The Securities and Exchange Commission may be moving toward greater acceptance of the professional judgment of accountants in interpreting financial standards, and that can’t happen soon enough.
The SEC’s outside Advisory Committee on Improvements to Financial Reporting released a draft decision memo last week with a call for less complexity in the standards. Accountants are swamped now with rules, regulations, guidance and thousands of pages of standards that can often seem contradictory.
At the Global Public Policy Symposium in New York this week, the heads of the Big Four accounting firms, plus BDO International and Grant Thornton, discussed the headaches of the competing rules and the need to move toward more of a principles-based approach. Regulators and the heads of the standards bodies at the conference seemed to concur with their frustrations. The jargon in the current set of standards is often head-scratchingly difficult to master. Even the names of the rules can be confusing.
Indeed, standards are producing complexity upon complexity. The burgeoning number of financial restatements is not always due to financial chicanery. In many cases, the restatements are caused by the application of new accounting standards that cause companies to take a fresh look at their numbers. Companies and their accountants are understandably worried about litigation from investors and penalties from regulators if they don’t follow the right set.
Restoring a reliance on professional judgment ultimately could help accountants cope better with the morass of rules. As the accounting standards in the U.S. move closer toward the principles-based approach favored by international financial reporting standards, accountants will need to increasingly exercise their professional judgment.
Naturally the use of judgment can’t be an excuse to apply one’s own set of standards. The committee’s draft memo notes that sole reliance on judgment could lead to aggressive accounting practices in areas such as revenue recognition. And the subprime mortgage mess shows that there probably needs to be more stringent standards for accounting for complex transactions and financial instruments such as structured investment vehicles.
Accounting firms are probably still going to be asking for additional guidance to avoid being second-guessed by the regulators and the courts in case they make a bad call. Let’s hope, though, that the courts recognize “reasonable professional judgment” as a legitimate way to defend against a lawsuit.
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