Critical accounting policy and estimate disclosures: Company response to the evolving SEC guidance

In late 2001, soon after numerous financial reporting failures including the much publicized demise of Enron, the SEC began a series of initiatives to improve critical accounting policy (CAP) and critical accounting estimate disclosures included within the MD&A section of Form 10-K. The first announcement, in the form of cautionary guidance, was issued in December 2001. This was followed by a Proposed Rule in 2002, and additional disclosure guidance near the end of 2003. Combined, the guidance required companies to provide information that would help investors understand the impact of estimates, accounting policies and external factors on financial results. Through 2007, the SEC continued to provide guidance as to the content of CAP disclosures in the MD&A.In this study, we assess the extent to which companies responded to the initial CAP guidance, and determine the extent to which company disclosures changed with additional SEC guidance by analyzing CAP disclosures included in the 2001 and 2003 10-K filings for 112 of the Mid-Cap 400 companies. Our findings indicate that most, but not all, sampled companies included 2001 CAP disclosures consistent with the cautionary advice. We find that the disclosure content increased from 2001 to 2003, and that the disclosure quality also increased. However, some items remained underdisclosed in 2003, indicating that even after a 2-year period in which the SEC continued to provide additional guidance and reviewed company CAP disclosures, companies were not fully disclosing content identified as important by the SEC, particularly when the guidance was included in the Proposed Rule.