
[Federal Register: February 28, 2008 (Volume 73, Number 40)]
[Notices]               
[Page 10897-10939]
From the Federal Register Online via GPO Access [wais.access.gpo.gov]
[DOCID:fr28fe08-124]                         


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Part III





Securities and Exchange Commission





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 Progress Report of the SEC Advisory Committee on Improvements to 
Financial Reporting; Notice


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SECURITIES AND EXCHANGE COMMISSION

[Release Nos. 33-8896; 34-57331; File No. 265-24]

 
Progress Report of the SEC Advisory Committee on Improvements to 
Financial Reporting.

AGENCY: Securities and Exchange Commission.

ACTION: Request for comments.

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SUMMARY: The Advisory Committee is publishing its progress report and 
is soliciting public comment. The progress report contains the 
Committee's developed proposals, conceptual approaches, and matters for 
future considerations on improving the financial reporting system in 
the United States.

DATES: Comments should be received on or before March 31, 2008.

ADDRESSES: Comments may be submitted by any of the following methods:

Electronic Comments

     Use the Commission's Internet comment form (http://
www.sec.gov/rules/other.shtml); or
     Send an e-mail message to rule-comments@sec.gov. Please 
include File Number 265-24 on the subject line.

Paper Comments

     Send paper comments in triplicate to Nancy M. Morris, 
Federal Advisory Committee Management Officer, Securities and Exchange 
Commission, 100 F Street, NE., Washington, DC 20549-1090.

All submissions should refer to File No. 265-24. This file number 
should be included on the subject line if e-mail is used. To help us 
process and review your comment more efficiently, please use only one 
method. The Commission will post all comments on its Web site (http://
www.sec.gov/about/offices/oca/acifr.shtml). Comments also will be 
available for public inspection and copying in the Commission's Public 
Reference Room, 100 F Street, NE., Washington, DC 20549, on official 
business days between the hours of 10 a.m. and 3 p.m. All comments 
received will be posted without change; we do not edit personal 
identifying information from submissions. You should submit only 
information that you wish to make available publicly.

FOR FURTHER INFORMATION CONTACT: Questions about this release should be 
referred to James L. Kroeker, Deputy Chief Accountant, or Shelly C. 
Luisi, Senior Associate Chief Accountant, at (202) 551-5300, Office of 
the Chief Accountant, Securities and Exchange Commission, 100 F Street, 
NE., Washington, DC 20549-6561.

SUPPLEMENTARY INFORMATION: At the request of the SEC Advisory Committee 
on Improvements to Financial Reporting, the Commission is publishing 
this release soliciting public comment on the Committee's progress 
report. The full text of this progress report is attached and also may 
be found on the Committee's web page at http://www.sec.gov/about/
offices/oca/acifr.shtml. The progress report contains the Committee's 
developed proposals, conceptual approaches, and matters for future 
considerations on improving the financial reporting system in the 
United States. This progress report has been approved for issuance by 
the Committee. It does not necessarily reflect any position or 
regulatory agenda of the Commission or its staff.
    All interested parties are invited to comment on the enclosed 
progress report. Comments on the progress report are most helpful if 
they (1) indicate the specific paragraph and/or page number to which 
the comments relate, (2) contain a clear rationale, and (3) include any 
alternative(s) the Committee should consider.

    Authority: In accordance with section 10(a) of the Federal 
Advisory Committee Act, 5 U.S.C. App. 1, Sec.  10(a), James L. 
Kroeker, Designated Federal Officer of the Committee, has approved 
publication of this release at the request of the Committee. The 
solicitation of comments is being made solely by the Committee and 
not by the Commission. The Commission is merely providing its 
facilities to assist the Committee in soliciting public comment from 
the widest possible audience.

    Dated: February 14, 2008.
Nancy M. Morris,
Committee Management Officer.

Appendix

Progress Report of the Advisory Committee on Improvements to Financial 
Reporting to the United States Securities and Exchange Commission

February 14, 2008

Progress Report of the Advisory Committee on Improvements to Financial 
Reporting to the United States Securities and Exchange Commission

Table of Contents

Transmittal Letter
Executive Overview
Introduction
Chapter 1: Substantive Complexity
Chapter 2: Standards-Setting Process
Chapter 3: Audit Process and Compliance
Chapter 4: Delivering Financial Information
Appendices
    A--Separate Statement of Mr. Wallison
    B--Examples of Substantive Complexity
    C--Committee Members, Official Observers, and Staff

SEC Advisory Committee on Improvements to Financial Reporting, 
Washington, DC 20549

February 14, 2008
The Honorable Christopher Cox
Chairman
Securities and Exchange Commission
100 F Street, NE., Washington, DC 20549-1070

Dear Chairman Cox:
    It is my pleasure and privilege to present to you, and the other 
Commissioners, on behalf of the Advisory Committee on Improvements to 
Financial Reporting, a progress report of the Committee's developed 
proposals, conceptual approaches, and currently identified matters for 
future consideration.
    Our Committee has worked diligently to provide an interim progress 
report to you. The developed proposals in our progress report are 
proposals that we believe could be implemented by the Commission, its 
staff, or other bodies, as appropriate. These 12 proposals are 
summarized in the executive overview of our progress report. Conceptual 
approaches represent our initial views, which are based on discussions 
on a particular subject, but which require additional vetting before 
formalization into a developed proposal. Matters for future 
consideration are areas in which deliberations and research have not 
yet begun. After the conclusion of the Committee's work later this 
year, we will issue a final report with written recommendations.
    We commend the Commission for its initiative in creating the 
Committee. You have been generous in furnishing staff and other 
resources. We would like to thank the staff members whose participation 
was invaluable during this phase of the Committee's work. These include 
from the Commission staff:

Conrad Hewitt
John W. White
James Daly
Bert Fox
Stephanie Hunsaker
Nili Shah
Brett Williams
James Kroeker
Wayne Carnall
Adam Brown
Todd E. Hardiman
Shelly Luisi
Amy Starr

    These also include Russell Golden, Holly Barker and Christopher 
Roberge

[[Page 10899]]

from the Financial Accounting Standards Board and Sharon Virag from the 
Public Company Accounting Oversight Board.
    We also want to thank our Official Observers whose participation 
and counsel have been invaluable to the Committee during this time:

Robert Herz
Kristen Jaconi
Mark Olson
Charles Holm
Phil Laskawy

    We look forward to working with the Committee staff and Official 
Observers in the coming months as we develop our final report and 
recommendations.
    Respectfully submitted on behalf of the Committee,

/s/ Robert C. Pozen
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Robert C. Pozen
Committee Chairman

cc: Commissioner Paul S. Atkins
Commissioner Kathleen L. Casey
Members and Official Observers of the Committee
Conrad Hewitt
John White
James L. Kroeker
Nancy M. Morris

Executive Overview \1\
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    \1\ This report has been approved by the Committee and reflects 
the views of a majority of its members. It does not necessarily 
reflect any position or regulatory agenda of the Commission or its 
staff.
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    In July 2007, the U.S. Securities and Exchange Commission (SEC or 
Commission) chartered the Advisory Committee on Improvements to 
Financial Reporting (Committee). The Committee's assigned objective is 
to examine the U.S. financial reporting system in order to make 
recommendations intended to increase the usefulness of financial 
information to investors,\2\ while reducing the complexity of the 
financial reporting system to investors, companies, and auditors.
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    \2\ The term ``investor(s)'' is used throughout this progress 
report to refer to investors, creditors, rating agencies, and other 
users.
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    After the conclusion of our work, we will issue a final report with 
written recommendations to the Chairman of the SEC. In order to 
maximize our effect, we intend to issue a limited number of focused 
recommendations that address acknowledged problem areas and that we 
believe can be adopted without legislation, rather than attempting to 
address all perceived shortcomings in the financial reporting system.
    All Committee members present at our February 11, 2008 meeting 
voted unanimously to issue to the Chairman of the SEC this progress 
report of the Committee's developed proposals, conceptual approaches, 
and currently identified matters for future consideration and to 
publish the progress report in order to encourage public feedback. 
Developed proposals are proposals that we believe could be implemented 
by the Commission, its staff,\3\ or other bodies, as appropriate; these 
are summarized in the second part of this executive overview. 
Conceptual approaches represent our initial views, which are based on 
discussions on a particular subject, but which still require additional 
vetting before formalization into a developed proposal. Matters for 
future consideration are areas in which deliberations and research have 
not yet begun.
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    \3\ We note that some of our developed proposals, conceptual 
approaches, and matters for future considerations may require SEC 
action, while others may be implemented by SEC staff. We have, 
however, generally adopted a convention of addressing these areas to 
the SEC for convenience. We leave the determination of whether the 
proposals require SEC or SEC staff action to the discretion of the 
SEC and its staff.
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    This progress report represents our work to date, which has 
included four public meetings where these topics were deliberated by 
the full Committee. In generating this progress report, we also 
considered all of the public comments received to date on our work.\4\ 
All of the developed proposals, conceptual approaches and matters for 
future consideration were adopted unanimously (except for one 
dissenting vote on one proposal, as noted herein, which resulted in one 
separate statement from Mr. Wallison, attached as appendix A of this 
progress report).
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    \4\ Comments to the Committee are available at http://
www.sec.gov/comments/265-24/265-24.shtml. We have and continue to 
welcome feedback at any time from investors, registrants, auditors, 
and others on our work. Information on how to submit comments is 
available at: http://www.sec.gov/about/offices/oca/acifr.shtml.
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    We explain each of our developed proposals, conceptual approaches 
and matters for future consideration in the body of this progress 
report. The progress report is organized by the topics considered by 
the four subcommittees that were created in order to research, develop, 
and propose preliminary recommendations to the full Committee for 
discussion and decision-making. Thus, chapter one is on substantive 
complexity; chapter two on the standards-setting process; chapter three 
on audit process and compliance; and chapter four on delivery of 
financial information. Later in 2008, we will also identify and analyze 
some of the issues involved with the potential movement from a U.S.-
based accounting regime to a global accounting system.
    This executive overview highlights the key themes that tie together 
the chapters in this progress report, with a few examples to illustrate 
each theme.\5\ The main themes are:
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    \5\ We wish to emphasize that the examples we give are 
illustrative only. We do not mean to imply any order of priority.
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    1. Increasing emphasis on the investor perspective in the financial 
reporting system.
    2. Consolidating the process of setting and interpreting accounting 
standards.
    3. Promoting the design of more uniform and principles-based 
accounting standards.
    4. Creating a disciplined framework for the increased use of 
professional judgment.
    5. Taking steps to coordinate generally accepted accounting 
principles in the U.S. (GAAP) with international financial reporting 
standards (IFRS).

I. Themes

I.A. Investor Perspective

    The current system of financial reporting, including the process by 
which financial reporting standards are developed, attempts to balance 
the interests of relevant parties such as preparers, auditors, and 
investors. In practice, however, the system has sometimes been more 
responsive to the interests of preparers and auditors than to the needs 
of investor groups.
    We believe that the financial reporting system should give pre-
eminence to the needs of investors, while not ignoring the interests of 
other relevant parties. In this regard, we propose that investors be 
better represented on the Financial Accounting Standards Board (FASB) 
and the Financial Accounting Foundation (FAF). We also propose that the 
determination of how to correct financial statement errors should be 
based on the needs of current investors, who should, in any event, be 
provided with more disclosure regarding such errors.
    With regard to the delivery of financial information, we propose 
that the SEC clarify certain legal issues related to the use of company 
websites as a vehicle for providing useful information to different 
types of investors in order to facilitate creative methods to present 
such information, such as in tiered formats. We also propose a gradual 
phase-in of interactive disclosure technology (i.e., XBRL-tagging) to 
facilitate the ability of investors to more easily access comparative 
arrays of company

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information, while minimizing the burdens on preparers (especially 
smaller companies). A phase-in approach would allow for enhanced 
understanding of the technology, proven use of the new XBRL U.S. GAAP 
Taxonomy, and further development of tagging and rendering software.

I.B. Setting Standards and Interpretative Process

    The current financial reporting system is characterized by a large 
volume of standards, including individual standards that are too long 
or complicated; interpretations; and detailed application guidance from 
a variety of public and private sources. This volume and complexity 
have led to concerns about whether the FASB is following appropriate 
priorities within a consistent conceptual framework in adopting 
standards, and whether investors, preparers, and auditors can 
efficiently find the complete body of authoritative literature on an 
accounting issue.
    While the FASB has made considerable progress in addressing both 
concerns, we believe that certain measures are needed to enhance the 
process for adopting new standards and issuing interpretations of 
existing standards.\6\ For example, we propose that the FASB should set 
explicit priorities based on consultation with an Agenda Advisory 
Group, which would include representatives of the SEC and the Public 
Company Accounting Oversight Board (PCAOB), as well as representatives 
from the investor, preparer, and auditor communities. Further, the FASB 
should fully explain and expose for comment, in documents containing 
proposed significant new standards, its process for conducting cost-
benefit studies, including field interviews and testing before 
finalizing any significant new accounting standard. Also, we propose 
that the FASB, with input from the Agenda Advisory Group, should 
conduct periodic assessments of existing standards to determine if they 
are operating as intended.
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    \6\ We recognize that the FASB has processes that are moving in 
the direction of the objectives underlying our interim developed 
proposals. We look forward to further discussion with the FASB to 
evaluate whether additional improvements would more effectively 
achieve the desired objectives. We plan to consider this dialogue in 
making final recommendations for process enhancements to the U.S. 
standards-setter.
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    With the implementation of these proposals, we propose that the 
FASB should be, to the extent practicable, the sole standards-setter 
for GAAP and the primary source of broad interpretations of existing 
accounting standards. The FASB should perform these functions with a 
high degree of independence, but it should coordinate closely with the 
SEC, including through the proposed Agenda Advisory Committee. When it 
is necessary for the SEC to issue broadly applicable interpretations, 
we are considering the manner in which the SEC develops and 
communicates those interpretations. Nevertheless, we believe the SEC 
should continue to provide comments on registrant-specific matters, but 
these comments should not be viewed as broadly applicable. We propose 
that the authoritative source of GAAP should be limited, as much as 
possible, to the contents of the FASB's codification project, which 
will be updated on a regular basis.

I.C. Design of Standards

    GAAP contains many detailed rules with several industry-specific 
exceptions and alternative accounting policies for the same 
transaction. Moreover, some of these rules have all-or-nothing results, 
which stem from bright line tests. This combination allows companies 
and auditors to reach a technically compliant conclusion that may be 
inconsistent with the underlying economic substance of the transaction, 
thereby potentially undermining an investor's complete and accurate 
understanding of the transaction. For example, transactions involving 
the right to use an asset for a promise to pay a series of payments in 
the future can be kept off a company's balance sheet if detailed rules 
are followed.
    In response, we propose that the FASB move away from industry-
specific guidance to activity-based guidance (e.g., from banking as an 
industry to lending as an activity by any company) and strive to reduce 
the number of alternative ways available under GAAP to account for the 
same transaction. We also plan to consider, among other possibilities, 
the feasibility of proportionate recognition, rather than all-or-
nothing results, to better reflect the rights conveyed by agreements 
and obligations incurred.
    Some believe an increased use of fair value measurements will 
better portray the current valuation of past transactions and improve 
financial reporting. Others believe the increased use of fair value 
measurements will cause unnecessary volatility, will decrease the 
reliability of financial statements, and will only increase investor 
confusion. We plan to deliberate whether, among other approaches, to 
support the FASB's project to consider changing the income statement 
format into two or more groupings designed to help investors better 
understand the different sources of changes in a company's income--for 
example, by separating cash or accrued earnings from changes resulting 
from fluctuations in the fair value of assets such as publicly-traded 
bonds.
    More broadly, we will consider recommending that the FASB design 
accounting standards with more general principles and fewer detailed 
rules in order to prevent the manipulation of technical requirements to 
reach pre-conceived accounting results.

I.D. Professional Judgment

    The preparation and audit of financial statements have always 
required the use of judgment. The recent evolution of accounting 
requires even more judgment--for example, the more frequent use of fair 
value involves estimates of value that may be less objectively 
determined than historical cost measures. Similarly, the revised 
auditing standards recently issued by the PCAOB emphasize the need for 
professional judgment in taking a risk-based approach to performing 
internal control audits.
    As noted above, we are about to study the merits of moving in the 
direction of more principles and fewer detailed rules. Also, as 
mentioned below, international accounting standards, as they exist 
today, contain less detailed guidance and fewer rules than GAAP. 
Detailed rules not only increase the complexity of the financial 
reporting system, but they also permit the structuring of transactions 
to achieve a particular accounting result, even if the results are 
inconsistent with the economic substance of the transactions or the 
underlying purposes of the rules.
    In recognition of the increasing use of accounting judgment, we are 
making two developed proposals. First, we propose asking the FASB to 
conduct post-adoption reviews of significant new standards, generally 
within one to two years of their effective dates to ascertain the 
degree of diversity in practice in using judgment when applying those 
standards. If that diversity is too broad or otherwise inappropriate, 
we would expect the FASB to amend the standard or issue interpretative 
guidance.
    Second, we propose that the SEC and PCAOB adopt frameworks for 
reviewing the exercise of judgment. The framework applicable to 
accounting judgments would require a disciplined process, including the 
identification of available alternatives, analysis of the relevant 
literature, review of the pertinent facts, and a well-reasoned 
explanation of the conclusions--all

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documented contemporaneously with the making of the accounting 
judgment. We believe adoption of these frameworks would encourage 
executives and auditors to follow a disciplined process in making 
judgments, and thereby give investors more confidence in the ways in 
which accounting and auditing judgments are being exercised.

I.E. Global Convergence

    At present, U.S. companies follow GAAP; in most other countries, 
publicly-traded companies are increasingly following IFRS as adopted by 
the International Accounting Standards Board (IASB). We support the 
long-term goal of converging GAAP with IFRS in order to reduce 
accounting costs to investors and others in an increasingly global 
business environment. But we recognize that there are various paths to 
convergence, and it may take years for full convergence to be achieved. 
Therefore, we believe that it is quite useful to propose enhancements 
to the financial reporting system in the U.S.
    Later in 2008, we will identify and analyze some of the issues to 
be resolved in the move toward global convergence of accounting 
standards. At this time, we note that the principles contained in IFRS 
are less encumbered by detailed rules than GAAP; accordingly, GAAP will 
probably need to become less rules-based in order to promote the goal 
of global convergence. We also note that IFRS has little industry-
specific guidance, and we encourage the IASB to continue in this 
manner, consistent with our proposal that the FASB issue activity-based 
standards rather than industry-specific accounting standards.
    On the other hand, IFRS contains a number of alternative accounting 
policies for the same activity, and there are political pressures to 
add exceptions in certain countries. As part of the effort to promote 
global convergence, we urge the IASB to continue to reduce the number 
of alternative accounting policies currently available and to resist 
the political pressures for country exceptions.

II. Summary of Developed Proposals

    Summarized below are our developed proposals based on our work to 
date. These developed proposals are discussed in greater detail in the 
remainder of this progress report. These developed proposals are 
numbered consecutively in this executive overview, with a reference in 
parentheses to their position in the body of the report.
    1. GAAP should be based on business activities,\7\ rather than 
industries. As such, the SEC should recommend that any new projects 
undertaken jointly or separately by the FASB be scoped on the basis of 
business activities rather than industries. Any new projects should 
include the elimination of existing industry-specific guidance in 
relevant areas as a specific objective of those projects, unless, in 
rare circumstances, retaining industry guidance can be justified on the 
basis of cost-benefit considerations (discussed in section II.A of 
chapter 1).
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    \7\ As discussed in section II.B of chapter 1 regarding 
management intent, we have not taken a position as to whether intent 
is an appropriate basis of accounting. Similarly, we express no view 
on whether intent provides a meaningful distinction between business 
activities.
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    The SEC should also recommend that, in conjunction with its current 
codification project, the FASB add a project to its agenda to remove or 
minimize existing industry-specific guidance that conflicts with 
generalized GAAP, taking into account the pace of convergence 
efforts.\8\ (Chapter 1--developed proposal 1.1)
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    \8\ Some constituents understand ``convergence'' to mean that 
GAAP and IFRS (as published by the IASB) will eventually be 
harmonized, at which point no substantive differences will exist 
between the two bodies of accounting literature. Others understand 
it to mean a discrete transition from GAAP to IFRS at a specified 
date without respect to whether the two bodies of literature are 
substantially harmonized. The timing of these two approaches may 
differ, which would likely impact the prioritization of this 
proposal to eliminate existing U.S. industry-specific guidance on 
the FASB's agenda. In either case, we believe industry-specific 
guidance should be substantially eliminated prior to convergence--
either as a component of the convergence plan, or by establishing a 
specified date after which the use of industry-specific guidance 
would be prohibited.
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    2. GAAP should be based on a presumption that formally promulgated 
alternative accounting policies should not exist. The SEC should 
recommend that any new projects undertaken jointly or separately by the 
FASB not provide additional optionality, unless, in rare circumstances, 
it can be justified. Any new projects should include the elimination of 
existing alternative accounting policies in relevant areas as a 
specific objective of those projects, unless, in rare circumstances, 
the optionality can be justified. (Chapter 1--developed proposal 1.2)
    3. Additional investor representation on standards-setting bodies 
is central to improving financial reporting. Only if investor 
perspectives are properly considered by all parties will the output of 
the financial reporting process meet the needs of those for whom it is 
primarily intended to serve. Therefore, the perspectives of investors 
should have pre-eminence. To achieve that pre-eminence in standards-
setting, the SEC should encourage the following improvements:
     Add investors to the FAF to give more weight to the views 
of different types of investors, both large and small.
     Give more representation on both the FASB and the FASB 
staff to experienced investors who regularly use financial statements 
to make investment decisions to ensure that standards-setting considers 
fully the usefulness of the resulting information. (Chapter 2--
developed proposal 2.1)
    4. The SEC should assist the FAF with enhancing its governance of 
the FASB, as follows:
     By encouraging the FAF to develop performance metrics to 
assess the FASB's adherence to the goals in its mission statement, 
objectives, and precepts and to improve its efficiency.
     By supporting the FAF's changes outlined in its Request 
for Comments on Proposed Changes to Oversight, Structure and Operations 
of the FAF, FASB and GASB, with minor modifications regarding 
composition of the FAF and the FASB, as proposed in section II of 
chapter 2, and agenda-setting, as proposed in section IV of chapter 2.
     By encouraging the FAF to amend the FASB's mission 
statement, stated objectives, and precepts to emphasize that an 
additional goal should be to minimize avoidable complexity. (Chapter 
2--developed proposal 2.2)
    5. The SEC should encourage the FASB to further improve its 
standards-setting process and timeliness, as follows:
     Create a formal Agenda Advisory Group that includes strong 
representation from investors, the SEC, the PCAOB, and other 
constituents, such as preparers or auditors, to make recommendations 
for actively managing U.S. standards-setting priorities.
     Refine procedures for issuing new standards by: (1) 
Implementing investor pre-reviews designed to assess perceived benefits 
to investors, (2) enhancing cost-benefit analyses, and (3) requiring 
improved field visits and field tests.
     Improve review processes for new standards by conducting 
post-adoption reviews of every significant new standard, generally 
within one to two years of its effective date, to address interpretive 
questions and reduce the diversity of practice in applying the 
standard, if needed.
     Improve processes to keep existing standards current and 
to reflect changes in the business environment by conducting periodic 
assessments of

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existing standards. (Chapter 2--developed proposal 2.3)
    6. The number of parties that either formally or informally 
interprets GAAP and the volume of interpretative implementation 
guidance should continue to be reduced. The SEC should coordinate with 
the FASB to clarify roles and responsibilities regarding the issuance 
of interpretive implementation guidance, as follows:
     The FASB Codification, a draft of which was released for 
verification on January 16, 2008, should be completed in a timely 
manner. In order to fully realize the benefits of the FASB's 
codification efforts, the SEC should ensure that the literature it 
deems to be authoritative is integrated into the FASB Codification to 
the extent possible, or separately re-codified, as necessary.
     To the extent practical, going forward, there should be a 
single standards-setter for all authoritative accounting standards and 
interpretive implementation guidance that are applicable to a 
particular set of accounting standards, such as GAAP or IFRS. For GAAP, 
the FASB should continue to serve this function. To that end, the SEC 
should only issue broadly applicable interpretive implementation 
guidance in limited situations (see section VI of chapter 2).
     All other sources of interpretive implementation guidance 
should be considered non-authoritative and should not be required to be 
given more credence than any other non-authoritative sources that are 
evaluated using well-reasoned, documented professional judgments made 
in good faith. (Chapter 2--developed proposal 2.4)
    7. The FASB or the SEC, as appropriate, should issue guidance 
reinforcing the following concepts:
     Those who evaluate the materiality of an error should make 
the decision based upon the perspective of a reasonable investor.
     Materiality should be judged based on how an error affects 
the total mix of information available to a reasonable investor.
     Just as qualitative factors may lead to a conclusion that 
a quantitatively small error is material, qualitative factors also may 
lead to a conclusion that a quantitatively large error is not material. 
The evaluation of errors should be on a ``sliding scale.''
    The FASB or the SEC, as appropriate, should also conduct both 
education sessions internally and outreach efforts to financial 
statement preparers and auditors to raise awareness of these issues and 
to promote more consistent application of the concept of materiality. 
(Chapter 3--developed proposal 3.1)
    8. The FASB or the SEC, as appropriate, should issue guidance on 
how to correct an error consistent with the principles outlined below:
     Prior period financial statements should only be restated 
for errors that are material to those prior periods.
     The determination of how to correct a material error 
should be based on the needs of current investors. For example, a 
material error that has no relevance to a current investor's assessment 
of the annual financial statements would not require restatement of the 
annual financial statements in which the error occurred, but would need 
to be disclosed in an appropriate document, and, to the extent that the 
error remains uncorrected in the current period, corrected in the 
current period.
     There may be no need for the filing of amendments to 
previously filed annual or interim reports to reflect restated 
financial statements, if the next annual or interim period report is 
being filed in the near future and that report will contain all of the 
relevant information.
     Restatements of interim periods do not necessarily need to 
result in a restatement of an annual period.
     All errors, other than clearly insignificant errors, 
should be corrected no later than in the financial statements of the 
period in which the error is discovered. All material errors should be 
disclosed when they are corrected.
     The current disclosure during the period in which the 
restatement is being prepared, about the need for a restatement and 
about the restatement itself, is not consistently adequate for the 
needs of investors and should be enhanced. (Chapter 3--developed 
proposal 3.2)
    9. The FASB or the SEC, as appropriate, should develop and issue 
guidance on applying materiality to errors identified in prior interim 
periods and how to correct these errors. This guidance should reflect 
the following principles:
     Materiality in interim period financial statements must be 
assessed based on the perspective of the reasonable investor.
     When there is a material error in an interim period, the 
guidance on how to correct that error should be consistent with the 
principles outlined in developed proposal 8 above. (Chapter 3--
developed proposal 3.3)
    10. The SEC should adopt a judgment framework for accounting 
judgments. The PCAOB should also adopt a similar framework with respect 
to auditing judgments. Careful consideration should be given in 
implementing any framework to ensure that the framework does not limit 
the ability of auditors and regulators to ask appropriate questions 
regarding judgments and take actions to require correction of 
unreasonable judgments.
    The proposed framework applicable to accounting-related judgments 
would include the choice and application of accounting principles, as 
well as the estimates and evaluation of evidence related to the 
application of an accounting principle. We believe that a framework 
that is consistent with the principles outlined in this developed 
proposal to cover judgments made by auditors based on the application 
of PCAOB auditing standards would be very important and would be 
beneficial to investors, preparers, and auditors. Therefore, we propose 
that the PCAOB develop a professional judgment framework for the 
application and evaluations of judgments made based on PCAOB auditing 
standards. (Chapter 3--developed proposal 3.4)
    11. The SEC should, over the long-term, mandate the filing of XBRL-
tagged financial statements after the satisfaction of certain 
preconditions relating to: (1) Successful XBRL U.S. GAAP Taxonomy 
testing, (2) capacity of reporting companies to file XBRL-tagged 
financial statements using the new XBRL U.S. GAAP Taxonomy on the SEC's 
EDGAR system, and (3) the ability of the EDGAR system to provide an 
accurately rendered version of all such tagged information. The SEC 
should phase in XBRL-tagged financial statements as follows:
     The largest 500 domestic public reporting companies based 
on unaffiliated market capitalization (public float) should be required 
to furnish to the SEC, as is the case in the voluntary program today, a 
document prepared separately from the reporting companies' financial 
statements that are filed as part of their periodic Exchange Act 
reports. This document would contain the following:
    [cir] XBRL-tagged face of the financial statements.\9\
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    \9\ To allow this first phase, the SEC EDGAR system must permit 
submissions using the new XBRL U.S. GAAP Taxonomy.
---------------------------------------------------------------------------

    [cir] Block-tagged footnotes to the financial statements.\10\
---------------------------------------------------------------------------

    \10\ We understand that tagging beyond the face of the financial 
statements and block-tagging of footnotes, such as granular tagging 
of footnotes and non-financial data, may require significant effort 
and would involve a significant number of tags.
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     Domestic large accelerated filers (as defined in SEC 
rules, which would include the initial 500 domestic public reporting 
companies) should be added

[[Page 10903]]

to the category of companies, beginning one year after the start of the 
first phase, required to furnish XBRL-tagged financial statements to 
the SEC.
     Once the preconditions noted above have been satisfied and 
the second phase-in period has been implemented, the SEC should 
evaluate whether and when to move from furnishing to the SEC to the 
official filing of XBRL-tagged financial statements with the SEC for 
the domestic large accelerated filers, as well as the inclusion of all 
other reporting companies, as part of a company's Exchange Act periodic 
reports. (Chapter 4--developed proposal 4.1) \11\
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    \11\ A dissenting vote on developed proposal 4.1 was cast by 
Peter Wallison.
---------------------------------------------------------------------------

    12. The SEC should issue a new comprehensive interpretive release 
regarding the use of corporate Web sites for disclosures of corporate 
information, which addresses issues such as liability for information 
presented in a summary format, treatment of hyperlinked information 
from within or outside a company's Website, treatment of non-GAAP 
disclosures and GAAP reconciliations, and clarification of the public 
availability of information disclosed on a reporting company's Web 
site.
    Industry participants should coordinate among themselves to develop 
uniform best practices on uses of corporate websites for delivering 
corporate information to investors and the market. (Chapter 4--
developed proposal 4.2)
* * * * *
    We believe publication of this progress report will increase the 
chances of our recommendations being implemented. The developed 
proposals in this progress report are described with enough detail to 
enable the SEC and public commentators to evaluate whether regulatory 
action in these areas is warranted. The description of conceptual 
approaches in this progress report will hopefully stimulate discussion 
and debate on these topics so that we can put forward additional 
developed proposals later this year.
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    \12\ This report has been approved by the Committee and reflects 
the views of a majority of its members. It does not necessarily 
reflect any position or regulatory agenda of the Commission or its 
staff.
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Introduction\12\

I. Our Objective

    In July 2007, the U.S. Securities and Exchange Commission (SEC or 
Commission) chartered the Advisory Committee on Improvements to 
Financial Reporting (Committee). The Committee's assigned objective is 
to examine the U.S. financial reporting system in order to make 
recommendations intended to increase the usefulness of financial 
information to investors,\13\ while reducing the complexity of the 
financial reporting system to investors, companies, and auditors.
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    \13\ The term ``investor(s)'' is used throughout this progress 
report to refer to investors, creditors, rating agencies, and other 
users.
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    More specifically, our charter identifies the following areas of 
inquiry:
     The current approach to setting financial accounting and 
reporting standards, including: (1) The principles-based versus rules-
based standards, (2) the inclusion within standards of exceptions, 
bright lines, and safe harbors, and (3) the process for providing 
timely guidance on implementation issues and emerging issues.
     The current process of regulating compliance with 
accounting and reporting standards.
     The current system for delivering financial information to 
investors and accessing that information.
     Other environmental factors that drive avoidable 
complexity, including the possibility of being second-guessed, the 
structuring of transactions to achieve an accounting result, and 
whether there is a hesitance by professionals to exercise professional 
judgment in the absence of detailed rules.
     Whether there are current accounting and reporting 
standards that do not result in useful information to investors, or 
impose costs that outweigh the resulting benefits.
     Whether the growing use of international accounting 
standards has an impact on the relevant issues relating to the 
complexity of U.S. accounting and reporting standards and the 
usefulness of the U.S. financial reporting system.

II. Our Guiding Principles

    We believe that financial reporting should provide information that 
aids investors in making investment, credit, and similar resource 
allocation decisions.\14\ However, some argue that, over time, 
financial reporting has become a burdensome compliance exercise with 
decreasing relevance to investors. This effect can be attributed, in 
part, to: (1) The evolution of new business strategies and financing 
techniques that stretch the limits of what the traditional reporting 
framework can effectively convey, and (2) an overly litigious culture 
that, arguably, results in financial reporting designed as much to 
protect against liability as to inform investors. As a result, we 
believe the disconnect between current financial reporting and the 
information necessary to make sound investment decisions has become 
more pronounced.
---------------------------------------------------------------------------

    \14\ Adapted from the FASB Preliminary Views document and IASB 
Discussion Paper, Conceptual Framework for Financial Reporting: 
Objective of Financial Reporting and Qualitative Characteristics of 
Decision-Useful Financial Reporting Information (July 6, 2006), 
which states, ``The objective of general purpose external financial 
reporting is to provide information that is useful to present and 
potential investors and creditors and others in making investment, 
credit, and similar resource allocation decisions.''
---------------------------------------------------------------------------

    A key factor often cited as driving this disconnect is complexity, 
which has rarely been defined in the context of financial reporting. We 
have developed and applied the following definition of complexity in 
this context to guide our deliberations:
Definition of Complexity
    The state of being difficult to understand and apply. Complexity in 
financial reporting refers primarily to the difficulty for:
    1. Investors to understand the economic substance of a transaction 
or event and the overall financial position and results of a company.
    2. Preparers to properly apply generally accepted accounting 
principles in the U.S. (GAAP) and communicate the economic substance of 
a transaction or event and the overall financial position and results 
of a company.
    3. Other constituents to audit, analyze, and regulate a company's 
financial reporting.
    Complexity can impede effective communication through financial 
reporting between a company and its stakeholders. It also creates 
inefficiencies in the marketplace (e.g., increased investor, preparer, 
audit, and regulatory costs) and suboptimal allocation of capital.
Causes of Complexity
    The causes of complexity are many and varied. We have identified 
the following significant causes of complexity:
    1. Complex activities--The increasingly sophisticated nature of 
business transactions can be difficult to understand, particularly with 
respect to the growing scale and scope of companies with operations 
that cross international boundaries and financial reporting regimes.
    2. Incomparability and inconsistency--Incomparable reporting of 
activities within and across entities

[[Page 10904]]

arises because of factors such as exceptions to general principles, 
bright lines, and the mixed attribute model. Some of this guidance 
permits the structuring of transactions in order to achieve particular 
financial reporting results. Further, to the extent new pronouncements 
are adopted prospectively, past and present periods of operating 
results are not comparable. This is compounded by the rapid pace at 
which new accounting pronouncements are being adopted, which hinders 
the ability of all constituents to understand and apply new guidance in 
relatively short timeframes.
    3. Nature of financial reporting standards--Standards can be 
difficult to understand and apply for several reasons, including:
     The existence of opposing points of view that were taken 
into account when developing standards--most importantly, the attempts 
by public companies to smooth amounts that vary from period to period, 
versus the requests from those who want such amounts marked to market 
each period.
     The challenge of describing accounting principles in 
simple terms (i.e., plain English) for highly sophisticated 
transactions.
     The presence of detailed guidance for numerous specific 
fact patterns.
     The impact of multiple bodies setting standards.
     The development of such standards on the basis of an 
incomplete and inconsistent conceptual framework.
    4. Volume--The vast number of formal and informal accounting 
standards, regulations, and interpretations, including redundant 
requirements, make finding the appropriate standard or interpretation 
challenging for particular fact patterns.
    5. Audit and regulatory systems that challenge the use of 
professional judgment--The risk of litigation and the fear of being 
``second-guessed'' results in (1) a greater demand for detailed rules 
on how to apply accounting standards to an ever increasing set of 
specific situations, (2) unnecessary restatements that are not 
meaningful to investors, and (3) legalistic disclosures that are 
difficult to understand.
    6. Educational shortcomings--Undergraduate and graduate education 
in accounting has traditionally emphasized the mechanics of double-
entry bookkeeping, which favors the use of detailed rules rather than 
the full understanding of relevant principles. The same approach is 
evident in the certified public accountant exam, as well as continuing 
professional education requirements.
    7. Information delivery--The need for information varies by 
investor type and is often driven by a legal, rather than an investor, 
perspective. In addition, the amount and timing of information, as well 
as the method by which it is transmitted, may result in complex and 
hard-to-navigate disclosures that cause investors to sort through 
material that they may not find relevant in order to identify pieces 
that are. These factors make it difficult to distinguish the sustaining 
elements of an entity from non-operating or other influences.
    We observe that two types of substantive complexity exist: (1) 
Unavoidable complexity, which is a function of the underlying 
transaction or item being accounted for, such as the first cause of 
complexity noted above, and (2) avoidable complexity, which is 
introduced from other sources. Our focus is on avoidable complexity, 
with an emphasis on improvements that are feasible in the near-term.

III. Our Scope

    We have limited our deliberations to matters involving SEC 
registrants. While financial reporting matters and, more specifically, 
GAAP, also apply to private entities, including nonprofit 
organizations, our focus is consistent with our role as an advisory 
committee to the SEC.
    We have also focused our scope as it relates to international 
matters. The SEC recently amended its rules to eliminate the 
requirement for a GAAP reconciliation for foreign private issuers 
reporting under international financial reporting standards (IFRS) as 
issued by the International Accounting Standards Board (IASB), and 
issued a concept release to explore a more far-reaching prospect--the 
possibility of giving domestic issuers the alternative to report using 
IFRS. We have proceeded based on two premises: (1) That, despite any 
potential actions by the Commission to permit IFRS reporting by 
domestic issuers, GAAP will continue to be utilized by many U.S. public 
companies for a significant number of years, and (2) that the 
convergence process between GAAP and IFRS will continue. As a result, 
we believe it is productive to make recommendations on improving GAAP, 
as well as the related processes at the Financial Accounting Standards 
Board (FASB or the Board), the Public Company Accounting Oversight 
Board (PCAOB), and the SEC. At the same time, we will point out how our 
developed proposals can be coordinated with the work of the IASB and 
the development of IFRS, with the objective of promoting convergence.

IV. Our Approach

    After the conclusion of our work, we will issue a final report with 
written recommendations to the Chairman of the SEC. In order to 
maximize our effect, we intend to issue a limited number of focused 
recommendations that address acknowledged problem areas and that we 
believe can be adopted without legislation, rather than attempting to 
address all perceived shortcomings in the financial reporting system.
    To facilitate the development of these recommendations, we have 
created subcommittees that report to the full Committee for discussion 
and deliberation. The subcommittees are:
    1. Substantive Complexity.
    2. Standards-Setting Process.
    3. Audit Process and Compliance.
    4. Delivering Financial Information.
    Matters related to international coordination will be addressed, as 
appropriate, as part of our deliberations later in 2008.
    The purpose of this progress report is to present our developed 
proposals, conceptual approaches, and matters for future considerations 
based on our work to date. Developed proposals are proposals that we 
believe could be implemented by the Commission, its staff,\15\ or other 
bodies, as appropriate. Conceptual approaches represent our initial 
views, which are based on discussions on a particular subject, but 
which still require additional vetting before formalization into a 
developed proposal. Matters for future considerations are areas in 
which deliberations and research have not yet begun.
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    \15\ We note that some of our developed proposals, conceptual 
approaches, and matters for future considerations may require SEC 
action, while others may be implemented by SEC staff. We have, 
however, generally adopted a convention of addressing these areas to 
the SEC for convenience. We leave the determination of whether the 
proposals require SEC or SEC staff action to the discretion of the 
SEC and its staff.
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    Our work to date has included four public meetings where these 
topics were deliberated by the full Committee. In generating this 
progress report, we also considered all of the public comments received 
to date on our work.\16\ All of the developed proposals, conceptual 
approaches and matters for future consideration were adopted 
unanimously (except for one dissenting vote on one proposal, as noted 
herein, which resulted in one separate

[[Page 10905]]

statement from Mr. Wallison, attached as appendix A of this progress 
report).
---------------------------------------------------------------------------

    \16\ Comments to the Committee are available at http://
www.sec.gov/comments/265-24/265-24.shtml. We have and continue to 
welcome feedback at any time from investors, registrants, auditors, 
and others on our work. Information on how to submit comments is 
available at: http://www.sec.gov/about/offices/oca/acifr.shtml.
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Chapter 1: Substantive Complexity

I. Introduction

    Public companies in the U.S. submit financial statements to the SEC 
so investors can monitor their financial performance and make decisions 
about capital allocation. Traditionally, those financial statements are 
prepared using a common framework referred to as GAAP. A casual review 
of audited financial statements might create a perception that amounts 
reported in a balance sheet or income statement are mechanical and 
precise, when they in fact reflect a great deal of choices, estimation 
and judgment.
    While ideally GAAP should provide clear and consistent guidance for 
preparing financial statements, this is not always true. A number of 
factors undermine this ideal, including the causes of complexity 
enumerated in the Introduction to this progress report. As a result, 
certain parts of GAAP may actually hinder effective comparison of 
financial performance between companies. For instance, a large company 
may purchase a smaller company to acquire a newly-developed patent that 
the smaller company obtained to protect a promising new product. In 
that scenario, the purchasing company would record the patent as an 
asset under GAAP. However, if the smaller company was not purchased, 
but continued developing the product on its own, it would be prohibited 
by GAAP from recording an asset to reflect the patent on its balance 
sheet.
    This example is just one illustration of the avoidable complexity 
embedded in the current substantive standards of GAAP. We have 
identified what we consider to be the three most pressing forms of 
avoidable substantive complexity that currently exist in financial 
reporting: (1) Exceptions to general principles, (2) bright lines, and 
(3) the mixed attribute model that blends the use of fair value and 
historical cost.
    Exceptions to general principles create complexity because they 
deviate from established standards that are applicable to most 
companies. In effect, investors and preparers no longer speak a uniform 
language to communicate financial information; they must learn new 
dialects. Other constituents in that communication process are 
similarly impacted. Our work in this area is divided into four 
categories. First, there are many examples of industry-specific 
guidance, some of which conflict with more generalized GAAP that 
applies across most industries.\17\ Second, alternative accounting 
policies give preparers options among acceptable practices, such as 
whether or not to apply hedge accounting,\18\ which reduce 
comparability across companies. Third, scope exceptions other than 
industry-specific guidance represent departures from a principle and 
require detailed analyses to determine whether they apply. Fourth, 
competing models create requirements to apply different accounting 
models to similar types of transactions or events, depending on the 
balance sheet or income statement items involved. This diversity 
requires all constituents to understand assorted implementation 
methods, even though they are based on similar fundamental principles.
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    \17\ See comparison of Statement of Financial Accounting 
Standard (SFAS) No. 51, Financial Reporting by Cable Television 
Companies, with SEC Staff Accounting Bulletin (SAB) 104, Revenue 
Recognition (as codified in SAB Topic 13), later in this chapter.
    \18\ Hedge accounting guidance is provided in SFAS No. 133, 
Accounting for Derivatives and Hedging Activities.
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    Bright lines are problematic because they create superficial 
borders along a continuous spectrum of transactions. More 
fundamentally, certain reporting standards require drastically 
different accounting treatments on either side of a bright line. Lease 
accounting is often cited as an illustration of bright lines. Consider, 
for example, a lessee's accounting for a piece of machinery. Under 
current requirements, the lessee will account for the lease in one of 
two significantly different ways: Either (1) reflect an asset and a 
liability on its balance sheet, as if it owns the leased asset or (2) 
reflect nothing on its balance sheet. The accounting conclusion depends 
on the results of two quantitative tests,\19\ where a mere 1% 
difference leads to very different accounting.
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    \19\ See discussion of bright lines below for further details.
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    The mixed attribute model results in amounts that are a blend of 
accounting conventions. Some assets and liabilities are measured at 
historic cost, others at lower of cost or market, and still others at 
fair value. Combinations or subtotals of these numbers thus may not be 
intuitively useful to investors. While some advocate using fair value 
for the entire balance sheet as a solution, this would exacerbate the 
existing questions about relevance and reliability, including 
considerable subjectivity in the valuation of thinly-traded assets and 
liabilities.
    The remainder of this chapter discusses each of these areas and the 
manner in which they contribute to complexity in greater depth. It also 
contains developed proposals or conceptual approaches to reduce their 
effects. The sequence in which these areas are presented does not 
necessarily indicate their relative priority to one another. Rather, 
certain areas warrant additional research and deliberation before 
reasonable proposals can be fully developed, such as those related to 
the mixed attribute model and more meaningful groupings of individual 
line items on the financial statements. We intend to pursue these 
topics during the course of our work later in 2008. Lastly, while 
deliberations have been conducted primarily in the context of GAAP, we 
believe that our analyses and proposals are similarly applicable under 
IFRS.

II. Exceptions to General Principles

II.A. Industry-Specific Guidance

    Developed Proposal 1.1: GAAP should be based on business 
activities,\20\ rather than industries. As such, the SEC should 
recommend that any new projects undertaken jointly or separately by the 
FASB be scoped on the basis of business activities rather than 
industries. Any new projects should include the elimination of existing 
industry-specific guidance in relevant areas as a specific objective of 
those projects, unless, in rare circumstances, retaining industry 
guidance can be justified on the basis of cost-benefit considerations 
(discussed below).
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    \20\ As discussed in section II.B of this chapter regarding 
management intent, we have not taken a position as to whether intent 
is an appropriate basis of accounting. Similarly, we express no view 
on whether intent provides a meaningful distinction between business 
activities.
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    The SEC should also recommend that, in conjunction with its current 
codification project, the FASB add a project to its agenda to remove or 
minimize existing industry-specific guidance that conflicts with 
generalized GAAP, taking into account the pace of convergence 
efforts.\21\
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    \21\ Some constituents understand ``convergence'' to mean that 
GAAP and IFRS (as published by the IASB) will eventually be 
harmonized, at which point no substantive differences will exist 
between the two bodies of accounting literature. Others understand 
it to mean a discrete transition from GAAP to IFRS at a specified 
date without respect to whether the two bodies of literature are 
substantially harmonized. The timing of these two approaches may 
differ, which would likely impact the prioritization of this 
proposal to eliminate existing U.S. industry-specific guidance on 
the FASB's agenda. In either case, we believe industry-specific 
guidance should be substantially eliminated prior to convergence--
either as a component of the convergence plan, or by establishing a 
specified date after which the use of industry-specific guidance 
would be prohibited.

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[[Page 10906]]

Background
    Industry-specific guidance refers to: (1) Exceptions to general 
accounting standards for certain industries, (2) industry-specific 
guidance created in the absence of a single underlying standard or 
principle, and (3) industry practices not specifically addressed or 
based in GAAP. Industries covered by this guidance include, but are not 
limited to, the insurance, utilities, oil and gas, mining, cable 
television, financial, real estate, casino, broadcasting, and film 
industries.\22\
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    \22\ Refer to appendix B for additional examples.
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    Industry-specific guidance has developed for a number of reasons. 
These include multiple standards-setters issuing guidance without 
consistently coordinating their efforts, a desire to enhance uniformity 
throughout an industry, and efforts to customize accounting standards 
for allegedly ``special'' transactions or investor needs. In some 
cases, industries have developed their own practices in the absence of 
applicable authoritative literature.
    Industry-specific guidance contributes to avoidable complexity by 
making financial reports less comparable.\23\ This is evident across 
industries, when conflicting accounting models are used for similar or 
identical transactions. It may also be used as an improper analogy to 
achieve desired results or to require more conservative accounting 
treatments (e.g., by auditors).\24\ In addition, the use of an industry 
to define an accounting treatment raises serious questions about which 
companies are within the scope of specific guidance. This issue is 
especially pronounced for diversified companies, which may be involved 
in a number of different industries.
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    \23\ As noted previously in the Study Pursuant to Section 108(d) 
of the Sarbanes-Oxley Act of 2002 on the Adoption by the United 
States Financial Reporting System of a Principles-Based Accounting 
System (July 2003):
    The proliferation of specialized industry standards creates two 
problems that can hinder standard setters' efforts to issue 
subsequent standards using a more objectives-oriented regime.
     The existence of specialized industry practices may 
make it more difficult for standard setters to eliminate scope 
exceptions in subsequent standards (e.g., many standards contain 
exceptions for insurance arrangements subject to specialized 
industry accounting)
     The specialized standards may create conflicting GAAP, 
which makes it more difficult for accounting professionals to 
determine the appropriate accounting.
    \24\ For instance, some auditors may use concepts in revenue 
recognition from the software industry (Statement of Position (SoP) 
97-2) as a basis for postponing the revenue recognition of companies 
in other industries without on-point literature. Opponents of this 
practice argue such revenue deferral is too conservative and does 
not adequately portray the extent to which a company may have 
satisfied its product or service obligations in a long-term or 
multiple-element contract.
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    Further, industry-specific guidance unnecessarily increases the 
volume of accounting literature. This, in turn, adds to the costs of 
implementing such literature and maintaining it (e.g., monitoring it 
for interaction with other new and existing standards and expanding the 
size and scope of technical resources and databases). Industry-specific 
guidance also increases the cost of training accountants and retaining 
industry experts, while compounding the complexity that investors 
experience in understanding the present variety of accounting and 
disclosure standards. Lastly, it hinders more widespread use of XBRL by 
increasing the number of data tags that need to be created, maintained, 
and properly used to deliver financial information.
    On the other hand, industry-specific guidance may alleviate 
complexity by allowing industry reporting to better meet the specific 
investor needs in that industry and enhancing comparability across 
entities within an industry. Further, it may depict important 
differences in the economics of an industry, particularly where 
application of a generalized principle may not result in accounting 
that is faithful to a transaction's substance. We also note that 
historically, some industry-specific guidance has filled a need where 
GAAP is otherwise lacking, and simplified or reduced the amount of 
guidance a preparer in an industry would need to consider (even though 
it might increase complexity across industries generally). Finally, 
specialized guidance has been able to address prevalent industry issues 
quickly because it was written for a narrower audience than generalized 
GAAP.
    Industry-specific guidance can be broken into three categories. 
First, some industry-specific guidance is explanatory in nature and 
consistent with generalized GAAP, such as portions of AICPA Accounting 
and Auditing Guides that assist preparers interpret and apply existing, 
generalized GAAP. Second, other industry-specific guidance is 
inconsistent with generalized GAAP. For example, SFAS No. 51, Financial 
Reporting by Cable Television Companies, requires that initial hookup 
revenue (a type of nonrefundable upfront fee) is recorded to the extent 
of direct selling costs incurred; the remainder is deferred and 
recorded in income over the estimated average period that subscribers 
are expected to remain connected to the system. However, generalized 
guidance indicates this practice is inappropriate unless it is 
specifically prescribed elsewhere (such as SFAS No. 51).\25\ Therefore, 
similar activities like upfront fees for gym memberships are not 
afforded equal treatment. Third, still other industry-specific guidance 
was created in the absence of a general principle that applies across 
industries. For instance, while there is no comprehensive revenue 
recognition standard, SoP 81-1, Accounting for Performance of 
Construction-Type and Certain Production-Type Contracts, discusses 
revenue and cost recognition in areas such as the construction 
industry.
---------------------------------------------------------------------------

    \25\ SAB Topic 13.
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Discussion
    We generally believe that industry-specific guidance should be 
eliminated to reduce avoidable complexity, particularly as generalized 
GAAP is developed. However, we acknowledge that industry-specific 
guidance has merit when cost-benefit considerations indicate that the 
enhanced information investors would receive under generalized GAAP is 
not justified by the direct costs to preparers and the indirect costs 
to investors to account for activities in that manner. In such cases, 
the SEC should encourage the FASB to work with the relevant industry 
participants to identify long-term ways to improve the benefits and 
mitigate the costs of the general standard. After making these changes, 
the related industry-specific guidance should be phased out as 
efficiently as possible. Towards that end, the SEC should encourage the 
FASB to provide sufficient time to allow companies to adopt generalized 
GAAP with minimal transition costs.
    Similarly, we recognize that industry-specific guidance may be 
helpful in situations in which: (1) It interprets, rather than 
contradicts, principles, and (2) the activities in question are 
legitimately different, which are expected to be rare. But to the 
extent that such guidance interprets principles (i.e., relates to 
implementation), we generally believe it should not be considered 
authoritative GAAP.\26\ Further, to the extent that it applies to

[[Page 10907]]

activities that are legitimately different, such guidance should be 
scoped and applied on the basis of business activities, rather than 
industries.
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    \26\ We are aware of constituents, such as the AICPA, that have 
historically issued industry-specific implementation guidance. We 
generally believe such guidance should not be considered 
authoritative. Rather, all authoritative guidance should continue to 
be issued by designated standards-setters, such as the FASB in the 
U.S., as discussed in chapter 2 of this progress report. If a 
designated standards-setter issues implementation guidance for 
activities that are prevalent in particular industries, we believe 
it should be applicable to all transactions of the type in question, 
regardless of the industry in which a company operates.
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    In implementing this proposal, we note that the FASB's codification 
project can be used to sort existing industry-specific guidance into 
one of the three categories identified above (consistent with GAAP, 
inconsistent with GAAP, or there is no comparable GAAP). We believe 
efforts to reduce existing industry-specific guidance should focus 
primarily on cases in which it is inconsistent with generalized GAAP. 
Further, as the FASB develops new generalized guidance in areas like 
revenue recognition, it should eliminate industry-specific guidance to 
the maximum extent feasible. Similarly, the SEC should eliminate its 
industry-specific guidance in related areas, if any.
    From an international perspective, we note that IFRS currently 
contains less industry-specific guidance than GAAP and that such 
guidance focuses more on the nature of the business activity (e.g., 
agriculture, insurance contracts, exploration and evaluation of mineral 
resources). Nonetheless, the SEC should encourage the IASB to be 
mindful of developed proposal 1.1 as it continues to develop a more 
comprehensive body of standards. The SEC might also encourage the IASB 
to limit future industry-specific guidance to activities whose 
economics are legitimately different from other business activities. 
Otherwise, we believe specialized accounting for only certain subsets 
of similar activities will create avoidable complexity.
    We acknowledge that the elimination of existing industry-specific 
guidance may result in more complexity over the short-term to the 
industries losing special treatment. Nonetheless, we believe it is an 
acceptable cost for a long-term reduction in avoidable complexity.

II.B. Alternative Accounting Policies

    Developed Proposal 1.2: GAAP should be based on a presumption that 
formally promulgated alternative accounting policies should not exist. 
The SEC should recommend that any new projects undertaken jointly or 
separately by the FASB not provide additional optionality, unless, in 
rare circumstances, it can be justified. Any new projects should 
include the elimination of existing alternative accounting policies in 
relevant areas as a specific objective of those projects, unless, in 
rare circumstances, the optionality can be justified.
Background
    Alternative accounting policies refer to optionality in GAAP. The 
following discussion addresses formally-promulgated options in GAAP, 
but does not address choices available to preparers at more of a 
practice or implementation level.\27\ Examples of optionality in GAAP 
include:\28\
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    \27\ For example, companies are free to choose from among 
several depreciation methods--straight-line, double-declining 
balance, etc.
    \28\ Refer to appendix B for additional examples.
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     The indirect versus the direct method of presenting 
operating cash flows on the statement of cash flows.
     The application of hedge accounting.\29\
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    \29\ We have noted complexities arising from the application of 
hedge accounting, which allows entities to mitigate reported 
volatility over the life of the hedge relationship. In this regard, 
we generally feel that instead of assessing hedge effectiveness to 
determine whether companies qualify for this alternative accounting 
treatment, a better policy would be to simply record the ineffective 
portion of a hedge in earnings (i.e., a proportionate approach 
versus an all-or-nothing approach). We are also aware of the FASB's 
derivatives project in this area and are generally supportive of its 
progress.
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     The option to measure certain financial assets and 
liabilities at fair value.
     The immediate or delayed recognition of gains/losses 
associated with defined benefit pension and other post-retirement 
employee benefit plans.
     The successful efforts or full cost accounting method 
followed by oil and gas producers.
    Alternative accounting policies arise for a number of reasons. 
These reasons include circumstances in which the pros and cons of 
competing policies may be balanced and thus do not result in a single, 
clearly preferable approach. Other causes encompass political pressure 
that results in standards-setters providing for a preferred and an 
alternative accounting method, high administrative costs of the 
preferred alternative to preparers (e.g., cost-benefit considerations), 
and a portrayal of differences in management intent.
    Alternative accounting policies contribute to avoidable complexity 
by making financial reports less comparable. This is evident across 
companies when identical activities are accounted for differently. Such 
alternatives may permit accounting that is less reflective of economic 
substance to the extent that they are based on political pressure, and 
facilitate differences in accounting policies selected by preparers to 
achieve the most favorable treatment. The unnecessary proliferation of 
accounting literature to codify these alternatives also adds to 
avoidable complexity.
    On the other hand, alternative accounting policies may alleviate 
complexity by allowing preparers to determine the best accounting for 
particular entities based on cost and economic substance, to the extent 
that more than one accounting policy is conceptually sound. In 
addition, certain alternative policies may be developed more quickly 
than a final ``perfect'' standard to minimize the effect of other 
unacceptable practices. In other words, they may function as a short-
term fix on the road to ideal accounting.
Management Intent
    Some alternative accounting policies are based on management 
intent.\30\ Management intent is a present assertion about management's 
plans for future courses of action.\31\
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    \30\ For example, SFAS No. 115 Accounting for Certain 
Investments in Debt and Equity Securities, allows management to 
classify certain debt instruments as either a held-to-maturity, an 
available-for-sale, or a trading security based on the company's 
intent and ability with respect to the holding period of its 
investment. The financial statement treatment differs for all three 
categories.
    \31\ The definition of management intent and certain other 
concepts in the discussion of alternative accounting policies are 
adapted from a FASB Special Report: Future Events: A Conceptual 
Study of Their Significance for Recognition and Measurement (1994).
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    We have separately considered the merits of alternative accounting 
policies arising from differences in management intent. Opponents of 
the use of management intent as a basis for accounting believe that 
because intentions are subjective, it is difficult to use intent as a 
basis for accounting. Opponents also believe that intent does not 
change the economics of a transaction and thus, would not be a 
representationally faithful basis of accounting.
    Proponents assert that the economics of a transaction do, in fact, 
change based on the nature of the activity, which is driven by 
management intent. Proponents also note that, while management intent 
is subjective and could change, this characteristic is no different 
from a management estimate, which is common in financial reporting. 
Proponents further argue that financial reporting that ignores 
management intent results in irrelevant information for investors, for 
instance, reporting the fair value of a held-to-maturity security that 
will not be settled for 30 years.
    Due to the varying levels of management intent throughout GAAP and 
the merits of the arguments both for and against its use, we have 
determined that accounting based on management intent is too dependent 
on facts and circumstances to feasibly address within our timeframe.

[[Page 10908]]

Discussion
    Setting aside any consideration of management intent, we believe 
alternative accounting policies should be eliminated, except in limited 
circumstances in which they may have merit. Possible justifications for 
retaining alternative accounting policies include situations in which: 
(1) Multiple accounting alternatives exist that are consistent with the 
conceptual framework, and none are determined to provide significantly 
better information to investors than others, and (2) an alternative or 
interim treatment can be developed more quickly than a final 
``perfect'' standard to minimize the effect of other unacceptable 
practices.
    If one or both of the justifications above apply, we believe that 
the provision of alternative accounting principles should be coupled 
with a long-term plan by the FASB to eliminate the alternative(s) 
through the use of sunset provisions and that the effect of applying 
the alternative policy not selected by preparers should be clearly and 
succinctly communicated to investors (e.g., through footnote 
disclosure).
    Further, as new guidance is issued, including that which is issued 
through the convergence process, the SEC should eliminate its 
alternative accounting policies in related areas, if any.
    From an international perspective, we note that IFRS currently 
permits numerous alternative accounting policies. While we acknowledge 
the IASB's efforts in reducing some of these alternative treatments, we 
nonetheless believe that the SEC should encourage the IASB, like the 
FASB, to be mindful of this proposal, and seek to eliminate 
alternatives as part of its standards-setting projects.

III. Bright Lines

    Conceptual Approach 1.A: We are considering recommending expanded 
use of the following, in place of the current use of bright lines, to 
better reflect the economic substance of an activity:
     Proportionate recognition--We use the term ``proportionate 
recognition'' in contrast to the current all-or-nothing recognition 
approach in GAAP. For example, consider a lease in which the lessee has 
the right to use a machine, valued at $100, for four years. Also assume 
that the machine has a 10-year useful life. Under proportionate 
recognition, a lessee would recognize an asset for its right to use the 
machine (rather than for a proportion of the asset) at approximately 
$40 \32\ on its balance sheet. Under the current accounting literature, 
the lessee would either recognize the machine at $100 or recognize 
nothing on its balance sheet, depending on the results of certain 
bright line tests.
---------------------------------------------------------------------------

    \32\ Calculated as (4 year lease/10 year useful life) x $100 
machine value. The example is only intended to be illustrative and 
is not prescriptive. For instance, the basis of proportionate 
recognition may be an asset's estimated useful life, future cash 
flows, or the share of a company's liabilities in a structured 
investment vehicle. We are planning additional deliberations in this 
regard.
---------------------------------------------------------------------------

     Additional disclosure--We recognize that proportionate 
recognition is not universally applicable. In those cases, enhanced 
disclosure may be more appropriate. We have yet to define the possible 
scope of proportionate recognition and/or enhanced disclosure, but it 
may extend to areas such as leases, consolidation policy and off-
balance sheet activity.
     Rules-of-thumb or presumptions, both coupled with 
additional considerations--We use rule-of-thumb and presumption to 
describe a method by which an accounting conclusion may be initially 
favored, subject to the consideration of additional factors. These are 
less stringent than bright lines, and may be appropriate where 
proportionate recognition may not apply.
    Conceptual Approach 1.B: Further, we are considering a 
recommendation related to the education of students, as well as to the 
continuing education of investors, preparers, and auditors. The 
recommendation would encourage understanding of the economic substance 
and business purposes of transactions, in contrast to mechanical 
compliance with rules without sufficient context.
Background
    Bright lines refer to two main areas: quantified thresholds and 
pass/fail tests.\33\
---------------------------------------------------------------------------

    \33\ Refer to appendix B for additional examples other than 
those discussed in this section.
---------------------------------------------------------------------------

    Quantified thresholds include hard-and-fast cutoffs, as well as 
rules-of-thumb or presumptions--both coupled with additional 
considerations. Lease accounting is often cited as an example of bright 
lines in the form of quantified thresholds. Consider, for example, a 
lessee's accounting for a piece of machinery. Under current 
requirements, the lessee will account for the lease in one of two 
significantly different ways: Either (1) reflect an asset and a 
liability on its balance sheet, as if it owns the leased asset, or (2) 
reflect nothing on its balance sheet. The accounting conclusion depends 
on the results of two quantitative tests,\34\ where a mere 1% 
difference in the results of the quantitative tests leads to very 
different accounting.
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    \34\ Specifically, SFAS No. 13, Accounting for Leases, requires 
that leases be classified as capital leases and recognized on the 
lessee's balance sheet where (1) the lease term is greater than or 
equal to 75% of the estimated economic life of the leased property 
or (2) the present value at the beginning of the lease term of the 
minimum lease payments equals or exceeds 90% of the fair value of 
the leased property, among other criteria.
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    With respect to rules-of-thumb, consolidation guidance \35\ 
generally requires at least a 10% equity investment in a company (i.e., 
the equity investment expressed as a percentage of total assets) to 
demonstrate that the investee company is not considered a variable 
interest entity (VIE). The determination as to whether an entity is a 
VIE drives who, if anyone, ultimately consolidates the VIE in its 
financial statements. However, entities with investments above and 
below the 10% level can still be considered VIEs, depending on the 
particular facts and circumstances. That is, the 10% rule-of-thumb is 
not determinative in its own right.
---------------------------------------------------------------------------

    \35\ FASB Interpretation No. (FIN) 46 (revised December 2003), 
Consolidation of Variable Interest Entities (FIN 46R).
---------------------------------------------------------------------------

    Similarly, the business combination literature \36\ contains an 
example of a presumption coupled with additional considerations. There 
are situations in which selling shareholders of a target company are 
hired as employees by the purchaser. For instance, the purchaser may 
wish to retain the sellers' business expertise. The payments to the 
selling shareholders may either be treated as: (1) Part of the cost of 
the acquisition, which means the payments are allocated to certain 
accounts on the purchaser's balance sheet, such as goodwill, or (2) 
compensation to the newly-hired employees, which are recorded as an 
expense in the purchaser's income statement, reducing net income. Some 
of these payments may be contingent on the selling shareholders' 
continued employment with the purchaser, e.g., the individual must 
still be employed three years after the acquisition in order to 
maximize the total sales price. GAAP provides several factors to 
consider

[[Page 10909]]

when deciding whether these payments should be treated as an expense or 
not, but establishes a presumption that any future payments linked to 
continued employment should be treated as an expense. It is possible 
this presumption may be overcome depending on the circumstances.
---------------------------------------------------------------------------

    \36\ Emerging Issues Task Force (EITF) 95-8, Accounting for 
Contingent Consideration Paid to the Shareholders of an Acquired 
Enterprise in a Purchase Business Combination. We note EITF 95-8 is 
nullified by a new FASB standard, SFAS No. 141 (revised 2007), 
Business Combinations. SFAS No. 141 (revised 2007) states ``A 
contingent consideration arrangement in which the payments are 
automatically forfeited if employment terminates is compensation* * 
*'' However, the guidance in EITF 95-8 is still helpful in 
describing our approach with respect to the use of presumptions 
coupled with additional considerations in GAAP.
---------------------------------------------------------------------------

    As indicated above, the other area of bright lines in this section 
includes pass/fail tests, which are similar to quantitative thresholds 
because they result in recognition on an all-or-nothing basis. However, 
these types of pass/fail tests do not involve quantification. For 
example, a software sales contract may require delivery of four 
elements. Revenue may, in certain circumstances, be recognized as each 
element is delivered. However, if appropriate evidence does not exist 
to support the allocation of the sales price to, for example, the 
second element, software revenue recognition guidance requires that the 
timing of recognition of all revenue be deferred until such evidence 
exists or all four elements are delivered.
    Bright lines arise for a number of reasons. These reasons include a 
drive to enhance comparability across companies by making it more 
convenient for preparers, auditors, and regulators to reduce the amount 
of effort that would otherwise be required in applying judgment (i.e., 
debating potential accounting treatments and documenting an analysis to 
support the final judgment), and the belief that they reduce the chance 
of being second-guessed. Bright lines are also created in response to 
requests for additional guidance on exactly how to apply the underlying 
principle. These requests often arise from concern on the part of 
preparers and auditors of using judgment that may be second-guessed by 
inspectors, regulators, and the trial bar. Finally, bright lines 
reflect efforts to curb abuse by establishing precise rules to avoid 
problems that have occurred in the past.
    Bright lines can contribute to avoidable complexity by making 
financial reports less comparable. This is evident in accounting that 
is not faithful to a transaction's substance, particularly when 
application of the all-or-nothing guidance described above is required. 
Bright lines produce less comparability because two similar 
transactions may be accounted for differently. For example, as 
described above, a mere 1% difference in the quantitative tests 
associated with lease accounting could result in very different 
accounting consequences. Some bright lines also permit structuring 
opportunities to achieve a specific financial reporting result (e.g., 
whole industries have been developed to create structures to work 
around the lease accounting rules). Further, bright lines increase the 
volume of accounting literature as standards-setters and regulators 
attempt to curb abusively structured transactions. The extra literature 
creates demand for additional expertise to account for certain 
transactions. All of these factors add to the total cost of accounting 
and the risk of restatement.
    On the other hand, bright lines may alleviate complexity by 
reducing judgment and limiting aggressive accounting policies. They may 
also enhance perceived uniformity across companies, provide convenience 
as discussed above, and limit the application of new accounting 
guidance to a small group of companies, where no underlying standard 
exists. In these situations, the issuance of narrowly-scoped guidance 
may allow for issues to be addressed on a more timely basis. In other 
words, narrowly-scoped guidance and the bright lines that accompany 
them may function as a short-term fix on the road to ideal accounting.
Discussion
    We are still in the process of debating when, if at all, bright 
lines are justified in accounting literature. We note that even if the 
FASB limits the issuance of bright lines, other parties might continue 
to create similar non-authoritative guidance. As such, recommendations 
to limit bright lines would require a cultural shift towards acceptance 
of more judgment. Accordingly, any recommendations in the context of 
bright lines will incorporate our consideration of a professional 
judgment framework, as discussed in chapter 3, and our consideration of 
interpretive implementation guidance and a new design approach to 
accounting standards, as discussed in chapter 2.

IV. Mixed Attribute Model and the Appropriate Use of Fair Value

    Conceptual Approach 1.C: Measurement framework--While we may not 
have time to fully address when fair value is the appropriate 
measurement attribute, we understand that the FASB's joint conceptual 
framework project includes a measurement phase. We intend to study this 
project further and are considering a recommendation for the SEC to 
endorse that, as part of this project, the FASB develop a decision 
framework to provide a systematic approach for consistently determining 
the most appropriate measurement attribute for similar activities or 
assets/liabilities based on consideration of the trade off between 
relevance and reliability, and the various constituents involved in the 
financial reporting process.
    Conceptual Approach 1.D: Judicious Use of Fair Value--Due to 
implementation complexities, as noted below, we are considering whether 
the SEC should request that the FASB be judicious about issuing new 
standards and interpretations that require the expanded use of fair 
value in areas where it is not already required, until completion of a 
measurement framework. Over the long-term, this framework would be used 
to determine measurement attributes systematically.\37\ We will also 
consider whether improvements related to certain existing, 
particularly-complex, standards that incorporate fair value, such as 
SFAS Nos. 133 \38\ and 140,\39\ are warranted in the near-term.
---------------------------------------------------------------------------

    \37\ We recognize that the joint FASB/IASB conceptual framework 
project, including the measurement phase, is a significant 
undertaking that most likely will not be completed in the near-term. 
Consequently, we may explore whether a recommendation is warranted 
for a formal SEC study regarding when fair value is appropriate in 
financial reporting. The study's report could then be incorporated 
in future standards-setting activity.
    \38\ Accounting for Derivatives and Hedging Activities.
    \39\ Accounting for Transfers and Servicing of Financial Assets 
and Extinguishments of Liabilities.
---------------------------------------------------------------------------

    Conceptual Approach 1.E: Groupings in Financial Statement 
Presentation--We believe that a more consistently aggregated 
presentation of financial statements would alleviate some of the 
confusion and concerns regarding the use of fair value. Such 
presentation should result in the grouping of amounts and line items by 
nature of activity and measurement attribute within and across 
financial statements. We believe such a grouping would be more 
understandable to investors, particularly as it would more clearly 
delineate the nature of changes in income (e.g., fair value volatility, 
changes in estimate, and business activity). This presentation might 
also help investors assess the degree to which management controls each 
source of income.
    As part of the financial statement presentation project, the FASB 
has tentatively decided to segregate the financial statements into 
business (further divided into operating and investing) and financing 
activities. The FASB has also tentatively decided to require a 
reconciliation of the statement of cash flows to the statement of 
comprehensive income. This reconciliation would disaggregate changes in 
assets and liabilities based

[[Page 10910]]

on cash, accruals, and changes in fair value, among others.
    We intend to study this project further and consider whether it 
would address the our leanings in this area and sufficiently facilitate 
investors' understanding of fair value.
    Conceptual Approach 1.F: Additional Disclosure--We have identified 
potential areas for additional disclosure to more effectively signal to 
investors the level of uncertainty associated with fair value 
measurements in financial statements.\40\ Specifically, we note that in 
some cases, there is no ``right'' number in a probability distribution 
of figures, some of which may be more fairly representative of fair 
value than others. Potential areas to be considered for additional 
disclosure may include:
---------------------------------------------------------------------------

    \40\ We acknowledge uncertainty also exists in other measurement 
attributes, such as historic cost, which may warrant similar 
disclosure.
---------------------------------------------------------------------------

     The valuation model.
     Statistical confidence intervals associated with certain 
valuation models.
     Key assumptions, including projections.
     Sensitivity analyses depending on the selection of key 
assumptions.
     The entity's position versus that of the entire market.
    Conceptual Approach 1.G: Disclosure Framework--We seek to balance 
additional disclosure requirements, including, if any, those under 
conceptual approach 1.F, with: (1) The perception that amounts 
recognized in financial statements are generally subject to more 
precise calculations by preparers and higher degrees of scrutiny by 
investors compared to merely disclosing such amounts in the footnotes, 
and (2) concerns regarding disclosure redundancies. To minimize the 
effect of diminishing returns on potential new disclosure improvements 
identified during the course of our efforts and future standards-
setting activity, we are considering recommending: (1) That the SEC 
request the FASB to develop a disclosure framework that integrates 
existing disclosure requirements into a cohesive whole (e.g., eliminate 
redundant disclosures and provide a single source of disclosure 
guidance across all accounting standards), (2) improvement to the 
piecemeal approach to establishing disclosures (i.e., standard-by-
standard), and (3) that the SEC develop a process to regularly evaluate 
and, as appropriate, update its disclosure requirements as new FASB 
standards are issued.

Background

    As previously noted, the mixed attribute model is one in which the 
carrying amounts of some assets and liabilities are measured based on 
historical cost, others at lower of cost or market, and still others at 
fair value. This complexity is compounded by requirements to record 
some adjustments to carrying amounts in earnings and others in 
comprehensive income.
    Examples of accounting standards that result in mixed attribute 
measurement include two FASB standards related to financial 
instruments. SFAS No. 159, The Fair Value Option for Financial Assets 
and Financial Liabilities, permits the fair valuation of certain assets 
and liabilities. As a result, some assets and liabilities are measured 
at fair value, while others are measured at amortized cost or some 
other basis. SFAS No. 115, Accounting for Certain Investments in Debt 
and Equity Securities, requires certain investments to be recognized at 
fair value and others at amortized cost.
    In practice, the costs associated with (potentially uncertain) fair 
value estimates can be considerable. Some preparers' knowledge of 
valuation methodology is limited, requiring the use of valuation 
specialists. Auditors often require valuation specialists of their own 
to support the audit. Some view the need for these valuation 
specialists as a duplication of efforts, at the expense of the 
preparer. In addition, there are recurring concerns about second-
guessing by auditors, regulators, and courts in light of the many 
judgments and imprecision involved with fair value estimates. 
Regardless of whether such estimates are prepared internally or by 
valuation specialists, the effort and elapsed time required to 
implement and maintain mark-to-model fair values is significant.
    Nevertheless, some have advocated mandatory and comprehensive use 
of fair value as a solution to the complexities arising from the mixed 
attribute model. However, opponents argue that this would only shift 
the burden of avoidable complexity from investors to preparers and 
auditors, among others. Specifically, certain investors may find 
uniform fair value reporting simpler and more meaningful than the 
current mixed attribute model. But under a full fair value approach, 
some objectivity would be sacrificed because many amounts that would 
change to fair value are currently reported on a more verifiable basis, 
such as historic cost. These amounts would have to be estimated by 
preparers and certified by auditors, as discussed above. Such estimates 
are made even more subjective by the lack of a single set of generally 
accepted valuation standards and the use of inputs to valuation models 
that vary from one company to the next. Likewise, significant variance 
exists in the quality, skill, and reports of valuation specialists, 
which preparers have limited ability to assess. Finally, there is no 
mechanism to ensure the ongoing quality, training, and oversight of 
valuation specialists. As a result, some believe a wholesale transition 
to fair value would reduce the reliability of financial reports to an 
unacceptable degree.
    Therefore, we assume that a complete move to fair value is most 
unlikely. Within this context, the partial use of fair value increases 
the volume of accounting literature. Said differently, when more than 
one measurement attribute is used, guidance is required for each one. 
In addition, some entities may operate under the impression that 
investors: (1) Are averse to market-driven volatility, and as a result, 
(2) incorporate unfavorable assumptions or discounts within their 
assessments of a company's financial performance. Consequently, 
entities have demanded exceptions from the use of fair value in 
financial reporting, resisted its use, and/or entered into transactions 
that they otherwise would not have undertaken to artificially limit 
earnings volatility. These actions have resulted in a build up in the 
volume of accounting literature. More generally, some believe that 
attempts by companies to smooth amounts that are not smooth in their 
underlying economics reduce the efficiency and the effectiveness of 
capital markets.
    Information delivery is made more difficult by fair value. 
Investors may not understand the uncertainty associated with fair value 
measurements (i.e., that they are merely estimates and in many 
instances lack precision), including the quality of unrealized gains 
and losses in earnings that arise from changes in fair value. Some 
question whether the use of fair value may lead to counterintuitive 
results. For example, an entity that opts to fair value its debt may 
recognize a gain when its credit rating declines. Others question 
whether the use of fair value for held to maturity investments is 
meaningful. Finally, preparers may view disclosure of some of the 
inputs to the assumptions as sensitive and competitively harmful.
    Despite these difficulties, the use of fair value may alleviate 
some aspects of avoidable complexity. Such information may provide 
investors with

[[Page 10911]]

management's perspective, to the extent management makes decisions 
based on fair value, and it may improve the relevance of information in 
many cases, as historical cost is not meaningful for certain items.
    Fair value may enhance consistency by reducing confusion related to 
measurement mismatches. For example, an entity may enter into a 
derivative instrument to hedge its exposure to changes in the fair 
value of debt attributable to changes in the benchmark interest rate. 
The derivative instrument is required to be recognized at fair value, 
but, assuming no application of hedge accounting or the fair value 
option, the debt would be measured at amortized cost, resulting in 
measurement mismatches. Fair value might also mitigate the need for 
detailed application guidance explaining which instruments must be 
recorded at fair value and help prevent some transaction structuring. 
Specifically, if fair value were consistently required for all similar 
activities, entities would not be able to structure a transaction to 
achieve a desired measurement attribute.
    Fair value also eliminates issues surrounding management's intent. 
For example, entities are required to evaluate whether investments are 
impaired. Under certain impairment models, entities are currently 
required to assess whether they have the intent and ability to hold the 
investment for a period of time sufficient to allow for any anticipated 
recovery in market value. As discussed in section II.B of this chapter, 
management intent is subjective and, thus, less auditable. However, use 
of fair value would generally make management intent irrelevant in 
assessing the value of an investment.

Discussion

    We acknowledge the view that a complete transition to fair value 
would alleviate avoidable complexity resulting from the mixed attribute 
model. However, we also recognize that expanded use of fair value would 
increase avoidable complexity, as discussed above, unless numerous 
implementation questions related to relevance and reliability are 
addressed, which extend beyond the scope of our work.
    In light of our limited duration, we recognize that we may not 
independently develop a comprehensive measurement framework, but we 
plan to provide input to the FASB's projects in this area (see 
conceptual approach 1.C on the measurement framework and conceptual 
approach 1.E on groupings in financial statement presentation). As a 
result, we believe that recommendations requiring a systematic 
measurement framework and better communication of measurement 
attributes would more feasibly reduce avoidable complexity resulting 
from the mixed attribute model. Such communication encompasses footnote 
disclosure of each measurement attribute's characteristics (e.g., 
uncertainty associated with fair value), as well as a more systematic 
presentation of distinct measurement attributes on the face of the 
primary financial statements.

V. Future Considerations

    As noted in the introduction to this chapter, exceptions to general 
principles create complexity because they deviate from established 
standards that are applicable to most companies. Our developed 
proposals with respect to industry-specific guidance and alternative 
accounting policies address two forms of this diversity. We intend to 
deliberate two remaining forms of such diversity during the course of 
our work later in 2008.

Scope Exceptions in GAAP Other Than Industry-Specific Guidance \41\

    As noted previously, scope exceptions other than industry-specific 
guidance represent departures from a principle. They contribute to 
avoidable complexity because they result in different accounting for 
similar activities, require detailed analyses to determine whether or 
not they apply in particular situations, and increase the volume of 
accounting literature. On the other hand, the value of scope exceptions 
will be considered in light of cost-benefit considerations, practical 
approaches to issuing guidance in the near-term before more principled 
standards can be developed, and the magnitude of change that would 
result from eliminating or reducing them.
---------------------------------------------------------------------------

    \41\ We have limited our focus to scope exceptions, while 
acknowledging there are other types of exceptions in GAAP. This 
limited approach was considered appropriate in light of our short 
duration.
---------------------------------------------------------------------------

    Examples of scope exceptions include: (1) A contract that has the 
characteristics of a guarantee under FIN 45, Guarantor's Accounting and 
Disclosure Requirements for Guarantees, Including Indirect Guarantees 
of Indebtedness to Others, but is treated as contingent rent under SFAS 
No. 13, Accounting for Leases; (2) the business scope exception to the 
applicability of FIN 46R, Consolidation of Variable Interest Entities, 
subject to certain criteria; and (3) the application of SFAS No. 157, 
Fair Value Measurements, to share-based payment transactions.

Competing Models

    Competing models are distinguished here from alternative accounting 
policies. Alternative accounting policies, as explained above, refer to 
different accounting treatments that preparers are allowed to choose 
under existing GAAP (e.g., whether to apply the direct or indirect 
method of cash flows). By contrast, competing models refer to 
requirements to apply different accounting models to account for 
similar types of transactions or events, depending on the balance sheet 
or income statement items involved.
    Examples of competing models include different methods of asset 
impairment testing such as inventory, goodwill, and deferred tax 
assets, etc.\42\ Other examples include different methods of revenue 
recognition in the absence of a general principle, as well as the 
derecognition of most liabilities (i.e., removal from the balance 
sheet) on the basis of legal extinguishment compared to the 
derecognition of a pension or other post-retirement benefit obligation 
via settlement, curtailment, or negative plan amendment.
---------------------------------------------------------------------------

    \42\ For instance, inventory is assessed for recoverability 
(i.e., potential loss of usefulness) and remeasured at the lower of 
cost or market value on a periodic basis. To the extent the value of 
inventory recorded on the balance sheet (i.e., its ``cost'') exceeds 
a current market value, a loss is recorded. In contrast, goodwill is 
tested for impairment annually, unless there are indications of loss 
before the next annual test. To determine the amount of any loss, 
the fair value of a ``reporting unit'' (as defined in GAAP) is 
compared to its carrying value on the balance sheet. If fair value 
is greater than carrying value, no impairment exists. If fair value 
is less, then companies are required to allocate the fair value to 
the assets and liabilities in the reporting unit, similar to a 
purchase price allocation in a business combination. Any fair value 
remaining after the allocation represents ``implied'' goodwill. The 
excess of actual goodwill compared to implied goodwill, if any, is 
recorded as a loss. Deferred tax assets are tested for realizability 
on the basis of future expectations. The amount of tax assets is 
reduced if, based on the weight of available evidence, it is more 
likely than not (i.e., greater than 50% probability) that some 
portion or all of the deferred tax asset will not be realized. 
Future realization of a deferred tax asset ultimately depends on the 
existence of sufficient taxable income of the appropriate character 
(e.g., ordinary income or capital gain) within the carryback and 
carryforward periods available under the tax law.
---------------------------------------------------------------------------

    Competing models contribute to avoidable complexity in that they 
lead to inconsistent accounting for similar activities, and they 
contribute to the volume of accounting literature. On the other hand, 
the value of competing models will be considered in light of cost-
benefit considerations, practical approaches to issuing guidance in the 
near-term before more principled standards can be developed, and the

[[Page 10912]]

magnitude of change that would result from eliminating or reducing 
them. We will also explore the relationship between competing models 
and the FASB's conceptual framework.

Chapter 2: Standards-Setting Process

I. Introduction

    A robust standards-setting process is the foundation of an 
efficient system of financial accounting and reporting, on which 
capital providers may rely to make investment decisions. Although the 
U.S. approach to financial reporting has been quite effective in 
achieving that overarching objective, GAAP has evolved over many years 
to a point whereby some of the basic principles are obfuscated by 
detailed interpretive rules, as well as various exceptions and 
alternatives, which reduce the usefulness of the resulting financial 
reporting. Historically, interpretative rules on how to implement GAAP 
(interpretive implementation guidance) have proliferated from a variety 
of sources and, intentionally or not, have become perceived as 
additional GAAP. This increases the complexity of the financial 
reporting system and reduces its transparency for investors, especially 
when questions exist about the authoritative nature of such guidance or 
conflicts exist between interpretations.
    This chapter advances developed proposals, conceptual approaches, 
and matters for future consideration intended to alleviate some of 
these concerns. Specifically, after examining the U.S. standards-
setting process, we propose changes in the following areas:
     Increased investor representation in standards-setting.
     Enhancements in governance and oversight.
     Improvements in the process of setting new standards.
     Narrowing the sources of interpretive implementation 
guidance.
    In general, we believe the design of the U.S. financial reporting 
system and the role played by each participant are appropriate. 
However, improvements to the existing standards-setting process, 
including the process of issuing interpretive implementation guidance, 
may significantly influence behaviors and thereby help financial 
reporting better serve the needs of investors.
    Some of our proposals may be partially or substantially addressed 
by actions recently taken or in the process of being taken by the FAF, 
the FASB, and the SEC, which we reference where applicable. Other 
aspects of our proposals are already in place or occur informally in 
practice, but may not be fully effective or well understood. 
Nevertheless, our proposals are designed to increase the effectiveness 
and transparency of these processes.

II. Investor Representation

    Investor representation in standards-setting is critical to 
maintaining an effective system of financial reporting, yet the 
intricacy of certain accounting matters has sometimes made it difficult 
to attract meaningful investor participation. Our proposals are 
intended to underscore the pre-eminence of investor perspectives in 
developing and administering a well-designed and effective system of 
financial reporting. The current standards-setting process attempts to 
balance the views of different stakeholders. However, the financial 
reporting system would best be served by recognizing that the 
perspectives of investors should be pre-eminent when competing 
interests cannot be aligned, because all stakeholders benefit from a 
system that allocates capital more efficiently.
    We acknowledge the FASB's significant recent efforts to increase 
investor participation in standards-setting. Specifically, the FASB 
leveraged a number of existing advisory groups and created additional 
advisory groups to increase investor involvement. Our proposal below is 
intended to provide the FASB with more focused, efficient, and timely 
feedback from investors, both large and small.
    Developed Proposal 2.1: Additional investor representation on 
standards-setting bodies is central to improving financial reporting. 
Only if investor perspectives are properly considered by all parties 
will the output of the financial reporting process meet the needs of 
those for whom it is primarily intended to serve. Therefore, the 
perspectives of investors should have pre-eminence. To achieve that 
pre-eminence in standards-setting, the SEC should encourage the 
following improvements:
     Add investors to the Financial Accounting Foundation (FAF) 
to give more weight to the views of different types of investors, both 
large and small.
     Give more representation on both the FASB and the FASB 
staff to experienced investors who regularly use financial statements 
to make investment decisions to ensure that standards-setting considers 
fully the usefulness of the resulting information.
    FAF: Our proposal complements the FAF's recently proposed 
governance reforms.\43\ The FAF proposes to expand the sources of FAF 
Trustee nominations, change terms of service, and create flexibility in 
the size of the FAF itself. We support these proposals, particularly 
the decision to reduce reliance on constituent-based sponsoring 
organizations to put forward FAF Trustees. However, we believe 
additional investor representation on the FAF should also be 
emphasized. Such representation should strive to consider differing 
perspectives in the investing community.
---------------------------------------------------------------------------

    \43\ FAF, Request for Comments on Proposed Changes to Oversight, 
Structure and Operations of the FAF, FASB and GASB (December 18, 
2007). Our deliberation of the FAF request for comments focused on 
the FAF and FASB proposals, as the Governmental Accounting Standards 
Board (GASB) is outside of our scope.
---------------------------------------------------------------------------

    FASB and FASB Staff: Increasing direct investor involvement on the 
Board would benefit the FASB by bringing investor perspectives to the 
forefront of standards-setting and the process of issuing interpretive 
implementation guidance. We propose that the composition of the Board 
include no fewer than one, and perhaps more than one, experienced 
investor who regularly uses third-party financial statements to make 
investment decisions.
    Our proposal assumes that the FAF will implement its proposed 
reduction in the size of the FASB from seven to five members. If this 
reduction is made, we believe the composition of the Board should be 
reconsidered to require that a preparer, an auditor, and at least one 
experienced investor who regularly uses third-party financial 
statements to make investment decisions are all represented. In our 
view, although academic representation on the Board should be actively 
sought, it should not be mandated. If the FASB consists of five 
members, our suggested approach would increase the influence of 
investors. While we recognize that workload capacity concerns may be 
created by a reduction in the size of the Board, we believe that these 
concerns may be mitigated by more delegation of responsibilities to 
senior staff members and a possible increase in the size of the FASB 
staff. On the other hand, if the FAF does not reduce the FASB's size, 
at least two investors should be required on the Board. The remaining 
at-large Board members should be selected from the most qualified 
individuals who possess a breadth of experiences that will ensure that 
the perspectives of investors are carefully considered.
    There may be opportunities to increase investor representation on 
the FASB staff as well. The FASB has a few staff with professional 
investing experience. The FASB also has had a fellowship program for 
many years, but

[[Page 10913]]

fellows usually come from the auditor and preparer communities. The 
FASB has approached investor groups about the possibility of sponsoring 
fellows, but, thus far, has had limited success. Investors should 
promote the fellowship positions and encourage qualified applicants to 
join the FASB staff to help enhance investor input in standards-
setting.
    In addition, the FAF should consider staffing alternatives that 
make greater use of part-time Board members or part-time senior staff 
for particular projects or purposes. However, we recognize that 
conflict of interest and independence issues would have to be resolved.

III. FAF and FASB Governance

    The FAF Board of Trustees is responsible for the oversight, 
funding, and appointment of Board members of the FASB and the GASB. 
While the FAF Board of Trustees does not direct the standards-setting 
activities of the FASB, it does have a responsibility to periodically 
review the FASB's structure and governance to assess its effectiveness 
and efficiency. The FAF has always maintained oversight of the FASB as 
one of its main priorities. Our proposal below is designed to promote 
more active FAF oversight of the FASB--in order to shorten the time 
taken to develop standards, as well as to improve their quality:
    Developed Proposal 2.2: The SEC should assist the FAF with 
enhancing its governance of the FASB, as follows:
     By encouraging the FAF to develop performance metrics to 
assess the FASB's adherence to the goals in its mission statement, 
objectives, and precepts and to improve its efficiency.
     By supporting the FAF's changes outlined in its ``Request 
for Comments on Proposed Changes to Oversight, Structure and Operations 
of the FAF, FASB and GASB,'' with minor modifications regarding 
composition of the FAF and the FASB, as proposed in section II of this 
chapter, and agenda-setting, as proposed in section IV of this chapter.
     By encouraging the FAF to amend the FASB's mission 
statement, stated objectives, and precepts to emphasize that an 
additional goal should be to minimize avoidable complexity.
    Performance Metrics: The FAF should develop performance metrics to 
assess the FASB's adherence to the goals in its mission statement, 
objectives, and precepts. These metrics should track the timeliness and 
effectiveness of the FASB's standards-setting process. Such metrics 
would not have a detrimental impact on the FASB's independence. Rather, 
they would improve accountability in standards-setting.
    Proposed FAF Governance Changes: We support the FAF's governance 
proposals as outlined below, with minor modifications regarding 
composition of the FAF and the FASB, as proposed in section II of this 
chapter, and agenda-setting, as proposed in section IV of this chapter:
    FAF Oversight: The FAF proposes to increase its active oversight of 
the FASB. We support this proposal, but we note that the FAF has not 
described how it intends to implement it. Many of the developed 
proposals and conceptual approaches in this chapter provide input 
regarding how and in what areas to strengthen such oversight.
    FASB Voting: The FAF proposal maintains the FASB's current simple 
majority voting requirement. We support simple majority rather than 
supermajority voting to promote the timeliness of standards-setting.
    Mission and Objectives: The FASB's mission statement, objectives, 
and precepts acknowledge that efficient capital markets rely on 
credible, concise, and understandable financial information. They also 
recognize the importance of the following:
     Improving the usefulness of financial information by 
focusing on relevance, reliability, comparability, and consistency.
     Keeping standards current.
     Considering promptly significant areas of deficiency that 
need improvement.
     Promoting international convergence.
     Improving the understanding of the nature and purpose of 
information in financial reports.
     Being objective in decision-making and promoting 
neutrality of information.
     Weighing carefully the views of constituents.
     Satisfying the cost-benefit constraint.
     Minimizing disruption by providing reasonable effective 
dates and transition provisions.
     Reviewing the effects of past decisions in a timely 
fashion to interpret, amend, or replace standards, when necessary.
     Following an open, orderly process for standards-setting.
    We believe minimizing avoidable complexity should be added to this 
list. Although we do not believe the FASB sets out to issue complex 
standards, amending the mission statement, stated objectives, and 
precepts may promote more explicit consideration of less complex 
accounting alternatives during standards-setting.

IV. Standards-Setting Process Improvements

    The U.S. standards-setting process requires significant due 
process. The FASB's activities are open to public participation and 
observation, and the FASB actively solicits the views of its various 
constituents on accounting issues. We believe the FASB's approach to 
obtaining significant input through its open due process is fitting, 
although there is a difficult trade-off between a transparent due 
process and expediency.
    We believe the FASB's processes need improvement. Critics argue 
that it may take too long for the issuance of new accounting standards 
or interpretive implementation guidance in response to changes in 
business practices or the economic environment. They point to projects 
that have been on the FASB's agenda for years to illustrate that 
fundamental issues are routinely given low priorities. They further 
argue that new standards are not always consistent and may be based on 
several different, or even conflicting, principles. This may be due to 
a number of reasons, including the lack of a completed conceptual 
framework, competing priorities placed on the Board, or the 
evolutionary nature of standards-setting in the U.S.
    Due to its practice of being continually open to constituent input, 
the FASB may receive conflicting advice regarding its agenda. Projects 
are frequently added to the agenda in response to requests from 
constituents, but projects not being actively considered are seldom 
removed. The FASB may be working on projects that could be better 
addressed in other ways, or not at all. In either case, such projects 
divert resources from other important agenda items. Further, even 
though the FASB has a transparent due process, new standards are often 
met with requests for interpretive implementation guidance, 
implementation deferral, or amendment.
    Our proposal below is designed to further enhance the U.S. 
standards-setting process and its timeliness.
    Developed Proposal 2.3: The SEC should encourage the FASB to 
further improve its standards-setting process and timeliness, as 
follows:
     Create a formal Agenda Advisory Group that includes strong 
representation from investors, the SEC, the PCAOB, and other 
constituents, such as preparers or auditors, to make recommendations 
for actively managing U.S. standards-setting priorities.
     Refine procedures for issuing new standards by: (1) 
Implementing investor

[[Page 10914]]

pre-reviews designed to assess perceived benefits to investors, (2) 
enhancing cost-benefit analyses, and (3) requiring improved field 
visits and field tests.
     Improve review processes for new standards by conducting 
post-adoption reviews of every significant new standard, generally 
within one to two years of its effective date, to address interpretive 
questions and reduce the diversity of practice in applying the 
standard, if needed.
     Improve processes to keep existing standards current and 
to reflect changes in the business environment by conducting periodic 
assessments of existing standards.
    Some of our proposed process improvements call for formalizing or 
improving existing processes, or implementing new processes to improve 
standards-setting outputs. Our proposed Agenda Advisory Group would 
help the FASB, the SEC, and other participants in the financial 
reporting community focus efforts on the most meaningful activities and 
centralize constituent input to improve the timeliness of standards-
setting.
    Agenda Advisory Group: The first step in standards-setting is 
agenda-setting. The FASB receives many requests to act on various 
topics from many constituents, including the SEC. The FASB also needs 
to fulfill its obligations under the Memo of Understanding with the 
IASB regarding international convergence. Requests for interpretations 
or amendments divert attention from other critical agenda items. FASB 
agenda decisions often add rather than delete projects. Further, given 
the volume of activity on the FASB agenda, Board and staff 
prioritization conclusions are not always clear to constituents. What 
may result is that projects being addressed may not be responsive to 
widely acknowledged needs, or projects may not have sufficiently-
defined scopes to address these needs in a timely fashion. The FASB has 
a number of existing advisory groups and committees that it consults 
about issues that may affect its agenda and project priorities; 
however, we believe there needs to be increased accountability to the 
FAF on agenda-setting and project priorities.
    An Agenda Advisory Group that includes strong representation from 
investors, the SEC, the FASB, and the PCAOB, as well as other 
interested parties such as preparers and auditors, should be created to 
provide advice on agenda-setting. By identifying emerging issues and 
building consensus about which group is best positioned to deal with 
them (e.g., the FASB, the EITF, or the SEC) and in what form, the 
Agenda Advisory Group would give immediate input about how best to 
prioritize near-term versus long-term priorities. The main goals of 
such a group would be to:
     Help standards-setting become more nimble.
     Assist the FASB is setting an achievable, strategic 
agenda, rather than one that includes projects proposed for many years 
with little progress.
     Recommend when it is appropriate for the SEC or other 
parties to issue interpretive implementation guidance related to 
emerging issues and issues observed by the SEC in its registrant 
reviews.
     Help the FASB maintain the usefulness of its authoritative 
guidance by recommending areas that need to be kept current.
     Shield the FASB from influence by any single group of 
constituents, thereby protecting its independence.
     Inject accountability into agenda-setting for all involved 
parties.
    Our proposal complements the FAF's proposed changes to the FASB's 
agenda-setting process in which the FAF would give the FASB Chairman 
control over the FASB's agenda. We believe instilling more decision-
making authority in the FASB Chairman, combined with a requirement to 
consult with the proposed Agenda Advisory Group, would be a positive 
step toward increasing the FASB's efficiency.
    In creating such an Agenda Advisory Group, the SEC and the FASB 
should consider ways to implement the following objectives:
     Timeliness. The Agenda Advisory Group should be convened 
both on a regular schedule and on short notice telephonically to deal 
with urgent matters, as necessary.
     Accountability. The Agenda Advisory Group should vote on 
certain aspects of the standards-setting agenda and provide that 
information in an advisory capacity to the FASB Chairman, who would 
then make the final agenda decision. Part of the rationale for calling 
a vote would be to increase accountability of the FASB Chairman to the 
FAF regarding agenda-setting effectiveness.
     Active involvement of key groups of investors. Key 
investor groups should be actively involved in agenda-setting to 
maintain an appropriate focus on investor needs.
     Involvement of the SEC. Due to the SEC's oversight 
responsibility for standards-setting, one or more senior 
representatives from the SEC Office of the Chief Accountant (OCA) 
should be on the Agenda Advisory Group, as the SEC typically identifies 
practice issues before the FASB does. In addition, active involvement 
by the SEC will allow coordination of how and by whom guidance should 
be issued, thereby reducing the impetus for the SEC to issue 
interpretive implementation guidance separately from the codified 
version of GAAP (see section VI of this chapter).
     Involvement of the FASB. All Board members should be 
invited as official observers.
     Involvement of the PCAOB. A senior representative from the 
PCAOB should be invited as an official observer, as actions taken by 
the PCAOB significantly impact behavior of participants in the U.S. 
financial reporting community.
     Involvement of others. Constituents otherwise not 
represented should be able to submit agenda requests and track agenda 
decisions, similar to the way in which the EITF functions.
    Formulating and Proposing New Standards: The FASB has an elaborate 
process for formulating and proposing new standards. This process is 
designed to ensure that proposed standards properly address significant 
issues, are consistent with business practices and economics, and have 
benefits that justify accounting changes. It involves staff preparation 
of a draft proposal, publication of the proposal with an opportunity 
for public comment, and approval of the final standard. Throughout the 
process, the FASB consults with and receives input from a diverse group 
of constituents. This process is time consuming, often taking many 
years, and could be made more efficient. The Board's outreach to 
certain constituents sometimes seeks advice only on detailed issues 
rather than the scope of projects and broad matters. Our proposal would 
increase the efficiency and effectiveness of standards-setting by 
obtaining more focused inputs at an earlier stage through investor pre-
reviews, enhanced cost-benefit analyses, and more field visits and 
field testing.
    Investor Pre-Reviews: Although the FASB regularly consults with a 
number of standing investor advisory groups, we believe that there may 
be opportunities to both increase and more effectively manage investor 
involvement, so that interested parties know when and how to engage the 
FASB and its staff to assist in standards-setting. Specifically, the 
FASB should implement a scalable investor pre-review to assess 
perceived investor benefits prior to exposing new standards for public 
comment. The FASB should consider the following attributes when 
designing such a pre-review:

[[Page 10915]]

     Seek detailed comments from a diverse panel of investors 
(e.g., buy-side analysts, sell-side analysts, and rating agencies), all 
of whom should have strong interests in the outcome.
     Ask investors to consider the accounting guidance through 
the eyes of a serious retail investor to determine whether the new 
information provided would be decision-useful (whether it will provide 
better information than what is currently available). This should 
entail an evaluation of the costs and benefits of updating data 
analysis models with the new or improved information, as necessary.
     Revisit or even discontinue standards-setting projects 
based on the feedback received.
    Cost-Benefit Analyses: The FASB evaluates whether the benefits of a 
proposed standard justify its costs prior to exposing it for public 
comment. However, participants in standards-setting have long 
acknowledged that reliable, quantitative cost-benefit calculations are 
seldom feasible, in large part because of the lack of available 
information on the costs and the difficulty in quantifying the 
benefits. Further, the magnitude of the benefits and costs is difficult 
to assess prior to actual implementation of the standard. As a result, 
cost-benefit considerations are often based on anecdotal evidence and 
do not always include useful input from preparers, auditors, investors, 
and regulators. Cost-benefit analyses should be a more rigorous, 
essential part of standards-setting and should be given more weight 
than they are today.
    The FASB is currently considering new initiatives to improve its 
cost-benefit analyses. We support these efforts and, to complement 
them, the FASB should consider the following enhancements to its cost-
benefit procedures:
     Select preparers, auditors, investors, and regulators to 
be involved based on their interest in the standard or interpretive 
implementation guidance being developed. Such participants should be 
involved in the process of assessing costs and benefits, as well as 
performing field visits and field testing, to the extent feasible.
     Expose the entire cost-benefit analysis for public comment 
(rather than a summary or abstract), thereby enhancing the ability of 
interested constituents to comment on the conclusions reached and the 
basis for these conclusions.
     Attempt to better quantify the costs (in addition to 
providing qualitative assessments). If there is concern about the 
accuracy or reliability of the data, frame these concerns in the 
analysis rather than omitting the data. The FASB should request a cost 
estimate and underlying methodology from constituents who claim that 
costs are excessive.
     Use information collected in the investor pre-review to 
supplement the assessment of the benefits.
     Refrain from discussing costs and benefits on a net basis, 
as this sometimes creates opacity around the data underlying such 
conclusions. The analyses of costs and benefits should be prepared 
separately, with an indication of how the Board weighed the evidence in 
its conclusion.
     Add auxiliary information to put the accounting standard 
or interpretive implementation guidance in context (e.g., include an 
expectation of the number of companies to be impacted by the standard, 
their overall market capitalization, or other metrics).
     Improve the documentation of the cost-benefit conclusions 
in new standards so that they may be referred to over time.
     Consider hiring an economist to assist in preparing and 
reviewing cost-benefit analyses.
    Field Visits and Field Testing: Throughout the deliberation 
process, the FASB meets with a number of interested constituents 
regarding proposed standards (referred to as ``field visits''). Once 
the proposed standard is exposed for public comment, the FASB at its 
discretion may conduct field tests, in which the implementation of a 
proposed standard is beta tested so that issues may be identified and 
resolved prior to final issuance of the new standard. However, as a 
practical matter, and because of resource constraints, robust field 
testing has not been part of the process for setting many recent 
standards. As a result, new standards are often met with requests for 
interpretive implementation guidance, implementation deferral, or 
amendment.
    Whenever possible, scalable field visits and field tests should be 
a required part of standards-setting for all significant new standards 
to identify and resolve as many conceptual and implementation issues as 
practicable prior to issuance. These procedures may also identify less 
costly alternative accounting treatments. The rigor required for these 
procedures should be scaled based on the difficulty and length of time 
required to implement and the magnitude of the impact of the standard 
or interpretive implementation guidance. In addition, whenever 
possible, field visits and field testing should occur 
contemporaneously, to improve the focus and efficiency of receiving 
constituent input. Although robust field testing and field visits 
require resources and time, combining these efforts will make efficient 
use of the Board's and its staff's time. Moreover, by researching 
implementation questions prior to issuing a new standard, the FASB 
would reduce the amount of time spent considering possible interpretive 
implementation guidance, implementation deferral, or amendment.
    The FASB also should leverage work already being done by preparers, 
auditors, and investors to assess the costs, benefits, operationality, 
and auditability of proposed standards. Requesting assistance from 
preparers, auditors, and investors, either directly or through task 
forces and resource groups (perhaps on more of a rotational basis than 
is done in practice today), would bring additional subject matter 
expertise and recent business experience to each field visit and field 
test.
    Post-Adoption Reviews of New Standards: We acknowledge that it is 
difficult to identify and address all possible implementation issues in 
a new standard prior to it being issued and adopted. Issues and 
questions are often identified during the initial implementation phase 
as preparers and auditors begin to apply a new standard in practice. 
Preparers, auditors, and others often monitor and take measures to 
reduce diversity in practice when implementing new standards by 
conferring amongst themselves and issuing non-authoritative 
interpretive implementation guidance. During this initial period, 
requests are often made of the FASB and the SEC to provide interpretive 
implementation guidance for new standards.
    In the current financial reporting environment, preparers and 
auditors are sometimes viewed as being penalized for implementing their 
understanding of new accounting standards immediately after adoption. 
This is because any ambiguity or substantial gaps identified in the 
implementation period may lead the regulators to issue interpretive 
implementation guidance that differs from conclusions originally 
reached by the preparers and auditors.
    The FASB should improve existing processes to consistently ensure 
timely consideration of implementation issues for new accounting 
standards. The goal of post-adoption reviews of new standards would be 
to determine if the new standard is accomplishing its intended purpose 
or whether it has unintended consequences that need to be resolved. The 
FASB currently does address questions that arise after new

[[Page 10916]]

standards are issued--it regularly receives input from various 
constituents and periodically revisits some standards. However, the 
process of completing post-adoption reviews should be formalized in 
policy, be more systematic, involve input from a broader range of 
constituents, and be monitored using relevant performance metrics.
    Specifically, the FASB should perform a post-adoption review for 
every significant new standard. The review should be completed no more 
than one to two years after the effective date of the standard, with 
completion sooner if the scale of the new standard is narrow or a large 
number of implementation questions arise. At the end of the review 
period, the FASB should reach a formal conclusion on each new standard 
to determine if interpretive implementation guidance would serve the 
needs of investors by reducing diversity in practice or otherwise 
improving the application of the standard (e.g., by resolving 
ambiguities in the wording or filling-in unintended gaps in the 
standard).
    We believe that, when necessary, interpretive implementation 
guidance for new standards is best given by the FASB using:
     A transparent due process with public comment.
     Appropriate transition guidance and required disclosures 
that will provide investors with useful information regarding possible 
changes in accounting.
     The codified version of GAAP.
    Understandably, some interpretive implementation guidance may be of 
such an urgent nature that a transparent due process would not be 
responsive to the needs of market participants. Therefore, we envision 
that the SEC or other parties, through representation on the Agenda 
Advisory Group, could assist by agreeing to issue interpretive 
implementation guidance in such situations (see section VI of this 
chapter).
    Under our proposal, it is not contemplated that preparers would 
have the flexibility to implement new standards at different times nor 
have the ability to adopt early or late. Following the recent policy 
decision by the FASB precluding early adoption of new standards, our 
proposal contemplates transition guidance for a new standard with a 
stated, required implementation date. Similarly, this proposal is not a 
safe harbor. Violations of GAAP will continue to be dealt with by the 
SEC through the review, comment, restatement, and enforcement 
processes. However, the SEC should give appropriate consideration to 
situations in which there were ambiguities or gaps in the new standards 
that could be subject to more than one reasonable interpretation. For 
example, it may be inappropriate for the SEC to bring an SEC 
enforcement proceeding based on a new accounting standard if, after 
careful analysis and due diligence made in good faith, the registrant 
took a reasonable and supportable view of that standard, which was 
subsequently changed by formal amendment or published interpretation.
    Periodic Assessment of Existing Standards: After a new accounting 
standard has been in place for a reasonable period, more data is likely 
to be available to evaluate its benefits and costs. Further, over time 
economic conditions and business practices may change, such that older 
accounting standards may lose their relevance and effectiveness. Some 
participants in the financial reporting community have commented that 
numerous accounting standards or models need immediate reevaluation. In 
today's economic environment, the accounting for securitizations and 
structured products with off-balance sheet risk are cited as needing 
reevaluation.\44\ The accounting for financial guarantees, convertible 
debt, and derivatives and hedging activities are also frequently cited 
areas for improvement.
---------------------------------------------------------------------------

    \44\ SEC Staff, 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 (June 2005).
---------------------------------------------------------------------------

    The process by which the FASB receives, evaluates, and addresses 
concerns about the usefulness of standards in a timely fashion is 
critical to the proper functioning of the U.S. capital markets. The 
FASB should improve and formalize this process to ensure that standards 
continue to be useful in the current economic and business environment. 
This should be done by formalizing the process of periodically 
requesting feedback from investors, preparers, auditors, and regulators 
regarding what areas of GAAP need reevaluation because they create 
practice problems or are unnecessarily complex. In addition, to 
identify other specific areas of GAAP in need of review, the FASB 
should consider the following:
     Restatement activity.
     Emerging issues and the amount of interpretive 
implementation guidance issued on particular standards.
     Changes in business practices and the economy.
     New cost-benefit information as it becomes available.
    Further, when evaluating the feedback received from constituents 
and the results of its own research, the FASB should seek advice from 
the Agenda Advisory Group to help prioritize its agenda.

V. Interpretive Implementation Guidance

    We believe that there are too many sources of interpretive 
implementation guidance. Historically, this guidance proliferated from 
a variety of sources, which intentionally or not, has been viewed as 
additional GAAP. In other words, interpretive implementation guidance 
that is not formally authoritative often is erroneously perceived by 
participants in the financial reporting and legal communities to be 
quasi-authoritative. The key risks associated with a proliferation of 
interpretive implementation guidance are that: (1) The appropriate rule 
may not be identified and considered, and (2) it may conflict with 
authoritative guidance, as well as with other non-authoritative 
guidance, causing uncertainty in application and legal risk.
    Over the past few years, the FASB and the SEC have taken steps 
intended to reduce the proliferation of interpretive implementation 
guidance from different authoritative bodies. For example, the SEC 
recognized the standards of the FASB as generally-accepted, and the 
FASB limited the ability of other bodies to create authoritative 
guidance without FASB ratification. Nevertheless, the SEC staff 
continues to be a source of interpretive implementation guidance in its 
own right, through such vehicles as comment letters, staff speeches, 
SABs, and other forms of exchange that, although typically non-
authoritative, are perceived as quasi-authoritative. Similarly, actions 
taken by the FASB and the SEC have not sufficiently curbed the creation 
of other non-authoritative interpretive implementation guidance, such 
as that from audit firms, preparer and industry groups, academia, the 
Center for Audit Quality (CAQ), and other regulators.
    Our proposal below, which should be read in conjunction with 
conceptual approach 2.A, is designed to recognize recent 
accomplishments in this area, clarify what guidance is authoritative 
and non-authoritative, and further influence the behaviors that have 
led to the desire for more guidance:
    Developed Proposal 2.4: The number of parties that either formally 
or informally interprets GAAP and the volume of interpretative 
implementation guidance should

[[Page 10917]]

continue to be reduced. The SEC should coordinate with the FASB to 
clarify roles and responsibilities regarding the issuance of 
interpretive implementation guidance, as follows:
     The FASB Codification, a draft of which was released for 
verification on January 16, 2008, should be completed in a timely 
manner. In order to fully realize the benefits of the FASB's 
codification efforts, the SEC should ensure that the literature it 
deems to be authoritative is integrated into the FASB Codification to 
the extent possible, or separately re-codified, as necessary.
     To the extent practical, going forward, there should be a 
single standards-setter for all authoritative accounting standards and 
interpretive implementation guidance that are applicable to a 
particular set of accounting standards, such as GAAP or IFRS. For GAAP, 
the FASB should continue to serve this function. To that end, the SEC 
should only issue broadly applicable interpretive implementation 
guidance in limited situations (see section VI).
     All other sources of interpretive implementation guidance 
should be considered non-authoritative and should not be required to be 
given more credence than any other non-authoritative sources that are 
evaluated using well-reasoned, documented professional judgments made 
in good faith.
    FASB Codification: The FASB has undertaken a significant project to 
develop a comprehensive, integrated Codification of existing accounting 
literature organized by subject matter that is intended to become an 
easily retrievable single source of GAAP. To that end, on January 16, 
2008, the FASB released a draft of the FASB Codification that will be 
subject to a one-year verification period. We applaud the FASB's 
foresight on such a project and recognize the significant effort the 
project has entailed. The FASB Codification:
     Brings together all GAAP from all authoritative sources 
except the SEC and classifies it by topic into a single, searchable 
database so that it may be more easily researched.
     Clarifies what guidance is authoritative versus non-
authoritative.
     Puts accounting standards into a consistent format, to the 
extent possible.
    Although the FASB Codification does not change the substance of 
GAAP, it should make its application easier. However, SEC literature, 
which has developed through different mechanisms, is not as easily 
integrated into the FASB Codification.\45\ Similarly, the FASB 
Codification does not deal with either the root causes of the 
proliferation of interpretive implementation guidance or the behavior 
of participants in the U.S. financial reporting community that caused 
the complexity. Notwithstanding these concerns, we support the FASB's 
efforts to verify the Codification. To further improve the 
Codification, the SEC should re-codify its guidance using a consistent 
format, and the FASB and the SEC should consider a second phase of the 
codification project that would systematically revisit GAAP, as 
discussed in section VI of this chapter.
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    \45\ Two of the benefits of the FASB Codification are its search 
feature and decimal system, which consistently organizes topics and 
subtopics within GAAP. No SEC guidance is currently included in the 
FASB Codification. To improve its usability in the future, the 
Codification will include authoritative content issued by the SEC, 
as well as selected SEC staff interpretations. However, the 
inclusion of SEC guidance will be for administrative convenience and 
will not supersede such guidance in its current form. Further, the 
SEC guidance will not follow the same organizational structure as 
the rest of GAAP.
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    Non-Authoritative Guidance: Although the FASB Codification will 
help clarify the roles of authoritative and non-authoritative guidance, 
meaningful improvements in financial reporting will be difficult if 
non-authoritative interpretive implementation guidance continues to be 
perceived, as it is today, as having quasi-authority in the 
marketplace. Our proposal is intended to foster acceptance of 
reasonable professional judgments made in good faith when they are 
supportable under GAAP. Specifically, non-authoritative interpretive 
implementation guidance should not be used to force restatements when 
other reasonable views exist that are supportable under GAAP.
    We recognize there is often a need for interpretive implementation 
guidance and that such guidance can serve an important purpose. The 
volume of interpretative implementation guidance should be reduced, and 
it should be clearly identified as non-authoritative.

VI. Conceptual Approaches and Future Considerations

    As discussed more fully below, we are considering a number of 
conceptual approaches and matters for future consideration to improve 
standards-setting:
    Conceptual Approach 2.A: To further reduce interpretive 
implementation guidance associated with GAAP, we are considering 
proposing that the SEC further clarify its role vis-[agrave]-vis the 
FASB, as well as its internal roles and responsibilities, to mitigate 
the risk of its actions unintentionally driving behavior by market 
participants, as follows:
     The SEC should clarify that registrant-specific matters 
are not authoritative forms of interpretive implementation guidance 
under GAAP and, accordingly, registrants other than the specific 
registrant in question are not required to take into account such 
registrant-specific matters.
     The SEC staff should refrain from informally communicating 
broadly applicable interpretive implementation guidance (e.g., staff 
speeches) that are likely to be perceived as changing the application 
of GAAP. Rather, such communications should be used to highlight 
authoritative interpretive implementation guidance that has already 
been issued.
     In instances in which the SEC staff identifies registrant-
specific accounting matters that it believes may result in the need for 
broader interpretive implementation guidance or a clarification of an 
accounting standard under GAAP, the SEC staff should refer these items 
to the FASB as part of the Agenda Advisory Group.
     When it is necessary for the SEC or its staff to issue 
broadly applicable interpretive implementation guidance, it should try 
to provide such guidance: (1) In a clear communication identified as 
authoritative, (2) so that it can easily and immediately be integrated 
into a codification of SEC literature (as proposed in section V of this 
chapter), and (3) when expected to significantly change the application 
of GAAP, only after transparent due process and public comment to the 
extent practicable.
     The SEC staff should revisit internal procedures and take 
further steps necessary to improve the consistency of its views on the 
application of GAAP.
    The SEC sometimes issues rules and interpretations that comprise 
part of authoritative GAAP. The SEC's rule-making activities are 
generally open to public participation and observation. However, other 
activities of the SEC and its staff do not occur with the same level of 
transparent due process and public comment. As discussed below, 
registrant-specific guidance is published in the form of comment 
letters, but appropriately does not need to be proposed in advance or 
subject to public comment. On the other hand, to the extent the SEC 
promulgates interpretive implementation guidance that is broadly 
applicable and is expected to significantly change the application of 
GAAP, we are considering whether it should do so only after public 
notice and comment, whenever practicable.

[[Page 10918]]

    Registrant-Specific Guidance: The SEC Division of Corporation 
Finance (Corp Fin) reviews and comments on financial reports filed by 
registrants that are not investment companies. Corp Fin has a process 
for facilitating the public availability of comment letters and 
registrant responses to these comment letters on the SEC's Web site 
upon completion of the review process. Corp Fin also receives letters 
from specific registrants requesting concurrence on various reporting 
and disclosure issues. Similarly, OCA and Corp Fin receive requests 
from specific registrants for concurrence on specific interpretative 
implementation issues. These letters are commonly referred to in the 
marketplace as ``pre-clearance'' letters.
    Preparers and auditors may misconstrue registrant-specific 
accounting outcomes as quasi-authoritative. However, registrant-
specific matters are appropriately not subject to the same public 
deliberation and comment as SEC rule-making, because they are 
registrant-specific and are not intended to be applied more broadly. 
Nevertheless, preparers and auditors may overreact by applying these 
outcomes to similar, yet different, transactions, sometimes believing 
that restatement is required.
    We are deliberating whether the SEC should make clear that comments 
provided to a specific registrant are not binding on other registrants. 
Clarifying that such comments are non-authoritative would help:
     Prevent preparers and auditors from giving undue 
significance to SEC staff comments made to individual registrants.
     Reduce the need for other parties to issue interpretive 
implementation guidance.
     Support our proposal to refer broadly applicable 
accounting matters that require interpretive implementation guidance to 
the FASB.
    Broadly Applicable Guidance: To inform the public about broadly 
applicable interpretive implementation guidance, the SEC uses various 
forms of communication, including SABs,\46\ letters to industry, staff 
speeches, public announcements, and training manuals. In addition, Corp 
Fin publishes and maintains interpretive implementation guidance on the 
SEC's Web site. While all of these publications contain disclaimers as 
to their non-authoritative nature, many participants in the financial 
reporting community consider these disclaimers to be boilerplate and 
regard such interpretive implementation guidance as quasi-
authoritative.
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    \46\ The SEC authorized the use of SABs in 1975 to achieve a 
wider dissemination of the administrative interpretations and 
practices utilized by the SEC staff in reviewing financial 
statements. There had been concern that smaller audit firms and 
issuers would be disadvantaged because there had previously been no 
formal dissemination of staff practices. SABs were also designed to 
provide a means by which new or revised interpretations and 
practices could be quickly and easily communicated to registrants 
and their advisors. As they are designed to disseminate staff 
administration practices on a timely basis to the broader public, 
SABs are generally not exposed for public comment before release.
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    These publications are typically viewed by the SEC staff as 
confirmations of existing accounting standards, rather than as 
supplemental interpretive implementation guidance. However, many of 
these publications have and continue to influence market behavior 
because they sometimes include SEC staff views that do, in fact, 
supplement existing GAAP. The SEC staff sometimes refers registrants to 
these publications to support their views on registrant-specific 
matters. As such, many argue that these documents exemplify the SEC 
staff effectively setting standards without transparent due process and 
public comment and point to restatements sometimes following the 
release of these documents as evidence of their quasi-authoritative 
nature in practice.
    In addition, other individual sources of non-authoritative 
implementation guidance (e.g., audit firms and the CAQ) often publish 
their own guidance to broadly communicate what they perceive to be SEC 
staff's views and to drive consistency in practice. However, as 
discussed below, if the SEC were to increase its formal referral of 
broadly applicable interpretive matters to the FASB, which could issue 
guidance in an authoritative, timely fashion, the overall volume of 
interpretive implementation guidance would be reduced, as would 
conflicts between interpretations from different sources. We believe 
this would further influence behaviors that have led to the desire for 
more guidance.
    We recognize that the SEC staff publishes guidance to address 
issues other than the application of GAAP. This conceptual approach is 
not directed towards such publications. We also recognize that the SEC 
staff, based on its review of thousands of filings each year, is in a 
unique position to publish its comment letters. Such publications are 
intended to reduce comments that each registrant receives in the review 
process by promoting a high degree of compliance with GAAP. We continue 
to consider what proposals to make in this area, but believe that the 
SEC staff should be diligent when preparing this information not to 
present comments in a manner that is likely to be perceived as 
interpretative implementation guidance.
    Referral of Issues to the FASB: As discussed in section IV of this 
chapter, there were a number of standards that were communicated to the 
FASB that were in need of improvement that have yet to be improved. The 
SEC should formalize the mechanism by which it refers issues to the 
FASB, and one of the goals of SEC representation on the proposed Agenda 
Advisory Group would be to strengthen such a referral mechanism. This 
will permit the FASB to address the need for authoritative interpretive 
implementation guidance that is broadly applicable in a codified form, 
thereby reducing the need for the SEC to do so. It will also give the 
SEC greater insight into when the FASB and the EITF do not intend to 
issue interpretive implementation guidance, which will allow the SEC to 
be more responsive by issuing guidance, in the limited circumstances 
when necessary.
    Consistency: We are considering whether there is a need for more 
coordination between the various offices and divisions within the SEC 
to improve the consistency of accounting advice given by the SEC staff. 
Although there are processes in place to build consensus on accounting 
matters within the SEC, there may be room for improvement.
    The possibility of inconsistent accounting advice emanating from 
the SEC staff creates confusion in the marketplace.
    Two processes exist (one in Corp Fin and one in OCA) for 
registrants to request reconsideration of conclusions expressed in 
either comment letters or in pre-clearance letters when registrants 
disagree with staff guidance or believe they are receiving inconsistent 
advice compared to other registrants. However, registrants may not 
always use these processes for a number of reasons, such as: (1) To 
avoid additional delays and missed market opportunities, (2) to avoid 
the risk of opening other accounting conclusions to reconsideration, 
and (3) fear of possible retribution (misguided or not). Therefore, 
although the SEC staff has created checks-and-balances in the form of 
reconsideration processes, they may not be utilized as anticipated.
    We do not intend to limit the ability of the SEC staff to carry out 
its regulatory responsibilities in a timely fashion. That is why we 
have not yet proposed a specific course of action. We understand the 
SEC staff is reviewing its procedures in many of these areas and 
expects to unveil a number of changes in the coming months, including 
new procedures to enhance the consistency

[[Page 10919]]

of registrant-specific accounting interpretations during filing reviews 
and increasing the understanding and usefulness of its reconsideration 
processes. We support these efforts and plan to review progress with 
the SEC staff in the coming months as we continue our deliberations.
    Conceptual Approach 2.B: We are considering proposing that the SEC 
continue to encourage improvement in the way standards are written, as 
follows:
     By supporting the writing of accounting standards 
according to an agreed-upon framework of what constitutes an optimal 
standard. Such standards should not strive to answer every question and 
close every loophole, but should be written with more clearly stated 
objectives and principles that may be applied to broad categories of 
transactions.
     By supporting the writing of accounting standards in a 
manner that promotes trust and confidence in efficient markets by 
encouraging the use of professional judgments made in good faith. 
Specifically, preparers and auditors should apply the standards 
faithfully, and regulators should monitor and address abusive 
application of the standards.
    Optimal Design of Standards: Some participants in the U.S. 
financial reporting community believe that certain accounting standards 
do not clearly articulate the objectives and principles upon which they 
are based, because they are sometimes obscured by detailed rules, 
examples, scope exceptions, safe harbors, cliffs, thresholds, and 
bright lines. In addition, GAAP is often not written in plain English. 
This can create uncertainty in the application of GAAP, as rules cannot 
cover all possibilities and the underlying principles and objectives 
may not be clear.
    Another significant concern about the current system of accounting 
standards is that the proliferation of accounting rules fosters 
accounting-motivated structured transactions. As discussed further in 
chapter 1, standards that have scope exceptions, safe harbors, cliffs, 
thresholds, and bright lines are vulnerable to manipulation by those 
seeking to avoid accounting for the substance of transactions using 
structured transactions that are designed to achieve a particular 
accounting result. This ultimately hurts investors, because it reduces 
comparability and the usefulness of the resulting financial 
information. Therefore, a move toward more objectives-oriented (or 
principles-based) standards may ultimately improve the quality of the 
financial reporting upon which investors rely.
    The question of how to design standards going forward is at the 
center of a decade-long principles-based versus rules-based accounting 
standards debate. There has been much discussion in the marketplace on 
this topic, and there are differing views. The SEC has been a frequent 
participant in the debate and has long been supportive of principles-
based (or objectives-oriented) standards.\47\ The question of how 
standards should be designed going forward is a critical aspect of the 
standards-setting process.
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    \47\ For example, the SEC issued Policy Statement: Reaffirming 
the Status of the FASB as a Designated Private-Sector Standard 
Setter (April 2003), which included numerous recommendations for the 
FAF and FASB to consider, including greater use of principles-based 
accounting standards whenever reasonable to do so. The SEC staff 
also issued Study Pursuant to Section 108(d) of the Sarbanes-Oxley 
Act of 2002 on the Adoption by the United States Financial Reporting 
System of a Principles-Based Accounting System (July 2003), which 
further lauded the benefits of objectives-oriented standards.
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    Rather than engaging in a debate over terms such as ``principles-
based,'' ``objectives-oriented,'' or ``rules-based,'' we prefer to 
think of the design of accounting standards in terms of the 
characteristics they should possess. We are considering various 
suggestions for the optimal design of standards, including the work of 
the CEOs of the World's Six Largest Audit Networks. These CEOs are 
attempting to build consensus in the financial reporting community 
about what optimal accounting standards should look like in the future 
and whether a framework could be created that the standards-setters may 
refer to over time to ensure that these characteristics are optimized.
    Their proposed framework was presented at the Global Public Policy 
Symposium in January 2008, which recommends that optimal accounting 
standards have the following characteristics:
     Faithful presentation of economic reality.
     Responsive to investors' needs for clarity and 
transparency.
     Consistency with a clear conceptual framework.
     Based on an appropriately-defined scope that addresses a 
broad area of accounting.
     Written in clear, concise, and plain language.
     Allows for the use of reasonable judgment.\48\
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    \48\ In his testimony before the U.S. Senate Subcommittee on 
Securities, Insurance and Investment (October 24, 2007), the 
Chairman of the IASB, Sir David Tweedie, noted a similar set of four 
characteristics, two of which augment the aforementioned six, 
including whether they: (1) Can be explained simply in a matter of a 
minute or so, and (2) make intuitive sense.
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    As we continue to deliberate this and other work, we are 
considering supporting the increased use of objectives-oriented 
standards.
    Future Considerations: We also plan to deliberate what optimal 
transition provisions should be in the future and whether new standards 
should be applied prospectively or retrospectively. The goal of such 
deliberations will be to balance the investor need for consistent 
information with preparer and auditor concerns about feasibility and 
the costs of recasting historical information.
    Conceptual Approach 2.C: In addition to considering the other 
proposals in this report (and subject to the conclusions reached in our 
future deliberations of international considerations), we are 
considering proposing that the SEC encourage a re-prioritization of the 
standards-setting agenda that balances the need for international 
convergence, improvements to the conceptual framework, and maintaining 
existing GAAP. Further, we are deliberating whether the FASB and the 
SEC should add to their agendas a second phase of the codification 
project to consider systematically revisiting GAAP to:
     Be more coherent after codification.
     Remove conflicts between standards or with the conceptual 
framework.
     Be less complex, where possible.
     Be designed more optimally as discussed above.
     Readdress frequent practice problems (as identified by 
restatement volumes, input from the SEC, implementation guidance 
issued, or frequently asked questions).
     Remove redundancies between SEC disclosure requirements 
and other sources of GAAP.
     Amend, replace, or remove outdated standards.
    As part of our deliberation of the Agenda Advisory Group proposed 
in section IV of this chapter, we are also deliberating a conceptual 
approach regarding immediate standards-setting priorities in the 
current environment. We plan to finalize a proposal after completing 
deliberations on international considerations later in 2008, which may 
significantly affect our approach. In fact, some participants in the 
U.S. financial reporting community have indicated that a full-scale 
adoption of IFRS in the U.S. may be the most expeditious way to shorten 
the lengthy timeline that would be required to complete such a list of 
priorities.
    Second Phase of Codification: As noted above, the Codification does 
not

[[Page 10920]]

change the substance of GAAP, which continues to be encumbered by 
detailed rules, bright lines, scope exceptions, industry guidance, 
accounting alternatives, and other forms of complexity. Because of the 
evolutionary nature of U.S. standards-setting, the Codification does 
not read consistently in all parts. Further, even after any needed re-
codification of SEC literature proposed in section V of this chapter, 
there will be opportunities to remove redundancies between SEC and FASB 
disclosure requirements and make other simplifications. Therefore, we 
are deliberating whether and when the FASB and the SEC should perform a 
second phase of the codification project, which would involve a 
comprehensive periodic assessment of existing accounting standards like 
the one we proposed previously in this chapter.

Chapter 3: Audit Process and Compliance

I. Introduction

    We have concentrated our efforts to date regarding audit process 
and compliance on the subjects of financial restatements, including the 
potential benefits from providing guidance with respect to the 
materiality \49\ and correction of errors; and professional judgment: 
Specifically, whether a judgment framework would enhance the quality of 
judgments and the willingness of others to respect judgments made.
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    \49\ A fact is material if there is a substantial likelihood 
that a reasonable investor in making an investment decision would 
consider it as having significantly altered the total mix of 
information available. Basic, Inc. v. Levinson, 485 U.S. 224, 231-32 
(1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 
(1976).
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II. Financial Restatements

II.A. Background

Likely Causes of Restatements
    The number of financial restatements \50\ in the U.S. financial 
markets has been increasing significantly over recent years, reaching 
approximately 1,600 companies in 2006.\51\ Restatements generally occur 
because errors that are determined to be material are found in a 
financial statement previously provided to the public. Therefore, the 
increase in restatements appears to be due to an increase in the 
identification of errors that were determined to be material.
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    \50\ For the purposes of this chapter, a restatement is the 
process of revising previously issued financial statements to 
reflect the correction of a material error in those financial 
statements. An amendment is the process of filing a document with 
revised financial statements with the SEC to replace a previously 
filed document. A restatement could occur without an amendment, such 
as when prior periods are revised in a current filing with the SEC.
    \51\ U.S. Government Accountability Office (GAO) study, 
Financial Restatements: Update of Public Company Trends, Market 
Impacts, and Regulatory Enforcement Updates (March 2007), and Audit 
Analytics study, 2006 Financial Restatements A Six Year Comparison 
(February 2007).
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    The increase in restatements has been attributed to various causes. 
These include more rigorous interpretations of accounting and reporting 
standards by preparers, outside auditors, the SEC, and the PCAOB; the 
considerable amount of work done by companies to prepare for and 
improve internal controls in applying the provisions of section 404 of 
the Sarbanes-Oxley Act; and the existence of control weaknesses that 
companies failed to identify or remediate. Some have also asserted that 
the increase in restatements is the result of an overly broad 
application of the concept of materiality and discussions regarding 
materiality in SAB 99, Materiality (as codified in SAB Topic 1M)--that 
is, resulting in errors being deemed to be material when an investor 
may not consider them to be important.
    It is essential that companies, auditors, and regulators strive to 
reduce the frequency and magnitude of errors in financial reporting. 
However, the goal is not to reduce the number of restatements per se. 
Indeed, companies should restate their financial statements to correct 
errors that are important to current investors. Investors need accurate 
and comparable data and restatement is the only means to achieve those 
goals when previously filed financial statements contain material 
errors. Efforts to improve company controls and audit quality in recent 
years should reduce errors, and there is evidence this is currently 
occurring.\52\ We believe that public companies should focus on 
reducing errors in financial statements. At the same time, we believe 
that some of our developed proposals in the areas of substantive 
complexity, as discussed in chapter 1, and the standards-setting 
process, as discussed in chapter 2, will also be helpful in reducing 
some of the frequency of errors in financial statements.
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    \52\ A Glass Lewis & Co. report, Brief Alert Weekly Trend 
(December 17, 2007), shows that restatements in companies subject to 
section 404 of the Sarbanes Oxley Act have declined for two 
consecutive years, although the total number of restatements has 
been increasing.
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    While reducing errors is the primary goal, it is also important to 
reduce the number of unnecessary restatements (i.e., those that do not 
provide important information to current investors). Unnecessary 
restatements can be costly for companies and auditors, may reduce 
confidence in reporting, and may create confusion that reduces the 
efficiency of investor analysis. This portion of this chapter describes 
our proposals regarding: (1) Additional guidance on the concept and 
application regarding materiality, and (2) the process for and 
disclosure of the correction of errors.
Our Research
    We have considered several publicly-available studies on 
restatements.\53\ We are also aware that the Treasury Department has 
recently selected University of Kansas Professor Susan Scholz to 
conduct an examination of the impact of and the reasons for 
restatements of public company financial statements. We will review the 
Treasury Department's study and consider its findings as they are made 
available.
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    \53\ Studies considered include the GAO study, Financial 
Restatements: Update of Public Company Trends, Market Impacts, and 
Regulatory Enforcement Updates (March 2007); Glass Lewis & Co. 
study, The Errors of Their Ways (February 2007); and two Audit 
Analytics studies, 2006 Financial Restatements A Six Year Comparison 
(February 2007) and Financial Restatements and Market Reactions 
(October 2007). We have also considered findings from the PCAOB's 
Office of Research and Analysis's (ORA) working paper, Changes in 
Market Responses to Financial Statement Restatement Announcements in 
the Sarbanes-Oxley Era (October 18, 2007), understanding that ORA's 
findings are still preliminary in nature as the study is still going 
through a peer review process.
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    The restatement studies we have reviewed all indicate that the 
total number of restatements has increased in recent years. Market 
reaction to restatements may be one indicator as to whether 
restatements contain information considered by investors to be 
material. While there are limitations \54\ to using market reaction as 
a proxy for materiality, based on these studies, it would appear to us 
that there may be restatements occurring that investors may not 
consider important due to a lack of a statistically significant market 
reaction. We, therefore, believe additional guidance on determining 
whether an error is material and whether a restatement is necessary 
would be beneficial in reducing the frequency of unnecessary 
restatements.
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    \54\ Examples of the limitations in using market reaction as a 
proxy for materiality include (1) the difficultly of measuring 
market reaction because of the length of time between when the 
market becomes aware of a potential restatement and the ultimate 
resolution of the matter, (2) the impact on the market price of 
factors other than the restatement, and (3) the disclosure at the 
time of the restatement of other information, such as an earnings 
release, that may have an offsetting positive market reaction.
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    We have also considered input from equity and credit analysts and 
others about investors' views on materiality and how restatements are 
viewed in the

[[Page 10921]]

marketplace. Feedback we have received included:
     Bright lines are not really useful in making materiality 
judgments. Both qualitative and quantitative factors should be 
considered in determining if an error is material.
     Companies often provide the market with little financial 
data during the time between a restatement announcement and the final 
resolution of the restatement. Limited information seriously undermines 
the quality of investor analysis, and sometimes triggers potential loan 
default conditions or potential delisting of the company's stock.
     The disclosure provided in connection with restatements is 
not consistently adequate to allow an investor to evaluate the 
likelihood of errors in the future. Notably, disclosures often do not 
provide enough information about the nature and impact of the error, 
and the resulting actions the company is taking.
     Interim periods should be viewed as more than just a 
component of an annual financial statement for purposes of making 
materiality judgments.

II.B. Developed Proposals

    Based on our work to date, we believe that, in attempting to 
eliminate unnecessary restatements, it is helpful to consider two 
sequential questions: (1) Was the error in the financial statement 
material to those financial statements when originally filed? and (2) 
How should a material error in previously issued financial statements 
be corrected? We believe that framing the principles necessary to 
evaluate these questions would be helpful. We also believe that in many 
circumstances investors could benefit from improvements in the nature 
and timeliness of disclosure in the period between identifying an error 
and filing restated financial statements.
    With this context, we have developed the following proposals 
regarding the assessment of the materiality of errors to financial 
statements and the correction of financial statements for errors.\55\
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    \55\ We have developed principles that we believe will be 
helpful in reducing unnecessary restatements. In developing these 
principles, we have not determined if the principles are 
inconsistent with existing GAAP, such as SFAS No. 154, Accounting 
Changes and Error Corrections, or APB Opinion No. 28, Interim 
Financial Reporting. To the extent that the implementation of our 
proposals would require a change to GAAP, the SEC should work with 
the FASB to revise GAAP.
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    Developed Proposal 3.1: The FASB or the SEC, as appropriate, should 
issue guidance reinforcing the following concepts:
     Those who evaluate the materiality of an error should make 
the decision based upon the perspective of a reasonable investor.
     Materiality should be judged based on how an error affects 
the total mix of information available to a reasonable investor.
     Just as qualitative factors may lead to a conclusion that 
a quantitatively small error is material, qualitative factors also may 
lead to a conclusion that a quantitatively large error is not material. 
The evaluation of errors should be on a ``sliding scale.''
    The FASB or the SEC, as appropriate, should also conduct both 
education sessions internally and outreach efforts to financial 
statement preparers and auditors to raise awareness of these issues and 
to promote more consistent application of the concept of materiality.
    We believe that those who judge the materiality of a financial 
statement error should make the decision based upon the interests, and 
the viewpoint, of a reasonable investor and based upon how that error 
impacts the total mix of information available to a reasonable 
investor. One must ``step into the shoes'' of a reasonable investor 
when making these judgments. We believe that too many materiality 
judgments are being made in practice without full consideration of how 
a reasonable investor would evaluate the error. When looking at how an 
error impacts the total mix of information, one must consider all of 
the qualitative factors that would impact the evaluation of the error. 
This is why bright lines or purely quantitative methods are not 
appropriate in determining the materiality of an error to annual 
financial statements. It is possible that an error that results in a 
misclassification on the income statement (without a change in net 
income) may not be deemed to be material, while an error of the same 
magnitude that impacts net income may be deemed material based on the 
effect of the error on the total mix of information available to a 
reasonable investor.
    We believe that, in current practice, materiality guidance such as 
SAB Topic 1M is interpreted as being one-directional in that 
qualitative considerations can make a quantitatively small error 
material, but a quantitatively large error is material without regard 
to qualitative factors. We believe that qualitative factors not only 
can increase, but also can decrease, the importance of an error to the 
reasonable investor. Specifically, we believe that there should be a 
``sliding scale'' for evaluating errors. On this scale, the higher the 
quantitative significance of an error, the stronger the qualitative 
factors must be to result in a judgment that the error is not material. 
Conversely, the lower the quantitative significance of an error, the 
stronger the qualitative factors must be to result in a judgment that 
the error is material.
    The following are examples of some of the qualitative factors that 
could result in a conclusion that a large error is not material. (Note 
that this is not an exhaustive list of factors, nor should this list be 
considered a ``checklist'' whereby the presence of any one of these 
items would make an error not material. Companies and their auditors 
should continue to look at the totality of all factors when making a 
materiality judgment):
     The error impacts metrics that do not drive reasonable 
investor conclusions or are not important to reasonable investor 
models.
     The error is a one time item and does not alter investors' 
perceptions of key trends affecting the company.
     The error does not impact a business segment or other 
portion of the registrant's business that investors regard as driving 
valuation or risks.
     The error relates to financial statement items whose 
measurement is inherently highly imprecise.
    Education and outreach efforts can be instrumental in increasing 
the awareness of these concepts and ensuring more consistent 
application of materiality. Many of the issues with materiality in 
practice are caused by misunderstandings by preparers, auditors and 
regulators. Elimination of these misunderstandings would be a 
significant step toward reducing unnecessary restatements.
    Developed Proposal 3.2: The FASB or the SEC, as appropriate, should 
issue guidance on how to correct an error consistent with the 
principles outlined below:
     Prior period financial statements should only be restated 
for errors that are material to those prior periods.
     The determination of how to correct a material error 
should be based on the needs of current investors. For example, a 
material error that has no relevance to a current investor's assessment 
of the annual financial statements would not require restatement of the 
annual financial statements in which the error occurred, but would need 
to be disclosed in an appropriate document, and, to the extent that the 
error remains uncorrected in the current period, corrected in the 
current period.
     There may be no need for the filing of amendments to 
previously filed

[[Page 10922]]

annual or interim reports to reflect restated financial statements, if 
the next annual or interim period report is being filed in the near 
future and that report will contain all of the relevant information.
     Restatements of interim periods do not necessarily need to 
result in a restatement of an annual period.
     All errors, other than clearly insignificant errors, 
should be corrected no later than in the financial statements of the 
period in which the error is discovered. All material errors should be 
disclosed when they are corrected.
     The current disclosure during the period in which the 
restatement is being prepared, about the need for a restatement and 
about the restatement itself, is not consistently adequate for the 
needs of investors and should be enhanced.
    The current guidance that is detailed in SAB 108 (as codified in 
SAB Topic 1N) may result in the correction of prior annual periods for 
immaterial errors occurring in those periods because the cumulative 
effect of these prior period errors would be material to the current 
annual period, if the prior period errors were corrected in the current 
annual period. In the process of reflecting these immaterial 
corrections to prior annual periods, some believe that the prior annual 
period financial statements should indicate that they have been 
restated. There is diversity in practice on this issue, and 
clarification is needed from the SEC on the intent of SAB Topic 1N. We 
believe that prior annual period financial statements should not be 
restated or corrected for errors that are immaterial to the prior 
annual period. Instead of the approach specified in Topic 1N, we 
believe that, where errors are not material to the prior annual periods 
in which they occurred but would be material if corrected in the 
current annual period, the error could be corrected in the current 
annual period \56\ with appropriate disclosure at the time the current 
annual period financial statements are filed with the SEC.
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    \56\ We are focused on the principle that prior periods should 
not be restated for errors that are not material to those periods. 
Correction in the current period for errors that are not material to 
prior periods could be accomplished through an adjustment to equity 
or to current period income (which might potentially require an 
amendment to GAAP). We believe that there are merits in both 
approaches and that the FASB and the SEC, as appropriate, should 
carefully weigh both approaches before determining the actual 
approach to utilize.
---------------------------------------------------------------------------

    We believe that the determination of how errors should be corrected 
should be based on the needs of current investors. This determination 
should be based on the facts and circumstances of each error. For 
example, an error that does not affect the annual financial statements 
included within a company's most recent filing with the SEC may be 
determined to not be relevant to current investors. For errors that do 
not require restatement but were material in the annual period in which 
they occurred, companies could be required to provide appropriate 
disclosure about the error and the periods impacted.
    For material errors that are discovered within a very short time 
period prior to a company's next regularly scheduled reporting date, it 
may be appropriate in certain instances to report the restatement in 
the next filing with appropriate disclosure of the error and its impact 
on prior periods, instead of amending previous filings with the SEC. 
This option should be further studied with regard to the possibility of 
abuse and, if appropriate, should be included in the overall guidance 
on how to correct errors.
    Assuming that there is an error in an interim period within an 
annual period for which financial statements have previously been filed 
with the SEC, the following guidance should be utilized:
     If the error is not material to either the previously 
issued interim period or to the previously issued annual period, the 
previously issued financial statements should not be restated.
     If the prior period error is determined to be material 
only to the previously issued interim period, but not the previously 
issued annual period, then only the previously issued interim period 
should be restated (i.e., the annual period that is already filed 
should not be restated and the Form 10-K should not be amended). 
However, there should be appropriate disclosure in the company's next 
Form 10-K to explain the discrepancy in the results for the interim 
periods during the previous annual period on an aggregate basis and the 
reported results for that annual period.
    We believe that all errors, excluding clearly insignificant errors, 
should be corrected no later than in the financial statements of the 
annual or interim period in which the error is discovered. That being 
said, there should be a practicality exception for immaterial errors 
discovered shortly before the issuance of the financial statements, but 
in this case, the errors should be corrected in the next annual or 
interim period being reported upon.\57\ Nevertheless, all material 
errors should be disclosed during the period in which they are 
corrected.
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    \57\ We understand that sometimes there may be immaterial 
differences between a preparer's estimate of an amount and the 
independent auditor's estimate of an amount that exist when 
financial statements are issued. These differences might or might 
not be errors, and may require additional work to determine the 
nature and actual amount of the error. This additional work is not 
necessary for the preparer or the auditor to agree to release the 
financial statements. Due care should be taken in developing any 
guidance in this area to provide an exception for these legitimate 
differences of opinion, and to ensure that any requirement to 
correct all ``errors'' would not result in unnecessary work for 
preparers or auditors.
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    Typically, the restatement process involves three primary reporting 
stages:
    1. The initial notification to the SEC and investors that there is 
a material error and that the financial statements previously filed 
with the SEC can no longer be relied upon;
    2. The ``dark period'' or the period between the initial 
notification to the SEC and the time restated financial statements are 
filed with the SEC; and
    3. The filing of restated financial statements with the SEC.
    We believe that a major effect on investors due to restatements is 
the lack of information when companies are silent during stage 2, or 
the ``dark period.'' This silence creates significant uncertainty 
regarding the size and nature of the effects on the company of the 
issues leading to the restatement. This uncertainty often results in 
decreases in the company's stock price. In addition, delays in filing 
restated financial statements may create default conditions in loan 
covenants; these delays may adversely affect the company's liquidity. 
We understand that, in the current legal environment, companies are 
often unwilling to provide disclosure of uncertain information. 
However, we believe that when companies are going through the 
restatement process, they should be encouraged to continue to provide 
any reasonably reliable financial information that they can, 
accompanied by appropriate explanations of ways in which the 
information could be affected by the restatement. Consequently, 
regulators should evaluate the company's disclosures during the ``dark 
period'' taking into account the difficulties of generating reasonably 
reliable information before a restatement is completed.
    We believe that the current disclosure surrounding a restatement is 
often not adequate to allow investors to evaluate the company's 
operations and the likelihood that such errors could occur in the 
future. Specifically, we believe that all companies that have a 
restatement should be required to disclose information related to: (1) 
The nature of the error, (2) the impact of the

[[Page 10923]]

error, and (3) management's response to the error, to the extent known, 
during all three stages of the restatement process. Some suggestions of 
disclosures that would be made by companies include the following:

Nature of Error

     Description of the error.
     Periods affected and under review.
     Material items in each of the financial statements subject 
to the error and pending restatement.
     For each financial statement line item, the amount of the 
error or range of potential error.
     Identity of business units/locations/segments/subsidiaries 
affected.

Impact of Error

     Updated analysis on trends affecting the business if the 
error impacted key trends.
     Loan covenant violations, ability to pay dividends, and 
other effects on liquidity or access to capital resources.
     Other areas, such as loss of material customers or 
suppliers.

Management Response

     Nature of the control weakness that led to the restatement 
and corrective actions, if any, taken by the company to prevent the 
error from occurring in the future.
     Actions taken in response to covenant violations, loss of 
access to capital markets, loss of customers, and other consequences of 
the restatement.
    If there are material developments related to the restatement, 
companies should update this disclosure on a periodic basis during the 
restatement process, particularly when quarterly or annual reports are 
required to be filed, and provide full and complete disclosure within 
the filing with the SEC that includes the restated financial 
statements.
    We believe that the issuance by the FASB or the SEC, as 
appropriate, of guidance on how to correct and disclose errors in 
previously issued financial statements will provide to investors higher 
quality information (e.g., prior periods would not be restated for 
immaterial items and for errors that have no relevance to current 
investors, and more consistently good disclosure would be made during 
and about the restatement process) and reduce the burdens on companies 
related to unnecessary restatements. In addition, since our proposals 
would require that all material errors be disclosed, relevant 
information about such errors would be communicated to investors.
    Developed Proposal 3.3: The FASB or the SEC, as appropriate, should 
develop and issue guidance on applying materiality to errors identified 
in prior interim periods and how to correct these errors. This guidance 
should reflect the following principles:
     Materiality in interim period financial statements must be 
assessed based on the perspective of the reasonable investor.
     When there is a material error in an interim period, the 
guidance on how to correct that error should be consistent with the 
principles outlined in developed proposal 3.2.
    Based on prior restatement studies, approximately one-third of all 
restatements involved only interim periods. Authoritative accounting 
guidance on assessing materiality with respect to interim periods is 
currently limited to paragraph 29 of APB Opinion No. 28, Interim 
Financial Reporting.\58\ Differences in interpretation of this 
paragraph have resulted in variations in practice that have increased 
the complexity of financial reporting. This increased complexity 
impacts preparers and auditors, who struggle with determining how to 
evaluate the materiality of an error to an interim period, and also 
impacts investors, who can be confused by the inconsistency between how 
companies evaluate and report errors. We believe that guidance as to 
how to evaluate errors related to interim periods would be beneficial 
to preparers, auditors and investors.
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    \58\ Paragraph 29 of APB Opinion No. 28, Interim Financial 
Reporting, states the following:
    In determining materiality for the purpose of reporting the 
cumulative effect of an accounting change or correction of an error, 
amounts should be related to the estimated income for the full 
fiscal year and also to the effect on the trend of earnings. Changes 
that are material with respect to an interim period but not material 
with respect to the estimated income for the full fiscal year or to 
the trend of earnings should be separately disclosed in the interim 
period.
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    We have observed that a large part of the dialogue about interim 
materiality has focused on whether an interim period should be viewed 
as a discrete period or an integral part of an annual period. 
Consistent with the view expressed at the outset of this section, we 
believe that the interim materiality dialogue could be greatly 
simplified if that dialogue were refocused to address two sequential 
questions: (1) What principles should be considered in determining the 
materiality of an error in interim period financial statements? and (2) 
How should errors in previously issued interim financial statements be 
corrected? We believe that additional guidance on these questions, 
which are extensions of the basic principles outlined in developed 
proposals 3.1 and 3.2 above, would provide useful guidance in assessing 
and correcting interim period errors. We believe that while these 
principles would assist in developing guidance related to interim 
periods, additional work should also be performed to fully develop 
robust guidance regarding errors identified in interim periods.
    We believe that the determination of whether an interim period 
error is material should be made based on the perspective of a 
reasonable investor, not whether an interim period is a discrete 
period, an integral part of an annual period, or some combination of 
both. An interim period is part of a larger mix of information 
available to a reasonable investor. As one example, a reasonable 
investor would use interim financial statements to assess the 
sustainability of a company's operations and cash flows. In this 
example, if an error in interim financial statements did not impact the 
sustainability of a company's operations and cash flows, the interim 
period error may very well not be material given the total mix of 
information available. Similarly, just as a large error in annual 
financial statements does not determine by itself whether an error is 
material, the size of an error in interim financial statements should 
also not be necessarily determinative as to whether an error in interim 
financial statements is material.
    We believe that applying the principles set forth above would 
reduce restatements by providing a company the ability to correct in 
the current period immaterial errors in previously issued financial 
statements and as a practical matter obviate the need to debate whether 
the interim period is a discrete period, an integral part of an annual 
period, or some combination of both.
    We also note that these principles will provide a mechanism, other 
than restatement, to correct through the current period a particular 
error that has often been at the center of the interim materiality 
debate--a newly discovered error that has accumulated over one or more 
annual or interim periods, but was not material to any of those prior 
periods.

III. Professional Judgment

III.A. Background

Overview
    Professional judgment is not new to the areas of accounting, 
auditing, or securities regulation--the criteria for making and 
evaluating professional judgment have been a topic of discussion for 
many years. The recent increased focus on professional judgment, 
however, comes from several

[[Page 10924]]

different developments, including changes in the regulation of auditors 
and a focus on more ``principles-based'' standards--for example, FASB 
standards on fair value and IASB standards. Investors will benefit from 
more emphasis on ``principles-based'' standards, since ``rules-based'' 
standards (as discussed in chapters 1 and 2) may provide a method, such 
as through exceptions and bright-line tests, to avoid the accounting 
objectives underlying the standards. If properly implemented, 
``principles-based'' standards should improve the information provided 
to investors while reducing the investor's concern about ``financial 
engineering'' by companies using the ``rules'' to avoid accounting for 
the substance of a transaction. While both auditors and issuers appear 
supportive of a move to less prescriptive guidance, they have expressed 
concern regarding the perception that current practice by auditors and 
regulators in evaluating judgments does not provide an environment in 
which such judgments may be generally respected. This, in turn, can 
lead to repeated calls for more rules, so that the standards can be 
comfortably implemented.
    Many regulators also appear to encourage a system in which 
professionals can use their judgment to determine the most appropriate 
accounting and disclosure for a particular transaction. Regulators 
assert that they do respect judgments, but may also express concerns 
that some companies and auditors may attempt to inappropriately defend 
certain errors as ``reasonable judgments.'' Identifying standard 
processes for making professional judgments and criteria for evaluating 
those judgments, after the fact, may provide an environment that 
promotes the use of judgment and encourages consistent evaluation 
practices among regulators.
Goals of a Framework
    The following are several issues that a potential framework may 
help address:
    a. Investors' lack of confidence in the use of judgment--A 
professional judgment framework may provide investors with greater 
comfort that there is an acceptable rigor that companies follow in 
exercising reasonable professional judgment.
    b. Preparers' and auditors' concern regarding whether reasonable 
judgments are respected--In the current environment, preparers and 
auditors may be afraid to exercise judgment for fear of having their 
judgments overruled, after the fact, by auditors, regulators and legal 
claimants.
    c. Lack of agreement in principle on the criteria for evaluating 
judgments--The criteria for evaluating reasonable judgment, including 
the appropriate role of hindsight in the evaluation, may not be clearly 
defined and thus may lead to increased uncertainty.
    d. Concern over increased use of ``principles-based'' standards--
Companies, auditors and investors may be less comfortable in their 
ability to implement more ``principles-based'' standards if there is a 
concern over how reasonable judgments are reached and how they will be 
assessed.
Categories of Judgments That Are Made in Preparing Financial Statements
    There are many categories of accounting and auditing judgments that 
are made in preparing financial statements, and a framework should 
encompass all of these categories, if practicable. Some of the 
categories of accounting judgment are as follows:
1. Selection of Accounting Standard
    In many cases, the selection of the appropriate accounting standard 
under GAAP is not a highly complex judgment (e.g., leases would be 
accounted for using lease accounting standards and pensions would be 
accounted for using pension accounting standards). However, there are 
cases in which the selection of the appropriate accounting standard can 
be highly complex.
    For example, the standards on accounting for derivatives contain a 
definition of a derivative and provide scope exceptions that limit the 
applicability of the standard to certain types of derivatives. To 
evaluate how to account for a contract that has at least some 
characteristics of a derivative, one would first have to determine if 
the contract met the definition of a derivative in the accounting 
standard and then determine if the contract would meet any of the scope 
exceptions that limited the applicability of the standard. Depending on 
the nature and terms of the contract, this could be a complex judgment 
to make, and one on which experienced accounting professionals can have 
legitimate differing, yet acceptable, opinions.
2. Implementation of an Accounting Standard
    After the correct accounting standard is identified, there are 
judgments to be made during its implementation.
    Examples of implementation judgments include determining if a hedge 
is effective, if a lease is an operating or a capital lease, and what 
inputs and methodology should be utilized in a fair value calculation. 
Implementation judgments can be assisted by implementation guidance 
issued by standards-setters, regulators, and other bodies; however, 
this guidance could increase the complexity of selecting the correct 
accounting standard, as demonstrated by the guidance issued on 
accounting for derivatives.
    Further, many accounting standards use wording such as 
``substantially all'' or ``generally.'' The use of such qualifying 
language can increase the amount of judgment required to implement an 
accounting standard. In addition, some standards may have potentially 
conflicting statements.
3. Lack of Applicable Accounting Standards
    There are some transactions that may not readily fit into a 
particular accounting standard. Dealing with these ``gray'' areas of 
GAAP is typically highly complex and requires a great deal of judgment 
and accounting expertise. In particular, many of these judgments use 
analogies from existing standards that require a careful consideration 
of the facts and circumstances involved in the judgment.
4. Financial Statement Presentation
    The appropriate method to present, classify and disclose the 
accounting for a transaction in a financial statement can be highly 
subjective and can require a great deal of judgment.
5. Estimating the Actual Amount to Record
    Even when there is little debate as to which accounting standard to 
apply to a transaction, there can be significant judgments that need to 
be made in estimating the actual amount to record.
    For example, opinions on the appropriate standard to account for 
loan losses or to measure impairments of assets typically do not 
differ. However, the assumptions and methodology used by management to 
actually determine the allowance for loan losses or to determine an 
impairment of an asset can be a highly judgmental area.
6. Evaluating the Sufficiency of Evidence
    Not only must one make a judgment about how to account for a 
transaction, the sufficiency of the evidence used to support the 
conclusion must be evaluated. In practice, this is typically one of the 
most subjective and difficult judgments to make.
    Examples include determining if there is sufficient evidence to 
estimate sales returns or to support the collectability of a loan.

[[Page 10925]]

Levels of Judgment
    There are many levels of judgment that occur related to accounting 
and auditing. Preparers must make initial judgments about uncertain 
accounting issues; the preparer's judgment may then be evaluated or 
challenged by auditors, investors, regulators, legal claimants, and 
even others, such as the media. Similarly, planning and performing an 
audit requires numerous judgments. These judgments are also potentially 
subject to evaluation and challenge by investors, regulators, legal 
claimants and others, especially when, in hindsight, it has become 
clear that the auditor failed to detect material errors in the 
financial statements. Therefore, in developing a potential framework, 
differences in role and perspective between those who make a judgment 
and those who evaluate a judgment should be carefully considered. A 
framework should not make those who evaluate a judgment (auditors, 
regulators, and others) re-perform the judgment according to the 
framework. Instead, a framework should provide guidance to those who 
would evaluate a judgment on factors to consider while making that 
evaluation.
Hindsight
    One appropriate tool used in auditing is hindsight--the ability of 
the auditor to use facts that are available through the completion of 
the audit work to evaluate the sufficiency of management's estimates 
and assumptions based on actual facts that become available after those 
estimates are made.
    For example, auditors will frequently test the accuracy of the 
company's accounts payable balance at period-end by looking at cash 
disbursements made after the period-end. This evidence allows the 
auditor to determine whether the accrual for unpaid expenses at year-
end is adequate.
    However, the use of hindsight to evaluate a judgment where the 
relevant facts were not available at the time of the initial release of 
the financial statements (including interim financial statements) is 
not appropriate. Determining at what point the relevant facts were 
known to management or the auditor, or should have been known,\59\ can 
be difficult, particularly for regulators who are often evaluating 
these circumstances after substantial time has passed. Therefore, the 
use of hindsight should only be used based on the facts reasonably 
available at the time the annual or interim financial statements were 
issued.
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    \59\ We believe that those making a judgment should be expected 
to exercise due care in gathering all of the relevant facts prior to 
making the judgment.
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Form of Framework
    Some have proposed that a ``safe harbor'' be developed that 
protects the exercise of judgment in accordance with a specified 
framework. That approach would seem to provide greater support to 
auditors and preparers than a statement of policy. However, it is 
unclear to us whether a legal or regulatory safe harbor (i.e., an 
effective legal or regulatory defense based on conformity with the 
framework) could be adopted by the SEC or whether it would require 
changes to existing statutes.
    Another approach is for the SEC and the PCAOB to issue policy 
statements that describe a framework for the exercise of professional 
judgment and state that auditors, the SEC or the PCAOB, as applicable, 
would take into account the implementation of the framework in 
evaluating a judgment made by a registrant or an auditor. The SEC has 
utilized similar frameworks in the past with success. Examples of 
previous frameworks by the SEC include the ``Seaboard'' report (October 
23, 2001) on the relationship of cooperation by a company to taking 
action in an enforcement case and the SEC's framework for assessing the 
appropriateness of corporate penalties (January 4, 2006).
    While not an automatic defense of the registrant's or auditor's 
judgment, a framework would provide more support to registrants and 
auditors that the applicable regulator would be likely to accept a 
judgment made if the registrant or the auditor had fully implemented 
the framework. The framework is likely to enhance the quality of 
judgments by providing incentives to follow a rigorous process for 
making accounting and auditing judgments. The increased use of this 
rigorous process should, in turn, provide more comfort to investors 
about the quality of accounting judgments made in connection with 
financial statements.
    It is unclear to us whether, as a matter of regulatory strategy, 
this judgment framework should be implemented through a safe harbor or 
policy statement. We leave to the SEC and its staff the resolution of 
these difficult issues.
The Nature and Limitations of GAAP
    Some have suggested that the standard in a potential professional 
judgment framework for the selection and implementation of GAAP be a 
requirement to reflect the economic substance of a transaction or be a 
standard of selecting the ``high road'' in accounting for a 
transaction. We agree that qualitative standards for GAAP such as these 
would be desirable and we encourage regulators and standards-setters to 
move financial reporting in this direction. However, such standards are 
not always present in financial reporting today and we cannot recommend 
the adoption of such standards in a professional judgment framework 
without anticipating a fundamental long-term revision of GAAP--a change 
that would be beyond our purview and one that would not be doable in 
the near- or intermediate-term.
    For example, there is general agreement that accounting should 
follow the substance and not just the form of a transaction or event. 
Many believe that this fundamental principle should be extended to 
require that all GAAP judgments should reflect economic substance. 
However, reasonable people disagree on what economic substance actually 
is, and many would conclude that significant parts of current GAAP do 
not require and do not purport to measure economic substance (e.g., 
accounting for leases, pensions, certain financial instruments and 
internally developed intangible assets are often cited as examples of 
items reported in accordance with GAAP that would not meet many 
reasonable definitions of economic substance).
    Similarly, some would like financial reporting to be based on the 
``high road''--a requirement to use the most preferable principle in 
all instances. Unfortunately, today a preparer is free to select from a 
variety of acceptable methods allowed by GAAP (e.g., costing inventory, 
measuring depreciation, and electing to apply hedge accounting are just 
some of the many varied methods allowed by GAAP) without any 
qualitative standard required in the selection process. In fact, a 
preferable method is required to be followed only when a change in 
accounting principle is made, and a less preferable alternative is 
fully acceptable absent such a change.
    We believe that adopting a requirement that accounting judgments 
reflect economic substance or the ``high road'' would require a 
revolutionary change not achievable in the foreseeable future. Our 
suggested judgment framework could and, we believe, would enhance 
adherence to GAAP, but it cannot be expected to correct inherent 
weaknesses in the standards to which it would be applied.

[[Page 10926]]

III.B. Developed Proposals

    We have developed the following proposal:
    Developed Proposal 3.4: The SEC should adopt a judgment framework 
for accounting judgments. The PCAOB should also adopt a similar 
framework with respect to auditing judgments. Careful consideration 
should be given in implementing any framework to ensure that the 
framework does not limit the ability of auditors and regulators to ask 
appropriate questions regarding judgments and take actions to require 
correction of unreasonable judgments.
    The proposed framework applicable to accounting-related judgments 
would include the choice and application of accounting principles, as 
well as the estimates and evaluation of evidence related to the 
application of an accounting principle. We believe that a framework 
that is consistent with the principles outlined in this developed 
proposal to cover judgments made by auditors based on the application 
of PCAOB auditing standards would be very important and would be 
beneficial to investors, preparers, and auditors. Therefore, we propose 
that the PCAOB develop a professional judgment framework for the 
application and evaluations of judgments made based on PCAOB auditing 
standards.
    We propose that the framework for accounting judgments be 
consistent with the following concepts:
Framework for Professional Judgment in Accounting
The Concept of Professional Judgment
    Professional judgment, with respect to accounting matters, should 
be the outcome of a process in which a person or persons with the 
appropriate level of knowledge, experience, and objectivity form an 
opinion based on the relevant facts and circumstances within the 
context provided by applicable accounting standards. Professional 
judgments could differ between knowledgeable, experienced, and 
objective persons. Such differences between reasonable professional 
judgments do not, in themselves, suggest that one judgment is wrong and 
the other is correct. Therefore, those who evaluate judgments should 
evaluate the reasonableness of the judgment, and should not base their 
evaluation on whether the judgment is different from the opinion that 
would have been reached by the evaluator.
    This framework would serve as the primary, though not exclusive, 
approach to evaluating the process of making professional judgments. 
While regulators would strongly support the principles of this 
framework, the mere completion of the process outlined in the framework 
in making a judgment would not prevent an auditor and/or regulator from 
asking appropriate questions about the judgment or asking companies to 
correct unreasonable judgments. A judgment framework would not 
eliminate debate, nor should it attempt to do so. Rather, it organizes 
analysis and focuses preparers and others on areas to be addressed 
thereby improving the quality of the judgment and likelihood that 
auditors \60\ and regulators will accept the judgment. Conversely, not 
following the framework would not imply that the judgment is 
unreasonable.
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    \60\ It should be noted that, while auditors should be using the 
framework to evaluate a client's judgments and should respect 
reasonable judgments, they still have a requirement to follow PCAOB 
auditing standards, which would include expressing an opinion 
regarding whether the client's financial statements are fairly 
presented, in all material respects, in accordance with GAAP. 
Therefore, this framework would not require auditors to issue an 
unqualified audit opinion when they disagree with a judgment.
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    This framework reflects the fact that GAAP does not always reflect 
the economic substance of a transaction and that it may be difficult to 
determine how the accounting would meet the needs of investors. In 
addition, this framework would be applicable to accounting matters only 
to the extent that judgments were required in the choice or application 
of accounting principles, in estimating the amount to record, or in 
evaluating the sufficiency of the evidence.
    In applying the components of the framework, it would be expected 
that the amount of documentation, disclosure, input from professional 
experts,\61\ and level of effort in making a professional judgment 
would vary based on the complexity, nature (routine versus non-routine) 
and materiality of a transaction or issue requiring judgment.
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    \61\ In many cases, input from professional experts would 
include consultation with a preparer's independent auditors.
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Components of a Framework
    Critical and Good Faith Thought Process--Professional judgment 
should be based on a critical and reasoned evaluation made in good 
faith, prior to the exercise of the judgment, of an identified issue, 
including the nature and scope of the issue based on:
    1. An analysis of the transaction, including the substance and 
business purpose of the transaction.
    2. The material facts reasonably available at the time that the 
financial statements are issued.
    3. A thorough review and analysis of relevant literature, including 
the relevant underlying principles.
    4. Alternative views or estimates, including pros and cons for 
reasonable alternatives.
    5. The rationale for the choice selected, including reasons for the 
alternative or estimate selected and linkage of the rationale to 
investors' information needs and the judgments of competent external 
parties.
    6. Linkage of the alternative or estimate selected to the substance 
and business purpose of the transaction or issue being evaluated.
    7. Known diversity in practice regarding the alternatives or 
estimates.\62\
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    \62\ If there is not diversity in practice, it would be 
significantly harder to select a different alternative.
---------------------------------------------------------------------------

    8. The consistency of application of alternatives or estimates to 
similar transactions.
    9. The appropriateness and reliability of the assumptions and data 
used.
    The critical thought process should include input from personnel 
with an appropriate level of professional expertise and should include 
a sufficient amount of time and effort to properly consider the 
judgment.
    Material issues or transactions that were analyzed pursuant to the 
application of the framework should be disclosed in accordance with 
existing disclosure requirements. This disclosure should be transparent 
so that the investor understands the transaction and assumptions that 
were critical to the judgment. When evaluating professional judgment, 
auditors, and/or regulators should take into account the disclosure 
relevant to the judgment.
    Documentation--The alternatives considered and the conclusions 
reached should be documented contemporaneously. The lack of 
contemporaneous documentation may not mean that a judgment was 
incorrect, but would complicate an explanation of the nature and 
propriety of a judgment made at the time of the release of the 
financial statements.

IV. Future Considerations

    We intend to examine the area of regulation and compliance for 
issues that create avoidable complexity in financial reporting. Some of 
the areas that we intend to focus on include: (1) The interaction 
between companies and their auditors, the SEC, and the PCAOB, (2) the 
interaction between audit firms and the SEC and PCAOB, and (3) the 
levels of enforcement and regulation of standards in other developed 
markets around the world.

[[Page 10927]]

Chapter 4: Delivering Financial Information

I. Introduction

    We have been evaluating the information needs of investors, methods 
by which financial information is provided to investors, and means to 
improve delivery of financial information to all market constituencies. 
In evaluating the information needs of investors, we have recognized 
that the information needs of different types of investors are not 
always the same. We have agreed that information must be delivered in a 
manner that is efficient, reliable, and cost-effective for each of the 
relevant investor groups and will not significantly increase burdens on 
reporting companies.
    We have determined that we will focus our efforts on financial 
information provided by reporting companies in their periodic and 
current reports under the Securities Exchange Act of 1934 (``Exchange 
Act'') and other ongoing disclosures provided by reporting companies to 
investors and the market.\63\ We believe that we can make some useful 
proposals to enhance ongoing reporting that will enable investors to 
better understand reporting companies.
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    \63\ We have determined that we will not address information 
delivery in registered offerings under the Securities Act of 1933 
for two primary reasons. First, the SEC already has addressed 
information delivery in registered securities offerings when it 
adopted new communication rules in 2005 for registered offerings by 
issuers other than registered investment companies. Second, we view 
information delivery relating to ongoing company reporting by public 
companies as the area needing greater focus.
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    Based on the above, we have analyzed two ways to improve the 
delivery of financial information to investors and the market. These 
are:
     Tagging of financial information (XBRL).
     Improving corporate website use.
    We also intend to look at the following in the future:
     Use of executive summaries as an integral part of Exchange 
Act periodic reports.
     Disclosures of key performance indicators (KPIs) and other 
metrics to enhance business reporting.
     Improved quarterly press release disclosures and timing.
     Continued need for improvements in the management 
discussion and analysis (MD&A) and other public company financial 
disclosures.

II. Tagging of Financial Information (XBRL)

II.A. Background

Description of XBRL
    XBRL is an international information format standard designed to 
help investors and analysts find, understand, and compare financial and 
non-financial information by making this information machine-readable. 
It enables companies to better control how their financial or non-
financial information is presented and disseminated and reduce 
reporting costs by integrating their operating data with their 
financial reporting disclosure. XBRL is a computer language which uses 
standardized XML (eXtensible Markup Language) technology and permits 
the automation of what are now largely manual steps for access, 
validation, analysis, and reporting of disclosure. For example, an 
investor or analyst who wants to compare the sales of all 
pharmaceutical companies will be able to use software applications to 
take the XBRL-tagged information, extract the sales numbers and 
download them directly to a spreadsheet.
    XBRL uses standardized definitions of terms, like a dictionary. The 
standardized terms are then arranged in a logical structure called a 
taxonomy. A GAAP financial statement itself, in that its underlying 
details are summarized in the line items of a balance sheet or income 
statement, is a kind of taxonomy. There are taxonomies for different 
kinds of businesses. For example, the banking industry sector taxonomy 
differs from that of a software industry sector company.
Status of XBRL-Tagged Financial Statements in SEC Reports
    The SEC has adopted a voluntary pilot program for the use of XBRL 
in which participants submit voluntarily supplemental tagged financial 
information using the XBRL format as exhibits to specified EDGAR 
filings.\64\ Voluntary pilot participants may use existing standard 
XBRL taxonomies. Over four dozen companies are participating in the 
pilot program and have agreed to voluntarily submit their annual, 
quarterly and other reports with interactive data for a period of one 
year. The SEC recently expanded the voluntary filing program to include 
mutual funds which will file using a risk and return taxonomy developed 
by the Investment Company Institute.
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    \64\ The SEC's voluntary XBRL rules specify the form, content, 
and format of XBRL submissions, description of XBRL data, timing of 
XBRL submissions, and use of Taxonomies. For example, the rules 
require the tagged data to be described either as ``unaudited'' or, 
for quarterly financial statements, ``unreviewed.''
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    On December 5, 2007, XBRL-US published a draft XBRL U.S. GAAP 
Taxonomy and draft preparer's guide for public testing and comment. The 
XBRL U.S. GAAP Taxonomy includes tags for a company's financial 
statements and notes. Public review currently is scheduled to end April 
5, 2008, and XBRL-US has stated that it anticipates that the final XBRL 
U.S. GAAP Taxonomy and preparer guidance will be issued in spring 2008. 
After the final XBRL U.S. GAAP Taxonomy and preparer guidance is 
issued, the SEC EDGAR system must be modified to accept submissions 
tagged using the XBRL U.S. GAAP Taxonomy.
    The SEC has stated that it will use the initial financial 
statements prepared using the new XBRL U.S. GAAP Taxonomy to help it 
further update its EDGAR system so that it will be able to ``seamlessly 
accept and render the filings.'' We understand that currently, the 
SEC's EDGAR system does not yet accept and render financial statements 
with XBRL tags based on the newly-developed XBRL U.S. GAAP Taxonomy.
    In addition, we understand that the software industry has been 
engaged in developing tagging and rendering (turning the XBRL-tagged 
information into a human readable format) software for XBRL-tagged 
financial statements. Companies generally use two methods to tag their 
financial statements using XBRL. The first method, called a ``bolt-on'' 
approach, involves developing the XBRL reports after the filed 
financial statements are developed--a process known as ``mapping.'' 
Companies also may use XBRL as part of an integrated approach to 
financial reporting. In an integrated approach, companies incorporate 
XBRL into their internal company financial systems which allows 
financial reports to be created from the XBRL-tagged financial systems, 
without first preparing such financial statements in ``human readable 
format.'' XBRL-tagging using a ``bolt-on'' approach may involve 
somewhat more effort than using an integrated approach. Currently, 
there is software that allows companies to XBRL-tag their financial 
statements using the ``bolt-on'' approach.\65\ At this time it is 
unknown how many companies have begun integrating XBRL-tagging into 
their internal financial reporting systems and, therefore, it is not 
clear when a significant number of companies would

[[Page 10928]]

move from a ``bolt-on'' to an integrated approach to XBRL-tagging of 
their financial statements.
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    \65\ Using the ``bolt-on'' method, companies can prepare their 
financial statements (including notes) in a number of formats, such 
as Adobe (pdf), Word, and HTML.
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Time and Costs Involved in XBRL-Tagging
    We understand that while the XBRL U.S. GAAP Taxonomy has a 
significant number of individual tags or elements, it contains all of 
the terms or concepts commonly used in financial statements prepared in 
accordance with GAAP. We understand that reporting companies would use 
only a limited number of tags or elements. For example, one large 
voluntary filer uses approximately 192 tags (it tags its notes as 
blocks rather than at a granular level) to tag its Form 10-Q. We 
understand that there may be the need for customized ``extensions'' if 
the XBRL U.S. GAAP Taxonomy does not include a tag for the particular 
item in the company's financial statements. Because the XBRL U.S. GAAP 
Taxonomy currently out for public comment tracks GAAP, we believe that 
there likely will be less need for customized extension elements. One 
of the purposes of the comment period on the XBRL U.S. GAAP Taxonomy 
and preparer guidance is to identify additional tags or elements that 
should be added to the XBRL U.S. GAAP Taxonomy, reducing the need for 
customized extensions. The draft preparer guidance out for public 
comment also will be evaluated by preparers, investors, and others to 
determine whether it provides adequate guidance for determining when an 
extension should be used by preparers.
    The type of information that is tagged also is relevant to 
understanding XBRL-tagged financial statements. Companies participating 
in the voluntary program have been tagging the face of their financial 
statements using existing taxonomies and software. As to the notes to 
the financial statements, additional effort may be involved. While the 
notes to the financial statements may easily be tagged as a block of 
text, unlike preparation of notes to the financial statements in a 
paper-based format, tagging the individual information in each note 
will involve additional tags and, therefore, more work than block-
tagging the text.
    Certain preparers participating in the SEC's voluntary program have 
indicated that the initial number of hours it took to tag the face of 
their financial statements using existing standard taxonomies (not the 
new XBRL U.S. GAAP Taxonomy) and a ``bolt-on'' approach ranged from 80-
100 hours and that the number of hours dropped significantly for 
subsequent reports (due to the lack of a need to replicate the tagging 
process for most items).\66\ For preparers also tagging the notes to 
their financial statements using a ``block'' tag, the number of hours 
increased slightly. The costs to tag the face of the financial 
statements using standardized software were not significant. Additional 
time and cost was spent by at least one preparer to validate the tags 
that were used. In these cases, there was no auditor involvement in the 
process.
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    \66\ For example, one S&P 500 company participating in the 
voluntary pilot spent 80 hours learning the tagging tool, 
understanding SEC requirements, creating extensions for tags, and 
creating a process for ongoing tagging and future submissions.
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Smaller Public Company Reactions to XBRL-Tagging
    Smaller public company representatives recognize the benefits that 
XBRL offers their companies over the long-term, but are concerned about 
initial implementation costs, which could be alleviated with the 
development of improved tagging and verification software. The 
representatives strongly support a phase-in approach in which such 
smaller public companies would be included at the end, once larger 
public companies had worked through any significant implementation 
issues, including use of company resources involved in tagging and 
verification of XBRL tags.
Potential Benefits of XBRL
    We see a number of potential benefits of XBRL for reporting 
companies and investors of financial and non-financial information. 
First, XBRL-tagging could benefit reporting companies by permitting 
improved communications with analysts and investors. Released corporate 
data could be instantaneously and immediately usable by analysts in 
their models without the need for them to wait for third party 
aggregators or staff to input the data into their own format. There 
would be a reduction in search costs. Further, such reduced search 
costs could potentially increase coverage of companies, especially mid-
size and smaller companies, by sell-side and buy-side analysts, and at 
both major brokerage and independent research firms. XBRL-tagging also 
would likely improve the quality of data \67\ and the ability of a 
company to control the presentation of its financial information. The 
elimination or reduction of the manual input would likely reduce error 
rates in reporting and inputting of corporate data by aggregators.
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    \67\ Although XBRL is frequently called ``interactive data,'' 
the use of the term ``data'' should not be deemed to imply numerical 
data alone. XBRL also is useful for the tagging of narrative 
information.
---------------------------------------------------------------------------

    Second, XBRL has the potential to improve the integration of 
company operating and reporting data. Using XBRL, operating data can be 
accessed in the internal enterprise applications where it is regularly 
stored, and thus will be used for financial reporting purposes without 
the necessity of downloading to paper or manual search. The same 
electronically accessible data can be used for other purposes beyond 
those of financial statements, including tax, industrial filings, 
audit, benchmarking, performance reporting, internal management, and 
sustainability. We believe that the full economic benefits of XBRL will 
most likely come when companies incorporate XBRL into their internal 
reporting, instead of using it as a ``bolt-on'' after their financial 
reports are prepared.
    Finally, XBRL-tagged financial statements can provide a number of 
benefits to investors, including both retail investors and the ``model 
builder/research analyst.'' Investors can benefit from, among other 
things, a reduced cost of locating and inputting data into analytical 
frameworks, elimination of manual input thereby reducing the likelihood 
of input error by an investor or data aggregator, reduced investor 
dependence on proprietary and inconsistent data sources, increased 
likelihood of more investors utilizing primary data sources, and 
reduced cost of and improved company comparisons. The XBRL-tagged 
financial statements should enable investors and experienced analysts 
at research organizations to spend more time analyzing data than data 
gathering.
    We recognize, however, that notwithstanding the potential benefits, 
many company officers may not understand how XBRL works or what 
improvements it could bring to both their financial reporting and their 
costs of reporting. In addition, there currently is limited acceptance 
of XBRL due, in part, to companies needing greater certainty that XBRL 
will be adopted before they will expend the necessary resources to 
understand it and its benefits. Companies may have other concerns about 
potential start-up costs in adopting XBRL, including purchase of 
software and personnel resources for data input and training. Further, 
analysts and software developers generally are unaware or uninformed 
about XBRL.

[[Page 10929]]

Implementation of XBRL-Tagging of Financial Statements
    We believe that the SEC should, over the long-term, require all 
public reporting companies (preparing their financial statements using 
GAAP) to tag the financial statements (including footnotes) they are 
required to file with the SEC as part of their Exchange Act reports 
using XBRL. We believe that an implementation roadmap from the SEC is 
needed to encourage the involved parties to move beyond a wait-and-see 
approach and commit resources toward the necessary development of 
software. That software would tag financial information and enable the 
viewing and reading of the XBRL-tagged information, the use of XBRL-
tagged data by investors such as analysts and investors, and the 
integration of XBRL by companies. We believe that full implementation 
of mandated XBRL-tagged financial statements will require a phase-in 
over a period of time, as discussed below, to enable preparers and 
investors to understand XBRL by preparers and investors, to permit 
successful use of the new XBRL U.S. GAAP Taxonomy, and to enable the 
further development of tagging and rendering software. We believe that 
such a phase-in should be sensitive to the concerns of smaller public 
companies regarding mandated XBRL-tagged financial statements.
    We believe that mandatory implementation of XBRL will involve a 
number of steps leading to the ultimate goal of requiring public 
reporting companies to tag their financial statements using XBRL.
    Full mandatory implementation may not be possible until all the 
following preconditions are met:
     Taxonomy development.
    [cir] Testing of the XBRL U.S. GAAP Taxonomy is completed. The 
testing process for the new XBRL U.S. GAAP Taxonomy, which is to 
determine whether disclosures are complete and relevant in the current 
market environment, is now underway.
    [cir] The final XBRL U.S. GAAP Taxonomy and preparer guide are 
released following public review and comment.
    [cir] Voluntary filers have successfully used the XBRL U.S. GAAP 
Taxonomy and preparer guide for a period of time.

--Status: On December 5, 2007, XBRL published the draft of XBRL U.S. 
GAAP Taxonomy and draft preparer guide for public testing and comment. 
The XBRL U.S. GAAP Taxonomy includes tags for a company's financial 
statements and footnotes. Public review currently is scheduled to end 
April 5, 2008, and it is anticipated that the final XBRL U.S. GAAP 
Taxonomy and preparer guide will be issued in spring 2008.

     Ability of SEC EDGAR to ``seamlessly'' accept XBRL 
submissions using the new XBRL U.S. GAAP Taxonomy and other XBRL-tagged 
data and provide an accurate rendered version of all such tagged 
information.
    [cir] Status: The SEC has stated that it will use the initial 
financial statements prepared using the new XBRL U.S. GAAP Taxonomy to 
help it update EDGAR so that it will be able to ``seamlessly accept and 
render the filings.'' Currently, the SEC's EDGAR system does not accept 
financial statements with XBRL tags based on the newly-developed XBRL 
U.S. GAAP Taxonomy.
    We believe that, to achieve the desired acceptance of XBRL, after 
the XBRL U.S. GAAP Taxonomy precondition is satisfied, on an interim 
basis XBRL-tagged financial statements should be required to be 
implemented on a phase-in basis as follows:
     The largest 500 domestic public reporting companies based 
on unaffiliated market capitalization (public float) should be required 
to furnish to the SEC, as is the case in the voluntary program today, a 
document prepared separately from the reporting companies' financial 
statements that are filed as part of their periodic Exchange Act 
reports. This document would contain the following:
    [cir] XBRL-tagged face of the financial statements.\68\
---------------------------------------------------------------------------

    \68\ To allow this first phase, the SEC EDGAR system must permit 
submissions using the new XBRL U.S. GAAP Taxonomy.
---------------------------------------------------------------------------

    [cir] Block-tagged footnotes to the financial statements.\69\
---------------------------------------------------------------------------

    \69\ We understand that tagging beyond the face of the financial 
statements and block-tagging of footnotes, such as granular tagging 
of footnotes and non-financial data, may require significant effort 
and would involve a significant number of tags.
---------------------------------------------------------------------------

     Domestic large accelerated filers (as defined in SEC 
rules, which would include the initial 500 domestic public reporting 
companies) should be added to the category of companies, beginning one 
year after the start of the first phase, required to furnish XBRL-
tagged financial statements to the SEC.
    We believe that a phase-in would provide businesses, financial 
planners, software developers, and investors with the impetus to move 
forward in building systems based on XBRL. For example, in connection 
with the mandatory implementation of XBRL, we are aware that, if 
tagging were mandated for companies, they may use a ``bolt-on'' 
solution in-house or use a service provider in the early stages before 
moving to a broader integrated interactive data approach. This ``bolt-
on'' approach, for many, could be used as a means to begin to climb the 
learning curve in a cheap, easily managed manner. In this regard, we 
believe that companies should have the capacity to compare XBRL-tagged 
and rendered financial statements to avoid errors and the SEC should 
take steps to assist in that regard. We believe that the SEC should 
encourage or commission the development of free software to compare 
rendered and filed statements.
    During the phase-in period, the SEC and PCAOB should seek input 
from companies, investors, and other market participants as to the 
experience of such persons in preparing and using XBRL-tagged financial 
statements using the XBRL U.S. GAAP Taxonomy, and related costs. The 
SEC should consider conducting or commissioning a study of the rate of 
errors by companies in using the appropriate XBRL tags in comparison to 
the financial statement items, which should be done only after filers 
use the final uniform Taxonomy and preparer guidance to tag their 
financial statements.
    As mentioned above, under the phase-in approach, the XBRL-tagged 
financial statements would still be considered furnished to and not 
filed with the SEC. As part of the mandatory implementation, we believe 
that, as is the case in the voluntary program, the SEC should make 
clear what liability provisions the XBRL-tagged financial statements 
would be subject to under the federal securities laws.
    Finally, at the end of the phase-in period described above, and as 
promptly as practicable after all the preconditions to full 
implementation discussed above are met, the SEC should evaluate the 
results from the phase-in period to determine whether and when to move 
from furnishing to the SEC to the official filing of XBRL-tagged 
financial statements with the SEC by domestic large accelerated filers, 
as well as whether and when to include all other reporting companies, 
as part of a company's Exchange Act periodic reports.

II.B. Developed Proposals

    We would like to make recommendations that increase the certainty 
that XBRL will be a significant part of the reporting landscape so that 
preparers, investors, auditors, software developers and regulators make 
the needed investment in XBRL.
    Based on the above considerations, we have developed the following 
proposal:

[[Page 10930]]

    Developed Proposal 4.1: The SEC should, over the long-term, mandate 
the filing of XBRL-tagged financial statements after the satisfaction 
of certain preconditions relating to: (1) Successful XBRL U.S. GAAP 
Taxonomy testing, (2) capacity of reporting companies to file XBRL-
tagged financial statements using the new XBRL U.S. GAAP Taxonomy on 
the SEC's EDGAR system, and (3) the ability of the EDGAR system to 
provide an accurately rendered version of all such tagged information. 
The SEC should phase-in XBRL-tagged financial statements as follows:
     The largest 500 domestic public reporting companies based 
on unaffiliated market capitalization (public float) should be required 
to furnish to the SEC, as is the case in the voluntary program today, a 
document prepared separately from the reporting companies' financial 
statements that are filed as part of their periodic Exchange Act 
reports. This document would contain the following:
    [cir] XBRL-tagged face of the financial statements.\70\
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    \70\ To allow this first phase, the SEC EDGAR system must permit 
submissions using the new XBRL U.S. GAAP Taxonomy.
---------------------------------------------------------------------------

    [cir] Block-tagged footnotes to the financial statements.\71\
---------------------------------------------------------------------------

    \71\ We understand that tagging beyond the face of the financial 
statements and block-tagging of footnotes, such as granular tagging 
of footnotes and non-financial data, may require significant effort 
and would involve a significant number of tags.
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     Domestic large accelerated filers (as defined in SEC 
rules, which would include the initial 500 domestic public reporting 
companies) should be added to the category of companies, beginning one 
year after the start of the first phase, required to furnish XBRL-
tagged financial statements to the SEC.
     Once the preconditions noted above have been satisfied and 
the second phase-in period has been implemented, the SEC should 
evaluate whether and when to move from furnishing to the SEC to the 
official filing of XBRL-tagged financial statements with the SEC for 
the domestic large accelerated filers, as well as the inclusion of all 
other reporting companies, as part of a company's Exchange Act periodic 
reports.\72\
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    \72\ A dissenting vote on developed proposal 4.1 was cast by 
Peter Wallison.
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II.C. Assurance

    An important issue related to tagging public company financial 
statements using XBRL involves whether assurance should be provided by 
a third party. We understand that among the primary benefits of 
providing independent assurance of XBRL documents is that financial 
statement investors could quickly build confidence in interactive data 
and increase their use of such data. One primary reason for not 
obtaining such independent assurance of XBRL documents is the concern 
that the cost and time incurred to obtain such assurance may 
significantly outweigh the benefits to preparers and investors.
    As to assurance, we understand that questions arise as to whether 
assurance should be provided as to matters such as:
    1. The appropriate use of the proper XBRL U.S. GAAP Taxonomy and 
accurate tagging of financial statements.
    2. The reasonableness of any company extensions to the XBRL U.S. 
GAAP Taxonomy.
    3. The compliance of the XBRL-tagged document (also called the 
``instance document'') with SEC content and format requirements.
    4. The separate performance of validation checks over footings and 
inter-checks (for example, whether inventory is reported more than once 
throughout the document determine if amounts reported are consistent) 
of the XBRL instance document.
    5. Whether the information in the XBRL instance document is the 
same as the information in the official filed financial statements 
(applicable under a ``bolt-on'' state).
    We note that there are ways in which companies may, inadvertently 
or deliberately, create XBRL reports in a manner that will potentially 
mislead investors. Accordingly, one of our members believes that 
independent assurance of XBRL documents prepared by management should 
be provided, as described in items (1) and (5) above (at a minimum), 
provided that such assurance does not result in a significant increase 
in costs. This member noted that accounting knowledge and professional 
judgment would be required in providing that assurance, but believed 
that the assurance process is relatively simple, should not take a 
significant amount of time because many steps can be automated, and, 
therefore, should not be an expensive or time-consuming activity.
    The concept of obtaining assurance on the correct tags and matching 
the XBRL rendered documents to the filed statements is predicated on 
the belief that the incremental monetary and human resource costs to 
provide the assurance will be very small. Reviewing the tags the first 
time will involve significant effort, but subsequent reviews may be 
limited to new or changed tags. Moreover, the costs and benefits of 
assurance reviews may differ depending on whether companies are using 
the ``bolt-on'' rather than the integrated tagging approach. Therefore, 
our other members believe that it is appropriate to study the assurance 
process during the phase-in period to assess the actual costs and 
benefits of assurance that might be provided on the XBRL-tagged 
financial statements.
    The type, timing, and extent of assurance, if any, on a company's 
XBRL-tagged financial statements and other tagged information required 
to be furnished to the SEC should take into account the needs of 
investors, and other market participants, along with the costs to 
reporting companies. Until a group of reporting companies has been 
required to furnish to the SEC XBRL-tagged financial statements and 
notes using the new XBRL U.S. GAAP Taxonomy for a period of time that 
will allow investors and other market participants to evaluate the 
reliability of such XBRL-tagged financial statements and notes, it is 
premature to make concrete suggestions regarding assurance.
    Accordingly, our developed proposal does not include any assurance 
proposal. During the interim phase-in period discussed above, the SEC 
and PCAOB should seek input from companies, investors, and other market 
participants as to the type, timing, and extent of desired or needed 
assurance, if any. This input should include the experience of such 
persons in preparing and using XBRL-tagged financial statements using 
the newly-developed XBRL U.S. GAAP Taxonomy, and related costs. 
Additionally, after public companies are required to tag their 
financial statements using XBRL, whether in accordance with our 
proposals or otherwise, the SEC should consider initiating a voluntary 
pilot program in which companies obtain assurance on their XBRL-tagged 
financial statements (whether using a ``bolt-on'' or integrated 
approach) in order to evaluate fully potential costs and benefits 
associated with such effort.

III. Improved Corporate Web site Use

Background

    We have been examining the integral role that technology and 
corporate Web sites play in informing the markets and investors about 
important corporate information and developments, including Web site 
disclosure presentations that are under development by software 
vendors. A valuable element of many of such Web site presentations is 
that they present the most important general information about a 
company on the opening page,

[[Page 10931]]

with embedded links that enable the reader to drill down to more detail 
by clicking on the links. In this way, viewers can follow a path into, 
and thereby obtain increasingly greater details about the financial 
statements, a company's strategy and products, its management and 
corporate governance, and its many other areas in which investors and 
others may have an interest.
    Improving the use of corporate Web sites can enable shareholders 
and investors to gather information about a company that is at a level 
they believe is satisfactory for their purposes, without requiring them 
to wade through large amounts of written material that may provide a 
level of detail beyond their particular needs.
    Corporate Web sites offer reporting companies a cost-effective, 
efficient method to provide information to investors and the market. 
Encouraging reporting companies to increase their use of their Web 
sites, including developing a tiered approach to deliver such corporate 
information on their Web sites, would benefit investors of all types, 
retail and institutional. Enhanced corporate Web site usage could 
decrease the complexity of information presentation and would enhance 
its accessibility. In addition, through coordination by industry 
participants, uniform best practices on uses of corporate Web sites 
could be developed.
    The SEC has issued a series of interpretive releases and rules 
addressing the use of electronic media to deliver or transmit 
information under the federal securities laws. The SEC issued its last 
comprehensive interpretive release on the use of electronic media, 
including corporate Web sites, in 2000. Since 2000, significant 
technological advances have increased both the market's demand for more 
timely corporate disclosure and the ability of investors to capture, 
process, and disseminate this information. Recognizing this, the SEC 
has adopted a large number of rules that mandate, permit, or require 
disclosure of the use of corporate Web sites to provide important 
corporate information and developments.
    We have been informed, however, that there are continuing concerns 
about the treatment of Web site disclosures under the federal 
securities laws that some have argued may be impeding greater use of 
corporate Web sites. These concerns include liability for information 
presented in a summary format, the treatment of hyperlinked information 
from within or outside a company's Web site, the disclosure of non-GAAP 
measures and required reconciliations to GAAP, and the need for 
clarification of the public availability of information disclosed on a 
reporting company Web site. Consequently, we believe that the SEC 
should issue a new comprehensive interpretive release regarding the use 
of corporate Web sites for disclosures of corporate information. We 
believe that SEC guidance would encourage further creative use of 
corporate Web sites by reporting companies to provide information, 
including Web site disclosure formats following industry developed best 
practice guidelines.

Developed Proposal

    Based on the above, we have developed the following proposal:
    Developed Proposal 4.2: The SEC should issue a new comprehensive 
interpretive release regarding the use of corporate Web sites for 
disclosures of corporate information, which addresses issues such as 
liability for information presented in a summary format, treatment of 
hyperlinked information from within or outside a company's Web site, 
treatment of non-GAAP disclosures and GAAP reconciliations, and 
clarification of the public availability of information disclosed on a 
reporting company's Web site.
    Industry participants should coordinate among themselves to develop 
uniform best practices on uses of corporate Web sites for delivering 
corporate information to investors and the market.

IV. Future Considerations

Use of Executive Summaries in Exchange Act Periodic Reports

    We have been exploring a requirement to include an executive 
summary in reporting company annual and quarterly Exchange Act reports 
(Forms 10-K and 10-Q). We understand that a summary report prepared on 
a stand-alone basis would not necessarily provide investors with 
information they need in a desired format. However, an executive 
summary included in the forepart of an Exchange Act periodic report may 
provide investors with an important roadmap to the company's 
disclosures located in the body of such a report. The executive summary 
in the Exchange Act periodic report would provide summary information, 
in plain English, in a narrative and perhaps tabular format of the most 
important information about a reporting company's business, financial 
condition, and operations. As with the MD&A, the executive summary 
would use a layered approach that would present information in a manner 
that emphasizes the most important information about the reporting 
company and would include cross-references to the location of the 
fuller discussion in the annual report.
    The goal of the executive summary would be to help investors 
fundamentally understand a company's businesses and activities through 
a relatively short, plain English presentation. An executive summary in 
a periodic report may be most useful if it included high-level 
summaries across a broad range of key components of the annual or 
quarterly report, rather than detailed discussion of a limited number 
of variables. The executive summary approach may be an efficient way to 
provide all investors, including retail investors, with a concise 
overview of a company, its business, and its financial condition. For 
the more sophisticated investor, an executive summary may be helpful in 
presenting the company's unique story, which the sophisticated investor 
could consider as it engages in a more detailed analysis of the 
company, its business and financial condition.
    The executive summary in a periodic report should be brief, and it 
might fruitfully build on the overview that the SEC has identified 
should be in the forepart of the MD&A disclosure. The MD&A overview is 
expected to ``include the most important matters on which a company's 
executives focus in evaluating the financial condition and operating 
performance and provide context.'' \73\ The executive summary should 
build on the MD&A overview disclosure and include the following:
---------------------------------------------------------------------------

    \73\ SEC, Commission Guidance Regarding Management's Discussion 
and Analysis of Financial Condition and Results of Operations, 
Securities Act Release No. 33-8350 (December 19, 2003).
---------------------------------------------------------------------------

    1. A summary of a company's current financial statements.
    2. A digest of the company's GAAP and non-GAAP KPIs.
    3. A summary of key aspects of company performance.
    4. A summary of business outlook.
    5. A brief description of the company's business, sales and 
marketing.
    6. Page number references to more detailed information contained in 
the document.
    The executive summary would be required to be included in the 
forepart of a reporting company's annual or quarterly report filed with 
the SEC or, if a reporting company files its annual report on an 
integrated basis (the glossy annual report is provided as a wraparound 
to the filed annual report), the executive summary instead could be

[[Page 10932]]

included in the forepart of the glossy annual report. If the executive 
summary was included in the glossy annual report, it would not be 
considered filed with the SEC.
    We will continue to evaluate the concept of requiring an executive 
summary in a public company's Exchange Act periodic reports such as the 
annual report on Form 10-K and the quarterly report on Form 10-Q.

Disclosures of KPIs and Other Metrics To Enhance Business Reporting

    Enhanced business reporting and KPIs are disclosures about the 
aspects of a company's business that are the source of its value. The 
Enhanced Business Reporting Consortium,\74\ has stated that the value 
drivers for a business ``can be measured numerically through KPIs or 
may be qualitative factors such as business opportunities, risks, 
strategies and plans--all of which permit assessment of the quality, 
sustainability and variability of its cash flows and earnings.'' KPIs 
include supplemental non-GAAP financial reporting disclosures that 
proponents have stated can improve disclosures by public companies. 
KPIs are leading indicators of financial results and intangible assets 
that are not encompassed on a company's balance sheet. Proponents of 
the use of KPIs note that they are important because they inform 
judgments about a company's future cash flows--and form the basis for a 
company's stock price. Managers and boards of directors of companies 
are said to use KPIs to monitor performance of companies and of 
management. Market participants and the SEC have identified KPIs as 
important supplements to GAAP-defined financial measures.
---------------------------------------------------------------------------

    \74\ The Enhanced Business Reporting Consortium was founded by 
the AICPA, Grant Thornton LLP, Microsoft Corporation, and 
PricewaterhouseCoopers in 2005 upon the recommendation of the AICPA 
Special Committee on Enhanced Business Reporting. The EBRC is an 
independent, market-driven non-profit collaboration focused on 
improving the quality, integrity and transparency of information 
used for decision-making in a cost-effective, time efficient manner.
---------------------------------------------------------------------------

    The important issues for us to examine are what types of KPIs 
should be made available, in what format and at what time, and whether 
they are clearly and consistently defined over time. Currently, 
companies are disclosing some company-specific KPIs in their periodic 
reports filed with the SEC or in other public statements. Other people 
in the market are working on developing industry-specific KPIs in order 
to improve comparability of companies on an industry basis. We will 
explore ways to encourage companies to disclose company and industry-
specific KPIs. In addition, we will examine who should develop the 
disclosure standards for defining and measuring KPIs to assure 
consistency among companies and through time, and whether XBRL should 
be extended by industry sector to include KPIs and information on 
intangible assets. Further, we will examine the interplay between the 
use of non-GAAP measures and KPIs. We also will examine ways in which 
consistent KPIs can be developed through industry coordination.

Improved Quarterly Press Release Disclosures and Timing

    The quarterly press release, being the first corporate 
communication about the result of the quarter just ended, is viewed as 
an important corporate communication. This communication often receives 
more attention than the formal Form 10-Q submission which often occurs 
a week or two later.
    We intend to review the earnings press release for its consistency, 
understandability and its timeliness. We will consider the consistent 
provision of income statement, balance sheet and cash flow tables in 
the quarterly release. We also intend to consider the positioning and 
prominence of GAAP and non-GAAP figures, GAAP reconciliation, the 
consistent placement of topics, and clear communication of any changes 
to accounting methods or key assumptions. Ultimately, we view the goal 
for an earnings release as a consistent, reliable communication form 
that all investors can easily navigate.
    In addition, we will evaluate the advisability of requiring the 
issuance of the earnings releases on the same day that the periodic 
report (e.g., Form 10-Q) is filed, in contrast to the current practice 
in which the earnings release often is issued before the periodic 
report is filed. In this regard, we will review a survey of CFA 
Institute members on a similar proposal, as well as the comments 
received by the SEC when this idea was put forth in prior SEC rule 
proposals. We will consider, among other things: (1) The savings in 
time spent cross-referencing two separate but fairly identical reports 
separated by a very short period of time, and (2) the elimination of 
the concern that the two reports may not perfectly match.
    We do not intend to deliberate the potential elimination of the 
issuance of quarterly earnings results. The elimination of quarterly 
reports would deprive investors of important sources of information 
about a company's performance. However, we may discuss public 
projections of next quarter's earnings by company officials, since some 
believe that this practice is an important underlying source of 
reporting complexity and other accounting problems. Moreover, as 
mentioned above, we will focus on efforts to encourage corporate 
reporting of KPIs and other measures of sustainable business progress 
over longer periods.

Continued Need for Improvements in the MD&A and Other Public Company 
Financial Disclosures

    Every public company is required to include a MD&A section in its 
annual and quarterly reports filed with the SEC. The three principal 
objectives of the MD&A are to:
     Provide a narrative explanation of a company's financial 
statements that enables investors to see the company through the eyes 
of management
     Enhance the overall financial disclosure and provide the 
context within which financial information should be analyzed
     Provide information about the quality of, and potential 
variability of, a company's earnings and cash flow so that investors 
can ascertain the likelihood that past performance is indicative of 
future performance.
    The SEC has made clear that the quality of the MD&A in public 
company periodic reports is not as good as it should be. In 2003, the 
SEC concluded, based in part on the Fortune 500 report issued by Corp 
Fin, that additional guidance was useful in the following areas:
     The overall presentation of the MD&A
     The focus and content of the MD&A (including materiality, 
analysis, key performance measures and known material trends and 
uncertainties)
     Disclosure regarding liquidity and capital resources
     Disclosure regarding critical accounting estimates.
    The SEC has stated that the MD&A should not be a recitation of 
financial statements in narrative form or a series of technical 
responses to the MD&A requirements.
    We understand that investors and other market participants believe 
that while there has been some improvement in the MD&A disclosures 
since publication of the SEC's interpretive release in 2003, 
significant improvement is still needed both in terms of additional 
disclosures and elimination of what the SEC termed ``unnecessary detail 
or duplicative or uninformative disclosure that obscures material 
information.''

[[Page 10933]]

    Under the Sarbanes-Oxley Act of 2002, the SEC is generally required 
to review every public company's filings at least every three years. In 
that regard, we believe that through the review process, the SEC will 
gain important insight into whether there has been improvement in the 
MD&A disclosures and the types of ongoing concerns regarding such 
disclosures. We will be evaluating whether the SEC should periodically 
issue a report on common types of comments issued on the MD&A and other 
financial disclosures, similar to the Fortune 500 report, to provide 
additional guidance on improving the MD&A in accordance with the SEC's 
most recent interpretive guidance.\75\
---------------------------------------------------------------------------

    \75\ We note that the SEC's comment letters on a reporting 
company's filings are made publicly available on the SEC Web site 
after completion of the SEC's review of such filings. We also note 
that third parties prepare reports on the MD&A disclosures.
---------------------------------------------------------------------------

Appendices

Index of Appendices
A--Separate Statement of Mr. Wallison
B--Examples of Substantive Complexity
C--Committee Members, Official Observers, and Staff

Appendix A

Separate Statement of Mr. Wallison

Introduction

    In its meeting on January 11, 2008, the Committee endorsed the use 
of XBRL for financial reports with this statement: ``The Committee 
believes that the SEC should eventually require all public companies 
(preparing their financial statements using U.S. GAAP) to tag the 
financial statements (including footnotes) they are required to file 
with the SEC as part of their Exchange Act reports using XBRL. The 
Committee believes such a mandate is necessary in order to encourage 
the commitment of resources toward the necessary software development 
for tagging, viewing and reading of XBRL tagged information * * * 
''.\76\
---------------------------------------------------------------------------

    \76\ Draft report, p. 81
---------------------------------------------------------------------------

    Yet, despite the value the Committee saw in mandating the use of 
XBRL by reporting companies, the Committee adopted an extended phase-in 
that will delay the widespread use of XBRL for financial reporting well 
into the next decade. I dissented from the Committee's vote--and am 
filing this separate statement--because I believe the Committee's 
proposed timetable is (i) based on an erroneous assessment of the 
potential costs of auditor assurance, (ii) applies restrictions on 
reporting that will be harmful to XBRL and to users, and (iii) 
unnecessarily delays the date on which XBRL will be available to 
investors and analysts.
    In the Committee's timetable, the first phase begins with the 500 
largest reporting companies. These companies would be required to 
``file'' their regular audited financial statements, as they do today, 
and at the same time to ``furnish'' a supplement consisting of the XBRL 
tags that were applied to the filed statements (for purposes of this 
memorandum, I will refer to this supplemental XBRL material as the 
``XBRL financial statements''). In the Committee's recommendation, the 
XBRL financial statements would include both the facing financials and 
block-tagged footnotes (block-tagging means that one XBRL tag is 
applied to the entire footnote, instead of applying individual tags to 
each of the individual disclosures within the footnote).
    The first phase would not begin until certain technical 
preconditions have been resolved, the most significant of which is the 
upgrading of the SEC's website to receive XBRL filings. John White, the 
director of the SEC's Division of Corporation Finance, told the 
Committee that he did not think the first phase would begin until the 
fall of 2008. One year after the first phase begins, domestic large 
accelerated filers (perhaps 1500 additional companies) would be 
required to ``file'' their regulator audited financial statements, and 
``furnish'' a set of XBRL financial statements. Some time after the 
second phase has begun, the SEC is to decide ``whether and when to move 
from furnishing to the official filing of XBRL financial statements for 
the domestic large accelerated filers, as well as the inclusion of all 
other reporting companies.''

The Delay

    Assuming that the first phase begins in the fall of this year, it 
seems unlikely that the companies involved will be required to begin 
with their 10-K reports, which for the most part are due to be filed no 
later than March 31, 2009. So in reality, the first phase 500 companies 
will be filing reports and furnishing XBRL financial statements for the 
quarters ended in 2009 and the 10-K due in March 2010. The second phase 
will begin late in 2009 (one year after the beginning of the first 
phase) and will include the financial statements that are due (for most 
companies) in the first three quarters of 2010 and the 10-K due at the 
end of the first quarter of 2011. We are already three years from 
today, and only 2000 or so companies will have been required to prepare 
XBRL financial statements.
    Only after the second phase has begun in late 2009 or early 2010 
will the SEC (in the Committee's recommendation) begin to consider 
whether to require any companies to file (rather than furnish) their 
XBRL-tagged financial statements. Since the second phase companies will 
(in the Committee's recommendation) be permitted to furnish rather than 
file their XBRL financial statements, that must mean they won't be 
required to file their XBRL financial statements until after their 10-
Ks are filed in March 2011. That means no company, large or small, will 
be required to file a 10-K with XBRL financial statements until March 
of 2012. That's four years from now, and quite a generous phase-in, 
considering we are talking about only 2000 or so of the largest and 
most sophisticated companies in the U.S. When the remaining 13,000 
reporting companies will be required to file XBRL financial statements 
under this ``mandatory'' phase-in is anybody's guess.
    The distinction between furnishing and filing is important. Under 
the Securities Exchange Act of 1934, companies are absolutely liable 
for false or misleading material filed with the SEC. However, in the 
case of material that is merely furnished to the SEC, liability only 
attaches if it can be shown that the material was intentionally false 
or misleading. Accordingly, the Committee seems to have adopted the 
idea of furnishing rather than filing XBRL financial statements because 
of its concern about the possible cost of auditor assurance. It seems 
to have reasoned that, if XBRL financial statements were furnished 
rather than filed, the reduced liability would permit companies to 
dispense with auditor assurance entirely, and thus to avoid these 
potential costs. However, as I will discuss below, the concern about 
assurance costs is misplaced and ultimately self-defeating. Not only 
was there no need to require the furnishing of XBRL financial 
statements, but allowing XBRL financial statements to be furnished 
rather than filed will severely impair the value of XBRL for investors 
and analysts and is an important source of what will be an enormous and 
unnecessary delay in the adoption of XBRL in the United States.
Will auditor assurance as to the accuracy of XBRL-tagged financial 
statements be costly?
    As noted above, the Committee's phase-in recommendation, and its 
distinction between filing and furnishing XBRL financial statements, 
were apparently motivated by concern that auditor assurance as to the 
accuracy

[[Page 10934]]

of the XBRL tagging will be costly. Some committee members, without any 
supporting evidence, referred to the process of auditor assurance as 
potentially as costly as Section 404 of Sarbanes-Oxley--erroneous 
statements that were picked up in some media reports of the meeting. 
However, as I will discuss below, concerns about the cost of assurance 
are unfounded and should not have been a factor in the Committee's 
deliberations.
    Today, most companies that tag their financial statements use the 
so-called bolt-on method. It is the simplest, although not potentially 
the least costly, approach to tagging financial statements. In the 
bolt-on method, financial statements are prepared and audited in the 
usual way. When the audit is completed, the financial statements are 
``mapped'' to the XBRL taxonomy. This means simply that the various 
items in the company's financial statement are tagged with the 
appropriate XBRL tag. The tagging can be done largely automatically, 
with existing software that reads the financial statement and applies 
the appropriate tag, or manually through a drag and drop method that 
also uses available open source (zero cost) software.
    Once the items in the financial statements have been tagged, the 
question arises whether the tags have been correctly selected and 
applied. It is at this point that the question of assurance becomes 
significant. It is also important to note that there is no relationship 
between the audit of the financial statements and the assurance process 
on the application of the XBRL tags we are discussing here. The audit 
of the financial statements has been completed when the bolt-on process 
begins. The assurance process for the XBRL tags does not make the audit 
in any way more complicated or costly. The only remaining question is 
whether the tagging, after the audit, has been done properly. For 
purposes of this memorandum, the key question is what it would cost for 
the company's auditor, having completed the audit, to determine that 
the company properly applied the XBRL tags after the audit's 
completion.
    There are only three significant questions that must be answered 
for the auditors to assure themselves--and to provide assurance to 
others--as to the accuracy of the tagging:
     Did the company choose the correct XBRL taxonomy (there 
are several different XBRL taxonomies, because the financial statements 
of banks, for example, are different from the financial statements of 
operating companies);
     Did the company properly tag each disclosure in its 
financial statements? (For example, is the ``revenue'' item in the 
financial statements properly mapped to the correct ``revenue'' tag in 
XBRL?)
     Did the company add extensions to the tags that were not 
appropriate in light of the company's business? (Adding extensions to 
the tags already included in the XBRL taxonomy, although permissible, 
could make it difficult to compare one company's financial statements 
with another's.) \77\
---------------------------------------------------------------------------

    \77\ In the brief discussion at the Committee meeting on January 
11, one member suggested that more financial information was 
included in XBRL material associated with a financial statement than 
in the financial statement itself. This is not correct. XBRL does 
not contain any more financial data than the company chooses to 
disclose in its financial statements.
---------------------------------------------------------------------------

    To put this in some perspective, one S&P 50 technology company told 
Subcommittee 4 that its 10 Q report, including the financial 
statements, block-tagged footnotes, and the MD&A, required only 192 
tags. So the assurance process, had it been done for that company by 
its auditors, would have required that the auditors answer the three 
questions above for only 192 tags. In the end, the company performed 
its own assurance, which required only 10 hours of work by one lower 
level accountant.
    Despite the seeming simplicity of the three principal questions, 
and the relatively small number of tags likely to be involved, is it 
possible that auditors would have to go through complex steps in order 
to provide assurance as to the tagging? The answer is no. There is a 
simple way for assurance to be done, and no reason why a company's 
auditors would not follow it.
    Today, most companies prepare their financial statements in Excel, 
Word, or some other desktop publishing software; those companies that 
are furnishing or will furnish XBRL financial statements will use the 
bolt-on method to add the XBRL tags. Once the tagging has been 
completed, all these desktop publishing applications can be used to 
print out a set of financial statements, and when printed out these 
statements should be an exact replica of the audited human-readable 
statements. The two financial statements can then be compared either 
manually, through a visual comparison, or through an automated 
comparative analysis. If they match, the XBRL tagging must have been 
accurate--otherwise the XBRL financial statements could not produce an 
exact replica of the audited human-readable statements. If there are 
discrepancies, errors in the tagging will be immediately apparent.
    Any suggestion that this simple process will or could involve costs 
remotely like section 404 of Sarbanes-Oxley is thus completely 
fanciful. A better description of the costs involved in auditor 
assurance would be one word: trivial.
Is assurance by auditors necessary?
    Certainly. There are two reasons. First, without a third-party 
review, companies will get careless in the rush to complete their XBRL 
financial reports and file with the SEC. No matter how simple the 
tagging process, mistakes will be made. Mistakes are especially likely 
if the tagged financial statements are furnished rather than filed. In 
that case, companies will believe that they don't have to be 
particularly careful with the mapping to the XBRL taxonomy, since there 
will be little likelihood of liability for mere negligence. If, as some 
have suggested, the SEC will offer some kind of safe harbor for XBRL-
tagged financials that are furnished rather than filed, this problem 
will be compounded; companies will have little incentive to take the 
time to get the tagging right, and many incentives to get the tagging 
wrong if they are hoping to avoid unfavorable comparisons with their 
peers. Under these circumstances, errors in the tagging--and incorrect 
information in the XBRL financial statements--will not be an infrequent 
occurrence; the result will be to raise questions about the value and 
usefulness of XBRL. In this way, a potentially valuable resource for 
investors, which could have been introduced without flaws, will be 
damaged and diminished. And all this because of an unfounded fear that 
auditor assurance will be costly.
    Second, and perhaps even more important, in the absence of any 
consistent rules for tagging, imposed either by regulation or reporting 
standards and monitored by auditors, many companies may add extensions 
to their tags that will make it difficult or impossible to compare 
their financial results from period to period or with others in their 
industry. The XBRL taxonomy is a set of standardized categories for 
typical financial reports. The designers have made efforts to include 
all the tags that would be necessary to achieve some degree of 
comparability between companies in the same business. However, 
companies, on their own, can add extensions to the standard tags in the 
XBRL taxonomy. In some cases, these extensions may more accurately 
describe a company's specific unique disclosures (e.g., business

[[Page 10935]]

segments), but they can also make comparability more difficult.
    In the development of XBRL, it was assumed that the tagging process 
would be reviewed by the company's auditors--not only to assure that 
the tagging was done properly, but also to impose some period-to-period 
consistency on the process by which companies choose their tags or add 
extensions to the standard tags in the XBRL taxonomy. The Committee's 
proposal to allow XBRL financial statements to be furnished without 
assurance will invite a chaotic outcome, in which it will be possible 
for companies to add unnecessary or inappropriate extensions to the 
XBRL tags. This will impair comparability, one of the principal 
purposes of XBRL, and substantially reduce XBRL's value to investors 
and analysts.
Is the furnished vs filed distinction sustainable?
    No. The Committee's draft report conceives of the audited human-
readable financial statements and the XBRL financial statements as two 
separate documents. This is certainly true as the bolt-on method is 
used today. The result is two documents, with the XBRL materials 
furnished, while the human readable (audited) financial statements are 
filed. However, if companies follow the Committee's suggestion, they 
will have to forego the use of a major advance in the formatting of 
filed documents that will be available to companies around the world in 
only a few months. This new document format is known as Microformat, 
and should be available by this coming May. When it is available, it 
will be usable through the bolt-on method as well as other more 
efficient and less costly approaches. The technical specifications that 
will make the Microformat standard possible will be published soon by 
XBRL International--the umbrella group for the development and 
worldwide promulgation of XBRL--and this will enable software 
manufacturers to prepare updated plug-ins, so that existing report-
writer and desktop publishing applications will be able to create 
Microformat documents. Using the XBRL Microformat standard, it will be 
possible to both print out a human-readable financial statement, and 
download an XBRL financial statement into a model, from a single XBRL 
Microformat document.
    In this case, of course, there can't be a separate filing of the 
XBRL and human-readable financial statements; nor can the human 
readable portion be filed while the XBRL portion is furnished; they 
will both be included in the same document and rely on the same data. 
If that data contains an error, both the human readable portion and the 
XBRL disclosures will reflect that error, because both are derived from 
the same underlying information. In other words, it will make no sense 
to apply different liability standards to the human-readable document 
and to the XBRL tagged disclosures, because both the human-readable 
audited financial statement and the XBRL financial statement will come 
out of the same data source.
    Under these circumstances, one of two things will happen: either 
the Committee's distinction between furnishing and filing will be 
ignored by companies that decide to use the Microformat document, or--
more likely--the distinction between filing and furnishing that the 
Committee (and perhaps the SEC) has offered will induce U.S. companies 
to forego the Microformat option and continue to use older and less 
efficient technology for their financial reporting. Accordingly, the 
Committee's hope that a mandatory timetable for filing financial 
statements in XBRL format will bring about the adoption of new 
technology will have been thwarted by the Committee's own (unnecessary) 
requirements. In addition, the huge efficiency benefits that would come 
from the creation of a single Microformat document, which can produce 
both a human-readable statement and be downloaded into a model, will be 
lost.

Conclusion

    Auditor assurance as to the accuracy of tagging is a simple 
process, and cannot under any imaginable circumstances be costly for 
companies--large or small--that are required to file XBRL financial 
statements. There are many ways that assurance can be accomplished 
through efficient automatic means, but one way that even non-technical 
people can understand is that the XBRL financial statements can be used 
to print out a set of human-readable financial statements, which can 
then be compared visually with the audited statements. If they match, 
the tagging must have been done correctly. Accordingly, there is no 
need to distinguish between furnishing and filing XBRL financial 
statements, and no need for more than a limited SEC inquiry to confirm 
that the costs are trivial. After that, the SEC can determine how and 
at what pace it should require companies to file their financial 
statements in XBRL format.
    In my view, therefore, the Committee should eliminate both the 
distinction between filing and furnishing XBRL financial statements, 
and the entire phase-in plan contained in its draft report of January 
11. Instead, it should--for the reasons stated in the January 11 
draft--endorse a requirement that all companies file their financial 
statements in XBRL Microformat, and leave it to the SEC to determine on 
what timetable this should occur.

Appendix B

Examples of Substantive Complexity

1. Industry-Specific Guidance

    1. Below is a list of examples of industry-specific guidance in 
GAAP. Note that this list does not reflect all industry-specific 
guidance or all industries subject to its own guidance.

------------------------------------------------------------------------
           Industry                             Sources
------------------------------------------------------------------------
Broadcasting Industry........  SFAS No. 63, 139; EITF 87-10; SOP 00-2.
Banking and Thrift Industries  APB Opinion 23; SFAS No. 72, 91, 104,
                                109, 114, 115, 147; Technical Bulletin
                                85-1; FSP 85-24-1; SOPs 90-3, 03-3;
                                EITFs 97-3, 93-1, 92-5, 89-3, 88-25, 88-
                                19, 87-22, 86-21, 85-44, 85-42, 85-41,
                                85-31, 85-24, 85-8, 84-20, 84-9, 84-4, D-
                                Topics D-78, D-57, D-47, D-39, SEC
                                Regulation S-X--Article 9, SEC Industry
                                Guide; AICPA Auditing and Accounting
                                Guide.
Cable Television Industry....  SFAS No. 51.
Computer Software to be Sold,  SFAS No. 2, 86.
 Leased, or Otherwise
 Marketed.
Contractor Accounting:         ARB 43, Chapter 11, ARB 45, SFAS No. 111;
 Construction-Type Contracts    SOP 81-1.
 & Government Contracts.
Development Stage Enterprises  Opinion 18; SFAS No. 7, 95, 154;
                                Interpretation 7; SOP 98-5; AICPA
                                Auditing and Accounting Guides.
Finance Companies............  SFAS No. 91, 111, 115; SOP 01-6; AICPA
                                Auditing and Accounting Guide.

[[Page 10936]]


Franchising: Accounting by     SFAS No. 45, 141.
 Franchisors.
Insurance Industry...........  SFAS No. 5, 60, 91, 97, 109, 113, 114,
                                115, 120, 124, 133, 135, 140, 144, 149,
                                156; Interpretation 40; FSP FAS 97-1;
                                AICPA Auditing and Accounting Guides;
                                EITFs 99-4, 93-6, 92-9; D-Topics D-54, D-
                                35. D-34, SEC Regulation S-X--Article 7,
                                SEC Industry guide.
Investment Companies.........  SFAS No. 102; FSP AAG INV-1; SOPs 94-4-1,
                                93-1, 93-4, 95-2, 00-3, 01-1; AICPA
                                Auditing and Accounting Guide; D-Topics
                                D-76 D-74, D-11, SEC Regulation S-X--
                                Article 6.
Mortgage Banking Activities..  SFAS No. 65, 91, 114, 115, 124, 125, 133,
                                134, 140, 149, 156; Technical Bulletin
                                87-3; SOP 97-1, 03-3; EITF 95-5, 90-21,
                                87-34, 85-13, 84-19, D-Topics D-10, D-4,
                                D-2.
Motion Picture Industry......  SFAS No. 139, SOP 00-2.
Oil and Gas Producing          SFAS No. 19, 25, 69, 95, 109, 131, 143,
 Activities.                    144, 145, 153; Interpretation 33, 36,
                                FSP FAS 19-1, 141/142-1, 142-2; AICPA
                                Auditing and Accounting Guide; SEC
                                Industry Guide, SEC Reg S-X Rule 4-10,
                                SAB Topic 12, FRR Section 406; EITFs 04-
                                6, 04-4, 04-3, 04-2, 90-22.
Pension Funds: Accounting and  SFAS No. 35, 75, 102, 110, 135, 149; SOPs
 Reporting by Defined Benefit   92-6, 94-4, 94-6, 95-1, 99-2, 99-3, 01-
 Pension Plans.                 2.
Real Estate: Sales &           SFAS No. 13, 34, 66, 67, 91, 98, 114,
 Accounting for Costs and       140, 144, 152; Interpretation 43; SOPs
 Initial Rental Operations of   75-2, 78-9, 92-1, 97-1, 04-2; AICPA
 Real Estate Projects.          Auditing and Accounting Guide; EITF 06-
                                8, 05-3, 98-8, 97-11, 95-7, 95-6, 94-2,
                                94-1, 91-10, 91-2, 90-20, 89-14, 88-24,
                                88-12, 87-9, 86-7, 86-6, 85-27, 84-17,
                                SEC Regulation S-X--Rule 3-14, SEC SAB
                                Topic 5N, 5W.
Record and Music Industry....  SFAS No. 50.
Regulated Operations.........  SFAS No. 71, 87, 90, 92, 98, 101, 106,
                                109, 135, 142, 144, Interpretation 40;
                                Technical Bulletin 87-2; EITFs 97-4, 92-
                                7; D Topics D-21, D-5; SAB Topic 10.
Title Plant..................  SFAS No. 61, 144.
------------------------------------------------------------------------

    2. Industry-specific exceptions in GAAP, such as the scope 
exception for registered investment companies and life insurance 
entities in FIN 46R, Consolidation of Variable Interest Entities and 
for U.S. savings and loan associations, other ``qualified'' thrift 
lenders, and stock life insurance companies in SFAS No. 109, Accounting 
for Income Taxes.
    3. Industry practice such as accounting for certain types of 
inventory at fair value.

2. Alternative Accounting Policies

    Examples of alternative accounting policies are as follows:
     SFAS No. 87, Employer's Accounting for Pensions and SFAS 
No. 106, Employers' Accounting for Postretirement Benefits Other Than 
Pensions, which permits alternatives for amortizing delayed recognition 
amounts and for measuring return on plan assets.
     SFAS No. 95, Statement of Cash Flows, which permits 
alternative presentations of the form and content of the statement.
     SFAS No. 115, Accounting for Certain Investments in Debt 
and Equity Securities (specifically Q&A 35 of the SFAS 115 
Implementation Guide), which indicates that companies are not precluded 
from classifying securities as trading, even if they have no intention 
of selling them in the near-term.
     SFAS No. 130, Reporting Comprehensive Income, permits a 
choice in presenting comprehensive income. An entity may present other 
comprehensive income below the total for net income in a single 
statement, in a separate statement that begins with net income, or in a 
statement of changes in equity.
     SFAS No. 133, Accounting for Derivative Instruments and 
Hedging Activities, which permits, but does not require, the use of 
hedge accounting, which, in certain circumstances, may mitigate 
earnings volatility from marking derivative instruments to market.
     SFAS No. 159, The Fair Value Option for Financial Assets 
and Financial Liabilities, which permits, but does not require, the 
measurement of certain financial assets and financial liabilities at 
fair value.
     EITF 88-1, Determination of Vested Benefit Obligation for 
a Defined Benefit Plan, which permits vested benefit obligations to be 
determined as the actuarial present value of the vested benefits to 
which the employee is entitled if the employee separates immediately or 
the actuarial present value of the vested benefits to which the 
employee is currently entitled but based on the employee's expected 
date of separation or retirement.
     EITF 06-3, How Taxes Collected from Customers and Remitted 
to Governmental Authorities Should Be Presented in the Income Statement 
(That Is, Gross Versus Net Presentation), which permits that certain 
taxes, such as sales, use, and value added taxes, may be presented 
either on a gross or net basis.
     EITF Topic D-98, Classification and Measurement of 
Redeemable Securities, which permits a choice of methods of accreting 
to the redemption value.
     FIN 48, Accounting for Uncertainty in Income Taxes, which 
permits an entity to classify interest and penalties as either interest 
or taxes.
     FSP AUG AIR-1, Accounting for Planned Major Maintenance 
Activities, which prohibits the accrue in advance method, but allows 
for continued use of one of three other alternatives: direct expense, 
built-in overhaul, or deferral methods.
     Oil & gas accounting: The two accounting methods followed 
by oil and gas producers are the successful efforts method and the full 
cost method. Successful efforts accounting essentially provides for 
capitalizing only those costs directly related to proved properties; 
the costs associated with exploratory dry holes are expensed as 
incurred. Full cost accounting generally provides for capitalizing 
(within a cost center) all costs incurred in exploring for, acquiring, 
and developing oil and gas reserves-regardless of whether or not the 
results of specific costs are successful.
     SAB Topic 5H, Accounting for Sales of Stock by a 
Subsidiary, which permits gains/losses on sales of stock by a 
subsidiary to be recognized in income or equity.

[[Page 10937]]

3. Bright Lines

    Examples of bright lines, rules of thumb, and pass/fail models 
include the following:
A. Bright Lines
     Lease Accounting
    Current lease accounting is based on a principle: when a lease 
transfers substantially all of the benefits and risks of ownership of 
the property, it should be accounted for as an asset and a 
corresponding liability by the lessee and the asset is derecognized by 
the lessor (capital lease); otherwise, rental expense is recognized as 
amounts become payable (operating lease). However, to apply this 
principle, SFAS No. 13, Accounting for Leases, provides the following 
bright lines for classifying leases as capital or operating. Meeting 
any one of these criteria results in capital lease treatment.
    [cir] The lease transfers ownership of the property to the lessee 
by the end of the lease term.
    [cir] The lease contains a bargain purchase option.
    [cir] The lease term is equal to 75 percent or more of the 
estimated economic life of the leased property.
    [cir] The present value at the beginning of the lease term of the 
minimum lease payments, excluding certain items, equals or exceeds 90 
percent of the excess of the fair value of the leased property.
     Consolidation
    For those entities that are not subject to the FIN 46R model, ``the 
usual condition for a controlling financial interest is ownership of a 
majority voting interest, and therefore, as a general rule, ownership 
by one company * * * of over 50% of the outstanding voting shares of 
another company is a condition pointing toward consolidation.'' \78\ 
Further, there is a presumption that an investment of 20%-50% requires 
equity method accounting. In addition, the equity method is required 
for investments in limited partnerships unless the interest ``is so 
minor that the limited partner may have virtually no influence over 
partnership operating and financial policies'' (SoP 78-9, Accounting 
for Investments in Real Estate Ventures). In this case, practice has 
used a 3%-5% bright line to apply the ``more than minor'' provision. 
This practice has been acknowledged by the SEC staff in EITF Topic No. 
D-46, Accounting for Limited Partnership Investments.
---------------------------------------------------------------------------

    \78\ ARB No. 51, Consolidated Financial Statements, paragraph 2.
---------------------------------------------------------------------------

     Revenue Recognition
    Bright lines may also be found in revenue recognition literature. 
One example is SFAS No. 66, Accounting for Sales of Real Estate, which 
provides bright lines for determining the buyer's minimum initial 
investment requirements for real estate sales.
     Business Combinations
    When an SEC registrant undergoes a change in control, the company 
must reflect the new basis of accounting arising from its acquisition 
in its stand-alone financial statements (i.e., apply purchase 
accounting to its own stand-alone financial statements) if the company 
becomes substantially wholly-owned. ``Substantially wholly-owned'' is 
defined such that this push down accounting is prohibited if less than 
80% of the company is acquired, permitted if 80% to 95% of the company 
is acquired, and required if 95% or more of the company is acquired.
    In addition, SFAS No. 141, Business Combinations, requires that the 
purchase price allocation period in a business combination usually not 
exceed one year from the consummation date.\79\
---------------------------------------------------------------------------

    \79\ We note SFAS No. 141, Business Combinations, has been 
superseded by a new FASB standard, SFAS No. 141 (revised 2007), 
Business Combinations, which similarly states in paragraph 51, ``* * 
* the measurement period shall not exceed one year from the 
acquisition date.''
---------------------------------------------------------------------------

     Pension and Other Post-Retirement Employment Benefit 
Accounting
    SFAS No. 87, Employers' Accounting for Pensions, and SFAS No. 106, 
Employers' Accounting for Postretirement Benefits Other Than Pensions, 
permit the use of smoothing mechanisms that delay the recognition of 
the effects of changes in actuarial assumptions and differences between 
actual results and actuarial assumptions. However, these standards 
contain a bright line as to when the delayed recognition amounts should 
be recognized.
     Hedge Accounting
    SFAS No. 133, Accounting for Derivative Instruments and Hedging 
Activities, requires that derivative instruments be recognized at fair 
value, with changes in fair value recognized in income. However, in an 
effort to mitigate earnings volatility, SFAS No. 133 permits the use of 
hedge accounting when a derivative is highly effective in achieving 
offsetting changes in fair value or cash flows attributable to the risk 
being hedged. GAAP, however, does not define ``highly effective.'' 
Instead, practice has defined ``highly effective'' as an offset ratio 
of 80% to 125%.
     Classification
    Bright lines are also present in classification requirements. For 
example, SFAS No. 95, Statement of Cash Flows, clarifies the definition 
of ``cash equivalents'' by stating that ``generally, only investments 
with original maturities of three months or less qualify under that 
definition'' (paragraph 8). Despite use of the word ``generally,'' this 
bright line is often interpreted stringently.
    In addition, SEC Regulation S-X includes bright lines for separate 
presentation of amounts that would otherwise be included in lines such 
as revenue, other current assets and liabilities, and other assets and 
liabilities.
     Disclosure
    Bright lines also exist with respect to the determination of 
related parties for the purposes of disclosing related party 
transactions and the identification of segments for the purposes of 
determining which operating segments require separate presentation.
    Further, SEC Regulation S-X includes a number of bright lines 
regarding requirements to present stand-alone acquiree financial 
statements, stand-alone equity method investee financial statements, 
and pro forma financial information, among others. These bright-lines 
are based on the results of certain significance tests, or 
calculations, defined in Regulation S-X. These significance tests 
compare the acquiree or investee to the registrant in the areas of 
assets, investments, and income.
B. Rules of Thumb
     Consolidation Accounting
    The fall of Enron in late 2001 refocused attention on the effect of 
bright lines as they relate to consolidation accounting. Enron, and 
others, took advantage of bright lines related to the consolidation of 
special purpose entities (SPEs) to avoid reporting assets and 
liabilities, to defer reporting losses, and/or report gains. At the 
time, the consolidation of SPEs hinged on an analogy to guidance that 
required lessees to consolidate SPE lessors that lacked a substantive 
investment at risk from an unrelated party. ``Substantive'' was defined 
as 3%, at a minimum, with the caveat that a greater investment may be 
necessary in certain facts and circumstances. Despite this caveat, 
which would suggest the need for judgment, the presence of the 3% 
bright line gave rise to numerous structured transactions to achieve a 
specific accounting purpose.
    In December 2003, the FASB issued FIN 46R, Consolidation of 
Variable Interest Entities, which superseded the

[[Page 10938]]

3% rule. FIN 46R requires consolidation in certain circumstances by the 
party that holds the majority of the risks and rewards of an entity, 
rather than equity ownership and voting rights. This model has led some 
to assert that FIN 46R is a principles-based standard. However, even 
FIN 46R contains a rule of thumb--a presumption that if equity 
investment at risk is less than 10% of the entity's total assets, the 
entity is a variable interest entity subject to the FIN 46R model, with 
similar caveats that require additional analysis, judgment and 
consideration.
     Contingencies
    SFAS No. 5, Accounting for Contingencies, provides an example of 
rules of thumb in interpretations of GAAP. SFAS No. 5 establishes 
recognition and disclosure requirements based on the likelihood--
remote, possible, probable--that a liability has been incurred. 
Although GAAP does not define these terms, audit firms have developed 
rules of thumb for these terms.
C. Pass/Fail Tests
     SFAS No. 48, Revenue Recognition When Right of Return 
Exists, requires that where a right of return exists, revenue be 
recognized at the time of sale only if certain criteria, such as the 
amount of future returns can be reasonably estimated. Otherwise, 
revenue recognition is deferred until the right expires or the criteria 
are subsequently met.
     SFAS No. 133, Accounting for Derivative Instruments and 
Hedging Activities--if critical terms do not match or if documentation 
does not comply with the rules, then companies are not eligible to 
apply hedge accounting.
     SFAS No. 140, Accounting for Transfers and Servicing of 
Financial Assets and Extinguishments of Liabilities contains 
requirements, all of which must be satisfied, to achieve sale 
accounting for a transfer of financial assets. Otherwise, the transfer 
is treated as a secured borrowing with a pledge of collateral.
     EITF 00-19, Accounting for Derivative Financial 
Instruments Indexed to, and Potentially Settled in, a Company's Own 
Stock, identifies a number of criteria that must be met in order for an 
instrument to be classified as an equity instrument. Failure to meet 
any of these criteria results in classification as a liability, which 
is marked to market through income. The criteria do not provide for 
probability assessments or judgments based on the preponderance of 
evidence.
     SoP 97-2, Software Revenue Recognition, related 
interpretations, and audit firm guidance contain the following pass/
fail tests:
    [cir] If vendor specific objective evidence (VSOE) does not exist 
for all of the undelivered elements of a software sales arrangement, 
the recognition of all revenue from the arrangement must be deferred 
until sufficient evidence exists, or until all elements have been 
delivered, unless certain exceptions are met.
    [cir] Extended payment terms usually result in a deferral of 
revenue. Specifically, when extended payment terms are present, a 
presumption exists that the vendor's fee is not fixed or determinable, 
due to the possibility that the vendor may provide a refund or 
concession to a customer. While there are factors to overcome this 
presumption, interpretive guidance sets the hurdle to overcome this 
presumption extremely high, generally resulting in the deferral of 
revenue until payment is due.

Appendix C

Committee Members, Official Observers, and Staff

Members

Robert C. Pozen, Chairman, MFS Investment Management. (Ex Officio 
Member of All Subcommittees)
Dennis R. Beresford, Ernst & Young Executive Professor of 
Accounting, University of Georgia. (Standards-Setting Process 
Subcommittee)
Susan S. Bies, Former Member, Board of Governors, Federal Reserve 
System. (Chairperson, Substantive Complexity Subcommittee)
J. Michael Cook, Former Chairman and CEO, Deloitte & Touche LLP. 
(Chairperson, Audit Process and Compliance Subcommittee)
Jeffrey J. Diermeier, CFA, President and CEO, CFA Institute. 
(Chairperson, Delivering Financial Information Subcommittee)
Scott C. Evans, Executive Vice President, Asset Management, TIAA-
CREF. (Standards-Setting Process Subcommittee)
Linda L. Griggs, Partner, Morgan, Lewis & Bockius LLP. (Audit 
Process and Compliance Subcommittee)
Joseph A. Grundfest, William A. Franke Professor of Law and 
Business, Stanford Law School. (Substantive Complexity Subcommittee)
Gregory J. Jonas, Managing Director, Moody's Investors Service. 
(Audit Process and Compliance Subcommittee)
Christopher Liddell, Chief Financial Officer, Microsoft Corp. 
(Delivering Financial Information Subcommittee)
William H. Mann, III, Senior Analyst, The Motley Fool. (Delivering 
Financial Information Subcommittee)
G. Edward McClammy, Senior Vice President, Chief Financial Officer 
and Treasurer, Varian, Inc. (Substantive Complexity Subcommittee)
Edward E. Nusbaum, CEO and Executive Partner, Grant Thornton LLP. 
(Audit Process and Compliance Subcommittee)
James H. Quigley, Chief Executive Officer, Deloitte Touche Tohmatsu. 
(Standards-Setting Process Subcommittee)
David H. Sidwell, Former Chief Financial Officer, Morgan Stanley. 
(Chairperson, Standards-Setting Process Subcommittee)
Peter J. Wallison, Arthur F. Burns Chair in Financial Market 
Studies, American Enterprise Institute. (Delivering Financial 
Information Subcommittee)
Thomas Weatherford, Former Executive Vice President and Chief 
Financial Officer, Business Objects S.A. (Substantive Complexity 
Subcommittee)

Official Observers

Robert Herz, Chairman, Financial Accounting Standards Board.

    Assisted by: Thomas Linsmeier (Substantive Complexity 
Subcommittee). Leslie Seidman (Standards-Setting Subcommittee). 
Larry Smith (Audit Process and Compliance Subcommittee). Donald 
Young (Delivering Financial Information Subcommittee).

Charles Holm, Associate Director and Chief Accountant, Banking 
Supervision and Regulation, Federal Reserve Board.
Phil Laskawy, Chairman of the Trustees, International Accounting 
Standards Committee Foundation.
Mark Olson, Chairman, Public Company Accounting Oversight Board.

    Assisted by: Charles Niemeier (Substantive Complexity 
Subcommittee). Dan Goelzer (Audit Process and Compliance 
Subcommittee).

Kristen E. Jaconi, Senior Policy Advisor to the Under Secretary for 
Domestic Finance, U.S. Department of the Treasury.

Committee Staff

Conrad Hewitt, Chief Accountant, Office of the Chief Accountant, 
U.S. Securities and Exchange Commission.
James Kroeker, (Designated Federal Officer), Deputy Chief 
Accountant, Office of the Chief Accountant, U.S. Securities and 
Exchange Commission.
John W. White, Director, Division of Corporation Finance, U.S. 
Securities and Exchange Commission.
Wayne Carnall, Chief Accountant, Division of Corporation Finance, 
U.S. Securities and Exchange Commission.
James Daly, Associate Director, Division of Corporation Finance, 
U.S. Securities and Exchange Commission.
Russell Golden (Senior Advisor to the Committee Chairman), Director 
of Technical Application and Implementation Activities, Financial 
Accounting Standards Board.
Holly Barker, Project Manager, Financial Accounting Standards Board.
Adam Brown, Professional Accounting Fellow, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission.
Bert Fox, Professional Accounting Fellow, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission.

[[Page 10939]]

Todd E. Hardiman, Associate Chief Accountant, Division of 
Corporation Finance, U.S. Securities and Exchange Commission.
Stephanie Hunsaker, Associate Chief Accountant, Division of 
Corporation Finance, U.S. Securities and Exchange Commission.
Shelly Luisi, Senior Associate Chief Accountant, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission.
Christopher Roberge, Project Manager, Financial Accounting Standards 
Board.
Nili Shah, Assistant Chief Accountant, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission.
Amy Starr, Senior Special Counsel to the Director, Division of 
Corporation Finance, U.S. Securities and Exchange Commission.
Sharon Virag, Director of Technical Policy Implementation, Public 
Company Accounting Oversight Board.
Brett Williams, Professional Accounting Fellow, Office of the Chief 
Accountant, U.S. Securities and Exchange Commission.

[FR Doc. E8-3544 Filed 2-27-08; 8:45 am]

BILLING CODE 8011-01-P
