to reflect changes in the business environment by conducting periodic
assessments of existing standards.
    Some of our proposed process improvements call for formalizing or
improving existing processes, or implementing new processes to improve
standards-setting outputs. Our proposed Agenda Advisory Group would
help the FASB, the SEC, and other participants in the financial
reporting community focus efforts on the most meaningful activities and
centralize constituent input to improve the timeliness of standards-
setting.
    Agenda Advisory Group: The first step in standards-setting is
agenda-setting. The FASB receives many requests to act on various
topics from many constituents, including the SEC. The FASB also needs
to fulfill its obligations under the Memo of Understanding with the
IASB regarding international convergence. Requests for interpretations
or amendments divert attention from other critical agenda items. FASB
agenda decisions often add rather than delete projects. Further, given
the volume of activity on the FASB agenda, Board and staff
prioritization conclusions are not always clear to constituents. What
may result is that projects being addressed may not be responsive to
widely acknowledged needs, or projects may not have sufficiently-
defined scopes to address these needs in a timely fashion. The FASB has
a number of existing advisory groups and committees that it consults
about issues that may affect its agenda and project priorities;
however, we believe there needs to be increased accountability to the
FAF on agenda-setting and project priorities.
    An Agenda Advisory Group that includes strong representation from
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 agenda-setting. By identifying emerging issues and
building consensus about which group is best positioned to deal with
them (e.g., the FASB, the EITF, or the SEC) and in what form, the
Agenda Advisory Group would give immediate input about how best to
prioritize near-term versus long-term priorities. The main goals of
such a group would be to:
     Help standards-setting become more nimble.
     Assist the FASB is setting an achievable, strategic
agenda, rather than one that includes projects proposed for many years
with little progress.
     Recommend when it is appropriate for the SEC or other
parties to issue interpretive implementation guidance related to
emerging issues and issues observed by the SEC in its registrant
reviews.
     Help the FASB maintain the usefulness of its authoritative
guidance by recommending areas that need to be kept current.
     Shield the FASB from influence by any single group of
constituents, thereby protecting its independence.
     Inject accountability into agenda-setting for all involved
parties.
    Our proposal complements the FAF's proposed changes to the FASB's
agenda-setting process in which the FAF would give the FASB Chairman
control over the FASB's agenda. We believe instilling more decision-
making authority in the FASB Chairman, combined with a requirement to
consult with the proposed Agenda Advisory Group, would be a positive
step toward increasing the FASB's efficiency.
    In creating such an Agenda Advisory Group, the SEC and the FASB
should consider ways to implement the following objectives:
     Timeliness. The Agenda Advisory Group should be convened
both on a regular schedule and on short notice telephonically to deal
with urgent matters, as necessary.
     Accountability. The Agenda Advisory Group should vote on
certain aspects of the standards-setting agenda and provide that
information in an advisory capacity to the FASB Chairman, who would
then make the final agenda decision. Part of the rationale for calling
a vote would be to increase accountability of the FASB Chairman to the
FAF regarding agenda-setting effectiveness.
     Active involvement of key groups of investors. Key
investor groups should be actively involved in agenda-setting to
maintain an appropriate focus on investor needs.
     Involvement of the SEC. Due to the SEC's oversight
responsibility for standards-setting, one or more senior
representatives from the SEC Office of the Chief Accountant (OCA)
should be on the Agenda Advisory Group, as the SEC typically identifies
practice issues before the FASB does. In addition, active involvement
by the SEC will allow coordination of how and by whom guidance should
be issued, thereby reducing the impetus for the SEC to issue
interpretive implementation guidance separately from the codified
version of GAAP (see section VI of this chapter).
     Involvement of the FASB. All Board members should be
invited as official observers.
     Involvement of the PCAOB. A senior representative from the
PCAOB should be invited as an official observer, as actions taken by
the PCAOB significantly impact behavior of participants in the U.S.
financial reporting community.
     Involvement of others. Constituents otherwise not
represented should be able to submit agenda requests and track agenda
decisions, similar to the way in which the EITF functions.
    Formulating and Proposing New Standards: The FASB has an elaborate
process for formulating and proposing new standards. This process is
designed to ensure that proposed standards properly address significant
issues, are consistent with business practices and economics, and have
benefits that justify accounting changes. It involves staff preparation
of a draft proposal, publication of the proposal with an opportunity
for public comment, and approval of the final standard. Throughout the
process, the FASB consults with and receives input from a diverse group
of constituents. This process is time consuming, often taking many
years, and could be made more efficient. The Board's outreach to
certain constituents sometimes seeks advice only on detailed issues
rather than the scope of projects and broad matters. Our proposal would
increase the efficiency and effectiveness of standards-setting by
obtaining more focused inputs at an earlier stage through investor pre-
reviews, enhanced cost-benefit analyses, and more field visits and
field testing.
    Investor Pre-Reviews: Although the FASB regularly consults with a
number of standing investor advisory groups, we believe that there may
be opportunities to both increase and more effectively manage investor
involvement, so that interested parties know when and how to engage the
FASB and its staff to assist in standards-setting. Specifically, the
FASB should implement a scalable investor pre-review to assess
perceived investor benefits prior to exposing new standards for public
comment. The FASB should consider the following attributes when
designing such a pre-review:

     Seek detailed comments from a diverse panel of investors
(e.g., buy-side analysts, sell-side analysts, and rating agencies), all
of whom should have strong interests in the outcome.
     Ask investors to consider the accounting guidance through
the eyes of a serious retail investor to determine whether the new
information provided would be decision-useful (whether it will provide
better information than what is currently available). This should
entail an evaluation of the costs and benefits of updating data
analysis models with the new or improved information, as necessary.
     Revisit or even discontinue standards-setting projects
based on the feedback received.
    Cost-Benefit Analyses: The FASB evaluates whether the benefits of a
proposed standard justify its costs prior to exposing it for public
comment. However, participants in standards-setting have long
acknowledged that reliable, quantitative cost-benefit calculations are
seldom feasible, 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 actual implementation of the standard. As a result,
cost-benefit considerations are often based on anecdotal evidence and
do not always include useful input from preparers, auditors, investors,
and regulators. Cost-benefit analyses should be a more rigorous,
essential part of standards-setting and should be given more weight
than they are today.
    The FASB is currently considering new initiatives to improve its
cost-benefit analyses. We support these efforts and, to complement
them, the FASB should consider the following enhancements to its cost-
benefit procedures:
     Select preparers, auditors, investors, and regulators to
be involved based on their interest in the standard or interpretive
implementation guidance being developed. Such participants should be
involved in the process of assessing costs and benefits, as well as
performing field visits and field testing, to the extent feasible.
     Expose the entire cost-benefit 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 these conclusions.
     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 these concerns in the
analysis rather than omitting the data. The FASB should request a cost
estimate and underlying methodology from constituents who claim that
costs are excessive.
     Use information collected in the investor pre-review to
supplement the assessment of the benefits.
     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.
     Add auxiliary information to put the accounting standard
or interpretive implementation guidance in context (e.g., include an
expectation of the number of companies to be impacted by the standard,
their overall market capitalization, or other metrics).
     Improve the documentation of the cost-benefit conclusions
in new standards so that they may be referred to over time.
     Consider hiring an economist to assist in preparing and
reviewing cost-benefit analyses.
    Field Visits and Field Testing: Throughout the deliberation
process, the FASB meets with a number of interested constituents
regarding proposed standards (referred to as ``field visits''). Once
the proposed standard is exposed for public comment, the FASB at its
discretion may conduct field tests, in which the implementation of a
proposed standard is beta tested so that issues may be identified and
resolved prior to final issuance of the new standard. However, as a
practical matter, and because of resource constraints, robust field
testing has not been part of the process for setting many recent
standards. As a result, new standards are often met with requests for
interpretive implementation guidance, implementation deferral, or
amendment.
    Whenever possible, scalable field visits and field tests should be
a required part of standards-setting for all significant new standards
to identify and resolve as many conceptual and implementation issues as
practicable prior to issuance. These procedures may also identify less
costly alternative accounting treatments. The rigor required for these
procedures should be scaled based on the difficulty and length of time
required to implement and the magnitude of the impact of the standard
or interpretive implementation guidance. In addition, whenever
possible, field visits and field testing should occur
contemporaneously, to improve the focus and efficiency of receiving
constituent input. Although robust field testing and field visits
require resources and time, combining these efforts will make efficient
use of the Board's and its staff's time. Moreover, by researching
implementation questions prior to issuing a new standard, the FASB
would reduce the amount of time spent considering possible interpretive
implementation guidance, implementation deferral, or amendment.
    The FASB also should leverage work already being done by preparers,
auditors, and investors to assess the costs, benefits, operationality,
and auditability of proposed standards. Requesting assistance from
preparers, auditors, and 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 and field
test.
    Post-Adoption Reviews of New Standards: We acknowledge that it is
difficult to identify and address all possible implementation issues in
a new standard prior to it being issued and adopted. Issues and
questions are often identified during the initial implementation phase
as preparers and auditors begin to apply a new standard in practice.
Preparers, auditors, and others often monitor and take measures to
reduce diversity in practice when implementing new standards by
conferring amongst themselves and issuing non-authoritative
interpretive implementation guidance. During this initial period,
requests are often made of the FASB and the SEC to provide interpretive
implementation guidance for new standards.
    In the current financial reporting environment, preparers and
auditors are sometimes viewed as being penalized for implementing their
understanding of new accounting standards immediately after adoption.
This is because any ambiguity or substantial gaps identified in the
implementation period may lead the regulators to issue interpretive
implementation guidance that differs from conclusions originally
reached by the preparers and auditors.
    The FASB should improve existing processes to consistently ensure
timely consideration of implementation issues for new accounting
standards. The goal of post-adoption reviews of new standards would be
to determine if the new standard is accomplishing its intended purpose
or whether it has unintended consequences that need to be resolved. The
FASB currently does address questions that arise after new

standards are issued--it regularly receives input from various
constituents and periodically revisits some standards. However, the
process of completing post-adoption reviews should be formalized in
policy, be more systematic, involve input from a broader range of
constituents, and be monitored using relevant performance metrics.
    Specifically, the FASB should perform a post-adoption review for
every significant new standard. The review should be completed no more
than one to two years after the effective date of the standard, with
completion sooner if the scale of the new standard is narrow or a large
number of implementation questions arise. At the end of the review
period, the FASB should reach a formal conclusion on each new standard
to determine if interpretive implementation guidance would serve the
needs of investors by reducing diversity in practice or otherwise
improving the application of the standard (e.g., by resolving
ambiguities in the wording or filling-in unintended gaps in the
standard).
    We believe that, when necessary, interpretive implementation
guidance for new standards is best given by the FASB using:
     A transparent due process with public comment.
     Appropriate transition guidance and required disclosures
that will provide investors with useful information regarding possible
changes in accounting.
     The codified version of GAAP.
    Understandably, some interpretive implementation guidance may be of
such an urgent nature that a transparent due process would not be
responsive to the needs of market participants. Therefore, we envision
that the SEC or other parties, through representation on the Agenda
Advisory Group, could assist by agreeing to issue interpretive
implementation guidance in such situations (see section VI of this
chapter).
    Under our proposal, it is not contemplated that preparers would
have the flexibility to implement new standards at different times nor
have the ability to adopt early or late. Following the recent policy
decision by the FASB precluding early adoption of new standards, our
proposal contemplates transition guidance for a new standard with a
stated, required implementation date. Similarly, this proposal is not a
safe harbor. Violations of GAAP will continue to be dealt with by the
SEC through the review, comment, restatement, and enforcement
processes. However, the SEC should give appropriate consideration to
situations in which there were ambiguities or gaps in the new standards
that could be subject to more than one reasonable interpretation. For
example, it may be inappropriate for the SEC to bring an SEC
enforcement proceeding based on a new accounting standard if, after
careful analysis and due diligence made in good faith, the registrant
took a reasonable and supportable view of that standard, which was
subsequently changed by formal amendment or published interpretation.
    Periodic Assessment of Existing Standards: After a new accounting
standard has been in place for a reasonable period, more data is likely
to be available to evaluate its benefits and costs. Further, over time
economic conditions and business practices may change, such that older
accounting standards may lose their relevance and effectiveness. Some
participants in the financial reporting community have commented that
numerous accounting standards or models need immediate reevaluation. In
today's economic environment, the accounting for securitizations and
structured products with off-balance sheet risk are cited as needing
reevaluation.\44\ The accounting for financial guarantees, convertible
debt, and derivatives and hedging activities are also frequently cited
areas for improvement.
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    \44\ SEC Staff, Report and Recommendations Pursuant to Section
401(c) of the Sarbanes-Oxley Act of 2002 On Arrangements with Off-
Balance Sheet Implications, Special Purpose Entities, and
Transparency of Filings by Issuers (June 2005).
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    The process by which the FASB receives, evaluates, and addresses
concerns about the usefulness of standards in a timely fashion is
critical to the proper functioning of the U.S. capital markets. The
FASB should improve and formalize this process to ensure that standards
continue to be useful in the current economic and business environment.
This should be done by formalizing the process of periodically
requesting feedback from investors, preparers, auditors, and regulators
regarding what areas of GAAP need reevaluation because they create
practice problems or are unnecessarily complex. In addition, to
identify other specific areas of GAAP in need of review, the FASB
should consider the following:
     Restatement activity.
     Emerging issues and the amount of interpretive
implementation guidance issued on particular standards.
     Changes in business practices and the economy.
     New cost-benefit information as it becomes available.
    Further, when evaluating the feedback received from constituents
and the results of its own research, the FASB should seek advice from
the Agenda Advisory Group to help prioritize its agenda.

V. Interpretive Implementation Guidance

    We believe that there are too many sources of interpretive
implementation guidance. Historically, this guidance proliferated from
a variety of sources, which intentionally or not, has been viewed as
additional GAAP. In other words, interpretive implementation guidance
that is not formally authoritative often is erroneously perceived by
participants in the financial reporting and legal communities to be
quasi-authoritative. The key risks associated with a proliferation of
interpretive implementation guidance are that: (1) The appropriate rule
may not be identified and considered, and (2) it may conflict with
authoritative guidance, as well as with other non-authoritative
guidance, causing uncertainty in application and legal risk.
    Over the past few years, the FASB and the SEC have taken steps
intended to reduce the proliferation of interpretive implementation
guidance from different authoritative bodies. For example, the SEC
recognized the standards of the FASB as generally-accepted, and the
FASB limited the ability of other bodies to create authoritative
guidance without FASB ratification. Nevertheless, the SEC staff
continues to be a source of interpretive implementation guidance in its
own right, through such vehicles as comment letters, staff speeches,
SABs, and other forms of exchange that, although typically non-
authoritative, are perceived as quasi-authoritative. Similarly, actions
taken by the FASB and the SEC have not sufficiently curbed the creation
of other non-authoritative interpretive implementation guidance, such
as that from audit firms, preparer and industry groups, academia, the
Center for Audit Quality (CAQ), and other regulators.
    Our proposal below, which should be read in conjunction with
conceptual approach 2.A, is designed to recognize recent
accomplishments in this area, clarify what guidance is authoritative
and non-authoritative, and further influence the behaviors that have
led to the desire for more guidance:
    Developed Proposal 2.4: The number of parties that either formally
or informally interprets GAAP and the volume of interpretative
implementation guidance should

continue to be reduced. The SEC should coordinate with the FASB to
clarify roles and responsibilities regarding the issuance of
interpretive implementation guidance, as follows:
     The FASB Codification, a draft of which was released for
verification on January 16, 2008, should be completed in a timely
manner. In order to fully realize the benefits of the FASB's
codification efforts, the SEC should ensure that the literature it
deems to be authoritative is integrated into the FASB Codification to
the extent possible, or separately re-codified, as necessary.
     To the extent practical, going forward, there should be a
single standards-setter for all authoritative accounting standards and
interpretive implementation guidance that are applicable to a
particular set of accounting standards, such as GAAP or IFRS. For GAAP,
the FASB should continue to serve this function. To that end, the SEC
should only issue broadly applicable interpretive implementation
guidance in limited situations (see section VI).
     All other sources of interpretive implementation guidance
should be considered non-authoritative and should not be required to be
given more credence than any other non-authoritative sources that are
evaluated using well-reasoned, documented professional judgments made
in good faith.
    FASB 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 GAAP. To that end, on January 16,
2008, the FASB released a draft of the FASB Codification that will be
subject to a one-year verification period. We applaud the FASB's
foresight on such a project and recognize the significant effort the
project has entailed. The FASB Codification:
     Brings together all GAAP from all authoritative sources
except the SEC and classifies it by topic into a single, searchable
database so that it may be more easily researched.
     Clarifies what guidance is authoritative versus non-
authoritative.
     Puts accounting standards into a consistent format, to the
extent possible.
    Although the FASB Codification does not change the substance of
GAAP, it should make its application easier. However, SEC literature,
which has developed through different mechanisms, is not as easily
integrated into the FASB Codification.\45\ Similarly, the FASB
Codification does not deal with either the root causes of the
proliferation of interpretive implementation guidance or the behavior
of participants in the U.S. financial reporting community that caused
the complexity. Notwithstanding these concerns, we support the FASB's
efforts to verify the Codification. To further improve the
Codification, the SEC should re-codify its guidance using a consistent
format, and the FASB and the SEC should consider a second phase of the
codification project that would systematically revisit GAAP, as
discussed in section VI of this chapter.
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    \45\ Two of the benefits of the FASB Codification are its search
feature and decimal system, which consistently organizes topics and
subtopics within GAAP. No SEC guidance is currently included in the
FASB Codification. To improve its usability in the future, the
Codification will include authoritative content issued by the SEC,
as well as selected SEC staff interpretations. However, the
inclusion of SEC guidance will be for administrative convenience and
will not supersede such guidance in its current form. Further, the
SEC guidance will not follow the same organizational structure as
the rest of GAAP.
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    Non-Authoritative Guidance: Although the FASB Codification will
help clarify the roles of authoritative and non-authoritative guidance,
meaningful improvements in financial reporting will be difficult if
non-authoritative interpretive implementation guidance continues to be
perceived, as it is today, as having quasi-authority in the
marketplace. Our proposal is intended to foster acceptance of
reasonable professional judgments made in good faith when they are
supportable under GAAP. Specifically, non-authoritative interpretive
implementation guidance should not be used to force restatements when
other reasonable views exist that are supportable under GAAP.
    We recognize there is often a need for interpretive implementation
guidance and that such guidance can serve an important purpose. The
volume of interpretative implementation guidance should be reduced, and
it should be clearly identified as non-authoritative.

VI. Conceptual Approaches and Future Considerations

    As discussed more fully below, we are considering a number of
conceptual approaches and matters for future consideration to improve
standards-setting:
    Conceptual Approach 2.A: To further reduce interpretive
implementation guidance associated with GAAP, we are considering
proposing that the SEC further clarify its role vis-[agrave]-vis the
FASB, as well as its internal roles and responsibilities, to mitigate
the risk of its actions unintentionally driving behavior by market
participants, as follows:
     The SEC should clarify that registrant-specific matters
are not authoritative forms of interpretive implementation guidance
under GAAP and, accordingly, registrants other than the specific
registrant in question are not required to take into account such
registrant-specific matters.
     The SEC staff should refrain from informally communicating
broadly applicable interpretive implementation guidance (e.g., staff
speeches) that are likely to be perceived as changing the application
of GAAP. Rather, such communications should be used to highlight
authoritative interpretive implementation guidance that has already
been issued.
     In instances in which the SEC staff identifies registrant-
specific accounting matters that it believes may result in the need for
broader interpretive implementation guidance or a clarification of an
accounting standard under GAAP, the SEC staff should refer these items
to the FASB as part of the Agenda Advisory Group.
     When it is necessary for the SEC or its staff to issue
broadly applicable interpretive implementation guidance, it should try
to provide such guidance: (1) In a clear communication identified as
authoritative, (2) so that it can easily and immediately be integrated
into a codification of SEC literature (as proposed in section V of this
chapter), and (3) when expected to significantly change the application
of GAAP, only after transparent due process and public comment to the
extent practicable.
     The SEC staff should revisit internal procedures and take
further steps necessary to improve the consistency of its views on the
application of GAAP.
    The SEC sometimes issues rules and interpretations that comprise
part of authoritative GAAP. The SEC's rule-making 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
transparent due process and public comment. As discussed below,
registrant-specific guidance is published in the form of comment
letters, but appropriately does not need to be proposed in advance or
subject to public comment. On the other hand, to the extent the SEC
promulgates interpretive implementation guidance that is broadly
applicable and is expected to significantly change the application of
GAAP, we are considering whether it should do so only after public
notice and comment, whenever practicable.

    Registrant-Specific Guidance: 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 these comment letters on the SEC's Web site
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 on specific interpretative
implementation issues. These letters are commonly referred to in the
marketplace as ``pre-clearance'' letters.
    Preparers and auditors may misconstrue registrant-specific
accounting outcomes as quasi-authoritative. However, registrant-
specific matters are appropriately not subject to the same public
deliberation and comment as SEC rule-making, because they are
registrant-specific and are not intended to be applied more broadly.
Nevertheless, preparers and auditors may overreact by applying these
outcomes to similar, yet different, transactions, sometimes believing
that restatement is required.
    We are deliberating whether the SEC should make clear that comments
provided to a specific registrant are not binding on other registrants.
Clarifying that such comments are non-authoritative would help:
     Prevent preparers and auditors from giving undue
significance to SEC staff comments made to individual registrants.
     Reduce the need for other parties to issue interpretive
implementation guidance.
     Support our proposal to refer broadly applicable
accounting matters that require interpretive implementation guidance to
the FASB.
    Broadly Applicable Guidance: To inform the public about broadly
applicable interpretive implementation guidance, the SEC uses various
forms of communication, including SABs,\46\ letters to industry, staff
speeches, public announcements, and training manuals. In addition, Corp
Fin publishes and maintains interpretive implementation guidance on the
SEC's Web site. While all of these publications contain disclaimers as
to their non-authoritative nature, many participants in the financial
reporting community consider these disclaimers to be boilerplate and
regard such interpretive implementation guidance as quasi-
authoritative.
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    \46\ The SEC authorized the use of SABs in 1975 to achieve a
wider dissemination of the administrative interpretations and
practices utilized by the SEC 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 generally not exposed for public comment before release.
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    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 and continue to influence market behavior
because they sometimes include SEC staff views that do, in fact,
supplement existing GAAP. The SEC staff sometimes refers registrants to
these publications to support their views on registrant-specific
matters. As such, many argue that these documents exemplify the SEC
staff effectively setting standards without transparent due process and
public comment and point to restatements sometimes following the
release of these documents as evidence of their quasi-authoritative
nature in practice.
    In addition, other individual sources of non-authoritative
implementation guidance (e.g., audit firms and the CAQ) often publish
their own guidance to broadly communicate what they perceive to be SEC
staff's views and to drive consistency in practice. However, as
discussed below, if the SEC were to increase its formal referral of
broadly applicable interpretive matters to the FASB, which could issue
guidance in an authoritative, timely fashion, the overall volume of
interpretive implementation guidance would be reduced, as would
conflicts between interpretations from different sources. We believe
this would further influence behaviors that have led to the desire for
more guidance.
    We recognize that the SEC staff publishes guidance to address
issues other than the application of GAAP. This conceptual approach is
not directed towards such publications. We also recognize that the SEC
staff, based on its review of thousands of filings each year, is in a
unique position to publish its comment letters. Such publications are
intended to reduce comments that each registrant receives in the review
process by promoting a high degree of compliance with GAAP. We continue
to consider what proposals to make in this area, but believe that the
SEC staff should be diligent when preparing this information not to
present comments in a manner that is likely to be perceived as
interpretative implementation guidance.
    Referral of Issues to the FASB: As discussed in section IV of this
chapter, there were a number of standards that were communicated to the
FASB that were in need of improvement that have yet to be improved. The
SEC should formalize the mechanism by which it refers issues to the
FASB, and one of the goals of SEC representation on the proposed Agenda
Advisory Group would be to strengthen such a referral mechanism. This
will permit the FASB to address the need for authoritative interpretive
implementation guidance that is broadly applicable in a codified form,
thereby reducing the need for the SEC to do so. It will also give the
SEC greater insight into when the FASB and the EITF do not intend to
issue interpretive implementation guidance, which will allow the SEC to
be more responsive by issuing guidance, in the limited circumstances
when necessary.
    Consistency: We are considering whether there is a need for more
coordination between the various offices and divisions within the SEC
to improve the consistency of accounting advice given by the SEC staff.
Although there are processes in place to build consensus on accounting
matters within the SEC, there may be room for improvement.
    The possibility of inconsistent accounting advice emanating from
the SEC staff creates confusion in the marketplace.
    Two processes exist (one in Corp Fin and one in OCA) for
registrants to request reconsideration of conclusions expressed in
either comment letters or in pre-clearance letters when registrants
disagree with staff guidance or believe they are receiving inconsistent
advice compared to other registrants. However, registrants may not
always use these processes for a number of reasons, such as: (1) To
avoid additional delays and missed market opportunities, (2) to avoid
the risk of opening other accounting conclusions to reconsideration,
and (3) fear of possible retribution (misguided or not). Therefore,
although the SEC staff has created checks-and-balances in the form of
reconsideration processes, they may not be utilized as anticipated.
    We do not intend to limit the ability of the SEC staff to carry out
its regulatory responsibilities in a timely fashion. That is why we
have not yet proposed a specific course of action. We understand the
SEC staff is reviewing its procedures in many of these areas and
expects to unveil a number of changes in the coming months, including
new procedures to enhance the consistency

of registrant-specific accounting interpretations during filing reviews
and increasing the understanding and usefulness of its reconsideration
processes. We support these efforts and plan to review progress with
the SEC staff in the coming months as we continue our deliberations.
    Conceptual Approach 2.B: We are considering proposing that the SEC
continue to encourage improvement in the way standards are written, as
follows:
     By supporting the writing of accounting standards
according to an agreed-upon framework of what constitutes an optimal
standard. Such standards should not strive to answer every question and
close every loophole, but should be written with more clearly stated
objectives and principles that may be applied to broad categories of
transactions.
     By supporting the writing of accounting standards in a
manner that promotes trust and confidence in efficient markets by
encouraging the use of professional judgments made in good faith.
Specifically, preparers and auditors should apply the standards
faithfully, and regulators should monitor and address abusive
application of the standards.
    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, because they are sometimes obscured by detailed rules,
examples, scope exceptions, safe harbors, cliffs, thresholds, and
bright lines. In addition, GAAP is often not written in plain English.
This can create uncertainty in the application of GAAP, as rules cannot
cover all possibilities and the underlying principles and objectives
may not be clear.
    Another significant concern about the current system of accounting
standards is that the proliferation of accounting rules fosters
accounting-motivated structured transactions. As discussed further in
chapter 1, standards that have scope exceptions, safe harbors, cliffs,
thresholds, and bright lines are vulnerable to manipulation by those
seeking to avoid accounting for the substance of transactions using
structured transactions that are designed to achieve a particular
accounting result. This ultimately hurts investors, because it reduces
comparability and the usefulness of the resulting financial
information. Therefore, a move toward more objectives-oriented (or
principles-based) standards may ultimately improve the quality of the
financial reporting upon which investors rely.
    The question of how to design standards going forward is at the
center of a decade-long principles-based versus rules-based accounting
standards debate. There has been much discussion in the marketplace on
this topic, and there are differing views. The SEC has been a frequent
participant in the debate and has long been supportive of principles-
based (or objectives-oriented) standards.\47\ The question of how
standards should be designed going forward is a critical aspect of the
standards-setting process.
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    \47\ For example, the SEC issued Policy Statement: Reaffirming
the Status of the FASB as a Designated Private-Sector Standard
Setter (April 2003), which included numerous recommendations for the
FAF and FASB to consider, including greater use of principles-based
accounting standards whenever reasonable to do so. The SEC staff
also issued Study Pursuant to Section 108(d) of the Sarbanes-Oxley
Act of 2002 on the Adoption by the United States Financial Reporting
System of a Principles-Based Accounting System (July 2003), which
further lauded the benefits of objectives-oriented standards.
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    Rather than engaging in a debate over terms such as ``principles-
based,'' ``objectives-oriented,'' or ``rules-based,'' we prefer to
think of the design of accounting standards in terms of the
characteristics they should possess. We are considering various
suggestions for the optimal design of standards, including the work of
the CEOs of the World's Six Largest Audit Networks. These CEOs are
attempting to build consensus in the financial reporting community
about what optimal accounting standards should look like in the future
and whether a framework could be created that the standards-setters may
refer to over time to ensure that these characteristics are optimized.
    Their proposed framework was presented at the Global Public Policy
Symposium in January 2008, which recommends that optimal accounting
standards have the following characteristics:
     Faithful presentation of economic reality.
     Responsive to investors' needs for clarity and
transparency.
     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.
     Allows for the use of reasonable judgment.\48\
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    \48\ In his testimony before the U.S. Senate Subcommittee on
Securities, Insurance and Investment (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 whether they: (1) Can be explained simply in a matter of a
minute or so, and (2) make intuitive sense.
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    As we continue to deliberate this and other work, we are
considering supporting the increased use of objectives-oriented
standards.
    Future Considerations: We also plan to deliberate what optimal
transition provisions should be in the future and whether new standards
should be applied prospectively or retrospectively. The goal of such
deliberations will be to balance the investor need for consistent
information with preparer and auditor concerns about feasibility and
the costs of recasting historical information.
    Conceptual Approach 2.C: In addition to considering the other
proposals in this report (and subject to the conclusions reached in our
future deliberations of international considerations), we are
considering proposing that the SEC encourage a re-prioritization of the
standards-setting agenda that balances the need for international
convergence, improvements to the conceptual framework, and maintaining
existing GAAP. Further, we are deliberating whether the FASB and the
SEC should add to their agendas a second phase of the codification
project to consider systematically revisiting GAAP to:
     Be more coherent after codification.
     Remove conflicts between standards or with the conceptual
framework.
     Be less complex, where possible.
     Be designed more optimally as discussed above.
     Readdress frequent practice problems (as identified by
restatement volumes, input from the SEC, implementation guidance
issued, or frequently asked questions).
     Remove redundancies between SEC disclosure requirements
and other sources of GAAP.
     Amend, replace, or remove outdated standards.
    As part of our deliberation of the Agenda Advisory Group proposed
in section IV of this chapter, we are also deliberating a conceptual
approach regarding immediate standards-setting priorities in the
current environment. We plan to finalize a proposal after completing
deliberations on international considerations later in 2008, which may
significantly affect our approach. 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 such a list of
priorities.
    Second Phase of Codification: As noted above, the Codification does
not

change the substance of GAAP, which continues to be encumbered by
detailed rules, bright lines, scope exceptions, industry guidance,
accounting alternatives, and other forms of complexity. Because of the
evolutionary nature of U.S. standards-setting, the Codification does
not read consistently in all parts. Further, even after any needed re-
codification of SEC literature proposed in section V of this chapter,
there will be opportunities to remove redundancies between SEC and FASB
disclosure requirements and make other simplifications. Therefore, we
are deliberating whether and when the FASB and the SEC should perform a
second phase of the codification project, which would involve a
comprehensive periodic assessment of existing accounting standards like
the one we proposed previously in this chapter.

Chapter 3: Audit Process and Compliance

I. Introduction

    We have concentrated our efforts to date regarding audit process
and compliance on the subjects of financial restatements, including the
potential benefits from providing guidance with respect to the
materiality \49\ and correction of errors; and professional judgment:
Specifically, whether a judgment framework would enhance the quality of
judgments and the willingness of others to respect judgments made.
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    \49\ 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).
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II. Financial Restatements

II.A. Background

Likely Causes of Restatements
    The number of financial restatements \50\ in the U.S. financial
markets has been increasing significantly over recent years, reaching
approximately 1,600 companies in 2006.\51\ 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.
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    \50\ For the purposes of this chapter, a restatement is the
process of revising previously issued financial statements to
reflect the correction of a material error in those financial
statements. An amendment is the process of filing a document with
revised financial statements with the SEC 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 SEC.
    \51\ U.S. Government Accountability Office (GAO) study,
Financial Restatements: Update of Public Company Trends, Market
Impacts, and Regulatory Enforcement Updates (March 2007), and Audit
Analytics study, 2006 Financial Restatements A Six Year Comparison
(February 2007).
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    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 materiality and discussions regarding
materiality in SAB 99, Materiality (as codified in SAB Topic 1M)--that
is, 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.\52\ We believe that public companies should focus on
reducing errors in financial statements. At the same time, we believe
that some of our developed proposals in the areas of substantive
complexity, as discussed in chapter 1, and the standards-setting
process, as discussed in chapter 2, will also be helpful in reducing
some of the frequency of errors in financial statements.
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    \52\ A Glass Lewis & Co. report, Brief Alert Weekly Trend
(December 17, 2007), shows that restatements in companies subject to
section 404 of the Sarbanes Oxley Act have declined for two
consecutive years, although the total number of restatements has
been increasing.
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    While reducing errors is the primary goal, it is also important to
reduce the number of unnecessary restatements (i.e., those that do not
provide important information to current investors). Unnecessary
restatements can be costly for companies and auditors, may reduce
confidence in reporting, and may create confusion that reduces the
efficiency of investor analysis. This portion of this chapter describes
our proposals regarding: (1) Additional guidance on the concept and
application regarding materiality, and (2) the process for and
disclosure of the correction of errors.
Our Research
    We have considered several publicly-available studies on
restatements.\53\ We are also aware that the Treasury Department 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. We will review the
Treasury Department's study and consider its findings as they are made
available.
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    \53\ Studies considered include the 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). We have also considered findings from the PCAOB's
Office of Research and Analysis's (ORA) working paper, Changes in
Market Responses to Financial Statement Restatement Announcements in
the Sarbanes-Oxley Era (October 18, 2007), understanding that ORA's
findings are still preliminary in nature as the study is still going
through a peer review process.
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    The restatement studies we have reviewed all indicate that the
total number of restatements has increased in recent years. Market
reaction to restatements may be one indicator as to whether
restatements contain information considered by investors to be
material. While there are limitations \54\ to using market reaction as
a proxy for materiality, based on these studies, it would appear to us
that there may be restatements occurring that investors may not
consider important due to a lack of a statistically significant market
reaction. We, therefore, believe 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.
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    \54\ 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.
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    We have also considered input from equity and credit analysts and
others about investors' views on materiality and how restatements are
viewed in the

marketplace. Feedback we have received 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.
     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 in connection with restatements is
not consistently adequate to allow an investor 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 our work to date, we believe 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? and (2)
How should a material error in previously issued financial statements
be corrected? We believe that framing the principles necessary to
evaluate these questions would be helpful. We also believe that in many
circumstances investors could benefit from improvements in the nature
and timeliness of disclosure in the period between identifying an error
and filing restated financial statements.
    With this context, we have developed the following proposals
regarding the assessment of the materiality of errors to financial
statements and the correction of financial statements for errors.\55\
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    \55\ We have developed principles that we believe will be
helpful in reducing unnecessary restatements. In developing these
principles, we have not determined if the principles are
inconsistent with existing GAAP, such as SFAS No. 154, Accounting
Changes and Error Corrections, or APB Opinion No. 28, Interim
Financial Reporting. To the extent that the implementation of our
proposals would require a change to GAAP, the SEC should work with
the FASB to revise GAAP.
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    Developed Proposal 3.1: The FASB or the SEC, as appropriate, should
issue guidance 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 affects
the total mix of information available to a reasonable investor.
     Just as qualitative factors may lead to a conclusion that
a quantitatively small error is material, qualitative factors also may
lead to a conclusion that a quantitatively large error is not material.
The evaluation of errors should be on a ``sliding scale.''
    The FASB or the SEC, as appropriate, should also conduct both
education sessions internally and outreach efforts to financial
statement preparers and auditors to raise awareness of these issues and
to promote more consistent application of the concept of materiality.
    We believe 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. We believe 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 (without a change in net
income) 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.
    We believe 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 small error
material, but a quantitatively large error is material without regard
to qualitative factors. We believe that qualitative factors not only
can increase, but also can decrease, the importance of an error to the
reasonable investor. Specifically, we believe 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
considered a ``checklist'' whereby the presence of any one of these
items would make an error not material. Companies and their auditors
should continue to 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 toward reducing unnecessary restatements.
    Developed Proposal 3.2: The FASB or the SEC, as appropriate, 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.
     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 would need
to be disclosed in an appropriate document, and, to the extent that the
error remains uncorrected in the current period, 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. All material errors should be
disclosed when they are corrected.
     The current disclosure during the period in which the
restatement is being prepared, about the need for a restatement and
about the restatement itself, is not consistently adequate for the
needs of investors and should be enhanced.
    The current guidance that is detailed in SAB 108 (as codified in
SAB Topic 1N) may result in the correction of prior annual periods for
immaterial errors occurring 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. In the process of reflecting these immaterial
corrections to prior annual periods, some believe that the prior annual
period financial statements should indicate that they have been
restated. There is diversity in practice on this issue, and
clarification is needed from the SEC on the intent of SAB Topic 1N. We
believe that prior annual period financial statements should not be
restated or corrected for errors that are immaterial to the prior
annual period. Instead of the approach specified in Topic 1N, we
believe 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 period \56\ with appropriate disclosure at the time the current
annual period financial statements are filed with the SEC.
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    \56\ We are 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 (which might potentially require an
amendment to GAAP). We believe that there are merits in both
approaches and that the FASB and the SEC, as appropriate, should
carefully weigh both approaches before determining the actual
approach to utilize.
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    We believe 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 SEC 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.
    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 with appropriate disclosure of the error and its impact
on prior periods, instead of amending previous filings with the SEC.
This option should be further studied with regard to the possibility of
abuse and, if appropriate, should be included in the overall guidance
on how to correct errors.
    Assuming that there is an error in an interim period within an
annual period for which financial statements have previously been filed
with the SEC, 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 be material
only 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 Form 10-K should not be amended).
However, there should be appropriate disclosure in the company's next
Form 10-K to explain the discrepancy in the results for the interim
periods during the previous annual period on an aggregate basis and the
reported results for that annual period.
    We believe that all errors, excluding clearly insignificant errors,
should be corrected no later than in the financial statements of the
annual or interim period in which the error is discovered. That being
said, 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.\57\ Nevertheless, all material
errors should be disclosed during the period in which they are
corrected.
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    \57\ We understand 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.
---------------------------------------------------------------------------

    Typically, the restatement process involves three primary reporting
stages:
    1. The initial notification to the SEC and investors that there is
a material error and that the financial statements previously filed
with the SEC can no longer be relied upon;
    2. The ``dark period'' or the period between the initial
notification to the SEC and the time restated financial statements are
filed with the SEC; and
    3. The filing of restated financial statements with the SEC.
    We believe that a major effect on investors due 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
decreases in the company's stock price. In addition, delays in filing
restated financial statements may create default conditions in loan
covenants; these delays may adversely affect the company's liquidity.
We understand that, in the current legal environment, companies are
often unwilling to provide disclosure of uncertain information.
However, we believe that when companies are going through the
restatement process, they should be encouraged to continue to provide
any reasonably reliable financial information that they can,
accompanied by appropriate explanations of ways in which the
information could be affected by the restatement. 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.
    We believe that the current disclosure surrounding a restatement is
often not adequate to allow investors to evaluate the company's
operations and the likelihood that such errors could occur in the
future. Specifically, we believe 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.
     Material items in each of the financial statements subject
to the error 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, and
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, and other consequences of
the restatement.
    If there are material developments related to the restatement,
companies should update this disclosure on a periodic basis during the
restatement process, particularly when quarterly or annual reports are
required to be filed, and provide full and complete disclosure within
the filing with the SEC that includes the restated financial
statements.
    We believe that the issuance by the FASB or the SEC, as
appropriate, of guidance on how to correct and disclose errors in
previously issued financial statements will provide to investors higher
quality information (e.g., prior periods would not be restated for
immaterial items and for errors that have no relevance to current
investors, and more consistently good disclosure would be made during
and about the restatement process) and reduce the burdens on companies
related to unnecessary restatements. In addition, since our proposals
would require that all material errors be disclosed, relevant
information about such errors would be communicated to investors.
    Developed Proposal 3.3: The FASB or the SEC, as appropriate, 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 3.2.
    Based on prior 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.\58\ 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, and also
impacts investors, who can be confused by the inconsistency between how
companies evaluate and report errors. We believe that guidance as to
how to evaluate errors related to interim periods would be beneficial
to preparers, auditors and investors.
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    \58\ Paragraph 29 of APB Opinion No. 28, Interim Financial
Reporting, states the following:
    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.
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    We have 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, we
believe 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)
How should errors in previously issued interim financial statements be
corrected? We believe that additional guidance on these questions,
which are extensions of the basic principles outlined in developed
proposals 3.1 and 3.2 above, would provide useful guidance in assessing
and correcting interim period errors. We believe that while these
principles would assist in developing guidance related to interim
periods, additional work should also be performed to fully develop
robust guidance regarding errors identified in interim periods.
    We believe 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.
    We believe 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.
    We also note 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.

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 have 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. Investors will benefit from
more emphasis on ``principles-based'' standards, since ``rules-based''
standards (as discussed in chapters 1 and 2) may provide a method, such
as through exceptions and bright-line tests, to avoid the accounting
objectives underlying the standards. If properly implemented,
``principles-based'' standards should improve the information provided
to investors while reducing the investor's concern about ``financial
engineering'' by companies using the ``rules'' to avoid accounting for
the substance of a transaction. 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 in
which 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 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. Investors' lack of confidence 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. Preparers' and auditors' concern 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 ``principles-based'' 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 judgment are as follows:
1. Selection of Accounting Standard
    In many cases, the selection of the appropriate accounting standard
under GAAP is not a highly complex judgment (e.g., leases would be
accounted for using lease accounting standards and pensions would be
accounted for using pension accounting standards). However, there are
cases in which 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 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 on which experienced accounting professionals can have
legitimate differing, yet acceptable, opinions.
2. Implementation of an Accounting Standard
    After the correct accounting standard is identified, there are
judgments to be made during its implementation.
    Examples of implementation judgments include determining if a hedge
is effective, if a lease is an operating or a capital lease, and what
inputs and methodology should be utilized in a fair value calculation.
Implementation judgments can be assisted by implementation guidance
issued by standards-setters, regulators, and 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.
    Further, 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.
    For example, opinions on the appropriate standard to account for
loan losses or to measure impairments of assets typically do not
differ. However, the assumptions and methodology used by management to
actually determine the allowance for loan losses or to 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 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, and 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
disbursements made after the period-end. This evidence allows the
auditor to determine whether the accrual for unpaid expenses at year-
end is adequate.
    However, the use of hindsight to evaluate a 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,\59\ 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 on the facts reasonably
available at the time the annual or interim financial statements were
issued.
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    \59\ We believe that those making a judgment should be expected
to exercise due care in gathering all of the relevant facts prior to
making the judgment.
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Form of Framework
    Some have proposed 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 than a statement of policy. However, it is
unclear to us whether a legal or regulatory safe harbor (i.e., an
effective legal or regulatory defense based on conformity with the
framework) could be adopted by the SEC or whether it would require
changes to existing statutes.
    Another approach is for the SEC and the PCAOB to issue policy
statements that describe a framework for the exercise of professional
judgment and state that auditors, the SEC 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 SEC has
utilized similar frameworks in the past with success. Examples of
previous frameworks by the SEC include the ``Seaboard'' report (October
23, 2001) on the relationship of cooperation by a company to taking
action in an enforcement case and the SEC'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 framework is likely to enhance the quality of
judgments by providing incentives to follow a rigorous process for
making accounting and auditing judgments. The increased use of this
rigorous process should, in turn, provide more comfort to investors
about the quality of accounting judgments made in connection with
financial statements.
    It is unclear to us whether, as a matter of regulatory strategy,
this judgment framework should be implemented through a safe harbor or
policy statement. We leave to the SEC and its staff the resolution of
these difficult issues.
The Nature and Limitations of GAAP
    Some have suggested that the standard in a potential professional
judgment framework for the selection and implementation of GAAP be a
requirement to reflect the economic substance of a transaction or be a
standard of selecting the ``high road'' in accounting for a
transaction. We agree that qualitative standards for GAAP such as these
would be desirable and we encourage regulators and standards-setters to
move financial reporting in this direction. However, such standards are
not always present in financial reporting today and we cannot 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, and a less preferable alternative is
fully acceptable absent such a change.
    We believe that adopting a requirement that accounting judgments
reflect economic substance or the ``high road'' would require a
revolutionary change not achievable in the foreseeable future. Our
suggested judgment framework could and, we believe, would enhance
adherence to GAAP, but it cannot be expected to correct inherent
weaknesses in the standards to which it would be applied.

III.B. Developed Proposals

    We have developed the following proposal:
    Developed Proposal 3.4: The SEC should adopt a judgment framework
for accounting judgments. The PCAOB should also adopt a similar
framework with respect to auditing judgments. Careful consideration
should be given in implementing any 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 applicable to accounting-related judgments
would include the choice and application of accounting principles, as
well as the estimates and evaluation of evidence related to the
application of an accounting principle. We believe that a framework
that is consistent with the principles outlined in this developed
proposal to cover judgments made by auditors based on the application
of PCAOB auditing standards would be very important and would be
beneficial to investors, preparers, and auditors. Therefore, we propose
that the PCAOB develop a professional judgment framework for the
application and evaluations of judgments made based on PCAOB auditing
standards.
    We propose that the framework for accounting judgments be
consistent with the following concepts:
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 form 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 \60\ and regulators will accept the judgment. Conversely, not
following the framework would not imply that the judgment is
unreasonable.
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    \60\ It should be noted that, while auditors should be using the
framework to evaluate a client's judgments and should respect
reasonable judgments, they still have a requirement to follow PCAOB
auditing standards, which would include expressing an opinion
regarding whether the client's financial statements are fairly
presented, in all material respects, in accordance with GAAP.
Therefore, this framework would not require auditors to issue an
unqualified audit opinion when they disagree with a judgment.
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    This framework reflects the fact that GAAP does 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. In
addition, 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,\61\ and level of effort in making a professional judgment
would vary based on the complexity, nature (routine versus non-routine)
and materiality of a transaction or issue requiring judgment.
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    \61\ In many cases, input from professional experts would
include consultation with a preparer's independent auditors.
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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:
    1. An analysis of the transaction, including the substance and
business purpose of the transaction.
    2. The material facts reasonably available at the time that the
financial statements are issued.
    3. A thorough review and analysis of relevant literature, including
the relevant underlying principles.
    4. Alternative views or estimates, including pros and cons for
reasonable alternatives.
    5. The rationale for the choice selected, including reasons for the
alternative or estimate selected and linkage of the rationale to
investors' information needs and the judgments of competent external
parties.
    6. Linkage of the alternative or estimate selected to the substance
and business purpose of the transaction or issue being evaluated.
    7. Known diversity in practice regarding the alternatives or
estimates.\62\
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    \62\ If there is not diversity in practice, it would be
significantly harder to select a different alternative.
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    8. The consistency of application of alternatives or estimates to
similar transactions.
    9. 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 transparent
so that the investor understands the transaction and assumptions that
were critical to 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 complicate an explanation of the nature and
propriety of a judgment made at the time of the release of the
financial statements.

IV. Future Considerations

    We intend to examine the area of regulation and compliance for
issues that create avoidable complexity in financial reporting. Some of
the areas that we intend to focus on include: (1) The interaction
between companies and their auditors, the SEC, and the PCAOB, (2) the
interaction between audit firms and the SEC and PCAOB, and (3) the
levels of enforcement and regulation of standards in other developed
markets around the world.

Chapter 4: Delivering Financial Information

I. Introduction

    We have 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, we have recognized
that the information needs of different types of investors are not
always the same. We have agreed that information must be delivered in a
manner that is efficient, reliable, and cost-effective for each of the
relevant investor groups and will not significantly increase burdens on
reporting companies.
    We have determined that we will focus our 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.\63\ We believe that we can make some useful
proposals to enhance ongoing reporting that will enable investors to
better understand reporting companies.
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    \63\ We have determined that we will not 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, we view
information delivery relating to ongoing company reporting by public
companies as the area needing greater focus.
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    Based on the above, we have analyzed two ways to improve the
delivery of financial information to investors and the market. These
are:
     Tagging of financial information (XBRL).
     Improving corporate website use.
    We also intend 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 (KPIs) and other
metrics to enhance business reporting.
     Improved quarterly press release disclosures and timing.
     Continued need for improvements in the management
discussion and analysis (MD&A) and other public company financial
disclosures.

II. Tagging of Financial Information (XBRL)

II.A. Background

Description of XBRL
    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 enables companies to better control how their financial or non-
financial information is presented and disseminated and reduce
reporting costs by integrating their operating data with their
financial reporting disclosure. XBRL is a computer language which uses
standardized XML (eXtensible Markup Language) technology and permits
the automation of what are now largely manual steps for access,
validation, analysis, and reporting of disclosure. For example, an
investor or analyst who wants to compare the sales of all
pharmaceutical companies will be able to use software applications to
take the XBRL-tagged information, extract the sales numbers and
download them directly to a spreadsheet.
    XBRL uses standardized definitions of terms, like a dictionary. The
standardized terms are then arranged in a logical structure called 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.
Status of XBRL-Tagged Financial Statements in SEC Reports
    The SEC has adopted a voluntary pilot program for the use of XBRL
in which participants submit voluntarily supplemental tagged financial
information using the XBRL format as exhibits to specified EDGAR
filings.\64\ 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 expanded the voluntary filing program to include
mutual funds which will file using a risk and return taxonomy developed
by the Investment Company Institute.
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    \64\ 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.''
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    On December 5, 2007, XBRL-US published a draft XBRL U.S. GAAP
Taxonomy and draft preparer's guide for public testing and comment. The
XBRL 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 anticipates that the final XBRL
U.S. GAAP Taxonomy and preparer guidance will be issued in spring 2008.
After the final XBRL U.S. GAAP Taxonomy and preparer guidance is
issued, the SEC EDGAR system must be modified to accept submissions
tagged using the XBRL U.S. GAAP Taxonomy.
    The SEC has stated that it will use the initial financial
statements prepared using the new XBRL U.S. GAAP Taxonomy to help it
further update its EDGAR system so that it will be able to ``seamlessly
accept and render the filings.'' We understand that currently, the
SEC's EDGAR system does not yet accept and render financial statements
with XBRL tags based on the newly-developed XBRL U.S. GAAP Taxonomy.
    In addition, we understand 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 as part of an integrated approach to
financial reporting. In an integrated approach, companies incorporate
XBRL into their internal company financial systems which allows
financial reports to be created from the XBRL-tagged financial systems,
without first preparing such financial statements 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 ``bolt-on'' approach.\65\ 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 of
their financial statements.
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    \65\ 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.
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Time and Costs Involved in XBRL-Tagging
    We understand that while the XBRL 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 GAAP. We understand 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. We
understand that there may be the need for customized ``extensions'' if
the XBRL U.S. GAAP Taxonomy does not include a tag for the particular
item in the company's financial statements. Because the XBRL U.S. GAAP
Taxonomy currently out for public comment tracks GAAP, we believe that
there likely will be less need for customized extension elements. One
of the purposes of the comment period on the XBRL U.S. GAAP Taxonomy
and preparer guidance is to identify additional tags or elements that
should be added to the XBRL U.S. GAAP Taxonomy, reducing the need for
customized extensions. The draft preparer guidance out for public
comment also will be evaluated by preparers, investors, and others to
determine whether it provides adequate guidance for determining when an
extension should be used by preparers.
    The type of information that is tagged also is relevant to
understanding XBRL-tagged financial statements. Companies participating
in the voluntary program 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.
    Certain 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 using existing standard taxonomies (not the
new XBRL U.S. GAAP Taxonomy) and 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).\66\ 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.
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    \66\ For example, one S&P 500 company participating in the
voluntary pilot spent 80 hours learning the tagging tool,
understanding SEC requirements, creating extensions for tags, and
creating a process for ongoing tagging and future submissions.
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Smaller Public Company Reactions to XBRL-Tagging
    Smaller public company representatives recognize the benefits that
XBRL offers their companies over the long-term, but are concerned about
initial implementation costs, which could be alleviated with the
development of improved tagging and verification software. The
representatives strongly support a phase-in approach in which such
smaller public companies would be included at the end, once 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
    We see a number of potential benefits of XBRL for reporting
companies and investors of financial and non-financial information.
First, XBRL-tagging could benefit reporting companies by permitting
improved communications with analysts and investors. Released corporate
data could be instantaneously and immediately usable by analysts in
their models without the need for them to wait for third party
aggregators or staff to input the data into their own format. There
would be a reduction in search costs. Further, such reduced search
costs could potentially increase coverage of companies, especially mid-
size and smaller companies, by sell-side and buy-side analysts, and at
both major brokerage and independent research firms. XBRL-tagging also
would likely improve the quality of data \67\ and the ability of a
company to control the presentation of its financial information. The
elimination or reduction of the manual input would likely reduce error
rates in reporting and inputting of corporate data by aggregators.
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    \67\ 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.
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    Second, XBRL has the potential to improve the integration of
company operating and reporting data. Using XBRL, operating data can be
accessed in the internal enterprise applications where it is regularly
stored, and thus will be used for financial reporting purposes without
the necessity of downloading to paper or manual search. The same
electronically accessible data can be used for other purposes beyond
those of financial statements, including tax, industrial filings,
audit, benchmarking, performance reporting, internal management, and
sustainability. We believe that the full economic benefits of XBRL will
most likely come when companies incorporate XBRL into their internal
reporting, instead of using it as a ``bolt-on'' after their financial
reports are prepared.
    Finally, XBRL-tagged financial statements can provide a number of
benefits to investors, including both retail investors and the ``model
builder/research analyst.'' Investors can benefit from, among other
things, a reduced cost of locating and inputting data into analytical
frameworks, elimination of manual input thereby reducing the likelihood
of input error by an investor or data aggregator, reduced investor
dependence on proprietary and inconsistent data sources, increased
likelihood of more investors utilizing primary data sources, and
reduced cost of and improved company comparisons. The XBRL-tagged
financial statements should enable investors and experienced analysts
at research organizations to spend more time analyzing data than data
gathering.
    We recognize, however, that notwithstanding the potential benefits,
many company officers may not understand how XBRL works or what
improvements it could bring to both their financial reporting and their
costs of reporting. In addition, there currently is limited acceptance
of XBRL due, in part, to companies needing greater certainty that XBRL
will be adopted before they will expend the necessary resources to
understand it and its benefits. Companies may have other concerns 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 generally are unaware or uninformed
about XBRL.

Implementation of XBRL-Tagging of Financial Statements
    We believe that the SEC should, over the long-term, require all
public reporting companies (preparing their financial statements using
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. We believe that an implementation roadmap from the SEC is
needed to encourage the involved parties to move beyond a wait-and-see
approach and commit resources toward the necessary development of
software. That software would tag financial information and enable the
viewing and reading of the XBRL-tagged information, the use of XBRL-
tagged data by investors such as analysts and investors, and the
integration of XBRL by companies. We believe that full implementation
of mandated XBRL-tagged financial statements will require a phase-in
over a period of time, as discussed below, to enable preparers and
investors to understand XBRL by preparers and investors, to permit
successful use of the new XBRL U.S. GAAP Taxonomy, and to enable the
further development of tagging and rendering software. We believe that
such a phase-in should be sensitive to the concerns of smaller public
companies regarding mandated XBRL-tagged financial statements.
    We believe 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.
    Full mandatory implementation may not be possible until all the
following preconditions are met:
     Taxonomy development.
    [cir] Testing of the XBRL U.S. GAAP Taxonomy is completed. The
testing process for the new XBRL U.S. GAAP Taxonomy, which is to
determine whether disclosures are complete and relevant in the current
market environment, is now underway.
    [cir] The final XBRL U.S. GAAP Taxonomy and preparer guide are
released following public review and comment.
    [cir] Voluntary filers have successfully used the XBRL U.S. GAAP
Taxonomy and preparer guide for a period of time.

--Status: On December 5, 2007, XBRL published the draft of XBRL U.S.
GAAP Taxonomy and draft preparer guide for public testing and comment.
The XBRL 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 XBRL U.S. GAAP
Taxonomy and preparer guide will be issued in spring 2008.

     Ability of SEC EDGAR to ``seamlessly'' accept XBRL
submissions using the new XBRL U.S. GAAP Taxonomy and other XBRL-tagged
data and provide an accurate rendered version of all such tagged
information.
    [cir] Status: The SEC has stated that it will use the initial
financial statements prepared using the new XBRL 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 XBRL
U.S. GAAP Taxonomy.
    We believe that, to achieve the desired acceptance of XBRL, after
the XBRL U.S. GAAP Taxonomy precondition is satisfied, on an interim
basis XBRL-tagged financial statements should be required to be
implemented on a phase-in basis as follows:
     The largest 500 domestic public reporting companies based
on unaffiliated market capitalization (public float) should be required
to furnish to the SEC, as is the case in the voluntary program today, a
document prepared separately from the reporting companies' financial
statements that are filed as part of their periodic Exchange Act
reports. This document would contain the following:
    [cir] XBRL-tagged face of the financial statements.\68\
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    \68\ To allow this first phase, the SEC EDGAR system must permit
submissions using the new XBRL U.S. GAAP Taxonomy.
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    [cir] Block-tagged footnotes to the financial statements.\69\
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    \69\ We understand 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.
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     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.
    We believe that a phase-in would provide businesses, financial
planners, software developers, and investors with the impetus to move
forward in building systems based on XBRL. For example, in connection
with the mandatory implementation of XBRL, we are aware that, if
tagging were mandated for companies, they 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, we
believe 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. We believe 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 XBRL U.S. GAAP Taxonomy, 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 the final uniform Taxonomy and preparer guidance to tag their
financial statements.
    As mentioned above, under the phase-in approach, the XBRL-tagged
financial statements would still be considered furnished to and not
filed with the SEC. As part of the mandatory implementation, we believe
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.
    Finally, at the end of the phase-in period described above, and as
promptly as practicable after all 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 the SEC to the official filing of XBRL-tagged
financial statements with the SEC by domestic large accelerated filers,
as well as whether and when to include all other reporting companies,
as part of a company's Exchange Act periodic reports.

II.B. Developed Proposals

    We would like to make recommendations that increase the certainty
that XBRL will be a significant part of the reporting landscape so that
preparers, investors, auditors, software developers and regulators make
the needed investment in XBRL.
    Based on the above considerations, we have developed the following
proposal:

    Developed Proposal 4.1: The SEC should, over the long-term, mandate
the filing of XBRL-tagged financial statements after the satisfaction
of certain preconditions relating to: (1) Successful XBRL U.S. GAAP
Taxonomy testing, (2) capacity of reporting companies to file XBRL-
tagged financial statements using the new XBRL U.S. GAAP Taxonomy on
the SEC's EDGAR system, and (3) the ability of the EDGAR system to
provide an accurately 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 furnish to the SEC, as is the case in the voluntary program today, a
document prepared separately from the reporting companies' financial
statements that are filed as part of their periodic Exchange Act
reports. This document would contain the following:
    [cir] XBRL-tagged face of the financial statements.\70\
---------------------------------------------------------------------------

    \70\ To allow this first phase, the SEC EDGAR system must permit
submissions using the new XBRL U.S. GAAP Taxonomy.
---------------------------------------------------------------------------

    [cir] Block-tagged footnotes to the financial statements.\71\
---------------------------------------------------------------------------

    \71\ We understand 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.
---------------------------------------------------------------------------

     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.
     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 SEC to the
official filing of XBRL-tagged financial statements with the SEC 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.\72\
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    \72\ A dissenting vote on developed proposal 4.1 was cast by
Peter Wallison.
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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. We understand that among the primary benefits of
providing independent assurance of XBRL documents is that financial
statement investors 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 investors.
    As to assurance, we understand that questions arise as to whether
assurance should be provided as to matters such as:
    1. The appropriate use of the proper XBRL U.S. GAAP Taxonomy and
accurate tagging of financial statements.
    2. The reasonableness of any company extensions to the XBRL U.S.
GAAP Taxonomy.