(The article featured below is a selection from PCAOB Reporter, which is available to subscribers of that publication.)

SEC Institute Hosts Discussion on PCAOB Developments and SEC Accounting Topics

George Botic, an associate director of PCAOB inspections, provided updates of recent PCAOB activity regarding inspections, standards setting activity, new rules and other areas at the SEC Institute's Midyear Reporting Conference. Botic reviewed the PCAOB inspections process and described several milestones the Board has recently achieved. He outlined the different categories of firms subject to the PCAOB's inspections: large firms, domestic small firms and international small firms, and noted that the approximately 1,000 registered domestic small firms were quite varied in terms of firm size. The PCAOB has performed over 700 inspections of small firms since its inception, only 10% of which had more than 26 issuer audit clients. In addition, the Board has successfully conducted inspections of more than 75 firms in 18 countries with the cooperation of home country audit oversight bodies in four countries, he said.

Botic reiterated that published inspection reports contain both public and nonpublic portions. While the public portions of inspection reports are posted on the PCAOB's Web site, the nonpublic portions address quality control issues and may discuss criticisms of the firm's quality control systems, he said. Botic noted that even the publicly available inspection report omits certain facts about an issuer, including its name and unique identifying characteristics.

Botic outlined the inspection process in more detail. He advised that a firm has 10 days to return a comment form after receiving notice from the Board. He emphasized that although at times the inspection staff will discuss matters with the chair of the audit committee, in general the PCAOB does not interact directly with the issuer. After a draft report is sent to the firm, the firm has 30 days to respond and to go through the review process. At the conclusion of the review process, the Board approves and issues the inspection report, which is then published on the PCAOB Web site. Botic also drew attention to the remedial process in the wake of an inspection report. A firm has 12 months to correct quality control deficiencies. If the Board accepts the firm's remedial efforts, it marks the end of the process. If the Board is not satisfied, the report will be made public on the PCAOB Web site, Botic said. Firms may then be required to perform follow-up procedures, and possible violations of the securities laws will be referred to other authorities.

Botic also provided an update on recent PCAOB standard-setting activities. He described new Auditing Standard No. 6, which aligns auditing standards with FAS 154 and gives specific directions for auditors reporting on restatements. He also talked about the recent amendment to rule 3523. The amendment excludes from the scope of the rule tax services provided during the portion of the audit period that precedes the beginning of the professional engagement period. The original rule provided that a registered public accounting firm is not independent of its audit client if it or any of its affiliates provides any tax service to a person in a financial reporting oversight role or an immediate family member of such a person during the audit and professional engagement period. The amendment excludes from the scope of the rule tax services provided prior to the professional engagement period. New rule 3526 requires that accounting firms communicate any possible independence issues to the audit committee.

Botic discussed a proposed amendment to mandate an engagement quality review. Currently, only the AICPA requires such a review, but the proposed rule, if adopted, would require all registered firms to conduct engagement quality reviews and to document the findings. When asked if such a review would impact fees, Botic said that any change would be more incremental than complete. In his view, the changes "are not all that significant in terms of fee assessment."

Botic also addressed a recent PCAOB practice alert on auditing fair value and the use of a specialist. Although he emphasized that the practice alert is not an auditing standard and is only intended to highlight certain items of concern, he directed preparers to use it as a guide when evaluating fair value and specialist standards.

SEC Accounting Topics

Robert Malhotra, a Professional Accounting Fellow in the SEC's Office of the Chief Accountant ("OCA") and Russell Hodge, a former OCA Professional Accounting Fellow who is now the global controller at General Electric, discussed hot SEC accounting topics. The discussion focused on the OCA's involvement with International Financial Reporting Standards ("IFRS") and the interim recommendations of the SEC's Advisory Committee on Improvements to Financial Reporting.

On the topic of IFRS, Malhotra said that the recent elimination of the GAAP reconciliation requirement for foreign private issuers using IFRS represented a "good first step" on the path towards a global reporting standard. Hodge believes that OCA is right to focus on the "inevitable convergence" and offered his perspective from the private sector on IFRS. He said that for multinational companies, it can be expensive to have dual reporting obligations, and since many of GE's competitors use IFRS, GE faces a competitive challenge without it. He emphasized his opposition to a "U.S. version of IFRS" and said that in the time leading up to convergence, he is trying to reduce his own bias in favor of U.S. GAAP. The learning curve will also be shorter for multinationals who have already been exposed to IFRS, he noted.

Malhotra also spoke about U.S. GAAP bias at the SEC. He said that the staff struggles with its partiality towards U.S. GAAP because it is the regime that staff members have been using for a long time and it is one with which they are comfortable. He noted that IFRS is still not widely taught in American universities and is not on the CPA exam. He maintained, however, that where one set of standards provides additional latitude, the staff will respect it. He also said that most current projects at the SEC are either being done jointly or with the help of officials trained in IFRS or with convergence in mind. The SEC staff has been encouraged to reach out to the International Accounting Standards Board staff for assistance on technical issues, he said.

Malhotra and Hodge also discussed recommendations by the subcommittees of the Commission's Advisory Committee on Improvements to Financial Reporting, focusing on the issues of complexity, materiality and the use of professional judgment. On the issue of complexity, Hodge said that he found the discussions interesting, but wondered if addressing the issue at this point amounted to "rearranging the deck chairs on the Titanic" because of the looming convergence to IFRS. Malhotra expressed his desire to get rid of some of the negativity associated with complexity. In his view, complexity is not necessarily a bad thing and in some cases should actually be termed "precision" instead. He also noted that complexity of accounting is often the result of the complexity of the transaction at hand.

Hodge said that he tries to view the complexity issue from the standpoint of a mid-size firm that does not have the resources to apply 25,000 pages of accounting literature to its business, and believes that this kind of complexity should be reduced. He encouraged the full committee to follow up on the complexity subcommittee's recommendation to eliminate some of the industry-specific guidance. For example, providing financing should receive similar accounting treatment whether the issuer is a bank or in some other industry, he said.

The work of the Audit Process and Compliance Subcommittee was another area of discussion. This subcommittee has been primarily concerned with the definition of materiality and a proposed framework for the use of professional judgment. Regarding materiality, Malhotra cautioned that it is important to keep in mind from whose perspective a particular item or event is material. Because a lot of money is spent in the process, issuers and regulators must make sure it is going toward something that investors actually care about, he said. In his opinion, the recent increase in restatements was due to the general business environment and the fact that accounting has become more conservative in the wake of the Sarbanes-Oxley Act, and not necessarily the adoption of Staff Accounting Bulletin 108, which addresses the process of quantifying financial statement misstatements.

The panel also addressed the subcommittee's proposed professional judgment framework. Malhotra said that a framework sounds like a good idea, but implementation would be easier said than done. Hodge echoed this sentiment, noting that there is a healthy level of concern among accounting professionals about being second-guessed, and wondered if the proposed framework would actually result in more work if it required following a prescribed series of steps. He also voiced support for the subcommittee's decision to decline to adopt a specific safe harbor provision for the exercise of professional judgment.

Corporation Finance Chief Accountant

In the keynote speech at the conference, SEC Division of Corporation Finance Chief Accountant Wayne Carnall addressed recent topics and issues in which his office has been involved. Outlining the broad goals of his office, he emphasized that his staff aims to be pragmatic and encourages communication. He said that the chief accountant's office takes a proactive approach in order to resolve problems before they become bigger issues. His staff is open to different perspectives and often reaches out to others in the profession, including accounting firms and investor groups, according to Carnall.

Carnall attempted to clarify misconceptions about a sample letter the SEC sent to public companies on MD&A disclosure regarding fair value measurements under FAS 157. Although the intent of the letter had been to offer suggestions on MD&A disclosure, Carnall said that some of the initial reaction had been erroneous. He detailed different reactions in the press and on financial blogs the weekend following the letter's release. He said that some people remarked that the SEC was amending the FASB standard on its own, even though the SEC does not have unilateral authority to change GAAP. Other erroneous assertions he observed included that the SEC was suspending FAS 157, and even that fair value accounting had been eliminated. Carnall emphasized that all of these interpretations of the SEC's letter were wrong and that the letter only suggested MD&A disclosure, nothing more.

Carnall also discussed global accounting standards and the efforts of the SEC in the area of International Financial Reporting Standards ("IFRS"). He noted that the 2005 IFRS roadmap had envisioned the elimination of the GAAP reconciliation requirement for foreign private issuers by 2009, and that this goal had been met in December 2007. He also drew attention to last year's concept release, which marked the beginning of the transition to allowing U.S. companies to use IFRS instead of GAAP. Carnall noted that the SEC has held several roundtable discussions in preparation for the "fundamental change" of convergence to a global reporting standard. There are several practical issues that must be ironed out, he said, such as the fact that LIFO cost accounting, used in U.S. GAAP, is banned under IFRS, and that the S&P requires adherence to U.S. GAAP.

Despite these difficulties, Carnall said that most people agree that the trend towards a single high-quality, global standard is inevitable, and that the standard will be IFRS and not U.S. GAAP. Although everyone agrees that convergence is coming, there is no agreement on how to define convergence, he said. Some people see convergence as eliminating any and all differences in accounting standards, while others think that agreement on broad concepts is enough. He also added that advocates for IFRS need to justify its adoption by purely domestic companies that have no international business activity.

Carnall warned against being too cautious on the road to convergence. He said that if the U.S. wants to remain a force in the global economy, the adoption of a global standard is essential. If the U.S. waits a decade, "the train will have already left the station," he said. U.S. participation is crucial in order to have a role in establishing IFRS. He acknowledged that the U.S. does not face the same pressures and benefits that other countries have in adopting IFRS. For example, convergence in Europe was necessary to avoid 25 different national GAAPs, and developing countries found that it is easier to enter global markets by using IFRS. Carnall urged the U.S. to lead on the issue of convergence. Otherwise it risks getting left behind economically. SEC Chairman Christopher Cox anticipates a revised roadmap for IFRS later this year, he said.

Carnall also noted that politics may play a role in the use of IFRS as opposed to the U.S. version of GAAP. The status of the U.S. has suffered due to the Iraq war, which has caused animosity towards the U.S., he said. He also observed that some foreign officials have pointed to financial scandals such as Enron and WorldCom as examples of deficiencies in the U.S. system, although he noted that this attitude required ignoring other countries' own financial scandals.

Carnall sought to dispel myths about the use of IFRS. He took issue with an often-repeated characterization of IFRS as "principles-based" and U.S. GAAP as "rules-based." He said that both regimes had elements of principles and rules. He also disagreed with the assertion that IFRS was easier to apply than GAAP. Although he acknowledged that U.S. GAAP has more rules, he said that sometimes it is easier to follow rules rather than attempt to figure out what is allowed under a principles-based analysis. He strongly cautioned against the idea that the SEC staff would not review IFRS-based accounting decisions. Although the SEC will not impose GAAP on companies using IFRS, those companies will be treated exactly the same during reviews as those using U.S. GAAP, he said.

Corporation Finance Developments

Kevin Vaughn, a branch chief in the Division of Corporation Finance, discussed recent developments at the SEC. The SEC has been busy over the last six months, he said. The Commission has adopted new rules involving smaller reporting companies, private offering reform, shareholder nominations of directors, electronic shareholder forums, Form S-11 incorporation by reference, two new Staff Accounting Bulletins and the elimination of the GAAP reconciliation requirement for foreign private issuers using International Financial Reporting Standards ("IFRS"). Vaughn noted that SEC staff is participating in training in IFRS in preparation of what is thought to be the eventual adoption of IFRS by domestic firms. He also said that some large banks have created mockup financial statements using IFRS in anticipation of a new IFRS roadmap later in the year.

Vaughn offered a Division perspective on the staff review and comment letter process. He emphasized that the initial comment letter should be viewed as the opening of a dialogue with the staff. He also encouraged filers to take advantage of the reconsideration process, noting that asking for a reconsideration of an initial letter is not viewed as a "black mark" against the company by the SEC staff. Vaughn contrasted the recent comment letter process, where the final comment letter is posted on the SEC's Web site within 45 days of completion, with the old process of obtaining staff comments, which usually required a Freedom of Information Act request.

Vaughn briefly addressed the March 2008 letter regarding fair value disclosure and FAS 157 that was sent to approximately 30 companies and posted on the SEC's Web site. He noted that the letter did not change GAAP in any way and the intent of the staff was just to identify a number of disclosure issues a company should consider in preparing Management's Discussion and Analysis. Fair value is already a complex issue, he said, and in the wake of a "perfect storm" of many factors, chief among them the recent credit crunch, the staff will be focusing on the issue even more. Vaughn identified some fair value issues which he described as particularly difficult, including a situation where current fair value is materially different than what the issuer ultimately expects to realize and sensitivity analysis regarding the effect of using different assumptions. With respect to the latter, assumptions should be reasonably likely rather than hypothetical changes, he said.

Vaughn spoke about the SEC's October report on its targeted review of 350 companies' disclosures under the new executive compensation rules. He stressed that Compensation Discussion and Analysis should describe the issuer's overall compensation plan and the philosophy behind it. CD&A should also describe how the plan was implemented and how the company arrived at specific executive compensation decisions and policies, he said. He emphasized the importance of using plain English in the CD&A. When asked if the staff's observations regarding its initial review of the new rules led to better disclosure, he replied, "definitely."

Other Corporation Finance topics addressed by Vaughn included revenue recognition, litigation settlements and the use of experts' opinions in financial statements. He highlighted the importance of being clear on the triggers for revenue recognition and said that circular policies and boilerplate language should be avoided. Regarding litigation settlements, Vaughn advised preparers to disclose pending litigation. The conclusion of a settlement agreement should not be the first time litigation issues are disclosed, he said.

The SEC staff has noticed an increase in references to valuation professionals and other experts in company filings, Vaughn said. He reminded preparers that if an expert is credited, the expert must be named. He also noted that, although the expert's consent is not required in 1934 Act filings, it is required in 1933 Act filings, which can have implications if 1934 Act filings are incorporated by reference into 1933 Act filings.