Paul Munter was named chief accountant in the Office of the Chief Accountant (OCA) at the SEC in January; he had been serving as the acting chief accountant since 2021. He earned his PhD in accounting from the University of Colorado. Richard Jones is the chair of FASB; he began his term as its eighth chair in July 2020. Prior to that, Jones was a partner at Ernst & Young and served as the firm’s chief accountant on technical accounting matters.
Munter and Jones presented the opening remarks at Baruch College’s 21st Annual Financial Reporting Conference, held on May 4, 2023. The following is an edited and condensed transcript of their remarks and conversation with moderator Norman Strauss, EY Executive Professor-in-Residence and conference chair, Baruch College. The views expressed are their own and not necessarily those of the SEC, FASB, the commissioners, the board members, or the staff. Official positions of FASB are only reached after extensive due process and deliberations.
Norman Strauss: My opening question relates to the current priorities of both the SEC and FASB. Paul, I’ll start with you: What are the hot topics for the OCA? And then, Rich, same question?
Paul Munter: In terms of our priorities, you have to think about our mission. As you all know, we are an investor-focused agency. We have an investor protection mandate. From the standpoint of the OCA, we are typically thinking through the lens of, “What can we do to help improve the quality of the information that investors receive, so that they can make more informed capital allocation decisions?”
Now that sounds theoretical, and at times it is, but it’s also really important. Stated differently, if we can support higher-quality information in the hands of investors, they can make better capital allocation decisions, which results in a lower cost of capital. There is a tangible consequence to improving the quality of information that investors receive that will drive better pricing decisions, because they can better understand what risks are inherent in the decisions they make.
That is what financial reporting is about. If you think back to your very first accounting class, probably in the first chapter of that class, you saw, “Accounting is the language of business.” If you think about it, financial reporting is about trying to take commercial arrangements, sometimes very complex commercial arrangements, and translate those into information that is understandable and consumable by investors. Stated differently, in financial reporting what we’re trying to do is communicate in a transparent fashion with investors, so that they can understand the consequences of commercial arrangements that companies have entered into when they make pricing decisions.
To think about the challenges of high-quality financial reporting, there are really three key components:
One, you have to have high-quality standards and rules applicable to the financial reporting process, so that we have an increase in the consistency of information provided from one company to another.
Second, you have to have high-quality application of an issuer’s fact pattern against those standards or rules, so that the financial reporting reflects the underlying economics.
And third, to the extent that we have audited financial statements, we have to have high-quality audits to provide additional confidence to investors in the information they are receiving.
We focus on these three things. On the first component, we spend a lot of time externally understanding the priorities and needs of investors, engaging with Rich and his team on the projects they are working on, and how they can develop standards that will improve the quality of information that investors receive. We engage internally in our rule-making process as we contemplate rules for information largely outside the financial statements, but part of the periodic reporting, and how that will improve the overall context of the information that investors receive.
In terms of application of the standards, we engage in a number of different fashions. Through our consultation process, we’re engaging with issuers, their auditors, and audit committees in terms of their unique fact patterns and how best to comply with the applicable accounting framework, in a fashion that yields transparency for investors.
And then we work very closely with the PCAOB in its standards setting to develop higher-quality audit standards. We engage regularly on auditor independence matters, and if you follow communications from our office, you’ve seen that’s a topic that we have spoken about quite a bit. It’s foundational to the value proposition that auditors bring to the table. We also obviously engage with enforcement, both in our agency and the PCAOB’s agency, in circumstances where there’s been a failure to properly apply accounting or auditing or independence standards.
Richard Jones: Our focus at the FASB has been on executing our agenda. A little bit about how we got to where we are today: My term started in 2020, so I got to transition during a pandemic. One of the first things that me and my fellow board members started on was extensive outreach with our stakeholders. Because I thought it was an important time to reset our agenda and make sure that it reflected the critical needs of our stakeholders.
We did that through extensive outreach. We met with over 200 of our stakeholders. We took those results, we put them in an open-ended document, and we called it an invitation to comment, where we simply summarized what we had heard, without necessarily inserting our own views.
The response from our stakeholders was tremendous. We kicked off our agenda outreach process in December 2020. By June 2021, we issued our document summarizing some of the things we heard. Beginning in September 2021, through June 2022, every single issue that we had heard as part of that process came back in front of our board and was publicly discussed. And our board effectively reset our agenda.
Now, we are benefiting from all of that outreach. What you are seeing is our board moving—what, for FASB, would be viewed as fairly quickly—through those projects. One of the reasons is the extensive input that we’ve been given as part of that agenda outreach.
I often say that I think we have done the right outreach, I think we have the right agenda, and now our job is to execute on that agenda.
Listening to Stakeholders
Strauss: Could you generalize about how you both balance the needs of investors and the wants of preparers and auditors? Is it tough to get that right?
Jones: Accounting standards have to be able to be applied by accountants, audited by auditors, and provide relevant information to investors. It has to work through with all of those stakeholders. There’s tension between, “Give me more information; it costs more to give more information”—or, “Give me different information; it costs more to give different information.”
But I view that as a healthy tension. I think you come to the best answer by keeping in mind that your mission is to provide relevant information to an investor. I would also say that preparers often come to the table with a problem-solving approach, sharing what they find their investors find relevant. It’s all parties working together.
Munter: I think that’s absolutely right, that the guiding principle in standards setting is: “What will provide better information to investors?” The standards have to be operational, obviously, and that means you’re going to need input from preparers and auditors. But it can’t come in a fashion that causes standards setters to lose focus of that objective.
I acknowledge that it’s oftentimes easier to get information on the cost side than the benefit side. But I would also observe that the discussion about costs tends to be about what I would call transition costs—and without a doubt, there are costs that are going to be incurred as companies implement new accounting standards. But the benefits of better information to investors are not one-time benefits, because you have an improvement in the overall quality of information; not just in the year of transition, but on an ongoing basis.
Jones: The only thing I’d add is: There’s no lock for a single stakeholder group—say, for preparers it’s only costs, or for investors it’s only benefits. There’s a cost and a benefit to investors, depending on what we’re talking about.
The Standards Setting Process
Strauss: This year, FASB will be celebrating its 50th anniversary. How would you respond to whether you’re staying up to date with the changes over the years?
Munter: Access to information today is just completely different than when the FASB started. In 1973, if you wanted a company’s financial statements, you either had to be a shareholder and get it in the mail, or you had to go to our offices in Washington and photocopy it. When you’ve got limitations on access to information, you’re probably going to be focused on less of the total information package simply because of access and timeliness.
Now, when you have access to information instantaneously and access to tools that make it more efficient to process that information, is it any surprise that investors use more information in their capital allocation decisions? Candidly, I don’t find that the least bit surprising.
That does not mean, at least in my view, that the financial statements have lost their relevance. Financial statements are a critical part of the financial reporting process, and when we think about rulemaking for other information that’s going to be included in a periodic filing, we try to think about it in terms of how that other information will complement the information provided in the financial statements and help provide additional context. I think we have to look at financial reporting in terms of the totality of the information that investors are receiving—acknowledging that they’re going to take advantage of information that is available today and wasn’t in years past.
Jones: It’s interesting when you think about the evolution of the economy. When people raise that issue, it’s often in the context of, “Should more things be placed on the balance sheet?” That’s certainly a theme that we’ve heard, and sometimes it’s related to labor and people’s efforts, and sometimes it’s related to intangibles.
But the next question, when it comes to putting something on the balance sheet, is, “How do you measure? Do you simply want an accumulation of costs?” Some people think that’s very relevant. Other people say, “All it did was tell me what your sunk costs were.” Still others would say, “No, I’d like a fair value for this item that, practically speaking, we don’t think there will ever be a transaction to confirm or dispute that estimate.” So, which measurement do you really want?
This topic came up over and over again as part of our agenda outreach. We heard an awful lot of investors say, “Please don’t put anything else on the balance sheet, because I’m going to adjust it out once you put it on there.”
I think it comes back to, “Is it possible that what people are really looking for is more information about the investments companies are making in the periods that they’re making them? Are the expenditures related to people, are they research and development efforts, are they efforts related to building their brand?”
That was in a lot of the feedback that we got from investors about disaggregation of expenditures. You had that group who wanted everything on the balance sheet at fair value. You had some who wanted historical cost. But there were an awful lot who said, “No, please, don’t put it there. Just tell me more about it.”
Strauss: What about the project on whether the cash flow statements should be revisited?
Jones: Possible improvements to the statement of cash flows was something that we heard as part of our agenda outreach. The interesting thing was, we heard different things. There’s a subset that thought: “The FASB already has something called the direct method of cash flows, roll that out.” There were others who said, “No, I actually prefer the indirect method”—which is the method that pretty much every public registrant uses today—“don’t change that. But I’d like more information about the categories.”
That was one bucket of feedback. The other was that the statement of cash flows for certain industries isn’t really relied upon by investors. Think about a bank: when your business is cash, the statement of cash flows, including things in investing and financing when your business is investing and financing, somehow separating those from operations may not be the most logical breakout. But it’s not only for financial services. What are the additional details that investors need related to cash flows that they would find helpful?
So we’re looking at it in two pieces. Part of the reason it’s on our research agenda is because, to actually move the project forward, a majority of our board needs to agree on the direction. And this is a way for us to gather additional information, and to possibly scope a project that our board can be more successful in.
Munter: With respect to cash flow statements specifically, I think there’s a couple of things that are that are worth noting. We have had a number of consultations that, at least anecdotally, indicate that the cash flow statement doesn’t receive the same degree of attention, the same rigor of process, the same structure of controls around it, as the other financial statements.
I think it’s worth noting that the codification does not relegate the cash flow statement to some lesser level of importance compared to the other statements. I think, first and foremost, that means that issuers need to think about what they can do to make sure that they have the same degree of quality of processes, effectiveness of controls, and timeliness of preparing the information that goes into the cash flow statement as goes into the other financial statements.
I think the same thing might also be true in terms of the auditor’s attention to the cash flow statement; perhaps that doesn’t receive the same degree of attention and timely focus in the audit process as the other financial statements. There’s an opportunity for improvement in issuers’ and auditors’ perspectives about the importance of the statement of cash flows, and the attention to detail and effectiveness of controls around that statement.
Secondly, what we hear a lot is that, when somebody does focus on it, they find they have a misclassification in the cash flow statement, and issuers say, “it’s just a classification matter. It can’t possibly be material.”
If you think about the cash flow statement, classification is what you’re doing. If you have an error in classification, that might indicate that that’s a qualitative factor that would be fairly important in evaluating whether you’ve got a material error.
Bear in mind that an assessment of effectiveness of controls is not about what did happen, but about what could have happened. Even if an issuer is able to successfully demonstrate that they have an immaterial error in the cash flow statement, that does not mean that they don’t have a material weakness with respect to the effectiveness of controls around the cash flow statement.
I think it goes back to the perspective and focus on all of the financial information. There’s nothing that would prohibit an issuer from providing additional context around the information in the cash flow statements—obviously subject to our rules about non-GAAP reporting.
Strauss: What could be done to get standards out faster?
Jones: I think every standard has a story. That’s not to justify why something took a long time, but if you look back at some of the joint projects with the IASB, you added another party to the deliberations, and that certainly affects the time. And there’s also a difference between when a standard is issued, and when it’s ultimately adopted—I think Rev Rec got extended a few times since 2016—so that that can be part of it.
I would come back to the way we did our agenda outreach, and the way that our board has set our agenda today. We are focused on, when adding a project to our agenda, that we have a path forward that a majority of our board is willing to pursue. I think that’s very important.
What’s the right answer on speed? I think scoping projects correctly gives you a chance to accomplish them on a more timely basis than if you bring them to the table, add them to the agenda, and then search for a path forward. My hope is the projects on our agenda fit that bill. Does that mean they’ll be more timely? Possibly. But at the end of the day, we don’t shortcut any part of our due process.
Munter: I think timeliness of standards setting is important, without a doubt, but it does get to scoping. What is the problem that you’re trying to address? Rich was talking about items on the research agenda, which involve a lot of thinking about scope and finding a path forward that is achievable.
We were talking earlier about considering cost/benefit as part of the overall analysis. If you think about goodwill, if you were to take a poll here and ask whether you think we should be in an amortization with impairment model, or an impairment-only model, or some other model, my guess is, we’d get a split vote. Which, if you’re in FASB’s seat, trying to figure out “where is the case for change?”, it’s difficult to make one in circumstances like that.
For other projects, the case for change is much clearer, particularly when you’re thinking about things that are unrecognized as economic phenomena. Take SFAS 106 and post-employment benefits as an example. While that was a big project, and it took quite a while to do, I think many recognized that there was a pretty significant item that wasn’t being reflected in the financial statements. I think you have to balance the question being asked and how you answer it.
Strauss: Some have contended that the recent events in our capital markets shone a light on potential deficiencies in what audit committees are doing. What are your thoughts on this?
Munter: Audit committees are a critical part of the gate-keeping function. The financial reporting process starts with management, but then you have audit committees that, at least for listed companies, are charged with oversight of the financial reporting process and oversight of the independent audit process. And then obviously you have the external auditors as a key part of the gatekeeping system for the protection of investors.
I think there are several things at play here. One is we are in a dynamic market, and there are more demands that are being put on audit committees, sometimes on topics that are outside of their core responsibility to oversee the financial reporting process and external audit process. I think audit committees need to be continuously vigilant to make sure that have enough time on their agendas to focus on their core mission and serve as a key gatekeeper for the protection of investors—and that they don’t let these other important topics crowd out time that they need to focus on their core responsibilities.
Secondly, audit committees need to make sure that they are not either intentionally or inadvertently delegating their responsibilities to management. By our rules, it is the audit committee that is responsible for engaging, determining the compensation of, and evaluating the performance of, the external auditor. It is not management’s responsibility. And so the audit committee should be the one deciding whether to re-engage the audit firm. Deciding, in discussion with the audit firm, on the qualifications of the lead audit partner, and determining the appropriate compensation for the external audit.
That also means they should be actively engaging with the audit firm to understand what the firm is doing. What are the qualifications of the team? Particularly in multinational circumstances, where the lead auditor is probably using the work of component teams from a number of different countries around the world, what is the quality of that work? Many of you work in global audit networks, and—if your experience is like mine—you know in your heart of hearts that audit quality is not equal around the globe within the network. There are some where the practices are of higher quality than of others, and that puts a lot of responsibility on the lead auditor to make sure they understand the quality of the work being done by the component teams, and evaluating and overseeing that work so that the audit in totality is at a high-quality level.
Lastly, I think audit committees can be more transparent about what they do and how they are fulfilling their responsibilities. We’ve certainly seen anecdotally improvements in the quality of information that audit committees disseminate. But there is an opportunity for further improvement.
Strauss: Have the events of the day—the banking issues—led anyone to rethink hold-to-maturity? It turned out that a lot of banks couldn’t do it as the depositors took back all their money.
Jones: Hold-to-maturity accounting is certainly something that’s gotten people’s attention. I think it’s important to baseline what we’re talking about. We’re talking about an item—in this case, agency-issued mortgage-backed securities that the entity commits they have the intent to hold to maturity. If they are following hold-to-maturity accounting, they are following amortized costs but they are presenting, in many cases right on the face of the balance sheet, the fair value of those items. The issue is: which should be the better accounting, given you have both numbers presented? Some feel that fair value is better accounting. Some feel that the historical cost, amortized cost, is better accounting. But both of them have both numbers to make any decision they need to make.
I think there are some who consistently push for fair value for all financial instruments, including loans. Others feel differently, though. I’ll give you an example: We did outreach with buy-side and sell-side analysts recently to ask them if we should change the accounting for held-to-maturity securities—and they all said “No.” They thought they had the information they needed to do their job, and they actually preferred amortized cost.
I don’t think the debate ends there. I think we’ll have lots of different inputs, and I think that that’s something that our staff and our board can consider.