s Chief Accountant of the SEC, Donald T. Nicolaisen, CPA, is charged with overseeing the commission’s accounting and auditing policies and standard-setting initiatives at the national and international levels. He and his staff spent a November morning chatting with the Journal of Accountancy. In this first of a two-part interview, Nicolaisen talks about issues ranging from Sarbanes-Oxley section 404 to fair value, from fraud to the future of AICPA-PCAOB relations. (Part two of the interview will appear in the February issue.) This article is for any CPA, student or educator whose work comes into contact with the SEC.
JofA: You’ve been on the job a little over a year now. Where have you devoted most of your time and attention?
Nicolaisen: When I joined the SEC over a year ago, I knew that dealing with complex accounting issues and registrant matters would consume a significant amount of my time. These activities have historically been within the purview of the Chief Accountant. What’s new is the Sarbanes-Oxley Act, which established an appropriate foundation to improve financial reporting. With key provisions of the act taking hold, I have spent time working with the PCAOB as it established itself as a regulator and further defined its role. In addition, I have spent considerable time on the Sarbanes-Oxley internal control requirements. I also believe that there has been a renewed focus on strengthening corporate governance and restoring investor confidence. These are all positive developments, and it is very rewarding for me personally to have a role in helping to shape these changes.
change, I should also mention the FASB and the IASB, who are
very enthusiastic about the convergence of accounting
standards. This is an enormous undertaking, and one that I
These are just a few of the issues that I have been working on. As you can imagine, the last year and a half have been very busy, and I expect that will continue.
JofA: When you arrived at the OCA, you were very keen on the need for change at the top. Have you made progress?
Nicolaisen: This is a time of immense change; that’s one of the reasons I chose to join the SEC. Sarbanes-Oxley has given us an opportunity to restructure all aspects of the financial reporting process—governance, audit committees, standard setting and peer review, compliance reporting, evaluation of and reporting publicly on internal controls, management reporting on the accuracy of its financial statements—and, of course, the establishment of the PCAOB. Those are very significant changes.
These pieces are in place, and I believe they will improve the financial reporting process as well as help to restore investor confidence. But doing the right thing and instilling strong moral and ethical standards cannot be done through legislation or regulation alone. This has to come from the private sector. I think it’s important that we recognize the many market participants who have worked tirelessly and diligently over the past few years to improve our systems and to regain investor confidence. There’s been a real dedication on the part of many people to change. For example, there’s been a focus on substantively improving corporate governance and the role of audit committees. And my sense is that preparers and auditors are focusing intently on the importance of financial reporting and of the audit process. Across corporate America significant additional resources have been added, training and continuing education have increasingly focused on ethical and technical matters, and there is a real push—starting at the top of business organizations—to make the tough calls and to get the numbers right. These are all positive developments.
That being said, I also recognize that we continue to discover both industry-wide and company-specific failures of business ethics and of disclosures to shareholders. These failures are unacceptable and highlight the need for continuing vigilant oversight and enforcement.
The internal control requirements are another area of major change. Of all the reforms contained in Sarbanes-Oxley, I believe that the internal control requirements may have the greatest effect on improving the accuracy and reliability of financial reporting. It is also what I consider to be the most urgent financial reporting challenge facing a large share of corporate America and the audit profession certainly through the first quarter of 2005.
JofA: Can you give us a little detail?
Nicolaisen: We’ve talked about management and auditors reporting on internal controls over financial reporting for as long as I’ve been in the profession. Now it’s a reality. The amount of effort required to implement this change has been daunting for both auditors and preparers. Coupled with that is a renewed recognition of the importance of auditing. Auditors are working hard, training their people, and spending significant resources and energy to implement the internal control requirements. It’s important that with all the focus on internal controls, we don’t lose sight of the importance of doing a high quality audit. And, from everything that I hear, people believe that the audit function matters and that the contributions that CPAs make do matter. So there’s been a tremendous strengthening of the quality of the audit.
Likewise the preparer community has been working overtime implementing and enhancing their processes. When you look at all the things they’ve addressed in the past couple of years, especially the internal control requirements, it’s a tremendous amount of change. I sincerely appreciate these efforts by both the preparer and auditor communities. The academic community also has focused on areas that can improve financial reporting. So the whole system seems to be working and moving in a positive direction. And I would say that’s also true of standard setting and regulatory bodies, such as the FASB, the PCAOB and the SEC.
JofA: Some say that practitioners and academics don’t always communicate about the changes in the profession. What’s your reaction to that?
Nicolaisen: I think the academic community has a lot to offer. One of my first staff hires was Andy Bailey. His academic background has been invaluable to the work of the commission. So I’m a strong advocate of increasing the level of communication among practitioners, regulators, standard setters and academics.
For example, at the American Accounting Association session in Orlando last year, I had an opportunity to talk to a number of academics and get a good sense of what they think are the important issues. The conference included very relevant presentations, research papers and discussions. And I believe we can all benefit from this.
JofA: Would it be fair to say the profession has turned the corner?
Nicolaisen: Yes, I believe so, with the caveat that we still have much to do before the profession has fully implemented all the recent change needed to regain the trust of the investing public. As a result of Sarbanes-Oxley, accounting firms that audit public companies now are regulated entities. They’re subject to inspection, and reports on their audit practice are made public. The responsibilities they have, the relationships they’ve built, the accountability to audit committees, the recognition that what they do is on behalf of investors and not management are dramatic changes that have taken place in a very short period of time.
That’s not to say that we are yet where we want to be. We are in a period of transition. For example, I’m a strong proponent of principles-based or objectives-based accounting, and also a believer in “keep it simple.” Unfortunately some accounting standards are simply too rules-based and overly complex. The leasing literature and pension accounting come to mind as areas that are ripe for review.
The FASB has a challenging agenda. The “low hanging fruit” has been picked; now the FASB is dealing with the remaining issues which are difficult, complex and have long been on the agenda, some for a decade or more—including consolidation matters and when to use fair value. The FASB is doing this in an orderly manner, subject to an extensive notice and comment process, and I expect that there will be much dialogue along the way. For example, if a decision is made to use fair value in new areas, that will have a dramatic impact on the financial reporting process. Preparers will have to be conversant with valuation terms. Auditors will have to learn a new language and work in areas where they have a lower comfort level. So, while the FASB is working diligently, we do need to be patient and realize that some of their projects are long-term.
JofA: What areas still need attention?
Nicolaisen: We need to simplify the financial reporting model—not dumb it down, but simplify it. For the most part, that means fewer exceptions to the basic rules, less boilerplate disclosures and fewer redundancies. And our use of technology has to keep up with the tremendous progress that has been made in the past decade. I also think there’s an expectation gap around the auditor’s responsibility for detecting fraud.
JofA: On the subject of technology, you recently put out a press release about using XBRL for your voluntary program for reporting financial information and hired Jeff Naumann of the AICPA to spearhead that effort. What’s your view on XBRL?
Nicolaisen: This is a project that is near and dear to me, and something I’m very enthusiastic about. Jeff is an outstanding individual, and I am very pleased that he has joined the commission. Neither the concept of tagging data nor the use of XBRL is new. Better use of technology offers the potential for registrants to provide accurate data faster and at a lower cost. For investors, analysts, auditors, and those who extend credit or are otherwise involved in the capital markets, data tagging ought to be a positive development. For the preparer community, over time, it will be an enabler of better communication with investors and a more cost-effective manner of filing with us.
But XBRL is just a part of what I mean by making better use of technology. Some in the profession are looking at alternative measures of performance and enhanced financial reporting in general. These efforts are contributing significantly to the financial reporting process. Throughout this process, we need to think outside of the box and consider broader use of, for example, Web-based solutions. We currently place too much emphasis on earnings per share, and we should look for alternative measures to help investors better understand the company’s operating performance.
JofA: Do you see XBRL as a global phenomenon?
Nicolaisen: Yes. It’s being talked about in other parts of the world, and other regulators have either adopted it as their standard or are in the process of doing so.
JofA: Do you have a timetable for achieving some of your more challenging objectives?
Nicolaisen: I came to the SEC with an aggressive agenda. I had my 100-day plan and my first-year plan. I hesitate to put out a timetable because we’re dealing with matters that are broad in scope and may involve changes in how people think about the financial reporting process and the profession. That takes time, training and support. There’s a learning curve that comes with change, and it’s important that we allow that process to take place. We want a real improvement in financial reporting. Some improvements will originate with those in standard setting and other leadership positions, while other improvements will be driven by investor demand. What is important is that we have to embrace change. And we need to build a process that challenges the status quo, where students entering the profession retain a desire to improve the profession throughout their careers.
JofA: What do you see as the role for the AICPA against this backdrop?
Nicolaisen: The AICPA has been a leader in training, in educating and in raising the bar of the profession. It’s where auditors, preparers and others have historically come together, identified issues and contributed to their resolution. It has a tremendous role to play with respect to companies that are not public, as well as in helping identify ways to do things better, faster and cheaper.
We need to make reporting more timely and cost effective. The members of the AICPA are dealing with new issues and transactions every day and are well-equipped to communicate their needs in areas where they think practices can be improved.
So the AICPA has a tremendous role to play in making the profession stronger and more relevant. Whether CPAs practice publicly or privately, it’s their reputation that really matters, and we all recognize that it has suffered through a tough period.
JofA: What’s your view on the relationship between the SEC and the PCAOB?
Nicolaisen: The SEC has oversight responsibilities for both the PCAOB and the FASB. I support their efforts. The creation of the PCAOB as an independent body that oversees the accounting profession, writes auditing and professional standards, and inspects the firms is a major change for all involved. The inspection process allows the PCAOB to look at a cross-section of firms of all sizes—and at the registrant community as well—to see how the registrant prepares financial statements and how auditors deal with emerging issues faced by registrants. With that knowledge base, the PCAOB will hopefully be able to identify best practices at the firms and develop more cost-effective rules, accounting principles and standards.
JofA: There were some challenging discussions in recent months between the AICPA and the PCAOB over copyright issues for standards. Are you satisfied with how it was resolved?
Nicolaisen: I am. The issues were understandable; the debate was wholesome; it’s been settled. I take my hat off to the PCAOB and AICPA in being open to working out the issues. It’s very positive for the profession, and it puts auditing standards in the public domain, where they belong. The AICPA and PCAOB are working closely together. There’s much for all of us to do.
JofA: How is Sarbanes-Oxley section 404 going to affect small publicly traded companies and small private companies?
Nicolaisen: During the SEC’s Sarbanes-Oxley rulemaking initiatives, we received many comments focusing on the increased burden that the proposed rules would place on smaller-sized public companies. I have heard similar concerns expressed about the impact of some of the FASB’s proposed standards, such as its exposure draft on accounting for stock options.
The cost of compliance for our smaller registrants is of concern to me, and it is something upon which we will have to stay focused in the future, not just in the area of internal controls but in other areas as well.
With respect to the internal control requirements, we have deferred the requirements for smaller businesses to give them and their auditors the opportunity to learn from the experiences of the larger companies. Also I’ve encouraged the private sector, COSO in particular, to develop a framework by the spring of 2005 that would be applicable to smaller and less sophisticated businesses. I believe such a framework will be very helpful as the preparer community tries to satisfy itself, its auditors and the investing public that its controls are appropriate and adequate and functional.
I also supported the commission’s deferral of the final phase of our accelerated reporting deadlines to provide registrants and auditors with extra time and a small margin of breathing room.
JofA: You mentioned COSO. What’s your take on its Enterprise Risk Management Integrated Framework?
Nicolaisen: It enhances the basic COSO framework for internal controls over financial reporting by addressing risks more broadly within an enterprise. At the outset, I think it likely will be embraced by larger or more sophisticated companies, such as those in the financial services industry, but that may evolve over time. The bottom line is that I think it has real potential.
JofA: The AICPA is looking at the impact of GAAP on stakeholders in private businesses. What’s your view?
Nicolaisen: As a general matter, I believe that small business should be expected to adhere to the same general standards and principles to the extent that they have like transactions. For example, it’s hard to imagine that recognition of a transaction as revenue or expense would differ simply because a company is private rather than public. However, as I mentioned before, the burden to smaller companies is disproportionate and needs to be appropriately weighed against the protection of investors. This balancing act is something that I will continue to closely monitor, and it is also an important consideration for the FASB, the PCAOB and the AICPA. Clearly, we all need to strike the right balance.
JofA: How do you see the relationship of the AICPA and the PCAOB today and in the future?
Nicolaisen: Their relationship is beginning to form. The PCAOB is responsible for overseeing auditors of public companies so that’s changed the dynamics considerably. Also the PCAOB is responsible for setting auditing standards for public companies. I think the AICPA has been supportive of those efforts. And I hope it will continue to be so. The AICPA membership has valuable input to provide, and it would be a shame not to take advantage of that input.
JofA: Can you address the role of state CPA societies?
Nicolaisen: The time is ripe for a serious dialogue to occur about whether more consistent regulation of CPAs is needed at the state level. This is an area where I readily admit I don’t have all the answers, but I do think this issue deserves an open and candid debate. And I would very much appreciate hearing the views of your readers on this topic. I suspect that whether a CPA’s license is in New York or California or Texas or Vermont makes very little difference to the investing public. What the public is looking for is the assurance of a CPA’s report on an audit of financial statements. While all states have the goal of licensing only accountants who can meet the public’s expectations, the difference in licensing requirements across the states does add complications. The Uniform Accountancy Act hasn’t worked well enough to encourage licensing authorities to pursue a consistent approach. On one hand, it’s in the best interest of the investing public to have uniform, national qualifications for CPA licensure; on the other hand, the states clearly have an interest in licensing professionals who practice within their borders.
We’re at a unique juncture in the history of the CPA profession, and uniform licensing is a legitimate issue to consider. That being said, a debate on this issue should be structured around the need to preserve the states’ legitimate interest in licensure while serving the national interest as it relates to CPAs’ importance to the investing public.
JofA: Can you talk a little about fraud detection?
Nicolaisen: Fraud detection has been a major challenge for the profession for as long as I have been a CPA, and probably long before. I fully support the PCAOB’s consideration of this issue. Over the years, an expectation gap has been created between the investing public’s perception of what the auditor’s responsibility is for fraud detection and what the auditor is in fact required to do. This gap needs to be addressed.
JofA: Are the crooks getting smarter?
Nicolaisen: Some percentage of them have always been smart. But now they have access to better technology and there are more ways for them to perpetrate and hide fraudulent activities. That makes the auditor’s job even more difficult. Management has to be involved as well as the auditor to make sure the right processes are in place and there’s appropriate governance oversight. For example, I think the internal control requirements will help in terms of ensuring the right processes are in place, but it certainly will not stop fraud from occurring.
JofA: Let’s talk a little bit about the evolution of the audit. What do you see in that area?
Nicolaisen: The audit has always been important, and I am pleased to see that the audit firms recognize that the audit is their most important service. Their brand and their reputation are based on the quality of their audit practice, and they have a unique responsibility to the investing public.
I believe that audit firms have gone back to the basics. By that I mean that the audit is their most important and core service—and they’re putting more time, talent and money into the audit process. There is better use of technology and smart systems. They’re pulling together more data points—from analysts’ reports to their own research to other risk factors—to make the audit process even more effective.
The tough questions are when and how much judgment to use; the audit firms are wrestling with that. They want to get it right. But there is a tension here. They support the general notion of principles- or objectives-based standards, but in practice they often ask for more detailed rules. Given the current environment, I have some sympathy and understand their concern about being second-guessed. But I do hope that this will be temporary.
JofA: What’s your view on enhanced business reporting? Is progress being made to your satisfaction?
Nicolaisen: As you know, the project is under way. The AICPA is taking a leadership position and a major investment is being made. We’ve had periodic updates from the enhanced business reporting committee. Now is the right time to look for better ways to present financial and other information to investors. So I think they have an important role to play, but I’m also realistic and know that it’s a tough challenge.
JofA: Do you have a timetable for that scenario?
Nicolaisen: No. These things tend to have their own right time. But I’m hopeful that in the next several years we’ll see a framework emerge from the project that is really useful for the preparer and investor communities.
JofA: You recently spoke with the world standard setters at the IASB meeting in London. What did you tell them?
Nicolaisen: I wanted to make a couple of very clear points: I support convergence between U.S. and international accounting standards. Having a common accounting language that’s usable around the globe would be a dream come true. For U.S. investors to be able to understand one set of international standards rather than those of 50 different countries will be a tremendous improvement. I also wanted to be clear that we’re looking for the best accounting standards globally, not the lowest common denominator. I’m very supportive of the way in which the IASB has conducted its affairs, and the European community ought to be commended for moving in the direction of international accounting standards in such a short period of time. It’s a tremendous change.
JofA: Can the AICPA help in this evolution?
Nicolaisen: The AICPA should be involved in the international arena. Every community comprises people who invest abroad and companies who have made investments here in the United States, and being able to communicate across geographic borders is very useful. So I encourage the AICPA’s involvement.
JofA: The AICPA recently made a presentation to the SEC on the Center for Public Company Audit Firms. What was your reaction?
Nicolaisen: The AICPA is starting to carve out a role for itself in the new regulatory environment. It can play a role in improving the quality of the audit process and of accounting. You can identify issues that need to be dealt with. You can educate your members. You can bring best practices and technologies to the forefront, and invest in research that will be helpful for investors.
JofA: The AICPA’s five-year Internet student recruitment program has made contact with more than 500,000 students interested in accounting and helped drive substantial increases in accounting programs nationwide. What else should the profession do to ensure the adequate supply of CPAs?
Nicolaisen: I understand that there’s increased interest among students in the accounting profession. Some are driven by a view that this is a noble and important profession, and some by the view that it’s a profession that needs help. In any event, such idealism is positive. When I spoke in May to University of Southern California accounting graduates, I was impressed by the quality of students and their interest in what’s happening in the world of accounting and auditing. If that caliber of student gets involved, supports the profession and believes what they do is important, the profession will have a bright future.
JofA: What final messages would you like to send the accounting profession through the pages of the JofA ?
Nicolaisen: I’d start by saying that the accounting profession does matter. It matters immensely to the investor community and to society—and that puts a tremendous responsibility on its members.
Second, the profession needs to continue to right itself in the eyes of investors and address not just the issues of yesterday or today, but those of tomorrow. I think that journey has begun, but we still have much to do.
Third, I’d say focus on quality. Understand what you’re doing, why you’re doing it and to whom it’s important. Be relentless in paying attention to your piece of the responsibility. Recognize that it is yours, and no one else’s.
And finally, cash flows do matter. I strongly encourage the preparer community to use the preferred method of reporting cash flows—the direct method of reporting the statement of cash flows, not just the indirect method that's used by so many companies. I think that will increase the level of communication dramatically.