At the SEC roundtable on uncertainty in financial reporting, panelists focused on three things that iinvestors are looking for from audited financial statements: transparency, comparability and objectivity. There was a consensus that it is currently very difficult to compare one company’s financial statements to another company’s financial statements. The panelists also recognized that there is a great deal of estimates and uncertainty around the financial statements.
Uncertainty exists in financial statements where measurements to a large extent are based on estimates, judgments, and models rather than exact depictions As the level of uncertainty increases, challenges may exist for: financial statement preparers to estimate the future outcome of the uncertainties inherent in many business transactions, for auditors to verify the subjective judgments about those uncertainties, and for investors to understand those uncertainties and assess their potential impact on future earnings or cash flows.
PCAOB Chair James Doty said that comparability is not the Holy Grail in the minds of investors that it once was, but it is still important. Transparency and objectivity are more important, he noted, especially after the financial crisis.
With regard to transparency, Pinto Nuri, Investment Counsel, Flaherty & Crumrine Inc., said that consistency of application is more important than a completely transparent look through the financial statements. With regard to comparability, Anna Dopkin, Co-Director of U. S. Research, T. Rowe Price, said that at times the application of the principle is so broad it becomes meaningless. She also noted that there is not a lot of consistency from one company to another. Lack of comparability can become frustrating for investors. Ms. Dopkin also said that more guidance is needed on methodologies. Similarly, Adam Litge, Chief Risk Strategist, Bloomberg L.P. noted that more guidance is needed on the classification of assets, like Level I, Level II and Level 3 assets. SEC Chief Accountant James Kroeker noted that the IRS has issued guidance on tax uncertainties that is helpful for enhanced transparency and comparability.
With regard to fair value, Jennifer Paquette, Chief Investment Officer, Colorado PERA, said there needs to be more disclosure of input drivers and metrics that are used to determine the measurements. The disclosures should allow users of financial statements to assess the numbers. PERA would like to hear from the auditors on what models or measures are being used. Loretta Cangialosi, Senior Vice President and Controller, Pfizer Inc, said that intangibles are hard to measure, and fair value creates uncertainties in the financial statements. Pinto Suri, said that fair value should be moved into disclosure.
PCAOB Chair Doty said that the Board is interested in what investors want to know. The Board recognizes the distinction between a disclosure and an attestation. The PCAOB is interested in auditors understanding the valuation placed on intangibles. The Board also wants to know how much can be said in the audit report about the range of possible estimates and how the valuation of financial instruments was arrived at. More information may be needed on how management arrived at the valuations. He also noted that the Board has a task force on intangibles.
With regard to the role of the audit committee, Chairman Doty said that the PCAOB wants to enhance and foster better communications between the auditor and the audit committee. This is a very real issue and much on the Board’s mind. A lesson learned from the financial crisis is the difficulty of dealing with estimates. Another lesson was that investors believed that there should have been more robust discussions with audit committees. Chairman Doty also noted that there is a range of talent and activity levels on audit committees.
SEC Division of Corporation Finance Director Meredith Cross said that division staff use the rules at their disposal to enhance meaningful disclosure in financial reporting, adding that companies are generally cooperative in this regard. Director Cross believes that supplemental disclosure can solve many of the uncertainties around financial reporting.