ADVISORY COMMITTEE 

ON IMPROVEMENTS TO 

FINANCIAL REPORTING 

DRAFT DECISION MEMO 

January 11, 2008 
Advisory Committee 

on Improvements to Financial Reporting 

Draft Decision Memo

TABLE OF CONTENTS 

Chapter 1: Introduction..............................................................................2 

Chapter 2: Substantive Complexity................................................................7 

Chapter 3: Standard-Setting Process .............................................................28 

Chapter 4: Audit Process and Compliance......................................................55 

Chapter 5: Delivering Financial Information....................................................74 

Appendices............................................................................................95 

A – Committee Members, Official Observers, and Staff 

B – Examples of Substantive Complexity 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

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CHAPTER 1: INTRODUCTION 

In July 2007, the United States Securities and Exchange Commission (SEC or 

Commission) chartered the Advisory Committee on Improvements to Financial 

Reporting (Committee). The Committee’s objective is to examine the U.S. financial 

reporting system to identify ways to improve it. To accomplish its objective, the 

Committee is focusing on ways to make information presented by U.S. public companies 

more useful and understandable for investors, while reducing the complexity of such 

information to investors, preparers, and financial professionals. 

The Committee believes that financial reporting should provide information that aids 

users in making investment, credit, and similar resource allocation decisions.1 However, 

some argue that over time, financial reporting has become a burdensome compliance 

exercise with decreasing relevance to users. This effect can be attributed, in part, to i) the 

fact that evolution of new business strategies and financing techniques stretches the limits 

of what the traditional reporting framework can effectively convey, and ii) an overly 

litigious culture that, arguably, results in financial reporting designed as much to protect 

against liability as to inform investors. As a result, the Committee believes the 

disconnect between current financial reporting and the information necessary to make 

sound investment decisions has become more pronounced. 

A key factor often cited as driving this disconnect is complexity, which has rarely been 

defined in this context. The Committee proposes to apply the following definition of 

complexity during its deliberations on financial reporting. 

Definition of Complexity 

The state of being difficult to understand and apply. Complexity in financial 

reporting refers primarily to the difficulty for: 

(1) users to understand the economic substance of a transaction or event and the 

overall financial position and results of a company, 

(2) preparers to properly apply generally accepted accounting principles (GAAP) and 

communicate the economic substance of a transaction or event and the overall 

financial position and results of a company, and 

(3) other constituents to audit, analyze, and regulate a company’s financial reporting. 

1

Adapted from the FASB Preliminary Views document and IASB Discussion Paper, Conceptual 

Framework for Financial Reporting: Objective of Financial Reporting and Qualitative Characteristics of 

Decision-Useful Financial Reporting Information, issued on July 6, 2006, which states, “The objective of 

general purpose external financial reporting is to provide information that is useful to present and potential 

investors and creditors and others in making investment, credit, and similar resource allocation decisions.” 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 2 -
Complexity can impede effective communication through financial reporting between 

a company and its stakeholders. It also creates inefficiencies in the marketplace (e.g., 

increased preparer, audit, user, and regulation costs) and suboptimal allocation of 

capital. 

Causes of Complexity 

Significant causes of complexity include (not an all-inclusive list): 

(1) Complex activities – The increasingly sophisticated nature of business 

transactions can be difficult to understand, particularly with respect to the 

growing scale and scope of companies with operations that cross international 

boundaries and financial reporting regimes. 

(2) Incomparability and inconsistency – Incomparable reporting of activities within 

and across entities arises because of factors such as exceptions to general 

principles, bright lines and the mixed attribute model. Some of this guidance 

permits the structuring of transactions in order to achieve particular financial 

reporting results. Further, to the extent new pronouncements are adopted 

prospectively, past and present periods of operating results are not comparable. 

This is compounded by the rapid pace at which new accounting pronouncements 

are being adopted, which hinders the ability of all constituents to understand and 

apply new guidance in relatively short timeframes. 

(3) Nature of financial reporting standards – Standards can be difficult to understand 

and apply for several reasons, including: 

• Opposing points of view, such as lobbying on both sides of a debate, that are 

taken into account when developing standards. Most importantly, attempts by 

public companies to smooth amounts that are not smooth in their underlying 

economics contribute to complexity. 

• The challenge of describing accounting principles in simple terms (i.e., “plain 

English”) for highly sophisticated transactions; 

• The presence of detailed guidance for numerous specific fact patterns; 

• The impact of multiple bodies setting standards over time; 

• The development of such standards on the basis of an incomplete and 

inconsistent conceptual framework. 

(4) Volume – The vast number of formal and informal accounting standards, 

regulations, and interpretations, including redundant requirements, make finding 

the appropriate standard challenging for particular fact patterns. 

(5) Audit and regulatory systems that challenge the use of professional judgment – 

The risk of litigation and of being “second-guessed” creates significant 

consequences for failing to communicate unbiased financial information 

appropriately. 

(6) Educational shortcomings – Undergraduate and graduate education in accounting 

have traditionally emphasized the mechanics of double-entry bookkeeping, which 

favors the use of detailed rules rather than the full understanding of relevant 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

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principles. The same approach is evident in the CPA exam, as well as continuing 

professional education requirements. 

(7) Information delivery – The need for information varies by investor type and is 

often driven by a legal, rather than a user, perspective. In addition, the amount 

and timing of information, as well as the method by which it is transmitted, may 

result in complex and hard-to-navigate disclosures that cause users to sort through 

material that they may not find relevant in order to identify pieces that are. These 

factors make it difficult to distinguish the sustaining elements of an entity from 

non-operating or other influences. 

The Committee observes two types of substantive complexity exist: (1) unavoidable 

complexity, which is a function of the underlying transaction or item being accounted for, 

such as the first cause of complexity noted above, and (2) avoidable complexity, which is 

introduced from other sources. The Committee’s focus is on avoidable complexity, with 

an emphasis on improvements that are feasible in the near term. 

More specifically, the Committee's charter identifies the following areas of inquiry to 

make financial reporting more useful and understandable for investors: 

• The current approach to setting financial accounting and reporting standards, 

including (a) the principles-based vs. rules-based standards, (b) the inclusion within 

standards of exceptions, bright lines, and safe harbors, and (c) the process for 

providing timely guidance on implementation issues and emerging issues; 

• The current process of regulating compliance with accounting and reporting 

standards; 

• The current system for delivering financial information to investors and accessing 

that information; 

• Other environmental factors that drive avoidable complexity, including the possibility 

of being second-guessed, the structuring of transactions to achieve an accounting 

result, and whether there is a hesitance by professionals to exercise professional 

judgment in the absence of detailed rules; 

• Whether there are current accounting and reporting standards that do not result in 

useful information to investors, or impose costs that outweigh the resulting benefits; 

and 

• Whether the growing use of international accounting standards has an impact on the 

relevant issues relating to the complexity of U.S. accounting and reporting standards 

and the usefulness of the U.S. financial reporting system. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 4 -
Upon conclusion of the Committee's work (and possibly at interim dates), the Committee 

will provide written recommendations to the Chairman of the SEC on how to improve the 

financial reporting system in the U.S. These recommendations may cover many aspects 

of the financial reporting system for the SEC to consider, including recommendations 

that involve the Financial Accounting Standards Board (FASB), the Public Company 

Accounting Oversight Board (PCAOB), and other appropriate organizations. 

In order to maximize the benefits of this Committee, it intends to issue a limited number 

of recommendations. The Committee intends for the recommendations to be doable; that 

is, they will be adoptable by administrative action and not require legislation. The 

Committee also intends for the recommendations to be focused. It acknowledges that 

financial reporting involves myriad aspects and does not expect to address every issue. 

Instead, the Committee seeks to focus on those areas where there is a consensus that a 

problem exists and where it is feasible to find ways to implement improvements. As part 

of this focus, the Committee has limited its deliberations to matters involving SEC 

registrants. While financial reporting matters and, more specifically, GAAP, similarly 

apply to private entities, including nonprofit organizations, the Committee has taken this 

approach in its role as an advisory committee to the SEC. 

The Committee has also focused its scope as it relates to international matters. The 

Committee notes that the SEC recently adopted rules to no longer require a U.S. GAAP 

reconciliation for foreign private issuers reporting under IFRS as issued by the IASB, and 

issued a concept release to explore a more far-reaching prospect – the possibility of 

giving domestic issuers the alternative to report using IFRS. The Committee has 

proceeded on two premises: (1) that, despite any potential actions by the Commission to 

permit IFRS reporting by domestic issuers, U.S. GAAP will continue to be utilized by 

many U.S. public companies for a significant number of years, and (2) that the 

convergence process between U.S. GAAP and IFRS will continue. As a result, the 

Committee believes it is productive to make recommendations on improving U.S. GAAP, 

as well as the related processes at the FASB, the PCAOB and the SEC. At the same 

time, the Committee will point out how its recommendations can be coordinated with the 

work of the IASB and the development of IFRS, with the objective of promoting 

convergence. 

To facilitate the forming of these recommendations, the Committee has created 

subcommittees which report to the Committee for full discussion and deliberation. The 

subcommittees are listed below. 

I. Substantive Complexity 

II. Standard-Setting Process 

III. Audit Process and Compliance 

IV. Delivering Financial Information 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 5 -
Matters related to international coordination will be addressed, as appropriate, as part of 

the Committee’s deliberations beginning in 2008. 

The purpose of this draft decision memo is to present the Committee’s developed 

proposals, conceptual approaches, and future considerations based on the Committee’s 

work to date. Developed proposals are sufficiently formed so that, shortly after approval 

at this meeting, they will be formally submitted to the Commission. Conceptual 

approaches differ from developed proposals in that conceptual approaches represent the 

Committee’s initial discussions and leanings on a particular subject, but still require 

significant additional deliberation prior to formalization into a developed proposal. 

Future considerations represent areas where deliberation is still pending. 

Questions for the Committee: 

1.1) Do you agree with the proposed definition of complexity? Are there any 

revisions you would recommend? 

1.2) Have the most significant causes of complexity been identified? If not, what 

other causes should be considered? How might they be addressed? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 6 -
CHAPTER 2: SUBSTANTIVE COMPLEXITY 

I. Scope 

This chapter of the Draft Decision Memo focuses on avoidable substantive complexity 

that currently exists in GAAP. Subsequent chapters address financial reporting 

improvements through changes in the standard-setting, audit, regulatory, and information 

delivery processes. 

The Committee has identified the following manifestations of avoidable substantive 

complexity: 

• Exceptions to general principles in the form of: 

o Industry-specific guidance 

o Alternative accounting policies 

o Scope exceptions other than industry-specific guidance 

o Competing models 

• Bright lines 

• Mixed attribute model and the appropriate use of fair value 

Exceptions to general principles create complexity because they deviate from established 

standards that were developed in due process. In effect, users and preparers no longer 

speak a uniform language to communicate financial information; they must learn new 

dialects. Other constituents in that communication process are similarly impacted. 

Bright lines are problematic because they create superficial borders along a continuous 

spectrum of transactions. However, the more fundamental issue is the fact that financial 

reporting standards require drastically different accounting treatments on either side of a 

bright line. 

The mixed attribute model results in amounts that are a blend of accounting conventions. 

Some assets and liabilities are measured at historic cost, others at lower of cost or market, 

and still others at fair value. Combinations or subtotals of these numbers thus may not be 

intuitively useful to users. While some advocate using fair value for the entire balance 

sheet as a solution, there are difficult questions about relevance and reliability with which 

to contend, including considerable subjectivity in the valuation of thinly-traded assets and 

liabilities. 

The remainder of this chapter discusses each of these areas and the manner in which they 

contribute to complexity in greater depth. It also contains developed proposals or 

conceptual approaches to reduce their effects. The sequence in which these areas are 

presented does not necessarily indicate their relative priority to one another. Rather, 

certain areas warrant additional research and deliberation before reasonable proposals can 

be fully developed, such as the mixed attribute model and more meaningful grouping of 

This report has been prepared by the individual subcommittee and does not necessarily reflect either the 

views of the Committee or other members of the Committee, or the views or regulatory agenda of the 

Commission or its staff. 

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individual line items on the financial statements. The Committee intends to pursue these 

topics in 2008. Lastly, while deliberations have been conducted primarily in the context 

of U.S. GAAP, the Committee believes that its analyses and proposals are similarly 

applicable under IFRS. 

Questions for the Committee: 

2.1) Do you agree with the scope in the area of substantive complexity? Are there 

any areas you would recommend adding, removing or revising? 

II. Exceptions to General Principles 

II.A. Industry-Specific Guidance 

Background 

Industry-specific guidance refers to (1) exceptions to general accounting standards for 

certain industries, (2) industry-specific guidance created in the absence of a single 

underlying standard or principle (e.g., Statement of Position 97-2, Software Revenue 

Recognition), and (3) industry practices not specifically addressed or based in GAAP. 

Industries covered by this guidance include, but are not limited to, insurance, utilities, oil 

and gas, mining, cable television companies, financial institutions, real estate, casinos, 

investment companies, broadcasters, and the film industry. Refer to Appendix B for 

specific examples. 

Industry-specific guidance can be categorized in one of the following: 

• Guidance that is consistent with generalized GAAP – for example, certain guidance 

in AICPA Accounting and Auditing Guides is issued to assist preparers in 

interpreting and applying existing, generalized GAAP. 

• Guidance that is inconsistent with generalized GAAP – for example, SFAS No. 51, 

Financial Reporting by Cable Television Companies, requires that initial hookup 

revenue (a type of nonrefundable up-front fee) is recorded to the extent of direct 

selling costs incurred. The remainder is deferred and recorded in income over the 

estimated average period that subscribers are expected to remain connected to the 

system. However, SEC Staff Accounting Bulletin (SAB) 104, Revenue Recognition, 

(as codified in SAB Topic 13) which provides more generalized guidance, indicates 

this practice is inappropriate unless it is specifically prescribed elsewhere (such as 

SFAS No. 51). Therefore, similar activities like up-front fees for gym memberships 

are not afforded equal treatment. 

• Guidance for which no generalized GAAP exists – for example, SoP 81-1, 

Accounting for Performance of Construction-Type and Certain Production-Type 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 8 -
Contracts, discusses revenue and cost recognition in areas such as the construction 

industry, due to the absence of a general revenue recognition standard. 

Industry-specific guidance has developed for a number of reasons, including: 

• A lack of general standards in certain areas of GAAP (e.g., a single comprehensive 

revenue recognition standard). 

• The activities of multiple standard-setting organizations. 

• A desire by some to customize accounting standards for allegedly “special” 

transactions and user needs (each industry believes it is unique). 

• A desire by some, including preparers, users, standard-setters, and regulators, to 

enhance uniformity throughout an industry. 

• A tendency by industries to develop their own practices in the absence of applicable 

authoritative literature, coupled with the documentation of such practices by standardsetting organizations (i.e., documentation of what preparers are doing rather than 

consideration of what they should be doing). 

Industry-specific guidance contributes to avoidable complexity in the following ways: 2 

• Incomparable and inconsistent reporting, such as: 

o Reduced comparability across industries, if conflicting accounting models are 

used for transactions with similar or identical economic substance. 

o Improper analogizing to industry standards in order to achieve desired results or 

to require a more conservative accounting treatments (e.g., by auditors). 

o Diverse conclusions as to whether similar companies are within the scope of 

specific guidance. This issue becomes problematic for diversified companies who 

may be involved in a number of different industries with conflicting industryspecific guidance. 

• Unnecessarily increasing the volume of accounting literature. This volume, in turn, 

may result in: 

o Increased costs of implementing accounting literature. 

o Increased costs in maintaining accounting literature and more expansive standardsetting. 

o Increased costs of training accountants and retaining industry experts. 

2 As noted previously in the 2003 SEC report to Congress on the adoption in the United States of a 

principles-based accounting system: 

The proliferation of specialized industry standards creates two problems that can hinder standard setters’ 

efforts to issue subsequent standards using a more objectives-oriented regime: 

• The existence of specialized industry practices may make it more difficult for standards setters to 

eliminate scope exceptions in subsequent standards (e.g., many standards contain exceptions for

insurance arrangements subject to specialized industry accounting) 

• The specialized standards may create conflicting GAAP, which makes it more difficult for accounting 

professionals to determine the appropriate accounting. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 9 -
o Complexity for users in understanding the variety of accounting and disclosure. 

• Hindering more wide-spread use of XBRL, as it increases the number of different 

data tags that need to be created, maintained, and properly used in information 

delivery. 

On the other hand, industry-specific guidance may alleviate complexity in the following 

ways: 

• By allowing industry reporting to better meet the specific user needs in that industry. 

• By enhancing comparability across entities within an industry. 

• By depicting important differences in the economics of an industry, particularly 

where application of a generalized principle may not result in accounting that is 

representationally faithful to a transaction’s economic substance. 

• By developing guidance where it is otherwise lacking in generalized GAAP. 

• By simplifying or reducing the amount of guidance a preparer in an industry would 

need to consider, even though it might increase complexity across industries 

generally. 

• By addressing prevalent industry issues quickly. Specifically, industry-specific 

guidance may be easier to issue on an accelerated basis due to its narrower audience 

than that of generalized GAAP. 

The Committee acknowledges that industry-specific guidance has merit in certain 

situations, such as (1) where it interprets, rather than contradicts, principles and (2) where 

the activities in question are legitimately different (which are expected to be rare). 

However, the Committee believes that decreasing the amount of industry-specific 

guidance would reduce avoidable complexity. In this regard, to the extent that such 

guidance interprets principles (i.e., relates to implementation), it should not be included 

in GAAP. Further, to the extent that it applies to activities that are legitimately different, 

such guidance should be scoped and applied on the basis of business activities, rather 

than industries. 

Developed Proposals 

Based on the above considerations, the Committee has developed the following 

proposals: 

Developed Proposal 2.1: GAAP should be based on activities, rather than 

industries. 

• Any new projects undertaken separately by the FASB or IASB should be scoped 

on the basis of activities rather than industries. 

• Any new joint projects between the FASB and the IASB should be scoped on 

the basis of activities rather than industries, and should include the elimination 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 10 -
of existing industry-specific guidance in relevant areas as a specific objective of 

those projects, unless in rare circumstances, retaining such guidance can be 

justified. 

As described above, one cause of industry-specific guidance is the absence of on-point, 

generalized GAAP. As generalized GAAP is developed, the Committee believes that 

industry-specific guidance should be eliminated. 

Nevertheless, the Committee acknowledges that cost/benefit considerations might justify 

industry-specific guidance in limited situations. For example, cost/benefit considerations 

may indicate that the enhanced information investors would receive under generalized 

GAAP is not justified by the direct costs to preparers and the indirect costs to investors to 

account for activities in that manner. In such cases, the FASB should work with the 

relevant industries to identify long-term ways to phase out industry-specific guidance 

with as little cost as possible. In addition, the FASB should provide sufficient time to 

allow companies to transition to generalized GAAP, to help reduce the costs of transition. 

From an international perspective, the Committee notes that IFRS currently contains less 

industry-specific guidance than U.S. GAAP and that such guidance focuses more on the 

nature of the activity (e.g., agriculture, insurance contracts, exploration and evaluation of 

mineral resources). Nonetheless, the IASB should be mindful of this recommendation, if 

adopted, as it continues to develop a more comprehensive body of standards. Further, if 

this recommendation is adopted, the IASB should also ensure that any future industryspecific (i.e., activity-based) guidance is limited to activities whose economics are 

legitimately different from other business activities. Otherwise, the Committee believes 

specialized accounting for only certain subsets of similar activities will create avoidable 

complexity. 

• In conjunction with its current codification effort, the FASB should add a 

project to its agenda to remove or minimize existing industry-specific guidance 

that conflicts with generalized GAAP prior to achieving full convergence. 

The Committee has observed the FASB’s codification project can be used to divide 

existing industry-specific guidance into one of three categories: 

a. Guidance that conflicts with generalized GAAP 

b. Guidance for which there is no generalized GAAP on point 

c. Guidance which duplicates generalized GAAP 

The Committee believes efforts to reduce existing industry-specific guidance should 

focus primarily on Category a. above. Further, as new, generalized guidance is issued, 

including that which is issued through the convergence process, the SEC staff should 

eliminate its industry-specific guidance in those areas, if any. Please refer to chapter 3 of 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 11 -
this report for the relative priority on the FASB’s agenda of this proposal to reduce 

specialized accounting. 

The Committee acknowledges that the elimination of existing industry-specific guidance 

may result in more complexity over the short-term to the industries losing special 

treatment. Nonetheless, the Committee believes it is an acceptable cost for a long-term 

reduction in avoidable complexity. 

Questions for the Committee: 

2.2) Do you agree with the presumption of basing GAAP on activities, rather than 

industries? If not, please explain why you believe industry-scoped accounting 

standards are preferable. 

2.3) Do you agree with the developed proposal to minimize future industry-specific 

guidance? What revisions, if any, would you suggest? 

2.4) Do you agree that industry-specific guidance which conflicts with generalized 

GAAP (category a. guidance above) is best addressed by adding a separate 

project to retroactively address such conflicts? Or are constituents better 

served by addressing conflicts in the context of new standard-setting projects? 

II.B. Alternative Accounting Policies 

Background 

Alternative accounting policies refer to optionality in GAAP. The following discussion 

addresses formally-promulgated options in GAAP (i.e., it does not address choices 

available to preparers at more of a practice / implementation level3). Examples of 

optionality in GAAP include, but are not limited to: (a) the indirect vs. the direct method 

of presenting operating cash flows on the statement of cash flows, (b) the application of 

hedge accounting,4 (c) the option to measure certain financial assets and liabilities at fair 

value, (d) the immediate or delayed recognition of gains/losses associated with defined 

benefit pension and other post-retirement employee benefit plans, and (e) the successful 

3

An example is determining the depreciation method that most accurately reflects the pattern of 

consumption in a particular fact pattern—straight-line, double-declining balance, etc. 4

The Committee has noted complexities arising from the application of hedge accounting, which allows 

entities to mitigate reported volatility over the life of the hedge relationship. In this regard, the Committee 

generally feels that instead of assessing hedge effectiveness to determine whether companies qualify for 

this alternative accounting treatment, a better policy would be to simply record the ineffective portion of a 

hedge in earnings (i.e., a pro rata approach versus an all or nothing approach). The Committee is also 

aware of the FASB’s derivatives project in this area and is generally supportive of its progress. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 12 -
efforts or full cost accounting method followed by oil and gas producers. Refer to 

Appendix B for additional examples. 

Alternative accounting policies arise for a number of reasons, including: 

• Circumstances where the pros and cons of competing policies may be balanced and 

thus, not result in a single, clearly preferable approach. 

• Political pressure results in standard-setters providing for a preferred and an 

alternative accounting method. 

• Administrative convenience of the preparer (e.g., cost-benefit considerations). 

• A portrayal of differences in management intent. 

Alternative accounting policies contribute to avoidable complexity in the following ways: 

• Incomparable and inconsistent reporting, such as: 

o Reduced comparability across companies, if identical activities are accounted for 

differently. 

o Accounting that is less reflective of economic substance, to the extent that 

alternative accounting policies are based on political pressure.

o Differences in accounting policies selected by preparers to achieve the most 

favorable accounting treatment. 

• Unnecessarily increasing the volume of accounting literature to address each 

alternative accounting policy. 

On the other hand, alternative accounting policies may alleviate complexity in the 

following ways: 

• By allowing preparers to determine the best accounting for particular entities based 

on cost and economic substance, to the extent that more than one accounting policy is 

conceptually sound. 

• By developing alternatives more quickly than a final “perfect” standard and 

minimizing the effect of other unacceptable practices. In other words, alternative 

accounting policies may function as a short-term fix on the road to ideal accounting 

(evolution of accounting theory). 

While the Committee believes that the elimination of alternative accounting policies 

would reduce avoidable complexity, it acknowledges that such alternatives may have 

merit in certain circumstances. Accordingly, any recommendation should allow for these 

circumstances, which are articulated below. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 13 -
Management Intent 

Some alternative accounting policies are based on management intent.5 Management 

intent is a present assertion about management’s plans for future courses of action.6 

The Committee has separately considered the merits of alternative accounting policies 

arising from differences in management intent. Opponents of the use of management 

intent as a basis for accounting believe that because intentions are subjective, it is a 

difficult to use intent as a basis for accounting. Opponents also believe that intent does 

not change the economics of a transaction and thus, would not be a representationally 

faithful basis of accounting. 

Proponents of the use of management intent assert that the economics of a transaction do, 

in fact, change based on the nature of the activity, which is driven by management intent. 

Proponents also note that while management intent is subjective and could change, this 

characteristic is no different than a management estimate, which is common in financial 

reporting. Proponents further argue that financial reporting that ignores management 

intent results in irrelevant information for investors, for instance, reporting the fair value 

of a held-to-maturity security that will not be settled for 30 years. 

Due to the varying levels of management intent throughout GAAP and the merits of the 

arguments both for and against its use, the Committee has determined that accounting 

based on management intent is too dependent on facts and circumstances to feasibly 

address within the Committee’s timeframe. 

Developed Proposals 

Based on the above considerations, the Committee has developed the following 

proposals with respect to alternative accounting policies, other than those arising from 

management intent: 

Developed Proposal 2.2: GAAP should be based on a presumption that formally 

promulgated alternative accounting policies should not exist. 

• Any new projects undertaken separately by the FASB or IASB should not 

provide additional optionality, unless in rare circumstances, it can be justified. 

5

 For example, SFAS No. 115 Accounting for Certain Investments in Debt and Equity Securities, allows 

management to classify certain debt instruments as either held-to-maturity, available-for-sale, or as a 

trading security based on the company’s intent and ability with respect to the holding period of its 

investment. The financial statement treatment differs for all three categories. 6

 The definition of management intent and certain other concepts in the discussion of alternative accounting 

policies are adapted from a 1994 FASB Special Report: Future Events: A Conceptual Study of Their 

Significance for Recognition and Measurement.

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 14 -
• Any new joint projects between the FASB and the IASB should not provide 

additional optionality, but should include the elimination of existing alternative 

accounting policies in relevant areas as a specific objective of those projects, 

unless in rare circumstances, the optionality can be justified. 

Possible justifications for retaining alternative accounting policies include: 

• Multiple accounting alternatives exist that are consistent with the conceptual 

framework, and none are determined to provide significantly better information to 

investors than others. 

• An alternative or interim treatment can be developed more quickly than a final 

“perfect” standard, minimizing the effect of other unacceptable practices (evolution 

of accounting theory). 

In the event one or both of the justifications above applies, the Committee believes that: 

• The provision of alternative accounting principles should be coupled with a long-term 

plan to eliminate the alternative(s) through the use of sunset provisions. 

• The effect of applying the alternative policy not selected by the company should be 

clearly and succinctly presented, (i.e., either through financial statement presentation 

or footnote disclosure). 

From an international perspective, the Committee notes that IFRS currently permits 

numerous alternative accounting policies. While the Committee acknowledges the 

IASB’s efforts in reducing some of these alternative treatments, the Committee 

nonetheless believes that the IASB, like the FASB, should be mindful of this 

recommendation, if adopted, and seek to eliminate alternatives as part of its standardsetting projects. 

Further, as new guidance is issued, including that which is issued through the 

convergence process, the SEC staff should eliminate its alternative accounting policies in 

those areas, if any. 

Questions for the Committee: 

2.5) Do you agree with the presumption of minimizing alternative accounting 

policies? If not, please describe the circumstances in which they are preferable. 

2.6) Do you agree with the developed proposal to reduce alternative accounting 

policies in future standard-setting activity? What revisions, if any, would you 

suggest? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 15 -
2.7) Do you agree that reducing existing alternative accounting policies is best 

addressed in the context of future standard-setting? Or, are constituents better 

served by adding a separate project to standard setters’ agendas to retroactively 

address such alternatives? 

2.8) Do you believe that the issue of accounting based on management intent is so 

dependent of facts and circumstances that it is not feasible to address within the 

Committee’s duration? 

II.C. Scope Exceptions in GAAP Other Than Industry-Specific Guidance7 

Background 

Examples of scope exceptions in GAAP other than industry-specific guidance include: 

• A contract that has the characteristics of a guarantee under FIN 45, Guarantor’s 

Accounting and Disclosure Requirements for Guarantees, Including Indirect 

Guarantees of Indebtedness to Others, but is treated as contingent rent under SFAS 

No. 13, Accounting for Leases. 

• Business scope exception to the applicability of FIN 46R, Consolidation of Variable 

Interest Entities, subject to certain criteria. 

• Application of SFAS No. 157, Fair Value Measurements, to share-based payment 

transactions. 

Scope exceptions contribute to complexity because they result in different accounting for 

similar activities, require detailed analysis to determine whether or not they apply in 

particular situations, and increase the volume of accounting literature. On the other hand, 

the value of scope exceptions will be considered in light of cost-benefit considerations, 

the evolution of accounting theory discussed above, and the magnitude of change that 

would result from eliminating or reducing them. 

Future Considerations 

The Committee intends to deliberate this issue subsequent to the January 11, 2008 

meeting. 

7

 The Committee has limited its focus to scope exceptions, while acknowledging there are other types of 

exceptions in GAAP. This limited approach was considered appropriate in light of the Committee’s short 

duration. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 16 -
Questions to be Subsequently Considered by the Committee: 

2.9) Do you believe that scope exceptions in GAAP other than industry-specific 

guidance contribute to complexity? Why or why not? 

2.10) How significant would potential unintended consequences of eliminating scope 

exceptions be? Consider for example, the normal purchases and normal sales 

exception in SFAS No. 133, Accounting for Derivative Instruments and 

Hedging Activities. 

2.11) In what circumstances can scope exceptions be justified? Conceptually, how 

stringent should a presumption against scope exceptions be, if at all? 

2.12) Please describe examples where scope exceptions result in accounting that is 

more representationally faithful than applying the related general principle. 

II.D. Competing Models 

Background 

Competing models are distinguished here from alternative accounting policies. 

Alternative accounting policies, as explained above, refer to different accounting 

treatments that preparers are allowed to choose under existing GAAP (e.g., whether to 

apply the direct or indirect method of cash flows). By contrast, competing models refer 

to requirements to apply different accounting models to account for similar types of 

transactions or events, depending on the balance sheet or income statement items 

involved. 

Examples of competing models include: 

• Different models for asset impairment testing such as inventory, goodwill, and 

deferred tax assets, etc. 

o For instance, inventory is assessed for recoverability (i.e., potential loss of 

usefulness) and remeasured at the lower of cost or market value on a periodic 

basis. To the extent the value of inventory recorded on the balance sheet (i.e., its 

“cost”) exceeds a current market value, a loss is recorded. 

o In contrast, goodwill is tested for impairment annually, unless there are 

indications of loss before the next annual test. To determine the amount of any 

loss, the fair value of a “reporting unit (as defined in GAAP)” is compared to its 

carrying value on the balance sheet. If fair value is greater than carrying value, no 

impairment exists. If fair value is less, then companies are required to allocate the 

fair value to the assets and liabilities in the reporting unit, similar to a purchase 

price allocation in a business combination. Any fair value remaining after the 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 17 -
allocation represents “implied” goodwill. The excess of actual goodwill 

compared to implied goodwill, if any, is recorded as a loss. 

o Deferred tax assets are tested for realizability on the basis of future expectations. 

The amount of tax assets are reduced if, based on the weight of available 

evidence, it is more likely than not (i.e., greater than 50% probability) that some 

portion or all of the deferred tax asset will not be realized. Future realization of a 

deferred tax asset ultimately depends on the existence of sufficient taxable income 

of the appropriate character (e.g., ordinary income or capital gain) within the 

carryback and carryforward periods available under the tax law. 

• Different models for revenue recognition in the absence of a general principle. 

• Different models for derecognition of a pension or other post-retirement benefit 

obligation liability via settlement, curtailment, and negative plan amendments 

compared to derecognition of other liabilities on the basis of legal extinguishment. 

Competing models contribute to complexity in that they lead to inconsistent accounting 

for similar activities and they contribute to the volume of accounting literature. On the 

other hand, the value of competing models will be considered in light of cost-benefit 

considerations, the evolution of accounting theory discussed above, and the magnitude of 

change that would result from eliminating or reducing them. 

Future Considerations 

In future deliberations, the Committee intends to explore the role of competing models in 

increasing avoidable complexity. The Committee will also explore, as discussed in 

chapter 3, the relationship between these competing models and the FASB’s conceptual 

framework. 

Questions to be Subsequently Considered by the Committee: 

2.13) Do you believe that competing models in GAAP contribute to complexity? 

Why or why not? 

2.14) What would the consequences be of a recommendation to minimize such 

competing models? 

2.15) In what circumstances can different models for similar types of transactions or 

events be justified? 

2.16) Please describe examples where different models are necessary to result in 

representationally faithful accounting. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 18 -
III. Bright Lines 

Background 

Bright lines refer to two main areas: quantified thresholds and pass/fail tests. 

Quantified thresholds include hard-and-fast cutoffs, rules-of-thumb, and presumptions 

coupled with additional considerations. Lease accounting is often cited as an example of 

bright lines in the form of quantified thresholds. Consider, for example, a lessee’s 

accounting for a piece of machinery. Under current requirements, the lessee will account 

for the lease in one of two significantly different ways: either (1) reflect an asset and a 

liability on its balance sheet, as if it owns the leased asset or (2) reflect nothing on its 

balance sheet. The accounting conclusion depends on the results of two quantitative 

tests,8

 where a mere 1% difference in the results of the quantitative tests leads to very 

different accounting. 

Pass/fail tests are similar to quantitative thresholds in that they result in recognition on an 

all-or-nothing basis. However, pass/fail tests do not involve quantification. For example, 

a software sales contract may require delivery of four elements. Revenue may, in certain 

circumstances, be recognized as each element is delivered. However, if appropriate 

evidence does not exist to support the allocation of the sales price to, for example, the 

second element, software revenue recognition guidance requires that the timing of 

recognition of all revenue be deferred until such evidence exists or all four elements are 

delivered. 

Refer to Appendix B for additional examples. 

Bright lines arise for a number of reasons, including: 

• An effort to drive comparability across companies. 

• Convenience for preparers, auditors, and regulators because they reduce the amount 

of effort that would otherwise be required in applying judgment (i.e., the effort in 

understanding a transaction, debating potential accounting applications, and 

documenting that judgment) and the belief that they reduce the chance of being 

second-guessed. 

• Requests for additional guidance on exactly how to apply the underlying principle. 

These requests often arise from concern on the part of preparers and auditors of using 

judgment that may be second-guessed by inspectors, regulators, and the trial bar. 

8

 Specifically, SFAS No. 13, Accounting for Leases, requires that leases be classified as capital leases and 

recognized on the lessee’s balance sheet where (a) the lease term is greater than or equal to 75% of the 

estimated economic life of the leased property or (b) the present value at the beginning of the lease term of 

the minimum lease payments equals or exceeds 90% of the fair value of the leased property, among other 

criteria. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 19 -
• Efforts to curb abuse. For example, some argue that sole reliance on judgment may 

result in aggressive accounting practices, such as revenue recognition where 

sufficient supporting evidence may not exist. 

Bright lines contribute to avoidable complexity in the following ways: 

• Incomparable and inconsistent reporting, such as: 

o Accounting that is not representationally faithful to the economic substance of the 

arrangement, particularly due to the all-or-nothing recognition described above. 

o Less comparability because two similar transactions may be accounted for 

differently. For example, as described above, a mere 1% difference in the 

quantitative tests associated with lease accounting could result in very different 

accounting consequences. 

o Structuring opportunities to achieve a specific financial reporting result. For 

example, whole industries have been developed to create structures to work 

around lease and hedge accounting rules. 

• Unnecessarily increasing the volume of accounting literature. This volume: 

o May result from standard-setters and regulators attempting to curb abuse from 

structured transactions that result from bright lines by developing additional 

guidance. 

o May require additional expertise to account for certain transactions, which 

increases the cost of accounting and the risk of restatement. 

On the other hand, bright lines may alleviate complexity in the following ways: 

• By reducing judgment, which may limit aggressive accounting policies. 

• By enhancing perceived uniformity across companies. 

• By providing convenience, as discussed above. 

• By limiting the application of new accounting guidance to a small group of 

companies, where no underlying standard exists. In these situations, the issuance of 

narrowly-scoped guidance may allow for issues to be addressed more timely. In other 

words, narrowly-scoped guidance and the bright lines that accompany them may 

function as a short-term fix on the road to ideal accounting (evolution of accounting 

theory). 

Conceptual Approach 

The Committee is still in the process of debating when, if at all, bright lines are justified 

in accounting literature. The Committee notes that even if standard-setters limit the 

issuance of bright lines, audit firms and other parties would likely continue to create nonauthoritative guidance. As such, any recommendations to limit bright lines would require 

a cultural shift towards acceptance of more judgment. Accordingly, any 

recommendations in the context of bright lines will incorporate the Committee’s 

consideration of a professional judgment framework, as discussed in chapter 4, and the 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 20 -
Committee’s consideration of interpretive implementation guidance and transition to and 

design of new standards, as discussed in chapter 3. 

In addition, the Committee will continue to explore the following conceptual approaches: 

Conceptual Approach 2.A: The Committee is considering recommending expanded 

use of the following, in place of the current use of bright lines, to better reflect the 

economic substance of an activity: 

• Pro rata accounting - The Committee uses the term “pro rata accounting” to 

refer to proportional recognition, rather than the current all-or-nothing 

recognition approach. For example, consider a lease where the lessee has the 

right to use a machine, valued at $100, for four years. Also assume that the 

machine has a 10-year useful life. Under pro rata accounting, a lessee would 

recognize an asset for its right to use the machine (rather than an asset for a 

proportion of the asset) at approximately $409 on its balance sheet. Under the 

current accounting literature, the lessee would either recognize the machine at 

$100 or recognize nothing on its balance sheet, depending on the results of 

certain bright line tests. 

• Additional disclosure – The Committee recognizes that pro rata accounting is 

not universally applicable. In those cases, enhanced disclosure may be more 

appropriate. The Committee has yet to define the possible scope of pro rata 

accounting and/or enhanced disclosure, but it may extend to areas such as 

leases, consolidation policy and off-balance sheet activity. 

• Rules-of-thumb coupled with additional considerations – The Committee uses 

the phrase “rules-of-thumb coupled with additional considerations” to refer to 

a less stringent use of bright lines, where professional judgment factors into an 

accounting analysis. The Committee will also consider rules-of-thumb coupled 

with additional considerations in situations where pro rata accounting may not 

be applicable. 

Conceptual Approach 2.B: Further, the Committee is considering a 

recommendation related to the education of students, as well as to the continuing 

education of users, preparers and auditors, etc. The recommendation would 

encourage understanding of the economic substance and business purposes of 

transactions, in contrast to mechanical compliance with rules without sufficient 

context. 

9

 Calculated as (4 year lease / 10 year useful life) x $100 machine value. The example is only intended to 

be illustrative and is not prescriptive. For instance, the basis of pro rata accounting may be an asset’s 

estimated useful life, future cash flows or the share of a company’s liabilities in a structured investment 

vehicle. The Committee is planning additional deliberations in this regard. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 21 -
Question to be Subsequently Considered by the Committee: 

2.17) Some have argued that bright lines in U.S. GAAP result in structuring 

opportunities. Are structuring opportunities under U.S. GAAP more prevalent 

than under IFRS, which provides more generalized guidance in certain areas 

(e.g., lease accounting, revenue recognition, new basis / push down accounting, 

consolidations)? 

2.18) Under what circumstances would requirements based on each of the following 

be appropriate: 

• Bright lines 

• Pro rata accounting 

• Additional disclosure 

• Rules-of-thumb coupled with professional judgment? 

2.19) What other alternatives should be considered as viable alternatives to bright 

lines? 

IV. Mixed Attribute Model and the Appropriate Use of Fair Value 

Background 

As previously noted, the mixed attribute model is one where the carrying amounts of 

some assets and liabilities are measured based on historical cost, others at lower of cost or 

market, and still others at fair value. This complexity is compounded by the recognition 

of some adjustments to carrying amounts in earnings and others in comprehensive 

income. 

Examples of accounting standards that result in mixed attribute measurement include: 

• SFAS No. 159, The Fair Value Option for Financial Assets and Financial Liabilities, 

which permits the fair valuation of certain assets and liabilities. As a result, some 

assets and liabilities are measured at fair value, while others are measured at 

amortized cost or some other basis. 

• SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities, 

which requires certain investments to be recognized at fair value and others at 

amortized cost. 

As discussed earlier, some have advocated mandatory and comprehensive use of fair 

value as a solution to the complexities arising from the mixed attribute model. However, 

the use of fair value contributes to avoidable complexity in the following ways: 

• Incomparable and inconsistent reporting, due to: 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 22 -
o The lack of a single set of generally accepted valuation standards for financial 

reporting purposes. 

o Inputs to fair value models that are not easily verifiable. Consequently, according 

to some, there is too much subjectivity in the development of fair values, which 

significantly impacts the auditability of the numbers. 

o Significant variance in the quality, skill, and reports of valuation specialists. 

Preparers have limited ability to assess this variety. Further, there is no 

mechanism to ensure ongoing quality, training, and oversight of valuation 

specialists. 

• Financial reporting standards that are difficult to apply in practice 

o Some preparers’ knowledge of valuation methodology is limited, requiring the 

use of valuation specialists, which results in additional expense. 

o Auditors often also require valuation specialists to support the audit. Some view 

the need for these valuation specialists as a duplication of efforts, at the expense 

of the preparer. 

o The effort and elapsed time required to implement and maintain mark-to-model 

fair values would be significant whether performed internally or by valuation 

specialists. 

• Unnecessarily increasing the volume of accounting literature: 

o Some entities question whether investors are averse to volatility or hold 

management responsible for unfavorable results created by volatility from 

markets that management does not control. Consequently, entities have 

demanded exceptions from the use of fair value in financial reporting, resisted the 

use of fair value in financial reporting, and/or entered into transactions that they 

otherwise would not have undertaken to limit earnings volatility. These actions 

have resulted in an unnecessary increase in the volume of accounting literature. 

• Impact on audit and regulatory systems 

o There is concern about second guessing by auditors, regulators, and courts in light 

of the many judgments and imprecision involved with fair value estimates. 

• Making information delivery more difficult 

o Some users may not understand the uncertainty associated with measurements 

based on fair value (i.e., that they are merely estimates and in most instances lack 

precision), including the quality of unrealized gains and losses arising from 

changes in fair value. 

o Some question whether the use of fair value may lead to counter-intuitive results. 

For example, an entity that opts to fair value its debt may recognize a gain when 

its credit rating declines. 

o Some question whether the use of fair value for held to maturity investments is 

meaningful. 

o Preparers view disclosure of some of the inputs to the assumptions as sensitive 

and competitively harmful. 

On the other hand, the use of fair value may alleviate complexity in the following ways: 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 23 -
• By providing users with the same information as management, to the extent 

management makes decisions based on fair value. 

• By improving the relevance of information in many cases, as historical cost is not 

meaningful for certain items. 

• By enhancing consistency, such as: 

o By reducing confusion related to measurement mismatches. For example, an 

entity may enter into a derivative instrument to hedge its exposure to changes in 

the fair value of debt attributable to changes in the benchmark interest rate. The 

derivative instrument is required to be recognized at fair value, but, assuming no 

application of hedge accounting or the fair value option, the debt would be 

measured at amortized cost, resulting in measurement mismatches. 

o Mitigating the need for detailed application guidance explaining which 

instruments must be recorded at fair value. 

o Helping to prevent some transaction structuring. Specifically, if fair value were 

consistently required for all similar activities, entities would not be able to 

structure a transaction to achieve a desired measurement attribute. 

• By eliminating certain issues surrounding management’s intent. For example, entities 

are required to evaluate whether investments are impaired. Under certain impairment 

models, entities are currently required to assess whether they have the intent and 

ability to hold the investment for a period of time sufficient to allow for any 

anticipated recovery in market value. As discussed in the Management Intent section 

of this chapter, management intent is subjective and, thus, less auditable. However, 

use of fair value would generally make management intent irrelevant in assessing the 

value of an investment. 

The Committee acknowledges the view that a complete transition to fair value would 

alleviate avoidable complexity resulting from the mixed attribute model. However, the 

Committee also recognizes that expanded use of fair value would increase avoidable 

complexity, as discussed above, unless numerous implementation questions related to 

relevance and reliability are addressed, which extend beyond the scope of its work. 

In light of its limited duration, the Committee recognizes it may not independently 

develop a comprehensive measurement framework, but plans to provide input to the 

FASB’s project in this area (discussed below). As a result, the Committee believes that 

recommendations requiring a consistent measurement framework and better 

communication of measurement attributes would more feasibly alleviate avoidable 

complexity resulting from the mixed attribute model. Such communication encompasses 

footnote disclosure of each measurement attribute’s characteristics (e.g., uncertainty 

associated with fair value), as well as a more systematic presentation of distinct 

measurement attributes on the face of the primary financial statements. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 24 -
Conceptual Approach 

Based on the above, the Committee will continue to explore the following conceptual 

approaches: 

Conceptual Approach 2.C: Measurement framework – While the Committee may 

not be able to comprehensively address when fair value is the appropriate 

measurement attribute, it understands that the FASB’s conceptual framework 

project includes a measurement phase. The Committee intends to study this project 

further and is considering recommending that, as part of this project, the FASB 

develop a decision framework to provide a systematic approach for consistently 

determining the most appropriate measurement attribute for similar activities or 

assets / liabilities based on consideration of the trade off between relevance and 

reliability, and the various constituents involved in the financial reporting process. 

Conceptual Approach 2.D: Moratorium – Due to implementation complexities, as 

noted above, the Committee is considering whether the FASB should refrain from 

issuing new standards and interpretations that require the expanded use of fair 

value in areas where it is not already required, until completion of the 

measurement framework. The Committee will also consider whether exceptions to 

this moratorium should be provided to facilitate necessary improvements to certain 

complex standards, such as SFAS No. 133 and SFAS No. 140. 

Conceptual Approach 2.E: Grouping in Financial Statement Presentation – The 

Committee believes that a more consistently aggregated presentation of financial 

statements would alleviate some of the confusion and concerns regarding the use of 

fair value. Such presentation should result in the grouping of amounts and line 

items by nature of activity and measurement attribute within and across financial 

statements. The Committee believes that such a grouping would be more 

understandable to users, particularly as it would more clearly delineate the nature 

of changes in income (e.g., volatility, changes in estimate, business activity, etc.). 

This presentation might also help users assess the degree to which management 

controls each income item. 

As part of its financial statement presentation project, the FASB has tentatively 

decided to segregate the financial statements into business (further divided into 

operating and investing) and financing activities. The FASB has also tentatively 

decided to require a reconciliation of the statement of cash flows to the statement of 

comprehensive income. This reconciliation would disaggregate changes in assets 

and liabilities based on cash, accruals, and changes in fair value, among others. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 25 -
The Committee intends to study this project further and consider whether it would 

address the Committee’s leanings in this area and sufficiently facilitate users’ 

understanding of fair value. 

Conceptual Approach 2.F: Additional Disclosure – The Committee has identified 

potential areas for additional disclosure to more effectively signal to users the level 

of uncertainty associated with fair value measurements in financial statements. 

Specifically, the Committee notes that in some cases, there is no “right” number in 

a probability distribution of figures, some of which may be more fairly 

representative of fair value than others. Potential areas to be considered for 

additional disclosure may include: 

• The valuation model 

• Statistical confidence intervals associated with certain valuation models 

• Key assumptions, including projections 

• Sensitivity analyses depending on the selection of key assumptions 

• The entity’s position vs. that of the entire market. 

The Committee acknowledges uncertainty also exists in other measurement 

attributes, such as historic cost, which may warrant similar disclosure. 

Conceptual Approach 2.G: Disclosure Framework – The Committee seeks to 

balance additional disclosure requirements, including, if any, those under 

conceptual approach 2.F, with (1) the perception that amounts recognized in 

financial statements are generally subject to more precise calculations by preparers 

and higher degrees of scrutiny by users compared to merely disclosing such 

amounts in the footnotes and (2) concerns regarding disclosure redundancies. To 

minimize the effect of diminishing returns on potential new disclosure 

improvements identified during the course of Committee’s efforts and future 

standard-setting activity, the Committee is considering recommending (1) that the 

FASB develop a disclosure framework that integrates existing disclosure 

requirements into a cohesive whole (e.g., eliminate redundant disclosures and 

provide a single source of disclosure guidance across all accounting standards), (2) 

improvement to the piece-meal approach to establishing disclosures (i.e., standardby-standard), and (3) that the SEC develop a process to regularly evaluate and, as 

appropriate, update its disclosure requirements as new standards are issued. 

Questions for Subsequent Consideration by the Committee: 

2.20) Do you agree with the intention to refrain from determining the specific 

circumstances in which fair value should be used and, instead, primarily focus 

on ways to better communicate measurement attributes and the use of fair value 

to investors? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 26 -
2.21) Do you agree with the intention to refrain from addressing implementation 

issues, such as whether there is a need for valuation-related standard-setting and 

regulation? 

2.22) What key elements should a measurement framework incorporate? 

• How much weight should be placed on relevance vs. reliability? 

• Should a measurement framework prescribe a consistent measurement 

attribute for similar activities or similar assets / liabilities? 

2.23) Do you agree with a full or partial moratorium on future standards that require 

or permit the use of fair value until the measurement framework is complete? If 

you do not believe a full moratorium is appropriate, what is the proper degree, if 

any? 

2.24) Do you believe grouped financial statement presentation will be effective in 

reducing concerns about the mixed attribute model and the use of fair value? If 

not, what alternatives should be considered? 

2.25) Do you believe the additional disclosure described above, as applicable, should 

be applied to other measurement attributes, such as historic cost? Why or why 

not? 

2.26) Do you believe disclosure of company-specific projections used in fair value 

estimates, such as future revenue streams, are appropriate? How do concerns 

about the company harming its competitive position in the market factor in? 

2.27) What additional disclosures would you recommend to address concerns and 

confusion due to the current mixed attribute model? 

2.28) What specific improvements would you recommend to the FASB’s current 

piece-meal approach to establishing disclosure requirements? To the extent that 

you believe a disclosure framework would improve the FASB’s current 

approach, what key elements should such a framework incorporate? 

2.29) Do you agree with the view that the SEC should develop a process to regularly 

evaluate and, as appropriate, update its disclosure requirements as new 

standards are issued? Should the Committee identify specific indicators as to 

when SEC disclosure requirements are justified in addition to or in lieu of 

FASB disclosure requirements? If so, what indicators would you recommend? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 27 -
CHAPTER 3: STANDARD-SETTING PROCESS 

I. Scope 

This chapter examines the standard-setting process in the U.S. Specifically, this chapter 

addresses the following areas: 

• Increased user/investor involvement 

• FAF governance 

• Standard-setting process improvements 

• Interpretive implementation guidance 

• Transition to and design of new standards 

The Committee notes that certain of its proposals in this area may be partially or 

substantially addressed by actions recently taken or in the process of being taken by the 

FAF, the FASB and the SEC, which this chapter will acknowledge, where applicable. 

International Considerations: As further described in chapter 1, the Committee plans to 

address international considerations in its scope, but has deferred most of the discussion 

in this regard until later in 2008. The Committee believes that many of its developed 

proposals and conceptual approaches regarding the standard-setting process would be 

applicable to the international standard-setting process, with certain required 

modifications. Therefore, the Committee plans to revisit international considerations so 

that its recommendations will consider the fact that both U.S. GAAP and IFRS are 

currently accepted in the U.S. 

Question for the Committee: 

3.1) Do you agree with the scope as it relates to the standard-setting process and the 

process of issuing interpretive implementation guidance in the U.S.? Are there 

any areas you would recommend adding, removing or revising? 

II. Overview 

A robust standard-setting process is the foundation of a transparent, efficient system of 

financial reporting, which allows providers of capital to effectively monitor their 

investments. Although the U.S. approach to financial reporting has been quite effective 

in achieving these overarching objectives, U.S. GAAP has evolved over many years, with 

some of the basic principles becoming obfuscated by detailed rules, bright lines, 

exceptions and regulations, which reduce the transparency and usefulness of the resulting 

financial reporting. The structuring of accounting-motivated transactions partially gave 

rise to the creation of such detailed rules, many of which were intended to close loop 

This report has been prepared by the individual subcommittee and does not necessarily reflect either the 

views of the Committee or other members of the Committee, or the views or regulatory agenda of the 

Commission or its staff. 

- 28 -
holes and prevent abusive application of the accounting standards. This motivation was 

often driven by the desire of issuers to achieve certain earnings results or by the promises 

of sponsors that undertaking certain transactions would result in a particular accounting 

result. 

Historically, interpretative implementation guidance has proliferated from a variety of 

sources and, intentionally or not, become an additional source of U.S. GAAP that may 

add to the complexity in the financial reporting system, especially when questions exist 

about its authoritative nature or conflicts exist between interpretations. In addition, the 

fear of having reasonable, good-faith judgments second-guessed sometimes causes 

preparers, auditors and regulators to engage in what could be termed “defensive 

accounting and auditing,” which is the practice of requesting more rules and interpretive 

implementation guidance. Such defensive accounting and auditing may further 

exacerbate the problem. 

The Committee sets forth a number of proposals that serve to underscore the preeminence of the user perspective in designing and administering a well-designed and 

effective system of financial reporting. Using this perspective as a keystone will serve as 

a bulwark against the self-interest of those constituencies with a vested stake in a 

particular accounting treatment. In its creation, the founders of our modern accounting 

system equated maintaining balance amongst the different stakeholders as an important 

means of maintaining fairness in the system. The Committee believes that the system 

will be best served by recognizing the interests of users/investors as the foremost 

stakeholder when competing interests are unable to be completely aligned. 

This chapter presents a number of developed proposals and conceptual approaches 

intended to alleviate some of the aforementioned concerns. In general, the design of the 

U.S. financial reporting system and the roles that each participant plays are largely 

appropriate, but the behavior of each participant has been impacted by the current 

regulatory and legal environment. Therefore, the Committee believes that small 

improvements to the existing standard-setting process and the process of issuing 

interpretive implementation guidance in the U.S. may significantly influence behaviors 

and help financial reporting to better serve the needs of investors and other users. 

Also, many aspects of the proposals and approaches are already in place or occur 

informally in practice, but some of these existing processes may not be fully effective or 

well-understood. Therefore, the proposals and approaches are meant to both increase the 

effectiveness of these processes, as well as their transparency, which will be critical if the 

behavior of participants in the financial reporting process is to be influenced. However, 

the interdependence of the Committee’s proposals and approaches will necessitate many, 

if not all, of them being implemented if the perceived benefits are to be fully realized. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 29 -
III. Increased User/Investor Involvement 

As discussed more fully below, the Committee has developed the following proposal 

relating to increased user/investor involvement in the standard-setting and regulatory 

processes: 

Developed Proposal 3.1: Additional user/investor involvement in the standardsetting process is central to improving financial reporting. Only if user/investor 

perspectives are properly considered will the output of the financial reporting 

process meet the needs of those for which it is primarily intended to serve. The 

SEC should formally encourage the following improvements: 

• Additional users/investors should be added to the FAF to ensure that additional 

views of users/investors are brought to bear in the governance process. 

• Experienced users/investors who regularly use financial statements to make 

investment decisions should be better represented on both the FASB Board and 

its staff to ensure that the standard-setting process and the process of issuing 

interpretive implementation guidance better consider the usefulness of the 

resulting information. 

• As more fully described in developed proposal 3.4, consideration of 

user/investor views in the agenda-setting process should be increased as part of 

a formal Agenda Advisory Group. 

• The FASB should solicit comments from a diverse panel of experienced 

users/investors on whether the proposed changes improve the current approach 

prior to exposing new accounting standards or interpretive implementation 

guidance for public comment. 

• The FASB should consider other measures designed to ensure that the 

user/investor perspective is given preeminence when balancing the perspectives 

of constituents during the standard-setting process. 

Background: User/investor involvement is critical to maintaining effective financial 

reporting, yet the intricacy of certain accounting matters and the overly complex nature of 

the current debate often make it difficult to attract meaningful user/investor participation 

in the standard-setting process. The Committee believes that it is important to reiterate 

the preeminence of the user/investor perspective in the design and implementation of 

financial reporting. By properly emphasizing the perspective of users/investors, all 

stakeholders will benefit from a system that allocates capital more efficiently. This 

perspective can be best promoted by taking a number of basic steps in improving user 

representation throughout the standard-setting process. 

The Committee acknowledges the significant effort by the FASB over the past few years 

to increase user/investor involvement in standard-setting. Specifically, the FASB has 

leveraged a number of existing advisory groups and has established a number of 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 30 -
additional advisory groups to assist with bringing additional user/investor perspectives, 

including: 

• The Financial Accounting Standards Advisory Council (FASAC), which has more 

than 30 members, including several users of financial information. 

• In 2003, the FASB established the User Advisory Council (UAC), which includes 

representatives from individual and institutional investors, equity and debt analysts, 

lenders and credit rating agencies. 

• In 2005, the FASB established the Investor Task Force (ITC), which is comprised of 

representatives of many of the nation’s largest institutional asset managers. 

• In 2007, the FASB established the Investors Technical Advisory Committee (ITAC) 

to increase participation in the standard-setting process by users/investors with strong 

accounting backgrounds. 

• The FASB also creates resource groups to assist either formally or informally on 

major projects, which often includes some user/investor representation. 

• The EITF includes two user/investor representatives. 

Because users/investors often lack a monolithic viewpoint and have differing 

perspectives, the FASB may receive mixed messages with respect to a particular issue. 

Therefore, developed proposal 3.1 is intended to provide the SEC and FASB with more 

focused, efficient, and timely user/investor feedback. 

FAF and FASB: Increasing the direct involvement of users/investors on the FAF and 

FASB could have a significant benefit of bringing these perspectives to the forefront of 

the accounting standard-setting process and the process of issuing interpretive 

implementation guidance. Therefore, the Committee recommends that the composition 

of the FAF Trustees include more user/investor perspectives and that the FASB Board 

include no less than one, but perhaps more, users/investors who regularly use third party 

financial statements. 

The proposal complements the FAF’s proposed changes to the size and composition of 

the FAF and the FASB in its recent Request for Comments on Proposed Changes to 

Oversight, Structure and Operations of the FAF, FASB and GASB. The Committee is 

supportive of the FAF’s proposed changes, but believes that the composition of the FASB 

Board should be clarified to require (1) a preparer, an auditor, and at least one 

user/investor who regularly uses third party financial statements, and (2) that the 

remaining at-large Board members should be selected based upon the most qualified 

individuals that have a breadth of experiences to ensure that the perspectives of 

users/investors are represented. The Committee recognizes that a potential move towards 

five FASB Board members from seven would increase the influence of users/investors on 

the Board, and believes that such a result is fully consistent with a desire to continue to 

build and maintain a robust system of financial reporting. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 31 -
Some participants in the financial reporting community believe that a focus on 

user/investor needs could be enhanced in the standard-setting process without the need to 

actually increase user/investor involvement on the FAF and FASB. However, the 

Committee concluded, on balance, that increased direct, active user/investor involvement 

would (1) improve the transparency of and familiarity with the standard-setting process 

within the user/investor community, and (2) better align the traditionally distinct fields of 

accounting and finance over time. Additional representation on both the FAF and the 

FASB will not only bring additional user/investor perspectives from those individual 

representatives, but also from the users/investors they choose to consult. 

There may be opportunities to increase user/investor involvement on the FASB staff, as 

well. The FASB has a few individuals on staff whose principal professional experience 

is in the investing community, and the FASB has had a fellowship program in place for 

many years, but the auditor and preparer communities most frequently provide resources 

to fill these roles. The FASB has approached user/investor groups about the possibility 

of sponsoring fellows, but thus far has had limited success. The Committee believes that 

users/investors should work together to identify and advance qualified resources to join 

the FASB staff in fellowship positions to help improve the balance of user/investor 

perspectives during standard-setting. 

User/Investor Fatal-Flaw Review: To further increase the direct feedback from 

users/investors during the standard-setting process, the FASB should add a requirement 

to perform a scalable user/investor fatal-flaw review designed to assess perceived 

benefits to users/investors prior to the issuance of Exposure Drafts. The following 

attributes should be considered by the FASB when designing such a fatal-flaw review: 

• Seek formal comments from a diverse panel of users/investors (e.g., buy-side 

analysts, sell-side analysts, rating agencies), all of which should have strong interests 

in the outcome. 

• The goal should be to ask users/investors to consider the accounting guidance through 

the eyes of the typical, informed investor to determine whether the new information 

provided would be decision useful (whether it will provide better information than 

what is currently available), as well as meet the benefit portion of the cost-benefit 

constraint. 

• Perform the user/investor fatal flaw review prior to exposing the accounting guidance 

for public comment so the results may be factored into the cost-benefit analysis. 

• The Board should be willing to revisit or even discontinue a standard-setting project 

based upon the feedback received. 

Many aspects of the proposed user/investor fatal-flaw review may already occur on an 

informal basis, but the Committee notes that the benefits of such user/investor fatal-flaw 

reviews would best be achieved if other users/investors who may not be asked to 

participate in the process are at least aware of their existence. Therefore, the Committee 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 32 -
proposes that the process be formalized, required for all new standards, and made more 

transparent. 

Such a fatal flaw review would be analogous to obtaining experienced user/investor input 

that the reporting regime would improve as a result of the implementation of the 

proposed standard. The Committee does not envision that this requirement would 

supplant any of the other important, systematic user/investor feedback that the FASB 

receives throughout the standard-setting process. 

Other FASB Measures: The FASB does have comments in its mission statement, 

precepts, and objectives that speak to importance of users of financial information, and its 

precepts provide for balancing perspectives. However, the Committee believes that the 

FASB Board and staff should consider the user/investor perspective to be preeminent in 

their decision-making processes, given that (1) users/investors are the primary 

beneficiaries of financial reporting, and (2) such a focus ultimately benefits all 

stakeholders by making the capital markets more efficient and robust. 

Although it is important to strike an appropriate balance between the perspectives of 

users/investors, preparers and auditors, the objective in the near-term should be to 

improve that balance by increasing consideration of the users/investors’ perspectives in 

the standard-setting process. Therefore, the FASB should consider other measures, 

which may include clarifying the Board’s mission statement, stated objectives and 

precepts, designed to ensure that the user/investor perspective is given preeminence when 

balancing the perspectives of constituents during the standard-setting process. In 

addition, all Board members and staff should attempt to routinely evaluate accounting 

standards and interpretive implementation guidance from the perspective of a typical, 

informed user/investor. This is not to say that other perspectives should be ignored; 

rather, consideration of the needs of the recipients of the financial information itself 

should be paramount. 

Question for the Committee: 

3.2) Do you agree with developed proposal 3.1? What revisions, if any, would you 

recommend? 

IV. FAF Governance 

As discussed more fully below, the Committee has developed the following proposal 

relating to FAF governance: 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 33 -
Developed Proposal 3.2: The SEC should assist the FAF in enhancing its 

governance over the FASB, as follows: 

• By formally supporting the FAF’s proposals outlined in the “Request for 

Comments on Proposed Changes to Oversight, Structure and Operations of the 

FAF, FASB and GASB”, particularly the decision to end the constituent-based 

approach to selecting trustees. 

• By encouraging the FAF to amend the FASB’s mission statement, stated 

objectives or precepts to highlight that an additional goal should be to minimize 

avoidable complexity. 

• By encouraging the FAF to consider developing performance metrics to 

monitor the FASB’s compliance against its stated goals over time.

Proposed FAF Governance Changes: The Committee is supportive of the FAF’s recent 

Request for Comments on Proposed Changes to Oversight, Structure and Operations of 

the FAF, FASB and GASB, as outlined below. 

FAF Size and Composition: 

• The FAF proposes to expand the sources of FAF Trustee nominations, change terms 

of service and create flexibility in the size of the FAF itself. The Committee is 

supportive of these proposals, particularly the decision to end the constituent-based 

approach to selecting trustees, but believes that additional representation from 

users/investors as further described in developed proposal 3.1 should be considered. 

FAF Oversight: 

• The FAF proposes to increase its active oversight of the FASB. Many of the 

developed proposals and conceptual approaches in this chapter provide meaningful 

input and support regarding how and in what areas such oversight should be 

strengthened. 

• As noted below, the FAF should also consider establishing performance metrics to 

measure and track the efficiency and effectiveness of the standard-setting process 

over time. 

• As noted in developed proposal 3.3, establishing a formal Agenda Advisory Group 

will help reduce influence on the Board from any single group of constituents and 

maintain its independence. 

FASB Board Size and Composition: 

• The FAF proposes to change the size and composition of the FASB. The Committee 

is supportive of such changes, but as noted in developed proposal 3.1, the 

composition of the FASB Board should be clarified to require (1) a preparer, an 

auditor and at least one experienced user/investor who regularly uses third party 

financial statements. The Committee recognizes that a potential move towards five 

board members from seven would increase the influence of users/investors on the 

Board, but believes such a result is appropriate. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 34 -
FASB Voting: 

• The FAF proposes to maintain the FASB’s current majority voting requirement. The 

Committee is supportive of this proposal to further promote the timeliness of the 

standard-setting process and the process of issuing interpretive implementation 

guidance. 

Leadership of the Agenda by the FASB Chairman: 

• The FAF proposes to give the FASB Chairman control over the FASB’s agenda. The 

Committee understands that the FAF intends for the FASB Chairman to continue to 

consult with other Board members, the SEC and user/investor advisory groups when 

making agenda decisions. The proposed formal Agenda Advisory Group in 

developed proposal 3.3 could help serve that function. An Agenda Advisory Group, 

which would include more formal user/investor involvement than currently exists, 

would help shield the FASB from influence by any single group of constituents, while 

at the same time injecting transparency and accountability into the agenda-setting 

process for all involved parties. Given that the proposed Agenda Advisory Group 

would not have a binding impact on the FASB’s agenda, instilling more decisionmaking authority in the FASB Chairman, combined with a requirement to consult, 

would be a positive step towards increasing the efficiency of the Board. 

• However, the Committee would like to highlight that an essential aspect of effective 

management of the agenda would be to remove items based upon other priorities. 

This would allow the Board to be more effective in the projects it perceives as the 

most beneficial. 

Objectives: The FASB’s mission statement, objectives and precepts recognize that 

efficient functioning of the capital markets relies upon credible, concise, transparent and 

understandable financial information. They also discuss the importance of the usefulness 

of financial information, keeping standards current, considering areas of deficiency that 

need improvement, international convergence, understandability of the results, neutrality, 

weighing constituent views, satisfying the cost-benefit constraint, minimizing disruption 

by providing reasonable effective dates and transition provisions, following an open due 

process, and reviewing the effects of past decisions in a timely fashion to interpret, 

amend or replace standards, when necessary. 

The Committee believes that minimizing avoidable complexity (see definition in chapter 

1) should be an additional explicit goal to which the FASB aspires. Amending its 

mission statement, stated objectives or precepts may cause Board members and the FASB 

staff to give explicit and transparent consideration during the standard-setting process to 

whether or not there are less complex alternatives to the positions being evaluated during 

the standard-setting process. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 35 -
Performance Metrics: The FAF should also consider establishing performance metrics to 

measure and track the efficiency and effectiveness of the standard-setting process over 

time. The Committee does not believe that such metrics would have a detrimental impact 

on the Board’s independence; rather, they should be designed to introduce accountability 

into the standard-setting process. Properly established performance metrics may also 

assist the FAF in balancing the competing requirements in standard-setting of timeliness 

and conceptual merit. The FAF might consider developing performance metrics designed 

to assess timeliness and compliance with stated goals in the FASB’s mission statement, 

objectives and precepts as a starting point. 

Question for the Committee: 

3.3) Do you agree with developed proposal 3.2? What revisions, if any, would you 

recommend? 

V. Standard-Setting Process Improvements 

As discussed more fully below, the Committee has developed the following proposal and 

conceptual approach relating to improving the standard-setting process: 

Developed Proposal 3.3: The SEC should formally encourage the FASB to further 

refine its standard-setting process by performing the following: 

• Creating a formal Agenda Advisory Group that includes strong representation 

from users/investors, the SEC and the PCAOB to actively recommend priorities 

for managing standard-setting priorities in the U.S. 

• Improving its procedures for field testing, field visits and cost-benefit analyses, 

by: 

o Requiring that scalable field tests, field visits, and cost-benefit analyses be 

performed for new standards that would better leverage resources in the 

preparer, auditor, and user/investor communities; and 

o Implementing certain cost-benefit process improvements. 

Formal Agenda Advisory Group: A formal Agenda Advisory Group that includes strong 

representation from users/investors, the SEC, the FASB and the PCAOB, as well as other 

interested parties such as preparers and auditors, should be created to provide advice on 

the agenda of the standard-setting system, while at the same time maintaining an 

appropriate focus on user/investor needs. The Committee acknowledges that many of the 

consultations that would occur formally under its proposal occur informally today at the 

SEC and FASB; however, the Committee believes that formalizing the process and 

making it more transparent would assist in managing competing priorities and increase 

accountability. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 36 -
The primary goals of the formal Agenda Advisory Group would be to (1) help the 

standard-setting process become more nimble, (2) help the standard-setter keep its 

authoritative guidance as useful as possible by keeping it current, and (3) reduce the need 

for the SEC or other parties to issue interpretive implementation guidance. By 

identifying emerging issues and building consensus about which group is best positioned 

to deal with them (e.g., the FASB, EITF or SEC) and in what form, the formal Agenda 

Advisory Group would give immediate input about how best to prioritize near-term 

versus long-term priorities. 

The Committee does not believe that input currently received regarding the FASB’s 

agenda should be lessened in any way; rather, it should be centralized, more formal and 

more timely. A formal Agenda Advisory Group should be implemented 

contemporaneously with a reconsideration by the Board of whether to consolidate some 

of the input currently received regarding its agenda from other sources that may 

otherwise overlap with the Agenda Advisory Group. By involving representatives from 

its other advisory groups in the Agenda Advisory Group, the FASB Chairman may be 

able to centralize user/investor perspectives, thereby increasing their prominence during 

the agenda setting process (see developed proposal 3.1). 

The proposed formal Agenda Advisory Group would be different from the role already 

performed by FASAC. Timely involvement would be critical to proper functioning of 

the Agenda Advisory Group, and as such, it should be able to be convened on short 

notice, if necessary. The Agenda Advisory Group should also vote (and provide that 

information in an advisory capacity to the FASB Chairman, who would make the final 

agenda decision), thereby maintaining transparency and improving accountability. 

Lastly, the Agenda Advisory Group would include active involvement of the SEC in 

referring agenda matters in a transparent and timely manner. These are functions that 

FASAC does not currently perform, although representation similar to that currently 

enjoyed by FASAC members would be instrumental to the proper functioning of the 

formal Agenda Advisory Group. 

In creating such a formal Agenda Advisory Group, the SEC and FASB should consider 

the following additional elements: 

• Active user/investor involvement. 

• Timeliness. The Agenda Advisory Group should be convened both on a regular 

schedule, as well as, as noted above, on short notice telephonically to deal with urgent 

matters, as necessary. 

• Transparency and accountability. The Agenda Advisory Group should vote on 

certain aspects of the standard-setting agenda and provide that information in an 

advisory capacity to the FASB Chairman, who would make the final agenda decision. 

Part of the rationale for calling a vote would be to maintain transparency and increase 

accountability of the FASB Chairman to the FAF regarding the effectiveness of 

agenda decisions. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 37 -
• Involvement by the SEC. One or more senior representatives from the SEC Office of 

the Chief Accountant should be on the Agenda Advisory Group, as the SEC often 

identifies practice issues prior to the designated private-sector standard-setter. In 

addition, active involvement of the SEC will help coordinate how and by whom 

guidance should be issued, thereby reducing the impetus for the SEC to issue 

interpretive implementation guidance. 

• Openness versus timeliness. The general preference for open due process should be 

balanced with the need for ensuring timely advice on emerging issues so that the 

benefit of being able to build consensus on who is best able to deal with emerging 

issues may be achieved. 

• Involvement by the FASB Board. All FASB Board members should be invited as 

official observers of the Agenda Advisory Group so that they may hear the views of 

various constituents directly. 

• Involvement by the PCAOB. A senior representative from the PCAOB should be an 

official observer of the Agenda Advisory Group, as actions taken by the PCAOB 

significantly impact behavior of participants in the U.S. financial reporting 

community. 

• Involvement by others. Constituents otherwise not represented on the Agenda 

Advisory Group should be able to present agenda requests, similar to the function of 

the current EITF Agenda Committee. 

• Framework for agenda setting. A framework similar to that currently used by the 

EITF Agenda Committee should be developed that may assist the formal Agenda 

Advisory Group with making agenda setting and prioritization decisions. 

Field Visits, Field Testing and Cost-Benefit Analyses: The FASB often visits with a 

number of interested constituents regarding particular standards as they are being 

deliberated, referred to as field visits. During development of a standard, usually prior to 

issuance of an Exposure Draft, the FASB may choose to conduct field visits for the 

purpose of assessing the costs and benefits or operationality of the proposed standard. 

During the comment period, the FASB may also conduct field tests, during which the 

adoption of a proposed standard is actually tested so that issues may be identified and 

resolved. However, as a practical matter and in consideration of resource constraints, the 

setting of many recent standards has not included robust field testing. 

The FASB evaluates whether the benefits of each new standard justify its costs by 

determining that a proposed standard will meet a significant need and that the costs it 

imposes, compared with possible alternatives, are justified in relation to the perceived 

overall benefits. However, participants in the standard-setting process have long 

acknowledged that reliable, quantitative cost-benefit calculations may seldom be 

possible, in large part because of the lack of available information on the costs and the 

difficulty in quantifying the benefits. Further, the magnitude of the benefits and costs is 

difficult to assess prior to preparers using the standard in the preparation of financial 

statements, auditors auditing that information, regulators regulating it, and users/investors 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 38 -
assessing the benefits of the resulting accounting and disclosure. Further, cost-benefit 

considerations are sometimes based largely on anecdotal evidence, which does not 

consistently include preparers, auditors, users/investors, and regulators. 

The Committee believes the FASB could improve its procedures for field testing, field 

visits and cost-benefit analyses. Specifically, scalable field tests, field visits and costbenefit analyses should be a required part of the standard-setting process for all new 

standards. The rigor required in each of these procedures should be scaled based upon 

active consideration by the FASB of the length, difficulty and magnitude of impact of the 

accounting standard or interpretive implementation guidance, and the FASB may 

conclude that field visits and field tests may not be warranted for certain standards or 

interpretive implementation guidance. 

Ideally, field visits, field testing and cost-benefit analyses would occur at the same time, 

as the same participants would be involved in each for a particular standard. Therefore, 

the FASB should continue to leverage work already being done by preparers, auditors, 

task forces and user/investor groups to assess the impact, operationality and auditability 

of proposed standards to help inform its views. Requesting assistance from preparers, 

auditors and users/investors either directly or through task forces and resource groups 

(perhaps on more of a rotational basis than is done in practice today) would bring 

additional subject matter expertise and recent business experience to each field visit, field 

test and cost-benefit analysis. Many of these processes occur today, but additional 

benefits may ensure if they were consistently done in a more timely, systematic, and 

transparent fashion as a matter of policy. 

The FASB is currently considering new initiatives to improve its field testing and costbenefit analyses. The Committee supports the FASB’s efforts in this regard and as a 

complement to that initiative, the FASB should consider the following improvements to 

its existing cost-benefit procedures: 

• Select preparers, auditors, users/investors and regulators to be involved based upon 

their interest in the standard or interpretive implementation guidance being 

developed. 

• Improve the transparency around the amount of work that is currently done by 

exposing the entire analysis for public comment (rather than a summary or abstract), 

thereby enhancing the ability of interested constituents to comment on the 

conclusions reached and the basis for those conclusions. 

• Refrain from discussing costs and benefits on a net basis, as this sometimes creates 

opacity around the data underlying such conclusions. The analyses of costs and 

benefits should be prepared separately, with an indication of how the Board weighed 

the evidence in its conclusion. 

• Attempt to better quantify the costs (in addition to providing qualitative assessments). 

If there is concern about the accuracy or reliability of the data, frame those concerns 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 39 -
in the analysis rather than omitting the data. A cost estimate and how it was arrived 

at should be requested from constituents who claim that costs are excessive. 

• Add auxiliary information to put the accounting standard or interpretive 

implementation guidance into context (e.g., expectation of the impact of the standard 

on the number of companies, overall market capitalization metrics of constituents 

expected to be impacted). 

• Improve the discussion of the cost-benefit conclusions in the basis for conclusions of 

new standards so that it may be referred to over time when re-assessing the original 

cost-benefit conclusions as part of the post-adoption effectiveness reviews and 

reviews of the overall effectiveness of U.S. GAAP, as further described in developed 

proposal 3.5. 

• Consider leveraging economist resources to assist the FASB staff in preparing and 

reviewing cost-benefit analyses. 

Conceptual Approach 3.A: The Committee is considering proposing that subject to 

the conclusions reached in the future deliberations of international considerations 

described above the SEC encourage a re-prioritization of the standard-setting 

agenda, which may include the following: 

1. Consider the Committee’s proposals and the potential prioritization of those 

proposals. 

2. Verify, issue, and implement the codification of U.S. GAAP, including a recodification of existing SEC literature, if needed, (see developed proposal 3.4) 

and removal of redundancies between SEC disclosure requirements and other 

sources of GAAP (See chapter 2). 

3. Continue efforts towards international convergence (jointly with the IASB). 

4. Complete the conceptual framework (jointly with the IASB). 

5. As further described in developed proposal 3.5, add phase II of the codification 

project to the agenda and consider whether GAAP should be systematically 

revisited, as follows: 

• To be more coherent post codification. 

• To remove redundancies and/or conflicts with the conceptual framework. 

• As further described in developed proposal 3.2, to be less complex, where 

possible. 

• As further described in conceptual approach 3.C, to be designed optimally. 

• To readdress frequent practice problems (as identified by restatement 

volumes, input from the SEC, implementation guidance issued, frequentlyasked questions). 

• To amend, replace, or remove outdated standards. 

6. Create a disclosure framework that may be used by the FASB in the future 

when assessing what types of disclosures are necessary based upon the type of 

information being conveyed (See chapter 2). 

7. Address emerging issues that urgently require attention (either directly or 

through a delegate). 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 40 -
Background: The Committee recognizes that the priorities of both the SEC and the 

FASB are very difficult to manage; both organizations face significant challenges 

associated with competing priorities from a number of different constituents, as well as 

needing to manage both near-term and long-term priorities. In particular, the FASB has 

been constrained by its need and desire to fulfill its obligations under the Memo of 

Understanding with the IASB regarding international convergence matters. While 

commonly acknowledged as a priority in global standard-setting, the Committee 

recognizes that coordinating accounting conclusions amongst different Boards and staff is 

challenging. 

However, as part of its proposed formal Agenda Advisory Group, the Committee is 

deliberating a conceptual approach regarding what the priorities of both the FASB and 

SEC should be in the current environment. The Committee plans to finalize its proposal 

after completing its deliberations on international considerations later in 2008, which 

would be expected to significantly impact its proposal. In fact, some participants in the 

U.S. financial reporting community have indicated that a full-scale adoption of IFRS in 

the U.S. may be the most expeditious way to shorten the lengthy timeline that would be 

required to complete the list of priorities being deliberated by the Committee as noted 

above. 

Most of the Committee’s proposed priorities for the SEC and FASB are self-explanatory, 

but one merits additional explanation, as follows: 

Conceptual Framework: The completion of the conceptual framework, and a 

reconsideration of conflicts between the revised conceptual framework and U.S. GAAP, 

will be an important step to improving the coherence of U.S. GAAP. Specifically, the 

FASB should have such a conceptual framework that it may refer back to over time when 

setting standards to ensure cohesiveness and consistency. Many of the issues currently 

being addressed by the FASB as part of the conceptual framework project are challenging 

and will have a pervasive impact on U.S. GAAP. The Committee is highly supportive of 

the FASB’s efforts in this regard. Due to the potentially significant impact on U.S. 

GAAP of changes to the conceptual framework, it will be important that constituents 

agree with the direction of the FASB; to do so, there may be opportunities during Board 

deliberations to further clarify what the specific impacts will be of recommended changes 

to the conceptual framework. The FASB should be careful to highlight those changes to 

prevent consequences that are unintended or misunderstood by users/investors, preparers, 

auditors and regulators. 

Question for the Committee: 

3.4) Do you agree with developed proposal 3.3? What revisions, if any, would you 

recommend? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 41 -
Question to be Subsequently Considered by the Committee: 

3.5) Do you agree with conceptual approach 3.A? What revisions, if any, would you 

recommend? 

VI. Interpretive Implementation Guidance 

As discussed more fully below, the Committee has developed the following proposal and 

conceptual approach regarding interpretive implementation guidance: 

Developed Proposal 3.4: The number of parties both formally and informally 

interpreting U.S. GAAP should be reduced. The SEC should coordinate with the 

FASB to clarify roles and responsibilities regarding the issuance of interpretive 

implementation guidance, which would further reduce uncertainty in the U.S. 

financial reporting community. Specifically, the following steps should be taken: 

• The first phase of the FASB’s codification should be verified, issued and 

implemented in a timely manner. 

• So that the benefits of the FASB’s codification efforts may be fully realized, the 

SEC should ensure that the literature it deems to be authoritative is able to be 

integrated into the FASB codification to the extent practicable, including 

through a re-codification of such literature if necessary. 

• Going forward, there should be a single private-sector standard-setter for all 

authoritative accounting standards and interpretive implementation guidance 

applicable to a particular set of accounting standards (e.g., U.S. GAAP, IFRS). 

For U.S. GAAP, the FASB should continue to serve this function. The SEC 

and the FASB should also continue to be judicious when determining when to 

issue interpretive implementation guidance. 

• In instances when the SEC identifies accounting matters that it believes may 

apply or should be applied broadly, the SEC should refer those items to the 

FASB as part of the formalization of the informal feedback loop that is 

currently in place. 

• All other sources of interpretive implementation guidance should be considered 

non-authoritative and should not be given more credence than any other nonauthoritative sources that are evaluated using well-reasoned, documented 

professional judgments applied in good faith. 

Background: Historically, interpretative implementation guidance has proliferated from a 

variety of sources and, intentionally or not, becomes additional sources of U.S. GAAP 

that may add to the complexity in the financial reporting system, especially when 

questions exist about its authoritative nature or conflicts exist between interpretations. 

Over the past few years, the FASB has taken actions intended to reduce the proliferation 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 42 -
of authoritative interpretive implementation guidance from different bodies, including 

being recognized by the SEC as the private-sector accounting standard-setter for U.S. 

GAAP and limiting the ability of other bodies to create authoritative guidance without 

Board ratification. The SEC staff is also a source of interpretive implementation 

guidance, such as through comment letters, staff speeches, staff accounting bulletins and 

other forms of guidance that, although typically non-authoritative, are often perceived in 

the marketplace as quasi-authoritative. 

Codification: The FASB has undertaken a significant project to develop a 

comprehensive, integrated codification of existing accounting literature organized by 

subject matter that is intended to become an easily retrievable single source of U.S. 

GAAP. The Committee applauds the FASB’s foresight in working on such a project and 

recognizes the significant effort that the codification entails. The codification will (1) 

bring all sources of authoritative U.S. GAAP together by topic into a single, searchable 

database so that they may be more easily researched, (2) clarify what guidance is 

authoritative versus non-authoritative, and (3) put each standard into a more consistent 

format, to the extent possible. 

Although the codification will not change the substance of U.S. GAAP, the codification 

should make it easier to apply U.S. GAAP by gathering in one place all the relevant 

authoritative literature. However, SEC literature, which has developed through different 

mechanisms, may not be as easily integrated into the FASB codification. The 

codification will similarly not deal with the root causes of the proliferation of interpretive 

implementation guidance, nor the behavior of participants in the U.S. financial reporting 

community. 

Notwithstanding these concerns, the Committee is supportive of the FASB’s efforts to 

issue, validate and implement the codified version of U.S. GAAP over the upcoming 

year. Completion of the FASB’s codification project is an important aspect of clarifying 

roles and responsibilities between the SEC and the FASB by flattening the GAAP 

hierarchy to two levels and stating explicitly those sources that are authoritative and those 

that are not. With that in mind, the Committee proposes that the SEC work with the 

FASB to ensure that the FASB’s draft codification is verified, issued and implemented in 

a timely manner so that its benefits may be realized as quickly as practical. To improve 

existing U.S. GAAP, the FASB should consider a second phase of the codification 

project that would systematically revisit U.S. GAAP, as further described in developed 

proposal 3.5. The SEC should ensure that all interpretive implementation guidance it 

deems to be authoritative is also codified, which may require a re-codification of the SEC 

literature itself so that the benefits of the FASB’s codification project may be fully 

achieved. 

Authoritative Guidance: The Committee believes that authoritative interpretive 

implementation guidance that is broadly applicable to a particular set of accounting 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 43 -
standards (e.g., U.S. GAAP, IFRS) is best issued by a single, private-sector standardsetter such that the guidance may be immediately updated in the codified version of that 

set of accounting standards. For U.S. GAAP, the FASB should continue to serve this 

function. In addition, the SEC and the FASB should continue to be judicious when 

determining when to issue interpretive implementation guidance. 

Feedback Loop: The SEC should formalize the mechanism by which it currently 

informally refers agenda topics to the FASB such that the FASB may be the sole issuer of 

authoritative interpretive implementation guidance that is broadly applicable, thereby 

reducing the need for the SEC to do so. A formal Agenda Advisory Group on which 

representatives from the SEC staff and FASB both sit (as further described in developed 

proposal 3.3) could facilitate the feedback loop during which specific registrant matters 

with broad applicability are formally referred from the SEC to the FASB. Such a process 

would also leverage post-adoption effectiveness reviews of accounting standards by the 

standard-setter (as further described in developed proposal 3.5) and would require the 

formalization of the frequent, informal communication mechanisms that were 

strengthened between the SEC and the FASB in recent years. Such a formal, transparent 

feedback loop would help identify and prioritize issues with broad applicability that 

require authoritative interpretive implementation guidance from the designated standardsetter directly in the codified version of U.S. GAAP. 

Non-Authoritative Guidance: All other interpretive implementation guidance (e.g., 

industry guides, accounting firm guidance) should be considered to be non-authoritative 

(by virtue of the fact that it will not be included in the U.S. GAAP codification) and 

should therefore not have more credence than well-reasoned, documented conclusions 

based on other, potentially-conflicting non-authoritative interpretive implementation 

guidance applied using a professional judgment framework (see developed proposal 3.4). 

Although the FASB codification initiative will help clarify the role of authoritative versus 

non-authoritative interpretive implementation guidance, making meaningful 

improvements in financial reporting will be difficult if non-authoritative interpretive 

implementation guidance continues to have the perception it has today of pseudoauthority in the marketplace. 

Conceptual Approach 3.B: As a follow-up to developed proposal 3.4 to further 

reduce interpretive implementation guidance associated with U.S. GAAP, the 

Committee is considering proposing that the SEC further clarify its role vis-à-vis 

the designated private-sector standard-setter, as well as its internal roles and 

responsibilities, to mitigate the risk of its actions unintentionally driving behavior, 

as follows: 

• The SEC staff should clarify that registrant-specific matters are not 

authoritative forms of interpretive implementation guidance under U.S. GAAP 

that should be analogized to or applied more broadly than to the specific 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 44 -
registrant in question as the source for preparers to make changes to their 

financial statements. 

• In instances when the SEC staff identifies registrant-specific accounting 

matters that it believes may result in the need for interpretive implementation 

guidance or a clarification of an accounting standard under U.S. GAAP, the 

SEC staff should refer those items to the FASB as part of the proposed formal 

feedback loop and proposed formal Agenda Advisory Group (see developed 

proposals 3.3 and 3.4). 

• The SEC staff should refrain from informally communicating interpretive 

implementation guidance that would result in a change in the application of 

U.S. GAAP. 

• The FASB and SEC should continue to be judicious when issuing broadlyapplicable interpretive implementation guidance under U.S. GAAP. However, 

when it is necessary for the SEC to issue such broadly-applicable interpretive 

implementation guidance, similar to the processes followed by the FASB such 

guidance should (1) be deliberated with open due process and subject to public 

comment to the extent practicable, (2) be clearly communicated as authoritative, 

and (3) be easily and immediately integrated into the re-codification of SEC 

literature (see developed proposal 3.4). 

• The SEC staff should revisit internal procedures and/or take further steps 

necessary to improve the consistency of its views on the application of U.S. 

GAAP. 

SEC Due Process: The SEC (i.e., the full Commission) sometimes issues rules and 

interpretations that comprise part of authoritative U.S. GAAP. The Commission’s rulemaking activities are generally open to public participation and observation. However, 

other activities of the SEC and its staff do not occur with the same level of open due 

process. 

For example, the SEC Division of Corporation Finance (Corp Fin) reviews and 

comments on financial reports filed by registrants that are not investment companies. 

Corp Fin has a process for facilitating the public availability of comment letters and 

registrant responses to those comment letters on the SEC's website upon completion of 

the review process. Corp Fin also receives letters from specific registrants requesting 

concurrence on various reporting and disclosure issues. Similarly, OCA and Corp Fin 

receive requests from specific registrants for concurrence with conclusions on specific 

accounting interpretative implementation guidance issues. These letters are commonly 

referred to in the marketplace as pre-clearance. SEC staff may also issue public 

statements, such as Staff Accounting Bulletins (SABs), which are approved by the Chief 

Accountants in both Corp Fin and OCA. In addition, SEC staff give speeches and issue 

letters to industry expressing views on accounting topics. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 45 -
Consistency: The Committee considered how to improve internal processes between 

various Offices and Divisions within the SEC to improve the consistency of accounting 

advice given by the SEC staff. Although the Committee understands that there are 

processes in place to build consensus on accounting matters within the SEC, the 

Committee believes there is room for improvement in this regard. The possibility of 

inconsistent accounting advice emanating either across and within various Offices and 

Divisions within the SEC creates confusion in the marketplace. 

The Committee also understands that processes exist for registrants to request 

reconsideration of conclusions expressed in either comment letters or in pre-clearance 

letters within Corp Fin and/or, to the extent it relates to interpretative implementation 

guidance under U.S. GAAP, by OCA, when a registrant may disagree with staff guidance 

or believes it is receiving inconsistent advice. However, registrants may not always use 

these processes for a number of reasons, such as: (1) to avoid additional delay and 

potential impact on market opportunities, (2) to avoid the risk of opening other 

accounting conclusions to reconsideration, and (3) for fear of possible retribution 

(misguided or not). Therefore, although the SEC staff has created checks-and-balances in 

the form of these reconsideration processes, they may not by themselves effectively 

address all consistency issues. 

Registrant-Specific Guidance: Preparers and auditors may misconstrue registrantspecific accounting outcomes as quasi-authoritative forms of interpretive implementation 

guidance. However, the outcomes are typically fact-specific and are not always intended 

to be applied broadly. Nevertheless, preparers and auditors may overreact by applying 

those outcomes to similar, yet different sets of facts and circumstances, often believing 

that those outcomes require restatement. 

The SEC staff advised the Committee that it does not intend for registrant-specific 

guidance and outcomes to be applied broadly to other registrants with potentially 

different fact patterns. The Committee believes that interpretive implementation 

guidance that is applicable only to specific registrants should not be required to be 

applied more broadly than to the specific registrant and recommends that the staff 

publicly communicate this view. This clarification would help (1) prevent preparers, 

auditors and other regulators from overreacting to actions taken by the SEC staff, (2) 

facilitate the application of reasonable professional judgment, (3) reduce the need for 

other parties to issue interpretive implementation guidance, and (4) support the 

Committee’s proposal to refer broadly-applicable accounting matters that require 

interpretive implementation guidance to the designated private sector standard-setter. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 46 -
As noted above, the SEC staff also communicates with the public in various forms about 

broadly-applicable interpretive implementation guidance, including SABs,10 letters to 

industry, staff speeches and training manuals. In addition, Corp Fin publishes and 

maintains interpretive implementation guidance on the SEC website. While all of these 

publications contain disclaimers as to their non-authoritative nature, most financial 

reporting participants consider those disclaimers to be boilerplate and regard such 

interpretive implementation guidance as quasi-authoritative. 

These publications are typically viewed by the SEC staff as confirmations of existing 

accounting standards, rather than as supplemental interpretive implementation guidance. 

However, many of these publications have in the past and continue to influence market 

behavior because they sometimes include SEC staff views that do supplement existing 

U.S. GAAP. SEC staff sometimes refers registrants to these publications to support the 

staff’s view on registrant-specific matters. As such, many argue that such documents 

exemplify the SEC staff effectively setting accounting standards without open due 

process and point to restatements following their releases as evidence of their quasiauthoritative nature in practice. 

Partially in response to these concerns, the SEC staff sometimes attempts to exercise 

restraint by not formalizing its views, which presents a different challenge. Over time, 

even these informal SEC staff views become known, although not broadly disseminated. 

This often results in others in the financial reporting community issuing interpretive 

implementation guidance that broadly attempts to communicate the SEC staff’s views. 

This was likely one of the purposes of forming the Center for Audit Quality (CAQ), 

which appears to serve, in part, as a mechanism for the large audit firms to communicate 

with a unified voice to the marketplace about their direct communications with the 

standard-setters and regulators. 

The Committee does not intend to limit the ability of the SEC staff to carry out its 

regulatory responsibilities in a timely fashion. That is why the Committee has not yet 

proposed a specific course of action in response to the concerns raised herein. The SEC 

staff is reviewing its procedures in a number of these areas and expects to unveil changes 

during the coming months, including procedures to enhance consistency of accounting 

interpretations during filing reviews and increase the transparency and usefulness of the 

10 The Commission authorized the use of SABs in 1975 to achieve a wider dissemination of the 

administrative interpretations and practices utilized by the Commission's staff in reviewing 

financial statements. There had been concern that smaller audit firms and issuers would be 

disadvantaged because there had previously been no formal dissemination of staff practices. 

SABs were also designed to provide a means by which new or revised interpretations and 

practices could be quickly and easily communicated to registrants and their advisors. As they are 

designed to disseminate staff administration practices on a timely basis to the broader public, 

SABs are not generally exposed for public comment before release. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 47 -
reconsideration processes. The Committee is fully supportive of the SEC staff’s internal 

review process and plans to work with the SEC staff in its deliberations in the coming 

months. 

Question for the Committee: 

3.6) Do you agree with developed proposal 3.4? What revisions, if any, would you 

recommend? 

Question to be Subsequently Considered by the Committee: 

3.7) Do you agree with conceptual approach 3.B? What revisions, if any, would you 

recommend? 

VII. Transition to and Design of New Standards 

As discussed more fully below, the Committee has developed the following proposal and 

conceptual approach regarding the implementation and design of standards so that they 

promote the use of reasonable judgments: 

Developed Proposal 3.5: The SEC should formally encourage an objectives-based 

approach to the way standards are designed and implemented, which would allow a 

reasonable amount of diversity in practice, as follows: 

• By encouraging standard-setters to refine transition guidance in new standards 

to make clear that a reasonable amount of diversity may exist following initial 

adoption of standards, which may allow the SEC to regulate compliance with 

new standards without forcing restatements that may not be material to 

users/investors, so long as the basic principles in U.S. GAAP are followed, 

including the importance of promoting comparability amongst preparers. Such 

implementation and transition guidance would continue to have a stated, 

required implementation date, but should acknowledge that diversity in practice 

post-implementation will be monitored and addressed by the standard-setter in 

the form of post-adoption effectiveness reviews to maintain an appropriate 

amount of comparability. 

• By encouraging post-adoption effectiveness reviews of new standards to be 

conducted by the standard-setter within a reasonable timeframe after adoption 

of new standards, as determined by the standard-setter based upon the scale of 

the standards themselves. By identifying diversity that develops during the 

review period that is perceived to undermine comparability, the standard-setters 

should take immediate action to reduce diversity through the standard-setting 

process, with appropriate transition provided to avoid restatements that may not 

be perceived as material to users/investors. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 48 -
• By encouraging the standard-setter to also revisit all of U.S. GAAP for 

effectiveness on a periodic basis.

Transition Guidance: The Committee noted that one of the significant complexities of 

the current financial reporting and regulatory environment is that preparers, auditors and 

other participants are sometimes viewed as being penalized for improving their 

understanding and interpretations of accounting standards over time. Said differently, if a 

preferred interpretation of a new standard develops after the standard has been 

implemented, early adopters may be forced to retain less preferable accounting or restate 

in future periods. This issue can be especially problematic for new standards. 

Furthermore, the fear of having reasonable, good-faith judgments overturned, may cause 

preparers, auditors and regulators to engage in defensive accounting and auditing. 

Therefore, standard-setters should refine implementation and transition guidance in new 

standards to make clear that a reasonable amount of diversity may exist following initial 

adoption of new standards, which may allow the SEC to regulate compliance with new 

standards without forcing restatements that may not be perceived as material by 

users/investors, so long as the basic principles in U.S. GAAP are followed, including the 

importance of maintaining comparability. There will be a careful trade-off; within 

reasonable limits, comparability will not be undermined by permitting reasonable 

diversity, so long as the consequences are not material to investors. 

The goal of such refinements would be that the accounting standards themselves would 

not be written with an attempt to close every loop-hole to prevent abuse, nor answer 

every implementation issue in advance. Rather, with objectives-oriented standards, the 

financial reporting community would accept some diversity in practice in early years, and 

not compel restatements as experience is gained, but make as appropriate prospective 

changes to properly address longer-term comparability. 

This may be accomplished by the FASB providing a clear post-adoption effectiveness 

review period (review period) for all new standards (the length of which would be 

determined by the standard-setter based on the scale of the standard, but typically 1-2 

years), during which time preparers may benefit from authoritative or non-authoritative 

interpretive implementation guidance to learn about how the standard is being interpreted 

and implemented without being forced to restate (except in clear cases in which the 

registrant fails to comply with the basic principles of the standard). Such a review period 

may require the FASB to adopt standard transition guidance written into all new 

standards, and, because the SEC regulates based upon the standards themselves, may 

have the effect of allowing the SEC to regulate in a more flexible manner. 

However, this is not meant to imply that preparers should have the flexibility to 

implement new standards at different times. Rather, the review period would merely 

clarify that a reasonable amount of diversity may in some situations exist until the 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 49 -
FASB’s first post-adoption effectiveness review is completed. Thereafter, the standardsetter would re-evaluate the standard and may make additional amendments. 

Nor is this proposal meant to usurp the SEC’s authority to regulate abusive behavior. 

Clear violations of U.S. GAAP or inadequate disclosure would continue to be dealt with 

by the SEC through enforcement and the comment review processes. However, issues 

arising during the review period that are purely interpretive would be re-considered by 

the FASB either during or at the end of the review period in a post-adoption effectiveness 

review and standard-setting would be completed by the FASB to clarify the standard and 

reduce diversity in practice, as necessary. 

Post-Adoption Effectiveness Reviews: After a new accounting standard has been in 

place for a reasonable period of time, more data are likely to be available to evaluate its 

cost, efficacy, utility and/or relevance in the current environment. However, currently the 

FASB does not have a formalized, transparent process in place to do post-adoption 

effectiveness reviews of new standards in an agreed-upon timeframe or a broader 

effectiveness review of U.S. GAAP on a systematic basis. As such, standards may miss 

important matters, not properly consider implementation issues, have unintended 

consequences, and may lose their relevance and effectiveness over time. As a 

consequence, useful financial information might not be made available to the users of 

financial statements. 

The FASB has a stated mission and precept that obligates it to perform such effectiveness 

reviews,11 and in satisfaction of those requirements, the FASB regularly receives input 

from various constituents and periodically revisits some of its standards. However, the 

Committee believes that the process by which post-adoption effectiveness reviews are 

completed should be formalized in policy, be more systematic, be more transparent, 

involve input from a broader range of constituents, and be monitored using relevant 

performance metrics. The benefit of doing so would be to remove much of the 

uncertainty that exists in the marketplace around when, how and from whom interpretive 

implementation guidance will be issued. As noted earlier, the uncertainty is a direct 

consequence of the fear of being second-guessed and is a symptom of the tendency to 

engage in defensive accounting and auditing. By formalizing the process, the Committee 

hopes to diffuse some of those fears and change behavior of participants in the financial 

reporting community. 

The goal of post-adoption effectiveness reviews would be to assess whether or not the 

accounting standard accomplished its intended purpose, or whether it had unintended 

consequences that need to be resolved. Specifically, as a matter of policy, the FASB 

11 Part of the FASB’s stated mission is to “Consider promptly any significant areas of deficiency in 

financial reporting that might be improved through the standard-setting process” and one of the FASB’s 

stated precepts in the conduct of its activities is “To review the effects of past decisions and interpret, 

amend or replace standards in a timely fashion when such action is indicated.” 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 50 -
should conduct formal post-adoption effectiveness reviews of new standards within 1-2 

years of implementation (or earlier, based upon facts and circumstances as evaluated by 

the standard-setter) to do the following: 

• Deal with implementation matters that arise. 

• Ensure that only an acceptable amount of diversity in practice exists. 

• Ensure that the accounting that is being produced is what the standard-setter intended 

and is useful to readers of the financial statements. 

• Reassess the cost-benefit analysis, as necessary. 

Reviews of the Effectiveness of U.S. GAAP: In addition, the SEC and the standard-setter 

should perform a similar effectiveness review of U.S. GAAP periodically to formally 

consider the following: 

• Input from users/investors, preparers, auditors and regulators about standards that 

may be improved or eliminated. 

• Practice problems identified by the SEC. 

• Restatement activity. 

• The amount of interpretive implementation guidance required since that last postadoption effectiveness review. 

• The costs and benefits of standards (or accounting models in general). 

• The need to amend, replace or remove outdated standards. 

• Opportunities to be more coherent post codification (see conceptual approach 3.A). 

• Opportunities to reduce avoidable complexity. 

• Opportunities to migrate to an optimal design of standards (see conceptual approach 

3.C). 

Some participants in the financial reporting community have commented that there are a 

small number of accounting standards that are in immediate need of re-evaluation. The 

Committee believes that the formalization of a process for the standard-setter to receive, 

evaluate, and address such input is critical to the proper functioning of the U.S. capital 

markets. However, making a determination on specific standards would best be left to 

the FASB, with oversight from the FAF and input from the formal Agenda Advisory 

Group that assists with agenda-setting priorities. 

The Committee has considered the recent Request for Comments on Proposed Changes to 

Oversight, Structure and Operations of the FAF, FASB and GASB issued by the FAF and 

believes that FAF’s proposed changes to increase its monitoring of the FASB’s 

effectiveness complement the Committee’s proposal. The FAF should closely oversee 

whether post-adoption effectiveness reviews and periodic reviews of the overall 

effectiveness of U.S. GAAP are adequately implemented to ensure that they occur in a 

timely fashion. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 51 -
Impact on Standard-Setting: The Committee acknowledges that many of the aspects 

included in its proposal for post-adoption effectiveness reviews and overall GAAP 

effectiveness reviews occur in practice today. The Committee is supportive of the 

ongoing efforts of the FASB to accomplish these reviews and recognizes that its current 

convergence efforts and other pressing needs make agenda prioritization difficult. 

Formalizing these processes, including creation of the proposed Agenda Advisory 

Committee, and increasingly leveraging the FAF trustees and participants in the preparer, 

auditor, user/investor, and regulatory communities may increase the efficiency and 

effectiveness of these review procedures. In addition, the FAF and FASB should 

consider whether other increases in staffing may be required to facilitate the proposals 

herein. 

Conceptual Approach 3.C: As a follow-up to developed proposal 3.5, the 

Committee is considering proposing that the SEC formally encourage improvement 

in the way standards are written, as follows: 

• By supporting accounting standards being written following an agreed-upon 

framework of what constitutes an optimal standard. Such standards should not 

strive to answer every question and close every loop-hole, but rather, should be 

written with clearly-stated objectives and principles that may be applied to broad 

categories of transactions. 

• By supporting accounting standards being written in a manner that promotes 

trust and confidence in efficient markets by encouraging the use of professional 

judgments made in good-faith. The preparers and auditors should apply the 

standards faithfully, and the regulators should monitor and address abusive 

application of the standards. 

Professional Judgment: Chapter 4 of the report discusses a proposal regarding the 

creation of such a professional judgment framework. The success of such a framework is 

a condition precedent to the developed proposals and conceptual approaches in this 

chapter, for the following reasons: 

The Committee believes that the fear of having reasonable, good-faith judgments 

overturned significantly influences the behavior of participants in the U.S. financial 

reporting community and results in non-authoritative literature being perceived as quasiauthoritative in the marketplace. A professional judgment framework would change 

behaviors of participants in the financial reporting community, thereby making the 

standard-setting system in the U.S. more efficient. In proposing such a step, the 

Committee believes that such a framework will be dependent on changes in behavior 

from all participants in the financial reporting process, including preparers refraining 

from engaging in practices commonly construed as earnings management and 

gatekeepers, including auditors and underwriters, diligently serving their intended roles in 

the marketplace. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 52 -
Such changes in behavior – by preparers and auditors who should apply accounting 

standards faithfully and invoke the use of professional judgment only when appropriate – 

and by the regulatory and legal communities, who should exercise professional 

skepticism while respecting reasonable professional judgments made in good-faith – 

would rebalance the system of checks-and-balances that is critical to the efficient 

functioning of the U.S. capital markets. It would also enable a simplification in the 

design of standards and reduce the demand for further detailed interpretive 

implementation guidance in response to defensive accounting and auditing. This would 

allow the standard-setters to revisit U.S. GAAP with an eye to making its requirements 

easier to understand and apply. Without such changes in behavior by all parties, 

meaningful improvements in the standard-setting process will be difficult. 

Optimal Design of Standards: Some participants in the U.S. financial reporting 

community believe that certain accounting standards do not clearly articulate the 

objectives and principles upon which they are based. The objectives and principles 

inherent in existing U.S. GAAP are sometimes overwhelmed by detailed rules, examples, 

scope exceptions, safe harbors, cliffs, thresholds and bright lines. In addition, U.S. 

GAAP is not typically written in plain English. This makes it difficult for preparers and 

auditors to apply the standards’ underlying objectives and principles, which creates risk 

that the appropriate rule is not identified and considered, and causes uncertainty in 

application, because rules cannot cover all possibilities. This, in turn, may drive requests 

from preparers, auditors and regulators to answer every question in the form of more 

prescriptive rules, examples and additional guidance (termed earlier as defensive 

accounting and auditing). The result is an accounting system that is overly complex, has 

little room for professional judgment, and can engender a check-the-box approach. 

The Committee recognizes that the question of how to design standards going forward is 

at the center of a decade-long principles-based (or objectives-oriented) versus rules-based 

accounting standards debate. Rather than engaging in such a debate, the Committee 

prefers to think of optimal accounting standards in terms of what characteristics they 

might possess. The Committee is considering various suggestions on the optimal design 

of standards, including the work of the CEOs of the World’s Six Largest Audit Networks, 

who are attempting to build consensus about what optimal accounting standards might 

look like in the future and whether a framework should be created that the standardsetters may refer back to over time to ensure that such characteristics are optimized. The 

latest step in this effort was the creation of such a draft framework, which will be 

presented at the Global Public Policy Symposium in January 2008. 

The Committee is supportive of these efforts and understands that the draft framework 

will likely recommend that optimal accounting standards have the following 

characteristics: 

• Faithful presentation of economic reality, 

• Responsive to users' needs for clarity and transparency, 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 53 -
• Consistency with a clear Conceptual Framework, 

• Based on an appropriately-defined scope that addresses a broad area of accounting, 

• Written in clear, concise and plain language; and 

• Allows for the use of reasonable judgment. 

In addition, in his testimony before the United States Senate Subcommittee in Securities, 

Insurance and Investment on October 24, 2007, the Chairman of the IASB, Sir David 

Tweedie, noted a similar set of four characteristics, two of which augment the 

aforementioned six, including: (1) whether they can be explained simply in a matter of a 

minute or so, and (2) they make intuitive sense. 

Future Considerations: The Committee also plans to further deliberate what optimal 

transition guidance should be in the future that would balance user/investor needs for 

consistent information with feasibility and cost considerations associated with recasting 

historical information during the retrospective adoption of new accounting standards. 

Question for the Committee: 

3.8) Do you agree with developed proposal 3.5? What revisions, if any, would you 

recommend? 

Question to be Subsequently Considered by the Committee: 

3.9) Do you agree with conceptual approach 3.C and future considerations? What 

revisions, if any, would you recommend? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 54 -
CHAPTER 4: AUDIT PROCESS AND COMPLIANCE 

I. Scope 

The Committee has concentrated its efforts to date primarily on the subjects of financial 

restatements and whether the provision of guidance with respect to the materiality of 

errors and how to correct errors would be beneficial. The Committee has also considered 

professional judgment and whether a judgment framework would enhance the quality of 

judgments and the willingness of others to respect judgments made. 

Question for the Committee: 

4.1) Do you agree with the plan in the area of audit process and compliance?

II. Financial Restatements 

II.A. Background 

Potential Causes of Restatements 

A significant and increasing number of restatements12 have occurred in the U.S. financial 

markets in recent years. Restatements generally occur because errors that are determined 

to be material are found in a financial statement previously provided to the public. 

Therefore, the increase in restatements appears to be due to an increase in the 

identification of errors that were determined to be material. The increase in restatements 

has been attributed to various causes. These include more rigorous interpretations of 

accounting and reporting standards by preparers, outside auditors, the SEC, and the 

PCAOB; the considerable amount of work done by companies to prepare for and improve 

internal controls in applying the provisions of section 404 of the Sarbanes-Oxley Act; and 

the existence of control weaknesses that companies failed to identify or remediate. Some 

have also asserted that the increase in restatements is the result of an overly broad 

application of the concept of materiality13 (and discussions regarding materiality in SAB 

12 For the purposes of this chapter, a restatement is the process of revising previously issued financial 

statements to reflect the correction of an error in those financial statements. An amendment is the process 

of filing a document with revised financial statements with the Commission to replace a previously filed 

document. A restatement could occur without an amendment, such as when prior periods are revised in a 

current filing with the Commission. 13 A fact is material if there is a substantial likelihood that a reasonable investor in making an investment 

decision would consider it as having significantly altered the total mix of information available. Basic, Inc. 

v. Levinson, 485 U.S. 224, 231–32 (1988); TSC Industries, Inc. v. Northway, Inc., 426 U.S. 438, 449 

(1976). 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 55 -
99, Materiality, (as codified in SAB Topic 1M)) (i.e., resulting in errors being deemed to 

be material when an investor may not consider them to be important). 

It is essential that companies, auditors, and regulators strive to reduce the frequency and 

magnitude of errors in financial reporting. However, the goal is not to reduce the number 

of restatements per se. Indeed, companies should restate their financial statements to 

correct errors that are important to current investors. Investors need accurate and 

comparable data and restatement is the only means to achieve those goals when 

previously filed financial statements contain material errors. Efforts to improve company 

controls and audit quality in recent years should reduce errors, and there is evidence this 

is currently occurring.14 The Committee recommends that public companies focus on 

reducing errors in financial statements. At the same time, some of the other 

recommendations of this Committee, such as those that address the current complexity of 

financial reporting and improving the standard setting process, will also be helpful in 

reducing some of the frequency of errors in financial statements. 

While reducing errors is the primary goal, it is also important to reduce the number of 

any unnecessary restatements (i.e., those that do not provide important information to 

investors). Unnecessary restatements can be costly for companies and auditors, reduce 

confidence in reporting, and create confusion that reduces the efficiency of investor 

analysis. This portion of this chapter describes the Committee’s recommendations 

regarding (1) additional guidance on the concept and application regarding materiality 

and (2) the process for and disclosure of the correction of errors. 

Committee Research 

The Committee has considered several publicly-available studies on restatements.15 The 

Committee is aware that the Treasury Department also has recently selected University of 

Kansas Professor Susan Scholz to conduct an examination of the impact of and the 

reasons for restatements of public company financial statements. The Committee will 

review the Treasury Department’s study and consider its findings as they are made 

available. 

14 Glass Lewis & Co. report “Brief Alert Weekly Trend” issued December 17, 2007 shows that 

restatements in companies subject to Section 404 of the Sarbanes Oxley Act have declined for two 

consecutive years. 15 Studies considered include the U.S. Government Accountability Office (GAO) study “Financial 

Restatements: Update of Public Company Trends, Market Impacts, and Regulatory Enforcement Updates” 

(March 2007); Glass Lewis & Co. study “The Errors of Their Ways” (February 2007); and two Audit 

Analytics studies “2006 Financial Restatements A Six Year Comparison” (February 2007) and “Financial 

Restatements and Market Reactions” (October 2007). The Committee has also considered findings from 

the PCAOB’s Office of Research and Analysis’s (ORA) working paper released October 18, 2007, 

“Changes in Market Responses to Financial Statement Restatement Announcements in the Sarbanes-Oxley 

Era,” understanding that ORA’s findings are still preliminary in nature as the study is still going through a 

peer review process. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 56 -
The restatement studies all indicate that the number of restatements has increased in 

recent years. Market reaction to restatements might be one indicator of whether or not 

restatements contain information considered by investors to be material. While there are 

limitations16 to using market reaction as a proxy for materiality, based on these studies, it 

would appear that there may be many restatements occurring that investors may not 

consider important due to a lack of a statistically significant market reaction. The 

Committee believes that additional guidance on determining whether an error is material 

and whether a restatement is necessary would be beneficial in reducing the frequency of 

unnecessary restatements. 

The Committee has also considered input from equity and credit analysts and others 

about investors’ views on materiality and how restatements are viewed in the 

marketplace. Feedback included: 

• Bright lines are not really useful in making materiality judgments. Both qualitative 

and quantitative factors should be considered in determining if an error is material or 

not. 

• Companies often provide the market with little financial data during the time between 

a restatement announcement and the final resolution of the restatement. Limited 

information seriously undermines the quality of investor analysis, and sometimes 

triggers potential loan default conditions or potential delisting of the company’s 

stock. 

• The disclosure provided on restatements is not consistently adequate to allow a user 

to evaluate the likelihood of errors in the future. Notably, disclosures often do not 

provide enough information about the nature and impact of the error, and the resulting 

actions the company is taking. 

• Interim periods should be viewed as more than just a component of an annual 

financial statement for purposes of making materiality judgments. 

II.B. Developed Proposals 

Based on its work to date, the Committee believes that, in attempting to eliminate 

unnecessary restatements, it is helpful to consider two sequential questions: (1) Was the 

error in the financial statement material to those financial statements when originally 

filed? (2) How should a material error in previously issued financial statements be 

corrected? The Committee believes that framing the principles necessary to evaluate 

these questions would be helpful. The Committee also believes that in many 

circumstances investors could benefit from improvements in the nature and timeliness of 

16 Examples of the limitations in using market reaction as a proxy for materiality include (1) the difficultly 

of measuring market reaction because of the length of time between when the market becomes aware of a 

potential restatement and the ultimate resolution of the matter, (2) the impact on the market price of factors 

other than the restatement, and (3) the disclosure at the time of the restatement of other information, such as 

an earnings release, that may have an offsetting positive market reaction. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 57 -
disclosure in the period between identifying an error and filing restated financial 

statements. 

With this context, the Committee has developed the following proposals regarding the 

assessment of the materiality of errors to financial statements and the correction of 

financial statements for errors. 

Developed Proposal 4.1: Materiality 

The Commission or its staff should issue guidance17 reinforcing the following 

concepts: 

• Those who evaluate the materiality of an error should make the decision based 

upon the perspective of a reasonable investor. 

• Materiality should be judged based on how an error impacts the total mix of 

information available to a reasonable investor. 

• Just as qualitative factors can lead to a conclusion that a quantitatively small 

error is material, qualitative factors also can lead to a conclusion that a 

quantitatively significant error may not be material. The evaluation of errors 

should be on a “sliding scale.” 

The Commission should also direct its staff to conduct both education sessions 

internally and outreach efforts to auditors and financial statement preparers to 

raise awareness of these issues and to promote more consistent application of the 

concept of materiality. 

The Committee believes that those who judge the materiality of a financial statement 

error should make the decision based upon the interests, and the viewpoint, of a 

reasonable investor and based upon how that error impacts the total mix of information 

available to a reasonable investor. One must “step into the shoes” of a reasonable 

investor when making these judgments. The Committee believes that too many 

materiality judgments are being made in practice without full consideration of how a 

reasonable investor would evaluate the error. When looking at how an error impacts the 

total mix of information, one must consider all of the qualitative factors that would 

impact the evaluation of the error. This is why bright lines or purely quantitative 

methods are not appropriate in determining the materiality of an error to annual financial 

statements. It is possible that an error that results in a misclassification on the income 

statement may not be deemed to be material, while an error of the same magnitude that 

impacts net income may be deemed material based on the effect of the error on the total 

mix of information available to a reasonable investor. 

17 To the extent that the implementation of the Committee’s recommendations would require a change to 

GAAP, the Commission should work with the appropriate standard setters to revise GAAP. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 58 -
The Committee believes that, in current practice, materiality guidance such as SAB Topic 

1M is interpreted as being one-directional in that qualitative considerations can make a 

quantitatively insignificant error material, but a quantitatively significant error is material 

without regard to qualitative factors. The Committee believes that qualitative factors not 

only can increase, but also can decrease, the importance of an error to the reasonable 

investor. Specifically, the Committee believes that there should be a “sliding scale” for 

evaluating errors. On this scale, the higher the quantitative significance of an error, the 

stronger the qualitative factors must be to result in a judgment that the error is not 

material. Conversely, the lower the quantitative significance of an error, the stronger the 

qualitative factors must be to result in a judgment that the error is material. 

The following are examples of some of the qualitative factors that could result in a 

conclusion that a large error is not material. (Note that this is not an exhaustive list of 

factors, nor should this list be a “checklist” whereby the presence of any one of these 

items would make an error not material. Companies and their auditors should still look at 

the totality of all factors when making a materiality judgment): 

• The error impacts metrics that do not drive reasonable investor conclusions or are not 

important to reasonable investor models. 

• The error is a one time item and does not alter investors’ perceptions of key trends 

affecting the company. 

• The error does not impact a business segment or other portion of the registrant's 

business that investors regard as driving valuation or risks. 

• The error relates to financial statement items whose measurement is inherently highly 

imprecise. 

Education and outreach efforts can be instrumental in increasing the awareness of these 

concepts and ensuring more consistent application of materiality. Many of the issues 

with materiality in practice are caused by misunderstandings by preparers, auditors and 

regulators. Elimination of these misunderstandings would be a significant step forward 

to reducing unnecessary restatements. 

Question for the Committee: 

4.2) Do you agree with the recommendations on materiality to annual financial 

statements? Are there any areas you would recommend adding or removing? 

Developed Proposal 4.2: Correction and Disclosure of an Error 

The Commission or its staff should issue guidance on how to correct an error 

consistent with the principles outlined below: 

• Prior period financial statements should only be restated for errors that are 

material to those prior periods. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 59 -
• The determination of how to correct a material error should be based on the 

needs of current investors. For example, a material error that has no relevance 

to a current investor’s assessment of the annual financial statements would not 

require restatement of the annual financial statements in which the error 

occurred but may need to be disclosed and/or corrected in the current period. 

• There may be no need for the filing of amendments to previously filed annual 

or interim reports to reflect restated financial statements if the next annual or 

interim period report is being filed in the near future and that report will 

contain all of the relevant information. 

• Restatements of interim periods do not necessarily need to result in a 

restatement of an annual period. 

• All errors, other than clearly insignificant errors, should be corrected no later 

than in the financial statements of the period in which the error is discovered. 

• The current disclosure about the need for a restatement, during the period 

when the restatement is being prepared and about the restatement itself is not 

consistently adequate for the needs of investors and needs to be enhanced. 

The current guidance that is detailed in SAB 108 (as codified in SAB Topic 1N) may 

result in the restatement of prior annual periods for immaterial errors in those periods 

because the cumulative effect of these prior period errors would be material to the current 

annual period, if the prior period errors were corrected in the current annual period. The 

Committee believes that prior annual period financial statements should not be restated 

for errors that are immaterial to the prior annual period. An alternative to the approach 

specified in Topic 1N could be to require that, where errors are not material to the prior 

annual periods in which they occurred but would be material if corrected in the current 

annual period, the error could be corrected in the current annual period18 with appropriate 

disclosure. 

The Committee believes that the determination of how errors should be corrected should 

be based on the needs of current investors. This determination should be based on the 

facts and circumstances of each error. For example, an error that does not affect the 

annual financial statements included within a company’s most recent filing with the 

Commission may be determined to not be relevant to current investors. For errors that do 

not require restatement but were material in the annual period in which they occurred, 

companies could be required to provide appropriate disclosure about the error and the 

periods impacted. 

18The Committee is focused on the principle that prior periods should not be restated for errors that are not 

material to those periods. Correction in the current period for errors that are not material to prior periods 

could be accomplished through an adjustment to equity or to current period income. The Committee 

believes that there are merits in both approaches and that the Commission and its staff should carefully 

weigh both approaches before determining the actual approach to utilize. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 60 -
For material errors that are discovered within a very short time period prior to a 

company’s next regularly scheduled reporting date, it may be appropriate in certain 

instances to report the restatement in the next filing, instead of amending previous filings 

with the Commission. This option should be further studied and, if appropriate, should 

be included in the guidance. 

When evaluating the need to restate when an error is discovered that relates to an interim 

period within an annual period for which financial statements have previously been filed 

with the Commission, the following guidance should be utilized: 

• If the error is not material to either the previously issued interim period or to the 

previously issued annual period, the previously issued financial statements should not 

be restated. 

• If the prior period error is determined to only be material to the previously issued 

interim period, but not the previously issued annual period, then only the previously 

issued interim period should be restated (i.e., the annual period that is already filed 

should not be restated and the 10-K should not be amended). 

The Committee believes that all errors, excluding clearly insignificant errors, should be 

corrected19 no later than in the financial statements of the annual or interim period in 

which the error was discovered. There should be a practicality exception for immaterial 

errors discovered shortly before the issuance of the financial statements, but in this case, 

the errors should be corrected in the next annual or interim period being reported upon. 

Typically, the restatement process involves three primary reporting stages: 

1. The initial notification to the Commission and investors that there is a material error 

and that the financial statements previously filed with the Commission can no longer 

be relied upon; 

2. The “dark period” or the period between the initial notification to the Commission 

and the time restated financial statements are filed with the Commission; and 

3. The filing of restated financial statements with the Commission. 

The Committee believes that one of the major effects on investors related to restatements 

is the lack of information when companies are silent during stage 2, or the “dark period.” 

This silence creates significant uncertainty regarding the size and nature of the effects on 

the company of the issues leading to the restatement. This uncertainty often results in 

discounts of the company’s stock price. In addition, delays in filing restated financial 

19 The Committee understands that sometimes there may be immaterial differences between a preparer’s 

estimate of an amount and the independent auditor’s estimate of an amount that exist when financial 

statements are issued. These differences might or might not be errors, and may require additional work to 

determine the nature and actual amount of the error. This additional work is not necessary for the preparer 

or the auditor to agree to release the financial statements. Due care should be taken in developing any 

guidance in this area to provide an exception for these legitimate differences of opinion, and to ensure that 

any requirement to correct all “errors” would not result in unnecessary work for preparers or auditors. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 61 -
statements may create default conditions in loan covenants; these delays may adversely 

affect the company’s liquidity. The Committee understands that, in the current legal 

environment, companies are often unwilling to provide disclosure of uncertain 

information. However, the Committee believes that when companies are going through 

the restatement process, they should be encouraged to continue to provide whatever 

financial information they can provide accompanied by appropriate explanation of ways 

in which the information could be affected by the restatement if the information is 

believed by management to be reasonably reliable given the circumstances. 

Consequently, regulators should evaluate the company’s disclosures during the “dark 

period” taking into account the difficulties of generating reasonably reliable information 

before a restatement is completed. 

The Committee believes that the current disclosure surrounding a restatement is often not 

adequate to allow users to evaluate the company’s operations and the likelihood that such 

errors could occur in the future. Specifically, the Committee believes that all companies 

that have a restatement should be required to disclose information related to 1) the nature 

of the error; 2) the impact of the error; and 3) management’s response to the error, to the 

extent known, during all three stages of the restatement process. Some suggestions of 

disclosures that would be made by companies include the following: 

Nature of error 

• Description of the error. 

• Periods affected and under review. 

• Items in each of the financial statements subject to the errors and pending 

restatement. 

• For each financial statement line item, the amount of the error or range of 

potential error. 

• Identity of business units/locations/segments/subsidiaries affected. 

Impact of error 

• Updated analysis on trends affecting the business if the error impacted key trends. 

• Loan covenant violations, ability to pay dividends, or other effects on liquidity or 

access to capital resources. 

• Other areas such as loss of material customers or suppliers. 

Management Response 

• Nature of the control weakness that led to the restatement and corrective actions, 

if any, taken by the company to prevent the error from occurring in the future. 

• Actions taken in response to covenant violations, loss of access to capital markets, 

loss of customers or other consequences of the restatement. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 62 -
Companies should update this disclosure on a periodic basis during the restatement 

process, particularly when quarterly or annual reports required to be filed as material 

changes become known, with full and complete disclosure within the filing with the 

Commission that includes the restated financial statements. 

The Committee believes that by providing this guidance on how to correct and disclose 

errors in previously issued financial statements, investors will receive higher quality 

information (e.g., prior periods will not be restated for immaterial items and for errors 

that have no relevance to current investors, and more consistently good disclosure will be 

made during and about the restatement process) and the burdens on companies related to 

unnecessary restatements will be reduced. 

Questions for the Committee: 

4.3) Do you agree with the proposal regarding the consideration of current investors 

in determining the need to restate? 

4.4) Do you agree with the concept that prior periods should not be restated except 

for material errors? 

4.5) Do you agree with the proposal regarding additional disclosures during the 

restatement process and surrounding the restatement? Are the proposed 

disclosures sufficient? Do the proposed disclosures create too much of a burden 

on companies? Are additional or different disclosures needed for investors? 

4.6) Do you agree with the concept that all errors, except clearly insignificant errors, 

should be corrected no later than in the financial statements of the annual or 

interim period in which the error was discovered? 

Developed Proposal 4.3: Errors related to interim periods 

Based on available restatement studies, approximately one-third of all restatements 

involved only interim periods. Authoritative accounting guidance on assessing 

materiality with respect to interim periods is currently limited to Paragraph 29 of APB 

Opinion No. 28, Interim Financial Reporting.

20 Differences in interpretation of this 

paragraph have resulted in variations in practice that have increased the complexity of 

financial reporting. This increased complexity impacts preparers and auditors, who 

struggle with determining how to evaluate the materiality of an error to an interim period, 

20 “In determining materiality for the purpose of reporting the cumulative effect of an accounting change or 

correction of an error, amounts should be related to the estimated income for the full fiscal year and also to 

the effect on the trend of earnings. Changes that are material with respect to an interim period but not 

material with respect to the estimated income for the full fiscal year or to the trend of earnings should be 

separately disclosed in the interim period.” 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 63 -
and also impacts investors, who can be confused by the inconsistency between companies 

in evaluating and reporting errors. The Committee believes that guidance on how to 

evaluate errors related to interim periods would be beneficial to preparers, auditors and 

investors. 

The Committee has observed that a large part of the dialogue about interim materiality 

has focused on whether an interim period should be viewed as a discrete period or an 

integral part of an annual period. Consistent with the view expressed at the outset of this 

Section, the Committee believes that the interim materiality dialogue could be greatly 

simplified if that dialogue were refocused to address two sequential questions (1) What 

principles should be considered in determining the materiality of an error in interim 

period financial statements? And (2) If an error is material, what should be the acceptable 

methods for correcting an error in previously issued interim financial statements? The 

Committee believes that additional guidance on these questions, which are extensions of 

the basic principles outlined in developed proposals 4.1 and 4.2, respectively, would 

provide useful guidance in assessing and correcting interim period errors. The 

Committee believes while these principles will assist in developing guidance related to 

interim periods, the Committee believes that additional work should be done to fully 

develop robust guidance regarding errors identified in interim periods. 

The Commission or its staff should develop and issue guidance on applying 

materiality to errors identified in prior interim periods and how to correct these 

errors. This guidance should reflect the following principles: 

Materiality in interim period financial statements must be assessed based on the 

perspective of the reasonable investor. 

When there is a material error in an interim period, the guidance on how to correct 

that error should be consistent with the principles outlined in developed proposal 

4.2. 

The Committee believes that the determination of whether an interim period error is 

material should be made based on the perspective of a reasonable investor, not whether 

an interim period is a discrete period, an integral part of an annual period, or some 

combination of both. An interim period is part of a larger mix of information available to 

a reasonable investor. As one example, a reasonable investor would use interim financial 

statements to assess the sustainability of a company’s operations and cash flows. In this 

example, if an error in interim financial statements did not impact the sustainability of a 

company’s operations and cash flows, the interim period error may very well not be 

material given the total mix of information available. Similarly, just as a large error in 

annual financial statements does not determine by itself whether an error is material, the 

size of an error in interim financial statements should also not be necessarily 

determinative as to whether an error in interim financial statements is material. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 64 -
The Committee believes that applying the principles set forth above would reduce 

restatements by providing a company the ability to correct in the current period 

immaterial errors in previously issued financial statements and as a practical matter 

obviate the need to debate whether the interim period is a discrete period, an integral part 

of an annual period, or some combination of both. 

The Committee also notes that these principles will provide a mechanism, other than 

restatement, to correct through the current period a particular error that has often been at 

the center of the interim materiality debate - a newly discovered error that has 

accumulated over one or more annual or interim periods, but was not material to any of 

those prior periods. 

Question for the Committee: 

4.7) Do you agree with the proposal and principles outlined above related to 

evaluating materiality and correcting errors with respect to interim periods? 

III. Professional Judgment 

III.A. Background 

Overview 

Professional judgment is not new to the areas of accounting, auditing, or securities 

regulation – the criteria for making and evaluating professional judgment has been a topic 

of discussion for many years. The recent increased focus on professional judgment, 

however, comes from several different developments, including changes in the regulation 

of auditors and a focus on more “principles-based” standards – for example, FASB 

standards on Fair Value and IASB standards. While both auditors and issuers appear 

supportive of a move to less prescriptive guidance, they have expressed concern 

regarding the perception that current practice by auditors and regulators in evaluating 

judgments does not provide an environment where such judgments may be generally 

respected. This in turn can lead to repeated calls for more rules, so that the standards can 

be comfortably implemented. 

Many regulators also appear to encourage a system in which professionals can use their 

judgment to determine the most appropriate accounting and disclosure for a particular 

transaction. Regulators assert that they do respect judgments, but may also express 

concerns that some companies and auditors may attempt to inappropriately defend certain 

errors as "reasonable judgments." Identifying standard processes for making professional 

judgments and criteria for evaluating those judgments, after the fact, may provide an 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 65 -
environment that promotes the use of judgment and encourages consistent evaluation 

practices among regulators. 

Goals of a Framework 

The following are several issues that a potential framework may help address: 

a. Lack of confidence by investors in the use of judgment – A professional judgment 

framework may provide investors with greater comfort that there is an acceptable 

rigor that companies follow in exercising reasonable professional judgment. 

b. Concern by preparers and auditors regarding whether reasonable judgments are 

respected – In the current environment, preparers and auditors may be afraid to 

exercise judgment for fear of having their judgments overruled, after the fact, by 

auditors, regulators and legal claimants. 

c. Lack of agreement in principle on the criteria for evaluating judgments – The criteria 

for evaluating reasonable judgment, including the appropriate role of hindsight in the 

evaluation, may not be clearly defined and thus may lead to increased uncertainty. 

d. Concern over increased use of “principles-based” standards – Companies, auditors 

and investors may be less comfortable in their ability to implement more “principlesbased” standards if there is a concern over how reasonable judgments are reached and 

how they will be assessed. 

Categories of Judgments that are Made in Preparing Financial Statements 

There are many categories of accounting and auditing judgments that are made in 

preparing financial statements, and a framework should encompass all of these categories 

if practicable. Some of the categories of accounting judgments are as follows: 

1. Selection of accounting standard 

In many cases, the selection of the appropriate GAAP is not a highly complex 

judgment (e.g., you would account for a lease using lease accounting standards, 

pensions using pension accounting standards, etc.). However, there are cases when 

the selection of the appropriate accounting standard can be highly complex. 

For example, the standards on accounting for derivatives contain a definition of a 

derivative and provide scope exceptions that limit the applicability of the standard 

to certain types of derivatives. To evaluate how to account for a contract that has 

at least some characteristics of a derivative, one would first have to determine if 

the contract met the definition of a derivative in the accounting standard and then 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 66 -
determine if the contract would meet any of the scope exceptions that limited the 

applicability of the standard. Depending on the nature and terms of the contract, 

this could be a complex judgment to make, and one in which experienced 

accounting professionals can have legitimate differing, yet acceptable, opinions. 

2. Implementation of an accounting standard 

After the correct accounting principle is identified, there are judgments to be made 

during the implementation of the standard. 

Examples of implementation judgments include determining if a hedge is 

effective or not, determining if you have an operating or capital lease, and 

determining what inputs and methodology should be utilized in a fair value 

calculation. Implementation judgments can be assisted by implementation 

guidance issued by standard setters, regulators or other bodies; however, this 

guidance could increase the complexity of selecting the correct accounting 

standard, as demonstrated by the guidance issued on accounting for derivatives. 

Many accounting standards use wording such as “substantially all” or “generally.” 

The use of such qualifying language can increase the amount of judgment 

required to implement an accounting standard. In addition, some standards may 

have potentially conflicting statements. 

3. Lack of applicable accounting standards 

There are some transactions that may not readily fit into a particular accounting 

standard. Dealing with these “gray” areas of GAAP is typically highly complex and 

requires a great deal of judgment and accounting expertise. In particular, many of 

these judgments use analogies from existing standards that require a careful 

consideration of the facts and circumstances involved in the judgment. 

4. Financial Statement Presentation 

The appropriate method to present, classify and disclose the accounting for a 

transaction in a financial statement can be highly subjective and can require a great 

deal of judgment. 

5. Estimating the actual amount to record 

Even when there is little debate as to which accounting standard to apply to a 

transaction, there can be significant judgments that need to be made in estimating the 

actual amount to record. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 67 -
For example, there are typically not significant differences of opinions on the 

appropriate standard to account for loan losses or to measure impairments of 

assets. However, the assumptions and methodology used by management to 

actually determine the allowance for loan losses or determine an impairment of an 

asset can be a highly judgmental area. 

6. Evaluating the sufficiency of evidence 

Not only must one make a judgment about how to account for a transaction, the 

sufficiency of the evidence used to support the conclusion must be evaluated. In 

practice, this is typically one of the most subjective and difficult judgments to make. 

Examples would include determining if there is sufficient evidence to estimate 

sales returns or to support the collectability of a loan. 

Levels of Judgment 

There are many levels of judgment that occur related to accounting and auditing. 

Preparers must make initial judgments about uncertain accounting issues; the preparer’s 

judgment may then be evaluated or challenged by auditors, investors, regulators, legal 

claimants and even others, such as the media. Similarly, planning and performing an 

audit requires numerous judgments: these judgments are also potentially subject to 

evaluation and challenge by investors, regulators, legal claimants and others, especially 

when, in hindsight, it has become clear that the auditor failed to detect material errors in 

the financial statements. Therefore, in developing a potential framework, differences in 

role and perspective between those who make a judgment and those who evaluate a 

judgment should be carefully considered. A framework should not make those who 

evaluate a judgment (auditors, regulators, or others) re-perform the judgment according 

to the framework. Instead, a framework should provide guidance to those who would 

evaluate a judgment on factors to consider while making that evaluation. 

Hindsight 

One appropriate tool used in auditing is hindsight – the ability of the auditor to use facts 

that are available through the completion of the audit work to evaluate the sufficiency of 

management's estimates and assumptions based on actual facts that become available 

after those estimates are made. 

For example, auditors will frequently test the accuracy of the company's accounts 

payable balance at period-end by looking at cash disbursement made after the 

period-end. This evidence allows the auditor to determine whether the accrual for 

unpaid expenses at year-end is adequate. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 68 -
However, the use of hindsight to evaluate judgment where the relevant facts were not 

available at the time of the initial release of the financial statements (including interim 

financial statements) is not appropriate. Determining at what point the relevant facts 

were known to management or the auditor, or should have been known,21 can be difficult, 

particularly for regulators who are often evaluating these circumstances after substantial 

time has passed. Therefore, the use of hindsight should only be used based upon the facts 

reasonably available at the time the annual or interim financial statements were issued. 

Form of Framework 

Some have recommended that a “safe harbor” be developed that protects the exercise of 

judgment in accordance with a specified framework. That approach would seem to 

provide greater support to auditors and preparers. However, it is unclear to the 

Committee whether a legal or regulatory safe harbor (i.e., an effective legal or regulatory 

defense based on conformity with the framework) can be adopted by the Commission or 

whether it would require changes in existing statutes. The Committee encourages the 

Commission and its staff to resolve this issue. 

Another approach is for the Commission and the PCAOB to issue policy statements that 

describe a framework for the exercise of professional judgment and states that auditors, 

the Commission or the PCAOB, as applicable, would take into account the 

implementation of the framework in evaluating a judgment made by a registrant or an 

auditor. The Commission has utilized similar frameworks in the past with success. 

Examples of previous frameworks by the Commission include the “Seaboard” report 

(October 23, 2001) on the relationship of cooperation by a company to taking action in an 

enforcement case and the Commission’s framework for assessing the appropriateness of 

corporate penalties (January 4, 2006). 

While not an automatic defense of the registrant’s or auditor’s judgment, a framework 

would provide more support to registrants and auditors that the applicable regulator 

would be likely to accept a judgment made if the registrant or the auditor had fully 

implemented the framework. The policy statement or safe harbor might also enhance the 

quality of judgments by providing a rigorous structure for how judgments should be 

made, which would also provide protection to investors as to the quality of financial 

statements. 

The Nature and Limitations of Generally Accepted Accounting Principles: 

Some have suggested that the standard in a potential judgment framework for the 

selection and implementation of GAAP contain a requirement to reflect the economic 

21 The Committee believes that those making a judgment should be expected to exercise due care in 

gathering all of the relevant facts prior to making the judgment. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 69 -
substance of a transaction or be a standard of selecting the "high road" in accounting for a 

transaction. The Committee agrees that qualitative standards for GAAP such as these 

would be desirable and we encourage regulators and standard setters to move financial 

reporting in this direction. However, such standards are not always present in financial 

reporting today and we could not recommend the adoption of such standards in a 

professional judgment framework without anticipating a fundamental long-term revision 

of GAAP- a change that would be beyond our purview and one that would not be doable 

in the near or intermediate term. 

For example, there is general agreement that accounting should follow the substance and 

not just the form of a transaction or event. Many believe that this fundamental principle 

should be extended to require that all GAAP judgments should reflect economic 

substance. However, reasonable people disagree on what economic substance actually is, 

and many would conclude that significant parts of current GAAP do not require and do 

not purport to measure economic substance (e.g., accounting for leases, pensions, certain 

financial instruments and internally developed intangible assets are often cited as 

examples of items reported in accordance with GAAP that would not meet many 

reasonable definitions of economic substance). 

Similarly, some would like financial reporting to be based on the "high road"- a 

requirement to use the most preferable principle in all instances. Unfortunately, today a 

preparer is free to select from a variety of acceptable methods allowed by GAAP (e.g., 

costing inventory, measuring depreciation, and electing to apply hedge accounting are 

just some of the many varied methods allowed by GAAP) without any qualitative 

standard required in the selection process; in fact, a preferable method is required to 

be followed only when a change in accounting principle is made, a less preferable 

alternative is fully acceptable absent such a change. 

The Committee believes that adopting a requirement for economic substance or for taking 

the "high road" would require a revolutionary change not achievable in the foreseeable 

future and probably not worthy of serious attention until a principles-based approach to 

GAAP is uniformly applied and "rules" no longer govern GAAP; our suggested judgment 

framework can and we believe will enhance adherence to GAAP but cannot be expected 

to correct inherent weaknesses in the standards to which it is applied. 

III.B. Developed Proposals 

The Committee has developed the following proposals: 

Developed Proposal 4.4: The Commission should issue a policy statement or adopt 

a safe harbor on a professional judgment framework consistent with the concepts 

outlined below. The Commission should also encourage the PCAOB to consider 

similar action. Careful consideration should be made in implementing any 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 70 -
framework to ensure that the framework does not limit the ability of auditors and 

regulators to ask appropriate questions regarding judgments and take actions to 

require correction of unreasonable judgments. 

The proposed framework would be applicable to accounting related judgments, 

including the choice and application of accounting principles, as well as the 

estimates and evaluation of evidence related to the application of an accounting 

principle. The Committee believes that a framework that is consistent with the 

principles outlined in this framework to cover judgments made by auditors based 

on the application of PCAOB auditing standards is very important and would be 

beneficial to preparers, investors and auditors. Therefore, the Committee 

recommends that the PCAOB develop a professional judgment framework for the 

application of and evaluations of judgments made based upon PCAOB auditing 

standards. 

Framework for Professional Judgment in Accounting 

The Concept of Professional Judgment 

Professional judgment, with respect to accounting matters, should be the outcome of a 

process in which a person or persons with the appropriate level of knowledge, 

experience, and objectivity forms an opinion based on the relevant facts and 

circumstances within the context provided by applicable accounting standards. 

Professional judgments could differ between knowledgeable, experienced, and 

objective persons. Such differences between reasonable professional judgments do 

not, in themselves, suggest that one judgment is wrong and the other is correct. 

Therefore, those who evaluate judgments should evaluate the reasonableness of the 

judgment, and should not base their evaluation on whether the judgment is different 

from the opinion that would have been reached by the evaluator. 

This framework would serve as the primary, though not exclusive, approach to 

evaluating the process of making professional judgments. While regulators would 

strongly support the principles of this framework, the mere completion of the process 

outlined in the framework in making a judgment would not prevent an auditor and/or 

regulator from asking appropriate questions about the judgment or asking companies 

to correct unreasonable judgments. A judgment framework would not eliminate 

debate, nor should it attempt to do so. Rather, it organizes analysis and focuses 

preparers and others on areas to be addressed thereby improving the quality of the 

judgment and likelihood that auditors and regulators will accept the judgment. 

Conversely, not following the framework would not imply that the judgment is 

unreasonable. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 71 -
This framework also acknowledges that generally accepted accounting principles do 

not always reflect the economic substance of a transaction and that it may be difficult 

to determine how the accounting would meet the needs of investors. Therefore, this 

framework would be applicable to accounting matters only to the extent that 

judgments were required in the choice or application of accounting principles, in 

estimating the amount to record, or in evaluating the sufficiency of the evidence. 

In applying the components of the framework, it would be expected that the amount 

of documentation, disclosure, input from professional experts and level of effort in 

making a professional judgment would vary based on the complexity, nature (routine 

vs. non-routine) and materiality of a transaction or issue requiring judgment. 

Components of a Framework 

Critical and Good Faith Thought Process – Professional judgment should be based 

on a critical and reasoned evaluation made in good faith, prior to the exercise of the 

judgment, of an identified issue, including the nature and scope of the issue based on: 

a) Analysis of the transaction, including the substance and business purpose of the 

transaction; 

b) The facts reasonably available at the time that the financial statements are issued; 

c) A thorough review and analysis of relevant literature, including the relevant 

principles; 

d) Alternative views or estimates, including pros and cons for reasonable alternatives; 

e) Rationale for the choice selected, including reasons for alternative or estimate 

selected and linkage of rationale to investor’s information needs and the judgments of 

competent external parties; 

f) Linkage of the alternative or estimate selected to the substance and business 

purpose of the transaction or issue being evaluated; 

g) Diversity in practice regarding the alternatives or estimates;22 

h) Consistency of application of alternatives or estimates to similar transactions; and 

i) The appropriateness and reliability of the assumptions and data used. 

The critical thought process should include input from personnel with an appropriate 

level of professional expertise and should include a sufficient amount of time and 

effort to properly consider the judgment. 

Material issues or transactions that were analyzed pursuant to the application of the 

framework should be disclosed in accordance with existing disclosure requirements. 

This disclosure should be sufficiently transparent to inform the user of the financial 

statements about the substance of the transaction, including the relevant rights, 

obligations, risks and rewards, the relevant accounting principles, and the key 

22 If there is not diversity in practice, it would be significantly harder to select a different alternative. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 72 -
assumptions that went into the judgment. When evaluating professional judgment, 

auditors, and/or regulators should take into account the disclosure relevant to the 

judgment. 

Documentation – The alternatives considered and the conclusions reached should be 

documented contemporaneously. The lack of contemporaneous documentation may 

not mean that a judgment was incorrect, but would make it more difficult to support 

an assertion as to the nature and propriety of a judgment made at the time of the 

release of the financial statements. 

Questions for the Committee: 

4.8) Do you agree with the developed proposal that a professional judgment 

framework could be useful or should the focus be more on providing guidance 

on the use of professional judgment? What changes, if any, would you suggest? 

4.9) Do you agree that the form of the framework should be a policy statement, with 

a “safe harbor” only being explored depending upon experience with the policy 

statement and the need for such a safe harbor in order to enhance the use of 

principles-based accounting standards? 

4.10) Do you agree with the proposed framework? Do you have any comments 

regarding the proposed applicability or components of the framework? 

4.11) Does the framework sufficiently cover all types of judgments (e.g., not only 

choice and application of accounting principles, but making estimates and the 

appropriate way to evaluate the evidence used to make the judgment)? Are 

there types of judgments for which the framework would not work? What 

modifications would be appropriate? 

4.12) Should disclosure be required as a separate component of the framework rather 

than simply be considered depending upon whether disclosure is otherwise 

required by the Commission or GAAP? Are there other components that may 

be needed? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 73 -
CHAPTER 5: DELIVERING FINANCIAL INFORMATION 

I. Scope 

The Committee has been evaluating the information needs of investors, methods by 

which financial information is provided to investors, and means to improve delivery of 

financial information to all market constituencies. In evaluating the information needs of 

investors, the Committee has recognized that the information needs of different types of 

investors are not always the same. The Committee has agreed that information delivery 

must be provided in a manner that will make it efficient, reliable, and cost-effective for 

each of the relevant investor groups and will not significantly increase burdens on 

reporting companies. 

The Committee has determined to focus its efforts on financial information provided by 

reporting companies in their periodic and current reports under the Securities Exchange 

Act of 1934 (“Exchange Act”) and other ongoing disclosures provided by reporting 

companies to investors and the market.23 The Committee believes that it can provide 

some useful recommendations to enhance ongoing reporting that will enable investors to 

better understand reporting companies. 

Based on the above, the Committee has analyzed a number of ways to improve the 

delivery of financial information to investors and the market. These are: 

• Tagging of financial information (XBRL) 

• Improved corporate website use 

The Committee also intends to look at the following in the future: 

• Use of executive summaries as an integral part of Exchange Act periodic reports 

• Disclosures of key performance indicators and other metrics to enhance business 

reporting 

• Improved quarterly press release disclosures and timing 

• Continued need for improvements in management discussion and analysis (MD&A) 

and other public company financial disclosures 

In furtherance of its work, the Committee has considered the views of various 

constituents in the financial reporting process regarding the use of XBRL. The 

Committee also has evaluated other information disclosure models, including those 

23 The Committee has determined not to address information delivery in registered offerings under the 

Securities Act of 1933 for two primary reasons. First, the SEC already has addressed information delivery 

in registered securities offerings when it adopted new communication rules in 2005 for registered offerings 

by issuers other than registered investment companies. Second, the Committee viewed information 

delivery relating to ongoing company reporting by public companies as the area needing greater focus. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 74 -
involving enhanced uses of technology and corporate websites. The Committee intends 

to continue to evaluate the use of summaries as a component of periodic reports and ways 

in which financial disclosures by reporting companies can be improved. 

Question for the Committee: 

5.1) Do you agree with the preliminary scope in the context of information delivery? 

What areas, if any, would you recommend adding or removing? 

II. Tagging of Financial Information (XBRL) 

II.A. Background 

Description of XBRL 

The Committee has been examining the use of XBRL by public reporting companies 

because the SEC is moving rapidly in this area. In particular, the Committee has been 

examining the use of XBRL under the Exchange Act reporting regime. 

XBRL is an international information format standard designed to help investors and 

analysts find, understand, and compare financial and non-financial information by 

making this information machine-readable. It also offers benefits to companies by 

allowing them to better control how their financial or non-financial information is 

disseminated and, by integrating their operating data with their financial reporting 

disclosure, to reduce reporting costs. XBRL is a computer language that permits the 

automation of what are now largely manual steps for access, validation, analysis and 

reporting of disclosure. Because XBRL uses standardized XML (eXtensible Markup 

Language) technology, it can be read by a wide range of diverse software systems. 

Under current technology, for example, if an investor or analyst wants to compare the 

sales of all the pharmaceutical companies, he must download the financial statements of 

these companies and input the sales data into a spreadsheet. With XBRL, however, 

widely available software applications will be able to take the information companies 

submit to the SEC’s EDGAR system, extract the sales numbers and download them 

directly to a spreadsheet. This process will take seconds rather than the hours or days 

that might be required using current methods. 

XBRL does this through standardized definitions of terms, like a dictionary. For 

example, there might be several terms for the top line on an income statement, which 

might be called sales, turnover or revenues. All of these terms mean the same thing, and 

are translated in XBRL into a common symbol, readable by a computer. When 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 75 -
reproduced as a financial statement from the XBRL source, the statement will look 

exactly like the statement that the company produced for reading by humans. 

The standardized terms are then arranged in a logical structure called a taxonomy. Under 

sales, for example, there might be several subcategories, such as sales through retailers, 

sales over the Internet, etc. These would be similarly standardized and included under 

sales (or turnover or revenues) because they are all aggregated to produce the number for 

sales. That logical structure is a taxonomy. A GAAP financial statement itself, in that its 

underlying details are summarized in the line items of a balance sheet or income 

statement, is a kind of taxonomy. There are taxonomies for different kinds of businesses. 

For example, the banking industry sector taxonomy differs from that of a software 

industry sector company. 

XBRL also contains standardized relationships, such as EBITDA, so that if an investor or 

analyst wants to know the EBITDA of each of the pharmaceutical companies he would 

simply query the SEC’s EDGAR system with the appropriate search application. The 

numbers would again be able to be downloaded in seconds. There would be no need to 

download the complete financial statements, ferret out the constituents of EBITDA and 

do the necessary calculations. The standardized XBRL concept of EBITDA embedded in 

XBRL provides all the explicit rules that enable a search engine to find the specifically 

identified concepts necessary to compute the number. 

Status of XBRL Tagged Financial Statements in SEC Reports 

The SEC has adopted a voluntary pilot program for use of XBRL in which participants 

submit voluntarily supplemental tagged financial information using the XBRL format as 

exhibits to specified EDGAR filings.24 Voluntary pilot participants may use existing 

standard XBRL taxonomies. Over four dozen companies are participating in the pilot 

program and have agreed to voluntarily submit their annual, quarterly and other reports 

with interactive data for a period of one year. The SEC recently has expanded the 

voluntary filing program to include mutual funds which will file using a risk and return 

taxonomy developed by the Investment Company Institute. 

On December 5, 2007, XBRL-US published the draft of U.S. GAAP taxonomies and 

draft preparer’s guide for public testing and comment. The U.S. GAAP taxonomy 

includes tags for a company’s financial statements and notes. Public review currently is 

scheduled to end April 5, 2008 and XBRL-US has stated that it is anticipated that the 

final taxonomy and preparer guidance will be issued in Spring 2008. After the final 

24 The SEC’s voluntary XBRL rules specify the form, content, and format of XBRL submissions, 

description of XBRL data, timing of XBRL submissions, and use of taxonomies. For example, the rules 

require the tagged data to be described either as “unaudited” or, for quarterly financial statements, 

“unreviewed.” 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 76 -
taxonomy and preparer guidance is issued, the SEC EDGAR system must be modified to 

permit submissions tagged using such U.S. GAAP taxonomies. 

The SEC has stated that it will use the initial financial statements prepared using the new 

U.S. GAAP taxonomy to help it further update it’s EDGAR system so that it will be able 

to “seamlessly accept and render the filings.” The Committee understands that currently, 

the SEC’s EDGAR system does not yet accept and render financial statements with 

XBRL tags based on the newly developed U.S. GAAP taxonomy. 

In addition, the Committee understands that the software industry has been engaged in 

developing tagging and rendering (turning the XBRL tagged information into a human 

readable format) software for XBRL tagged financial statements. Companies generally 

use two methods to tag their financial statements using XBRL. The first method, called a 

“bolt-on” approach, involves developing the XBRL reports after the filed financial 

statements are developed – a process known as “mapping”. Companies also may use 

XBRL to tag their financial statements as part of an integrated approach to financial 

reporting. In an integrated approach, companies incorporate XBRL into their internal 

company financial systems. This integrated approach allows financial reports to be 

created from the XBRL tagged financial systems, without such financial statements first 

being prepared in “human readable format.” XBRL tagging using a “bolt-on” approach 

may involve somewhat more effort than using an integrated approach. Currently, there is 

software that allows companies to XBRL tag their financial statements using the “bolton” approach. Using the “bolt-on” method, companies can prepare their financial 

statements (including notes) in a number of formats, such as Adobe (pdf), Word, and 

HTML. At this time it is unknown how many companies have begun integrating XBRL 

tagging into their internal financial reporting systems and, therefore, it is not clear when a 

significant number of companies would move from a “bolt-on” to an integrated approach 

to XBRL tagging. 

Time and Costs Involved in XBRL Tagging 

The Committee understands that while the U.S. GAAP taxonomy has a significant 

number of individual tags or elements, it contains all of the terms or concepts commonly 

used in financial statements prepared in accordance with U.S. GAAP. The Committee 

understands that reporting companies would use only a limited number of tags or 

elements. For example, one large voluntary filer uses approximately 192 tags (it tags its 

notes as blocks rather than at a granular level) to tag its Form 10-Q. The Committee 

understands a related issue deals with the need for customized “extensions” if the U.S. 

GAAP taxonomy does not include a tag for the particular item in the company’s financial 

statements. Because the U.S. GAAP taxonomies currently out for public comment track 

U.S. GAAP, the Committee believes that there likely will be less need for customized 

extension elements. One of the purposes of the comment period is to identify additional 

tags or elements that should be added to the taxonomy, reducing the need for customized 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 77 -
extensions. The draft preparer guidance also out for public comment should be evaluated 

by preparers, users, and others to determine if it provides adequate guidance for 

determining when an extension should be used by preparers. 

Preparers participating in the SEC’s voluntary program have indicated that the initial 

number of hours it took to tag the face of their financial statements under existing 

standard taxonomies (not the new U.S. GAAP taxonomies) using a “bolt-on” approach 

ranged from 80-100 hours and that the number of hours dropped significantly for 

subsequent reports (due to the lack of a need to replicate the tagging process for most 

items).25 For preparers also tagging the notes to their financial statements using a 

“block” tag, the number of hours increased slightly. The costs to tag the face of the 

financial statements using standardized software were not significant. Additional time 

and cost was spent by at least one preparer to validate the tags that were used. In these 

cases, there was no auditor involvement in the process. 

Thus, the type of information that is tagged also is relevant to understanding XBRL 

tagged financial statements. Companies have been tagging the face of their financial 

statements using existing taxonomies and software. As to the notes to the financial 

statements, additional effort may be involved. While the notes to the financial statements 

may easily be tagged as a block of text, unlike preparation of notes to the financial 

statements in a paper-based format, tagging the individual information in each note will 

involve additional tags and, therefore, more work than block tagging the text. 

Smaller Public Company Reactions to XBRL Tagging 

Smaller public company representatives recognize the benefits that XBRL would have 

for these companies long term, but are concerned about initial implementation costs, 

which development of improved tagging and verification software could help alleviate. 

The representatives strongly support a phased-in approach in which such smaller public 

companies would be included at the end, once the larger public companies had worked 

through any significant implementation issues, including use of company resources 

involved in tagging and verification of XBRL tags. 

Potential Benefits of XBRL 

The Committee sees the following potential benefits of XBRL for reporting companies 

and users of financial and non-financial information: 

25 For example, for one S&P 500 company participating in the voluntary pilot, 80 hours was spent learning 

the tagging tool, understanding SEC requirements, creating extensions for tags, and creating a process for 

ongoing tagging and future submissions. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 78 -
• Benefits to reporting companies 

o Improved communications with analysts and investors 

- Release of corporate data could be instantaneous and immediately usable – 

data can be immediately assimilated into analysts’ models; there is no need to 

wait for third party aggregators or staff to input the data into their own format 

and to transmit it to subscribers 

- Reduction in search costs both for preparers and users 

- Because of reduced search costs, there is potential for increased coverage of 

companies, especially mid-size and smaller companies, by sell-side and buyside analysts, and at both major brokerage and independent research firms 

o Improved quality of data26 

- Because manual input is eliminated, there will be reduced error rates in 

reporting and inputting of corporate data by aggregators 

- Because aggregators will not be necessary, companies will be able to maintain 

control over their numbers; what they report will be what goes into the models 

- Improved ability of company to tell its own story 

o Improved integration of company operating and reporting data 

- As companies become more familiar with XBRL, the Committee believes it 

will be to their advantage to imbed the XBRL technology in an integrated 

manner into their databases to drive a variety of reports, of which the filed 

financial statements would be one set. 

- Operating data can be accessed in the internal enterprise applications where it 

is regularly stored, and thus used for financial reporting purposes without the 

necessity for downloading to paper or manual search 

- Same electronically accessible data can also be used for other purposes 

beyond those of financial statements, including tax, industrial filings, audit, 

benchmarking, performance reporting, internal management, and 

sustainability 

- Significant time and cost savings if integration is accomplished 

- The full economic benefits of XBRL for companies will most likely come 

when they incorporate XBRL in their internal reporting, instead of using it as 

a “bolt-on” after a company’s financial reports are prepared. 

26 Although XBRL is frequently called Interactive Data, the use of the term “data” should not be deemed to 

imply numerical data alone. XBRL also is useful for the tagging of narrative information. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 79 -
• Benefits to users, including both retail investors and the “model builder/research 

analyst.” 

o Development of more easily accessed, reliable sources of relevant information – 

lowered cost of search will increase quantity and quality of analysis 

- Reduces the cost of inputting data into analytical frameworks 

- By eliminating manual input, reduces the likelihood of input error either by 

the user or the aggregator 

- Reduces user dependence on proprietary and inconsistent data sources 

- Increases the likelihood that more users will utilize the primary sources of 

data 

- Reduces the cost to compare companies and improves comparability 

o Potential to reduce analysts time and cost of coverage, and allow analysts to cover 

more companies 

- Potentially increases coverage, especially of small companies that now have 

no or limited coverage because of the costs of analysts’ time 

- Reduces time spent finding and keying data into analytical models 

- Reduces cost of re-distributing data provided by third-party data providers 

- Research organizations will be able to utilize their higher priced talent to 

spend more time in analysis rather than data gathering 

o Eases accessibility of the reported information for all investors and market 

participants

- Analysts will see all of a company’s reported information, not just the 

information assembled and reported by aggregators 

- Eliminates time lag between the company filing its reports and analyst 

evaluation of the reported information 

- With simple search engines, all investors will be able to readily access all the 

information companies report. 

- Because of sharp reductions in costs of analysis, increases the likelihood that 

independent analysts will begin to offer their views to retail investors 

o Improves both analysis and dissemination of analysis to clients and others 

- Reported information goes directly into analysts’ models and is immediately 

accessible 

- Improves the efficient use of firm intellectual property for analysis and 

enables more rapid and effective collaboration/communication of these 

concept with clients 

- More information is contained in an XBRL report, lowering the cost of access 

for all reported information 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 80 -
The Committee recognizes, however, that notwithstanding the potential benefits, many 

company officers may not understand how XBRL works or the improvements it would 

bring to both their financial reporting and their costs of reporting. In addition, there 

currently is limited acceptance of XBRL due, in part, to the following: 

o Companies need greater certainty that XBRL will be adopted before they will expend 

the necessary resources to understand it and its benefits; and 

o Companies may be concerned about potential start-up costs in adopting XBRL, 

including purchase of software and personnel resources for data input and training. 

Further, analysts and software developers are generally unaware or uninformed about 

XBRL. 

Implementation of XBRL Tagging of Financial Statements 

The Committee believes, in conformity with the views of many preparers, users and 

auditors, that interactive data operating on an XBRL platform will offer significant 

benefits to public company preparers, users of public company reports, and the financial 

markets generally. XBRL has the potential to provide financial and non-financial 

information to the market in a way that is better, faster and cheaper than the current 

system, enhancing the availability, accessibility, consistency, and comparability of 

business information, together with cost-savings that will be of great benefit to 

companies, analysts, and investors alike. 

The Committee believes that the SEC should eventually require all public reporting 

companies (preparing their financial statements using U.S. GAAP) to tag the financial 

statements (including footnotes) they are required to file with the SEC as part of their 

Exchange Act reports using XBRL. The Committee believes such a mandate is necessary 

in order to encourage the commitment of resources toward the necessary software 

development for tagging, viewing and reading of the XBRL tagged information, use of 

XBRL tagged data by users such as analysts and investors, and company use of XBRL 

tagging internally, The Committee believes that full implementation of mandated XBRL 

tagged financial statements will require a phase-in over a period of time, as discussed 

below, to allow for enhanced understanding of XBRL by preparers and users, successful 

use of the new U.S. GAAP taxonomies, and further development of tagging and 

rendering software. The Committee believes that such a phase-in should be sensitive to 

the concerns of smaller public companies regarding mandated XBRL tagged financial 

statements. 

The Committee believes that mandatory implementation of XBRL will involve a number 

of steps leading to the ultimate goal of requiring public reporting companies to tag their 

financial statements using XBRL. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 81 -
First, full mandatory implementation may not be possible until the following 

preconditions are met: 

• Taxonomy development 

o Testing of taxonomies. The testing process for the new U.S. GAAP taxonomy, 

which is to determine that disclosures are complete and relevant in current market 

environment, is now underway 

o Release of the final U.S. GAAP taxonomy and preparer guide following public 

review and comment; 

- Successful use of U.S. GAAP taxonomy and preparer guide by voluntary 

filers for a period of time 

- Status: On December 5, 2007, XBRL published the draft of U.S. GAAP 

taxonomies and draft preparer’s guide for public testing and comment. The 

U.S. GAAP taxonomy includes tags for a company’s financial statements and 

footnotes. Public review currently is scheduled to end April 5, 2008 and it is 

anticipated that the final taxonomy and preparer guidance will be issued in 

Spring 2008. 

• Ability of SEC EDGAR to “seamlessly” accept XBRL submissions using the new 

U.S. GAAP taxonomy and other tagged XBRL tagged data and provide an accurate 

rendered version of all such tagged information. 

o Status: The SEC has stated that it will use the initial financial statements prepared 

using the new U.S. GAAP taxonomy to help it update EDGAR so that it will be 

able to “seamlessly accept and render the filings.” Currently, the SEC’s EDGAR 

system does not accept financial statements with XBRL tags based on the newly 

developed U.S. GAAP taxonomy. 

Second, the Committee believes that, to achieve the desire acceptance of XBRL, on an 

interim basis XBRL tagged financial statements should be required to be implemented on 

a phased-in basis as follows: 

• The largest 500 domestic public reporting companies based on unaffiliated market 

capitalization (public float) should be required to: 

o Furnish to the SEC, as is the case with the voluntary program today, a document 

prepared separately from the reporting company’s financial statements filed as 

part of their periodic Exchange Act reports that contains the following: 

- XBRL tagged face of the financial statements;27 and 

- Block tagged footnotes to the financial statements;28 and 

27 To allow this first phase, the SEC EDGAR system must permit submissions using the new U.S. GAAP 

taxonomies. 

 The Committee understands that tagging beyond the face of the financial statements and block tagging 

of footnotes, such as granular tagging of footnotes and non-financial data, may require significant effort 

and would involve a significant number of tags. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 82 -

28
• Domestic large accelerated filers (as defined in SEC rules, which would include the 

initial 500 domestic public reporting companies) should be added to the category of 

companies, beginning one year after the start of the first phase, required to furnish 

XBRL tagged financial statements to the SEC. 

The Committee believes that a phase-in would provide business, financial planners, 

software developers, and users the impetus to move forward in building systems based on 

XBRL. For example, in connection with the mandatory implementation of XBRL, the 

Committee is aware that, if mandated, preparers may use a “bolt-on” solution in-house or 

use a service provider in the early stages before moving to a broader integrated 

interactive data approach. This “bolt-on” approach, for many, could be used as a means 

to begin to climb the learning curve in a cheap, easily managed manner. In this regard, 

the Committee believes that companies should have the capacity to compare XBRL 

tagged and rendered financial statements to avoid errors and the SEC should take steps to 

assist in that regard. The Committee believes that the SEC should encourage or 

commission the development of free software to compare rendered and filed statements. 

During the phase-in period, the SEC and PCAOB should seek input from companies, 

investors, and other market participants as to the experience of such persons in preparing 

and using XBRL tagged financial statements using the U.S. GAAP taxonomies, and 

related costs. The SEC should consider conducting or commissioning a study of the rate 

of errors by companies in using the appropriate XBRL tags in comparison to the financial 

statement items, which should be done only after filers use uniform taxonomies and 

preparer guidance to tag their financial statements. 

In addition, as discussed under the phase-in approach described above, the XBRL tagged 

financial statements would still be considered furnished to and not filed with the SEC. 

As part of the mandatory implementation, the Committee believes that, as is the case in 

the voluntary program, the SEC should make clear what liability provisions the XBRL 

tagged financial statements would be subject to under the federal securities laws. 

Third, at the end of the phase-in period described above, and as promptly as practicable 

after the preconditions to full implementation discussed above are met, the SEC should 

evaluate the results from the phase-in period to determine whether and when to move 

from furnishing to official filing of XBRL tagged financial statements for domestic large 

accelerated filers, as well as the inclusion of all other reporting companies, as part of a 

company’s Exchange Act periodic reports. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 83 -
II.B. Developed Proposals 

The Committee would like to make recommendations that increase certainty that XBRL 

will be a significant part of the reporting landscape so that preparers, users, auditors, 

software developers and regulators make the needed investment in XBRL. 

Based on the above considerations, the Committee has developed the following proposal: 

Developed Proposal 5.1: The SEC should mandate the filing of XBRL-tagged 

financial statements within a defined time frame after certain preconditions 

relating to successful taxonomy testing and capacity of reporting companies to file 

XBRL tagged financial statements using the new U.S. GAAP taxonomy on the 

SEC’s EDGAR system and for the EDGAR system to provide an accurate rendered 

version of all such tagged information. The SEC should phase-in XBRL tagged 

financial statements as follows: 

• The largest 500 domestic public reporting companies based on unaffiliated 

market capitalization (public float) should be required to: 

o Furnish to the SEC, as is the case with the voluntary program today, a 

document prepared separately from the reporting company’s financial 

statements filed as part of their periodic Exchange Act reports that contains 

the following: 

o XBRL tagged face of the financial statements;29 and 

o Block tagged footnotes to the financial statements;30 

• Domestic large accelerated filers (as defined in SEC rules, which would 

include the initial 500 domestic public reporting companies) should be added to 

the category of companies, beginning one year after the start of the first phase, 

required to furnish XBRL tagged financial statements to the SEC; and 

• Once the preconditions noted above have been satisfied and the second phase-in 

period has been implemented, the SEC should evaluate whether and when to 

move from furnishing to the official filing of XBRL tagged financial statements 

for the domestic large accelerated filers, as well as the inclusion of all other 

reporting companies, as part of a company’s Exchange Act periodic reports. 

29 To allow this first phase, the SEC EDGAR system must permit submissions using the new U.S. GAAP 

taxonomies. 30 The Committee understands that tagging beyond the face of the financial statements and block tagging of 

footnotes, such as granular tagging of footnotes and non-financial data, may require significant effort and 

would involve a significant number of tags. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 84 -
Questions for the Committee: 

5.2) Should the SEC mandate the filing of XBRL tagged financial statements by all 

public reporting companies? If not, what should the SEC mandate to encourage 

the use of XBRL by public reporting companies? 

5.3) If you agree that the SEC should mandate the filing of XBRL tagged financial 

statements, should the SEC follow the phase-in approach described above or 

should it instead mandate the filing of XBRL tagged financial statements as part 

of the official filing at the outset?

 (a) If you agree with the phase-in approach, 

(i) do you agree that the phase-in should begin with the 500 largest 

domestic issuers based on public float and then expand to include large 

accelerated filers? 

(ii) do you agree that the initial phase-in should mandate the tagging of the 

face of the financial statements and the notes on a “block” basis? 

5.4) Are the preconditions described above necessary to be satisfied before the SEC 

should consider mandating the filing of XBRL tagged financial statements? If 

not, are there any preconditions that should be required to be satisfied? 

5.5) Should the SEC commission studies or the development of software to assist 

preparers and users in tagging, rendering, and viewing XBRL tagged financial 

statements? 

II.C. Assurance 

An important issue related to tagging public company financial statements using XBRL 

involves whether assurance should be provided by a third party. The Committee 

understands that among the primary benefits in providing independent assurance of 

XBRL documents would be that financial statement users could quickly build confidence 

in interactive data and increase their use of such data. One primary reason for not 

obtaining such independent assurance of XBRL documents is the concern that the cost 

and time incurred to obtain such assurance may significantly outweigh the benefits to 

preparers and users. 

As to assurance, the Committee identified that questions arise as to whether assurance 

should be provided to: 

1. determine if a company uses the proper XBRL taxonomy and accurately tags its 

financial statements; 

2. assess the reasonableness of any company extensions to the XBRL taxonomy; 

3. determine compliance with SEC content and format requirements; 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 85 -
4. perform validation checks over footings and interchecks (for example, if inventory is 

reported more than once throughout the document, determine if amounts reported are 

consistent); or 

5. determine if the information in the XBRL instance document is the same as the 

original filed document (applicable under a “bolt-on” state). 

The Committee notes that there are ways that companies, mistakenly or deliberately, can 

create XBRL reports in a manner that will potentially mislead users. Accordingly, some 

Committee members believe that independent assurance of XBRL documents prepared 

by management should be provided, as described in items #1 and #5 above (at a 

minimum), provided that such assurance does not result in a significant increase in audit 

costs. They noted that accounting knowledge and professional judgment would be 

required in providing that assurance, but they believe that providing such assurance 

should not be an expensive or time-consuming activity, as many steps can be automated 

and other steps can be quickly and cost effectively embedded within existing audit 

methodologies and audit procedures. 

The concept of obtaining assurance on the correct tags and matching the XBRL rendered 

documents to the filed statements is predicated on the belief that the incremental money 

and human resource costs to provide the assurance will be very small. Reviewing the 

tags the first time will involve significant effort, but subsequent reviews can be limited to 

new or changed tags. Moreover, the costs and benefits of assurance reviews may differ 

depending on whether companies are using the “bolt-on” rather than the integrated 

tagging approach. Therefore, other members of the Committee believe that it is 

appropriate to study the assurance process during the phase-in period to assess the actual 

costs and benefits of assurance that might be provided on the XBRL tagged financial 

statements. 

The type, timing, and extent of assurance, if any, on a company’s XBRL tagged financial 

statements and other tagged information required to be furnished with the SEC should 

take into account the needs of investors, companies, and other market participants and the 

costs to reporting companies. Until a group of reporting companies have been required to 

furnish to the SEC XBRL tagged financial statements and notes using the new U.S. 

GAAP taxonomy for a period of time that will allow investors and other market 

participants to evaluate the reliability of such XBRL tagged financial statements and 

notes, it may be premature to make concrete suggestions regarding assurance. 

Accordingly, the Committee’s developed proposal does not include a specific assurance 

proposal. During the interim phase-in period discussed above, the SEC and PCAOB 

should seek input from companies, investors, and other market participants as to the type, 

timing, and extent of desired or needed assurance, if any. This input should include the 

experience of such persons in preparing and using XBRL tagged financial statements 

using the newly developed U.S. GAAP taxonomies, and related costs. Additionally, after 

public companies are required to tag their financial statements using XBRL, whether in 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 86 -
accordance with the Committee’s proposals or otherwise, the SEC should consider 

initiating a voluntary pilot program in which companies obtain assurance on their XBRL 

tagged financial statements (whether using a “bolt-on” or integrated approach) in order to 

evaluate fully potential costs and benefits associated with such effort. 

Questions for the Committee: 

5.6) Do you agree that the SEC should implement a voluntary pilot program for 

companies to obtain assurance on their XBRL tagged financial statements to 

assess the costs and benefits of assurance? 

5.7) Should the SEC mandate that companies receive assurance during the phasein? If yes, what type of assurance should be provided? Should auditors be 

required to provide that assurance or may another third party be able to 

provide the assurance? If no, should there be another mechanism by which 

users can verify that the correct XBRL tags were chosen and that the XBRL 

tagged financial statements are the same as the underlying financial 

statements? Should management be required to provide a written certification 

that the company chose the correct XBRL tags for its financial statements, 

and, during a “bolt-on” state, the information furnished to the SEC agrees with 

the financial statements originally filed with the SEC? 

III. Improved Corporate Website Use 

Background 

The Committee has been examining the integral role that technology and corporate 

websites play in informing the markets and investors about important corporate 

information and developments, including website disclosure presentations that are under 

development by software vendors. A valuable element of such website presentations is 

that they often present the most important general information about the company on the 

opening page, with embedded links that enable the reader to drill down to more detail by 

clicking on the links. In this way, viewers--if they wish--can follow a path into the details 

of the financial statements, the company's strategy and products, its management and 

corporate governance, and many other areas in which investors and others may have an 

interest. 

Improving the use of corporate websites can enable shareholders and investors to gather 

the level of information about a company that they believe is satisfactory for their 

purposes, without requiring them to wade through large amounts of written material that 

may provide a level of detail beyond the needs of the particular shareholder or investor. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 87 -
Corporate websites provide reporting companies a cost-effective, efficient method to 

provide information to investors and the market. Encouraging reporting companies to 

increase their use of their websites, including developing a tiered approach to deliver 

such corporate information on their websites, would benefit investors of all types, retail 

and institutional. Enhanced corporate website usage could decrease the complexity of 

information presentation and would enhance its accessibility. In addition, through 

coordination by industry participants, uniform best practices on uses of corporate 

websites could be developed. 

The SEC has issued a series of interpretive releases and rules addressing the use of 

electronic media to deliver or transmit information under the federal securities laws. The 

SEC issued its last comprehensive interpretive release on the use of electronic media, 

including corporate websites in 2000. Since 2000, significant technological advances 

have increased both the market’s demand for more timely corporate disclosure and the 

ability of investors to capture, process, and disseminate this information. Recognizing 

this, the SEC has adopted a large number of rules that mandate, permit, or require 

disclosure of the use of corporate websites to provide important corporate information 

and developments. 

The Committee has heard, however, that there are continuing concerns about the 

treatment of website disclosures under the federal securities laws that some have argued 

may be impeding greater use of corporate websites. These concerns include liability for 

information presented in a summary format, the treatment of hyperlinked information 

from within or outside a company’s website, and the need for clarification of the public 

availability of information disclosed on a reporting company website. Consequently, the 

Committee believes that the SEC should issue a new comprehensive interpretive release 

regarding the use of corporate websites for disclosures of corporate information. The 

Committee believes that this SEC guidance would encourage further creative use of 

corporate websites by reporting companies to provide information, including website 

disclosure formats following industry developed best practice guidelines. 

Developed Proposal 

Based on the above, the Committee has developed the following proposal: 

Developed Proposal 5.2: The SEC should issue a new comprehensive interpretive 

release regarding the use of corporate websites for disclosures of corporate 

information addressing such issues as liability for information presented in a 

summary format, treatment of hyperlinked information from within or outside a 

company’s website, and clarification of the public availability of information 

disclosed on a reporting company website. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 88 -
Industry participants should coordinate among themselves to develop uniform best 

practices on uses of corporate websites for delivering corporate information to 

investors and the market. 

Questions for the Committee: 

5.8) Does the Committee agree with the proposal that the SEC should issue an 

updated, comprehensive interpretive release regarding the use of corporate 

websites? Should the interpretation be limited or expanded in any manner? 

5.9) Does the Committee agree that an industry developed set of uniform best 

practices is the right approach in encouraging greater use of corporate 

websites to inform investors and the market? If not, what alternatives can be 

proposed that would have such effect? 

IV. Use of Executive Summaries in Exchange Act Periodic Reports 

Background 

The Committee has been exploring a requirement to include an executive summary in 

reporting company annual and quarterly Exchange Act reports (Forms 10-K and 10-Q). 

The Committee understands that a summary report prepared on a stand-alone basis would 

not necessarily provide investors information they need in a desired format. However, a 

summary included in the forepart of an Exchange Act periodic report may provide 

investors with an important roadmap to the company’s disclosures located in the body of 

such report. The executive summary in the Exchange Act periodic report would provide 

summary information, in plain English, in a narrative and perhaps tabular format of the 

most important information about a reporting company’s business, financial condition, 

and operations. As with MD&A, the executive summary would use a layered approach 

that would present information in a manner that emphasizes the most important 

information about the reporting company and include cross-references to the location of 

the fuller discussion in the annual report. 

The goal of the executive summary would be to help investors fundamentally understand 

the companies’ businesses and activities through a relatively short, plain English 

presentation. An executive summary in a periodic report may be most useful if it 

included high-level summaries across a broad range of key components of the annual or 

quarterly report, rather than detailed discussion of a limited number of variables. The 

executive summary approach may be an efficient way to provide all investors, including 

retail, a concise overview of a company, its business, and its financial condition. For the 

more sophisticated investor, an executive summary may be helpful in presenting the 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 89 -
company’s unique story which the sophisticated investor could consider as it engages in a 

more detailed analysis of the company, its business and financial condition. 

One alternative for such an executive summary in a periodic report would be that the 

summary should no more than 2 pages in length and should include the following: 

1. Brief description of the company’s business, sales and marketing; 

2. Summary of a company’s current financial statements; 

3. A digest of the company’s GAAP and non-GAAP key performance indicators 

(KPI's); 

4. Summary of key aspects of company performance; 

5. Summary of business outlook; and 

6. References to more detailed information contained in the document, with page 

numbers. 

The executive summary would be required to be included in the forepart of a reporting 

company’s annual or quarterly report filed with the SEC or, if a reporting company files 

its annual report on an integrated basis (the glossy annual report is provided as a 

wraparound to the filed annual report), the executive summary instead could be included 

in the forepart of the glossy annual report. If the executive summary was included in the 

glossy annual report, it would not be considered filed with the SEC. 

Future Considerations 

The Committee will continue to evaluate the concept of requiring an executive summary 

in a public company’s Exchange Act periodic reports such as the annual report on Form 

10-K and quarterly report on Form 10-Q. 

Questions to be Subsequently Considered by the Committee: 

5.10) Do you believe the use of an executive summary as an integral part of a 

company’s Exchange Act periodic report would contribute to an investor’s 

ability to evaluate a company’s disclosures? 

5.11) Do you believe that an executive summary in an Exchange Act periodic report 

should be mandated or voluntary? 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 90 -
V. Disclosures of Key Performance Indicators and Other Metrics to Enhance 

Business Reporting 

Background 

Enhanced business reporting and key performance indicators (KPIs) are disclosures about 

a company’s business that is the source of its values. The Enhanced Business Reporting 

Consortium,

31 has stated that the value drivers for a business “can be measured 

numerically through key performance indicators or may be qualitative factors such as 

business opportunities, risks, strategies and plans—all of which permit assessment of the 

quality, sustainability and variability of its cash flows and earnings.” KPIs are 

supplemental non-GAAP financial reporting disclosures that proponents have stated can 

improve disclosures by public companies. Key performance indicators are leading 

indicators of financial results and intangible assets that are not encompassed on a 

company’s balance sheet. Proponents of the use of KPI’s note that they are important 

because they inform judgments about a company’s future cash flows – and form the basis 

for a company’s stock price. It has been stated that managers and company boards of 

directors use KPIs to monitor performance of companies and of management. Market 

participants and the SEC have identified KPIs as important supplements to GAAPdefined financial measures. 

Future Considerations 

The important issues for the Committee to examine are what types of KPIs should be 

made available, in what format, at what time, and whether they are clearly and 

consistently defined over time. Currently, companies are disclosing some companyspecific KPIs in their periodic reports filed with the SEC or in other public statements. 

Other people in the market are working on developing industry-specific KPIs in order to 

improve comparability of companies on an industry basis. The Committee will examine, 

among other matters, whether KPIs should be a voluntary or mandatory disclosure, who 

should develop the disclosure standards for defining and measuring KPIs to assure 

consistency among companies and through time, and whether XBRL should be extended 

by industry sector to include KPIs and information on intangible assets. The Committee 

also will examine ways in which consistent KPIs can be developed through industry 

coordination. 

31 The Enhanced Business Reporting Consortium was founded by the AICPA, Grant Thornton LLP, 

Microsoft Corporation, and PricewaterhouseCoopers in 2005 upon the recommendation of the AICPA 

Special Committee on Enhanced Business Reporting. The EBRC is an independent, market-driven nonprofit collaboration focused on improving the quality, integrity and transparency of information used for 

decision-making in a cost effective, time efficient manner. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 91 -
Question to be Subsequently Considered by the Committee: 

5.12) Do you agree that the Committee should evaluate the increased use of key 

performance indicators and other metrics to enhance business reporting? 

VI. Improved Quarterly Press Release Disclosures and Timing 

Background 

The quarterly press release, being the first corporate communication about the result of 

the quarter just ended, is viewed as an important corporate communication. It is 

perceived that this communication receives more attention than the formal 10 Q 

submission which often occurs a week or two later. 

Future Considerations 

The Committee intends to review the press release for its consistency, understandability 

and its timeliness. The Committee will consider the consistent provision of income 

statement, balance sheet and cash flow tables in the quarterly release. It also intends to 

consider the positioning and prominence of GAAP and non-GAAP figures, GAAP 

reconciliation, the consistent placement of topics, and clear communication of any 

changes to accounting methods or key assumptions. Ultimately, the Committee views the 

goal as a consistent, reliable communication form that all users can easily navigate. 

In addition, based on anecdotal evidence and a survey of CFA Institute members, and 

consideration of comments received by the SEC when this idea was put forth in prior 

SEC rule proposals, the Committee will evaluate the advisability of the quarterly press 

release being put forth on the same day as the Form 10-Q is submitted, as opposed to the 

current lagged structure. The Committee will consider, among other things, (i) the 

savings in time spent cross- referencing two separate but fairly identical reports separated 

by a very short period and (2) the elimination of the concern that the two reports may not 

perfectly match. 

The Committee does not intend to discuss the potential desire to do away with reporting 

quarterly results. Even though there is considerable concern that current financial 

reporting has a built in short term bias, eliminating quarterly reporting would likely lead 

investors to believe that they were being denied important guidepost information. The 

Committee elsewhere will focus on attempts to move corporate reporting in the direction 

of more fundamental and sustainable business measures which are often interpreted as 

having a longer term focus. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 92 -
Questions to be Subsequently Considered by the Committee: 

5.13) Do you agree that the Committee should evaluate the content and timing of 

quarterly press releases issued by reporting companies? 

5.14) Should the Committee evaluate other areas relating to quarterly press release 

disclosures? 

VII. Continued Need for Improvements in MD&A and Other Public Company 

Financial Disclosures 

Background 

Every public company is required to include a MD&A section in their annual and 

quarterly reports filed with the SEC. The three principal objectives of MD&A are to: 

• to provide a narrative explanation of a company’s financial statements that enables 

investors to see the company through the eyes of management; 

• to enhance the overall financial disclosure and provide the context within which 

financial information should be analyzed; and 

• to provide information about the quality of, and potential variability of, a company’s 

earnings and cash flow so that investors can ascertain the likelihood that past 

performance is indicative of future performance. 

The SEC has made clear that the quality of MD&A in public company periodic reports is 

not as good as it should be. In 2003, the SEC concluded, based in part on the Fortune 

500 report issued by the Division of Corporation Finance, that additional guidance was 

useful in the following areas: 

• the overall presentation of MD&A; 

• the focus and content of MD&A (including materiality, analysis, key performance 

measures and known material trends and uncertainties); 

• disclosure regarding liquidity and capital resources; and 

• disclosure regarding critical accounting estimates. 

The SEC has stated that MD&A should not be a recitation of financial statements in 

narrative form or a series of technical responses to MD&A requirements. 

Future Considerations 

The Committee understands that investors and other market participants believe that 

while there has been some improvement in MD&A disclosures since publication of the 

SEC’s interpretive release in 2003, significant improvement is still needed both in terms 

of additional disclosures and elimination of what the SEC termed “unnecessary detail or 

duplicative or uninformative disclosure that obscures material information.” 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 93 -
Under the Sarbanes-Oxley Act of 2002, the SEC is generally required to review every 

public company at least every three years. In that regard, the Committee believes that 

through the review process, the SEC will gain important insight on whether there has 

been improvement in company MD&A disclosures and the types of ongoing concerns 

regarding such disclosures. The Committee will be evaluating whether the SEC should 

periodically issue a report on common types of comments issued on MD&A and other 

financial disclosures similar to the Fortune 500 report to provide additional guidance on 

improving MD&A in accordance with the SEC’s most recent interpretive guidance.32 

Questions to be Subsequently Considered by the Committee: 

5.15) Should the Committee encourage the SEC to periodically issue reports on 

common disclosure comments issued on MD&A and other financial 

disclosures? 

5.16) Are there other steps the Committee would suggest be taken to improve the 

quality of MD&A disclosures? 

32 The Committee notes that the SEC’s comment letters on a reporting company’s filings are made publicly 

available on the SEC website after completion of the SEC’s review of such filings. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 94 -
APPENDICES 

Index of Appendices 

A – Committee Members, Official Observers, and Staff 

B – Examples of Substantive Complexity 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

- 95 -
Appendix A 

Members 

Robert C. Pozen, Chairman 

MFS Investment Management 

(Ex Officio Member of All Subcommittees) 

Dennis R. Beresford 

Ernst & Young Executive Professor of Accounting 

University of Georgia 

(Standard-Setting Process Subcommittee) 

Susan S. Bies 

Former Member, Board of Governors 

Federal Reserve System 

(Chairperson, Substantive Complexity Subcommittee) 

J. Michael Cook 

Former Chairman and CEO 

Deloitte & Touche LLP 

(Chairperson, Audit Process and Compliance Subcommittee) 

Jeffrey J. Diermeier, CFA 

President and CEO 

CFA Institute 

(Chairperson, Delivering Financial Information Subcommittee) 

Scott C. Evans 

Executive Vice President, Asset Management 

TIAA-CREF 

(Standard-Setting Process Subcommittee) 

Linda L. Griggs 

Partner 

Morgan, Lewis & Bockius LLP 

(Audit Process and Compliance Subcommittee) 

Joseph A. Grundfest 

William A. Franke Professor of Law and Business 

Stanford Law School 

(Substantive Complexity Subcommittee) 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

A-1 
Gregory J. Jonas 

Managing Director 

Moody's Investors Service 

(Audit Process and Compliance Subcommittee) 

Christopher Liddell 

Chief Financial Officer 

Microsoft Corp 

(Delivering Financial Information Subcommittee) 

William H. Mann, III 

Senior Analyst 

The Motley Fool 

(Delivering Financial Information Subcommittee) 

G. Edward McClammy

Senior Vice President, Chief Financial Officer and Treasurer 

Varian, Inc.

(Substantive Complexity Subcommittee) 

Edward E. Nusbaum 

CEO and Executive Partner 

Grant Thornton LLP 

(Audit Process and Compliance Subcommittee) 

James H. Quigley 

Chief Executive Officer 

Deloitte Touche Tohmatsu 

(Standard-Setting Process Subcommittee) 

David H. Sidwell 

Chief Financial Officer 

Morgan Stanley 

(Chairperson, Standard-Setting Process Subcommittee) 

Peter J. Wallison 

Arthur F. Burns Chair in Financial Market Studies 

American Enterprise Institute 

(Delivering Financial Information Subcommittee) 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

A-2 
Thomas Weatherford 

Former Executive Vice President and Chief Financial Officer 

Business Objects S.A. 

(Substantive Complexity Subcommittee) 

Official Observers 

Robert Herz 

Chairman 

Financial Accounting Standards Board 

Assisted by: 

Thomas Linsmeier (Substantive Complexity Subcommittee) 

Larry Smith (Audit Process and Compliance Subcommittee) 

Donald Young (Delivering Financial Information Subcommittee) 

Charles Holm 

Associate Director and Chief Accountant 

Banking Supervision and Regulation 

Federal Reserve Board. 

Phil Laskawy 

Chairman of the Trustees 

International Accounting Standards Committee Foundation 

Mark Olson 

Chairman 

Public Company Accounting Oversight Board 

Assisted by: 

Charles Niemeier (Substantive Complexity Subcommittee) 

Dan Goelzer (Audit Process and Compliance Subcommittee) 

Kristen E. Jaconi 

Senior Policy Advisor to the Under Secretary for Domestic Finance 

U.S. Department of the Treasury 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

A-3 
Committee Staff 

Conrad Hewitt 

Chief Accountant 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

James Kroeker 

(Designated Federal Officer) 

Deputy Chief Accountant 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

John W. White 

Director 

Division of Corporation Finance 

U.S. Securities and Exchange Commission 

Russell Golden (Senior Advisor to the Committee Chairman) 

Director of Technical Application and Implementation Activities 

Financial Accounting Standards Board 

Holly Barker 

Project Manager 

Financial Accounting Standards Board 

Adam Brown 

Professional Accounting Fellow 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

Bert Fox 

Professional Accounting Fellow 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

Todd Hardiman 

Associate Chief Accountant 

Division of Corporation Finance 

U.S. Securities and Exchange Commission 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

A-4 
Stephanie Hunsaker 

Associate Chief Accountant 

Division of Corporation Finance 

U.S. Securities and Exchange Commission 

Shelly Luisi 

Senior Associate Chief Accountant 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

Chris Roberge 

Project Manager 

Financial Accounting Standards Board 

Nili Shah 

Assistant Chief Accountant 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

Amy Starr 

Senior Special Counsel to the Director 

Division of Corporation Finance 

U.S. Securities and Exchange Commission 

Sharon Virag 

Director of Technical Policy Implementation 

Public Company Accounting Oversight Board 

Brett Williams 

Professional Accounting Fellow 

Office of the Chief Accountant 

U.S. Securities and Exchange Commission 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

A-5 
1. Industry-Specific Guidance 

1. Below is a list of examples of industry-specific guidance in GAAP. Note that this list does not reflect all 

guidance or all industries subject to its own guidance. 

Industry Sources 

Broadcasting Industry SFAS No. 63, 139; EITF 87-10; SOP 00-2 Banking and Thrift Industries APB Opinion 23; SFAS No. 72, 91, 104, 109, 114, 115, 147; Techni

85-24-1; SOPs 90-3, 03-3; EITFs 97-3, 93-1, 92-5, 89-3, 88-25, 88-185-42, 85-41,85-31, 85-24, 85-8, 84-20, 84-9, 84-4, D-Topics D-78, Regulation S-X – Article 9, SEC Industry Guide; AICPA Auditing a

Cable Television Industry SFAS No. 51 Computer Software to be Sold, Leased, or Otherwise Marketed 

SFAS No. 2, 86 

Contractor Accounting: Construction-Type Contracts & Government Contracts 

ARB 43, Chapter 11, ARB 45, SFAS No. 111; SOP 81-1 

Development Stage Enterprises Opinion 18; SFAS No. 7, 95, 154; Interpretation 7; SOP 98-5; AICP

Accounting Guides 

Finance Companies SFAS No. 91, 111, 115; SOP 01-6; AICPA Auditing and Accounting Franchising: Accounting by Franchisors SFAS No. 45, 141 Insurance Industry SFAS No. 5, 60, 91, 97, 109, 113, 114, 115, 120, 124, 133, 135, 140

Interpretation 40; FSP FAS 97-1; AICPA Auditing and Accounting G6, 92-9; D-Topics D-54, D-35. D-34, SEC Regulation S-X – Article 

Investment Companies SFAS No. 102; FSP AAG INV-1; SOPs 94-4-1, 93-1, 93-4, 95-2, 00

Auditing and Accounting Guide; D-Topics D-76 D-74, D-11, SEC R6, 

Mortgage Banking Activities SFAS No. 65, 91, 114, 115, 124, 125, 133, 134, 140, 149, 156; Tech

97-1, 03-3; EITF 95-5, 90-21, 87-34, 85-13, 84-19, D-Topics D-10, D

Motion Picture Industry SFAS No. 139, SOP 00-2 This report has been prepared for discussion and deliberation by the full Committee at a January 11, 2008 open meeting. Pending areport by the Committee, it does not necessarily reflect either the views of the Committee or other members of the Committee. It also reflect the views or regulatory agenda of the Commission or its staff. 

B-1 
Oil and Gas Producing Activities SFAS No. 19, 25, 69, 95, 109, 131, 143, 144, 145, 153; Interpretatio

141/142-1, 142-2; AICPA Auditing and Accounting Guide; SEC indX Rule 4-10, SAB Topic 12, FRR Section 406; EITFs 04-6, 04-4, 04

Pension Funds: Accounting and Reporting by Defined Benefit Pension Plans 

SFAS No. 35, 75, 102, 110, 135, 149; SOPs 92-6,94-4,94-6,95-1,99-

Real Estate: Sales & Accounting for Costs and Initial Rental Operations of Real Estate Projects 

SFAS No. 13, 34, 66, 67, 91, 98, 114, 140, 144, 152; Interpretation 41, 97-1, 04-2; AICPA Auditing and Accounting Guide; EITF 06-8, 095-6, 94-2, 94-1, 91-10, 91-2, 90-20, 89-14, 88-24, 88-12, 87-9, 86-7SEC Regulation S-X – Rule 3-14, SEC SAB Topic 5N, 5W 

Record and Music Industry SFAS No. 50 Regulated Operations SFAS No. 71, 87, 90, 92, 98, 101, 106, 109, 135, 142, 144, Interpret

Bulletin 87-2; EITFs 97-4, 92-7; D Topics D-21, D-5; SAB Topic 10 

Title Plant SFAS No. 61, 144 

2. Industry-specific exceptions in GAAP, such as the scope exception for registered investment companies a

entities in FIN 46R, Consolidation of Variable Interest Entities and for U.S. savings and loan associationthrift lenders, and stock life insurance companies in SFAS No. 109, Accounting for Income Taxes. 

3. Industry practice such as accounting for certain types of inventory at fair value 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 2008 open meeting. Pending areport by the Committee, it does not necessarily reflect either the views of the Committee or other members of the Committee. It also reflect the views or regulatory agenda of the Commission or its staff. 

B-2 
2. Alternative Accounting Policies 

Examples of alternative accounting policies are as follows: 

• SFAS No. 87, Employer’s Accounting for Pensions and SFAS No. 106, 

Employers’ Accounting for Postretirement Benefits Other Than Pensions, which 

permits alternatives for amortizing delayed recognition amounts and for 

measuring return on plan assets. 

• SFAS No. 95, Statement of Cash Flows, which permits alternative presentations 

of the form and content of the statement. 

• SFAS No. 115, Accounting for Certain Investments in Debt and Equity Securities 

(specifically Q&A 35 of the SFAS 115 Implementation Guide), which indicates 

that companies are not precluded from classifying securities as trading, even if 

they have no intention of selling them in the near term. 

• SFAS No. 130, Reporting Comprehensive Income, permits a choice in presenting 

comprehensive income. An entity may present other comprehensive income 

below the total for net income in a single statement, in a separate statement that 

begins with net income, or in a statement of changes in equity. 

• SFAS No. 133, Accounting for Derivative Instruments and Hedging Activities, 

which permits, but does not require, the use of hedge accounting, which, in 

certain circumstances, may mitigate earnings volatility from marking derivative 

instruments to market. 

• SFAS No. 159, The Fair Value Option for Financial Assets and Financial 

Liabilities, which permits, but does not require, the measurement of certain 

financial assets and financial liabilities at fair value. 

• EITF 88-1, Determination of Vested Benefit Obligation for a Defined Benefit 

Plan, which permits vested benefit obligations to be determined as the actuarial 

present value of the vested benefits to which the employee is entitled if the 

employee separates immediately or the actuarial present value of the vested 

benefits to which the employee is currently entitled but based on the employee's 

expected date of separation or retirement. 

• EITF 06-3, How Taxes Collected from Customers and Remitted to Governmental 

Authorities Should Be Presented in the Income Statement (That Is, Gross Versus 

Net Presentation), which permits that certain taxes, such as sales, use, and value 

added taxes, to be presented either on a gross or net basis. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-3 
• EITF Topic D-98, Classification and Measurement of Redeemable Securities, 

which permits a choice of methods of accreting to the redemption value. 

• FIN 48, Accounting for Uncertainty in Income Taxes, which permits an entity to 

classify interest and penalties as either interest or taxes. 

• FSP AUG AIR-1, Accounting for Planned Major Maintenance Activities, which 

prohibits the accrue in advance method, but allows for continued use of one of 

three other alternatives: direct expense, built-in overhaul, or deferral methods. 

• Oil & gas accounting: The two accounting methods followed by oil and gas 

producers are the successful efforts method and the full cost method. Successful 

efforts accounting essentially provides for capitalizing only those costs directly 

related to proved properties;33 the costs associated with exploratory dry holes are 

expensed as incurred. Full cost accounting generally provides for capitalizing 

(within a cost center) all costs incurred in exploring for, acquiring, and developing 

oil and gas reserves-regardless of whether or not the results of specific costs are 

successful. 

• SAB Topic 5H, Accounting for Sales of Stock by a Subsidiary, which permits 

gains/losses on sales of stock by a subsidiary to be recognized in income or 

equity. 

33 The estimated quantities of crude oil, natural gas, and natural gas liquids which geological and 

engineering data demonstrate with reasonable certainty to be recoverable in future years from known 

reservoirs under existing economics and operating conditions. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-4 
3. Bright Lines 

Examples of bright lines, rules of thumb, and pass/fail models include the 

following: 

A. Bright Lines 

• Lease Accounting 

Current lease accounting is based on a principle: when a lease transfers 

substantially all of the benefits and risks of ownership of the property, it 

should be accounted for as an asset and a corresponding liability by the 

lessee and the asset is derecognized by the lessor (capital lease); 

otherwise, rental expense is recognized as amounts become payable 

(operating lease). However, to apply this principle, SFAS No. 13, 

Accounting for Leases, provides the following bright lines for classifying 

leases as capital or operating. Meeting any one of these criteria results in 

capital lease treatment. 

o The lease transfers ownership of the property to the lessee by the end 

of the lease term. 

o The lease contains a bargain purchase option. 

o The lease term is equal to 75 percent or more of the estimated 

economic life of the leased property. 

o The present value at the beginning of the lease term of the minimum 

lease payments, excluding certain items, equals or exceeds 90 percent 

of the excess of the fair value of the leased property. 

• Consolidation 

For those entities that are not subject to the FIN 46R model, consolidation 

is required by the party that holds the majority of the voting interests, in 

effect, creating a bright line of 50%. Further, there is a presumption that 

an investment of 20% - 50% requires equity method accounting. In 

addition, the equity method is required for investments in limited 

partnerships unless the interest “is so minor that the limited partner may 

have virtually no influence over partnership operating and financial 

policies” (SoP 78-9, Accounting for Investments in Real Estate Ventures). 

In this case, practice has used a 3%-5% bright line to apply the “more than 

minor” provision. This practice has been acknowledged by the SEC staff 

in EITF Topic No. D-46, Accounting for Limited Partnership Investments. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-5 
• Revenue Recognition 

Bright lines may also be found in revenue recognition literature. One 

example is SFAS No. 66, Accounting for Sales of Real Estate, which 

provides bright lines for determining the buyer’s minimum initial 

investment requirements for real estate sales. 

• Business Combinations 

When an SEC registrant undergoes a change in control, the company must 

reflect the new basis of accounting arising from its acquisition in its standalone financial statements (i.e., apply purchase accounting to its own 

stand-alone financial statements) if the company becomes substantially 

wholly-owned. “Substantially wholly-owned” is defined such that this 

push down accounting is prohibited if less than 80% of the company is 

acquired, permitted if 80% to 95% of the company is acquired, and 

required if 95% or more of the company is acquired. 

In addition, SFAS No. 141, Business Combinations, requires that the 

purchase price allocation period in a business combination usually not 

exceed one year from the consummation date. 

• Pension and Other Post-Retirement Employment Benefit Accounting 

SFAS No. 87, Employers’ Accounting for Pensions, and SFAS No. 106, 

Employers’ Accounting for Postretirement Benefits Other Than Pensions, 

permit the use of smoothing mechanisms that delay the recognition of the 

effects of changes in actuarial assumptions and differences between actual 

results and actuarial assumptions. However, these standards contain a 

bright line as to when the delayed recognition amounts should be 

recognized. 

• Hedge Accounting 

SFAS No. 133, Accounting for Derivative Instruments and Hedging 

Activities, requires that derivative instruments be recognized at fair value, 

with changes in fair value recognized in income. However, in an effort to 

mitigate earnings volatility, SFAS No. 133 permits the use of hedge 

accounting when a derivative is highly effective in achieving offsetting 

changes in fair value or cash flows attributable to the risk being hedged. 

GAAP, however, does not define “highly effective.” Instead, practice has 

defined “highly effective” as an offset ratio of 80% to 125%. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-6 
• Classification 

Bright lines are also present in classification requirements. For example, 

SFAS No. 95, Statement of Cash Flows, clarifies the definition of “cash 

equivalents” by stating that “generally, only investments with original 

maturities of three months or less qualify under that definition” (paragraph 

8). Despite use of the word “generally,” this bright line is often 

interpreted stringently. 

In addition, SEC Regulation S-X includes bright lines for separate 

presentation of amounts that would otherwise be included in lines such as 

revenue, other current assets and liabilities, and other assets and liabilities. 

• Disclosure 

Bright lines also exist with respect to the determination of related parties 

for the purposes of disclosing related party transactions and the 

identification of segments for the purposes of determining which operating 

segments require separate presentation. 

Further, SEC Regulation S-X includes a number of bright lines regarding 

requirements to present stand-alone acquiree financial statements, standalone equity method investee financial statements, and pro forma financial 

information, among others. These bright-lines are based on the results of 

certain significance tests, or calculations, defined in Regulation S-X. 

These significance tests compare the acquiree or investee to the registrant 

in the areas of assets, investments, and income. 

B. Rules of Thumb 

• Consolidation Accounting 

The fall of Enron in late 2001 refocused attention on the effect of bright 

lines as they relate to consolidation accounting. Enron, and others, took 

advantage of bright lines related to the consolidation of special purpose 

entities (SPEs) to avoid reporting assets and liabilities, to defer reporting 

losses, and/or report gains. At the time, the consolidation of SPEs hinged 

on an analogy to guidance that required lessees to consolidate SPE lessors 

that lacked a substantive investment at risk from an unrelated party. 

“Substantive” was defined as 3%, at a minimum, with the caveat that a 

greater investment may be necessary in certain facts and circumstances. 

Despite this caveat, which would suggest the need for judgment, the 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-7 
presence of the 3% bright line gave rise to numerous structured 

transactions to achieve a specific accounting purpose. 

In December 2003, the FASB issued FIN 46R, Consolidation of Variable 

Interest Entities, which superseded the 3% rule. FIN 46R requires 

consolidation in certain circumstances by the party that holds the majority 

of the risks and rewards of an entity, rather than equity ownership and 

voting rights. This model has led some to assert that FIN 46R is a 

principles-based standard. However, even FIN 46R contains a rule of 

thumb – a presumption that if equity investment at risk is less than 10% of 

the entity’s total assets, the entity is a variable interest entity subject to the 

FIN 46R model, with similar caveats that require additional analysis, 

judgment and consideration. 

• Contingencies 

SFAS No. 5, Accounting for Contingencies, provides an example of rules 

of thumb in interpretations of GAAP. SFAS No. 5 establishes recognition 

and disclosure requirements based on the likelihood – remote, possible, 

probable – that a liability has been incurred. Although GAAP does not 

define these terms, audit firms have developed rules of thumb for these 

terms. 

C. Pass/fail tests 

• SFAS No. 48, Revenue Recognition When Right of Return Exists, requires 

that where a right of return exists, revenue be recognized at the time of 

sale only if certain criteria, such as the amount of future returns can be 

reasonably estimated. Otherwise, revenue recognition is deferred until the 

right expires or the criteria are subsequently met. 

• SFAS No. 133, Accounting for Derivative Instruments and Hedging 

Activities – if critical terms do not match or if documentation does not 

comply with the rules, then companies are not eligible to apply hedge 

accounting. 

• SFAS No. 140, Accounting for Transfers and Servicing of Financial 

Assets and Extinguishments of Liabilities contains requirements, all of 

which must be satisfied, to achieve sale accounting for a transfer of 

financial assets. Otherwise, the transfer is treated as a secured borrowing 

with a pledge of collateral. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-8 
• EITF 00-19, Accounting for Derivative Financial Instruments Indexed to, 

and Potentially Settled in, a Company’s Own Stock, identifies a number of 

criteria that must be met in order for an instrument to be classified as an 

equity instrument. Failure to meet any of these criteria results in 

classification as a liability, which is marked to market through income. 

The criteria do not provide for probability assessments or judgments based 

on the preponderance of evidence. 

• SoP 97-2, Software Revenue Recognition, related interpretations, and audit 

firm guidance contain the following pass/fail tests: 

o If vendor specific objective evidence (VSOE) does not exist for all of 

the undelivered elements of a software sales arrangement, the 

recognition of all revenue from the arrangement must be deferred until 

sufficient evidence exists, or until all elements have been delivered, 

unless certain exceptions are met. 

o Extended payment terms usually result in a deferral of revenue. 

Specifically, when extended payment terms are present, a presumption 

exists that the vendor’s fee is not fixed or determinable, due to the 

possibility that the vendor may provide a refund or concession to a 

customer. While there are factors to overcome this presumption, 

interpretive guidance sets the hurdle to overcome this presumption 

extremely high, generally resulting in the deferral of revenue until 

payment is due. 

This report has been prepared for discussion and deliberation by the full Committee at a January 11, 

2008 open meeting. Pending any further action on this report by the Committee, it does not necessarily 

reflect either the views of the Committee or other members of the Committee. It also does not necessarily 

reflect the views or regulatory agenda of the Commission or its staff. 

B-9