UNIFORMITY AND DISCLOSURE: SOME POLICY-MAKING DIRECTIONS

LEARNING OBJECTIVES

After reading this chapter, you should be able to: • Understand what relevant circumstances are.

• Understand the nature of finite and rigid uniformity and flexibility. Analyze whether standards are
utilizing finite uniformity, rigid uniformity, or flexibility.

• Understand the growing role of disclosure and its relation to uniformity.

Grasp the significance of how management earnings forecasts, management's discussion and
analysis, segmental disclosures, and quarterly reporting provide important information to users.

we have seen in Chapter 7 that the FASB has developed a metatheoretical structure of accounting.
Chapter 8 discussed the many new concepts and hypotheses, largely from eco nomics and finance,
that could potentially influence a metatheory. Uni formity and disclosure and their potential place in
such a structure are the subject of this chapter.

A conceptual framework is a normative structure because both the objectives and standards are the
result of choice. If a conceptual frame work is in place, it should provide guidance for standard
setting. A quasi-deductive relationship thus exists between a metatheoretical structure and rule
making. Although theoretical work should obviously be allowed to influence a conceptual framework
as it emerges, as well as the rule-making process itself, theory and policy making lie in separate
domains. However, Ijiri has pointed out that theory and policy appear to be more intertwined in
accounting than in other fields. We have already seen that attempting to combine these functions
led to the demise of the APB. The FASB has been and will continue to be under pressure from
outside bodies and groups over its part in both the conceptual framework and standard-setting
activities. Clearly, the issues and concepts that de rive from a metatheoretical structure must be as
clear and complete as possible in order to minimize discrepancies between the structure apd
subsequent policy making. In other words, conceptual clarity and com pleteness are necessary if the
resulting standards are to be consistent with the metatheoretical structure. While the FASB's
conceptual frame work has been criticized in Chapter 7, it at least provides a theoretical structure for
assessing potential standards as they move toward fruition despite the political maneuverings by
affected groups.

In this chapter we examine two extremely important conceptual issues that must play an important
role in determining the structure and com ponents of a metatheoretical framework: uniformity and
disclosure. The FASB's conceptual framework is apparently complete, but it should be remembered
that a metatheoretical structure in a discipline such as ac counting will always be an evolving
instrument, changing in response to new needs and new research findings.

We begin with an analysis of uniformity. It is a topic discussed exten sively in the accounting
literature and statements and pronouncements of policy-making organizations, but it has not been
precisely formulated. The type of uniformity desired should influence the structure of the
metatheoretical framework. Information economics (benefits/costs con siderations) obviously play a
key role in this determination.
An appropriate starting point for understanding uniformity comes, we believe, from an analysis of
event types. Events are economic occur rences that require accounting entries. They can be
classified as simple or complex. Complex events where "effect of circumstances" exists are broadly
similar and might justify different accounting treatments than simple events. Effect of circumstances,
or relevant circumstances, are thus economically significant variables that should be identified and
categorized.

After defining relevant circumstances, we are in a better position to analyze the uniformity question.
In our opinion, there are two concepts of uniformity-finite and rigid uniformity--that have been
evolving in the accounting literature.

The uniformity section concludes with an analysis of how certain accounting standards are
inconsistent with each other from the stand point of uniformity. The term flexibility is also
introduced in this part of the chapter.

Finally, we examine the concept of disclosure including the early dis tinction between protective and
informative disclosure. We also look at the forms of disclosure including management's discussion
and analysis in the annual report, segmental disclosure, quarterly reporting, and man agement
earnings forecasts. Disclosure, we believe, will continue to grow in importance in the foreseeable
future.

UNIFORMITY

In the accounting literature, the concept of uniformity appears to over lap with comparability. For
example, Sprouse has stated:

Finally, because comparing alternative investment and lending opportu nities is an essential part of
most investor and creditor decisions, the quest for comparability is central. The term comparability
is used here to mean accounting for similar transactions similarly and for different cir cumstances
differently. A conceptual framework should foster consistent treatment of like things, provide the
means for identifying unlike things, and leave open for judgment the estimates inherent in the
accounting process.

Sprouse sees comparability as both a process (accounting for circum stances in accordance with
similarities or differences) and an end result of this process (comparing alternatives in order to make
a decision). We view comparability here only in the latter context, while uniformity is seen as the
concept that influences comparability. Because compara bility is linked to uniformity, the degree of
comparability that users can rely on is directly dependent on the level of uniformity present in finan
cial statements

The relationship between uniformity and comparability espoused here is quite close to the position
taken in SFAC No. 2. Comparability is not an inherent quality of accounting numbers in the sense
that relevance and reliability are but instead deals with the relationship between ac counting
numbers: "The purpose of comparison is to explain similarities and differences 6 However, SFAC No.
2 also stales, "Comparability should not be confused with identity, and sometimes more can be
learned from differences than from similarities if the differences can be explained."

Although uniformity and comparability are usually discussed in terms of the need to account for
similar events in a similar manner. no exten sive formal attempt has been made to specify the
dividing line between similarity and difference. Consequently, a fruitful starting point for ex amining
the uniformity issue is analyzing events.

The Nature and Complexity of Events

Transactions are economic or financial events that are recorded in the firm's accounts. An event has
been defined in SFAC No. 6 as "a hap pening of consequence to an entity":8 Transactions occur
between enti ties, between a firm and its employees, and between a firm and investors or lenders.
Transactions are thus events external to an enterprise. Events that are internal to the firm also
require entries in the firm's ac counts. Examples would include recognition of depreciation and com
pletion of work-in-process inventories. It is up to the rules of accounting to specify the necessary
criteria for event recognition. Rules of rec ognition are concerned, for example, with the question of
when to recog- nize revenues as being earned.

Another aspect of events that particularly concerns us here is their degree of simplicity or
complexity. In a complicated and involved busi ness environment, events are often accompanied by
a complex set of re- strictions, contingencies, and conditions. For example, in the case of long-tern
leases, some of the factors would be:

1. A clause in the lease providing for cancellation by either party.

2. The proportion of the asset's life the lease period is expected to Cover.

3. The possible existence of favorable renewal privileges (either for purchase or rental) at the end of
the original lease period.

Some other examples of event complexity would involve situations such as the following:

1. Acquisition of common stock for control purposes where the percentage of stock owned may
vary.

2. Differing expected usage or benefit patterns of depreciable fixed assets and intangibles.

3. Deferred tax liabilities arising from income tax allocation situations that either grow indefinitely or
decrease during the planning horizon.

Before we examine the nature of complex events further, we should men tion that there are many
events that do not have any significant economic variables that lead to essentially different
recording. We denote these as simple events. For example, payment for services acquired on
account with no discount involved would be a simple event. Some complex events may also be
handled with dispatch. Whether the buyer or vendor will pay the freight for acquired inventories is
the key issue in recording this event, but under either circumstance it is easily handled. If the buyer
pays, the situation comes under the "cost rule," which charges all costs necessary for acquisition and
installation to the asset rather than directly to expense. If the seller pays, transportation costs are
charged to a freight-out type of account. These situations are similar enough to re sult in a highly
uniform recording of events. Complex events, however, can be considerably more involved than the
freight situation and may be much more difficult to resolve. The literature uses the term effect of
circumstances to describe these situations, but we prefer the less cum bersome relevant
circumstances.

Relevant Circumstances
With regard to the complex events mentioned before, we can say that, while the variables
mentioned represent potential economic differences between relatively similar events, there are
some subtle differences as well. In the case of leases, all the elements considered would be stipu
lated in the contract; hence, they would be known at the inception of the lease (except for the
expected life of the asset). Similarly, the percentage of common stock owned is a condition that
would be known at the time of the transaction. On the other hand, expected usage or benefit
patterns of depreciable assets and the question of the drawdown or reversal of de- ferred tax
liabilities pertain to future events.

The Terminology of Relevance

Relevant circumstances are economically significant circumstances that can affect broadly similar
events. These economically significant circumstances are general conditions or factors associated
with complex events that are expected to influence the incidence or timing of cash flows. As the
preceding examples suggest, relevant circumstances are of two general types. Those conditions
known at the time of the event will be referred to as present magnitudes. Factors that can be known
only at a later date shall be called future contingencies. Relevant circumstances pertain directly to
the event being accounted for and influence the ac counting method selected to represent that
event.

Some considerations concerning future contingencies should he care- fully noted. The two cases
previously mentioned, usage or benefit pat terns of fixed Rssels and the question of reversal of
deferred tax liabili ties. have some important qualitative differences. In the case of depreciation, we
are dealing with an allocation. There are several other relevant circumstances of the future
contingency type that are alloca tions. These include amortization of intangibles, such as goodwill, re
search and development costs, and depletion of natural resources. One method of avoiding the
allocation problem for at least some future con- tingency problems is by means of current
valuations. Hence, deprecia tion and depletion, at least, could he computed as the difference
between market values of their respective assels at the beginning and end of the period. However,
in the case of the prospective reversal of deferred tax liabilities arising from an excess of accelerated
depreciation for tax pur poses over straight-line depreciation for book purposes, the reversal is not
an allocation problem but rather a prediction question based on fac tors such as the pattern of
future capital acquisitions and their tax and book depreciation schedules. At present, the
prospective reversal of de ferred tax credits is a relevant circumstance in the United Kingdom but is
not in the United States. The whole tax allocation problem is discussed in depth in Chapter 14.

Future contingencies that are allocations may have information con tent if they attempt to portray
real phenomena such as the decline in the useful life of a fixed asset, for example. Likewise, future
contingencies that attempt to predict relevant future variables involving cash flows such as payment
of deferred taxes—also have significant information content for users. However, the degree of
verifiability of predictive vari ables that might be selected as factors governing accounting methods
be comes important.
A case can certainly be made thal one of the principal tasks of a rule making body should be
identifying appropriate relevant circumstances and setting up criteria for how they should govern
the recording of events or the format of financial statements. Rule-making bodies have done this in a
rather unsystematic fashion in such areas as lease capitalization (SFAS No. 13); purchase versus
pooling (APB Opinion No. 16): and choice among full consolidation, equity, and cost methods where
com mon stock in another firm is held for control purposes (ARB 51, APB Opinion No. 18, and SFAS
No. 94). Identifying relevant circumstances, not to mention setting criteria to govern choice among
accounting meth ods or format of financial statements, is a formidable task. Whether a conceptual
framework can be useful is an important question that will be addressed later in this chapter.

The Role of Management in Relevant Circumstances

Given that relevant circumstances are an extremely important aspect of the uniformity issue, the
question arises as to whether management should have the choice of determining them. Weldon
Powell, the former managing partner of a then Big Eight firm, regarded managerial influ ence as an
important consideration in terms of allowing different meth ods. For example, if two firms acquired
the same type of fixed asset but one intended to use it intensively in the early years whereas the
other an ticipated relatively even usage throughout its life, then, from Powell's viewpoint, the first
firm would be justified in using an accelerated de preciation method and the second could go for
straight-line depreciation.

These choices might be valid, but the problem is that selection of ac counting methods might be
guided by motives different from those dic tated by the presumed relevant circumstances. These
ulterior motives would include the following:

1. Maximizing short-run reported income if managerial compensation is based on it.

2. Minimizing short-run reported income if there is fear of governmental intervention on antitrust

grounds.

3. Smoothing income (minimizing deviations in income from year to year) if it is believed that
stockholders perceive the firm has a lower amount of risk than would be the case iſ greater
fluctuations of earn ings were present.

Because management is potentially capable of distorting income measurement, Cadenhead favors

limiting relevant circuemstances to ele ments beyond managerial control, elements he refers to as
environmental conditions. Environmental conditions differ between firms and lead to either
excessive measurement costs or a low degree of verifiability rela tive to the preferred accounting
method.13 If environmental conditions possess either of these two qualities, they are designated
circumstantial variables by Cadenhead. For example, if the valuation of inventories were to be based
on the specific identification method, the cost of record keeping would be exorbitant for retail firms
having extensive inventories with a low unit value. Also, if the net realizable value of inventories
were required, costs of completion and disposal might be extremely difficult to estimate in some
industries, leading to a low degree of verifiability. Only in cases involving circumstantial variables
would Cadenhead allow departure from rigidly prescribed accounting methods.

Despite the importance of relevant circumstances in allowing differ ent accounting treatments in
generally similar transactions, little re search has been done on the topic. Nevertheless, two
concepts of uni formity have evolved in both the accounting literature and the standards
propounded by rule-making bodies without a sharp underlying definition and explication of relevant
circumstances (or some similar term).

Finite and Rigid Uniformity

Finite uniformity attempts to equate prescribed accounting methods with the relevant
circumstances in generally similar situations. The word finite was selected in accordance with the
Random House Dictionary de finition of "having bounds or limits; not too great or too small to be
mea surable." SFAS No. 13 on long-term leases provides a good example of finite uniformity. If a
lessee has a long-term lease for 75 percent or more of the estimated economic life of an asset,
capitalization is required. However, if the lease period is for less than 75 percent of the estimated
economic life of the asset, the lease is not capitalized." This lease pro- 14 vision is one of four set
down in the standard, any of which is sufficient to require capitalization on the grounds that the
lease contract... transfers substantially all of the benefits and risks incident to the own ership of the
property.. ." to the lessee, including lower annual rental costs for the property due to the long-term
nature of the lease. An obvi ous difficulty with the 75 percent lease period provision is the fact that it
attempts to draw an exact boundary where a continuum exists. Would 70 percent or even 60
percent have been a better break-point between capital and operating leases? The point is very
debatable and can never be totally resolved. Furthermore, the door is open to manipulation if m-
agement wants noncapitalization. All it has to do is extend, within rea sonable bounds, the
estimated economic life of the asset or shorten the lease period to just under 75 percent of the
estimated economic life. 15

The Need for an Alternative to Finite Uniformity

Since establishing appropriate criteria for relevant circumstances is dif ficult and often somewhat
arbitrary, an alternative type of uniformity has been implicitly formulated. Rigid uniformity means
prescribing one method for generally similar transactions even though relevant circum stances may
be present. For example, SFAS No. 2 requires that research and development costs must be
expensed even though future benefits may be present. SFAS No. 96 requires that income tax
allocation must be used even if there is no anticipated reversal of deferred tax liabilities during the
foreseeable future.

SFAC No. 2 appears to accept implicitly the idea of finite uniformity, as the following example
reveals:

For example, to find whether a man is overweight, one compares his weight with that of other men
—not women of the same height. Clearly, valid comparison is possible only if the measurements
used quantities or ratios-reliably represent the characteristic that is the sub ject of comparison. 16

But it also implicitly mentions rigid uniformity in the context of improv ing comparability (by using
the same accounting method) in situations where representational faithfulness is not the goal.
However, "improv- ing" comparability may, in reality, be counterproductive:

Improving comparability may destroy or weaken relevance or reliability if, to secure comparability
between two measures, one of them has to be ob tained by a method yielding less relevant or
reliable information. Histori cally, extreme examples ... have been provided... in which the use of
standardized charts of accounts has been made mandatory in the interest of interfirm comparability
but at the expense of relevance and often relia bility as well. That kind of uniformity may even
adversely affect compara bility of information if it conceals real differences between enterprises.
An analogy may help to explain the difference between finite and rigid uniformity as well as the
greater utility of finite uniformity. Imagine an American diplomat in Europe. In dealing with
individuals, it is impor tant to know their country of origin but it is not "correct" to ask. Diplo mat A
can only tell if individuals are European or non-European. Diplo mat B is able to tell by the spoken
accent whether individuals are (a) Slavic, (b) Scandinavian, or (e) from the rest of Europe. Diplomat C
is able to tell by a combination of accent and name the particular country of origin of each individual.
The situation faced by Diplomat A is equiv alent to rigid uniformity, while Diplomat C has achieved
finite unifor mity; B is in between. The analogies to general event similarity and rel evant
circumstances are the general European origin and particular country (or region, in the case of B) of
birth, respectively. In accounting, we presume that if finite uniformity can be attained, it is superior
to rigid uniformity from the standpoint of usefulness in decision making or per formance evaluation.
However, meaningful finite uniformity could be ob lained only at a greater cost than rigid uniformity,
so the advantage is merely relative and depends on marginal benefits and costs.

Finite and Rigid Uniformity Relative to Representational Faithfulness and Verifiability

Finite uniformity should be more representationally faithful than rigid uniformity. If a fixed asset
were to be intensively utilized in its early years, a more faithful representation of unamortized cost
and deprecia tion expense would be provided by an accelerated method of deprecia tion rather than
straight-line depreciation (depreciation accounting is presently a matter of flexibility since free
choice is allowed relative to acceptable methods). In the case of research and development costs
under SFAS No. 2, rigid uniformity is applied. Greater representational faithfulness would result if
research and development costs were ac counted for similarly to successful efforts, an example of
finite unifor mity, in oil and gas accounting: successful research and development costs would be
capitalized whereas unsuccessful efforts would be ex pensed. The finite uniformity approach would
be more relevant but less verifiable than the immediate write-off required by SFAS No. 2.

The approach to representational faithfulness under finite uniformity is that there are degrees of
representational faithfulness: more versus less. Sterling sees representational faithfulness in a binary
context: ei ther a measurement of a characteristic of an asset is representationally faithful or it is not
18 Hence, for decision usefulness Sterling believes that representational faithfulness is a prime
characteristic of usefulness that cannot be "traded off" with verifiability even though some measure
ments of relevant qualities might "lack precision." Not surprisingly, Sterling totally rejects historical
costs as a viable valuation approach in favor of current values (he preſers exit values). We believe
that both of these orientations are internally consistent (historical costs using a mix of finite and
rigid uniformity under a policy approach to be discussed shortly versus a system embracing only
current values). We opt for the finite-rigid uniformity approach on the practical grounds that many
cur rent value measurements of unique fixed assets may be hampered by se vere verifiability
problems. Let us next examine finite and rigid unifor mity in practice and examine whether a policy
for their use in practice can be developed.

The Present Status of Uniformity

Finite uniformity and rigid uniformity are, to a certain extent, ideals. At present, a mixed system
exists in which some standards attempt to take into account relevant circumstances whereas others
are clearly examples of rigid uniformity. However, we must make clear several qualifications before
giving some examples.

First, the fact that a standard is an example of finite uniformity should not necessarily be construed
to mean that the standard cannot be im proved or even that the factor selected as the relevant
circumstance is appropriate. Second, where rigid uniformity is in effect, the underlying reasons may
be attributable to one or more of the following factors: (1) a desire for conservatism, (2) an inability
of the standard-setting organiza tion to determine meaningful relevant circumstances, (3) an
attempt to increase verifiability of the measurement, (4) recognition of the fact that an allocation is
involved. (5) the perception that, given adequate disclo sure and an efficient securities market, the
costs of implementing rele vant circumstances exceed the resulting benefits. Third, another ap
proach to the uniformity problem, usually called flexibility, has formed many accounting rules.

Flexibility applies to situations in which there are no discernible rel evant circumstances but more
than one possible accounting method ex ists, any of which may be selected at the firm's discretion.
The invest ment tax credit (now defunct) was a good example of flexibility. Holding aside the
carryforward problem, which was relatively rare, no relevant circumstance appeared to be present
(unless the firm expected to hold the asset for a relatively short period, in which case the
government would have recaptured some or all of the investment tax credit benefits). O However,
APB Opinion No. 4 allowed enterprises to take all benefits immediately in the year of acquisition, or
spread them over the useful life of the asset. Either alternative was acceptable.

We will give some examples of each of the three approaches to uni formity. These examples are
intended to be illustrative only and do not cover the entire range of policies comprising generally
accepted ac- counting principles. We will highlight relevant circumstances and al lowable
alternatives; intermediate or advanced accounting texts should be consulted for in-depth discussion
of the various methods and other details.

Rigid Uniformity

There are numerous examples of rigid uniformity in official pronounce ments of standard-setting
bodies. Comprehensive income tax allocation is required by SFAS No. 109 whether deferred tax
liabilities are realis tically expected to reverse. In the case of research and development costs,
despite the presumed presence of future benefits arising from an important proportion of these
costs, SFAS No. 2 requires they be imme dialely expensed.

Finite Uniformity

Examples of finite uniformity include long-term leases and ownership of common stock of another
firm for control purposes. In the former case, any one of four conditions is sufficient to warrant
capitalization, whereas the absence of all four results in an operating lease. In the second situ ation,
ownership of various percentage ranges of common stock results in either full consolidation, equity,
or fair market value method. How ever, the FASB recognized the fuzziness of stock ownership as a
criterion for degree of control when it noted in Interpretation No. 35 that the 20 percent
demarcation point between cost and equity methods is to be con strued as a guideline rather than
an inviolable rule.

These two illustrations of finite uniformity involve situations of pre sent magnitudes. The question of
reversal of deferred tax liabilities is a case of finite uniformity where future contingencies are
involved. Re versal is a relevant circumstance in the United Kingdom where partial tax allocation
must be used: allocation must be used if reversal is ex pected to occur. In the United States, we must
allocate. The assumption is that reversal will occur. Hence rigid uniformity must be used in the
United States. Another case of finite uniformity involving a future con tingency involves loss
contingencies. SFAS No. 5 sets up two conditions under which a contingent loss must be charged
against income of the current year: (1) the likely occurrence of an adverse future event, such as an
expropriation of assets by a foreign government, and (2) the ability to make a reasonable estimate of
the amount of the loss. If either or both of these conditions are not met, disclosure of the loss
contingency (pre sumably in the footnotes) should be made if there is at least a "reason able
possibility" of a loss occurring. SFAS No. 5 can also be interpreted as an example of conservatism
because gain contingencies are not men tioned except for the statement that ARB 50 is still in effect
relative to them. ARB 50 states that gain contingencies are not reflected in income prior to
realization. However, adequate disclosure is to be made, though care must be exercised in order to
avoid misleading implications as to the likelihood of realization, 20

Flexibility

Flexibility is very prevalent in generally accepted accounting principles. In addition to the investment
tax credit, inventory and cost of goods sold accounting is another illustration of flexibility. The actual
physical flow of inventory to cost of goods sold does not fall within the definition of relevant
circumstances presented here. Nevertheless, firms may choose among FIFO, LIFO, and weighted
average methods as they see fit (of course, intertwined with LIFO is the income tax situation which
does contain exogenously determined-by government-cash flow implications). If FIFO or weighted
average is used, the lower-of cost-or-market modification is required: lower-of-cost-or-market itself
is simply a valuation procedure that has been tacked onto FIFO and weighted average methods for
purposes of conservatism.

Depreciation accounting provides a special example of flexibility. The estimated usage pattern of the
asset provides a potential relevant cir cumstance.22 However, choice among the many acceptable
methods such as straight-line, accelerated methods, and the annuity method—is again at
management's discretion and need not be related to the esti mated pattern of usage.

Another example of flexibility is provided by treasury stock that is ac- quired for later reissuance.
Among the reasons for acquisition are: (1) is- suance to employees under stock option plans, (2)
acquiring stock of an other corporation in a business combination, and (3) supporting the market
value of the stock. The cash flow consequences of these different reasons are simply not clear. It is
thus very doubtful that they could be considered as future contingencies. Nevertheless, there are
two methods for handling treasury stock acquisitions: the par value and the cost meth ods. Once
again, either method can be used at the firm's option.

Overview of Practice

The present situation in financial accounting can, perhaps, be best un derstood by means of Exhibit
9-1, which shows a two-by-two matrix with one illustration in each cell. Column I represents
situations where rele vant circumstances are present. Column II represents situations where relevant
circumstances are not present. Row A depicts transactions in which a policy-setting body has treated
the situation as if it were finite. Similarly, Row B represents transactions in which a policy-setting
body has treated the situation as one of rigid uniformity.
The cells where policy matches the complexity of the situation are LA and IIB. In IA, a relevant
circumstance is present and the policy making body has given it recognition. In IIS, no relevant
circumstance is present and the rule-making organization has attempted to treat the situation with
rigid uniformity.

The cells where suboptimization is present are IIA and IB. In IIA, no relevant circumstances are
present but the policy-selling group has set up criteria as if relevant circumstances existed. The
result is two differ ent methods of treatment that do not appear to have any real basis in fact. In IB,
relevant circumstances are present but the policy-making group

Tabel

has not been able to implement them, resulting in a situation of rigid uni formity. Situation IIA is
more serious than IB. In the former, the standard setting group has expended resources and taken
actions that were not re quired and indeed led to extremely serious problems in the case of
purchase versus pooling.23 In IB, the group restricted alternative treatments because the different
circumstances were simply not verifiable. 24 Finally, we should stress once again that even though
cell IA provides a "match" between the standard-setting body's action and the complex ity of the
situation, it is not necessarily the case that relevant circum stances have been defined and applied
optimally; or, even if they have, that the benefits of the standard exceed its costs.

Formulating Accounting Policy

How can the concepts of finite uniformity, rigid uniformity, and flexibil ity be used for formulating
accounting policy? Wherever possible, flexi bility should be eliminated. In the various event
categories, if it is pos sible to discern relevant circumstances and they can be measured and
implemented in a cost-effective manner, finite uniformity should be im plemented. On the other
hand, if the event category is either a simple event or a complex event in which finite uniformity
cannot be instituted in a cost-effective manner, rigid uniformity should be employed. These
relationships are shown in Exhibit 9-2. We should also bear in mind that similarities of accounting
methods within industries do exist, a situation which we examine next.

Tabel

Uniformity Within Industries and Relevant Circumstances

A possible aid to standard setters, if they should attempt to bring about uniformity, is that within
industries, evidence exists that there is some degree of similarity relative to accounting method
choices, particularly if they are of a similar size.25 Numerous studies, with varying degrees of
success, have also tried to categorize similarity of accounting method choices across industries to
similarities of agency (contracting) theory conditions.26 Both of these types of situations can interact
or intersect with the type of uniformity analysis and policy being discussed here. For example,
Dopuch and Pincus show that long-term FIFO users do not forgo large tax savings by remaining on
FIFO.27 Hence, the market would be receiving a "good news" type of signal when industry norms are
not followed. These types of changes can also be viewed as possible rel evant circumstances as
discussed in this chapter. The authors also see the possibility of these changes being opportunistic
behavior by man agement attempting to, for example, manage earnings and therefore in crease
managerial compensation.28 Accounting changes toward industry norms are also viewed as
providing information to the market but in the opposite direction.
DISCLOSURE

Broadly interpreted, disclosure is concerned with information in both the financial statements and
supplementary communications—including footnotes, poststatement events, management's
discussion and analysis of operations for the forthcoming year, financial and operating forecasts, and
additional financial statements covering segmental disclosure and extensions beyond historical
costs. Financial reporting is often used as an umbrella term to cover both financial statements
themselves and the additional types of information mentioned before. SFAC No. 5 (para. 9) defines
disclosure as presentation of information by means other than recognition in the financial
statements, which is contrasted with recognition in the financial statements themselves and this is
the aspect of disclosure that we largely concentrate upon. Financial reporting is so complex that the
financial statements themselves must be supplemented by other forms of disclosure iſ an adequate
picture of financial condi tions and operations is to be available for user analysis,

The Disclosure Function of the SEC

It has always been implicitly recognized that disclosure as interpreted by the SEC has two aspects.29
One of these might be termed protective dis closure since the SEC has been concerned with
protecting unsophisti cated investors from unfair treatment. The other aspect is informative
disclosure, the full range of information useful for investment analysis purposes. Obviously, there is
some degree of overlap between these functions of disclosure.

In its earlier history, the SEC stressed protective rather than informa Live disclosure., The Securities
Act of 1933 required the filing of a regis tration statement with the SEC prior to the sale of a new
issue of securi tics. Included in the registration statement and the prospectus given to the purchaser
is extensive information about the business of the issuer, the securities being sold, and the identity
and relevant financial inter ests of those distributing the securities. In addition, extensive informa
tion about the underwriter's compensation and dealings between the cor poration and its officers,
directors, and principal shareholders must be provided in the registration statement. Much of this
information is pro teclive in nature, though there is certainly informative material in the registration
statement and the prospectus. The Securities Exchange Act of 1934 extended most of these rules for
new issues of securities to sales of existing issues. In effect, then, the intention was to keep the
informa tion on the initial registration current.

Several restrictions were put into effect when a firm filed a registra tion statement: a 20-day waiting
period; delivery of the prospectus to purchasers; and the potential imposition of rather heavy civil
liability damages upon the issuer, its officers, directors, and underwriters for fil ing inadequate or
misleading information. It was thought that this pack age of restrictions would be a strong deterrent
against blatant attempts to defraud investors. The SEC also had the authority to invalidate a regis
tration or suspend it if it had already become effective if the information was either incomplete or
inaccurate in any material respect.

The Shift Toward Informative Disclosure

Although the protective and informative aspects of disclosure tended to overlap, the SEC shied away
from requiring disclosure of "soft information.” However, since approximately the early 1970s, the
SEC appears to have shifted its emphasis toward informative disclosure. For example, the
commission had always shunned inflation accounting proposals—despite the presumed importance
for informative purposes-very likely on the grounds that the data were not highly verifiable and the
average investor would probably not understand the numbers. However, after the FASB ex posure
draft on general price-level statements came out, the SEC in ASR 190 required for most major firms
supplementary disclosures of replace ment cost information for depreciation expense, fixed-asset
valuation, cost of goods sold, and inventories. It is very likely that the movement to ward informative
disclosure has occurred as a result of the efficient markets hypothesis and its conclusion that naive
investors are not at a disadvantage in the market as long as they are properly diversified.

The SEC's movement toward informative disclosure was continued by the Advisory Committee on
Corporate Disclosure to the SEC. The com mittee prepared a voluminous report in 1977 summarizing
the present state of disclosure and making further recommendations about disclo sure. Although
stating that the existing disclosure system was adequate and not in need of drastic change, it
endorsed the shift away from hard information (as signified by objectively verifiable historical data)
toward the soft information embodied in opinions, forecasts, and analyses.

Among the committee's informative-disclosure suggestions were earn ings forecasts with a "safe
harbors" provision that would protect man agement from the liability penalties of the federal
securities laws, pro vided projections were reasonable and made in good faith.30 Other forward-
looking informative data recommended by the committee in cluded planned capital expenditures
and their financing, management plans and objectives, dividend policies, and policies relative to
enter prise capital structure.31 Other informative disclosures recommended by the committee
included standard product-line classifications for segmen tal reporting, determined on an industry-
by-industry basis, and disclo sure of social and environmental information if it was expected to affect
future financial performance, such as a constant violation of the law.32

The SEC acted on the recommendations of the committee by adopting in 1979 Rule 175, which
provided safe harbor from the liability provi sions of the federal securities laws for projections that
are reasonably based and made in good faith.

Imperfections of the Disclosure Process

The system of disclosure largely in effect today is called differential disclosure. The 10-K and 10-Q
reports filed annually and quarterly by management with the SEC are basically aimed toward
professional financial analysts. They are more detailed and technical than the an nual report going to
shareholders. The analysts act as intermediaries by interpreting the SEC filings for the investing
public. Beaver believed that the emphasis on more disclosure in the annual report would down
grade the importance of the differential disclosure approach.34 Differ ential disclosure should be
distinguished from selective disclosure. The latter indicates more information available to some
individuals. This constitutes insider information and raises the possibility that those in possession of
the insider information may be able to earn an abnor mal return.

Although informative disclosure should improve the evaluation of risk and return of enterprises,
there are several important qualifications to bear in mind. An important channel of disclosure
communication is that between the corporation and financial analysts representing bro kerage firms
and investment consultants. Several aspects of this arrangement were discussed in Chapter 4. Since
financial analysts do not pay for this information, it is likely to be overproduced as compared to the
information that would have been available if it were supplied on a market-oriented basis.

However, Brownlee and Young note that timely possession of financial information results in a
benefit to the holder (and user) of that information as opposed to later users. 35 Brownlee and
Young see financial analysts as aggressive seekers of information that can profitably be sold to
consumers (who have an advantage over other consumers who do not have the infor mation on as
timely a basis). Thus, they do not see a need for extensive additional disclosures. In effect, through
their aggressive information search, security analysts cause the market for financial information to
act efficiently in terms of providing adequate and timely information (with those willing to pay for
the information better off than those who do not pay, an equitable market-type solution to the
problem).

Another argument against regulations that would require the over production of disclosure
information is the possibility of information overload: the inability of users to process and
intelligently utilize all the information provided in financial reports. Still another problem with dis
closure, mentioned previously in this chapter, is that of competitive dis advantage. For example, in
an area such as segmental disclosure, firms may be somewhat reluctant to reveal information about
product lines be cause they might give vital information to competitors and damage their own
favorable market situations. Hence, an inequitable situation may be created, since some individuals
will tend to be unfavorably affected, such as present owners of securities of firms whose competitive
advan tage is revealed. A situation like this would be an economic conse quence of an accounting
standard. In this particular case, as long as there were no bias relative to firms in terms of the
information being re ported), neutrality (SFAC No. 2) should govern the disclosure: as long as the
information required is relevant and reliable, the effect on a partic ular interest should not be
considered.

There are other perceived limitations to the disclosure process. A point that has been mentioned in
the disclosure literature is that ade quate diversification by the investor may reduce the need for
information at the firm-specific level.37 The investor's concerns, it is argued, are with firm-specific
information only insofar as it affects the portfolio. However, separating firm-specific information into
categories, that which has no effect on the portfolio and that which is useful in terms of portfolio as
sessment, appears virtually impossible.

A complementary argument involves the undiversified investor. Because unsystematic risk can be
virtually eliminated by proper diversifi cation, the question arises as to responsibilities owed to the
undiversi fied investor in terms of disclosure, since the costs must be borne largely by others (costs
passed on to customers of the firm or lower dividends for all stockholders, for example).39 However,
it is difficult to separate in formation useful specifically for undiversified portfolios and that which is
also useful for diversified portfolios-not to mention the difficulty of separating information that is
portfolio-specific from that which is firm specific. Furthermore, if undiversified investors are also
among those possessing less information, a very reasonable hypothesis is that other parties would
gain by additional disclosure, the equity argument that all users benefit by additional disclosure,
mentioned before. Hence, the cost-benefit argument against additional disclosure to benefit
undiversi fied investors is somewhat mitigated.

Lev, however, has also made a very strong argument in favor of addi tional disclosure.40 Additional
disclosure benefits all users. The prob lem with information asymmetry (which is defended by
Brownlee and Young) is that those who do not have information will tend take de fensive measures,
such as not dealing in securities where limited infor mation is present, buying diversified portfolios,
or even staying out of the market altogether. When this occurs, a "thin" market results and those
with additional information would not get the full benefit of their advan tage. Hence, on the grounds
of equity, Lev favors additional disclosure (such as management's forecast of earnings), which is
beneficial to all parties: those having additional information as well as those not pos sessing this
information.
Moreover, Lev believes that there is a complementarity relative to the favorable effects of disclosure
for users that is also beneficial to the en terprise itself and its management. He believes that the firm
should have an organized disclosure policy that dovetails with corporate policies in production,
marketing, and investment. These disclosures would in volve areas such as new product
announcements, earnings forecasts, and research and development budgets. Lev would not restrict
disclosures to "good news" items only. He also advocates "bad news" disclosures such as justifying
dividend decreases because forthright announcements over the long run should mitigate the
adverse effect of the event itself. An or ganized disclosure policy is beneficial to all parties because
uncertainty about the firm is reduced over the long run, leading to higher security prices, lower price
volatility, and reduced spread between bid and ask prices, resulting in greater liquidity of the stock
(Chapter 4).

Forms and Methods of Disclosure

In this section we survey several forms of disclosure. We commence with Management's Discussion
and Analysis in the annual report.

Management's Discussion and Analysis

Since 1968, the SEC has required firms to include in their annual report a Management's Discussion
and Analysis (MD&A) section which would give readers a prospective view of future operations and
cash flows. 2 "Safe harbors" have been provided for forward-looking information as long as it is
determined on a reasonable basis and in good faith. Both ret rospective and prospective information
are required but the former basi cally serves as a benchmark for the latter. Specific information
required includes:

1. results of operations including information on selling price changes, cost changes, and volume
changes;

2. assessment of the enterprise's future liquidity;

3. capital resources and planned capital expenditures; 4. known trends, uncertainties, and future
events which might have a material impact upon numbers (1)-(3).

Signalling and Management Earnings Forecasts Signalling theory appears to be largely consistent
with the advocacy of greater disclosure. It is posited in signalling theory that firms with undis closed
"good news" information will attempt to distinguish themselves from firms not having good news"
by informing the market of their sit uation. The market, in turn, should reward these firms by
favorable price effects upon their securities. The non-disclosing firms that are assumed to have "bad
news" are then subject to price declines. Notice that sig. nalling theory is generally consistent with
the semistrong form of the efficient-markets hypothesis.

One form of signalling is in the area of voluntary disclosure of earn ings forecasts. Lev and Penman
found that firms that disclosed expected favorable earnings were indeed rewarded by favorable
changes in secu rity prices. However, they also found that non-disclosing firms in the same industry
as forecasting firms were not negatively affected by not publishing their earnings forecasts
Furthermore, some firms that did disclose "bad news" were subject to negative price reactions,
which is also consistent with the efficient-markets hypothesis. 45 This is not, how ever, necessarily
consistent in the short run with Levis general ideas regarding additional voluntary disclosure,
although Lev's disclosure ideas are more applicable to the long run.
Going beyond earnings forecasts, Kasznik and Lev are concerned with management disclosures in
the face of a major earnings surprise." 16 This type of disclosure may take the form of conference
calls with analysts or public announcements via news services such as Associated Press.
Approximately half of these firms did not provide any prior infor mation whatsoever to the major
earnings surprise. However, of those making announcements, firms with negative earnings were
twice as likely to provide information as those having positive news. Those firms providing
information of major earnings surprises were generally larger than firms not providing information.
Also, the larger the surprise, the more likely is management to communicate the information.

Segment Disclosure and Report of the Special Committee on Financial Reporting of the AICPA
(Jenkins Committee Report)

The Special Committee (hereinafter the committee") report was begun when the committee was
formed in 1991. The report was published in late 1994 and definitely represents a major effort
undertaken by the AICPA.47 The AICPA Board of Directors, which created the committee, gave it the
charge to recommend information that management should provide for users and the extent to
which auditors should report on this information. Unquestionably, the committee has attempted to
increase the importance of financial reporting in the areas of prediction and ac countability in
accordance with the relevance quality of SFAC No. 2 with, perhaps, more emphasis on predictive
uses emphasizing improving resource allocation decisions as opposed to accountability purposes.
The vehicle for improving financial reporting is largely in the area of im proved and additional
disclosures, with some emphasis upon changing the formatting of the financial statements.

The committee was concerned with helping users understand the na ture of a company's business
including the nature of its products and ser vices, understanding management's perspective and
what its plans are, and the risks and opportunities it faces. To accomplish these important goals, the
committee would really like investors and creditors to have an increased portion of management's
own information, which would cer tainly eliminate some insider trading advantages. The committee
disclo sure suggestions appear to have come largely from extended discussions with users.

Key disclosures recommended in the report are the following:

1. Segmental disclosures. Increasing the usefulness of segment report ing may be the single most
important purpose that the committee could accomplish, according to users who were questioned
by the committee. Users felt that SFAS No. 14 enabled firms to define seg ments too broadly. A
narrower segmentation in accordance with management's own uses was what was desired.
Important data on segments included gross margin numbers, core activities (see fol lowing), cash
flows, and working capital requirements. Geographic information was perceived to be less important
than primary indus try segments, but its presentation in accordance with management's Own
segmental information was also what was desired.

The committee was clearly cognizant of the costs of these disclo sures. These lie mainly in the area of
competitive disadvantage. The report stresses that some of this information is already known by
com petitors. In addition, costs would be reduced by discovering informa tion about competitors as
an offset of giving up information about one's own enterprise. It would appear, therefore, that
competitive disadvantage costs would fall most heavily upon industry leaders.

2. Report core and non-core activities separately. Core activities are usual or recurring activities,
whereas non-core activities are either unusual or non-recurring (or both). Hence, non-core activities
are broader than extraordinary items (APB Opinion No. 30), which muat be both non-recurring and
non-operating. Interest income and inter est expense would be included in non-core activities since
financing activities would not be a core activity. In addition, intra-statement income tax allocation
would be employed with tax expense split be tween core and non-core activities. The traditional
income statement is compared with the proposed statement in Exhibit 9-3.

The core/non-core concept would also be extended to the bal ance sheet and the cash flow
statement. In the balance sheet, non core assets are not put into separate classifications as in the
income statement. Instead, non-core current assets would be listed as the bottom item in the
current assets and non-core assets that are not current would be shown as the last item in the other
assets section, The same distinction applies to non-core current liabilities and other liabilities. The
report favors the retention of historical costs. However, the non-core assets and liabilities of a non-
monetary na ture would be carried at fair market value.

The committee's recommendation for the cash flow statement is that it be separated between core
and non-core activities. This di chotomy would mean that the present separation between financing
and investing activities would not be justified

Tabel

3. Interim reporting. Users desired to have separate fourth quarter in terim financial statements. SEC
filings presently require the first three quarters to be filed separately, but the fourth quarter is not
separated out of the annual financial statements. Users also desired to have segments accounted for
on a quarterly basis.

4. Other recommendations. While no distinction was made in the re port, the following
recommendations appear to be secondary. Improve disclosures for assets and liabilities with low
verifia

a. bility. These assets and liabilities should be identified with fur ther discussion of how the
measurements were derived as well as information about underlying assumptions and future events
considered in the measurement.

b. There should be more disclosures about innovative financial in struments (financial derivatives)
and off-balance sheet financ ing arrangements. The latter include lease arrangements and asset
securitizations. Securitizations involve sales of financial assets to a trust that issues securities to
investors. One of the significant issues relative to securitizations is whether the seller retains any
interests in the assets, which could result in either risks or retums stemming from the assets.

c. Users do not need forecasted financial statements, but they do need information that will enable
them to make their own forecasts.

d. The report is less concerned with eliminating alternatives in similar event situations (uniformity)
and more concerned with providing disclosure about alternatives and methods selected. Specific
mention was made of maintaining both the purchase and pooling methods in business
combinations.
e. Valuing internally generated intangibles such as goodwill was frowned upon. The report does not
believe that valuing inter nally generated intangibles would be particularly useful for helping users to
value enterprises because these measurements would have a low degree of verifiability and their
effect upon ture cash flows is difficult to determine. fu

f. Since the report desires to expand disclosures, it also calls for eliminating less relevant disclosures.
Hence, disclosures intended to educate users as new standards are introduced should be eliminated
when users become familiar with the stan dard.

The Special Committee Report is both valuable and useful. It has led to SFAS No. 3, a standard that
we examine next.

SFAS No. 131

The FASB implemented major parts of the special committee report in SFAS No. 131. As opposed to
SFAS No. 14's broad choice among major segments including products, production processes, and
marketing channels, SFAS No. 131 requires segment reporting by "management approach which... is
based on the way that management organizes the segments within the enterprise for making
operating decisions and as- sessing performance. 918 This is clearly intended to follow through on
the committee's segmental disclosure recommendation. Assuming that there are no escape hatches
from the intent of the standard, SFAS No. 131 rep resents an important advance in segment
reporting.

There is a question, however, relative to measuring segmental profit or loss. Reconciliation of

segment profit or loss to the enterprise's con solidated income may be done either to consolidated
income before in come taxes, extraordinary items, discontinued operations, and the cu mulative
effect of changes in accounting principles or to consolidated income after these items have been
deducted. To what extent this diver sity in financial reporting would effect comparability is an open
ques lion. 9

An operating segment is constituted by having either 10 percent or more of combined revenue, both
internal and external, of all operating segments; essentially 10 percent of combined profit of all
operating seg- ments; or 10 percent of the combined assets of all reporting segments.50 At least 75
percent of total consolidated revenue must be included in the reportable segments.

Segments assets must also be reported. Segment liabilities, however, are optional. In the balance
sheet area, SFAS No. 131 falls short of the special committee's report. In addition, segment cash
flows are not re quired.52 As with SFAS No. 14, SFAS No. 131 requires, where applica ble,
information by major geographical segment and by major customers where any individual customers
constitute 10 percent or more of corpo rate revenues. A new feature of SFAS No. 131 is that
segmental infor mation in interim periods must contain information on segment rev enues, segment
profit or loss, and segment assets.

While SFAS No. 131 has been outstanding only for a relatively short time, it appears to significantly
improve upon SFAS No. 14.
Quarterly Information

The SEC requires many publicly traded companies to disclose quarterly financial data. Interest in
these reports have perked up significantly in our age of instant information and communication. We
have already mentioned that in SFAS No. 131 quarterly earnings must also be disag gregated by
segments in terms of revenues, profit or loss, and segment assets.

Interim reports should include, among other items, income statement data and basic and fully
diluted earnings per share numbers. Balance sheet and cash flow statements are encouraged but not
required.

Perhaps the principal theoretical issue underlying quarterly data is whether each interim period
should be viewed as a separate period standing on its own called the discrete view as contrasted
with the inte gral view, which sees each quarterly report as a link or portion of the an nual report.
APB Opinion No. 28 favors the integral approach but the ground is not completely settled on this
issue. From a theoretical stand point, the integral view has more validity because a year is a natural
pe riod of time and many actions and events occurring during the year are really parts of a greater
whole. For example, pension expense, post retirement benefits other than pension, bad debts, and
management bonuses should be allocated among interim periods. In addition, interim income taxes
should be determined based upon the estimated annual ef- fective tax rate. Nevertheless, there are
items that are discrete to partic ular quarterly segments. Certainly sales and related cost of goods
sold as well as other types of revenues are discrete to particular quarterly seg ments where
recognition and matching occur. Similarly, extraordinary items should be charged or credited as
incurred within particular qu ters. While there are many quarterly issues that still remain to be defin
itively solved, the integral approach should hold sway except where events are very specific to
particular quarterly segments.

Despite the problems of the disclosure process, our value judgment is that, on balance, the
operations of securities markets and investors, as a totality, will benefit by expanding the disclosure
process. One piece of evidence supporting this position is provided by Sengupta. 5. He found in
Financial Analysts Federation ratings of corporate disclosure prac tices that highly evaluated firms
have a lower risk premium-due to quantity and quality of disclosures and a resultant lower cost of
debt.

Along the same line, Lang and Lundholm found that firms with more in formation disclosure policies
have a greater analyst following, more ac curate analyst earnings forecasts, and less volatility in
forecast revisions (analysts revise their own forecasts in light of management's own fore 55 casts).
Aspects of the disclosure process that we next examine involves several types of differential
disclosure.

Differential Disclosure Proposals

We examine three aspects of differential disclosure here: small versus large firms, summary annual
reports, and SEC streamlining attempts. The only one making any headway at this point is small
versus large firms.

Small Firms Versus Larger Firms

A contention is that small firms incur significantly higher costs than large ones in carrying out
complex accounting standards or disclosure re quirements, Hence, the FASB (and the SEC) has
provided some relief to smaller firms. S7 The FASB specifically considers implications of dis closures
for smaller firms with the express purpose of requiring disclo sures only where they are relevant and
cost effective. Furthermore, the FASB established a Small Business Advisory Committee of the
Financial Accounting Standards Advisory Council for facilitating communication concerning financial
reporting for both small enterprises and small pub lic accounting firms. Nevertheless, balancing costs
against benefits in fi nancial reporting for small firms is not an easy task. For example, SFAS No. 33
on current cost and constant dollar disclosures (essentially simi lar to general price-level
adjustments) was applicable only to firms hav ing either in excess of $125 million of property, plant,
and equipment or a billion dollars in total assets; similarly, privately held companies which are
generally smaller than publicly held firms are exempt from segmental disclosures and earnings per
share requirements.

However, recent research suggests that the disclosures of small firms, such as earnings
announcements as well as published financial state ments, have more information content than the
statements for larger firms. 58 The reason for this may be that much less information is pub licly
available on smaller firms, which makes their published financial statements and related disclosures
relatively more important for in vestors and therefore more comprehensive.59

Summary Annual Reports

Summary annual reports (SARs) are condensed financial statements that omit or boil down much of
the detail contained in the traditional audited financial statements and are a new development in
disclosure. Informa tion on property, plant, and equipment as well as expense breakdowns are
highly aggregated in SARs and most footnoted information is omit ted, though it may appear in the
management discussion and analysis. The management discussion and analysis in the SAR, on the
other hand, is generally more expansive than the one appearing with the traditional audited
financial statements in the corporate annual report. The SAR is intended to replace the traditional
corporate annual report and to be more understandable.

SARs evolved from a 1983 study sponsored by the Financial Execu tives Research Foundation (FERF)
of the FEI, which was concerned with the readability of corporate annual reports. After some
reluctance, in late 1986 the SEC accepted General Motors' proposal to prepare a SAR, but only after
General Motors agreed to append the fully audited financial statements including footnotes to the
proxy statement mailed to shareholders prior to the annual shareholders' meeting. In addition,
shareholders would still be able to acquire upon request copies of the firm's Form 10-K filed annually
with the SEC. Approximately 40 firms have prepared SARs since 1987 in place of the corporate
annual report.

The crucial issue is whether SARs constitute differential disclosure or selective disclosure. As long as
Form 10-K is considered publicly avail able information as well as the fact that audited financial
statements are attached in total to the proxy statement, many would undoubtedly see SARs as
differential disclosure. Nevertheless, two recent studies do raise significant issues. Nair and
Rittenberg question the use of SARs on the basis of the conceptual framework qualitative
characteristics of com pleteness, comparability, and understandability, particularly because of the
aggregation procedures that they think do not provide enough detail to elicit a full, meaningful
interpretation of enterprise operations. They also observe that while some firms have favorably
reacted to SARs, oth ers have expressed considerable skepticism.61 Lee and Morse did not observe
any overt attempts to obscure or mislead users in SARs—as op posed to the full financial statements
—but they were concerned with whether SARs can actually provide full disclosure and whether
auditors can really comply with GAAP.62 The wide use of SARs would be a rev olutionary
development in financial reporting.

SEC Attempts to Streamline Annual Reports

The SEC has also been interested in cutting down the size of the annual report. In 1995 it proposed
that financial statements in annual reports be streamlined by reducing the number of footnotes
(unlike SARs, which condense information in the body of the statements). The proposal was
abandoned about three months after it was introduced because many in vestors thought they were
being deprived of important information. Also, preparers responding to the SEC did not think that
their administrative burdens were being seriously reduced since all footnote information still had to
be filed with the SEC. The SEC proclaimed, however, that it would still continue its efforts at
streamlining.

SUMMARY

Under finite uniformity, policy-making organizations attempt to take into account relevant
circumstances in broadly similar event situations. Policy making bodies do not attempt to cope with
relevant circumstances under rigid uniformity. Their chief concern under rigid uniformity is to limit al
ternatives, which in turn, would lead to greater verifiability but less rel evance. Relevant
circumstances are different economic factors leading to potentially different patterns of cash flows
in broadly similar types of event situations.

Although finite uniformity should lead to greater relevance because rule making attempts to take
into account appropriate circumstances, it is not at all clear that the resulting additional benefits
would exceed the incremental costs of implementation. Certainly a more extensive metatheoretical
framework would be needed to delineate the accounting re quired for relevant circumstances. In
addition, extensive empirical re search would have to be focused on the search for relevant
circumstances.

Finite and rigid uniformity are ideals. It is unlikely that either could ever be totally and consistently
applied. At present, examples of both rigid and finite uniformity can be found in various
pronouncements of rule-making bodies. Perhaps finite uniformity could be instituted in event
situations where alternatives can be measured with a high degree of reliability and in a cost-effective
manner. Certainly one step that might be taken is to eliminate alternatives in event situations where
it does not appear that relevant circumstances exist.

The great complexity of business and financial and operating events means that financial statements
must be supplemented by an increasing array of disclosures. These include management's discussion
and analy sis, management earnings forecast (which is still optional), segment dis closure, and
quarterly financial reporting. The first two look forward whereas the last two provide feedback.
Relative to segment disclosure, SFAS No. 131 will hopefully provide an improvement over SFAS No.
14 because the disclosure supposed to accord with management's own way of making operating
decisions and assessing segmental performance. In the realm of differential disclosure, small firms
have received some amount of relief relative to financial reporting relative to large firms but
summary annual reports have not really caught on nor has the SEC's at- tempts to streamline
financial reporting. Despite some shortcomings with the disclosure process, it can only become more
important in the future.