ABOUT THE SPEAKERS
Wesley Bricker serves as the chief accountant for the SEC’s Office of the Chief Accountant (OCA). The accounting group advises the SEC on accounting and auditing matters and works closely with private sector accounting bodies such as FASB. Bricker was previously the OCA’s deputy chief accountant. Before joining the SEC, he was a partner at PricewaterhouseCoopers, where he was responsible for clients in the banking, capital markets, financial technology, and investment management sectors.
Russell Golden has served as chair of FASB since 2013, after previously being a board member for three years. Prior to that appointment, he served for two years as FASB’s technical director, overseeing FASB staff work on accounting standards and technical application and implementation activities. He also chaired FASB’s Emerging Issues Task Force (EITF). He has been with the board since 2004.
Bricker and Golden presented the opening remarks at Baruch College’s 17th Annual Financial Reporting Conference, held on May 3, 2018. The following is an edited transcript of their remarks. The views expressed are their own and not necessarily those of the SEC, FASB, the commissioners, or the staff.
I’ll spend my time sharing perspectives on the objective of financial reporting and its importance to the markets. I’ll then briefly comment on new accounting standards, non-GAAP measures and other developments. And then I’ll close by discussing the role of audit firm governance and culture. Let me start with the objective of financial reporting. General-purpose financial reporting is a core element of the disclosure of business and financial information to stakeholders. Its objective is to provide financial information about the reporting entity that is useful to existing and potential investors, lenders, and other creditors in making decisions about providing resources to the entity.
While other parties, such as regulators and members of the general public, also may find general-purpose financial reports useful, those reports are not primarily directed toward those other parties. Special-purpose financial reports, by contrast, are prepared using special-purpose frameworks to address particular needs of specific users. They have more limited purposes and more limited uses.
I make the distinction between general-purpose and special-purpose objectives to emphasize the value of keeping and maintaining general-purpose financial reporting free from those other objectives. When formulating standards for general-purpose financial reporting, FASB and the IASB do not seek to influence the outcome of investor allocation, capital allocation decisions, or actions from management. Rather, the boards design standards that provide better information to inform the decisions and actions of investors.
The alternative, whereby standards are designed to privilege certain objectives, economic activities, financial products, or market participants, could diminish the confidence in the accuracy or the quality of reported information, which could thereby impair capital formation and, in turn, negatively impact economic activity. Again, by keeping general and special-purpose financial reporting objectives clearly distinct, each is able to best serve its respective purposes.
I encourage you to support the standards-setting bodies that maintain general-purpose financial reporting frameworks distinct from special-purpose funds. The process advances with your broad participation, your robust feedback, your timely implementation, and ultimately, your quality application of the standards.
New Accounting Standards
High-quality accounting standards for general-purpose financial statements must continuously evolve, just as markets and investor behavior evolve over time. Against this backdrop, standards setting is not, nor can it be, a focus on maintaining the status quo in the face of evolving needs.
Even this year, several changes in accounting standards are effective that will result in better financial reporting to investors. For example, calendar year–end public companies are now reporting their revenue from contracts with customers under new revenue recognition standards issued by both FASB and the IASB. The reporting includes a substantial step forward for corporate reporting, including additional disclosures and greater consistency between the information reported and the underlying economics of contracts with those customers.
Across companies, this has been a substantial (though manageable) effort, which is a testament to the level of coordinated planning for the implementation, including from FASB, the AICPA, and other industry groups. But stakeholders must now continue their focus on successful implementation of the leasing standard for next year and the implementation of the new credit losses standard in 2020. I’m confident that this period of accounting change will leave our financial reporting system stronger.
Companies, auditors, and others have also responded swiftly to the significant changes brought about by the passage of income tax reform [the Tax Cuts and Jobs Act of 2017]. In December, the SEC staff released guidance on reporting the effects of income tax reform on the day the bill was signed by the President. FASB and its staff also provided guidance.
The SEC staff guidance clarified that the staff would not object to a company accounting for the effects of tax reform by utilizing a measurement period that ends when the entity has obtained, prepared, and analyzed the information necessary in order to complete the accounting, which is not to exceed 12 months. The staff expects companies to act in good faith to complete the accounting and, as they do, investors should receive insight through the disclosures described in SAB 118 about the status of companies accounting for the effects of income tax reform during the measurement period.
Companies are also planning how they will communicate with investors regarding changes in accounting requirements for stock held in other companies. Starting this year, companies will recognize a net income of the changes in the fair value of stock from one period to the next period. Investors will see the effects of management’s decisions to not only acquire or sell the stock, but also to hold it during the period. The reporting under the new standard reflects the economic realities of changing market values, and the standardized approach of reporting can facilitate comparisons across companies by investors and other users of the financial statements.
FASB’s standards-setting work in this area was designed to yield measures of items such as net income that are relevant and useful to users by providing a standardized scorecard of a company’s operations. This information can be supplemented with additional disclosures or non-GAAP information to provide additional information to investors; however, to be absolutely clear, non-GAAP reporting may supplement, but is never a substitute for, GAAP reporting.
Financial statements that are based on GAAP are intended to provide a complete and standardized view of historical operating performance. Management may also assess performance through non-GAAP financial measures. Non-GAAP financial measures disclosed together with the SEC’s required reconciliation to the most directly comparable GAAP financial measure and the related disclosures can provide investors with useful information regarding how management monitors performance and can facilitate investor analysis.
With non-GAAP and other disclosures, our rules require that companies must have disclosure controls and procedures in place, which typically would include appropriate governance practices regarding the measures, policies, and controls that prevent error, manipulation, or mischief with the numbers, including a policy that addresses how changes in non-GAAP measures will be reported and how corrections of errors will be evaluated.
Audit committees can play an important role in understanding whether, how, and why management uses any supplemental scorecards in understanding and tracking results and how that supplemental information may be used in addition to GAAP financial statements in the company’s public reporting.
Audit Firm Governance and Culture
Audit committees that clearly understand non-GAAP measures presented to the public and that take the time and the effort to review with management the preparation, the presentation, and ultimately the integrity of those metrics are an indicator of a strong compliance and reporting culture. Audit committees can review the metrics to understand how management understands and evaluates performance, whether the metrics are consistently prepared and presented from period to period, and the related disclosure policies. A demonstration of strong interest in these issues can have a very positive effect on the quality of the disclosures.
Another area where both audit committees and management can have a positive effect on the quality of disclosures is market risk information. There’s been a recent rise in the general level of market interest rates; while I have no view, of course, on the future direction or volatility of the markets, it is worthwhile to emphasize the importance of management’s attention to and financial reporting oversight of the disclosures companies make to investors about material risks in this area.
For example, some businesses’ balance sheets, results of operations, and cash flows are particularly sensitive to changes in economic and market conditions, such as changes in liquidity in markets or the level in the volatility of market prices and rates, including for debt and equity investments, and of market indices or other business and market sentiments that affect the markets. I encourage those involved in the disclosure preparation and oversight to be attentive to disclosures regarding changes in market risks.
Auditors also play a vital role in the capital markets, in part because of their impartial and objective judgment about companies’ financial reporting. The integrity and the credibility of their judgment are critical. They’re reinforced, of course, by auditors’ independence from company management, and just as auditors need to continually monitor and assess their maintenance of independence from their audit clients, we as regulators also need to monitor and assess our own auditor independence rules.
Just yesterday, the commission proposed for public comment rules to address certain substantial practical challenges to compliance related to one part of our auditor independence rules, which is known as the loan provision. In particular, yesterday’s proposed amendments seek to more accurately identify those lending relationships with equity owners of audit clients that can feasibly impair or even appear to impair the auditor’s objectivity and impartiality. I encourage you to read the proposal and provide us with your input as part of this rulemaking.
While the quality of a company’s financial reporting processes is foundational to reporting information to investors, so too is the quality of an auditor’s interim reviews and annual audits. Auditing is about confidence and trust in the transparency, accuracy, and reliability of financial information. But trust is earned through words and actions, as the profession consistently delivers audit quality and value to audit committees and to the investing public. Trust can be nurtured, but trust can be broken. It’s neither static nor assumed.
The audit profession continues to evolve, and audit quality has clearly improved over time, but audit committees and their key partner, the PCAOB, rightfully expect this evolution. Yet to meet the realities of growth and a multidisciplinary scope, and the need for greater consistency in the quality of audit work in all parts of the world, the audit profession must continue to focus, and in some respects, do more to maintain and to nurture trust.
One lesson regulators and leaders in the profession have learned is the key role of audit firm governance in maintaining an effective firm-wide or enterprise-wide risk management system that serves as the framework to anticipate and mitigate the risk of breakdowns and failures. It’s not a new concept for audit firms, although the maturity and the emphasis have increased over time.
Also, frameworks are just that: guidance that is flexible, scalable, and proportionate to the objectives and structure of the organization. To be clear, risk management frameworks may overlap with, but are never a substitute for, the standards of quality control for a CPA firm’s accounting and audit practice, as well as the governance and reporting practices more generally. Even with robust risk management systems and a strong commitment to quality control standards, certain risks will materialize and mitigation and remediation become essential. It’s in those circumstances that governance and reporting is even more critical.
Risk management frameworks may overlap with, but are never a substitute for, the standards of quality control for a CPA firm’s accounting and audit practice.
The Importance of Independence
Another lesson that regulators and leaders in the profession have learned over time is the importance of independent, diverse thinking on corporate boards, and particularly audit committees, brought by independent directors as an element of strong corporate governance. In addition to bringing valuable external perspectives to board deliberations, those directors take on the role and responsibility with substance and credibility because they are independent. Examples include resolving disputes between management and the external auditor, as well as oversight of complex and sensitive investigations. Also, independent directors are often in the best position to deliver candid—and sometimes tough—but critically important messages to management and other board members without fear of retribution.
I believe the strengthening of corporate audit committees with independent members is one of the most prominent recent enhancements to corporate governance. These enhancements have also been used by private companies. Good governance is not an isolated concept; it is intertwined with tone and culture, which is the understanding of ethical values, of risks and desired behaviors.
This means that audit quality and value can be more difficult for firm leaders to integrate into regular processes unless the firm as a whole, from top to bottom, across service lines and across geographies, views the mandate for audit quality and value as key to its success. Poorly diagnosed or designed culture initiatives do not tend to last long in addressing underlying behavioral norms.
The maturity of culture as I have experienced it tends to follow along the following spectrum. At one end of the spectrum, an indifferent culture personified by, “Requirements do not matter or apply to us.” Maybe another point on the spectrum, a reactive culture: “We respond and we address requirements when others tell us to do that.” Another point, a guiding culture: “We need employees to follow the requirements that we set for them.” Or a pervasive culture: “All of our people are involved in our requirements and aware of their connection to both our expectations and the expectations of others.” That’s where I think we need to get.
These points on the spectrum illustrate that culture is a human issue, and changing it requires both human solutions and structural changes, which in unison adjust behaviors effectively over time. It’s with these lessons in mind that the leaders of the largest, the most complex firms have appointed, or are now taking steps to appoint, independent directors or independent advisory council members with meaningful governance responsibilities. They understand that the benefits of outside perspectives can translate to audit firm governance as well. Regardless of the design, the purpose should be the same: to foster audit quality and to safeguard against noncompliance threats and the resulting costs to the reputation of the firm, its network, and the audit profession more generally.
In doing so, leaders have a view toward meeting both U.S. and global expectations. Audit firms in the U.S. are subject to local ownership, licensing, registration, and other regulatory requirements. Leaders within these firms are also appropriately challenging themselves to think across the network of firms to deliver to investors and the public consistency and quality around the globe, drawing on globally common tools and worldwide quality monitoring, among many other examples.
Accordingly, it’s important to consider risk management at both a U.S. and global level. These governance and culture considerations can be especially insightful to audit committees in overseeing the external audit relationship at the companies they serve. The largest audit firms voluntarily provide audit quality reports to communicate how the firm performs individual audits, how they run the business, and how they think about the role and the relevance of the profession.
In this context, I believe it is important to communicate meaningful information about the design of an audit firm’s governance and culture, including the design of the firm’s board, its membership, the particular responsibilities assigned to members, why a member of the board is determined to be independent of the firm, and the related information that would inform an audit committee’s consideration of the firm’s commitment to factors that impact audit quality. Note that many of the factors that I just cited, including independence and reporting structure, are just the qualities that we expect today of issuers.
I believe it’s critical that the audit profession continually look in the mirror and assess its conscience. Is it earning the public’s confidence and trust in audits? Taking a fresh look at the governance and culture as part of firm-wide risk management is one way that U.S. firms can take steps to meet the high standards expected of accountants.
Commitment to Quality
Market and regulatory forces are reshaping the accounting profession. Economic pressure and higher expectations, involving capital needs and technological innovation, are evident in virtually all aspects of the profession. And while those forces are individually familiar to many, their confluence is leading to changes within and across firms.
The importance of our longstanding public-private financial reporting arrangement cannot be overstated in its positive impact to the commission and the PCAOB’s ability to carry out our respective legislative mandates. Financial reporting is not strong in spite of the participation of accountants and others; it’s strong because of their participation.
If we are to continue to have the best financial reporting system, the commitment from accountants to high-quality financial reporting must continue. Standards setters and regulators need to have and to hear from individuals with diverse perspectives and experiences. The financial information reaching the public must continue to be credible and decision useful, and we should all collectively work toward that end.