The future of accounting and disclosure in an evolving world: The need for dramatic

change
Wallman, Steven M H. Accounting Horizons; Sarasota Vol. 9, Iss. 3, (Sep 1995): 81.

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A commentary reviews the recent stock option accounting debate and expresses support for the procedures utilized by FASB in

arriving at its disclosure-oriented approach, and for FASB's conclusions on this matter. The commentary primarily addresses

various issues related to the future of accounting and disclosure. While cognizant of the pitfalls of predictions, the commentary

argues for the need to develop both analytical systems for thinking about and anticipating changes in the business world and the

mechanisms and structures to ensure that one may respond appropriately from the standpoint of maintaining useful financial

accounting and disclosure.

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INTRODUCTION

For the past 60 years, the Securities and Exchange Commission (SEC) has relied heavily on the accounting profession. The

profession has helped the SEC satisfy its statutory responsibility to adopt accounting standards(1) for public companies and to

promulgate auditing standards that ensure our markets receive the highest quality financial information. In addition, the SEC relies

on accountants to ensue that public companies (i) record transactions accurately and fairly(2) and (ii) devise a system of internal

controls that maintains accountability for assets and permits preparation of financial statements that present fairly the company's

financial position and results of operations.(3)

Accountants are the gatekeepers of our financial markets. Without accountants to ensure the quality and integrity of financial

information, the markets for capital would be far less efficient, the cost of capital would be far higher, and our standard of living

would be lower. The accounting profession has undertaken a function that promises society a number of benefits, including lower

investment risk and better resource allocation. In turn, accountants have been granted a legally enforceable franchise-no company

can come to the public markets without an accountants' attestation. With real appreciation, I recognize the important role

accountants play in our society.

FASB AND THE STOCK OPTION CONTROVERSY

The primary focus of my remarks today relate to the future of accounting and disclosure in an evolving world--and the need for

dramatic change. However, before I turn to the future I would like to reflect a little on the recent past. In particular, I would like to

address the issue of stock option accounting and the role of the FASB in the recent stock option accounting debate.(4)
I understand the arguments made for and against a charge to income for stock option compensation and, alternatively, disclosure

of stock option compensation. While reasonable people can disagree over the merits of each

approach, I believe it is wrong to conclude that there could be only one right answer. The purpose of financial statements is to

provide useful information to the users of those statements. Given the context of the stock option debate, I believe the approach

adopted by FASB to permit disclosure, as opposed to requiring recognition, of the fair value of fixed stock options is an acceptable

solution to satisfy that purpose.

The FASB's solution takes into account the interests of those who advocated a charge to income by requiring disclosure of the

number representing the fair value of the options. The FASB's solution thereby recognizes the arguments of those who believe that

stock options are compensation and that their value should be shown instead of ignored. To do otherwise only would contribute to

the view that options are stealth compensation and ignore the reality that they have real value. The solution also takes into

account the interests of those who believe that no single number is sufficiently accurate to be included in the income statement.

In addition, the FASB's solution recognizes, at least at one level, the argument that equity grants may be viewed differently from

cash or the creation of a liability and so should be reflected differently from cash or liabilities in financial statements.

There can be no ignoring, however, the political and lobbying campaign that was waged with respect to this issue. Regardless of

your view as to whether FASB reached the preferred result, no one can believe that the best mechanism for establishing

accounting standards is to politicize them. I firmly believe that FASB's fundamental independence, integrity, wisdom, and sound

deliberative process are essential to the SEC's continued reliance on the private sector to set high-quality accounting standards. I

support the FASB fully, and will continue to do so in the future. I believe it is incumbent on the profession-as well as preparers and

users--to do the same.

With the stock option accounting issue now largely behind us, I hope that at least the same level of time, energy, and money spent

on resolving that issue can be channeled toward ensuring the continuing utility of financial statements and corporate disclosure.

That is the topic to which I would now like to turn.

THE UTILITY OF FINANCIAL STATEMENTS AND CORPORATE DISCLOSURE

Corporate financial reporting and corporate disclosure exist in the context of a dynamic, constantly changing business world.

Competitive challenges and business opportunities arise quickly. Firms are advantaged if they are agile in adapting corporate

structures and developing or utilizing innovative and sophisticated financial instruments. In the middle of this evolving business

world stands the accounting profession which needs to assure the continued utility and integrity of financial reporting.

As we approach the end of this century, I am concerned that financial accounting and corporate disclosure is not keeping pace

with the rapid changes in the business world. Not only is accounting and disclosure increasingly at risk of failing to satisfy its

promise to society, but I fear that, unless we begin to take actions to ensure its future utility, accounting and disclosure may

become a detriment--a deterrent--to worthwhile business innovation. In this context then, I believe it is critical for the accounting

profession, as well as for the SEC, to strive to develop a vision of what a better future might hold--and then to reach for it.
As mentioned earlier, the value and worth of financial reporting lies, in an almost exclusive way, in its usefulness to users.(5) I

would suspect it is the rare observer who finds an aesthetic benefit or poetry in financial statements or reads notes for a clever

turn of phrase. Moreover, the most elegant solution to an accounting and disclosure problem, which some may see pursuing as an

interesting end in itself, like solving a puzzle, is not worth much if users do not find the solution useful.

Of course, not all users are the same. Analysts attempting to discern or predict earnings or cash flows need different information

than managers reviewing the allocation and utilization of deployed assets. Investors attempting to employ relatively new measures

such as economic value-added(6) need still different information. The diversity of users complicates the task of peering into the

future.

I also recognize fully the pitfalls inherent in predictions. I remember being taken to the 1964 World's Fair when I was ten and

marveling at that era's vision of the 1980s--when there would be talking robots cooking and vacuuming around the house, and cars

on roads whisking travelers automatically to their destination with smiling and blinking computer controls doing the driving. As a

result, I know that predictions can be very wrong and, interestingly, I also remember there was no mention of derivatives at the

World's Fair.(7)

Still it is important to develop both analytical systems for thinking about what the future might bring and the mechanisms and

structures to respond appropriately. This is particularly important for those of us involved in the business of financial disclosure. If

we do not develop such systems and mechanisms, we run the risk as disclosure professionals of being marginalized, of

mechanically doing the same thing we did before because we are unable, or incapable, of doing anything else and of producing a

product that is increasingly less useful and less valuable. As a result, we will disserve those who rely on us--participants in the

financial markets, managements, regulators, and others who have to make decisions based on financial information. With regard to

the capital markets: if we do not stay on the frontier, there will be poorer information flows to investors, leading to greater

uncertainty and volatility in pricing, higher demanded returns, and a higher cost of capital.

I believe strongly that we have to develop a sufficiently dynamic and reliable analytical framework for anticipating and responding

to changes in the concept of the business enterprise, the relationship of that enterprise to, among others, investors, customers,

and suppliers and the tools, especially financial tools, that business utilizes. We then need to translate that framework into a

system that will ensure that high quality information flows are distributed on a timely basis to interested users.

FUTURE ACCOUNTING AND DISCLOSURE ISSUES

I would like to suggest four broad accounting and disclosure issues that may be critically important to the future of financial

reporting:

1. Recognition and measurement of the benefits and obligations of a business--in other words, what is it that we should report in

the financial statements of an enterprise;

2. The timeliness of financial reporting--in other words, when should recognized items be reported;

3. The concept of the firm--in other words, who are we measuring; and
4. The distribution channel and medium--in other words, where and how are we distributing this information.

The last question normally asked--the "why"--is usually the hardest to answer. Here it is the easiest. For all of the reasons

previously stated, financial reporting information flows are a critical component of our system of capitalism and democracy.

Without appropriate information, risk increases, as does demanded returns and the cost of capital. Our standard of living will be

less than what it could have been. It is clear--obvious--why financial reporting information flows must keep pace with changes in

the real world.

Recognition and Measurement

With regard to the issue of what should be measured, it used to be that financial statements reasonably and accurately reflected

the assets and liabilities of a company. I remember--when I was taking courses in business school--that we once believed that you

could use a balance sheet to obtain a pretty good picture of a company. Most of the assets were "hard" and, with certain

understood exceptions, were carried--as a matter of fact--at a reasonably current value. Of course, we recognized that the carrying

value of some assets--like land or natural resources (e.g., timber, mines, oil and gas reserves) could be significantly out of sync

with current value, but the idea of quarterly or annual appraisals was viewed as impractical. Similarly, measuring asset values

using indices of specific asset category price changes(8) or market values if known(9)--ideas that have been reviewed in the past

and that I believe need to be explored anew--were, and still are, viewed as unacceptable. However, we all agreed that the system

we had, although not perfect, was still very useful.

Today I think quite differently. I know that overall this is not a new topic and that some of these issues have been explored quite

extensively.(10) Nevertheless, the passage of time has made the historical carrying costs of some assets on the balance sheets of

certain major corporations unrealistic and unusable for any purpose.

Even more importantly, however, the inability to recognize at all as assets on the balance sheet some of the new and most

significant building blocks of business has resulted in balance sheets that bear little resemblance to the true financial position of

the firms they are supposed to describe. For example, there are major drug companies, such as Merck, that show no assets related

to most of their breakthrough products. In addition, for example, the tremendous and increasing value of the Coca-Cola trademark

is not reflected as an asset in the periodic financial statements of that company." Similarly, most intellectual property is not

recorded as assets on the balance sheet of the firms that own the property. Finally, there are major software companies, like

Microsoft, whose stock is worth tens of billions of dollars with balance sheets that make them look like much smaller companies.

(12)

My concerns, then, are that there are a significant number of assets that are poorly measured through historical cost accounting

and, more importantly, that we have entire categories of assets that are not recognized at all. And the problem is getting worse. In

particular, it is the latter group of assets--those that are not even recognized--that are the fastest growing and most important

parts of most of our new firms. In recent years, for example, service firms comprise the fastest growing segment of our economy.

Yet, the most important assets of many of these firms--intellectual property and human assets--will not be found anywhere on the

balance sheet of these entities.

responsive to the needs of the future--unless we wish simply to view the balance sheet as an increasingly limited-purpose, almost

anachronistic, statement. By consigning the balance sheet to the status of an antique, we are ignoring the needs of a broad array

of financial statement users, including users such as creditors who increasingly are lending on soft assets.(13) In addition,

because changes in balance sheet values also are recognized in both the income statement and the statement of cash flows, any

limitations of the balance sheet also will affect adversely the information provided in these statements.

We, of course, need to be careful. From my perspective as an SEC Commissioner, I believe we can never tolerate firms creating

numbers out of blue sky. Nor should we impose a burden of recognition and measurement that outweighs the benefits of such

presentation. But that is not to say that disclosure professionals should fail to explore new ways to make what is reported in the

balance sheet and other financial statements more relevant. One idea worth exploring to make financial statements more relevant,

while recognizing the uncertainty related to the measurement of soft assets, would be to disclose such measurements in a

location outside the traditional financial statements.

Timeliness of Financial Reporting

The timeliness of financial reporting also is increasing in importance. The rapid acceleration of events significantly affecting a firm

has started to make our system of annual audits and quarterly reports somewhat obsolete. Again, it used to be that if one had a

few years of annual audited financial statements, there was a good likelihood of being able to predict, at least within reasonable

ranges, performance over the next year. And with the financial statements of that next year, one could predict, again within some

reasonable ranges, the financial performance of the succeeding year.

Today, annual and even quarterly reports do not capture and communicate material developments in sufficient time to meet market

informational needs. Product cycles have shortened and products and whole companies become obsolete much more quickly now

than ever before. It is hard to obtain a great picture of a quickly moving and changing item when only slow snapshots are taken.

There are numerous examples where firms presented, accurately, glowing reports for a few years and then crashed.(14)

In addition, various new financial instruments have allowed companies to change their entire direction and risk profile literally

overnight. For example, we have witnessed the rapid development of certain derivatives that may be exposed to significant

monthly, weekly, and even daily market fluctuations. These instruments may cause material shifts in corporate portfolio values--

and even may imperil a firm's entire equity capital in a matter of a few months or less. For example, in the Barings PLC case,

Barings reported a net worth of approximately $450 to $500 million at year end 1994. By the end of February 1995--before their

1994 year-end annual report was actually completed--Barings was insolvent. Mark-to-market concepts may help in communicating

the business risks in these contexts and a type of value-at-risk disclosure(15) may prove even more useful, but even these

developments are limited by the extent to which they are disclosed in a timely manner. For example, disclosure of value-at-risk on

an annual basis may be of limited utility.

Our current system of periodicity and timing of reports has been in place for decades, but the business environment has changed

dramatically. Our financial reports need to reflect this change. I am not suggesting now a system of monthly, weekly, or daily
audits and report filings with the SEC. I am suggesting, though, that over time we will need to develop a system that fills the need

for timely financial information.

Stated differently, the intent of our efforts in assessing the future of accounting should be to lower the cost of capital by

decreasing risks and demanded returns. That is done, in part, by increasing the flow of relevant information to the market in a

timely manner. We need to consider whether our system of periodicity, in which firms submit comprehensive financial statements

on an annual and quarterly basis is compatible with this goal or whether another paradigm may be more appropriate. For example,

timing and cost considerations may dictate that more limited or abbreviated financial information--such as unaudited balance

sheets or cash flow statements--be distributed to the market on a more frequent basis (for example, monthly). This possibility, in

turn, raises a host of issues, such as the potential liability of firms for misstatements or omissions in such financial information

and whether a safe-harbor would be necessary or advisable for firms providing such information to the market. Whole new

paradigms and concepts for providing information disclosure and analysis, as described in more detail below, will also need to be

considered--and it may well be that these new paradigms and concepts hold the answer to many of these problems.

Concept of the Firm

The concept of what we call the firm is also changing. For example, it is harder no to define the outer edges of the firm. There are

public companies with multiple public subsidiaries, each with joint ventures, licensing arrangements, and other affiliations.

Increasingly, loose affiliations of enterprises in joint ventures or customer-supplier relationships that mimic integrated firms form

and dissolve in a matter of months or even weeks.

We will reach the day in the not-too-distant future--long before there are talking robots doing all the cleaning and cooking--where a

single product with its own cash flows and liabilities will constitute a firm(16) and where there will be '"virtual firms" with

hundreds or thousands of individuals networked together in combinations that form and dissolve as tasks are required to be

performed. The key assets of this "virtual firm" may well be only human resources or intellectual capital, its outer edges will

change daily, and its liabilities and cash flows will be sliced and diced as needed and as is efficient.

It will be a challenge to determine how one is to account for these virtual firms in a timely way that accurately and fairly measures

income, cash flows, and real assets and that makes the slightest sense from the perspective of a user of financial statements.

Current GAAP and SEC reporting requirements are struggling to keep pace with the rapid changes in firm structure and function

already upon us. We hardly have begun the planning necessary to anticipate how to cope with these future developments.

Understandably, there is a tendency to deal with difficult problems only if raised in the context of immediate and concrete

concerns, such as deciding who or what is the issuer in connection with certain types of asset-backed securities issues. But, if

financial reporting is to continue to fulfill its promise it must adjust to the sea change in business structures. The information

revolution is moving us to a new plateau where businesses can operate-for example in virtual firms--far more flexibly, quickly, and

with greater agility than ever before. And this change, this new found freedom, is not one merely of degree, but of type. The

reaction of financial reporting to this change must also be not one of degree, but of type. It will not be sufficient to add numbers
more quickly or to work faster. Financial reporting must be examined at the conceptual level and the changes necessary in such

reporting to accommodate the changes occurring in business are likely to occur in the foundations of financial reporting itself.

Information Distribution Channels

The final issue I want to discuss is the manner in which information is distributed. To ensure the continued utility of financial

reporting and disclosure, we must recognize that our current distribution channels and our methods of dissemination and analysis

have as much to do with what is reported as do the underlying concepts that dictate GAAP. We have traditionally relied on SEC

filings and periodic reports to shareholders, analysts, and others to inform the market of the financial health of companies. The

information in these reports has been aggregated commonly into historical accounting asset, liability, and equity categories and

disseminated directly through the mail or on a delayed basis via microfiche. Only recently have we made advances in terms of

developing computerized systems for distributing this information, such as via the SEC's Electronic Data Gathering and Retrieval

system ('EDGAR) or through commercial vendors, such as LEXIS/NEXIS.(17) In all instances though, the information we distribute

has been aggregated corporate information.

This aggregation was necessary, in significant part, because of the past state of technology. It has been impractical--physically-to

provide much disaggregated information because there has been no reasonable mechanism for distributing such a huge amount of

information and, more importantly, there has been no reasonable mechanism for analyzing it. Simply put, users needed aggregated

information because without it, the disaggregated information was unfathomable. Consequently, firms hired legions of accountants

to take the most useful information of all--all the independent data bits of the financial comings and goings of the firm--and

aggregate it so that it could be used. In essence, each reporting entity has engaged in its own detailed analytical review of its own

information. It then takes the output of that analytical review--the high level aggregated information--and publishes it.

To date, the entire history of financial reporting and corporate disclosure has been one of taking useful information and turning it

into useable information. In order to meet the accounting challenges discussed in this article, we need to consider whether this

historical approach to information dissemination is increasingly part of the problem. Certain sophisticated end-users already have

the means to perform high level analysis on disaggregated information. Analysts frequently spend substantial time and effort

attempting to disaggregate information aggregated by accountants and accounting requirements. Because of the need to

aggregate, we artificially require that certain judgments be made to force items into categories where they do not easily fit. And

we artificially decline to include other items at all, if they do not fit, even with forcing, into predefined categories. Moreover, all this

manipulating and aggregating takes time, reducing the timeliness of the reporting and imposing others' judgements on what is

relevant and worth measuring.

Consider, by contrast, whether some end-users today might benefit more from access to disaggregated raw data of issuers (even to

such extremes as information on raw materials, work-in-progress, asset appraisals, regional sales efforts, and other disaggregated

information) instead of the aggregated data currently provided in financial reports. In the future, more end-users clearly will have

access to the analytics and electronic data bases that will make this information highly useful and timely to them--if it is provided.
One could imagine then a world where this information might be provided through direct on-line access to select portions of a

company's management information system, thereby allowing end-users to retrieve and analyze the data for their own internal

purposes and arrive at decisions more closely tailored to their individual needs. Of course, concerns will be raised regarding

comparability, confidentiality, liability, integrity, quality, and other matters. The simple point, however, is that we may need to start

thinking about such a paradigm shift in financial reporting and corporate disclosure if we are to develop an accounting and

reporting system that best meets the challenges of the future.

IMPLICATIONS AND POTENTIAL OUTCOMES

If nothing is done to review and respond to the issues addressed in this paper, audited financial statements and other financial

disclosure will become increasingly less relevant to end-users.

I see three possible scenarios for financial reporting in the future. The first two could well arise if we fail to exercise sufficient

foresight and fail to design a better system.

One outcome of such inactivity might be a stratification of accounting information available to various types of end-users. For

example, institutional and other professional investors will purchase more detailed or timely financial information from special

purpose providers. Similarly, creditors and other constituencies that have bargaining power may demand from the firm timely

financial information of a consistently high quality. Average public investors, on the other hand, may be relegated to a hoped-for-

reliance on an efficient view of the market that suggests that they do not need to have relevant information as long as such

information is available to professional traders.

We are already starting to see this stratification.(18) Institutions solicited for private placements, banks, and other major creditors

of firms--especially firms using modern management techniques such as just-in-time-manufacturing--frequently demand and

receive real-time information from the management of these firms that is far more relevant than that available to the average

public investor.(19) Although we are not there yet, this possibility resembles in many ways the model followed by some of our

international competitors. For example, the major financing entity in a Japanese Keiretsu and the principal creditor bank to a

German company frequently have full access on a real-time basis to all the financial management information that the firm has

itself.

A second possible outcome of neglecting to consider adequately the future needs of an appropriate accounting system is that,

because of existing regulatory and accounting constraints, public companies that wish to engage in innovative business structures

and affiliations may find it harder to do so and may be discouraged from undertaking such ventures.(20) As a result, I suspect that

these firms will default into the private market for capital. But that will be unfortunate, and an advantage that these firms could

have had-access to the public market, its cheaper capital, and more extensive investor base--will be foregone.

A third, more positive outcome is for the accounting profession, along with those who are the financial managers within

companies, to take steps now to explore the issues discussed here and to begin to design a flexible information system that will be
able to address them. This is a race that we should not lose. However, because business continues to change rapidly, we are falling

farther and farther behind.

A CALL FOR ACTION

I commend the AICPA for two recent efforts to develop a dynamic, forward-looking framework for analyzing some of these issues.

The first effort was by the Jenkins Committee (AICPA's Special Committee on Financial Reporting) which was charged with

identifying the information companies should provide to investors and creditors and the extent to which auditors should be

associated with that information. This Committee has done a good job of considering, from a financial statement user's point of

view, some of the emerging issues I have outlined above. Second, the Elliott Committee (AICPA's Special Committee on the Future

of Audit/Assurance Functions) is undertaking an effort to develop a framework for analyzing and adapting to trends in financial

reporting expected over the next five to ten years. In particular, this Committee is evaluating the current range of audit functions

and considering whether they should be extended beyond the traditional financial statements to cover other corporate financial

information demanded by end-users.

Additional efforts are still needed, however, to broaden the scope of such reviews to include the perspectives of nonaccountants

and to consider issues beyond those of the current day, in particular the ones mentioned in this paper. Thus, I call for the SEC, the

FASB, preparers, issuers, investors, and others with an interest in financial reporting and corporate disclosure to start thinking

further about developing viable solutions in these areas in order for a consensus to be reached about future financial reporting

needs. I expect that such efforts will produce the needed and dramatic changes that will keep U.S. financial disclosure and

accounting at the frontier. The earlier we start these efforts the better. We must view and design such efforts as a strategic

planning function, with an indefinite life and a continuous mandate to peer into the future.

Finally, the role of accountants and auditors will also have to be re-evaluated as we explore the steps necessary for the continued

vitality of financial reporting in the future. As mentioned above, accountants and independent auditors are the gatekeepers to the

integrity of the markets. As forward looking changes discussed above are explored and implemented, the auditors' role will become

even more important. For example, such changes will cause an increased reliance on the internal controls and accounting

decisions of the firm itself. Real-time information would be more of a nightmare than a dream without appropriate and increasingly

reliable internal control mechanisms assuring the integrity of the information.(21) Moreover, whole new fields of information

disclosure and analysis will appear. Accounting will then provide, more than ever, the value added that permits the efficient

allocation of resources that drives capitalism and underpins our democracy. As a result, accountants will truly have earned their

franchise and fulfilled their societal mandate.

CONCLUSION

The issue now is not whether we should continue to tinker with the existing financial reporting system, but whether we have the

knowledge, courage, and vision to evaluate and make forward looking changes in our reporting system that will make available to

investors the most relevant and useful information. A great benefit we share is the existence of public capital markets that are the

deepest, most liquid, and most efficient of any, anywhere, and at any time. We shod not lose that benefit because of an
unwillingness to think about the future. We cannot have financial reporting and disclosure constraints that slow the pace of

progress in capital markets, decrease the rate of reduction in the cost of capital, or limit innovation. The next step collectively is

ours.

1 The securities laws grant authority to the Commission to prescribe accounting principles for public companies (see generally, 15

U.S.C. 77s(a); 15 U.S.C. 78m(b)). In Accounting Series Release No. 150, issued December 20, 1973, the Commission recognized the

Financial Accounting Standards Board (FASB) as the private sector standard setting body designated to establish and improve

accounting principles subject to oversight by the Commission. Likewise, the Commission has provided oversight over the private

standard setting efforts of FASB's predecessors: the Committee on Accounting Procedure (1939-1959) and the Accounting

Principles Board (1959-1973).

2 Section 13(b)(2)(A) of the Exchange Act requires issuer of securities to make and keep books, records, and accounts, which, in

reasonable detail, accurately and fairly reflect the transactions of the issuer (15 U.S.C. 78m(b)(2)(A)).

3 In particular, section 13(b)(2)(B))(ii) of the Exchange Act requires issuers to devise internal control systems that maintain

accountability for assets and that permit preparation of financial statements in accordance with generally accepted accounting

principles (15 U.S.C. 78m((b)(2)(B)(ii)).

4 The following is a brief history of the FASB's stock compensation project:

In June, 1993, FASB issued an Exposure Draft to address accounting and reporting for stock-based compensation paid to

employees. The anticipated standard would supersede APB Opinion No. 25. As exposed, the standard would have required

recognition as compensation expense of the fair value of all stock-based compensation paid to employees for their services

regardless of whether the stock plan was a fixed or performance based plan. (This is distinguished from APB Opinion No. 25 which

required expense recognition for performance based plans only.) FASB received more than 700 comment letters and in March, 1994

held six days of public hearings. Additionally, a field test of the proposed standard was conducted. FASB began redeliberation of

the issues in the Exposure Draft in June, 1994 and in December, 1994 decided to work toward improving disclosures about stock-

based compensation rather than requiring income statement recognition of an expense. Under this new approach, the FASB

expects to encourage, rather than require, companies to recognize as compensation expense the fair value of all stock-based

compensation at the date of grant. Companies would be permitted, however, to continue accounting under APB Opinion No. 25. In

addition, those companies who continue to apply Opinion No. 25 would be required to disclose in a footnote pro forma net income

and earnings per share if compensation awards were recognized at their estimated fair values. In the first quarter of 1995, the

FASB decided to move directly to issuing such a final standard with issuance expected in the third quarter of 1995. The standard

will be effective for financial statements for the 1996 fiscal year.

5 Financial reporting should provide information that is useful to present and potential investors and creditors and other users in

making rational investment, credit, and similar decisions (FASB, Statement of Financial Accounting Concepts No. I, paragraph 34).
6 See Stewart (1990) for further information describing how investors might determine and use the concept of economic value-

added.

7 It is difficult to obtain precise data on the derivatives market generally, let alone in 1964. However, recent estimates place the

worldwide notional value of derivatives at $35 trillion in 1993 (Wall Street Journal, August 25,1994).

8 See, Sunder (1978) for a discussion of index-based asset price valuation methods and Linsmeier et al. (1995) for empirical

evidence suggesting that index-based asset price valuation models provide incremental information to investors beyond that

provided by historical cost income.

9 See, Barth (1994) and Carroll and Linsmeier (1994) for recent empirical evidence portraying the valuation relevance of market

value disclosures.

10 See, American Accounting Association (1977) for a review of literature espousing market value accounting methods.

11 While, because of reliability concerns, U.S. accounting standard setters have been reluctant to allow firms to value and report

soft assets, other nations have been more aggressive in this area. For example, Australian and U.K. accounting authorities now

permit firms to value and disclose certain soft assets, such as brand names.

12 On December 31, 1994 the market value of Microsoft's common stock was $35.6 billion. In contrast, on that same date the book

value of Microsoft's net assets was $4.45 billion:

13 For example, see Crawford (forthcoming) for further information on lending on soft assets.

14 For example, financial statements provided little forewarning about America West's June 27, 1991 bankruptcy. See, SEC

Accounting and Auditing Enforcement Release No. 562 for further details.

15 Value-at-risk provides an estimate of potential loss in fair value in a company's financial and commodity instruments and

positions, including derivatives, that might arise with a specified probability of occurrence aver a specified period of time. As such,

value-at-risk represents one of a growing body of new disclosures that portray the risk and uncertainty inherent in a company's

business. AICPA Statement of Position (SOP) No. 94-6 entitled, "Disclosure of Certain Risks and Uncertainties,' requires that

companies disclose certain key business risks within the footnotes to the financial statements and, thereby, represents a

significant improvement in the information available publicly to securities market participants. Value-at-risk numbers are not

required to be disclosed by SOP No. 94-6. However, I believe that the public disclosure of value-at-risk is likely to make more

transparent the market risk inherent in the derivatives activities of a firm, especially if the value-at-risk numbers are presented for

a relevant time frame. For additional information on value-at-risk, see Carey (1995).

16 A distant analogy is found in the 1993 spin offs by Alza Corporation and Elan Corporation of special purpose entities formed by

Alza and Elan solely to conduct research and development activities.

17 In 1993, the SEC adopted the EDGAR system, which established the foundation for the electronic filing of financial reports by

SEC registrants. However, EDGAR--at its present stage of development and notwithstanding my kindest comments--would not
appear to be the sole answer to our financial reporting problems. Regrettably, EDGAR is limited in a number of ways, including in a

fundamental way by the timeliness problem discussed above-the system's advantage of being able to access instantly a registrants

filed financial information is tempered by the fact that the information that is filed is limited in its utility due to its age.

Nevertheless, the system may be a step in the right direction in that it provides users access to the public reports of SEC

registrants quickly and efficiently through electronic means, thereby eliminating the necessity of contacting the registrant or

involving the services of a commercial research firm. It also permits the earlier use of computers to analyze information in

financial databases. Thus, EDGAR might someday be used as a roadway for a real-time based system of financial disclosure.

However, a great deal more energy will have to be invested in this area if this potential goal is to be achieved.

18 I realize this stratification is caused by a number of factors that include such difficult issues as securities litigation and liability

concerns and interests in maintaining relationships with certain large shareholders and analysts. A full and separate discussion of

these matters must also be undertaken if we are to maintain the promise of our capital-raising structure.

19 It will be argued that providing such information to the public will present a competitive disadvantage to the disclosing firm.

Some observers have noted, however, that as a result of overlapping client and suppliers, and informal lines of communication

within an industry, a firm's peers and competitors typically have information about the firm superior to that available through

publicly filed reports.

20 In late 1988 four companies filed registration statements with the Commission seeking to register an innovative security

referred to as "unbundled stock units (USU)." A USU was a security which combined debt and equity features. In 1989 these

registration statements were withdrawn and the concept was abandoned. While not the critical reason for the abandonment,

reporting issues for the unique securities were an impediment to their acceptance.

21 The advisory panel established by the POB (Public Oversight Board) and chaired by Don Kirk also declares the importance of the

audit committee and clarifies the audit committee's overall responsibility, along with the rest of the board, for the integrity of

corporate financial reporting. See Public Oversight Board (1994). Because of the importance of the role of the audit committee, I

believe consideration should be given as to whether auditors should refuse to give audit opinions if the auditor has not obtained

from the audit committee assurances or representations that the audit committee: (i) has considered and understood its

responsibilities relating to the oversight of internal controls and reports and (ii) has understood and concurred in the judgments on

accounting principles, disclosure, and estimates reflected in the financial statements.

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--. 1978. Statement of financial Accounting Concepts No. 1, paragraph 34. Stamford, CT.

Linsmeier, T., C. Lobo, and G. Kanaan. 1995. Dispersion in industry price changes and the relative association between alternate

income measures and security returns. Journal of Accounting, Auditing and Finance (March): 365-382.

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--. 1994. Accounting and Auditing Enforcement Release No. 562.

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Copyright American Accounting Association Sep 1995