The complexity behind the inner workings of Wall Street is complicating the jobs of accounting and auditing regulators all the time. And as the financial crisis fades, those regulators are burning the midnight oil to get accounting and auditing standards in step with the greatest risks that keep investors awake at night.
“We've been working at an amazing pace,” Tom Linsmeier, a member of the Financial Accounting Standards Board, said during a keynote address at Compliance Week 2011. “We've put in many 90-hour weeks in the last four months—seriously—to try to achieve some outcomes by 2011.”
FASB's goal is to finish some sweeping new accounting rules that would not only update and improve U.S. Generally Accepted Accounting Principles, but also streamline them with the International Financial Reporting Standards that are followed in most of the industrialized world. The board is rewriting rules for how to recognize revenue, especially when companies have complicated relationship with customers where sales transactions are not cut-and-dry. FASB also is working through how to get leased assets on the balance sheet in a way that reflects the real economics of the obligation that companies assume when they enter into lease contracts.
Perhaps most vexing of all, FASB is knee-deep in the morass of complex financial instruments: trying to determine how companies should best explain to investors what they own, what it's worth, and what kind of risk it carries. And if the accounting weren't complicated enough, the auditing of such instruments adds another layer of complexity. The Public Company Accounting Oversight Board, re-energized in 2011 with three new board members and a new outcry from angry investors, is turning the page on its auditing standards to determine where some changes might be in order.
One of the PCAOB's newest members, Jay Hanson, opened Compliance Week 2011 with a wake-up call for corporate compliance officers. “Investors lost a lot of money during the financial crisis, and they're blaming a lot of people,” he said. “They're blaming management. They're blaming the auditors. And they're blaming us.”
Technology has given Wall Street's most creative thinkers a leg up on accountants and auditors, he said. They're using technology to create complex financial products that help investors realize a better return on their investment, but the complexity makes accounting for, and auditing of, those products difficult. “The fact is that accounting and auditing often lag business innovation,” he said. “If you can't look it up in the Wall Street Journal, you've got a real challenge trying to figure out what the value is. And as we move further into this fair-value model, everything is much more subjective.”
On the accounting side, Linsmeier said the accounting for financial instruments is the “big, big issue” facing the board today. FASB is working with the International Accounting Standards Board on a number of its most important projects to try to make U.S. and international rules as similar as possible, but they don't see eye to eye on financial instruments. “The two boards have different political pressures as to what to work on,” he said.
In the United States, the biggest outcry was to give investors a more transparent view of the most complicated investment products that were trading in hidden, off-balance-sheet entities, Linsmeier said. IASB, on the other hand, was under greater pressure to produce better standards for classifying and measuring financial instruments. That prompted the two boards to work separately, which is leading to different accounting solutions.
The separate paths raise a couple of different concerns. The Securities and Exchange Commission is watching the changes in accounting rules to determine whether the rules becomes similar enough that the United States should join the European Union and other major developed countries in following IFRS. The Group of Twenty nations directed FASB and IASB to come up with common approaches to financial instruments in particular to put the world's leading banks on a level playing field so their balance sheets would be more comparable.
PCAOB Member Jay Hanson, told the CW 2011 crowd, “Investors lost a lot of money during the financial crisis, and they're blaming a lot of people. They're blaming management. They're blaming the auditors. And they're blaming us.”
Linsmeier isn't pleased to see the boards developing different standards. “In my personal view, it could have an effect on future crises,” he said. “Banking crises around the world come up regularly. If we're really going to be successful in converging, we've got to get financial instruments converged.” But finding common answers is hard when the two boards are responding to different objectives. “I assure you the two boards are talking to each other,” he said.
On the auditing side, Hanson said the PCAOB heard most clearly from investors that they want more information to make investment decisions. They directed their outcry at the auditing regulator, demanding more information from auditors about what those firms observe, what they test, and what they question as they go about their auditing procedures. But the PCAOB isn't convinced that the entire solution lies in auditing rules, he said.
FASB Board Member Tom Linsmeier said the biggest obstacle to convergence is getting FASB and IASB together on how to treat financial instruments.
“There are many parties with roles in the financial reporting process,” he said. In addition to auditors, management, audit committees, corporate counsel, analysts, and rating agencies all play a part in communicating critical information to investors. “Who, among all of these parties, should be responsible for providing investors with the information that they are not getting today?” he asked.
Hanson said investors are asking auditors for something like an executive summary regarding the audit. The PCAOB is preparing a concept release to describe some possible changes to the auditing model that might answer that demand, and it could become the basis for a new auditing standard. But the effort and the debate over changes to the audit report are sure to raise additional questions about costs and benefits, he said.
“We are going to be very interested in the views of management of the companies whose audits will be affected,” he said. “The discussion that will take place over the next few months ultimately may have broad repercussions on aspects of the financial reporting process that go beyond audit requirements, and I would encourage you to pay attention and get involved.”
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