SEC Proposes New Rules On 'Critical' Accounting
The SEC first suggested the "critical" accounting proposal in a release  on cautionary advice issued in December 2001, but reviews of corporate disclosures indicate uneven compliance. Hence, the Commission is taking the next step of formally proposing a more detailed package of guidance. Its rule proposals introduce possible requirements for qualitative disclosures about both the "critical" accounting estimates made by the company in applying its accounting policies and disclosures about the initial adoption of an accounting policy by a company.
Although companies already provide footnote disclosures about significant accounting matters, investors have complained the footnotes are too voluminous and difficult to understand. The SEC's proposal would address this problem by highlighting the information and moving it into the portion of annual reports known as management's discussion and analysis (MD&A). This move is seen as a first step in the direction of layered financial reporting designed to provide helpful, plain-English, summary-level information, along with a clear path for drilling down deeper into the disclosure base.
Under the SEC's proposal, management would be required to alert shareholders to "critical" accounting decisions involving assumptions that are "highly uncertain" or apt to change over time, provided they would have a material effect on the firm's finances. They would also have to disclose instances in which they could have chosen an alternative accounting, yielding a different result.
Open questions include the extent to which auditors who specialize in a client's industry might be able to provide useful information to audit committees about prevailing industry practices without violating confidentiality agreements and whether or not (and if so how) audit committees should be required to report on their discussions with management and auditors about "critical" and alternative accounting policies.
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