About the Speakers
Richard Jones is the Chair of the Financial Accounting Standards Board (FASB). He began his term as the eighth chair of FASB in July 2020. Prior to that, Jones was a partner at Ernst & Young and served as the firm’s chief accountant on technical accounting matters. Paul Munter is the acting chief accountant in the Office of the Chief Accountant (OCA) at the Securities and Exchange Commission (SEC). He was named the acting chief accountant in 2021; previously, he was a deputy chief accountant. He earned his PhD in accounting from the University of Colorado. Jones and Munter presented the opening remarks at Baruch College’s 20th Annual Financial Reporting Conference, held on May 4–5, 2022. The following is an edited transcript of their remarks. The views expressed are their own and not necessarily those of the SEC, FASB, the commissioners, the board members, or the staff. Official positions of FASB are only reached after extensive due process and deliberations.
What I want to talk about is our priorities in the in the Office of the Chief Accountant, and the things we’ve been focusing on—in particular working with Rich and his team as they move their agenda priorities forward in the in the outcome of their agenda consultation process—and then some of our focus from a rulemaking perspective and some comments with respect to materiality evaluations.
The chief accountant is the principal advisor to the Commission on the matters of accounting, auditing, and auditor independence. Our priorities are anchored in the Commission’s mission and strategic plan, and our focus has always been on promoting high quality financial information by registrants for the benefit of investors.
Decision Useful Information
The way I describe my job is, that from the time I get up in the morning till the time I go to bed at night, I’m trying to think about what things we can do to improve the decision usefulness of information that investors are receiving. At the end of the day, the quality of the information that investors receive is really dependent upon three factors:
First is having high-quality accounting standards and regulatory rules and requirements in place that serve the needs of investors.
Second is high-quality application of those standards and rules to a registrant’s facts and circumstances.
Third is the extent that information is subject to assurance, high-quality audit, or attestation of the information that had been prepared by management.
Additionally, I think it is critical that we keep in mind that, first and foremost, financial reporting is a communication activity. It is not a compliance activity—it is a communication activity, trying to best inform investors about the circumstances of all registrants so that investors can understand the risks and accurately price risk into their investment decision making. That is why we are focused on decision useful information for investors as the starting point for our respective activities.
We achieve our priorities through a number of different avenues. First is stakeholder engagement, which includes consultations with companies, auditors, audit committees, and other stakeholders. It also involves outreach for investors. Second is our oversight of both the FASB and the PCAOB and their important roles in the quality of financial information disseminated to investors. Third, we engage very actively, not only domestically but internationally, with our regulatory colleagues abroad, as well as with international accounting, auditing, and sustainability standards bodies. And lastly, we obviously support the commission’s priorities, including its rulemaking agenda and its enforcement activities.
We support the commission’s oversight of the FASB in a number of ways. One is through our engagement with the trustees of the financial accounting foundation in support of their important oversight responsibilities. In addition, we of course work directly with Rich and other board members, Hillary Salo and other technical staff at the FASB, and I think we’ve developed a very strong collaborative working relationship from that open dialogue. Most recently, we’ve been actively engaged with Rich and his team on their priorities coming out of their agenda consultation process, and we’re going to continue that active engagement as the FASB continues to execute on its technical agenda.
Several months ago, we issued a statement reiterating the importance of input from investors and other stakeholders to the standards-setting process. From investors, we hear often about requests for greater disaggregation of information. The process of determining an effective path forward needs to consider how to balance timely, meaningful action with a rigorous due process that is necessary for high-quality standard setting. I’m very pleased with the progress that the FASB has made already towards achieving some of these goals.
Another priority, at least in terms of the volume of comment letters, is accounting and reporting for digital assets. That’s a very hot topic today, as investors and preparers alike commented that digital assets are expected to increase in significance in the coming years.
Digital assets are certainly a complicated area. In one fashion, they raised some very critical issues under the federal securities laws, and of course it is a rapidly evolving space. We think that there are some opportunities for targeted changes in accounting and disclosure requirements beyond what we have recently done with [SEC Staff Accounting Bulletin] 121 that could provide better information for investors.
Through outreach with various stakeholders, as well as through the consultation process itself, we continuously look for areas where there might be opportunities to improve other accounting reporting standards, which we regularly share with the FASB and staff.
Lastly, as part of our oversight we provide feedback to the FASB as they are developing exposure drafts, final accounting standards updates, as well as actively participating in a number of their advisory groups to both hear input from a variety of stakeholders and provide our own experiences.
As a starting point, registrants obviously have responsibility for disseminating information that is compliant with GAAP and our rules. So, when an error is identified in historical financial statements, the registrant has to determine whether the error is material to those historical financial statements. And materiality is, of course, based on the Supreme Court’s definition of materiality which is focused on the view of reasonable investors.
If a registrant determines the previously issued financial statements are materially misstated, those financial statements would need to be restated and reissued.
By comparison, if an error is not material to previously issued financial statements, but correcting the error in the current period would be material to the current-period financial statements, the registrant is not precluded from correcting the error in the current-period comparative financial statements by restating the prior period information and disclosing the error, which is of course colloquially referred to as a “little ‘r’” restatement. I think it’s extremely important to know, however, that this is nevertheless an accounting restatement that has occurred because of a material error with respect to the financial statements.
We’ve been trying to remind preparers, auditors, and audit committee members that when assessing whether an error is material, it’s not a mechanical exercise, it’s not a matter of just going through a checklist, and it’s certainly not based entirely on a quantitative analysis. Rather, the evaluation needs to take in consideration the total mix of information, including both quantitative and qualitative factors, to assess whether an error is material to a reasonable investor. Ultimately, materiality evaluation needs to be an objective and impartial evaluation, taking into consideration all facts and circumstances with respect to the error.
A couple of observations from our recent discussions with registrants: First, while SAB 99 certainly has some qualitative factors that might be relevant to a materiality evaluation, those factors should not be used as a checklist, and they’re not necessarily designed to be a comprehensive list of qualitative factors that might be relevant to a particular fact pattern.
And secondly, let me reiterate the importance of undertaking that evaluation in an objective and impartial fashion, as opposed to developing arguments why an error is not material. That approach, which we often find is the case, is not what I would describe as an objective evaluation. It’s worth noting that SEC Commissioner Allison Herren Lee really recently gave some remarks about materiality from a lawyer’s perspective.
And lastly, I would say, a critical part of that evaluation of the error is also an evaluation of internal control over financial reporting. Remember that an evaluation as to whether there’s a material weakness is a consideration of what could happen, not what did happen coming out of that deficiency. So it is extremely important that that evaluation be an objective and impartial one as well.
For the past 49 years, the SEC has entrusted the FASB to develop financial accounting and reporting standards for public companies. They’ve given investors, creditors, and other allocators of capital information that helps them make decisions. In keeping with that aim, we’ve worked hard to make sure that the financial statements provide the most relevant information possible.
Our standards benefit from a robust, thorough, and transparent process that results in high-quality standards that provide crucial decision-useful information to investors and other allocators of capital. Our standards are developed in full sunlight, with active participation of our stakeholders. In short, our processes drive the constant attention and fine-tuning that is needed to make sure that financial reporting is not headed off the side of the road, but instead reaches its destination and efficient and effective manner. After all, high-quality accounting standards that facilitate effective operation of the capital markets are in the public interest and protect investors.
Setting the Agenda
When I spoke at last year’s conference, the FASB was about a month away from publishing our invitation to comment, which gave all stakeholders the chance to share their views on which financial reporting issues the board should address next.
We developed this consultation document based on discussions with more than 200 stakeholders, over one-third of which were investors. And I will say the response to the invitation to comment was tremendous; we were surprised and gratified by the more than 500 responses received.
Since last year, the FASB has been actively addressing that input and prioritizing areas of significant investor feedback. And that’s a robust process, in part because “investors want it” and “it costs too much to produce” are not the end of the conversation but a starting point as we seek to understand how and when the information will actually influence investment and capital allocation decisions and the nature and extent of any costs to being heard.
I would say, overall, investors and other financial statement users generally noted that the board should prioritize projects that provide greater disaggregation of financial reporting information—in the income statement, in a statement of cash flow, or in the notes of the financial statements—and in many cases, that would affect capital allocation decisions that they make.
We use that feedback to reshape and improve key projects on our technical agenda. For example, the FASB struggled to define a path forward on our dormant project on financial performance reporting. Investor input obtained during the agenda consultation process gave a new direction. We renamed the project and revised its objective to improve the usefulness of a business’s income statements through the disaggregation of certain expense captions, focused primarily on selling general and administrative expenses, cost of sales and services, and cost of tangible products sold.
Investor input also helped us focus our long-term project on income tax disclosures to items that would benefit allocators of capital. We originally added that project to the technical agenda in 2014, and despite to exposure drafts, a significant change in tax law, 100 comment letters, and other extensive outreach performed over the years, we were still unable to define a clear path forward.
But once again, investor input obtained during the agenda consultation process proved critical. We revised the project objective to focus on improving transparency and usefulness of income tax disclosures. And we established a project scope that focused primarily on disaggregation of income taxes paid and the presentation of the effective rate reconciliation.
Achievable Standards Setting
I will say in both of those instances, investor feedback from the agenda consultation process put us on a path to what I call “achievable standard setting.” By that, I mean projects that fulfill our mission, and which can be completed.
We’re also evaluating other stakeholder priorities through the lens of achievable standard setting while recognizing that although disclosures can provide key information to investors, the underlying accounting is of utmost importance. After all, bad disclosure does not make up for bad accounting.
In December, I announced comprehensive changes to the FASB research agenda, adding projects to explore potential paths forward on issues including accounting for digital assets, environmental, social, and governance related transactions, and government grants.
During the agenda consultation process, stakeholders of all professional backgrounds agreed that our project to permit or require companies to account for certain digital assets at fair value should be a top priority. Currently, we are looking at digital assets and commodities because, in many cases, they do have certain things in common. They’re actively traded, they’re viewed as exchanges of value between parties, and they’re often exchange traded. This month, we expect to bring the results of that research back to the board to decide if there’s an overlap beyond digital assets where it would make sense to have one accounting model, and what that model might look like.
Similar to digital assets, ESG is an extremely broad area and people have different definitions of its subsets. Our research in this area will help the board understand where specific ESG issues intersect with financial accounting and reporting and potential solutions. For example, we’ve seen bonds linked to an individual company’s emissions target; if the company hits the emissions target, it may pay a lower rate of interest; if it doesn’t, it may pay a higher rate. Other bonds being issued offer different interest rates, based upon hiring goals. We’ll bring that research back to the Board in the coming months.
Also, the accounting for government grants was a priority identified by many of our stakeholders. Many suggested that adding GAAP guidance for the recognition and measurement of government grants would increase the relevancy and representational faithfulness of financial information provided to investors and other financial statement users. In the coming weeks, we expect to issue an invitation to comment to solicit feedback on whether the accounting for government grants under IAS [International Accounting Standard] 20 could be incorporated into GAAP.
Now I’ll turn my attention toward other existing technical projects. In the near future, we expect to issue a final standard on disclosure supplier finance programs that will help investors better consider the effect of supplier finance programs on a buyer’s working capital liquidity and cash flows. We took on this project because financial statement users, including analysts and rating agencies, asked the board to consider adding some explicit requirements and GAAP that require companies to disclose information about these programs on a standardized basis.
We also continue to make progress on our project on intangible assets and goodwill. We continue to pursue an impairment with amortization approach that would reflect that what is acquired and initially ascribed to goodwill decreases in value over time.
We expect to issue a proposed standard on segment reporting, an area of great importance to investors, during the third quarter of 2022. That project is aimed at improving segment disclosures by providing users with more detailed information about what a public company’s reportables say.
Finally, our post-implementation reviews of revenue recognition, leases, and credit losses continue to help us fine-tune GAAP guidance in these areas. In the past, we’ve issued several targeted improvements, including a standard on recognizing and measuring contract assets and contract liabilities in a business combination to help investors better understand the financial impact of these acquisitions. We also improved discount rate guidance for lessees that are not public business entities, including private companies. And we took what we learned from our May 2021 Credit Losses Roundtable and other stakeholder outreach to take fresh looks at the accounting for acquired financial assets and the troubled debt restructuring model.
FASB continues to work to earn the privilege of setting standards by engaging in the robust, inclusive process that built the comprehensive body of GAAP we have today. But we do need all your help to make sure our standards continue to drive our capital markets safely down the road.
The subjects in the SEC letter and that the FASB has been talking about, some of them go back to the beginning of time. Goodwill is an example, where it was so many years ago that I used to work on that and now again we’re readdressing the whole question. Is that just the way it has to be, that these projects don’t seem to quite ever get done?
I would say when you look at financial reporting it’s an evolution, and it’s incremental improvement over time. There is a saying: there’s not a lot of new accounting issues, it’s just different ways of looking at the issues in different ways, and communicating that story to investors. Whether it’s financial instrument accounting, whether it’s stock option accounting, very often there was initial standard setting and then there were carry-on standards that did something else. If you think about segment reporting, that that evolved into a management approach, the management view of the segments, and the operations of the company. What we’re looking at right now is actually something that’s providing more information about the expenses in those segment disclosures. It’s not throwing out the entire model by any means; it’s simply making incremental improvement.
When it comes to disaggregation, interestingly enough, when I was first being considered for this role, someone asked me what do I think the trend in in accounting and financial reporting is. And I answered, I thought it was dis-aggregation, because I think the appetite for information and the ability to process information has greatly increased. When you look at the largest of the Fortune 500 companies back in 1980 versus today, it’s seven times greater in revenues. And very often you say, “Is there additional information about that income statement that could be provided to investors to help them better understand those ever-growing companies?”
The SEC proposal [on ESG] is 500 pages long and comments are due in a couple of weeks—Paul, is that a challenge for companies to develop a thoughtful a common letter?
First and foremost, we’re very interested in receiving feedback on our proposal, which was made on March 21. It is a lengthy document, there’s no question. But broadly speaking, there what I’d call three buckets to our climate proposal. There are proposals in there that would amend Regulation S-X and would require a new financial statement footnote with respect to climate events that have impacted a company’s financial statements and/or estimations. There are proposals that would amend Regulation S-K and we would bring into play a new item with respect to climate, built primarily on the four pillars of the TCFD [Task Force on Climate-Related Financial Disclosures] model and disclosures around that, in terms of the risks that an entity has to climate change, what its strategies are and things of that variety. And then the third bucket specifically is their proposals for disclosures of scope one and scope two and, if material, scope three GHG [greenhouse gas] emissions with proposed assurance requirements around scope one and scope two, albeit phased in over time.
I think it’s also worth noting that the International Sustainability Standards Board issued two exposure drafts; first, on disclosures about climate and, second, what they call a “general presentation model,” on March 31. Their climate ED [exposure draft] has a lot of similarities to our proposals—it’s by no means identical, but there are a number of similarities, and we’re certainly going to be interested in feedback that comes to the ISSB as well.
Finally, the EFRAG [European Financial Reporting Advisory Group] in Europe issued a proposal in response to their market regulations just earlier this week. So, there are three very sizable proposals out there for stakeholders to take a look at. We’re going to be anxiously awaiting feedback, not only on our proposal, but on those others as well.
With inflation on everybody’s mind today, I was wondering if the FASB is considering looking back to 1980, when it actually issued a standard on inflation accounting. In those days, companies had to, among other things, disclose something called purchasing power. Is that something that the FASB has to dust off and start thinking about?
A few weeks ago, I was doing some reading on inflation… I found a paper from the appropriately named “Accounting Historians’ Notebook”; it’s called “the evolution of inflation accounting in the U.S.,” and I thought it was pretty interesting to see the journey that the different standard setters took in [when] coming up with that 1980 proposal.
That 1980 proposal is still in our codification; it’s just that the disclosures on changing prices are, “strongly encouraged.” versus “required.” I found it interesting why in the late ’80s, the FASB decided to move from “required” to “voluntary,” and it was really because it wasn’t really being effectively used. When I think about inflation today, I start recognizing that our financials are designed to work with what comes out of the SEC. When I look at the MD&A [management discussion and analysis] disclosures—I look at changes in revenue and costs, based on volume and pricing that are often in MD&A disclosures, coupled with the detail that’s provided on expenses and some of the detail we’re contemplating providing via the disaggregation of the income statement project—it appears that this may provide that detailed information that people could be looking for in a higher inflation environment.
Is OCA still active in responding to specific accounting questions from registrants, and could you comment on the types of questions that you get?
Yes, we see the consultation process as a critical way to support high-quality application of the standards. Jonathan Wiggins on the next panel will talk more about some of the specifics, but the themes fall into fairly predictable buckets. We’ve certainly seen in a number of issues around financial statement presentation. We’ve seen a number of segment reporting issues. Revenue recognition questions continue to be a very high level of consultation—debt versus equity issues, consolidation questions, business combinations, financial assets, compensation, and leases, just to name a few.
I should also note that, while certainly the majority of them are U.S. GAAP questions, they are not exclusively U.S. GAAP questions. Foreign private insurers are permitted to file financial statements with us on the basis of IFRS as issued by the IASB, and so we also have consultations on application of IFRS with respect to foreign private issuers.
Again, we actively encourage registrants, auditors, and audit committees to reach out to us and engage in the consultation process, because we have a shared objective of issuing materially correct financial information to investors.