"In the Public Interest, Part Two"

Second in a series of interviews with the SEC’s Office of the Chief Accountant.
BY GEOFF PICKARD

If you feel like the world is changing faster than you can keep track of it all, you’re not alone. The JofA recently spent a day at the Office of the Chief Accountant of the SEC, talking about changes at the SEC, the world of regulation, the global marketplace and the CPA profession itself. Over the past year and a half, SEC Chief Accountant Don Nicolaisen has restructured and more than doubled the size of OCA, and improved communications between OCA and other divisions within the commission. These changes have enabled Nicolaisen and his team to take on additional areas of responsibility, such as oversight of the PCAOB, and to be more proactive in a number of areas including accounting and auditing matters, testing and considering the use of new technology and risk management tools, and getting out in front of issues. Of all his accomplishments in the past year, Nicolaisen says he is most proud of restructuring and strengthening the office, and credits much of OCA’s success to the hard work and dedication of his staff. OCA now has three Deputy Chief Accountants with specific areas of responsibility: Scott Taub (accounting), Andrew Bailey (auditing) and Julie Erhardt (international). Robert Burns is Nicolaisen’s Chief Counsel. For part one of the series, an interview with SEC Chief Accountant Donald Nicolaisen, see the January issue, page 63, or www.aicpa.org/pubs/jofa/jan2005/prof.htm . In part two, we asked Nicolaisen’s four senior leadership team members to each offer one key message to the readers of the JofA . Here are their responses.

SCOTT TAUB
Deputy Chief Accountant, Accounting

M y key messages are that improvements can be made to financial reporting now, without the need for additional rules from the SEC or the FASB, and to remember that the purpose of financial statements is communication—to provide information to the readers of financial statements about the operations and financial position of the business. Preparing financial statements, footnotes and related disclosures shouldn’t simply be viewed as a compliance activity, but rather as a way to explain what went on. If you approach it that way, you’re more likely to make the right choices.

Users of financial statements, investors, preparers, auditors and others often provide us with helpful suggestions to improve financial reporting. This is a useful dialogue that we encourage. In some cases the suggestions require rulemaking before they can be implemented. But, more often than not, there is nothing to prohibit companies from making the suggested improvements—rulemaking would only be necessary to require the improvements across the board. So I would urge preparers to embrace these changes now. Don’t make improvements only when the FASB or the SEC issues rules.

For example, many users ask for information on the cash flow statement under the direct method, additional segment information beyond the minimum requirements in Statement 131 and additional disclosures about financial instruments. There’s nothing that stops companies from providing that information right now.

Another area where disclosure could be improved and made more relevant is in management’s discussion and analysis. There’s no need to regurgitate the boiler-plate language of the past—“sales increased 12.1%” or “increases in volume were offset by decreases in pricing.” The disclosure can be much more descriptive and robust by highlighting the big things: “We had a new product launch” or “The new product sold 20% more than the product it replaced.” I would encourage preparers to focus the disclosure on these types of issues and provide a clear and complete picture that is user-focused. Think of what users would want to know and look for ways to improve communication right now.

If accountants and auditors approach disclosure as a communication exercise where the interest of investors comes first, I believe that, for example, companies will be less likely to enter into transactions structured primarily to move things off the balance sheet without actually significantly changing the company’s risk profile.

Finally, I should mention that as a result of restructuring and doubling the size of our office, we have a greater capacity to get out in front of issues. So I would encourage your readers and others to engage in a dialogue about the issues you’re facing today. Let’s be proactive, anticipate what’s around the corner, and deal with troublesome matters before they become a crisis. That’s an important part of our mission, and we need to work together to ensure that our capital markets remain strong and vibrant.

ANDREW BAILEY
Deputy Chief Accountant, Auditing

M y key message to CPAs is: let’s get back to the basics where the core service is auditing. I’d like to see the quality of the audit once again be the highest priority of every firm; everything else should take a second seat. That’s not to say that firms shouldn’t provide other value-added services, but they need to regain and hold investor confidence in the audit. Auditors have a special duty to the investing public, and we need to get back to the point where a firm’s signature on the audit of the financial statements discharges that duty by adding credibility to the financial reporting process. I think we’re making progress, but we still have much to do.

An important piece of the progress that has been made to date can be attributed to the PCAOB. With auditors, the PCAOB and the SEC working together, I believe we can make a difference—catch problems early, have fewer restatements caused by management or auditor failures, and have fewer and smaller frauds with less impact on our markets. Internal controls are a key element to achieve this. Also as the inspection process matures, it will provide the investing public and the SEC with more information on how the firms function in the public interest. The information and insights coming out of the inspection process will, I believe, improve the quality and uniformity of audits across clients and across firms by identifying, among other things, best practices.

ROBERT BURNS
Chief Counsel

A s Chief Counsel in OCA, I advise the Chief Accountant and his staff on legal, regulatory and congressional issues. My message is to remind your readers that the mission of not only OCA but also the entire SEC staff is to be the investor’s advocate. We, along with the PCAOB and many members of the accounting profession, are working hard to restore investor confidence in the markets, in accounting and auditing, and in public companies’ financial statements. One way the commission staff accomplishes that mission is to bring enforcement or disciplinary actions against people who violate GAAP, professional standards and commission rules. As important as it is to punish those who have done wrong, however, it is equally important that those who do a good job of financial reporting and auditing are rewarded in the marketplace.

One important measure to restore investor confidence is the new requirement for management and auditor assessments and reports under section 404 of the Sarbanes-Oxley Act. The OCA staff believes that, of all the reforms in the act, these examinations of companies’ internal control systems have the greatest potential to improve the quality of financial reporting. To give companies and auditors more time to finish their examinations and to prepare their reports, the SEC recently extended the deadline for certain companies to file the reports with the commission We recognize that some companies may announce material weaknesses in their controls but, because these are the initial assessments under section 404, such announcements should neither be surprising nor trigger an immediate or severe reaction from regulators or the markets. More important than the initial disclosure of a material weakness should be how a company plans to strengthen that weakness and patch any hole in its control system.

As we do with other new reporting requirements, the commission staff intends to review the effectiveness and efficiency of the internal control reporting rules after the initial reports are filed. We would like to hear from your readers about their experiences in complying with the rules, especially comments that would help us either identify best practices or find ways to streamline the rules and possibly make them more cost-effective.

In short, while OCA will assist in bringing enforcement actions whenever appropriate, we also are eager to help resolve issues before they reach that critical stage. Contacting OCA to resolve issues early in the reporting process and provide feedback on our rules are two significant ways that the accounting profession can help protect investors.

JULIE ERHARDT
Deputy Chief Accountant, International

I ’d like to pose a question to your readers: Are you today getting ready for the international-based financial reporting system of the future? It’s probably easy with so many things going on day to day for an accountant to say, “That international stuff doesn’t affect me today, so I need not worry about understanding it now.” But one requirement for the SEC to ultimately accept an international financial reporting system is that it be firing on all cylinders—and one cylinder will be that all accountants are knowledgeable about the international financial reporting standards. So for accountants to think that they will wait to get knowledgeable about internal financial reporting standards until the commission accepts them presents a Catch 22 situation. This Catch 22 situation could keep what’s best for the public interest from happening in as timely a manner as it could.

Lest people conclude that this matter only affects “big company” CPAs, I would observe that with the advent of the Internet even smaller and medium-sized businesses are conducting business across borders. I would also observe that it is the personal responsibility of every CPA to become engaged in the significant current issues facing the profession. The movement toward greater use of international financial reporting standards is one such issue. I do not think a CPA can stay distant on this matter on the basis that it does not affect his or her work tomorrow morning. Being a CPA is not just a job; it’s a profession. That profession brings with it the attendant responsibilities.

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