DISCLOSURE EFFECTIVENESS

By Jacqueline Burke

The accounting profession has been under considerable scrutiny for its effectiveness in providing useful information to its users. According to Statement of Concepts No. 2, financial reporting should provide users with information that is useful in their decisionmaking process. Complaints have been made that users are overloaded and overburdened with information to the point that effective decisionmaking is hindered rather than helped. In March 1993, an article by Todd Johnson (staff member of FASB) appeared in Accounting Horizons, which called for research on disclosure effectiveness. In 1994, the Special Committee on Financial Reporting of the AICPA (the Jenkins Committee) investigated disclosure issues in its 1994 report Improving Business Reporting--A Customer Focus and recommended that "standard setters should search for and eliminate less relevant disclosures."

In the March 1995 issue of The CPA Journal, Ray Groves, retired chairman of Ernst & Young, expressed his concern on this country's financial disclosure process as follows:

"Many or most investors today do not have the time to read annual reports that contain very complex and lengthy disclosures. We need to, as professionals, help guide users to the key items they need for decisionmaking. We should make available clear, cogent, concise information for the typical user."

Specific accounting issues most frequently criticized in relationship to the magnitude of their disclosures include accounting for pensions, deferred income taxes, and leases. For example, our accounting standards currently require very detailed disclosures for pensions and other postretirement benefits (OPEB). Examples of information required include the total pension or OPEB expense for the period, the amount of the unfunded liability, service and interest cost components, the actual return on assets for the period, and the net total of all other components. In this and other articles, Grove raised issues such as: Does the average user need this information or, more importantly, use this information when making decisions? Would it be more reasonable only to provide the reader with total pension or OPEB expense for the period and the amount of the unfunded liability?

Also consider the accounting for deferred income taxes. Groves questioned the necessity of providing users with information currently required under SFAS No. 109, Accounting for Income Taxes. According to Groves, providing the financial statement users with the amount of total and deferred income tax expense is probably necessary for investment and credit decisions. On the other hand, it may not be necessary to provide users with the individual tax effect of various temporary differences for three years. Obviously, the key issue in making this decision is knowing whether or not the decisions of creditors and investors would be impacted by the inclusion or omission of such information.

According to the Jenkins Committee report, "Users have insatiable appetites for information. Some of that information is essential to their work, other portions are helpful, and the remainder is interesting but rarely results in key decisions."

SEC Response

In June 1995, the SEC issued a rule proposal Use of Abbreviated Financial Statements in Documents Delivered to Investors Pursuant to the Securities Act of 1933 and Securities Exchange Act of 1934, calling for abbreviated disclosures in the annual report to shareholders and other documents delivered to investors. The SEC proposed to eliminate automatic delivery of most footnotes to the financial statements, instead providing investors the option of requesting a copy of the footnotes from the company. The SEC decided not to proceed with the proposal, however, after reviewing over 1,500 comment letters received on the rule proposal. Although many respondents agreed there is too much information disclosed in financial statements, many expressed concern over the proposed changes by the SEC to address this issue. However, according to Meredith Cross, deputy director of the division of corporation finance of the SEC, the SEC still maintains a strong interest in improving disclosure effectiveness and is pursuing other ways to accomplish that goal, such as simplifying disclosure formats by using "plain English," known as the Plain English Initiative.

Response from Norwalk

Members of FASB have been actively involved in seeking ways to improve the disclosure process. In July 1995, FASB issued the prospectus, Disclosure Effectiveness, asking readers to consider changes that could be made to current disclosure requirements. FASB identified three approaches that could facilitate the process of simplifying financial statements:

* Elimination of less useful disclosures,

* Summary and two-tier financial reporting, and

* Reduction of disclosure overlap.

Eighty-five responses were received by the FASB in reply to the prospectus. Of these responses, 25 were research papers and academic comment articles and 60 were letters from CPAs and CPA firms, preparers, professional associations, and users. The majority of the letters provided support for some type of disclosure effectiveness project. Although there was no consensus on a method(s) of improving disclosure effectiveness, a significant number of respondents commented on disclosure problems with pensions, leases, and deferred taxes. Other accounting issues were also mentioned as problem areas, but these issues varied from firm to firm.

The Financial Accounting Standards Advisory Council (FASAC) met in January 1996 to discuss the responses to the prospectus. According to John Hepp, the FASB project manager, it was the opinion of staff that summary and two-tier reporting is not a feasible option based on results of comments the SEC received in response to its proposal. The staff also concluded that disclosure overlap should be addressed by the SEC "because FASB standards apply to a broader population of firms. Elimination of requirements on the basis of redundancy by the FASB could leave disclosure gaps for non-SEC firms." Consequently, the FASAC focused its discussion on the elimination of less useful disclosures. FASAC decided the most efficient way to approach disclosure effectiveness would be to consider specific problem areas. Accounting for pensions was chosen as the area to focus on first because many of the comment letters received focused on pension disclosures as a major concern.

Both the FASAC and the FASB staff concluded it would be feasible to carry out a project to improve the disclosures of pensions. The group identified several disclosures that are of interest to users that are not currently provided. Those disclosures explain the change in the funded status of the plan during the reporting period. Also identified as not being relevant were disclosures that--

* in practice, are too broad to provide users with useful information, and

* explain the difference between the funded status of the plan and the amount at the balance sheet date.

The staff also proposed to address OPEB when conducting this project because of the similarity in accounting issues.

What would the cost of the proposed changes be to the practitioners who prepare these statements? FASB staff believes there would be no extra costs to preparers because the information needed is available from actuarial figures already computed in the process of providing current disclosures. There are also little or no cost savings to the reporting company from eliminating those disclosures that are least relevant. According to Hepp,

The primary benefits of the revision accrue to users. The disclosures are more complete and would make it easy to discern the effects of amendments, acquisitions, divestitures, and current period cash flows that are now obscure. Considerable effort must now be expended to derive or estimate those amounts. Elimination of general disclosures that in practice have become little more than boilerplate would make the disclosures easier to read.

The board reviewed the project proposal at its August 7, 1996, meeting. Out of concern that those who supported reducing disclosures would disapprove the proposal because it actually added disclosures, the board decided to hold a special meeting on August 29, 1996, with representatives of various public constituents, including members of the Financial Executives Institute (FEI), the Association for Investment Management and Research (AIMR), and the Pension Benefit Guaranty Corporation (PBGC). The majority of those present strongly supported continuing with a project to revise pension disclosures. There were no criticisms about the additional disclosures proposed, but some disclosures proposed to be eliminated were added back based on responses from those present at the meeting.

The FASB is moving forward with its plans to improve disclosure effectiveness by proceeding with a project to amend disclosures for pensions and OPEB, researching further the purposes of disclosure and other specific disclosure issues such as deferred taxes and leases. The FASB plans to issue an exposure draft in May 1997 addressing the proposed changes to the accounting for pensions or other postretirement benefits. The anticipated comment deadline date is July 31, 1997, and a target date for a new standard is scheduled for
October 1997.

Only time will determine to what extent, if any, that disclosure policies will be revised. FASB's plans for addressing specific issues certainly seem more feasible than implementing policies that change our entire set of standards. Since the underlying goal of FASB's project is to improve the quality and relevance of information for decisionmakers, now is the time for users and preparers to express their viewpoints on the matter. Comments should be sent to:

John Hepp

Financial Accounting Standards Board

401 Merritt 7

P.O. Box 5116

Norwalk CT 06856-5116 *

Jacqueline Burke, CPA, is an instructor at Hofstra University and a PhD student in business education at New York University.

Editor:
Douglas R. Carmichael, PhD, CPA
Baruch College