And of course, the FASB goes out of its way to note that reducing the volume of the financial statements isn’t the primary focus of this project. In other words, financial statements could continue to present unnecessary information to financial statement users and continue to do more harm than good.
Fortunately for the FASB, I’m here to help. I have not (yet) sent comments to the FASB on its Disclosure Effectiveness project, nor has the FASB directly solicited my opinion on the subject. However, I think my overriding philosophy jives with what most financial statement users want: if the auditors are ok with the numbers, then companies should not be required to disclose additional information about those numbers in the footnotes unless said information could possibly have an impact on the users’ decisions about the company. Academics, lawyers at the SEC, and others who don’t live in the real world of financial statement preparation and analysis might disagree, but let me explain…
Some footnote disclosures make sense and are necessary in helping users make better decisions about a company. For example, the “Long-term Debt” line on the balance sheet, by itself, isn’t as useful to users as a schedule of debt balances and maturities in the footnote. Most serious financial statement users want to know about a company’s high interest rate debt or a large balloon payment due soon.
THAT disclosure makes sense.
What doesn’t make sense, what confuses financial statement users, and what gums up the financial statements, are stupid disclosures. The FASB has seemingly made it its mission to add as much information as possible to the financial statements (no matter the level of usefulness) in order to make sure that users have the opportunity to learn everything about the company. In the course of its rulemaking blitz over the past decade, the FASB has done more harm than good by forcing issuers to make some ridiculous disclosures. Off the top of my head, I can think of four stupid disclosures that the FASB should immediately make optional for all companies:
1) Pension fair value Levels. Most companies with defined benefit pension plans are either overfunded (have more plan assets than liabilities) or are underfunded. Overfunded plans are classified as assets on the balance sheet, while underfunded plans are liabilities. The theory goes that because over/under funded plans represents a large balance on the balance sheet, investors will be interested in the makeup of this balance. Plan assets are usually financial assets (equities, fixed income securities, hedge funds), and thus the FASB’s logic is that these assets should be subject to the same (useful?) rules that company-owned investments are required to disclosure. For example, companies are required to classify pension investments into Levels 1, 2, or 3. Also, Level 3 assets must have a rollforward.
The truth is that few, if any, users of financial statements touch the pension footnote, and if they do, they do not care what levels a company has classified its investments into. The FASB forces companies to waste untold investor resources in determining whether a pension plan’s mutual funds is Level 1 or 2, and for what? As long as the auditors have blessed the plan’s asset and liability balances, users likely don’t care what arbitrary fair value Level a company has classified its investments.
While we’re on the subject of dumb fair value disclosures…
2) Level 3 disclosures. Financial assets and liabilities with a “Level 3” fair value designation are generally those that are valued using unobservable inputs to extrapolate an estimated fair value. Because these values are internally derived, the risk is higher that the company is pulling these assets out of their, well…
As a result, the FASB wants to make sure that users know everything possible about these assets and liabilities, since they aren’t as “verifiable” as Level 1 or 2 instruments. Companies have to disclose a rollforward outlining why the balance changed, describing such pressing information like “transfers into Level 3.” Preparers also have to waste investor money and countless hours describing the inputs underlying the Level 3 investments, often in tabular form.
Investors care as much about Level 3 disclosures as they do about pension fair value disclosures. If the auditors have blessed the Level 3 balances, and there isn’t an outcry from the user community on the need to know more about Level 3 balances, then there is no need to disclose this information. No one – and I mean, no one – makes an investment decision based on Level 3 disclosures.
In fact, while we’re discussing ridiculous fair value standards, here’s one more…..
3) Fair value of debt. This one is more of a running joke in every SEC reporting department I’ve ever worked in, but I have yet to hear a good explanation for why companies should disclose the fair value of its debt liabilities. That goes for almost all assets and (especially) liabilities, and goes double for the ridiculous requirement to categorize these items into fair value levels. I can’t imagine financial statement users caring about what level the fair value of debt is in.
4) Most upcoming accounting standards. Laying out the impact that new accounting standards will have on the company is a good thing. What is NOT a good thing is describing accounting standards and then stating “this standard will have no impact on our financial position or results of operations.” For example, insurance companies aren’t all that impacted by ASU 2014-09 (the new revenue recognition standard), unless they sell administrative only products or provide other non-insurance related products. Even then, this new standard often has a minimal impact on an insurance company’s income statement. Yet, most insurance companies continue to discuss this standard. If it isn’t of use to financial statement users, then leave it out.
Do any of you use the above disclosures, or am I right that they could be done away with? Would love to hear from you on twitter @shafercpa.
