Congress Hears Five Ways GAAP Falls Short

At a May 14, 2002 hearing of a House Financial Services subcommittee on the issue of "Corporate Accounting Practices: Is There a Credibility GAAP?," lawmakers were briefed on a number of topics, including five areas in which generally accepted accounting principles (GAAP) fall short. Testimony on the five areas was provided by Steven Wallman, a former Commissioner of the Securities and Exchange Commission (SEC) and a popular and highly-regarded thought leader within the accounting profession.

"More than half a dozen years ago," Mr. Wallman recalls, "it was apparent that GAAP was beginning to fail, and materially so in important ways." But it took the current scandals to show just how outdated GAAP has become. Recapping a series of messages he delivered while a Commissioner in the mid-1990s, Mr. Wallman outlined the five key shortfalls:

  1. What is measured. GAAP does not adequately measure internally-generated intangibles and other drivers of wealth.
  2. Who is measured. GAAP does not clearly define the boundaries of the reporting entity. Off-balance sheet activities, derivatives, partnerships and various contractual arrangements have blurred the boundaries of the firm.
  3. Timeliness of measurement. Quarterly reporting is too backward-looking. More forward-looking disclosures and reporting are needed, but much of that is viewed as anathema to accounting concepts.
  4. Access to information. GAAP is the language of business. But it has become so esoteric and specialized with different dialects for different industries and circumstances that it is beyond the comprehension of lay and even professional investors. Asking a lay person to read a financial statement would be like asking him to interpret a foreign language he had never heard before.
  5. How it is measured. Accounting requirements are often too rules-oriented. In setting the requirements, standard-setters are more concerned with being able to ensure that preparers complied with the rules than they are about whether the resulting financial statements really make sense.

As a result of these shortcomings, Mr. Wallman said, "We have seen such entities as Standard & Poor's and others create their own form of pro forma statements" to view a company's financial position differently from GAAP. Over time, Mr.Wallman expects that technology will cure some of the issues, as the entire exercise of "taking disaggregated information and aggregating it so others can spend their careers attempting to disaggregate it" will go away. In the meantime, he says, GAAP must be revamped to address the five issues.

-Rosemary Schlank

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