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SubscribeRelevance of Accounting to Policymakers
Thank you for the introduction. It is a pleasure to spend this luncheon with you, here at the 2022 Journal of Accountancy and Public Policy Conference at the University of Maryland’s Robert H. Smith School of Business.
The views that I express here are my own and do not necessarily reflect the views of other PCAOB board members or staff.
One of my former career roles was serving as the Controller and Interim CFO of the University of Maryland. So, I am happy to be back here on UMD’s campus, and I am delighted to celebrate the 40th anniversary of the Journal with you today. Go Terps!!
I would like to share some ideas with you about the “Relevance of Accounting to Policymakers.” This is a topic near and dear to my heart. When I was the Deputy Assistant Secretary for the Office of Accounting Policy
at Treasury, I spent a lot of time trying to explain accounting and its relevance to policymakers. Although I doubt that I converted any policymakers to accountants, I was able to persuade a few to make policies that effectuated significant progress
in improving federal spending transparency and financial management.
Today, I’d like to start by sharing a brief history of accounting[1]. Where do you go when you want to learn more about the history of accounting in our modern
time? The Internet.
History of Accounting
According to Investopedia, the concept of accounting arose long before our modern civilization, during the Mesopotamia era. Mesopotamia is among the earliest human civilizations and known as the “Cradle of Civilization” for the many innovations
created in this region, which is part of modern-day Iraq, Kuwait, Turkey, and Syria[2]. This means that accounting is one of the oldest professions of
mankind, and the enduring legacy of accounting is well established. Mesopotamians made many discoveries that changed the world, including math and the concept of time.
In the 1400s, single-entry bookkeeping was the standard which eventually evolved to the double-entry accounting system that we utilize today; credit is given to a 15th Century Italian monk, magician, and lover of numbers, Luca Pacioli, who
codified the idea and described it in a 1,000-page treatise that the invention of printing allowed to move throughout the world.
Along the way in the late 1800s, various professional movements emerged, such as the American Association of Public Accountants (AAPA) and the drive to establish the requirement for Certified Public Accountants (CPAs). The AAPA is the former name of the
organization that we know today as the American Institute of Certified Public Accountants (AICPA)[3], which was originally created to promote the accountancy
profession, conduct rule-making and standard setting, and instill ethical accounting practices. Most of its original scope of responsibility was later supplanted by the securities laws including the Sarbanes-Oxley Act of 2002.
In 1929, the Great Depression began, and the stock market crashed. In response to the Crash, Congress passed the Securities Act of 1933, whose objectives include requiring that investors receive financial and other significant information concerning securities
being offered for public sale. Congress also established the U.S. Securities and Exchange Commission (SEC) in the Securities Exchange Act of 1934 and gave it broad authority over all aspects of the securities industry including setting accounting
standards and disclosure rules to be followed by public companies. Since then, the SEC has looked outside its own walls for leadership in establishing and improving the accounting methods used to prepare financial statements. The body that the SEC
looks to is known as the Financial Accounting Standards Board (FASB); the FASB’s structural and programmatic outline are set out in the Sarbanes-Oxley Act, and the Board is funded by the same accounting support fee that supports the PCAOB. [See
sections 108(a) and 109(e) of Sarbanes-Oxley.] The FASB can set, but cannot enforce, accounting standards to be used by public companies, and the SEC has both enforcement authority and ultimate responsibility to ensure that the FASB deals with issues
referred to it by the SEC. This cooperative effort has resulted in the United States having the best financial reporting system in the world.
Accounting’s Role in Policymaking
Accounting is not just about numbers or “being good at math”. It is based on fundamental principles, as Pacioli saw more than six centuries ago, that can enable us to record financial transactions accurately and completely. It is truly the
foundational financial data that paints the picture of an organization’s health and well-being as a business. It is the financial data that is critical to driving effective business strategies and decisions. In turn, the financial information
that companies present to the public allows investors to make informed investment choices.
So why is accounting relevant to policymakers? Few policymakers are accountants, but they all care about the Constitution. You might ask what accounting has to do with the Constitution? The preamble to the United States Constitution outlines four broad
missions: 1) to establish Justice and insure domestic Tranquility, 2) to provide for the common defence, 3) to promote the general welfare, and 4) to secure the Blessings of Liberty to ourselves and our Posterity.
Honest accounting helps turn those phrases into reality – decade after decade, generation after generation – because it facilitates transparency of companies’ performance. It goes hand in hand with auditing which facilitates investor
trust. Trust is vital to maintaining highly efficient and effective capital markets. Providing fair and transparent capital markets for investors to grow their wealth is part of the “Secure the Blessings of Liberty to ourselves and our Posterity”
mission in the preamble to the Constitution.
That trust was lost nearly 20 years ago because of significant accounting and auditing scandals. As it had in 1933 and 34, Congress stepped in again in 2002 and passed the Sarbanes-Oxley Act of 2002 nearly unanimously (99-1 in Senate, 423-3 in the House);
the law contained a wide range of measures aimed at – in the words of the Senate Banking Committee – addressing the systemic and structural weaknesses affecting our capital markets that were revealed by repeated failures of audit effectiveness.
No part of the long bill was more significant than the creation of a strong independent board to oversee the conduct of the auditors of public companies, you guessed it -the PCAOB - which ended more than 100 years of self-regulation by the accounting
profession. The statute, which I refer to as “SOX,” also clearly and firmly established that the PCAOB’s mission would be to protect the interests of investors and further the public interest in the preparation of informative, accurate,
and independent audit reports.
Looking back, it is fair to say that Congress’ intent to restore public trust in auditors of public companies has made a real difference. Our capital markets continued to grow, from a market cap of approximately $11T in 2002 to over $60T this year.
As a regulator, I have been thinking about the key factors that determine the most effective approach for regulation. Sometimes competition is enough to incentivize businesses to provide quality products or services. Other times, regulation is required.
In my opinion, trust is one of the key factors. The higher the level of trust required; the higher the degree of regulation that is warranted. For example, any products or services related to public health would require the highest degree of trust.
The public also needs to trust that the capital markets are fair and transparent for them to be willing to invest their life savings.
Most importantly, public trust is the cornerstone of a functioning democracy and is crucial to maintaining political participation and social cohesion. Successful public policies often rely on behavioral responses from the public. Trust leads to greater
compliance with rules or regulations. For example, we have the largest and most effective tax administration system in the world. That system mostly depends on voluntary compliance. Its success anchors on the public trusting that our tax system, though
imperfect, is a fundamentally fair system. Similarly, investors will likely not participate in our capital market system if they don’t trust it.
Shaping the Future
Although the Mesopotamians launched human innovation; we have continued to technologically evolve as a society. With technology disruption and market transformation, accounting and auditing is becoming more complex and involves a higher degree of professional
judgment. Has accounting caught up with the complexity of the business today? There is no question that accounting standards have become more complex. Why? Because businesses have become more complex, driven by the need to solve more complex and broad
problems in our society. From my perspective, the complexity is changing accounting in several ways:
- Nature: corporations are increasingly wrestling with the need to account for more intangible and indirect events that may have a material effect – positive or negative - on their finances. For example, all companies are affected by the Pandemic, war, and climate change. Trying to translate these intangible events into financial numbers can be challenging.
- Timing: historically, accounting takes place at period end. With digital assets, the need for real time accounting and auditing is emerging and could eventually become standard.
- Extent: business operations are becoming more digital and less manual. In addition, many business activities are being performed remotely. As a result, the extent of automation is increasing, and the scope of transactions is becoming more global or possibly even “virtual” (I.e., metaverse). For example, I have read about virtual world where players can buy and sell goods.
- Human capital: because of these changes, more specialized expertise is needed to understand the nature and impact of these new events and transactions. I have heard that firms are now hiring not only specialists like economists, technologists,
but also environmentalists. I expect that corporations are doing the same.
So, what do these changes tell us about the relevance of accounting? Not only do they mean that we need to continue to evolve and be forward-looking, but they also imply that if we want accounting to be relevant to policymakers, it needs to aim at solving
real societal and business problems. Since I became a board member at the PCAOB and in every public statement I have made, I continue to emphasize the importance of technology innovation and its impact on audit quality, and by extension investor protection.
In my opinion, data and technology innovation neither start nor end with auditing. Rather, it is imperative to integrate innovation from the origin, the accounting transactions, and throughout the entire financial lifecycle ending with reporting,
auditing, and ultimately publishing trusted financial statements for investor consumption.
At the beginning of May 2022, our Office of the Chief Auditor updated the standard-setting and research agendas to communicate the Board’s intention to pursue a significantly expanded standard-setting agenda, and also to enhance transparency to the public on our expectations of the timing of those actions. In the same way that ICFR from SOX section 404(b)
became one of the cornerstones for audit quality, and how other regulators around the world are still trying to enact something similar, I would like the PCAOB to continue to be at the forefront of creating standards that encourage and drive innovation
specifically for auditors but that may be useful for issuer consideration as well.
For example, we could play an active role to promote data standardization across the ecosystem, to allow implementation with economies of scale while promoting quality data and accurate financial information. Analyzing and utilizing data can assist in
identifying accounting patterns and anomalies that reveal divergent interpretations and implementation of the same standards. Consistency is essential to promoting a fair and balanced view of financial information that ultimately drives the capital
markets and the economy. Applying technology to perform data analytics can offer insightful perspectives to policy makers, who can consider these insights to actively tailor standards to emerging transformations that may not have been previously anticipated
or included in the current standards.
In summary, accounting is relevant to policymakers because it continues to provide a common and credible framework for presenting informative and accurate financial information for the benefit of the investors. Accounting and auditing facilitate investor
trust. When there is lack of trust in the capital markets, this impacts the financial ecosystem and by extension the economy. As a result, it is important for policymakers to continue to encourage and enforce ethical accounting practices and high-quality
independent audits to intrinsically protect investors.
Thank you for inviting me to this event. It has been a pleasure speaking to you today, and now I’d like to open it up for any questions.