In July 2007, the Securities and Exchange Commission created an Advisory Committee on Improvements to Financial Reporting (CIFR) to examine the U.S. financial reporting system and make recommendations to reduce unnecessary complexity and make financial reports more useful and understandable to investors.
On August 1, CIFR presented its Report to SEC Chairman Christopher Cox. The Report contains twenty-five recommendations, providing practical proposals to improve financial reporting in the following five areas:
- increasing the usefulness of information in SEC filings,
- enhancing the accounting standards-setting process,
- improving the substantive design of new standards,
- delineating authoritative interpretive guidance, and
- clarifying guidance on financial restatements and accounting judgments.
To make financial information more useful to investors and less complex, CIFR recommended the inclusion of a short executive summary at the beginning of a company’s annual report on Form 10-K (with material updates in quarterly reports on Form 10-Q), describing concisely the most important themes or other significant matters with which management is primarily concerned. It also expressed support for the SEC’s Extensible Business Reporting Language, or XBRL, initiative.
To enhance the accounting standards-setting process and to ensure that financial reports will be useful to investors, CIFR suggested increased investor representation on the Financial Accounting Standards Board (FASB) and the Financial Accounting Foundation (FAF).
CIFR recommended a new approach to the design of accounting standards focused on underlying objectives and principles, and advocated a move away from industry-specific guidance in authoritative literature to guidance based on the nature of the business activity itself, since the same activities may be carried out by companies in different industries. CIFR also recommended that the FASB eliminate alternative accounting methods for transactions with similar economics.
To reduce complexity associated with U.S. GAAP, CIFRstrongly supported the FASB’s efforts to complete the codification of all U.S. GAAP in one document. Others such as audit firms may still publish their views on accounting issues, but they should be labeled as non-authoritative. CIFR also called for a clearer delineation of functions on interpreting accounting standards — with the FASB taking the lead on broad issues and the SEC on registrant-specific issues.
Finally, to clarify guidance on financial restatements, CIFR recommended that the determination of whether an accounting error is material be separated from the decision as to how to correct the error. CIFR suggested that the correction of an accounting error should not automatically result in a restatement of financial statements for several prior years, expressing concern that during the time period involved in preparing restatements companies generally cease filing current financial reports, often resulting in a “dark period” during which investors receive only limited information. CIFR recommendedthat prior period financial statements be restated only if the error would be material to investors in making current investment decisions.
Chairman Cox has asked the SEC staff to immediately begin analyzing these recommendations, and to prepare relevant regulatory proposals wherever appropriate.