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.

The experiment addresses two research questions.  The first question is whether bright-line rules are more or less effective at curbing management’s aggressive reporting.  As indicated in a prior post (here), arguments could be made either way on this issue.  From this base case, the authors next examine how various auditor judgment frameworks affect the extent to which auditors curb aggressive reporting under both sets of standards.

Perhaps coincidentally, the study examines two transactions related to joint FASB/IASB convergence projects where the accounting differences are likely to disappear.  Nevertheless, it has important implications for how auditors are likely to behave as standards move from being rules-based to more principles-based and the potential advantages from developing/employing an auditor judgment framework.  As noted in the study, the Advisory Committee on Improvements to Financial Reporting (CIFiR) proposed judgment guidance, which would presumably yield higher quality auditor judgments (in addition, a judgment framework potentially could protect auditors from adverse legal judgments by providing explicit support for their decisions).  This study directly tests this assertion.

The findings from the study can be summarized as follows.  First, auditors are able to more effectively curb management’s aggressive reporting under less precise IFRS for the lease transaction (low ambiguity).  This result reflects favorably on principles-based standards.  In contrast, auditors were more likely to support management’s preferred revenue recognition approach under IFRS.  The authors place a negative connotation on this latter result as corroborating concerns that less precise standards are unable to curb management’s aggressive reporting when the underlying economics are ambiguous.  However, it’s not clear to me that the “aggressive reporting” under this highly ambiguous transaction is necessarily inappropriate.  In other words, it’s possible that most auditors (and users) would believe that early recognition is appropriate even without knowing management’s preference.  Therefore, while the paper seems to interpret this finding as an indictment against principles-based standards when the economics are ambiguous, I’m not sure we can definitively arrive at that conclusion.

With regard to the second research question, the study finds that employing a judgment framework is effective at further curbing management’s aggressive behavior, but only in cases when the underlying economics are not ambiguous (lease contract) and the standards are less precise (no bright-line rules).  None of the frameworks seemed to have any effect on auditor’s judgments when bright-line rules are used in the standards (i.e., the frameworks can’t overcome the effects of the bright-line rules) or even under less precise standards when the economics of the transaction is ambiguous.

The results from this study should be of interest to the FASB and IASB as they deliberate and promulgate standards that are based on principles and the potential effects of bright-line rules on auditors.  In addition, the PCAOB and the SEC should be interested in the evidence as it relates to developing auditor judgment frameworks.

On May 15, FASRI will host a Roundtable on the mechanics of using XBRL data.  While the platform is still new, the data problems that existed only a couple of years ago have been largely cleaned up.  XBRL holds potential for efficiently and cheaply gathering data from financial statement footnotes that are required to be tagged in the system.  In the Roundtable, members of the XBRL team at the FASB will discuss and demonstrate various methods and tools to manage XBRL data and how you might use this data in your research.  Also, we will have a brief discussion of how XBRL might influence standard setting and the research questions academics might want to pursue.

The Roundtable is scheduled at 4pm eastern time on Tuesday, May 15.

To participate in the Roundtable, please follow these instructions.

1) Go to http://intercall.webex.com anytime after 3:00 pm (New York time) on May 15.

2) Type in the following meeting number: 591 540 000 and click “Join Now”.

3) On the next page, fill in your name, email address, and the password “Fasri001” (case sensitive). Then click “Join”.

4) After joining the meeting, you will be prompted for your telephone number. Insert your telephone number and click the “Call Me” button. Your phone will ring, which you can use to hear and speak. Please remember to put yourself on mute when you are not speaking (can be done by clicking the mic next to your name).

5) If you experience trouble with the call-back feature, you can dial in yourself using the following numbers: 866-478-6348 or 224-554-0243.

A few weeks ago, I was involved in a Professional Development session here at the FASB.  The session’s topic was Comprehensive Income, and it included reading materials and cases that the participants were assigned to complete prior to attending the session.  The reporting of Other Comprehensive Income was the subject of a recently promulgated standard update (ASU 2011-05).  Also, FASAC has encouraged the FASB to place Comprehensive Income on its future agenda with a focus on determining what components belong in “earnings” and what components belong in “other comprehensive income” (or some other monikers).

With all this focus on comprehensive income, I was somewhat taken aback when prior to the PD session, an XBRL staff member, whose opinion I respect, approached me and essentially asked what’s the big deal?  In other words, with the electronic tools at our disposal, including XBRL, why should we even care how something is presented on a paper financial statement?  Assuming competitive markets and that analysts are sufficiently motivated to figure out what’s really important, the ease by which XBRL (or other tools) allows extraction of financial statement information would render presentation issues irrelevant.  This attitude was similarly expressed by Hans Hoogervorst, IASB Chairman, in a recent XBRL conference.  Here’s a quote from an Accounting Today article (full article here):

[Hoogervorst] noted that despite the potentials of the technology, certain aspects of financial reporting appear to be stuck in the offline, pre-PC world. He said he had witnessed endless debates about whether Other Comprehensive Income should be shown on the same sheet of printed paper as net income, or on a separate sheet. “Welcome to the 21st century!” he exclaimed. “XBRL has the potential to supplement the one-size-fits-all approach of today’s financial statements with an à la carte menu of financial information. Doing so will allow users to extract the information they need, and no more. Retail investors, employees and casual observers of a company will be able to extract information about the key metrics of a company. While more sophisticated users are free to slice and dice financial information and wade through as much or as little information as they need – all at the click of a mouse.”

Anecdotal evidence from letters commenting on the exposure draft that led to ASU 2011-05 suggests that many FASB constituents believe presentation is still important.  These constituents expressed a strong opinion that placing OCI items in the income statement, or presenting a per-share number for comprehensive income, would seriously muddy up the waters and confuse investors.  In addition, we have academic research with evidence that presentation matters.  Studies by Hirst and Hopkins (1998, JAR), Maines and McDaniel (2000, TAR), and Chambers et al. (2007, RAST) immediately come to mind.  However, a caveat is that these studies were executed in the “post-PC world” (using words similar to Hoogervorst) but prior to when XBRL was adopted.

The extant XBRL world provides many research opportunities for accounting academics.  A few early studies provide some preliminary evidence.  Using an experimental design, Hodge, Kennedy, and Maines (2004, TAR) find that the ability to obtain and integrate footnote disclosures by non-professional investors improves when they use XBRL technology relative to when they do not use this technology.  However, they also find that approximately half of their participants who had access to the technology did not use it, which reinforces the notion that investors must be willing to incur non-trivial start-up costs of employing new technology.  The result also suggests that education about the benefits of XBRL must be widely disseminated to induce financial statement users to access the technology.  As investors become more accustomed to XBRL technology, the realized benefits could very well increase.

Blankespoor, Miller, and White (2011, working paper) is an early study that employs mandatory XBRL data during the first phase-in period to investigate the effects of XBRL on information asymmetry and market efficiency.  The authors examine changes in trading behavior and price discovery around 10-K filings for XBRL adopting firms.  Their results are not favorable with respect to the effects of XBRL on the market.  Specifically, they find that trading volume and market liquidity decline, and price discovery is slower in the initial year of XBRL adoption.  Using a different design where the XBRL adopting firms are matched with non-adopting firms, the authors make the same inferences from their evidence, and there is some weak evidence suggesting the effects are greater for small investors.

While the Blankespoor et al. (2011) study is the most rigorous study on the effects of XBRL to date, there are significant caveats that must be considered when interpreting its evidence.  First, and perhaps most significant, the evidence relates to the initial transition period for XBRL.  In this respect, the evidence is consistent with the experimental study by Hodge et al. (2004) that investors are reluctant to incur the costs necessary to implement the technology.  Over time, as investors become more familiar with XBRL and its use is more wide-spread, these results could very well change.  Second, the study necessarily is restricted to very large firms that were required to adopt XBRL in its first phase.  Perhaps the information benefits from XBRL are more pronounced for small firms.  Finally, it’s difficult to understand why XBRL would result in a deterioration of a firm’s information environment, since the XBRL filings are in addition to (they do not replace) what the firm had provided previously.

Given these caveats, I expect research related to XBRL will proliferate as it becomes more widely used.  In addition, FASRI will do what it can to educate the public about XBRL.  FASRI has planned a Roundtable scheduled for May 15^th that will discuss XBRL and the mechanics of using it in your research.  Look for an upcoming announcement and plan to attend.

The FASB was the first standard setter to produce a framework for the purpose of establishing principles upon which all standards would be created.  Due to political forces and other factors, this effort has not always been successful over the FASB’s lifetime, but it would be unfair to characterize FASB standard-setting as void of principles.  Furthermore, principles without rules relative to ad-hoc standards can be equally problematic.  A primary reason why we have standards in the first place is to establish common financial reporting practices to facilitate comparisons across companies and over time.  Throwing out a principle as a standard without accompanying guidance that establishes some rules is likely to lead to various interpretations that result in inconsistent application.  The key is to find just the right amount of guidance to mix with the principles.

This post was prompted by an article in Forbes, whose author has a large audience.  The premise of the article is that E&Y is doing something nefarious by providing revenue recognition guidance to start-up companies using new technologies, while simultaneously perhaps providing auditing assurance that the guidance is consistent with U.S. GAAP.  While the article’s main point surrounds auditor independence, there is explicit mention that the guidance provided by E&Y is inconsistent with GAAP and furthermore, accounting regulators should be the body that provides the guidance – not experts in the field like E&Y.  There is no evidence in the article that the E&Y guidelines are not consistent with GAAP (only implication), but my issue comes back to how much guidance should standard setters provide?

Sir David Tweedie and other very smart people have said that principles based standards are superior to rules based standards because rules present opportunities for financial engineering.  As soon as a rule is created, the argument goes, it creates a boundary for financial engineers to work around.  As long as the engineers stay within the rules, the auditors/regulators are not capable of requiring something else that is more supportive of the underlying economics.  The counter to this is if a manager was determined to get someplace that required sophisticated financial engineering to achieve, wouldn’t it be easier to get there without the rule to work around?  And, couldn’t a fuzzy principle be interpreted in many different ways that would result in many different forms of accounting?  In fact, isn’t that what we have observed over time?  One of the reasons why U.S. GAAP is so dense is because new guidance (i.e., rules) is created to eliminate inconsistent practices that have evolved in practice.  Arguments on both sides are more complex than this, but the point is that the appropriate level of guidance to give to a principles-based standard is not an easy determination.

The FASB and IASB are working on their joint revenue recognition standard that is unmistakably principles based.  The proposed standard is public knowledge and while it is not yet final, the overarching principle and 5-step model is not likely to change.  Yet, there is still a demand in several circumstances for additional guidance, as indicated by Zynga and Facebook in the Forbes article.  This demand is completely rational on the part of the preparer as they want to avoid uncertainty.  Further, the demand will likely come from investors who desire some boundaries that will guide their analysis of the resulting accounting information and comparisons with other companies.  The case creates a dilemma: what are the accounting regulators to do?  If they provide more guidance, then the “purists” accuse standard setters of establishing too many rules that create opportunities for earnings management.  If they provide less guidance, the vacuum is likely to be filled by others, and standard setters are accused of not doing their jobs.

Perhaps the content of this post can generate a nice classroom discussion.

The issue in the paper is one of wealth transfers from creditors to shareholders/managers.  The study’s model employs control rights, which are frequently observed in debt covenants.  These rights give creditors control over whether to abandon or continue a project when the debt covenants are violated.  The main insight from the paper is that a conservative FV measure increases the likelihood that debt covenants will be violated, giving creditors the authority to abandon projects that produce a negative NPV.  The conservative FV measure they employ in their analysis is the lower of abandonment value or continuation value.  This is different from the FASB’s “highest and best use” concept, which is essentially the higher of those values.  The intuition is that the conservative FV measure enhances contracting efficiency between managers and creditors (relative to the FASB’s highest and best use) even though their conservative FV measure introduces a distortion in firm value.  The authors also recognize that creditors might inefficiently abandon too many projects – even some projects that are positive NPV.  So, they further analyze the offsetting effects of shareholders accepting negative NPV projects versus creditors abandoning positive NPV projects.  The authors conclude that contracting costs are minimized by using conservative FV measures.

It’s important to consider that Gigler et al. (2009 Journal of Accounting Research) find essentially the opposite results from this study; that is, Gigler et al. find that conservatism actually decreases debt covenant efficiency.  The reason for the difference is simply that Gigler et al. place more weight on an outcome where positive NPV projects are abandoned because the financial reporting numbers were too conservative.  Conservatism is more valuable in Caskey and Hughes because they assume that the costs of excessive abandonment fall disproportionately on inferior projects.  I can’t adequately assess which set of assumptions is more appropriate, but my intuition favors Caskey and Hughes.

More importantly, Caskey and Hughes assume perfect information for all shareholders and creditors.  Assuming away uncertainty, in my opinion, precludes the authors from implying that the FASB’s “highest and best use” measure is suboptimal for financial reporting purposes.  At the very least, this will be the case for firms where information asymmetry between managers and shareholders is high.  Using undistorted numbers to assess firm value is critically important to investors, and reducing agency costs will likely be more important to investors in these settings than reducing inefficient contracting costs.

However, I believe this paper has policy implications for firms where the source of capital is primarily debt and information asymmetry between capital providers and managers is relatively low.  Most private companies would probably meet these two criteria.

Accounting for asset securitizations is controversial, and critics have charged that GAAP allows companies to artificially deflate leverage ratios and thereby, effectively mask their inherent risk.  However, GAAP permits securitized assets to be treated as sold only when the following summarized conditions are met: 1) the transferred assets must be isolated from the transferor— put presumptively beyond the reach of the transferor and its creditors, even in bankruptcy or other receivership, 2) the transferee must have the right to pledge or exchange the assets without conditions or constraints, and 3) the transferor does not maintain effective control over the transferred assets.  Meeting all of these conditions would appear to transfer all of the risks and rewards to the transferee and therefore, accounting for the transfer as a sale would seem appropriate.

In their study, Barth et al. find a significant association between a transferor’s S&P credit rating and the retained portion of securitized assets.  The retained portion includes only those assets where the transferor retains a contractual interest and does not remove from their balance sheet.  Of primary interest, however, is the finding with respect to the portion of securitized assets that is removed from the balance sheet – the non-retained portion.  The authors find no significant relation between the non-retained portion and the transferor’s credit rating.  This finding is consistent with the accounting for these assets as sales, but inconsistent with claims by critics of “sale accounting” that the transferor retains the credit risk of transferred assets because of non-contractual but implicit obligations.

The findings of the study become more interesting when the authors use their second measure for credit risk in their tests – the firms’ quarterly bond spread, which is measured as the annualized bond yield less the compounded risk-free rate on one-month T-bills.  In this case, the authors find statistical significance for both the retained and non-retained portions of the securitized assets, which indicates that the transferor retains the risks inherent in the assets that they swept off the balance sheet.

The contrasting findings from using different measures of credit risk suggest that either the credit rating agencies or the bond market (or BOTH) got it wrong in their assessment of credit risk associated with securitized assets.  Both groups can’t be right (although, I suppose, they both could be wrong).  One could argue that credit rating agencies possess private information and expertise that facilitates their developing an accurate rating of the transferor’s credit risk.  However, the popular press has criticized the agencies’ ability to understand the underlying complexity of these transactions and their conflicts of interest, which might have compromised their objectivity.  In the wake of the financial crisis, the rating agencies are facing several lawsuits for substantially inaccurate ratings.  On the other hand, bond spreads might efficiently impound publicly available information about the transferor, but this information might be incomplete.  However, the case for the bond investors being right is supported by prior research that finds that securitized assets are also relevant in explaining market measures of equity risk.

The authors also find that the type of securitization – residential mortgages, consumer loans, and commercial loans – does not affect how the bond market views the credit risk.  But credit ratings are associated with only the retained portion of residential mortgages.

So, what are the implications for standard setting?  The results from this study (combined with research related to equity risk) might suggest that all transfers of financial assets should be accounted for as secured borrowings instead of sales, regardless of the contractual terms.  However, for those who believe there are significant economic differences across transfers (i.e., some transfers are effectively sales while others are secured borrowings), this might be going too far.  It should be noted that the sample period of this study was 2001-2006.  The FASB issued FAS 166 in 2009 with the expected outcome of reducing the number of transfers that are treated as sales and requiring additional disclosures for investors to properly assess the transactions.  Under FAS 166, the transferor must consider its continuing involvement in the transferred financial asset even if certain agreements were not entered into at the time of the transfer.  An interesting research question is whether FAS 166 has changed the way the bond and equity markets view asset securitizations.

Readers might be interested in this related article printed in Accounting Today (here).

The other basis for complaints about FV-NI accounting from bank managers falls in the category of cost/benefit.  Managers of small banks consistently argued that requiring them to mark their loans to market would be imprecise and provide little benefit, while adding another expensive burden to financial institutions that can ill afford it.

Left largely unspoken by bank managers, but surmised by various groups, is that financial institutions did not want FV-NI simply because it would introduce increased risk of regulatory violation due to a significant increase in income volatility.  A new working paper by Hodder and Hopkins (Accounting Slack and Banks’ Response to Proposed Fair Value Accounting for Loans, 2012) provides evidence that supports this view.  The authors find a significant association between the propensity of a bank to write a comment letter opposing the proposed standard and several variables that proxy for the banks’ demand for accounting slack (i.e., the extent of agency problems within the firm).  The authors summarize the implications of their findings as follows:

“Although the comment letters submitted by banks often include justification for current GAAP based on banks’ assertions about their strategy of holding loans until maturity, our reported results suggest that banks writing comment letters have greater agency problems and were more likely to opportunistically use the slack available in current GAAP for loans. This runs counter to the claims of those who oppose fair value accounting based on assertions of its lack of measurement precision and the discretion that managers might use in fair value reporting. Specifically, if firms exhibiting greater opportunistic use of slack under the incurred loss method of accounting are more likely to lobby against fair value accounting for loans, it is unlikely that these firms view fair value accounting as a source of greater accounting slack.”

Prior research has already documented that banks use built-in discretion provided by SFAS 115 to initially classify investment securities in a manner that helps them maintain regulatory capital.  The results from this study suggest that the first broad basis that banks used to justify their opposition to the proposed standard in 2010 might have been disingenuous.  Rather, the evidence suggests that the banks wanted to retain the slack within the accounting system that would facilitate their complying with regulatory requirements.  This reason is not irrational, nor is it sinister.  But, it doesn’t strike me as good justification for standard setters to relinquish their favored position of FV-NI.  (Of course, the second category of cost/benefit is a different matter, and one that I don’t address in this post.)

The authors suggest that the tight inter-relationship between GAAP and regulatory accounting policies might not be a good idea, and that regulators perhaps should be more free to relax some GAAP requirements when establishing regulatory requirements.  However, financial reporting that has the objective of providing quality information to financial statement users should not be driven by a desire to avoid violations of government regulatory requirements.

1)      IFRS convergence update

2)      FASB and GASB process of standard setting

3)      Auditor mandatory rotation (MAR).

Although MAR was stated as the third agenda item, it was obviously the primary reason for the hearing.  Furthermore, the congressional committee made clear throughout the hearing that they were not fond about MAR, to put things mildly.  Congressman Garrett implicitly suggested that the PCAOB was engaging in “mission creep” by deliberating on auditor rotation, i.e., crossing the line of auditor regulation into corporate governance.  Congressman Bachus (R-Ala) was more direct in his criticism stating, “Regulatory overreach, at least, appears to be alive at the PCAOB.”  (Ouch!)  Of course, the congressmen were reacting to the desires expressed by their constituents – companies located in their respective states.

A primary theme of the hearing was whether the PCAOB adequately assesses costs and benefits of their proposed standards – and by implication, whether other regulatory bodies do as well.  Chairman Doty received the brunt of the questioning with respect to MAR.  Congressman Garrett sponsors legislation that requires the SEC to identify the problem that any proposed rule is meant to address, and assess the costs and benefits of the rule – both qualitatively and quantitatively.  He quickly posed the question to Chairman Doty as to whether the PCAOB had conducted a quantitative cost-benefit analysis with respect to MAR, and embedded in his question was the following detail as to what he would like to see:

“…a) do you have a timeline on when that will begin, b) when you do that, will you be bringing in an economist to be making that examination, c) who, what sort, how many economists will be making that examination?”

As part of his response, Chairman Doty noted, “you cannot monetize the costs or the benefits.”  Congressman Garrett didn’t seem to like that response because he quickly interrupted Chairman Doty and asked,

“What specific type of economic analysis has been or will be done, what sort of data will you be looking to collect, what sort of people will be doing that, economists or otherwise?  Other than the general thought that this is an issue that should be looked at, was there any specific data that you had received from anyone to say, here is data that shows us that this is a problem area as opposed to anecdotal, just this is another topic area that we should be looking at?”

Chairman Doty’s response did not directly answer the question.  And, it’s a difficult one to answer.  The Congressman makes it clear that the type of cost-benefit analysis he wants to see includes data with monetary values, and he is suggesting that this quantitative analysis (not just qualitative) should be done early in the process.  But how do you monetize the benefits of accounting/auditing regulation?  We can’t observe the economic damages that were avoided by the issuance of a particular standard (this would be part of the benefit side of regulation).  Estimating the costs of a standard might be within the realm of possibility, but even that is not a straight-forward or simple task.  There is even some controversy as to what constitutes a cost of a standard (see this FASRI post).  Perhaps the legislation sponsored by Congressman Garrett requires something (a quantitative cost-benefit analysis) that does not itself pass the cost-benefit standard, because the benefits received from such a quantitative analysis are essentially zero due to the inherent uncertainty of what exactly the net benefits from any standard will be.  Slapping a monetary number on an analysis does not make it worth much, if anything, when there is such extreme uncertainty underlying the analysis.  In other words, the appearance of precision doesn’t make something precise.

Congress does not seem to realize that accounting regulators have debated how to measure costs and benefits of accounting standards for over 40 years.  At no point within this debate has there been a reasonable proposal on how regulators can quantify costs/benefits of accounting standards.  And yet, is the FASB now expected to perform such an analysis for every standard that is promulgated?  I really wanted to ask Congressman Garrett how he suggests this is to be done.  Has he really given it sufficient thought?  Does he really think that economists hold the secret to measuring the benefits of individual standards?

Consider some other comments made during the hearing.  In response to the pressure placed on him from Congressman Garrett concerning the cost-benefit analysis, Chairman Doty essentially said that since MAR is still in the “Concept Release” stage, that a quantitative cost-benefit analysis would be premature.  But, the congressmen were eager to pin him down that this needed to take place, even at the early stages.  From Congressman Bachus:

“There seems to be a misinformed public that you are well on your way to [making MAR an auditing standard].  I don’t know why that is….  Will [a C/B] analysis be part of the process?”

Doty: “It would be putting the cart before the horse to start evaluating costs and benefits of some form of rotation before you had any sense of whether you were going to go there or what it would be.”

Bachus: “Let me ask the SEC…will you do a C/B or an economic analysis of the effect?  And I know sometimes It’s hard to measure what is the cost of skeptism.”

Kroeker: “As Chairman Doty says, they’re not anywhere close to that point.”

Bachus: “Of course you know if you made a proposal, we’re gonna go to that, and if you hadn’t done a cost-benefit analysis, you know…”  The implication went unspoken.

Mr. Kroeker then indicated that of course, a cost-benefit analysis would be done prior to that point – the message I got was it would be a conventional cost-benefit analysis that monetizes the net benefit.  So, how is that going to be done again?

Then, there was this from Congressman Fitzgerald (R-PA):

” We really believe it is incredibly important to have a cost-benefit analysis at the very beginning.  Are you committed to doing a cost-benefit analysis, if so when, who is going to do it, and how’s it going to be done?”

Doty: “Before we came in with a proposal on MAR, we would be doing a very careful analysis of costs, unanticipated consequences, and benefits.”   

While Chairman Doty does not commit to an economic analysis that includes monetizing these factors, it’s clear that a quantitative analysis is what Congress wants.  So there you go; Congress effectively pinned down the PCAOB in conducting a conventional cost-benefit analysis that monetizes the net benefits.

Assessing costs and benefits is a significant current issue at the FASB, which is only going to become more important in the wake of the hearings yesterday.  It’s also an issue where academics might be uniquely positioned to contribute in developing methods to measure costs, and especially, benefits.

Each year, the FASB selects a member of the academic community to serve as a research fellow. The Research Fellowship Program began in 2007 and is a one year, in-residence position at the FASB in Norwalk, CT. The research fellow coordinates with the academic board member and staff directors to:

• Review existing research pertinent to Board projects and mission.
• Act as liaison with key constituencies performing research to inform them about standard setting issues.
• Coordinate sessions inviting lead researchers with cutting edge ideas to present their work to Board and staff.
• Evaluate circumstances where new research could inform the standard setting process. Act as catalyst to encourage such research by others or to perform research on own.
• Working with research project teams to facilitate timely completion of relevant research.
• Report on results of Board-related research activities to key constituents (including FASAC and other advisory bodies) to help frame dialogue with the Board.

More information about the Research Fellowship Program can be accessed here.  Contact me (llrees@fasb.org, 203-956-3472) to receive information about how to apply for the program in the future.