Disclosure Framework Update
The FASB’s Disclosure Framework team is close to issuing an Invitation to Comment, which will present the staff’s thinking on this important project. While this is a FASB only project, there are several other bodies that are watching the project closely, including the IASB and SEC. This post provides a brief update on the project and what you can expect to see from the Invitation to Comment.
The project was added to the FASB’s agenda in 2009. It was a response to several suggestions by FASB constituents that a framework be developed that would guide standard setters’ decisions on determining required disclosures. As disclosures have been continually added to GAAP, there is a perception that they have become fragmented and ineffective in conveying a clear message. Further, the SEC has been adding their own requirements, which sometimes results in redundancies. Then there is this “disclosure overload” problem, or at least, it is a perceived problem among some constituents. KPMG and the Financial Executives Research Foundation conducted a recently issued joint study (here) that documents a significant increase in the size of financial statements over the past few years.
The objective of the project is to somehow achieve a set of disclosures that cuts through all the clutter and provides more effective and clear communication to users. It should be noted that while disclosure overload was influential in getting this project on the FASB’s agenda, the overall objective of the project has never been to reduce disclosures. However, a natural outcome could be a significant reduction in the volume of disclosures. But, even if this doesn’t happen, it is expected that users should be able to more effectively interpret whatever volume of disclosures are provided when the information is presented in a more understandable manner.
The project is currently comprised of 3 major components. These are:
- A decision process that the Board can use to decide what disclosures will be mandated in their standards,
- A decision process that reporting entities can use to decide which mandated disclosures meet a materiality threshold to include in their financial statements, and
- Guidance on how to organize and format the notes to maximize their usefulness.
I’ll give you a general idea as to the composition of each of the three major components. First, the Board’s decision process: This component of the project describes a process for the Board to use when making decisions about required disclosures related to 1) general information about the reporting entity, 2) individual financial statement line items, and 3) other events and conditions that affect future cash flows. The Board might ask whether an alternative accounting method is acceptable under GAAP. Only if there are acceptable alternatives would companies be required to produce additional disclosures, especially when the method chosen by the company is unusual or has a significant effect on earnings. This practice could eliminate company disclosures that are currently made today for cases when GAAP does not require an alternative. In many cases, we observe extensive company disclosures about line items where there is no alternative in GAAP. Essentially, the disclosures are merely explaining GAAP, which is something that perhaps it’s ok for us to assume that users already know, or should know. This might eliminate needless clutter.
So, what about the reporting entity? The Disclosure Framework would rely critically on the reporting entity’s willingness to follow the framework in making decisions about materiality. The reporting entity would be required to determine what to include, and perhaps even more importantly, what to exclude from the financial statements. After the Board completes their decision process, they will have established a minimum level of disclosure and a full list of potential disclosures (or the maximum). The reporting entity would then use the thought process described in the framework to choose among three alternatives:
1) Do not provide any disclosures because nothing that could be said would make a difference to a user’s decision.
2) Provide the minimum disclosure because the information is barely material and none of the additional items in the full list provide any incremental value to users.
3) Provide the items of information in the full list that have material incremental value to users.
The reporting entity could then take that guidance and made a decision that fits their particular circumstances. The goal would be a full set of note disclosures that is more concise and cohesive than what we have today.
The third component of the framework provides guidance on how to organize and present information. Currently, we view notes that often do not have a systematic rationale for their organization. Unrelated items are often presented in the same footnote, and related items are often scattered throughout the footnotes. Unimportant information can sometimes be presented early, and critical information buried deep in the notes. Some guidance appears to be necessary to highlight the truly important information (see this related post by Rob Bloomfield).
What are the next steps in the project? As I’ve already mentioned, you can expect to see an Invitation to Comment come out very soon. Also, the staff intends to review existing disclosures using the Board’s decision process to see how things would be affected.