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Keeping Reporting Overseers on the Same Page

Robert Herz | October 28, 2014

At the June meeting of the Public Company Accounting Oversight Board’s Standing Advisory Group (SAG), there was some discussion of the nature and extent of the working relationship between the PCAOB, the Securities and Exchange Commission, and the Financial Accounting Standards Board.

Some SAG members raised the subject during the group’s discussion of whether and what type of auditing guidance the PCAOB might consider in connection with the new revenue recognition standard issued by FASB and the International Accounting Standards Board. In particular, certain SAG members questioned why, in light of the various areas in the new standard that involve significant estimates and judgment, this question was being raised by the PCAOB staff now instead of when the accounting standard setters were developing the new standard in order to ensure that the resulting financial information would be auditable.

Lawrence Smith, a FASB member and official SAG observer, responded by assuring the group that auditability had been addressed by FASB and IASB through their deliberations and extensive outreach on the joint project on revenue recognition. PCAOB Chief Auditor Martin Baumann noted that the PCAOB staff had been closely monitoring the project as it proceeded and, as appropriate, provided input to FASB on auditing considerations. He added that the SAG discussion was intended to address whether the PCAOB needed to add new auditing requirements to address the new accounting requirements. And, of course, many accounting firms provided significant input to the accounting standard setters on the auditing considerations.

Having participated in the revenue recognition project for many years as chairman of FASB and having followed it after I left FASB, I have no doubt that the issues relating to auditability were carefully considered in developing the new revenue recognition standard. That’s not to say that there will not be any challenges in auditing the revenue information resulting from management’s estimates, but some of the same challenges arise under the current revenue recognition standards and practices and, indeed, in many other areas of accounting that require the use of significant estimates.

Working Together

 Nevertheless, I believe the discussion at the June SAG meeting raises the broader subject of how the three organizations—the SEC, FASB, and PCAOB—work together to promote high-quality financial reporting and whether there are processes or mechanisms that might improve the overall level of coordination between their activities.

First, I think it’s important to remember that the SEC has a very central role in overseeing the reporting by public companies in the United States. As the federal agency with primary responsibility for our securities markets, enforcement of the securities laws, capital formation, and investor protection, the SEC’s mandate includes overall responsibility for financial reporting by pubic companies in our markets. With regard to the establishment of accounting standards, the SEC has looked for many years to the private sector, with FASB being the designated accounting standard setter since 1973. Because the SEC has delegated that responsibility, however, it maintains oversight over the activities of FASB and its parent, the Financial Accounting Foundation, while also respecting and, at times, helping defend the importance that FASB be able to conduct its standard-setting activities in a thorough and independent manner.

As a participant in CIFiR, I viewed the creation of an FRF-like process as an important recommendation, because I believed it could help surface issues in the reporting system more promptly, facilitate addressing them in a logical, coordinated, and effective manner, and generally provide an ongoing forum for continuing to seek ways to improve financial reporting and reduce complexity.

Accordingly, the SEC provides input into the selection of FAF Trustees and FASB board members, and reviews and approves FASB’s annual support fee request. The SEC staff, through the Office of the Chief Accountant, monitors FASB technical activities and provides input into the development of standards.

Under the Sarbanes-Oxley Act Congress established the PCAOB to oversee audits of public companies (and, under the Dodd-Frank Act, broker-dealers), including the registration and inspection of audit firms, enforcement against audit firms and individual auditors, and setting auditing standards. PCAOB board members are appointed by the SEC and its annual budget, and support fees are subject to approval by the SEC. New PCAOB standards and rules are not effective unless approved by the SEC. And SEC staff, through the Office of the Chief Accountant, monitor the PCAOB’s standard-setting activities.

Communication Channels

Beyond these formal links between the SEC, FASB, and the PCAOB, the three organizations have established various other ways of sharing perspectives and input, and where deemed appropriate, coordinating their activities. These include periodic tri-party meetings between officials at  FASB, PCAOB, and the SEC to discuss their respective activities and emerging issues. There are also frequent interactions between board and staff members of the organizations on standard-setting projects and current issues in the financial reporting system. Additionally, the SEC staff and PCAOB are represented as official observers at meetings of FASB’s Financial Accounting Standards Advisory Council. Similarly, the SEC staff and FASB are official observers at meetings of the PCAOB’s SAG.

 While all these formal and informal links between the SEC, FASB, and the PCAOB help promote coordination between the three organizations, and FASB and PCAOB receive lots of input from their respective advisory groups, public roundtables, and comment letters, some believe that the U.S. reporting system would also benefit from a broader process or mechanism that would periodically bring together key constituents.  These would include gathering  together senior representatives from the SEC, FASB, and the PCAOB, as well as investors, preparers, auditors, and other parties, to discuss significant issues and challenges affecting the reporting system as a whole and the longer-term direction of the system.

On the Way to the Forum

This type of mechanism is present in certain other countries, including, for example, the United Kingdom, which has the Financial Reporting Council. In the United States, this type of process was envisioned in the August 2008 report of the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR), which recommended the establishment of a Financial Reporting Forum, or FRF, which would bring together representatives of key stakeholder groups, the SEC, FASB, and the PCAOB, “to discuss pressures in the financial reporting system overall, both immediate and long term, and how individual constituents are meeting these challenges.”

 As a participant in CIFiR, I viewed the creation of an FRF-like process as an important recommendation, because I believed it could help surface issues in the reporting system more promptly, facilitate addressing them in a logical, coordinated, and effective manner, and generally provide an ongoing forum for continuing to seek ways to improve financial reporting and reduce complexity. So I very much welcomed the announcement in 2011 by then SEC Chief Accountant James Kroeker of the establishment of periodic public roundtables called the “Financial Reporting Series.”

The goal of the roundtables was to bring together representatives of key stakeholder groups to discuss risks related to financial information provided to investors and to search for areas for improvement. In November 2011, the SEC held the inaugural roundtable in the Financial Reporting Series to examine the extent to which financial information should include measurement uncertainties and the information investors find important in understanding and assessing those uncertainties.

Almost three years later, however, that first Financial Reporting Series remains as the only one convened by the SEC. I am not clear as to why that is the case. It may be due in part to turnover of top members of the SEC’s Office of Chief Accountant, including at the chief accountant and deputy chief accountant levels. It may also be due in part to the many other priorities of the SEC, including developing and issuing scores of regulations required by the Dodd-Frank Act and the 2012 Jumpstart Our Business Startups (JOBS) Act.

In any event, the idea of an FRF or a Financial Reporting Series is, in my view, still a good one. Certainly, there is no shortage of potential topics of system-wide importance that could be addressed in such forums, including, for example, the future of XBRL and interactive data in the U.S. reporting system; the current initiatives by FASB and the SEC around disclosure effectiveness and modernization; and perspectives on the evaluation of going concern by issuers, auditors, and investors, to name just three. So my hope and encouragement to the SEC is to seriously consider resuming the Financial Reporting Series or to commence a similar process.