Moving forward, echoes of 2007

Strategic Finance, Jan, 2008 by Paul A. Sharman

This January brings with it a time for changes in the world of finance and accounting--a time for renewal and to move forward. Again. Yes, I said something similar in a "Top Line" article last January. Since then, we have experienced some change, and many of the changes have been extremely encouraging.

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On SOX

Take the Sarbanes-Oxley Act of 2002 (SOX). In spring 2007, the Securities & Exchange Commission (SEC) recognized what we at the Institute of Management Accountants (IMA[R]) had been saying for more than a year--that American filers needed a different SOX 404 regime. In May, the Public Company Accounting Oversight Board (PCAOB) withdrew Auditing Standard No. 2 and replaced it with Auditing Standard No. 5. That same month, the SEC issued its "Guidance Regarding Management's Report on Internal Control over Financial Reporting."

In addition, IMA continued to call for further deferral of Section 404 applicability to smaller, nonaccelerated filers. Leading politicians also announced that SOX reform was a priority, and, since January 2007, a series of proposed reforms and rejections has been bouncing around.

In November, despite recent proposed reforms, a survey released by the U.S. Chamber of Commerce Center for Capital Markets Competitiveness, in cooperation with IMA and the American Stock Exchange, confirmed that SOX Section 404 burdens small businesses disproportionately. The survey, called Cost of SOX, also revealed that more than half the respondents believe that SOX 404 won't help detect and prevent fraud.

These results illustrate a dismal and discouraging reality for American businesses, and the anticipated benefits related to the reforms created by management guidance and AS5 have done little to change this outlook.

In order for the government to get the necessary and scalable SOX 404 reform right, IMA, the U.S. Chamber of Commerce, and several other professional organizations have called for a one-year delay in SOX 404 implementation for small businesses. In December 2007, SEC Chairman Chris Cox advised the House of Representatives Small Business Full Committee Hearing that he intended to propose to the SEC a one-year delay for the new reporting requirements for small businesses mandated under Section 404(b).

IMA supports Chairman Cox's proposal, but we believe that other issues remain:

* There are still no fundamental, systematic changes to create a practical implementation framework for small businesses. Management guidance is vague and not truly risk based for cost-effective implementation.

* Since there is no practical implementation framework, small businesses will have to rely on consultants and other third parties.

* The SEC's focus on lowering costs is reasonable, but there's no mention of improving restatement rates or the analysis that would predict, with some reliability, that there might be errors.

* This delay for small businesses actually creates a two-year time gap in which management (e.g., CEOs, CFOs, and audit committees) is solely responsible for opining on controls effectiveness, creating potential legal liability.

IMA also has reservations about the SEC Office of Economic Analysis Cost-Benefit Survey mentioned in Chairman Cox's proposal. At this stage of SOX 404(a) implementation, small business managers will lack sophistication and experience to adequately quantify compliance costs and benefits in their first year of implementation. IMA recommends that the SEC use best practices from the business community to quantify costs and benefits (e.g., process analysis, simulation modeling, etc.)

On Accounting Standards

Last summer the SEC created a new committee, known as the Advisory Committee on Improvements to Financial Reporting (CIFR). Led by Robert C. Pozen, it drew on senior members representing all aspects of the accountancy and investment community. The Committee created four subcommittees to address different aspects of the woes of finance and accounting conditions in the U.S.: (1) Substantive Complexity, (2) Standard Setting, (3) Audit Process and Compliance, and (4) Delivering Financial Information.

Of particular interest to IMA is the work of the Standard Setting Subcommittee because they invited IMA to brief them on our views on standards setting. We applaud the Subcommittee for its efforts to reconstitute our institutions to be more representative of the entire financial information supply chain. We urge it to propose increased preparer involvement early in the standards-setting process using the engineering profession's best practices. But we have doubts about the continued call for more user involvement. After all, they are way more concerned about future cash flows from effective and efficient business than they are about historical results. Field trials for proposed standards to ensure that practitioners are actually able to implement new standards in a practical and cost-effective way will be really helpful. We commented to the Subcommittee about the recommendation from IMA's Financial Reporting Committee to set up an "accounting court" in order to bring transparency to the SEC's otherwise closed review and decision-making process. Finally we support the Subcommittee's call for more principles- based standards and greater dependence on "professional judgment." This opens up the entire U.S. accounting mode of operating to a less heavy-handed, compliance-oriented approach.