Robert Elliott: leading the profession. (interview with the chairman of the American Institute of Chartered Public Accountants' Special Committee on Assurance Services) (Interview)by Craig, James L., Jr.
Robert Elliott is a man of vision and true intellect. He is comfortable discussing ideas and concepts in the offices of his partners at KPMG Peat Marwick LLP, in the meeting rooms of standard setters, and in the halls of academia. He is respected by all who gather in the name of what's good for the accounting profession and those in it. Just recently he was appointed chair of the AICPA Special Committee on Assurance Services, whose charge is to explore expansion of the assurance function, together with the existing attest function, into new areas of reformation--financial and nonfinancial--and systems that generate such information.
Elliott also served on the AICPA Special Committee on Financial Reporting under the chair of Edmund Jenkins. Elliott's committee is a natural follow-up to the work of the Jenkins committee.
The CPA Journal Managing Editor, James L. Craig, Jr., had a conversation with Robert Elliott to gain some insight into the work of the Jenkins committee and to learn about his plans for his special committee.
The CPA Journal: Let's begin the conversation with your activities and experience with the Jenkins committee. The committee has just issued its final report after over three years and two extensions of time. Previously, all the committee had officially produced was a report, The Information Needs of Investors and Creditors, that gave the results of research but did not really say what the final report would be or look like.
Robert Elliott: The committee had also issued a working document that we exposed to the preparer community that contained our proposed model for financial reporting and presented an example of financial reporting using the model. We wanted preparers to give us feedback on the cost of implementing the model. The distribution was limited. Our final report considers what we learned from reactions to these earlier reports. It is actually two reports. The full report of over 200 pages contains the detailed recommendations and a comprehensive example of reporting employing the recommendations. The long-form report will have somewhat limited distribution to standard setters, state societies, academics, accounting firms, and the like. It will also be available in diskette form and on the Internet. The second report is a shorter, glossy version of approximately 20 pages, which is going to all AICPA members and is being broadly distributed throughout the business and regulatory communities. In addition, our 1,600-page database, as a result of our work, is available.
CPAJ: Why did it take so long to complete the project? Was it difficult for the committee to make decisions or reach a final conclusion?
Elliott: In the process of deciding how to proceed with the project, after a few false starts, it became apparent we needed to understand what users of financial information needed. As soon as we put the focus on the user, we eliminated all technical bickering among ourselves about what was the best accounting--pooling versus purchase, historical cost versus fair value, etc. But where to find out what users need and want? Incidentally, for our purposes we limited our population of users to investors and creditors. We thought we would research what was written about deficiencies in financial reporting and what additional information would be helpful. We co-opted a group of professional staffers from our members' firms to analyze all the literature on what's wrong with, and how to improve, financial reporting and enter it into a database. Much to our chagrin, when we began analyzing the data we found users were not speaking. It was CPAs saying what users need, it was preparers saying what users should have, and it was academics saying what was wrong with the system. But users were silent--they just don't publish very much.
We also realized that while the FASB has a user-oriented mission, the users don't participate that much in responding to its proposals.
CPAJ: Why is that?
Elliott: Users are often reluctant to share their insights for competitive reasons. For example, why would an investor who thinks he or she has a special angle on information that gives a competitive advantage in finding that winning investment want to reveal that angle to everybody else? And users--investors and creditors--don't have the infrastructure to respond to FASB proposals and voice their opinions.
CPAJ: The committee, having decided to focus on users' needs, was left high and dry after some time had slipped by?
Elliott: We had no choice but to undertake the research by ourselves. We formed two users' groups--investors and creditors. We met with them repeatedly. We were able to identify issues, mull them over, challenge them, and finally evaluate them. We boiled down all the discussions and conclusions into a 100-page document, comprising 19 issues with some sub-issues. This process, along with our other research, quickly used up our two-year time allotment and we were forced to apply for a one-year extension to May 1994. And, as you know, that was not enough, as we have just now released our final report.
CPAJ: What did you do after you knew what users wanted?
Elliott: As I mentioned, we developed a financial model and a set of financial statements, which we circulated to the preparer community, principally through the Financial Executives Institute. We also had Lou Harris do a survey of 1,200 users to see if our conclusions were on target. The results of the poll helped us to free tune the model and illustrative financial statements that are the main thrust of the final report. The survey permitted us to rank user needs, most important to least important. For example, it became clear that number one--users want more and better segment information, and they want it more frequently.
CPAJ: Do you think the committee has accomplished what it set out to do? Are you satisfied with the outcome?
Elliott: I think the committee would have made a significant contribution even if no report had been issued. That contribution is changed behavior on the part of standard setters. The FASB has been a very active and close observer of our work. Three Board members have been intimately involved, and I would guess a dozen staff members have participated in some manner. The result is that the FASB has recognized the benefit of greater input from users and has learned from our successes and failures how to get that input. The Board has already allocated blocks of time to consider the committee's recommendations.
The SEC also had an observer at our meetings and we briefed the senior SEC staff from time to time. They too have already absorbed much from the process.
CPAJ: Does the report overturn everything that we hold dear?
Elliott: No, no. When we first started down the track of finding out what users needed, I felt we had to proceed cautiously. We had to get their input, but recognized that their input would not lead to a break- through product. As an analogy, if Thomas Edison had asked users of his day what they wanted, they would have told him they want a candle that bums 24 hours and doesn't smoke or drip. The last thing they would have asked for is an incandescent lamp. Our users also asked for incremental changes. The result is that our recommendations and model are somewhat conservative.
For example, users don't want fair-value statements. They want fair- value information in the notes. They are not very concerned about accounting alternatives--purchase versus pooling, how goodwill is treated, or capitalization of leases. They are interested in opportunities and risks--the upside and downside potentials. They are interested in more nonfinancial information, strategies, competitive position, and leading indicators.
The fact that our recommendations are conservative means that standard setters can begin to implement them immediately. They can be added to the existing model on a piecemeal basis.
CPAJ: I have to admit I breathed a sigh of relief when I saw the November report that did not throw the historical-cost baby out with the bath water.
Elliott: A disadvantage of responding to expressed user needs, however, is that it doesn't take us very far into the future. Looking back at the pace of change and technological improvements over the past 10 or 12 years--PCs on every desk, local area networks, wide area networks, downsizing by eliminating white-collar jobs on top of blue--we can expect every bit as much change in the next 10 or 12 years. Therefore we also established a break-through model task force, with some non- accountants, to look at what the needs would be in the year 2005. Will reports still be issued on paper? How will today's segment information be transformed by technology? It will probably be multi-dimensional with information by function, by industry, by geography, by type of customer, by location of customer. The only limiting factor will be the coding system used to capture transactions. With information available on networks, the user will be able to decide how to analyze and present the data.
CPAJ: How has the preparer community reacted to the committee's conclusions and recommendations?
Elliott: The range is from skeptical to hostile. It's a combination of things. First, as can be seen in the comments on FASB proposals, preparers generally oppose changes in accounting. No one likes the scoring rules to be changed in the middle of the game. Another thing, they fundamentally do not wish to reveal any more than they have to. They are concerned with competitive costs. For example, U.S. preparers resent that they have a higher level of disclosure than do overseas companies with which they compete. They are also concerned with the cost of providing information.
Notwithstanding their concerns, preparers gave the committee a lot of help in evaluating our recommendations--both the cost and the value. We did respond to many of their concerns.
CPAJ: Did the committee just take what users wanted and put it in the form of a model?
Elliott: No, we overlaid our other research and our professional judgment as to what is wanted versus what is needed, reflecting cost and competitive considerations.
CPAJ: How will the report impact financial reporting for nonpublic companies, for smaller entities? Their users are more likely to be creditors.
Elliott: Don't overlook owners as users. Often the CPA is the de facto CFO. We had five representatives of regional and local CPA firms on the committee--including Robert Israeloff, soon to be Chairman of the AICPA- -and they vigorously articulated the interests of smaller entities.
A basic tenet of our recommendations is that there is a set of financial statements, including segment information, as a minimum for every company. Beyond that there are other information modules, such as operating data, management's analysis, and forward-looking information, like opportunities and risks. The modules to be provided can be negotiated between the company and user. The result is a menu of choices. We expect there will be negotiations between user and preparer. The bank may say it wants the opportunities and risks module. The company will counter with how much it will cost and how long it will take. They will negotiate the financing terms, including the information modules to be provided and the interest rate on the loan. Perhaps with just the basic information the loan would be at prime plus three percent, but with the opportunities and risks module, it would be prime plus two percent. Normally, of course, it won't be this explicit, but that's the general idea.
CPAJ: Overall, are you satisfied with the results of the committee's work?
Elliott: I'm willing to work very hard for change to keep pace with the world around us. As you know from my writings, some of which have appeared in The CPA Journal, my concerns about the pace of change in the profession go much deeper than the committee was able to deal with. And so in that sense I feel the report and recommendations are conservative. But when you look at what's realistic, there is a lot of substance to the report and it represents a milestone. I don't think there has been anything quite like it since the Trueblood report in 1973.
CPAJ: What about auditor involvement with the new model and its nonfinancial information?
Elliott: We addressed this issue as we proceeded, asking the question for each proposed module: should it be subject to audit or some auditor involvement? We concluded that some components should get the traditional audit opinion. Other sections might be reported on in a similar manner to that of a forecast, that is, that it's based on reasonable assumptions. And there may be some parts that are not auditable. The aspects to be audited will be subject to negotiation between preparers and users in the manner discussed earlier.
Many users feel that auditors know more than they are telling. So they would like to see qualitative, evaluative reporting. Eighty percent of the respondents to the Harris poll said if the auditor had a different opinion than management on key reporting issues, they wanted to hear about it. But this is not popular with preparers.
CPAJ: Did your new special committee--the Special Committee on Assurance Services--spring from the need to explore how to audit the new financial model?
Elliott: Not really. The Jenkins report talks about applying traditional audit services to the new model. The new committee's task comes primarily out of visioning being done by leading professionals as to what can be done to refresh the audit product.
One problem is that financial statements are declining in value and losing relevance because of technology and other factors, which forces investors to turn elsewhere to get the information they need. As the value of the financial statements declines, so does the value of our audit report on them. We have to look beyond trying to deliver a better audit of the traditional financial statements. We must focus on the information users are currently demanding or will demand and see if our competence and skills can provide assurance services with respect to that information. Is there some way we can redeploy our very talented group of auditors to create more value for the people using our services? That is one question.
Another problem is that our traditional audit does not enhance all aspects of the quality of information. It focuses on only reliability. But there is a steady and vast flow of information going to users, and reliability is not the only issue. Is it the right information? Is it relevant? Is it timely? What is it we can do to enhance the total quality of the information they receive? There is much we could do to help. This can be demonstrated by looking at the accompanying figure. It appears in my article, "The Future of Audits," in the September 1994 issue of the Journal of Accountancy. The small red cube is the scope of existing services. But if we move beyond this to dealing with relevance, systems, and nonfinancial information, the door is opened to provide a wide range of additional services.
CPAJ: So your assignment is to find ways to expand the services the profession offers and ultimately expand the market for our services? In effect, feather our own nest?
Elliott: "Feather our own nest" sounds a bit self-serving. I'd prefer to say that by making our customers better off, we'll be better off too. For that I don't apologize.
When I recently met with financial executives, they voiced their suspicions that this was all about increasing audit fees. I responded that I was sure every one of their companies was trying to find ways to better satisfy their customers' needs in the hopes of increasing their revenues. I also said that we certainly wouldn't be able to increase our fees unless we created more value for them. I feel strongly that this is all about creating more value. If we can do that, we'll naturally prosper.
The reason we presently feel pressure on fees is that we are delivering a product that is somewhat old fashioned, not worth as much. People are not going to pay us more to give opinions on less relevant information. But if we can make a company better off in terms of lower capital costs or by helping it better serve its customers, it will be glad to pay our fees.
There is a unique aspect to the services we provide that limits us in distinguishing one CPA firm from another, as is the case between one make of automobile and another. That is the fact that we conduct our services in accordance with professional standards. A CPA firm can't compete on the basis of different GAAS or different GAAP. The whole profession must move in lockstep. My committee's charge reflects an attempt by our profession to upgrade our product. I hope we will be better off because of it.
That's not to say the committee will necessarily move in the direction of the accompanying figure. Our mission is to see if we can expand the value of an extended assurance function. The idea for the committee came out of a conference held in Santa Fe in 1993. The attendees concluded there was a need to expand the role of the auditor from reporting on the reliability of management's assertions, usually financial statements, to assurance services involving reports (written or oral) on the reliability or relevance of management's assertions or systems. This is a much bigger umbrella than today's audits.
Technology threatens our existing product. It also provides opportunity for new services. But someone else, unlicensed and uncredentialed, could exploit these opportunities before we are prepared to deal with them. A technology-based organization could conceivably enter the picture as a middle-person to suck in information; analyze, interpret, verify, and organize it; and deliver a report or other product to a third-party user. It could gobble up our markets.
CPAJ: As we are licensed by state boards of accountancy, do we have to keep them up to speed with what we are doing?
Elliott: I don't believe we can depend upon our licensing to keep our services in demand or maintain our "monopoly." Suppose Dow Jones came along with a software-based reliability-enhancement product that could beat our quality and beat our price. Do you think our monopoly would hold? Our insurance policy is to continuously increase the value of our services.
The whole foundation of licensure of accountants is third-party reliance, the audit function. To a greater and greater extent that function is being concentrated in a smaller and smaller number of firms. There is no license requirement for tax or consulting. As a result, the CPA exam is oriented toward audits; the ethics codes of the licensing and professional bodies are oriented to audits. But what most CPAs do is not audits. If you look at the total value of securities and loans in the U.S., my guess is that 20 CPA firms audit more than 80% of that value. Many years ago, the publicly recognized brand name for doing audits was "CPA," Increasingly, the recognized brand names are the names of the firms that dominate the audit business. As a result, my firm doesn't need the "CPA" on its letterhead to signal its credibility or competence. If we give an opinion on software performance, we don't need a CPA license.
CPAJ: Getting back to product improvement. Is that just a large-firm benefit?
Elliott: This product improvement program is not just for large firms. There are a lot of factors at work that are shrinking the market for services for local and smaller firms. First, many are giving up audits because of the liability exposure. Second, off-the-shelf, user-friendly accounting software is eating into the write-up market. And finally, $49 tax-preparation software is eroding the market for tax services. All CPAs will be looking for other opportunities for service. And clients of small firms are also concerned about accurate, timely, relevant information to help better run their businesses.
CPAJ: How is your committee shaping up? Who is on it? Will smaller firms be represented?
Elliott: We will have members from local, regional, and national CPA firms as well as the GAO. In addition, we will have two academics and, if all goes well, several "customer" representatives.
CPAJ: Is one of your charges to consider how to do a better audit? Jake Netterville, when he was Chairman of the AICPA, said we are going to catch all significant fraud. Can you help?
Elliott: That's an important issue, but it's not in our charge. That type of question is better answered by standard setters and researchers.
CPAJ: What about additional exposure to liability? Will your deliberations ignore that aspect of taking on new services?
Elliott: New products may create new liabilities, and that's a concern. The Jenkins committee has made some of its recommendations subject to some relief, perhaps a safe-harbor approach. That relates principally to reporting on forward-looking information. Interestingly, the Dodd- Domenici bill in the Senate includes a safe harbor for forward-looking information, not at the profession's request, but at the request of the high-tech community. However, we do not have the luxury to wait for liability reform. We must work on liability reform while at the same time exploring product enhancement.
CPAJ: Why do we underprice the audit, the one thing we have an exclusive license to do?
Elliott: When you say we underprice, it sounds like a voluntary act. But audits are provided in a competitive market. Auditors probably charge as much as they can. However, prices are depressed by two factors. Excess capacity in the audit profession leads to competitive bidding. And the decreasing relevance of GAAP has undermined the value of our audit to investors and creditors. The best way to increase our prices is to increase the value we create.
CPAJ: Observers would say the large firms are compensating for the loss on audits through the other services--tax and consulting.
Elliott: I can't speak for other firms. But my firm is not giving away audit services to get other work.
Audits have a great deal of value. If a company's financial statements are believable, it considerably reduces their cost of capital. Let's assume having reliable financials reduces the cost of capital for a very large company by a modest 25 basis points. For a large client I'm thinking of, that translates into annual savings of about $500 million. And, believe me, our audit fee is less than that! Our fee is lower because of competition, which drives it down toward the marginal cost of the low-cost producer. But we are not going to do audits for less than cost, including a reasonable return for our partners' time.
CPAJ: Bob, thank you for meeting with me today. I think our readers will be better able to understand the recommendations of the Jenkins committee because of the background and insights you have provided. And we look forward to the output of your special committee in the fall of 1996. It is time to modernize the assurance function, and with your leadership, it can be done.
THE CONSUMMATE PROFESSIONAL
Robert K. Elliott, CPA, is a partner in the Executive Office of KPMG Peat Marwick in New York and is currently Assistant to the Chairman. His responsibilities include strategic planning, government affairs, and intra-professional relations. He has at various times headed technology strategy, audit research, and audit policy formation for the U.S. firm and was instrumental in harmonizing worldwide policy after the Peat Marwick International-KMG merger in 1987.
Elliott chairs the Special Committee on Assurance Services of the AICPA. This committee is charged with broadening the traditional audit/attest function to create more value for information users and revitalize the public accounting profession's core service.
He is a past member of the AICPA's Board, Council, Strategic Planning Committee, Future Issues Committee, Auditing Standards Board, and Special Committee on Financial Reporting. He is also a past Vice President of the American Accounting Association and past member of its Executive Committee, Council, and Accounting Education Change Commission.
His publications, as author or coauthor, include five books and more than sixty articles.
The CPA Journal is broadly recognized as an outstanding, technical-refereed publication aimed at public practitioners, management, educators, and other accounting professionals. It is edited by CPAs for CPAs. Our goal is to provide CPAs and other accounting professionals with the information and news to enable them to be successful accountants, managers, and executives in today's practice environments.
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