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SEC Roundtable on Uncertainty in Financial Reporting

Published on: 14 Nov 2011

Last week, the SEC held the first of a series of scheduled roundtables on financial reporting. In discussions that focused on measurement of uncertainty in financial reporting, the three groups of panelists addressed topics including (1) what investors (or users) expect from financial reporting, (2) what information is needed by investors to analyze companies and related uncertainty, (3) suggestions or recommendations to improve financial reporting, and (4) the auditor’s role in reporting uncertainty. Participants included representatives from the SEC, PCAOB, and FASB as well as from various constituent groups, such as investors, preparers, users, academia, and auditors.

A significant amount of discussion was devoted to what investors look for, particularly related to uncertainty in financial reporting. Most panelists in the investor group highlighted that financial reporting should focus on transparency, comparability, and objectivity. They noted that meeting these three objectives can be challenging because current accounting requirements contain numerous management estimates and that preparers apply the applicable accounting on the basis of their interpretation, facts and circumstances, and company-specific assumptions, which results in inconsistently prepared financial statements that are not comparable to those of other companies.

Panelists contended that “uncertainty will always exist” and offered the view that a more consistent approach to applying financial accounting standards to all companies (or registrants) should be developed — one that improves comparability between companies. In addition, panelists noted that increased disclosure of the specific inputs and assumptions used to determine fair value and other estimates should be required. Panelists believed that such increased disclosure would enable users to perform their own sensitivity analysis on available information without being required to first “unwind” transactions and substitute user inputs and assumptions for a company’s.

Also, users highlighted that they are generally more interested in understanding the cash flow effects of certain transactions or within certain accounts. Because of their focus on cash flows, users often discount registrant balances for noncash items (e.g., most users indicated that they often ignore goodwill impairments). The overall conclusion was that the complexity of current accounting, particularly related to noncash charges, brings more estimates into the financial statements and footnotes and increases overall uncertainty in financial reporting to an extent that an end user would not find useful.

Another area of focus was the role of the auditor. Most panelists believed that the external auditor’s role is to independently analyze the amounts recorded in the financial statements. While panelists indicated their general belief that the auditor’s responsibility should include understanding the inputs, methods, and assumptions used by management when preparing their estimates, most thought that identifying and appropriately reporting uncertainty are the responsibility of company management rather than external auditors.

While members of the roundtable panels offered their views, no decisions were made and no conclusions were reached regarding uncertainty in financial reporting. In remarks made throughout each of the three panel discussions, representatives from the SEC, PCAOB, and the FASB all indicated that the roundtable provided valuable insight that will help them better understand what investors are looking for in financial reporting as well as identify challenges faced by (1) registrants when preparing the financial statements and (2) investors when analyzing a registrant’s financial condition, results of operations, and cash flows.

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