Financial reporting issues for preparers.
Thuener also said that materiality drives complexity due to the many different perspectives on the subject from preparers, regulators, auditors, and users. Cohen agreed, adding that the volume of standards is another factor in complexity, and that even simplification projects can add complexity in terms of requiring work in investor relations during implementation.
Turning specifically to the revenue recognition standard, Cohen noted that KPMG's guide to the standard is a thousand pages long, and that "I don't think they've even touched the surface of all the issues." He added that "we have to do a better job on what is material," noting that information overload can lead to users being unable to pick out what is useful.
Strauss asked the panel for their thoughts on disclosure, saying, "It seems to me that you can't read a financial statement anymore. It's hard to pick what's important." Thuener opined that this was similar to the materiality issue: "There's not always clarity around which are the most important notes."
Strauss talked about disclosure checklists, to which Uhl added that technology has enabled greater complexity in financial statements, to the point where "we've hit the saturation point." As a remedy, he recommended a more disciplined, cost-benefit approach to setting disclosure standards; consideration of disclosure though the entire standards-setting process; periodic disclosure reviews; better coordination between FASB and the SEC; and closer examination of interim reporting.
Laux then discussed the complexity of business models, saying, "We would really do investors a benefit if we focused on trying to better explain what the business models are." As an example, he cited Microsoft, where "the real focus in quarterly reporting is the earnings conference call. It's not the 10Q or the 10K, which is just a compliance document or investor's data." He added that "the problem with earnings conference calls is we get into short-termism, which is not the way that business models are done. They're done on a long-term basis."
Next, Strauss invited Uhl to discuss the working relationship between auditors and their clients. Uhl used the familiar triangle of the auditors, the audit committee, and management, saying that each party needs to understand the roles of all three and execute its own well, and that good communication is essential. "There has to be a strong tone at the top," he said, "and you have to hold each other accountable." Uhl added that auditors need to bring "skill and will"--that is, auditors with the right talents for the engagement and a skeptical, independent mindset--to engagements.
Thuener agreed, saying, "We've found that the relationship works well when there is really good, open communication and you're bringing your auditors in early." She also said that the move to principles-based standards is changing the auditor-management relationship: "In a principles-based standard, we should be able to make some judgments, and they might be different between management and the auditors. How do we deal with that?"
Laux then asked whether there was too much emphasis in the new standards on comparability versus informativeness. Uhl thought that there was, saying that the impetus comes from a desire for consistency, but that "we tend to sometimes take that too far, and that creates a lot of tension in the system." Comparability is needed, LaMonte said, because users compare companies when making investment decisions. "We're not only looking at performance over time for an individual entity," he said; "we're also looking at performance relative to peers." LaMonte and Uhl agreed that principles-based standards can sometimes lead auditors to try to compare the incomparable.
Strauss asked about auditors' relationship with the PCAOB and how that might affect companies. Laux commented that the relationship has become "unhealthy" and that "this detail on controls and this almost 'in the weeds' type of thinking has hurt the profession." LaMonte disagreed, saying that the PCAOB has accomplished its mission of restoring trust in the auditing profession. "We as users of financial statements are at a point where we have a high degree of confidence that we're getting better numbers than we did back in 2002 and 2003," he said. "I actually think," Laux countered, "we overreact as a profession to these crises."
Strauss brought up auditors' work consulting on standards and interpreting them for clients, saying that it is now considered a violation of independence. Thuener disagreed slightly; she said the key is for auditors to point companies in the right direction, but for management to be the one making the final conclusion. Uhl added that the relationship has changed, and that management now spends more effort, and consequently more resources, conducting its own analyses.
Responding to another question from Strauss, Cohen said that partner rotation on engagements has created "some issues" because of the learning curve involved. He also cited a recent study published in Accounting Today which found that a long-tenured partner actually helps with skepticism because "they understand the client better, and it's easier to give bad news to someone if you know them better." He also stressed the importance of communication throughout the process, even before transactions occur.
Strauss then turned the topic to relationships with the audit committee. Laux said that too much of committees' time is spent reviewing financial data, although he blamed this on the volume of the data rather than the auditors.
Cohen shared his experience with NBCUniversal's parent company, Comcast, whose audit committee conducts extensive reviews of its financial statements every quarter: "We'll take different areas within our company and sit down with them so that they understand the business, the judgments that we're making, and how that then applies to the financial statements." He added that committees are also asking the right questions. He also described the process as "an interactive discussion on a continuous rolling basis."
Strauss opined that audit committees don't always find the requirements of standards intuitive, to which Cohen said that explaining the accounting often takes an "exorbitant amount of time," adding, "maybe our focus is in the wrong place."
Laux commented that, in his experience, audit committees want to be "engaged and engaged early. They recognize that this is part of their job and they want to understand the standards." He also said that committees are spend ing more time on press releases, especially those regarding non-GAAP financial measures.
Effectiveness of Disclosures
Introducing the next topic, LaMonte dug deeper into FASB's disclosure effectiveness project. He compared financial statements to reading a print newspaper cover-to-cover, which is "not how information is consumed today." Moody's analysts, he said, get the data they need by combing through the statements with data aggregators and other tools. "They're not staring at balance sheets and income statements," he said.
Uhl directed the discussion towards users, saying that financial reports may "soon not be meeting the consumer's needs." He was particularly concerned with format, agreeing with LaMonte's point about data aggregation, but also addressing changes in communications. Financial statements, he said, are not up to speed with current technology: "We could do so much more with hyperlinks, pictures and graphs, and linked files. I'm disappointed that we're not innovating."
LaMonte noted that a Tweet about a new product can have more impact on share price than the financial statements, which demonstrates "the speed at which information is communicated in the modern world and what drives decisions." Thuener added that earnings releases also have a greater effect on stock prices. She cited General Electric as an example of a company that is innovating with its financial statements, but added: "The problem is there is no way to do it" in a 10-K or a 10-Q.
Asked for a wish list of disclosures, LaMonte said that he would like to see companies provide forward-looking information, saying it was a primary value driver. In response, Cohen said that there is already a lot of forward-looking material in financial statements, but there is room for improved presentation.
Integrated and Sustainability Reporting
Strauss turned to Laux to discuss integrated and sustainability reporting. Laux laid out the six capitals of integrated reporting (financial, manufactured, intellectual, human, relationship, and social), giving examples of each. Integrated reporting has, he said, gained popularity internationally because of environmental and social concerns and the need to innovate, but has hit difficulties in the United States. Laux attributed this to inertia: "It's all the detail that we talk about at conferences like this, and we just keep doing the same things. CEOs feel that they're forced into this quarterly earnings game and meeting [Wall Street] expectations, and it's just not healthy."
Laux clarified the difference between integrated and sustainability reporting, pointing out that sustainability reporting covers just two of the six capitals, environmental and social: "I think we need much more work, within companies and externally, about intellectual capital and human capital." He noted the gap between book value and market capitalization, and said that leading companies focus on more than just financial capital. FASB, he said, is working on a project for recognizing intangible assets, although, in his estimation, "double-entry bookkeeping just won't work" for that purpose.
Uhl added that, in his view, lack of education about integrated reporting and a perceived lack of market demand are the biggest obstacles in the United States. LaMonte said that the market demand is there, noting that Moody's spends "a tremendous amount of time" on sustainability as a potential revenue stream. "It's often hard to connect some of these issues to real near-term decisions about value or risk," he said, "but there certainly is a lot of momentum in this area."
The first questioner asked about comparability, and whether it is an excuse for companies not to distinguish themselves from their peers in their self-analyses. LaMonte disagreed, saying that investors have to compare companies to make investment decisions: "How are you going to allocate money to [for example] banks, without figuring out which bank is more valuable than the other?"
Another audience member asked for the panel's thoughts on the PCAOB's proposal regarding disclosure of critical audit matters in the auditor's report. "I'm not really going to care that much," LaMonte said, explaining that he is more concerned with the risks within the company itself than how difficult the audit was to conduct.
The next questioner asked about stakeholders other than investors, such as creditors or employees, and their perception of which information is valuable. LaMonte and Thuener both stressed that the information in financial statements is valuable. "It is the foundation upon which decisions are made," LaMonte said. Thuener added that financial statements provide "a great picture" of the company's operations, but the market has often already digested that information by the time they are released.
ABOUT THE PANELISTS
Norman Strauss, Distinguished Lecturer of Accountancy at Baruch College, moderated the panel. Amie Thuener, chief accountant at Google; Mark LaMonte, managing director at Moody's Investors Service; Robert Uhl, partner at Deloitte and Touche; Allan Cohen, controller at NBCUniversal Media; and Bob Laux, region lead for North America at the International Integrated Reporting Council, were the panelists.
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|Title Annotation:||In FOCUS|
|Publication:||The CPA Journal|
|Date:||Aug 1, 2017|
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