needs to be constructive. Both sides must work at it, but it's time for a change.

Business is both a preparer and user

For openers, the FASB needs to accept the notion that its critics in the preparer community are not totally preoccupied with the impact accounting standards may have on their bottom line. Financial statement preparers are also users of financial information, a reality which the Board tends to heavily discount. One seldom hears a Board member mention users and preparers in the same breath. Instead, the Board seems inclined to emphasize the distinction between industry as preparers and most everyone else as users.

The simple fact is that the same people who are preparers are probably the largest class of users of financial statements. For strategic planning purposes, for example, companies will analyze the competition's 10-K to determine information on market-share, costs, and a variety of ratios. They also analyze such data when considering investment possibilities, including those for pension funds, and when making potential merger and acquisition decisions.

This dual role as both preparer and user results in a unique ability to recognize the needs of both. But the Board clearly gives little weight to this, preferring the notion that we speak only as preparers, that we are overly resistant to change, and that our views, however articulate (or inarticulate), are suspect. It is this bias that fuels the argument of "they won't listen."

The Board has lamented that it receives relatively few comments on its proposals from those it perceives as the principal users of financial information, namely, investors and creditors. And so it manufactures what it thinks would be useful to them under the guise of serving the needs of users while discounting the legitimate concerns of preparer/users. One cannot help but feel that the Board is being overly influenced by what it deems to be the needs of a rather narrow slice of its constituency, and a relatively unresponsive slice at that.

In contrast to such users, industry, as both a preparer and user, submits two-thirds of the comments the Board receives on its proposals. It would seem to follow, then, that the Board, in measuring how well it is fulfilling its mission of serving the needs of users of financial information, must do more than just "listen" to industry's views. It needs to be less defensive and respond to industry's views in a more positive way, not just write them off as being self-serving or as a mere expression of resistance to change. The FASB needs to keep in mind that industry also speaks as a user of financial information.

Concept versus economic reality

The second issue which needs to be addressed is the notion of conceptual primacy in setting standards. While it is obvious that standards must have a legitimate conceptual basis, surely rigid adherence to concepts which produce answers that make no sense, or that are so complex it takes a battery of accountants to implement them, is of little use.

The recent standard on accounting for income taxes, FASB Statement 96, must by now be an embarrassment to the Board. Conceptual appeal with a non-sense result. Two of its more controversial features are the limitation it imposes on the recognition of deferred tax assets and the measurement of those assets at carryback tax rates, i.e., the so-called "46/34" problem. Both ignore reality. The probabilities are that most companies will realize these future tax deductions at tax rates other than those recognized in the financial statements.

While taking a more realistic approach to the recognition and measurement of deferred tax assets requires rounding some of the square corners of the conceptual base, the trade-off of more useful information--i.e., information that describes the real world--is well worth the compromise. Indeed, the pragmatic world of business suggests the relevance of pragmatic principles. The Board itself recognizes the importance of a useful result. But in this example, conceptual primacy was the clear victor over usefulness. It is this tendency that sets off the rockets in the business community.

And, of course, the frustration index in the business community continues to rise because of the perception that the Board isn't listening. Its only concession has been to delay the implementation date of Statement 96 to give companies more time to deal with the difficulties of implementation, while maintaining a fortress mentality toward making any change to the statement. For example, the FASB has asserted there is no way under the conceptual framework that deferred tax assets can be recognized based on the probability of realization. But this assertion, which itself is controversial, adds significantly to the complexity and cost with no demonstrated increase in the usefulness of the result.

Why does the Board feel so hesitant to step from behind the fortress of conceptual primacy, when to do so obviously simplifies implementation with no measurable reduction in usefulness? The individual members of the Board are among the best accounting minds that we have. To venture now and then from behind the breastworks won't result in the destruction of the fort. The strength of the Board can only be enhanced by occasional common sense intervention with the notion of conceptual primacy.

Will fine-tuning help?

A number of recommendations have recently been made which we think have the potential to improve the process of standard-setting: the idea of issuing a "prospectus" for public comment on projects the Board is considering adding to its project agenda; the suggestions which have been made on how project task forces can be more effectively used; and the idea that the Board issue for public comment its preliminary views on a project before it issues an exposure draft of a proposed standard. These are all good ideas that deserve serious consideration. The argument that such procedures would slow down the process is a red herring. What we need is more general acceptance of accounting standards, and we should take whatever time it takes to get them right.

Another recommendation, which has been around for a while, is that the Board field test its conclusions on major projects. We strongly support using field tests in projects which take the Board into "uncharted waters," and we applaud the members for those occasions when they have done so. This practice better than others can provide valuable insights into the practical consequences of applying its conclusions on a project. For example, field testing the Board's preliminary views on accounting for pensions, sponsored by Financial Executives Research Foundation (FERF) with the results published in 1983, confirmed that the FASB's tentative conclusions would have introduced a high degree of volatility in companies' annual pension expense, even when a given pension plan's provisions and plan population were unchanged. This resulted in the Board making changes in the final standard that helped to reduce volatility. And here, it must be said, they did listen--but it was not without considerable prodding.

More recently, a FERF field test of the Board's conclusions on accounting for postemployment benefits has already shed light on a number of measurement, data collection, and other issues--and did so even before the Board issued its exposure draft. The final report of this field test should help the FASB and its constituency understand the merits and weaknesses of the exposure draft.

We cannot help but believe that had the Board been receptive to field testing its conclusions on accounting for income taxes, Statement 96 would have turned out differently. In the past, the FASB has tended to look at field testing as a code word for delay. That is an indefensible position given the positive evidence already available that field testing improves the result.

The process will work

In our opinion, the FASB has contributed significantly toward improved financial reporting. But the current trend toward more complexity (recognizing that more complex issues are coming before the Board) dictates the need for the Board to improve its understanding of the impact on preparers. Meaningful dialogue and a willingness to compromise toward what is practical are essential. The Board continues to have the overwhelming support of its business constituency, but it can expect continual erosion if it fails to heed the increasing chorus of disenchantment.

We don't need major reform. The process will work. What we need is a genuine effort on the part of both the business community and the FASB to listen carefully to one another, to find acceptable compromises, and to extract the added strength that comes from a true partnership with its constituency. And we look to the Board to provide the leadership that will make this process work.
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Title Annotation:criticism of the Financial Accounting Standards Board's rule making process
Author:Jacobsen, John C.
Publication:Financial Executive
Date:Mar 1, 1989
Previous Article:How well does the FASB consider the consequences of its work?
Next Article:Corporate income taxes - where are they headed?

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