Improvements in US financial reporting – another step towards principles-based standards?

In my previous posting, I raised the perennial question of whether the future of accounting lies in a principles-based or rules-based world. We often read that there is reluctance in the US to taking too many steps towards a more principles-based model. Well, in mid-January a committee of the SEC published a draft decision memorandum setting out initial proposals to do just that. While it is focused on the US reporting model, and the role of the SEC and the FASB in particular, the memorandum gives an encouraging insight into where US thinking is moving.

The report is just over 100 pages long and is broader than the question of principles versus rules. But it makes some important observations on how standard setters, regulators, preparers and auditors can contribute if a more principles-based framework is to become a reality.

The role of the standard setters and regulators

The report comments that while the current US system has been "quite effective", it has evolved over many years with some of the basic principles becoming obfuscated by detailed rules, bright lines, exceptions and regulations, which reduce transparency and usefulness of the resulting financial reporting. The main recommendations here, which I would applaud, are:

• Additional user/investor involvement in the standard setting process is central to improving financial reporting.
• The creation of a formal Agenda Advisory Group, improving the prioritisation of work, procedures for field testing, field visits and cost benefit analysis.
• SEC to encourage an objective-based approach to the way standards are designed and implemented.

The Committee is also considering proposing that the SEC formally encourage improvement in the way standards are written - using an agreed upon framework that promotes trust and confidence in efficient markets by encouraging the use of professional judgements made in good faith.

The year-end process

The preparers of financial statements and the audit profession have their part to play too. The report recommends that the SEC should issue guidance reinforcing the following concepts:

• Evaluation of materiality should be based on the perception of a reasonable investor.
• This should reflect how an error impacts the total mix of information available to a reasonable investor.
• The evaluation of errors should be on a sliding scale where qualitative factors influence the decision.

The importance of professional judgement is emphasised. The Committee recognises that "many regulators appear to encourage a system in which professionals can use their judgement in determining the most appropriate accounting and disclosure for a particular transaction”. In this context the Committee recommends that the SEC should adopt a similar approach.

Conclusion

All in all, I think the report has real substance and should be seen very positively by those outside the US.  Clearly it is only the beginning of a process of change but I am encouraged – not only because of the issues being identified and addressed, but also because, without this contribution, the process of convergence to a higher quality reporting model would be even harder to envisage.  If you do find the time to read the report, I would be really interested in your views, please drop me a line by email or by commenting here.