Four years ago, I wrote in this space about FASB’s then-new Disclosure Framework project. The stated goal of the 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.” Achieving that goal requires both ensuring that important information is there and avoiding unimportant information as much as possible, in order to reduce the possibility that the important stuff is too difficult for readers to find.
FASB noted when it started the project 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.” So, while reducing disclosures wasn’t the goal, FASB at least believed a reduction was a likely outcome. This gave financial statement preparers, who generally believe that current GAAP requires too many disclosures, some optimism about the project.
The project was in its early stages back then, and we haven’t yet seen any final documents out of it. But that doesn’t mean there has been no progress. In fact, it looks like we may see some changes to the authoritative literature shortly. So let’s check in and see whether we are indeed headed toward a reduction in disclosures.
A helpful clarification
One of the things that unnecessarily increased the amount of footnote disclosure was that for certain items, a lot of detailed disclosures appear to be required even if the item itself isn’t very significant to the reporting company. FASB heard that concern from many and has proposed to clarify in the Accounting Standards Codification that disclosures enumerated in GAAP need only be presented to the extent they are material and that materiality should be considered separately for each item of disclosure.
While this seems like a relatively small change, it should—presuming it is finalized—help by giving companies that wish to do so the confidence to omit individual disclosures based on immateriality. As a result, the disclosures that remain should be those that are important, helping investors as well. Whether it does help, of course, depends on companies making the effort to identify immaterial items of disclosure and auditors and regulators accepting those judgments. But everybody seems to be on board with this clarification, so there is hope. Presuming it finalizes this roughly as proposed, FASB might well have found a way to take a significant step toward reducing disclosure overload before it even addresses specific requirements at all.
The concepts statement. FASB is also working on specific changes to disclosure requirements in four areas. In considering these requirements, the board is attempting to apply concepts that were included in a 2014 exposure draft of a new Statement of Financial Accounting Concepts. The proposed Concepts Statement included a very broad discussion of the kinds of things that might usefully be disclosed in footnotes, along with a discussion of limiting factors and other considerations relevant to determining the appropriate disclosures for a new standard. The proposal seems fine as far as it goes, in listing the broad categories that footnote information could cover, and the examples of information that would fit into those categories. The potential limiting factors discussed are all relevant, and the list of potential disclosures is not so open-ended as to encompass anything that you could possibly think of.
The proposed changes to SEC rules will, if finalized as they have been proposed, eliminate many items of disclosure. While each is generally fairly small on its own, the cumulative changes would result in a noticeable decrease in disclosures for many companies.
But, as the board noted, the intention is that the Concepts Statement will still allow for a very broad range of disclosures, which would be narrowed by FASB in individual standard-setting projects. Because of that, the Exposure Draft doesn’t really have enough information to figure out whether employing those concepts would result in more, less, or about the same volume of disclosure requirements as we have today. FASB added projects on four specific areas of disclosure in part to determine how the potential Concepts Statement would work in practice.
The specifics. First up, FASB has issued an Exposure Draft of changes to disclosures about defined benefit pension plans. The proposed amendments would eliminate a number of quantitative disclosures, add a small number of quantitative disclosures for certain plans, and increase qualitative disclosures. Overall, the new qualitative disclosure requirements seem like they’ll add more to pension footnotes than the reduced quantitative disclosures will take out.
With respect to fair-value measurements, an Exposure Draft has been issued proposing to eliminate certain disclosures, modify others, and add a couple of new ones (although only for public companies). It seems that these changes, if adopted as proposed, would result in slightly less disclosure overall, but that will vary by company.
FASB has also issued an Exposure Draft regarding disclosures about income taxes. Applying the proposed Concepts Statement to income taxes has produced the exact opposite result compared to what companies were hoping for, as the proposal on income tax disclosures adds a number of new quantitative and qualitative disclosures, offset by only one elimination.
Finally, FASB is currently deliberating potential changes to inventory disclosures. While no proposals have been made, the current required disclosures for inventory are minimal, so it is highly likely that the application of proposed Concepts Statement will identify additions to the requirements, not deletions.
Looking at where FASB is headed on those four projects, it seems that this part of the project will not have the effect of significantly reducing disclosures. While FASB has proposed eliminating some existing disclosures because they go beyond the range of disclosures suggested by the proposed Concepts Statement, the board is finding at least as many instances where there are holes in the existing disclosures. This is obviously still a work in process, but it appears that the reduction that some were hoping for isn’t likely.
No doubt, some believe that the failure to reduce disclosures indicates that the project is failing at this point. On the other hand, I believe FASB is finding that the concepts in the proposed Concepts Statement are enabling it to fashion more complete and coherent disclosure requirements, in which each item of disclosure specifically ties back to a stated goal. That being said, it seems FASB is leaning quite heavily on the planned change mentioned earlier, erring on the side of describing a large number of disclosures, and relying on companies and their advisers to eliminate the pieces of the disclosure that aren’t material.
The SEC is playing ball. I was concerned when FASB started its project that we might lose a chance at a significant reduction in disclosures if the SEC didn’t join in the effort. As it turns out, the SEC has embraced the effort, spurred at least in part by mandates to study disclosures included in both the JOBS Act and the FAST Act. Whatever the inspiration, the SEC has taken up a disclosure effectiveness initiative, which has seen the issuance of several reports, requests for comment, and studies regarding the disclosure system.
Of course, we’ve seen this kind of activity in the past without it leading anywhere. But in this case, the SEC has gone further. In July 2016, the SEC issued a proposed rule titled “Disclosure Update and Simplification”, in which the SEC proposes to amend disclosure requirements to eliminate duplication, simplify and streamline requirements, and remove requirements that have become outdated due to developments in the marketplace, intervening changes in GAAP, or other reasons.
This proposed rule is a huge step toward reducing disclosure requirements and modernizing the SEC rules in this area. It proposes eliminating certain things (e.g., say goodbye the Ratio of Earnings to Fixed Charges, which I never understood the usefulness of in the first place), changing others to recognize changes in the market, and eliminating SEC requirements that duplicate either GAAP requirements or other SEC requirements (yes, the SEC rules currently require certain disclosures in two places).
The financial reporting community is not shy about complaining about SEC actions that raise the costs of being a public company. But in this case, the SEC and its staff deserve a high five for pursuing changes that will meaningfully reduce the disclosure burden. While some have expressed concerns about taking information away from investors and other users of SEC filings, my view is that the proposal does an excellent job of making sure that no important information is lost.
So, where are we headed? After four years of work, it seems that we are likely headed for a reduction in public company disclosures, in particular due to the SEC’s work. The proposed changes to SEC rules will, if finalized as they have been proposed, eliminate many items of disclosure. While each is generally fairly small on its own, the cumulative changes would result in a noticeable decrease in disclosures for many companies.
On the GAAP side, it seems that any noticeable reduction in disclosure volume will come from eliminating disclosures on a company-by-company basis, based on judgments about materiality. This, of course isn’t what reporting companies were hoping for, as the decision to skip a suggested disclosure will always feel risky. Nonetheless, the framework does at least seem to be helping FASB to better focus the disclosures described in GAAP. Perhaps over time, both FASB and the reporting companies will become comfortable eliminating some of those disclosures from financial statements.