The New York Times - June 16, 2005
 

Report Card Says Auditing Still Needs Improvement

By FLOYD NORRIS
 

The state of American accounting is better than it was before the  Enron scandal, the Securities and Exchange Commission said yesterday in a report to Congress and President Bush. But, according to the report, accounting still needs much improvement.

The staff of the commission recommended that steps be taken to change accounting for leases, pensions and derivatives to make it easier for investors to determine the accurate state of balance sheets of American companies.

"Is the balance sheet transparent? The answer is that it is more transparent than it was before Sarbanes-Oxley," said Donald Nicolaisen, the chief accountant of the S.E.C. "But it is not nearly as transparent as it ought to be."

The report, ordered by Congress as part of the Sarbanes-Oxley Act, which imposed new rules on accountants and companies, was prompted by Enron's use of so-called special purpose entities to keep billions of dollars in debt off its balance sheet.

The Financial Accounting Standards Board, which sets accounting rules in the United States, responded with a rule that was intended to force more such entities to be consolidated into financial reports.

The S.E.C. said that the rule was complex and was causing some confusion, and that some companies had made changes to keep such entities off their reports. But the S.E.C. said it was too early to assess whether the rule was adequate.

The S.E.C. report, which was based in part on a study of financial reports filed by 200 companies, including the 100 largest in America, found that financial reports remain extremely complex and that presentations differ, making it difficult to discern all that a company is saying about its positions in derivatives, let alone compare companies.

"Trying to put all that together is often more than a challenging exercise," said Robert Fisher, an S.E.C. economist who helped to prepare the report. "It is very, very difficult."

Mr. Nicolaisen said he had a personal goal to get started on reducing that degree of complexity. He noted that a company that owned securities issued by another company could report the investment in four different ways, with widely varying values that might bear no relation to actual value.

He said that, in general, accounting should move toward reporting market values of financial investments, rather than historical costs.

The report criticized the current state of pension accounting rules, which allow companies to smooth earnings and thereby distort the value of their pension plans. For the companies studied, the report said, the pension funds were underfunded by about $86 billion. But on their financial statements, they showed net assets of $91 billion.

The report suggested that companies be required to consolidate their results with that of their pension plans. Mr. Nicolaisen said there might be ways to distinguish gains and losses in the pension plan from those of the operating business, but that the pension plan assets and liabilities should be consolidated into the company's financial reports.

Regarding leases, the report noted that under current rules some leases show up on the balance sheet and others do not and that economically identical transactions were accounted for differently. But Mr. Nicolaisen said that current disclosures made it possible for investors to figure out what was happening, something that was not so easy with derivatives and pensions.

While the report said that both FASB and the International Accounting Standards Board, which sets rules for Europe and some other areas, needed to make changes, it said companies and auditors had a responsibility to follow the rules.

"It is tempting to blame the use of accounting-motivated transactions on accounting standards that can be exploited," the report said. "However, while the fact that accounting standards may be vulnerable to exploitation may be thought of as representing a failure of the standard-setter, it is the creation and use of a structured transaction undertaken with the purpose and intent to obfuscate, conceal and/or deceive that reduces transparency, not the standards themselves."

The report added that companies, auditors and others "who work to implement transactions that are structured in ways that attempt to portray the transactions differently from their substance do not operate in the interests of investors and may be in violation of securities laws."