Will simpler also be better?

7 ways reduced complexity will affect the financial reporting world
By Maria L. Murphy, CPA

Will simpler also be better?
Photo by filonmar/iStock

It should be no surprise that accounting standards have become more complex over the years. Transactions have become increasingly challenging as new products and services emerge and financial instruments become more complicated in a global economy. Meanwhile, financial statement users’ demands for more information in a more timely fashion have caused standard setters to create more disclosure requirements to provide additional transparency. As the amount of information in financial statements has grown, “simplification” and “reducing complexity” have become themes in recent years for regulators and accounting standard setters.

Standard setters and regulators are acutely aware that investors can be confused and preparers overwhelmed by the complexity of accounting standards and by the content and volume of information presented in financial statements. FASB, the International Accounting Standards Board, and the SEC all have ongoing projects related to simplification and reducing disclosure overload (see the sidebar “The Pursuit of Simplification”). The Financial Accounting Foundation’s Private Company Council (PCC) has been working to modify GAAP for private companies to reduce unnecessary complexity, and the AICPA’s Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs) has been designed to give preparers a simple, cost-effective way to present non-GAAP financial statements.

“Complexity in accounting is costly for both investors and companies,” FASB Chairman Russell Golden said in December at the AICPA Conference on Current SEC and PCAOB Developments. “For investors, overly complex financial reports often obscure important information they need to make sound capital allocation decisions. For preparers, a complicated, unclear, hard-to-understand standard obscures its meaning. And even when an accounting treatment is clear, applying it can be lengthy, difficult, and expensive.”

Any relief from complexity can make a difference. Company executives and finance teams often complain about regulatory overload. Sixty percent of CPA executives participating in an AICPA Business and Industry Economic Outlook Survey in 2013 said their current employees had been required to produce more or work more hours over the previous five years as a result of increased regulatory pressures. Simplified accounting standards can help lessen the burden on finance staffs that are busy with reporting, strategic, and compliance responsibilities.

The effort to reduce complexity is not without challenges, though. In some cases, organizational resistance to change can make any significant alteration to application of accounting standards a difficult proposition. The time and cost required to make changes, including implementation efforts and educating staff, management, and boards, may not be perceived to be worth the benefit (see the sidebar “Be Ready to Simplify”). In circumstances where, for instance, FASB has given private companies optional GAAP alternatives, companies and their CPAs may need to clearly explore the benefits and costs of each option. And at least some of the PCC-originated GAAP alternatives for private companies may not be advisable for entities that may go public or be acquired by a public company in the future. In those cases, it may be necessary to undo the election of the alternative, which could more than offset any savings the alternative provided in the first place.

Preparers and auditors in some cases also may find security in following complex disclosure rules to the letter, particularly in a public company setting subject to regulatory review. This may be true even if some of these rules may result in boilerplate disclosures that significantly lengthen financial statements with little benefit to financial statement users.

Users of financial statements also may object to simplification in some cases, although standard setters and regulators are being careful to eliminate complexity in a way that will minimize loss of information that may be meaningful to users. And although FASB has moved forward with GAAP options that are strictly for private companies, there may always be dissenters with concerns that this creates a “two-GAAP” system that promotes simplicity at the expense of comparability.

Despite all these challenges, attempts to reduce complexity continue because many in the financial reporting arena believe the benefits of simplicity can be numerous. Here are seven impacts that experts foresee—or already are experiencing—in the financial reporting realm.

1. Preparers may benefit from simplicity

Some financial statement preparers say they see disclosure simplification efforts as a positive change.

“Nobody likes change for change’s sake,” said Chris Rogers, CPA, CGMA, the CFO of New Jersey software developer Infragistics Inc. “But if it adds to the ability to make informed financial decisions and makes my life easier, then I support it.”

David Duckwitz, CPA, director of quality control for RubinBrown, said: “FASB has done a good job of balancing interested parties’ perspectives. Users always want more, so it is a tricky endeavor.”

2. Cost savings for private companies

Reducing complexity and increasing disclosure effectiveness should result in financial reporting that is simpler and less costly. This is especially true for private companies. Rogers, who served on FASB’s former Private Company Financial Reporting Committee, believes FASB has already made meaningful accomplishments by adopting GAAP changes that simplified accounting and disclosures for private companies through the work of the PCC. “The reporting requirements and cost/benefit analysis are radically different for private versus public companies,” he said.

Users’ needs are different for each reporting company, and user demands have required preparers to disclose more information in different formats than they need to run their business—and more information than even GAAP requires. Rogers said the PCC’s accounting and disclosure simplifications for private companies make sense because private companies are more transparent to their financial statement users.

“A private company can tell its bankers things that a public company cannot, or can provide information in a more meaningful way, like by giving them a schedule and walking them through it,” he said. “… Audited financial statements of private companies should include a statement: ‘Additional information requests should be directed to [name].’ ”

3. More effective public company disclosures

The impact of the new initiatives for public companies is related to improving disclosure effectiveness. Susan Callahan, CPA, director, Americas Accounting and Global Accounting Policy at Ford Motor Co., said that what investors find useful may not always be the same as what is required.

“Our objective, in addition to compliance, is to disclose what is relevant for investors to make decisions,” she said. “Our investors will often ask questions about the business, and over the years and when appropriate, we have responded by modifying our disclosures to present the information they are requesting. This may not always cleanly align with what the standards require. We often find ourselves challenged in balancing our disclosures between what is required and what is relevant for the users, particularly when either the disclosure is for something that is immaterial, or when the volume or content of the required disclosure could obfuscate the important information.”

Callahan supports a global alignment of financial reporting standards because she believes consistency in financial accounting standards will help eliminate unnecessary complexity for global companies. She suggests that financial reporting should provide management with discretion for how to present the disclosures, unlike those standards that mandate not only the content but also the format. “Companies should at least have the discretion to decide whether a table is more or less useful than a narrative in order to comply with disclosure requirements,” she said.

4. Redeployment of finance resources

Reducing the level of complexity and reporting requirements may result in cost savings through efficiencies and reduction in required numbers of personnel. But the more likely outcome, experts say, is a redeployment of resources to improve the quality of reporting or to address other business needs.

“Every dollar spent in finance is a regulatory cost,” Rogers said. “But finance staff can partner within their organizations or with customers to make better business decisions, or pair up with information technology to fix systems or get real financial information to decision-makers. Junior accountants can be made into analysts to provide insight into other areas, like marketing, to improve ROI.”

Callahan agrees that simplification will have an impact on preparer resources and the quality of the disclosures.

“Once reporting is simplified and the disclosure processes have settled down, people should be freed up for more strategic thinking and analysis,” she said. “And the more we embrace principles-based, global standards, like the new revenue standard, we should replace time spent on disclosure compliance with time better spent on upfront analysis, documentation, and even more effective disclosures.”

5. Minimal changes for auditors and fees

Callahan does not believe that audit fees will be reduced in any significant way as a result of simplification, given new accounting standards, required audit documentation, and additional pressures from regulators, including the PCAOB.

Auditors say that applying private company accounting changes more broadly to simplify accounting for all companies is a positive development. Many companies had trouble with complex GAAP in areas such as impairment of goodwill and intangible assets, fair value, derivatives and hedging, and consolidation of variable-interest entities. These challenges resulted in difficult audit issues as well, and the time spent by all did not always result in financial information that was meaningful or useful to the users of those financial statements. Simplification in these areas of accounting should result in overall time and cost savings.

Accountants in public practice have an interest in simplification efforts because of the effect on their clients, firms, and staffs. This impact will depend on the types of clients in their practice and whether they include private companies eligible to use different frameworks. In general, small business clients stand to gain the most, but the audit workload isn’t expected to decrease significantly.

“PCC changes within GAAP are going to catch on and will be beneficial to small businesses that are unnecessarily impacted by complex standards,” said Harold L. Monk Jr., CPA, a partner with Carr, Riggs & Ingram. “For accounting firms, this may ultimately result in some decrease in time spent on engagements, but I don’t think the change will be so noticeable or extensive that it will impact gross revenues. It will just mean that we will be able to get jobs done more timely with some increase in margins.”

Duckwitz believes that the private company initiatives will provide some relief and be welcomed by companies and their auditors, but he does not expect them to cause a major change for RubinBrown or its clients.

“For most middle-market companies, the relief areas are narrow in scope, so I don’t think we will see a massive amount of relief for finance staffs,” he said. “We don’t expect a major change in our business or workload, as it is a relatively small piece of our overall engagements.”

6. New education and communication

Firms may have to address new and different available frameworks and standards in their training, procedures, and quality control.

“In firms with no centralized oversight of rules or system for dealing with new literature, like a national office standards group, new reporting models have the potential to be more challenging,” Duckwitz said.

It is important for CPAs to communicate with their clients about the new simplified frameworks that exist. Smaller companies may not be aware of options that are available to them and that would benefit their financial statement users, because they may not allocate resources to following emerging standards, Duckwitz said.

“Particularly in the area of FRF for SMEs, where preparers and users may be confused about the framework, CPAs can explain the differences upfront and why it may be a good fit, because it helps to eliminate some GAAP complexities,” he said.

Monk said more education for clients and their financial institutions about FRF for SMEs, so that they understand this basis as well as they understand the cash or tax basis, would likely lead to wider use of this framework.

“These changes can be beneficial to small businesses if they understand them,” he said.

7. Obstacles will remain—and emerge

While there is much going on to make financial reporting simpler, new standards on revenue recognition and leasing will add accounting complexity during implementation, as well as new disclosure requirements. The impact of such new standards intended to simplify accounting and improve consistency of financial reporting will need to be assessed over time as implementation and disclosure issues are addressed.

A challenge to companies that want to streamline their disclosures and remove information is their audit firm’s risk management and preference for more disclosure and reluctance to remove previously reported information. It may be easier for auditors to document companies’ compliance with standards when more disclosure is provided. This issue is more difficult for public company auditors subject to PCAOB inspections.

Standard setters and regulators are delivering a clear message through their simplification initiatives that they believe consistent, relevant, effective financial information is a goal with clear benefits to all. Preparers and auditors need to be vigilant in order to be prepared for the changes and take advantage of opportunities that simplification of standards may present.

Be ready to simplify

As regulators and standard setters work to simplify rules, preparers and auditors can prepare themselves by:

  • Being aware of emerging GAAP and financial reporting developments, along with what’s going on in private company accounting, including the Financial Reporting Framework for Small- and Medium-Sized Entities (FRF for SMEs), and changes that the Financial Accounting Foundation’s Private Company Council is developing.
  • Not getting caught by surprise. Watch the timing of pending literature, as certain standards can be adopted early or may affect prior-year financial statements. Early adoption might be risky. Evaluate whether these standards work for your company, and discuss them with primary users of your financial statements in advance.
  • Auditors: Becoming knowledgeable and able to discuss the standards with clients.
  • Preparers: Taking a fresh look at the notes to financial statements each year to make sure they are still relevant and comply with disclosure requirements. Then assess them from an operational and investor perspective to ensure they are useful and clear.
  • Auditors: When reviewing disclosures, thinking not only about the rules but about what FASB intended the rules to disclose.
  • Getting more involved with simplification initiatives. Read more. Choose continuing education in these areas. Get involved with professional organizations such as the AICPA. Volunteer to give back to the profession, and it will also help you to stay current on emerging developments in GAAP and financial reporting.

The pursuit of simplification

Regulators and standard setters are pursuing initiatives to simplify financial statement preparation and improve financial reporting. These include:

FASB: The Disclosure Framework Project’s objective is “to improve effectiveness of disclosures in notes to financial statements by clearly communicating information that is most important to users of each entity’s financial statements.” Part of this project is development of a framework for the board’s decision-making process while creating new standards and evaluating existing disclosure requirements. In June 2014, FASB launched a Simplification Initiative, identifying narrow-scope disclosure projects that the board can deliberate on to reach quick conclusions about changes that will reduce cost and complexity.

PCC: The Financial Accounting Foundation’s Private Company Council, created in 2012, determines when modifications to GAAP are needed for private companies to simplify accounting in complex areas, and proposes new GAAP alternatives (subject to FASB approval) that private companies can choose to adopt. It also advocates for private company interests in FASB standards.

FRF for SMEs: The Financial Reporting Framework for Small- and Medium-Sized Entities, developed by the AICPA and released in 2013, is a non-GAAP, special-purpose reporting framework that certain qualifying privately held companies may choose to use to simplify their accounting and reporting.

SEC: The SEC staff recommended in December 2013 that the commission undertake a comprehensive review of current SEC disclosure requirements as a starting point for overall disclosure simplification and effectiveness for all public companies. The intent of the SEC’s Disclosure Effectiveness project is to make disclosures less costly for preparers and more useful for investors.

IASB: The International Accounting Standards Board began a broad initiative in December 2012 to explore how disclosures in IFRS reporting can be improved and simplified. There are a number of projects and proposed amendments to existing standards included in the initiative. Amendments issued in December 2014 emphasize the importance of materiality and state that preparers should use professional judgment in determining the location and order of information in disclosures.

Maria L. Murphy (emailmariamurphy@gmail.com) is a freelance writer based in Wilmington, N.C.

To comment on this article or to suggest an idea for another article, contact Ken Tysiac, editorial director, at ktysiac@aicpa.org or 919-402-2112.

AICPA Resources

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