On Dec. 6, 2005, Financial Accounting Standards Board Chairman Robert Herz addressed the American Institute of CPAs National Conference on Current Securities and Exchange Commission and Public Company Accounting Oversight Board Reporting Developments in Washington.The chair traditionally speaks at this venue, but often the remarks are only perfunctory. This time, though, Herz showed his leadership by calling on capital market participants to lay aside their self-interest and work together to achieve "progress ... in improving the quality and transparency of financial reporting."
In addition, he said, "I also believe that we need to reduce the complexity of our reporting system." (The entire text can be found at www.fasb.org/herz _aicpa_12-06-05.pdf.)
The heart of the matter
These and other comments hit proverbial nails on the head. This statement from near the end of the speech especially reverberates: "I feel pretty strongly that the time has come for collective action to address these issues. And while I recognize that such an effort could result in significant changes to our reporting system, including institutional and structural changes, some of which could impact FASB, from where I sit, I believe the status quo is neither acceptable nor sustainable. Our reporting system, while probably the best in the world, is too complex and is capable of providing more transparent, more understandable and more useful information to investors and the capital markets."
We want to analyze his key points:
* His strong feelings. Herz is now a seasoned standard-setter, having seen firsthand the swift opposition that arises whenever proposals threaten to disrupt the status quo. Nevertheless, he offers up bold plans for progressive action. Why would he do so unless he feels strongly that something must be done, and done now? With his expressed vision and demonstrated commitment to progress, we think the world should count on him to do what he says.
* Collective action. His point is one that we've often made - nothing is likely to happen if the profession sits on its hands, waiting to be told what to do. Passive acceptance of mediocrity and begrudging compliance with meager change simply will not cut it. For those who wish to live in the past, well, get out of the way. This train is leaving the station.
* Significant changes. For those who like it the way it is and want nothing more than tweaks, look out, because Herz's goal is to bring major change to the system, even at a cost to the institution he leads. This comment shows extraordinary courage in the face of temptation to not rock the boat.
* The status quo. The next phrase ought to be dynamite for those who go to work each day without thinking about the quality of their output. Herz has proclaimed first that the status quo is unacceptable because it isn't producing high-quality and transparent financial statements.
He then goes further by proclaiming that the status quo isn't sustainable. By that, we think he means that the profession has to deliver financial statements that have real value because they're useful. We also think he means that accountants no longer have the political power to prevent change.
* What's wrong. Herz hits the right button by saying that accounting is too complex to get the job done. But he's not complaining that accounting practice is too hard; rather, he is lamenting that financial statements are so arcane that they don't actually communicate truth. Simplifying those messages likely means that it might become harder to be an accountant, especially in terms of creating and learning new techniques. And, yes, it will mean taking new risks to earn new rewards.
* The goal. The final phrase states Herz's goal for the reform process. Note that he doesn't want to make it easier for managers to manage their financial image and he doesn't want to make auditing safer for auditors either. He's also not looking to make it simpler for FASB.
As we have advocated for a long time, the test of any change will be two-fold: First, if current practice doesn't produce transparent, understandable and useful information for users and the markets, then it must be replaced. Second, it must be replaced only by new practices that do provide that information.
We think everyone can be sure that Chairman Herz is not just flapping his gums on these points. He is dead serious about building a coalition of change agents who share this vision, and he wants as many to come along as possible.
How is he going to do that? We found his words to be carefully crafted, but nonetheless right on point. In his speech's second paragraph, for example, he says that there are "a number of fundamental structural, institutional, cultural and behavioral forces that we believe have and continue to generate complexity in the system and that impede transparent reporting."
If it had been us, we would have been more direct and called them "political" forces that have, on one hand, strongly resisted any change in the status quo, and just as strongly tried to undermine any efforts to develop new practices, despite the fact that the aura of the precision and reliability of generally accepted accounting principles crumbled and disappeared before their eyes.
Again, Herz is calling it like it is. The problem lies with the people involved in financial reporting, not with the technology. The people need to re-orient themselves, or be replaced, so that today's amazing technology can be fully applied to fulfill the responsibility of providing transparent, useful and timely information to the markets.
What's happening?
Herz goes on to explain that FASB, with encouragement from the SEC, has already launched three initiatives to get the ball rolling. The first is a plan to "systematically re-address accounting standards in major areas for which the existing complex and outdated rules fail to provide relevant and transparent financial information." For example, pension accounting is back on the agenda, and the goal is clear - to get more information out of the footnotes and into the financial statements.
The second is a massive effort to restructure the authoritative literature so that everyone - preparers, auditors and users - can access and apply it. And the third is the board's major project to recast the Conceptual Framework to "provide a more solid and consistent foundation for the development of principles-based standards in the future."
He also makes it clear that he intends to press on, even against strong opposition. Here's what he said: "Over the last few years, counter to the goals of a principles-based system, at FASB we have experienced a constant flow of requests for detailed rules, bright lines and safe harbors from preparers and auditors."
There you have it, a forthright acknowledgement that managers and CPAs have not advanced users' interests in the past, thus setting the stage for Herz's call for a new future orientation.
The road ahead
Bob closed his talk with this pragmatic observation: "By acting together in the public interest, we can ensure that we continue to honor and fulfill [our] longstanding commitment to high-quality financial reporting. Given the many structural, institutional, cultural and behavioral issues facing the system, the effort to reduce complexity and improve transparency will not be easy and will take time, but I hope you agree that it is one of national importance and one that deserves the support of all of us."
While we applaud his vision, we have a different take on the future. There is no doubt that standard-setters and regulators can influence practice; however, we think the greatest impetus for transparent financial reporting will come from preparers and auditors who finally figure out that voluntarily telling the truth, the whole truth, and nothing but the truth in their statements will bring huge rewards through lower capital costs and the higher security prices that they so eagerly seek.
But until that paradigm rules the day, the lead will have to be taken by people like Bob Herz, who is No. 1 in our eyes.
Paul B.W. Miller is a professor at the University of Colorado at Colorado Springs, and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.
