evaluate the role of the auditors and their relationship with management. The audit committee also plays an important role in the selection of auditors and review of the depth and direction of the annual audit schedule. Although the practice has not been uniformly adopted, I believe the annual appointment of auditors should be approved by the shareholders. As to the desirability of a mandatory change of auditors, several corporations have already adopted such a practice on a voluntary basis. However, a mandatory change requirement could also result in a lessening of the quality of audit procedures rather than improvement. I must confess I am undecided regarding such a proposal. I believe that if we are to make meaningful progress in accountability and financial reporting, we must acknowledge that a corporate management that intentionally engages in improper accounting and financial reporting may successfully avoid detection by the most careful independent auditors. To be candid, the complexity and multiplicity of accounting transactions in a multinational corporation makes it very difficult for independent auditors to assure the public that improper transactions have not occurred or that all financial reports were prepared in a uniform manner. Independent auditors engage in sophisticated sampling techniques in evaluating the adequacy and accuracy of corporate accounting. That is not to say that current auditing techniques cannnot be improved upon. There is substantial opportunity for improvement. We must recognize, however, that the ultimate responsibility that corporate accounting and financial reporting meet the required standards rests with management. The only way that management can be assured that the prescribed standards are met is to maintain a comprehensive accounting system that provides required information on an accurate and timely basis. This, in turn, requires a complex information system staffed by capable and talented people that place a high value on integrity. It also requires that management establish an internal auditing staff to continuously monitor the corporate accounting and financial reporting system to assure compliance with corporate policies. Internal auditing staffs perform functions similar to public auditors and in conjunction with them. Some corporations require internal auditors to evaluate a much wider spectrum of activity including operational effectiveness. But no matter how elaborate the internal control system and efficient the independent auditors, there is no substitute for a clear and unequivocal statement regarding financial accounting and reporting that is communicated to all employees and enforced without exception. It is diffcult for me to envision new legislation or additional regulation that would assure the adoption and maintenance of such policies. I believe it might be beneficial to shareholders and the public if the annual reports of independent auditors regarding the adequacy of accounting and financial reporting systems of publicly held corporations However, such reports would only be useful if they were written in a style that permits shareholders and the public to understand the issues and explanations. If we fail to achieve that, we will only have created another document which confuses and frustrates the recipients. As members of this subcommittee have witnessed, the issue of corporate accountability and the role of independent auditors creates controversy. Those who defend the system argue that the financial reports and statements of U.S. corporations provide many times more information to the public than similar corporations in any other country. In fact, the gap between the U.S. and the rest of the world with respect to corporate accountability has probably widened in recent years. At the same time, critics argue that what is being achieved can be done better and more information is required if the public interest is to be served. Both sides make valid arguments. What we should seek to achieve are changes in the system that result in real progress without diminishing what we have already achieved. In my view, this requires greater effort and participation by corporate management, independent accountants and regulatory and rulemaking agencies. We need wider participation in determining appropriate accounting rules to assure adequate representation of the public interest. At the same time, we need a rulemaking body that has flexibility and the ability to respond to change. I do not believe we will achieve these objectives by permitting one of the participants to retain the entire responsibility for determining accounting rules. In my opinion, the current system can be improved upon and become the best solution. The measure of the effectiveness of any change we may consider is whether or not the shareholders and general public are better informed and possess greater understanding of the activities and performance of the reporting corporations. Thank you, Mr. Chairman. Senator METCALF. Thank you, very much, Mr. Hackett. We have been fortunate today in having two representatives of the business community testify, and we are grateful that you have come here and for your patience. I think perhaps the summary that you made in your last paragraph is so important, the effectiveness of whether or not the shareholders and the general public are informed. We had today witnesses who said that we need statements that are recognizable by the public, instead of an esoteric communication that only accountants can understand. Shareholders and people that are investing on the basis of these financial reports need to be protected. So we have two things that this committee is concerned with: One, we are concerned with the protection of those people so that the accounting standards do reflect the financial position of the companies. The other, of course, is in the public sector, where we are very much concerned about accounting principles which affect the reports upon which we rely for appropriations. I again want to reiterate that I am grateful that Senator Percy, who is a part of the community that you I want to thank you both for coming and giving us your views as to what should be done in improving the accounting profession. Mr. HACKETT. Mr. Chairman, if I may make one remark, that one witness this morning stated that we needed to do a better job of educating the public with respect to financial and accounting language terms. I quite agree with that. At the same time, I think we also need to do a better job of educating finance people and accountants in writing style and general language that the public can better understand. So I believe we need education on both sides in terms of communication. Senator METCALF. I concur completely. We need to do a better job in getting the accountants to help people who are maybe not wellinformed and so forth. We don't need to educate the people up to the accountants' level. We should educate the accountants to inform the people. That is what we have to do in this area. Thank you for coming. Thank you for your patience and for putting up with what we have had to do, running back and forth on rollcalls. You have made an outstanding contribution to our hearings. This was supposed to be the last hearing in this series of hearings. but we have another hearing scheduled for Monday, the 13th, at which time we are going to hear the SEC and Congressman Baucus who is a former employee of the SEC. That will wind up the hearings. For all intents and purposes, however, you people are the last witnesses, except for the witnesses we are going to have on Monday. We are grateful to all of the witnesses who participated and testified. I feel that maybe the committee has performed a service in calling the profession's attention to some of the needs which some of you are aware of, but haven't done anything about. I hope that when we have hearings next year, you will all be able to say, "We cleaned up the whole thing and everything is going very well.” Thank you, very much. We will be in recess until Monday, the 13th. [Whereupon, at 1:20 p.m., the subcommittee recessed, to reconvene at 10 a.m., on Monday, June 13, 1977.] ACCOUNTING AND AUDITING PRACTICES AND PROCEDURES MONDAY, JUNE 13, 1977 U.S. SENATE, SUBCOMMITTEE ON REPORTS, ACCOUNTING AND MANAGE- The subcommittee met at 10 a.m., pursuant to recess, in room 6226, Dirksen Senate Office Building, Hon. Lee Metcalf (chairman of the subcommittee) presiding. Present: Senators Metcalf and Percy. Staff present: Vic Reinemer, staff director; E. Winslow Turner, chief counsel; John B. Chesson III, counsel; Jeanne A. McNaughton, chief clerk; and Burleigh Leonard, minority counsel. Senator METCALF. The subcommittee will be in order. Today we are holding the last of 8 days of hearings on improvement of the accounting practices promulgated or approved by the Federal Government. We have heard many witnesses, from large accounting firms, small accounting firms, accounting organizations, and business groups, as well as others. The subcommittee's accounting hearings have produced a broad array of pledges from the accounting profession to reform themselves. However, many witnesses have emphasized that an active SEC is essential to achieving necessary accounting reforms. Congress originally intended that the SEC would actively exercise its accounting responsibilities. I believe the members of this subcommittee realize that the Commission is the key to meeting our concern that the public is protected. Because of the importance of the SEC in achieving accounting reforms, we have invited the entire Commission here to share their individual views with the subcommittee. After we have heard from the SEC, we will have a full record upon which to evaluate the types of accounting practices which should be followed by the Federal Government regarding publicly owned corporations. Our most helpful attendee and a valued member of this subcommittee has been Senator Percy, who is very much concerned. Before I introduce the first witness, I wonder if you have an opening statement on this closing day. Senator PERCY. I have no opening statement, Mr. Chairman. I have gone over the testimony to be given by Chairman Williams. I think that we are very much in accord. We have reached a meeting of (1751) agency. I worked at the CAB also for 1 year. I thought the CAB, frankly, was dismal compared to the SEC. So maybe I am splitting hairs when I am critical of its handling of the accounting profession. But I am just trying to make a near perfect agency a little closer to perfect. That is the reason for my statement here and my presence here today. Senator METCALF. Thank you very much, Congressman Baucus. Was it your opinion, when you were legal counsel and working for the SEC. that the SEC did have authority to do the things that you are sug gesting they should do? Mr. BAUCUS. Yes; I think it did, absolutely. We checked the statutes. I thought there was at least authority for the agency to do much more. I would have to go back and reexamine the statutes today to see whether I think they have sufficient authority. Certainly there was authority to do much more in my judgment at the time. Senator METCALF. As you know, we have had some excellent testimony from some of the leading accountants, members of the accounting profession. Price Waterhouse testified that there has to be reform. Mr. Biegler suggested legislation. Some of the others suggested there should be reform within the FASB. You express some misgivings about that. Is it your opinion that if the SEC really does the job it is authorized to do, we will not need legislation? Mr. BAUCUS. I think that is correct, Mr. Chairman. On the other hand, I have some pessimistic view of human nature. That is, everybody has to be prodded a little bit. To say that the Commission finally has sufficient authority may not be enough. I think it would be wiser to suggest that the Commission in the exercise of its present authority do much more, with the full knowledge and with the warning that if it doesn't, Congress comes back with quite stringent legislation. The main point would be to obviously help encourage the SEC to perform its job. Senator METCALF. I think that is Senator Percy's idea. I think that is mine. Senator Percy? Senator PERCY. We are very grateful for your coming over this morning and the respect we have for you as a Member of Congress. You are very valuable to us. My own impression through the 25 to 30 years I have worked with the SEC is it is one of the better regulatory agencies. It is more respected I think than most others. It has a fine tradition to live up to. I think Chairman Rod Hills has done a remarkable job in this rather grim situation we have had on payoffs and kickbacks and so forth. They have moved in and done an effective job there. I think they can do a fine job in the auditing field. It says in the forthcoming testimony that we have that they will issue an annual report beginning July 1, 1978, covering all the recommendations and scope of the hearings that we have held. It may be a very, very reassuring thing, not only to the Congress |