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Are Reduced Disclosure Requirements a Possibility?

Scott Taub | July 31, 2012

As the Financial Accounting Standards Board heads towards completion (hopefully) of its projects on revenue recognition, leases, and financial instruments, another project entitled “Disclosure Framework,” might have slipped under the radar.

It's understandable if not everyone is  following this project—it is in its early stages, and it won't affect the numbers in the core financial statements, since it is focused only on footnote disclosures. But don't ignore it for long. If completed, it would fix a glaring hole in FASB's conceptual framework, by explaining the principles that should guide decisions about what footnote disclosures to include. This project could significantly affect the amount of work it takes to prepare financial reports, and timely input from constituents just might help the project live up to its potential.

The stated goal of the disclosure framework project is “to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of each entity's financial statements.” Be careful what you read into that. It doesn't say that the goal is to reduce the level of disclosures, which, I suspect, is what most financial statements preparers would like the goal to be. FASB does note on its Website, however, that “Although reducing the volume of the notes to financial statements is not the primary focus, the Board hopes that a sharper focus on important information will result in reduced volume in most cases.”

I really like this project. The haphazard development of disclosures on a standard-by-standard basis has resulted in inconsistent decisions about the purpose of disclosures, the type of information to be conveyed, and the level of detail in which that information is conveyed. I came to these views in part based on my work on the SEC staff's Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements With Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers, commonly known as “The Off-Balance Sheet Report.” That report (which, as a matter of full disclosure, I had a large hand in drafting) recommended a disclosure framework be developed in order to address many shortcomings we noted in footnote disclosures during our work.

FASB has taken an important step toward streamlining disclosure requirements. Now it is time for preparers, users, auditors, and everybody else to weigh in on where improvements are possible.

It's been awhile since the Off-Balance Sheet Report, but I'm happy to see some activity on this front at long last. However, I'm not sure the project is going to do what many hope it will do—which is lead to a significant reduction of disclosure.  While there is certainly some detail in footnotes that could be eliminated, there are also plenty of things not in footnotes today that a conceptual framework on disclosures is likely to suggest should be added. We're likely to get better organization of disclosures, a clearer focus on what is material and important in footnotes, and hopefully, some common objectives for disclosures, which will therefore make the requirements easier to comply with. But if we also want a significant reduction in disclosures, I think we need to help FASB in a couple of respects.

First, it's important that FASB get feedback on its recently issued invitation to comment on this project regarding where the best opportunities for improvement and reduction lie. For example, one of the obvious problems is that certain detailed footnotes are required no matter how significant the related item is. Think of the detail regarding defined benefit pension plans, deferred taxes, stock options, and fair-value measurements. Every company that has these items has several pages of disclosure, even if the activity in the area is minimal and unimportant to the overall financial picture of the company. There must be a way to allow shorter disclosures when these items exist, but are relatively small or inconsequential.

Consider too the observation in the Off-Balance Sheet Report that the objectives driving existing disclosures seem to include all of the following, although none of them are applied consistently to all areas where they might be applied:

  • Provide information about alternative measurement attributes;
  • Explain the nature and extent of uncertainty in the reported figures;
  • Allow users to recompute certain items using different assumptions than those used by management;
  • Make it more difficult for management to engage in financial fraud;
  • Allow comparisons between issuers that have chosen different accounting policies;
  • Explain the sensitivity of the issuer's results to various risks;
  • Provide detailed breakdowns of certain financial statement captions;
  • Explain the issuer's future cash requirements;
  • Highlight the impact of unusual or non-recurring events;
  • Disaggregate the issuer's results;
  • Explain how management's intentions affected the reported financial position and results of operations; and
  • Confirm compliance with GAAP.

While it's easy to understand why all of these could be considered logical objectives for disclosures, it isn't possible to meet all of them for every significant area, so how should FASB decide what to focus on? Should certain choices regarding recognition and measurement result in reduced disclosures? Should some of these objectives be identified to be met in other ways besides footnote disclosures? Are some of them unnecessary?

And what about the issue of which disclosures are required on a quarterly basis. Until recently, very few FASB standards required quarterly disclosure, but recent standards have often explicitly required quarterly information that is sometimes quite detailed. Users of financial statements will always want useful information as often as possible, but that needs to be balanced against the fact that quarterly financial reports are supposed to be less detailed and are required to be filed more quickly. Principles to help decide what should be in quarterly financial statements might be rather helpful.

Getting the SEC on Board

Beyond the current scope of the project, however, a huge opportunity to reduce the disclosure burden will be missed if the SEC does not reconsider its disclosure requirements concurrent with FASB's project. Some of those who worked on the Off-Balance Sheet Report wanted the recommendation on disclosures to include discussion about the possibility for changes from the SEC to go along with FASB's changes. Although that part of the recommendation was not included in the final report, the SEC's Advisory Committee on Improvements to Financial Reporting did recommend in 2008 that the SEC and FASB work together to “integrate existing SEC and FASB disclosure requirements into a cohesive whole to ensure meaningful communication and logical presentation of disclosures, based on consistent objectives and principles. This would eliminate redundancies and provide a single source of disclosure guidance across all financial reporting standards.”

The CIFiR hit the nail on the head. A huge opportunity to rationalize and improve the disclosures by public companies will be missed if the SEC isn't open to reducing its disclosure requirements where they duplicate, conflict with, or add to the required disclosures about accounting items. There have been several initiatives in the past that started out with this kind of integration as a goal, but they all fizzled in whole or in part because of the SEC's reluctance to reduce its requirements. That's why I believe it will take significant feedback from the financial reporting community to get the SEC truly involved in this effort. FASB's invitation to comment is probably the best place to make the case for the SEC to join the disclosure framework effort.

It would be nice, for example, if the SEC and FASB could figure out what types of disclosures belong in footnotes versus elsewhere in the financial reports. Does it make sense for “critical accounting policies” to be discussed in the management, discussion, and analysis section, while “significant accounting policies” are required to be disclosed in the footnotes? What we usually get is a page or more of duplicate information with little, if any, additional insight.

We have liquidity disclosures in the MD&A, yet FASB just published a document that would require liquidity disclosures in the financial statements, and those disclosures would be more detailed than what is currently in the MD&A. Rollforwards of certain accounts are required by the SEC in audited schedules that are not part of the footnotes. Pro forma requirements in the footnotes and in the rest of a filing are inconsistent both in terms of when data is required and the level of required detail.

And, of course, financial instruments disclosures are spread throughout various areas of the footnotes, MD&A, and other parts of public company filings. Some are by risk, some are by accounting method, and some are organized by the level of measurement uncertainty—there must be a way to get a handle on that package and streamline it while providing the important information. These are just a few easy examples of areas where significant improvements to, and reduction in, the overall disclosure requirements are possible if the SEC gets involved in the disclosure framework project.

FASB has taken an important step toward streamlining disclosure requirements. Now it is time for preparers, users, auditors, and everybody else to weigh in on where improvements are possible, and what principles should drive footnote disclosures. And it's time to ask the SEC to step up and join the effort as well.