Accounting Principles

SEC Comment Letter from Hell -- Segments

noreply@blogger.com (Malcolm McKay) — Tue, 01 Mar 2016 17:37:00 +0000

Always thought this was one of the worst comments to receive from the SEC, questioning segment reporting. This was a comment by the SEC to Verizon. See the comment below, and Verizon's full (20 page!) response letter here. The SEC was not quite done with them and Verizon had to respond to a follow-up letter here and (ouch) a third time here.

Note 14. Segment Information

You disclose that you have operations in two reportable segments, Wireless and Wireline. We note on page 8 that you organize your Wireline service and product offerings by the primary customers targeted. In addition we note the remarks in your earnings calls of the impact on operating results of the FIOS platform. To help us understand how you applied the guidance in FASB ASC 280 in identifying your operating segments, please provide us with the following information:

● Provide your organization chart which identifies the positions, roles, or functions that report directly to your chief operating decision maker (“CODM”) and senior management team;

● Tell us the title and describe the role of your CODM and each of the individuals who report to the CODM;

● Identify for us each of the operating segments you have determined in accordance with FASB ASC 280;

● Identify and describe the role of each of your segment managers;

● Tell us how often the CODM meets with his/her direct reports, the financial information the CODM reviews to prepare for those meetings, the financial information discussed in those meetings, and who attends those meetings;

● Describe the information regularly provided to the CODM and tell us how frequently it is prepared;

● Describe the information regularly provided to the Board of Directors and tell us how frequently it is prepared;

● Describe the information about Wireline’s product and service offerings that are provided to the CODM, tell us whether there are managers accountable for the product and service offerings, and if so, tell us who they are accountable to;

● Explain how budgets are prepared, who approves the budget at each step of the process, the level of detail discussed at each step, and the level at which the CODM makes changes to the budget;

● Describe the level of detail communicated to the CODM when actual results differ from budgets and who is involved in meetings with the CODM to discuss budget-to-actual variances; and,

● Describe the basis for determining the compensation of the individuals that report to the CODM.

Your Next Activist Shareholder May Not Want More Money

noreply@blogger.com (Malcolm McKay) — Fri, 04 Apr 2014 11:00:00 +0000

Shareholders are driving changes in corporate policies and disclosures unthinkable a decade ago, on issues ranging from protecting rain forests to human rights. Even the threat of a proxy vote can be enough to bring company executives to the negotiating table.

So far this year, environmental and social issues have accounted for 56% of shareholder proposals, representing a majority for the first time, according to accounting firm Ernst & Young LLP. That is up from about 40% in the previous two years, and means shareholders are increasingly voting on things like greenhouse-gas emissions, political spending and labor rights.

While such proposals usually don’t grab the same headlines as changes sought by activist investors, their proponents often are effective at persuading companies to meet them halfway.

The proposals are “really meant to get the attention of the corporate leadership,” said Thomas DiNapoli, the New York comptroller who oversees the $160.7 billion New York State Common Retirement Fund. “Profitability that is at a sustainable and responsible level is very, very important to us.”

Mr. DiNapoli filed about 65 resolutions this past year, and he often succeeds in getting companies to agree to his requests before they come to a vote.

Last week, he persuaded grocer Safeway Inc. to make products with palm oil produced in ways that don’t hurt rain forests. In February, in response to proposals from Mr. DiNapoli and others, AT&T Inc. published its first “transparency report” on requests from the National Security Agency and law-enforcement agencies for customer data and phone records.

In both cases, he withdrew his proposal after the companies agreed to make changes.

Resolutions calling on companies to report their political spending and lobbying efforts are the top two shareholder proposals this year, according to EY’s review of some 700 proposals. By contrast, last year’s proposals were dominated by traditional corporate-governance topics, such as eliminating staggered terms for directors and appointing independent board chairmen.

More surprising still are the results. Nearly 80% of companies in the S&P 500 index now disclose at least some information about their political-spending policies, according to the Center for Political Accountability, a practice virtually unheard of a decade ago. Some 53% now publish sustainability reports, according to the Governance and Accountability Institute, addressing such matters as their energy efficiency and labor standards.

And, about 22% have human-rights policies, according to the Conference Board, a private research group.

Among the reasons for this year’s surge in social and environmental proposals is the strong stock market, which has left shareholders little room for complaints about performance.

“You’re not seeing the same sort of push-back on executive compensation this year,” said Wendy Hambleton, national director of the Securities and Exchange Commission practice at accounting firm BDO USA LLP.

The shareholders who push for these proposals aren’t agitating for higher returns like activists Dan Loeb and Carl Icahn but rather are long-term investors at pension funds, unions and coalitions of socially conscious shareholders.

For example, the American Federation of State, County and Municipal Employees, a labor union for public employees, has been pressuring dozens of companies to disclose their lobbying activity this year. Ceres, a nonprofit group that advocates sustainable business practices, is helping investors at many companies write environmental resolutions.

As investors win battles at some companies, they hope peer pressure will convince others to follow suit.

On Monday, Exxon Mobil Corp. issued its first carbon risk report, explaining whether changing emissions regulations might move it to abandon high-cost oil and gas reserves. Sustainability-focused investment firm Arjuna Capital had submitted a shareholder resolution seeking that information.

Exxon said it was “confident” that none of its hydrocarbon reserves would become “stranded.”

“This is helping set the standard for what companies should be disclosing,” said Danielle Fugere, president of As You Sow, a nonprofit group that worked with Arjuna on the resolution. The group is circulating the agreement as an example for other oil companies where it has similar proposals pending, including Consol Energy Inc., Hess Corp., Chevron Corp. and Anadarko Petroleum Corp.

Of course, environmental and social resolutions generally aren’t binding and many never make it to a vote. Companies often can exclude them on technicalities, and about 30% are withdrawn after their backers negotiate or reach deals with companies.

Typically, the environmental and social proposals that make it onto the ballot receive about 21% of shareholder votes, compared with 33% for shareholder proposals overall, according to EY.

But even failures can have an impact, especially if investors target an issue that resonates with a company’s customers. Activists often cite a 1999 vote to halt sales of wood from old-growth forests at Home Depot Inc. Around 12% of the home-improvement chain’s shareholders supported the proposal, but the retailer stopped selling that lumber.

A handful of these resolutions have garnered a majority of votes. Last year, at fertilizer maker CF Industries Inc., shareholder proposals calling on the company to disclose political contributions and publish a sustainability report each received more than 65% support.

CF Industries initially objected, saying the reports would be costly to produce and “an imprudent consumption of our resources.” But it began producing them after the shareholder votes.

CF spokesman Daniel Swenson said the engagement with shareholders has “resulted in valuable feedback” and contributed to the company’s decision making. He wouldn’t say how much the reports cost to produce.

Shareholder proposals on these issues are expected to gather steam as more companies agree to disclosures. Boston-based Walden Asset Management has submitted several political-spending disclosure proposals to companies this year on behalf of clients. According to Timothy Smith, a director at Walden:

“We’re getting to the point where companies are not just listening to a squeaky shareholder, but doing this because they believe it is a good thing to do for the company,”

By Emily Chasan at the Wall Street Journal

FASB, IASB Can't Agree on Financial Instruments Accounting

noreply@blogger.com (Malcolm McKay) — Thu, 03 Apr 2014 15:53:00 +0000

YOU MIGHT have long suspected it, but now it's official: the IASB and the US Financial Accounting Standards Board have failed to develop a common financial instruments accounting standard. We have no convergence.

The reality about the lack of a single asset impairment model emerged during a 23 January IASB meeting. It leaves preparers playing piggy in the middle between the competing IFRS and US GAAP models.

Speaking at the meeting, Hans Hoogervorst, chairman of the IASB, said the two boards would meet later this year "once the two models are completely clear". Regulators, he explained, have the option of imposing "additional disclosures" in order to bridge the gap.

Hoogervorst, a former Dutch securities regulator and finance minister, added: "But we cannot let the preparers pay the price for the two boards not getting completely converged."

On 20 February there was worse to come. On the parallel effort to finalise the board's approach to classification and measurement, Hoogervorst was forced to concede: "What can we say? A lot of work has been done for nothing, it seems."

IASB member Patrick Finnegan was equally blunt in his assessment: "I would just observe the same thing. I joined this board with a full expectation that there were great aspirations for global convergence in three or four major areas. ... It is a terrible disappointment, in my opinion, for global investors.

"I'm not quite sure what more we can do if the two boards continue to work the problem ... but the FASB has decided not to continue with the current IFRS 9 proposed work plan that we developed, and unfortunately that's the way it is."

The board also voted to fix a new effective date for IFRS 9, Financial Instruments, of 1 January 2018. IASB members were reluctant to delay the standard, or make further changes to it, pending decisions on the linked insurance contracts literature.

Later that same meeting, staff reported that the FASB will almost certainly reject two central features of the IFRS 9 classification and measurement approach - the business model and the contractual cash flow assessments for amortised cost.

So how did it come to this? The IASB embarked on its project to replace IAS 39 in early 2009. It is possible to distill any number of motivations and drivers for the project: to respond to the financial crisis; to reduce complexity; to address the too-much too-late criticism of the IAS 39 incurred-loss impairment model.

The project began under the chairmanship of Sir David Tweedie, and glancing back at an official IASB project summary document from 2009, a fully-fledged classification and measurement, impairment and hedging model was supposed to be in place by the final quarter of 2010.

As is now plain to see, the board failed. In 2009, it issued the first completed phase of IFRS 9, which dealt with the classification and measurement of financial assets. It followed this in 2010 with a further module addressing financial liabilities and the fair value option.

In its 2013 iteration, the standard has acquired a new hedging model. This approach to hedging is something of a marmite experience. On the one hand, its supporters claim it will make hedge accounting available in more situations; its critics point to its complexity.

Also in 2013, the board put out proposals to add a new category - fair value through OCI [other comprehensive income] - to IFRS 9. Redeliberation of those proposals is now complete and the IASB has confirmed it will include the FVOCI category alongside fair value and amortised cost.

Since 2009, the standard has also featured a presentational option that allows entities to book gains and losses on fair value holdings of equity investments in OCI. And impairment? Well, the board published its first proposals in November 2009 and followed this with a so-called supplementary document in January 2011. The 2011 document marked the high-water mark of the convergence drive with the FASB.

From that point onwards, what was supposed to be a convergence effort degenerated into a religious war. If the pre-crisis years had been marked out by the clash of fair value and amortised cost, the new battle lines were between 12-months initial loan loss allowance and the FASB's preference for full lifetime expected losses on initial recognition.

And it was here that the convergence effort truly floundered. But as insurmountable though the technical challenges of two competing financial instruments models might appear, there is a much bigger issue: politics.

In recent weeks, the European Parliament has shown an increased willingness to challenge the IASB, even going so far as to propose linking funding for the IASB's activities to specific outcomes.

Separately, the G20 nations have urged the two boards to come up with a single financial instruments model. At some point in time, Hoogervorst is going to have a very awkward conversation with his political masters.

by Stephen Bouvier at Financial Director

Experts Say Use Non-GAAP Measures Carefully

noreply@blogger.com (Malcolm McKay) — Thu, 27 Mar 2014 15:34:00 +0000

Normalized adjusted EBITDA less capex. Adjusted consolidated segment operating income. Adjusted EBITDA (as adjusted). Even enthusiasts of non-GAAP metrics have to admit that such measures often sound just a wee bit ridiculous.

Non-GAAP metrics, those not addressed in U.S. generally accepted accounting principles, are as controversial as ever. A small number of such measures, like EBITDA and free cash flow, have gained widespread acceptance in the investor community. But regulators often give companies flak for the way they use non-GAAP measures in public filings, press releases and other communications consumed by investors and analysts.

Groupon, the perpetrator of “adjusted consolidated segment operating income” (ASCOI), took heat from the Securities & Exchange Commission in 2012 because the metric excluded online marketing expenses, a critical part of the firm’s business model, from company performance. Groupon eventually dropped the metric from its initial public offering filing, but it absorbed further criticism for its post-IPO use of other non-GAAP measures.

Black Box, a telecommunications company, got some bad press in January 2013, when it included the metric “adjusted EBITDA (as adjusted)” in its quarterly earnings release. The metric subtracted from net income ordinary expenses such as a $2.7 million loss on a joint venture, creating EBITDA (as adjusted), then further excluded stock-based compensation expenses to create the final, rather silly-sounding redundancy. Black Box said the measure demonstrated its ability to service its debt. Others thought it made the company look like well, a black box.

A common opinion is simply that non-GAAP metrics are misleading to shareholders. “They may be perfectly understandable to accountants who know what that company is doing but confusing to others,” says Michele Amato, partner at accounting firm Friedman LLP. Indeed, the SEC has long subjected companies that use non-GAAP metrics to heightened scrutiny, and the chairman of the commission’s new accounting-fraud task force has vowed to keep up the pressure.

But companies that use these black-sheep metrics argue that they often depict financial performance more accurately than GAAP measures and afford investors a window to how management sees things.

Public companies are allowed to disclose non-GAAP metrics in their SEC filings, press releases and earnings calls, subject to certain rules. Under Regulation G, mandated by the Sarbanes-Oxley Act, use of a non-GAAP financial measure must be accompanied by the most directly comparable GAAP measure and a reconciliation of the two metrics.

Everything in Moderation

For her part, Amato says there’s a place for non-GAAP metrics:

“A very significant variance between GAAP and non-GAAP metrics that management uses as a baseline for internal financial analysis might be of some use,”

There is nothing wrong with using a non-GAAP metric to provide an additional perspective about something very germane to the company’s performance, like its valuation, credit standing or working-capital management, that can’t be communicated well through GAAP metrics alone, says Robert Rostan, CFO and principal at financial training firm Training the Street.

Original article by Marielle Segarra ad CFO.com

Is the Smartest MD&A the One With the Most Jargon?

noreply@blogger.com (Malcolm McKay) — Wed, 26 Mar 2014 00:22:00 +0000

“Plain English Works” in MD&A Statements

Those who prepare MDAs don’t have to prove how smart they are by using financial jargon, suggests the SEC’s ex-corporate finance director.

Excessive financial jargon in documents filed with the Securities and Exchange Commission often clouds intended messages, said speakers at an American Institute of Certified Public Accountants conference this week.

The sentiment particularly applies to the Management’s Discussion and Analysis (MD&A) section of quarterly and annual reports and other registration statements, where companies generally discuss their business, uncertainties, and market trends.

“Everyone likes to prove they’re the smartest person in the room because they understand the jargon,” said Brian Lane, partner in the Washington, D.C., office of Gibson Dunn & Crutcher and former SEC director of the division of corporate finance. “Plain English works.”

The best MD&As have “more tables and less jargon,” Lane opined. Tables, he noted, are easier to understand than mounds of text. In the text, companies often include too many comparisons going back several years, which is often unnecessary and even confusing, he said. It’s better to show simple comparisons between this year and last year in both the text and tables, and include information on other years just in tables.

Making sure MD&As are as readable and informative as possible may ward off or lessen the impact of SEC inquiries, Lane added. One key to doing that: in all areas of focus within the section, answer the question “why?” he said.

Actually, having more tables in financial reports is a widening theme. The Financial Accounting Standards Board made a push in that direction this past summer, requesting comments on a proposal calling for nonfinancial companies to disclose expected cash-flow obligations in a table segregated by time of expected maturity.

For one, Katherine Gill-Charest, controller and chief accounting officer at Viacom, should be prepared if the proposal is approved. She already is including more than the usual amount of detailed information in the company’s MD&A statements. To facilitate that, she holds “working meetings” with members of Viacom’s disclosure committee a couple of times a year, instead of having just one formal meeting at reporting time to head off any questions that might arise from the SEC. She also meets with the CFOs of Viacom’s divisions to be aware of pertinent issues in preparing MD&As.

For example, the SEC repeatedly has asked for information on how Viacom plans to fund its $10 billion share-repurchase program. Other questions come when an SEC official hears of a trend during an earnings call that is not included in the MD&A.

Lane supported that use of a firm’s disclosure committee. A good item to discuss with that committee, for example, is “cash runway,” a measure of how long a company’s cash on hand will last, he said. A hoard of $300 million in cash is not actually that much if the company is burning through it at $90 million a quarter.
Knowing what questions the SEC may have raised with competitors is important, too.

“If I know a peer of mine has gotten reviewed, we will always take a look at the SEC’s comments,” said Gill-Charest, noting that she treats any correspondence between a competitor and the SEC as if it were her own document.

That made sense to Lane:

“You do need to see what competitors and peers are disclosing, because the SEC is going to look at you in that same lens,” he said.

One area where some companies could ease up is their heavy use of forward-looking disclosure statements.

“Projections are not required in [the] MD&A,” said Lane. “You [just] have to talk about known uncertainties and how they could impact the future.”

By Kathy Hoffelder at CFO.com

FASB vs IASB: Split on Lease Accounting

noreply@blogger.com (Malcolm McKay) — Thu, 20 Mar 2014 16:14:00 +0000

The US Financial Accounting Standards Board (FASB) and the International Accounting Standards Board (IASB) failed to reach a consensus for new lease accounting guidance Wednesday but vowed to continue working together in pursuit of consistency.

During two days of meetings at FASB’s headquarters in Norwalk, Conn., the boards failed to reach common answers on key areas of lessee and lessor accounting. In particular, the IASB favored a single approach for lessees for recognition of all leases, while FASB voted for a dual-recognition approach for lessees, depending on the type of lease.

The boards issued a joint statement saying they had agreed on areas such as lease term and short-term leases. The boards also pledged to continue working together on the standard.

“While differences remain, most notably in their preferred approaches to expense recognition, the boards are committed to working together to minimize these differences and to creating greater transparency around lease transactions for the benefit of investors worldwide,” the boards said.

The boards are attempting to create a converged standard that would eliminate a hidden liability for lessees by bringing leases onto corporate balance sheets. But they have struggled to agree on how to do it.

No consensus for lessee accounting

IASB members this week expressed a preference for lessees to account for all leases as the purchase of a right-of-use asset on a financed basis. In this “Type A” approach, a lessee would recognize amortization of the right-of-use asset separately from the interest on the lease liability for all leases.

FASB members preferred a dual-recognition approach for lessees that would use a Type A interest-and-amortization method for leases classified as capital leases under existing guidance, and a “Type B” single, straight-line lease expense for operating leases.

But there may still be a chance for convergence on this issue. FASB Chairman Russell Golden asked the FASB staff to work with the IASB staff to conduct research that would help the boards understand the effects of a possible exception that would permit preparers not to apply the proposed standard’s requirements to leases of small, nonspecialized assets.

The IASB voted for the so-called small-ticket exception, while FASB voted against it. Golden asked for the staff research in hopes that a better understanding of the exception could lead to convergence, which could cause the boards to agree on a preferred method of expense recognition.

FASB member Tom Linsmeier said he would be more inclined to consider the Type A-only approach for lessees if the boards abandon the small-ticket exception.

Sticking point for lessor accounting

On lessor accounting, meanwhile, the boards agreed to keep standards similar to current guidance but couldn’t agree on one important detail. They agreed that lessors should classify their leases as Type A or Type B based on whether the lease is effectively a financing or a sale rather than an operating lease.

But the IASB preferred to make that determination by assessing whether the lessor transfers substantially all the risks and rewards incidental to ownership of the underlying asset.

FASB preferred to make the leases guidance consistent with the requirements for a sale in the soon-to-be-issued revenue recognition standard. FASB’s approach would preclude recognition of selling profit and revenue at lease commencement for any Type A lease that does not transfer control of the underlying asset to the lessee.

The core principle of the new revenue recognition standard will be that revenue should be recognized to depict a transfer of promised goods or services to the customer.

Despite the disagreement on lessor accounting, some IASB members said they could accept the FASB approach, with IASB Chairman Hans Hoogervorst holding a “swing vote” that Golden suggested could move the lessor accounting decision to a converged answer in the future.

Before the boards parted, Golden thanked IASB members and said the boards ought to work together on the definition of a lease, disclosures, and other aspects of the leases proposal.

“We will continue to work together to improve accounting in this area, to continue to meet our objective,” Golden said, “and I hope to continue to minimize any differences.”

The boards have been working since 2006 to come to agreement on a leases standard. Their second exposure draft on the topic, issued in 2013, caused many preparers and some investors to question the benefits of the information—and the costs—the proposal would have generated.

By Ken Tysiac at JofA

IFRS To Run Out of Money?

noreply@blogger.com (Malcolm McKay) — Wed, 19 Mar 2014 11:00:00 +0000

The International Financial Reporting Standards (IFRS) Foundation’s role in governing global accounting rules is under threat after European politicians said they were questioning whether the authority was “best suited” to the position.

The London-based authority, responsible for setting standards in 100 countries, has been severely criticised by MEPs for poor governance structures, a lack of transparency and its “close links to the accounting industry”.

Last week the European Parliament approved a new £50m five-year funding programme for the IFRS’s standard setting arm, the International Accounting Standards Board (IASB).

However, MEPs attached a series of conditions to the deal and warned if they are not met, the funding could be stopped in a year’s time.

Sharon Bowles, chairman of the influential European economic affairs committee and a Liberal Democrat MEP, said: “Questions have been raised by the European Parliament about the governance structures and lack of transparency of these bodies, as well as their close links to the accounting industry.

"The release of these EU funding streams will therefore only be forthcoming upon sufficient reform to prevent conflicts of interest, which will bring about much-needed trust and scrutiny on how these highly influential public bodies operate.”

Syed Kamall, a Tory MEP for London, who has raised concerns about the IFRS rules, said: “I am not convinced that it was right for the EU to outsource standard-setting to what is, in effect, a private sector body funded by public money.”

A spokesman for the IFRS Foundation said:

“The foundation takes seriously any such concerns and has already begun planning its constitutionally-required five-year review of its structure and effectiveness, to be undertaken during 2014, and we welcome any proposals to improve aspects of our work.”

The MEPs’ concerns about the IFRS Foundation’s governance were raised after The Telegraph first highlighted errors in the authority’s filings at Companies House in February. However, the politicians are also concerned IFRS accounting standards are seriously flawed.

Last year a group of British investors wrote to Michel Barnier, the EU’s internal markets commissioner, warning him that the accounting rules were harming shareholders and destabilising the economy. They argued that the IFRS rules, introduced in the UK in 2005, had allowed companies, and banks in particular, to hide the build-up of risks on their balance sheets.

The European Commission has said it will launch a review of the IFRS rules.

By Louise Armitstead, the Telegraph

11 Issues to be Aware of for Your Next Shareholder Meeting

noreply@blogger.com (Malcolm McKay) — Tue, 18 Mar 2014 19:11:00 +0000

U.S. public companies are operating in an environment full of both risk and opportunity as they prepare for their annual shareholder meetings.

Cyberthreats, disaster planning, and political and economic unrest are among many factors that make the current climate hazardous for many companies.

Although high values in the stock market indicate an environment that has improved significantly—if slowly—since the lowest depths of the global financial crisis, recent dips in the market indicate that volatility still exists.

Shareholders are likely to be focused on both the risks and the opportunities in upcoming shareholder meetings, according to Wendy Hambleton, CPA, a partner in the corporate governance practice who also heads up the SEC practice at BDO.

“There is still that overriding sense of still coming out of that economic downturn, whatever you want to call the period from 2007 to 2009,” Hambleton said. “I think people are cautious, so they want companies to be cautious and prudent with their funds. I don’t think people are pushing as much for huge growth as they are for measured growth and maybe a little more secure growth.”

Against this backdrop of risks and a desire for secure growth, BDO has compiled a list of issues in a news release that corporate management and boards of directors should be prepared to discuss with shareholders in connection with annual meetings this spring:

- M&A opportunities and takeover defenses. Is management seeking M&A opportunities? Are potential targets properly vetted to prevent buyer’s remorse? And are boards poised to fend off unwanted takeovers and maximize shareholder value if a transaction is accepted?

“We are seeing more M&A activity,” Hambleton said. “A lot of companies have some cash on hand, but I think everyone wants to be cautious to make sure plenty of due diligence is done, that it’s the right transaction, that it makes sense, no one is rushing into deals”

- Spinoff advocacy. Management and the board need to be prepared to respond to well-funded, activist shareholders who have the potential to try to break up companies, according to BDO. This can be a costly exercise, Hambleton said.

“If you’ve got activist shareholders making suggestions and urging the company to take certain actions, that takes a lot of time and in some cases dollars that the company might have wanted to use in an alternative way,” she said.

- Global economic concerns. Investors are concerned about how the crisis in Ukraine and slowing growth in China, Brazil, Japan, and other markets will affect the global economic recovery, according to the news release. Shareholders may ask about how prepared the company is to deal with a serious economic collapse in a certain country or region.

The crisis in Ukraine demonstrates that problems can occur in unexpected places, Hambleton said. And emerging markets pose different political and economic concerns than more mature markets such as the United States, Canada, and Western Europe, according to Hambleton.

“That’s not a reason not to go into those markets,” she said. “It’s just a reason to go in from a measured perspective. And from a shareholder perspective, that’s what people want to see is a measured perspective, that people are thinking about the risks, thinking about the concerns, and then taking a measured response to that.”

- Cybersecurity. Headlines about numerous high-profile breaches are certain to have shareholders’ attention, and companies should be prepared to explain their approach and their defenses. Hambleton notes:

“Companies need to be able to explain to shareholders—without getting into the minutiae of the details and what they do—how they monitor, what kind of controls they have in place,”

“Have they looked at refreshing their risk management approaches in this area? How often do they do certain types of monitoring activities?”

- Executive compensation. Performance-focused compensation models at public companies have gained favor in the wake of new avenues for shareholder feedback, according to the news release.

Since regulations do not require disclosure of the relationship between pay and company performance, it appears that an emerging consensus is that disclosures should report how the company’s total shareholder returns relate to the CEO’s realizable pay, BDO said. Shareholders will ask more questions when the executives are compensated handsomely while the company struggles, Hambleton said.

- Succession planning. An improving economy may create more opportunities for executives to change jobs. This could cause shareholders to ask whether the board has a succession plan and has identified candidates for CEO and other key positions. Surveys have shown that board members are interested in this issue, Hambleton said.

“If it’s something board members would want to spend time on, you’d think it’s something shareholders care about, too,” she said.

- Accessing public equity markets. In 2013, total U.S. initial public offerings and proceeds raised reached their highest levels since 2000, according to BDO. This may lead shareholders to wonder whether management is considering new securities offerings.

“Certainly, a good IPO market is an opportunity for companies that may be looking at spinning off either their noncore businesses or businesses that maybe would perform better in a separate company rather than as part of the overall conglomeration,” Hambleton said.

- Disaster planning. Events such as Hurricane Sandy in the United States and Typhoon Haiyan in the Philippines have caused tragic losses of human life and disrupted supply chains and operations. Shareholders may want to know if businesses have backup plans that will minimize the effects of such events.

For example, Hurricane Sandy showed that backup servers located far apart on the same coast may be vulnerable to the same storm.

“No one probably envisioned a storm that would start where it did and go all the way and cause so many blackouts that we need to have [servers] on opposite coasts or in the middle of the country or something like that,” Hambleton said.

- New COSO framework. Shareholders may want to know if a company has updated its system of internal control to reflect the guidance in the updated 2013 framework of the Committee of Sponsoring Organizations of the Treadway Commission (COSO).

“I wouldn’t expect there to be significant changes to companies’ assessments,” Hambleton said. “But the new framework does have more particular guidance built into it, so I think some of the controls and the mapping will need to change. There will be some work to do. Hopefully, some enhancement of controls will come out of it.”

- Conflict minerals. New SEC rules require public companies to report to the SEC whether their products contain certain minerals produced in mines in the Democratic Republic of Congo. In some cases, those mines are run by warlords who oppress residents of the region. Although some companies may be behind in gathering information needed to report on these minerals by the May 31 deadline for the 2013 calendar year, Hambleton said shareholders will have a wider perspective.

“They’re going to want to know if [the company is] going to have to report that they use conflict minerals,” she said. “And that gets into the whole question of sustainability and corporate social responsibility with companies.”

- Auditor tenure. Mandatory audit firm rotation no longer is part of the PCAOB’s agenda afterlegislative pushback on the issue, but BDO said management and audit committees should be prepared for shareholders to ask about the length of their auditor’s tenure and their process for hiring their auditors.

“If you’re an audit committee member, you will have heard the discussion, and you need to be prepared to answer the question, what consideration did they give,” Hambleton said. “Not that they should be making a change, but what consideration did they give to it?”

By Ken Tysiac Journal of Accountancy.

SEC Comment Letter Watch -- Segment Reporting

noreply@blogger.com (Malcolm McKay) — Fri, 07 Mar 2014 23:28:00 +0000

Segment reporting is one of the SEC's most common areas of comment. The SEC often asks for specifics of documents that the Chief Operating Decision Maker (CODM) reviews on a regular basis. Companies need to be cautious when answering similar questions since the next request from the SEC might be "please provide us with all regular reports that the CODM review on a regular basis." If the SEC sees something different in those CODM reports from the answer provided previously, that spells trouble. Here is a sample from a letter to Charter Communications:

SEC's question:
We note your response to comment 4. Please provide us additional information about all of the “certain operating metrics”, such as “CPE” and plant maintenance, that management, in particular the CODM, relies on to assess performance and allocate resources.

Describe for us what these non-financial business and operational data represent, at what level of detail does the CODM review them (e.g.KMA or lower), and how the CODM uses them to assess performance and allocate resources.

Company's answer:
Our CEO, as CODM, receives and reviews information at the consolidated level, whether financial or non-financial in nature, and uses that information to assess performance and allocate resources on a consolidated basis. The CEO routinely receives consolidated operating metrics that include customers by product (video, Internet, and phone), sales and disconnects by product, customer net gains, penetration of estimated passings, bundled customer statistics, sales channel performance, call center and truck roll statistics and headcount. In addition, the CEO receives certain statistics related to the quality of physical transactions occurring at a local level, specifically truck roll data and ratios which use the number of customer connections, disconnections and average customers by service to calculate service level ratios. These statistics assist with the review of activity in the field at the local level, but are not the primary data used for resource allocation. Our CEO makes resource allocation decisions to specific operating strategies that impact the performance of the consolidated company. Furthermore, he assesses the performance of the Company on a consolidated level as a result of the implementation of the company-wide operating strategies. The execution of those strategies is carried out by levels below the CODM.

Resources allocated to our strategic initiatives of enhancing the customer experience and increasing customer growth are driven on a consolidated basis by our CODM. One such example would be CPE procurement, which is budgeted based on a certain number of connects and devices per connect, both estimated for the entire company. Consequently, CPE is purchased on a company-wide basis in order to maximize scalability during negotiations with our vendors and to meet estimated connects on a company-wide basis. Plant maintenance is another example. The allocation of corporate resources to plant maintenance is based on the strategy to improve the performance and reliability of the network. Levels below the CODM are then tasked with execution of the strategy and ensuring resources are provided where they are needed. A third example is our strategy of our all-digital network roll-out. Again, the amount of resources required for the all-digital roll-out is based upon an allocation of resources to implement the roll-out company-wide. In executing the all-digital roll-out, managers below the CODM carry out the initiative within our footprint based upon the potential immediate impact on our customers. Other overall resource allocation examples include, but are not limited to, implementation of a back office system to support customer growth or a decision to change the type of modem used, both of which would be on a company-wide basis.

Cleaning Up OCI

noreply@blogger.com (Malcolm McKay) — Thu, 06 Mar 2014 16:12:00 +0000

Accounting ‘Dumping Ground’ Headed For Clean Up

International accounting rulemakers may focus on cleaning up rules for “other comprehensive income,” a category in a company’s earnings statement that can obscure the true profit and loss picture, the chairman of the International Accounting Standards Board said this week.

The board may restart its efforts to improve financial statement presentation guidance in this area and bring more “discipline” to the way companies decide what is classified as profit and loss or other comprehensive income, IASB Chairman Hans Hoogervorst said in a speech in Tokyo.

More than 100 countries use International Financial Reporting Standards, which are set by the IASB. The U.S. does not use them for domestic companies, but allows foreign companies to file their results with U.S. regulators under these standards. U.S. multinational companies often have to use these standards for foreign subsidiaries.

Other comprehensive income, which includes items initially excluded from net income in a particular accounting period, has gotten a reputation as a sort of dumping ground where companies are allowed store information that would be too damaging to earnings.

For example, he said passing employee benefit expenses through other comprehensive income, rather than earnings, has dis-incentivized companies from dealing with large liabilities head-on.

“In the last decade, some big American car manufacturers and airline companies were brought to their knees by employee benefits that had been building up over the years,” Mr. Hoogervorst explained. Such liabilities may not have been taken as seriously because they were in other comprehensive income, he said.

The other comprehensive income figure is crucial because it can distort common valuation techniques used by investors, such as the price-to-earnings ratio. If the profit and loss statement and earnings are the primary indicators of a company’s performance, they need “to be robust and tinker-free,” Mr. Hoogervorst said.

Mr. Hoogervorst said he’d been approached by Japanese accounting stakeholders about improving and clarifying other rules, as well as differences of opinion from other countries, such as Canada.

In an interview with CFO Journal, Dr. Nigel Sleigh-Johnson, head of financial reporting for the Institute of Chartered Accountants of England and Wales said Thursday, “At the moment there is no clear and consistent basis for,” other comprehensive income.

Accounting rulemakers should try to make it easier for companies to decide what items need to be recognized in profit and what has to go into other comprehensive income, he said.

The U.S. Financial Accounting Standards Board has also been working to clarify rules for other comprehensive income in the past few years and make the rules more transparent to investors. The board issued new guidance on how companies should present the figures in 2011 and updated accounting standards on items reclassified out of accumulated other comprehensive income last February.

Article by Emily Chasan, at the Wall Street Journal

Can Companies Smooth-Talk Investors?

noreply@blogger.com (Malcolm McKay) — Fri, 28 Feb 2014 16:15:00 +0000

Investors Prove Wise at Judging Self-Serving Earnings Explanations

Investors have proven to be sophisticated enough to dismiss implausible explanations from companies of their quarterly earnings results, according to a new study.

For example, a utility company might attribute their lower earnings to “warm weather and higher propane products costs,” while an insurance company might explain a good quarter by touting its “continued efforts on cost containment and operational efficiencies.” Self-serving attributions such as these, which typically blame outside factors for negative developments and claim that their own internal initiatives led to positive results, are a traditional part of corporate earnings reports and press releases. But that doesn’t mean investors generally believe them.

According to a new study in The Accounting Review, a journal of the American Accounting Association, market response to self-serving attributions depends in large part on two key tests of plausibility—how badly the company’s industry peers are doing and what the study calls “commonality,” the extent to which market or industry forces drive a company’s earnings.

The difference proved to be dramatic when those two key tests were applied to the 94 companies in the study, which was conducted by Michael D. Kimbrough of the University of Maryland and Isabel Yanyan Wang of Michigan State University. Firms with average positive earnings surprises who made the highest-plausibility attributions had three-day above-market returns of 4.77 percent on average, whereas those that offered the lowest-plausibility reasons actually averaged a slight decline of 0.79 percent. Meanwhile, among firms with average negative surprises, those with the lowest-plausibility attributions sustained average declines of 5.11 percent, while those with the highest-probability excuses had declines of only 1.42 percent.

“Firms which provide defensive attributions to explain earnings disappointments experience less severe market penalties when 1) more of the their industry peers also release bad news, and 2) their earnings share higher commonality with industry- and market-level earnings,” said the paper. “On the other hand, firms that provide enhancing attributions to explain good earnings news reap greater market rewards when 1) more of their industry peers release bad news, and 2) their earnings shares lower commonality with industry- and market-level earnings.”

“Collectively, our results suggest that investors neither completely ignore seemingly self-serving attributions nor accept them at face value, but use industry- and firm-specific information to assess their plausibility,” the professors added. “Further analyses reveal that investors’ use of industry peer performance and earnings commonality information appears justified because investors’ perceptions are consistent with the association between the plausibility measures and the ex post actual persistence of earnings surprises.”

In sum, “investors are somewhat sophisticated when interpreting these narrative disclosures,” Kimbrough and Wang wrote:

“Our findings ought to be of value to both investors and corporate leaders,” said Wang in a statement. “Hopefully it will disabuse those executives who are counting on the naiveté of investors to let them get away with empty words or phony excuses in their public communications. For investors, it provides standards they will need to meet to keep up with the investment community at large.”

“The tools needed to apply those standards are certainly available to institutional investors, even though determining commonality is probably beyond the reach of individual stock-pickers,” said Kimbrough. “Still, even they should have the means to stack up the claims of a given company against its industry peers, which can go a long way in assessing the plausibility of the firm's performance narrative.”

The study's findings are based on an analysis of press releases and earnings reports of 94 randomly chosen firms, a roughly equal mix of small, medium and large, over a seven-year period. Sufficient data was obtained for a total of 1,790 firm quarters, 1,023 of which featured self-serving attributions and 767 of which did not. The self-serving classification was assigned to quarters when companies attributed their success in meeting or beating consensus forecasts to internal factors, such as management strategies or introduction of new products, or blamed a negative earnings surprise on external factors, such as bad weather or rising costs or regulatory actions. Firm-years in the self-serving category featured at least one such attribution and an average of three to four in a given earnings press release.

The authors found a significant relationship between the plausibility of self-serving attributions, as determined by industry performance and commonality, and the market-adjusted cumulative return of firms' stocks in the three days centered on earnings announcements. In reaching that conclusion, they controlled for an array of factors likely to affect the market’s response to earnings announcements, including the size of companies, the volatility of their stock, and their book-to-market ratio.

What kind of companies are likely to issue suspect attributions? Preliminary evidence suggests, in the words of the study, “Firms which provide less plausible attributions are larger and have higher likelihood of insider trading around earnings announcements, higher analyst following, higher institutional ownership, higher return volatility, and lower book-to-market ratio. These findings imply that managers with insider trading incentives and those facing greater capital market scrutiny are more likely to offer seemingly self-serving attributions even if they lack plausibility, consistent with the ‘opportunistic behavior’ view of capital markets.”

This view, according to the paper, finds “that capital-market scrutiny combined with the linking of manager compensation with stock prices creates pressure for managers to prop up prices by biasing financial reporting. To the extent capital-market pressure is greater for firms with higher analyst following and/or institutional ownership, the ‘opportunistic behavior’ argument suggests that greater analyst following and/or institutional ownership may increase managers’ tendency to provide implausible attributions to either mitigate market reactions to negative earnings surprises or to increase market rewards to positive surprises.”

Still, given the hazards of implausible attributions, as revealed by the new study, why would managers make them? It’s a matter of what they believe, Wang and Kimbrough wrote. “If managers believe there is a chance that investors might be persuaded by their implausible seemingly self-serving attributions, they are more likely to offer them even if ex post it turns out that investors can see through them.”

This article is by Michael Cohn in Accounting Today. The study, “Are Seemingly Self-Serving Attributions in Earnings Press Releases Plausible? Empirical Evidence,” appears in the March/April issue of The Accounting Review, published six times a year by the American Accounting Association.

More on Less Complexity in Financial Reporting

noreply@blogger.com (Malcolm McKay) — Fri, 21 Feb 2014 22:25:00 +0000

Want simpler financial reporting? If you believe the SEC’s public statements, reduction in complexity may be on the way.

Edith Orenstein has posted the following in the FEI Financial Reporting Blog. Here is her full post:

One recent development at the SEC that ties into FASB’s “combating complexity” goal cited further above, is that noted by SEC Chairman Mary Jo White concurrent December 20, 2013 issuance of the SEC staff report, Report on Review of Disclosure Requirements in Regulation S-K. The report was conducted by the SEC as requested by Congress under the JOBS Act.

Importantly, as noted in the SEC's press release, White stated:

“This report [on Reg S-K] provides a framework for disclosure reform. As a next step, I have directed the staff to develop specific recommendations for updating the rules that dictate what a company must disclose in its filings. We will seek input from companies about how we can make our disclosure rules work better for them and will solicit the views of investors about what type of information they want and how it can best be presented. The ultimate objective is for the Commission to improve the disclosure regime for both companies and investors.”

Keith Higgins, Director of the SEC’s Division of Corporation Finance stated:

“Updating our rules is only one step – albeit an important one – in improving company disclosures. For their part, companies should examine how they can improve the quality and effectiveness of their disclosures and how our rules can be improved to facilitate clear and effective communications to investors. Better disclosure benefits everyone in the marketplace, and we plan to work with companies and investors to achieve this common goal.”

The press release also noted that:

“The SEC’s Office of the Chief Accountant will coordinate with the Financial Accounting Standards Board to identify ways to improve the effectiveness of disclosures in corporate financial statements and to minimize duplication with other existing disclosure requirements.”

Chairman White led up to this initiative in remarks given at the NACD’s annual conference in November, 2013, as we noted in this post, SEC’s White Calls for ‘A Meaningful Review of Disclosure Requirements.’

Commissioner Dan Gallagher also focused on the need for disclosure reform in a speech at the 2nd Annual Institute for Corporate Counsel on December 6, 2013, excerpted below:

“We can’t foster capital formation in fair and efficient capital markets through private investment unless the critically important information about public companies is routinely and reliably made available to investors. We need to take seriously however, the question whether there can be too much disclosure. Justice Louis Brandeis famously stated that sunshine is the best disinfectant. As my friend and former colleague Troy Paredes pointed out some years ago, though, it is possible to create conditions in which investors are 'blinded by the light.' That is to say that from an investor's standpoint, excessive illumination by too much disclosure can have the same effect as obfuscation - it becomes difficult or impossible to discern what really matters ...”

“I often hear from investors that disclosure documents are lengthy, turgid, and internally repetitive. In their present state, they are, in other words, not efficient mechanisms for transmitting the most critically important information to investors — especially not to ordinary, individual investors. They are not the sort of documents most people are likely to read, even if doing so is in their financial self-interest. For that reason, today’s disclosure documents raise questions of what their purpose actually is and whether they are meeting it.”

“Here, it seems to me, we must acknowledge a dilemma. The good we have done in shaping a detailed disclosure regime to assist and protect investors has, in fact, led to some potential but, I submit, avoidable harm. Corporate disclosure filings didn’t naturally evolve into their present convoluted state. Rather, the rules that require periodic corporate reporting and the detailed instructions that implement them, as well as the staff interpretations and guidance that supplement those rules and instructions, have been the principal forces shaping modern corporate disclosure filings.”

“But other, external forces have played a role as well, most notably the risk of litigation -- much of it absolutely frivolous and solely for the benefit of plaintiffs’ lawyers, not investors. The failure to disclose anticipatorily is often enough to prompt a shareholder lawsuit based on the assertion of a material omission. It is rational, in other words, for those who prepare corporate disclosure documents to prepare for the worst, thus perversely prioritizing the need to avoid the penalties that accompany claims of insufficient disclosure, it seems, over rendering the required disclosure in a manner intelligible to the average investor. In sum, the Commission has cause for self-examination where the question of the utility and lucidity of corporate disclosures arises.”

“And in that process we cannot ignore the impact of excessive and frivolous litigation.”

“Here, we come to a fundamental fork in the road. Should we jump in with both feet to begin a comprehensive review and possible overhal of SEC-imposed disclosure requirements under the securities laws, or should we take a more targeted approach, favoring smaller steps towards our ultimate reforming goals? Ordinarily, I would argue for a comprehensive approach to the solution of almost any problem. Where securities regulation is concerned, we often find that actions we take in one area have unforeseen and unintended effects in others.”

“However, disclosure reform may be the exception. Although I've publicly called on multiple occasions for a holistic, comprehensive review of market structure issues, I believe, on balance, that with disclosure reform it is better to start addressing discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched. On this point, I was very pleased to see the recent remarks by Chair White (citing NACD speech). I hope and expect that, under her stewardship, the Commission will begin to make real headway on disclosure reform. I am genuinely enthusiastic about the prospect of solving some of the real-world problems that have become obvious to all who focus on this area. In short, it’s time to get practical and time to get started.”

Inquiring minds may ask: why have I not put “disclosure reform” as the highest priority item for 2014 as relates to the SEC, instead of “Enforcement”? Well, it’s not just because “Disclosure Reform” is two words, and “Enforcement” is one. I truly believe that with so much messaging from the highest levels of the SEC of a “get tough” attitude that we will see some illustrations of that attitude. We have seen that messaging from the Chairman, the Director of Enforcement, and in speeches from the Office of the Chief Accountant, and although preparers and auditors may prefer to see “disclosure reform” I believe that is a longer term project, and that in the shorter term, specifically 2014, attention should be paid to dotting the I’s and crossing the t’s as well as the big picture, substance over form, etc. with an eye toward Enforcement.

Slimming Down Disclosures: SEC Speaks Out

noreply@blogger.com (Malcolm McKay) — Wed, 12 Feb 2014 01:40:00 +0000

A targeted, step-by-step approach is the best way for the SEC to review and overhaul its financial disclosure requirements under securities laws, SEC Commissioner Daniel Gallagher said Monday.

In a speech at the Forum for Corporate Directors in California, Gallagher said he hopes the SEC can “make real headway” in its initiative to reduce unnecessary disclosures. And he said a piece-by-piece approach is preferable to addressing the issue in a comprehensive fashion.

“I would prefer to address discrete issues now rather than risk spending years preparing an offensive so massive that it may never be launched,” Gallagher said.

In December, SEC Chairman Mary Jo White instructed the commission’s staff to develop recommendations for updating what companies should be required to disclose in public filings. Gallagher said it’s time to get started on disclosure reform even though the SEC has yet to complete about 60 rules mandated by the Dodd-Frank Wall Street Reform and Consumer Protection Act, P.L. 111-203.

Here are some of the issues Gallagher said the SEC may need to focus on:

Layering disclosures. This would mean making key information easily available in a standardized format, while making additional details available elsewhere. Gallagher said material information, such as a company’s financial statements, could be treated differently from information that he said is not material, such as the Dodd-Frank pay-ratio disclosures the SEC is developing.

Streamlining Form 8-K disclosures. “Does each of the categories of information now required to be disclosed on Form 8-K really require almost immediate disclosure when a change occurs?” Gallagher asked.

Location, location. Authoritative guidance can be provided, Gallagher said, about where issuers must disclose or need not disclose particular types of information, enabling analysts and others to easily find the information or identify its absence.

Streamlining proxy and registration statements. Permitting some required financial information to be included in an appendix to the proxy would aid investors and preparers, Gallagher said. He also said it could be helpful if the SEC permits forward incorporation by reference in Form S-1 registration statements. This could simplify the registration process by allowing reference to previous forms.

The potential of technology. Gallagher suggested testing a standardized system that would require one-time online disclosure of basic corporate information, mandating that it be updated as necessary with changes tracked. “We have not come anywhere close to realizing the potential technology holds for improving our disclosure system,” Gallagher said.

Improving guidance. SEC disclosure guidance could be more reliable and authoritative if significant guidance was issued only with the explicit endorsement of the commission, rather than as staff guidance, Gallagher said.

Opposing politically driven disclosures. The SEC’s newly required conflict minerals disclosures were cited by Gallagher as an example of “ill-advised anomalies” that should not be the realm of an independent, bipartisan agency.

“From an investor’s standpoint, excessive illumination by too much disclosure can have the same effect as inundation and obfuscation—it becomes difficult or impossible to discern what really matters,” Gallagher said.

By Ken Tysiac a Journal of Accountancy senior editor.

What have IASB and FASB convergence efforts achieved?

noreply@blogger.com (Malcolm McKay) — Mon, 17 Jun 2013 22:50:00 +0000

What have IASB and FASB convergence efforts achieved?

Paul Pacter CPA, Ph.D. served as a member of the International Accounting Standards Board (IASB) from July 2010 to December 2012. At the end of his term on the Board, he wrote the following article.

EXECUTIVE SUMMARY

In this opinion piece, former International Accounting Standards Board (IASB) member Paul Pacter describes the accomplishments of the convergence project undertaken in 2002 by the IASB and FASB. He says many standards have converged, and IFRS have been improved as a result of the process.

On a standard-by-standard basis, results of convergence have been mixed, Pacter says. Some standards have been improved. Some have not changed because the boards couldn’t agree on a converged solution. And a few—revenue recognition, leases, and financial instruments—remain under development.

According to Pacter, although progress has been made through convergence, adoption of IFRS for U.S. financial reporting is the ultimate goal. He says adoption is the best approach for any jurisdiction.

For nearly 40 years, the International Accounting Standards Board (IASB) and its predecessor, the International Accounting Standards Committee (IASC), have been working to develop a set of high-quality, understandable, and enforceable International Financial Reporting Standards (IFRS) to serve equity investors, lenders, creditors, and others in globalized capital markets. When the IASB took over from the IASC in 2001, few countries had adopted International Accounting Standards (as IFRS were then called) even for cross-border public sales of securities, let alone for domestic public companies.

That all changed—and quite dramatically—with two events. First, in 2000, the International Organization of Securities Commissions (IOSCO) endorsed IFRS for cross-border securities offerings in the world’s capital markets. Then, in 2002, the European Union made the bold decision to require IFRS for all companies listed on a regulated European stock exchange starting in 2005. Those events started a snowball rolling, to the point where today roughly 100 countries require IFRS or a national word-for-word equivalent for all or most listed companies.

Almost from the outset, a key goal of the IASB and the IFRS Foundation, under which the IASB operates, has been to bring the United States on board. In a plenary address at the World Congress of Accountants in 2002, Paul Volcker, the first chairman of the Foundation’s trustees, said: “I do not think it reasonable today, if it ever was, to take the position that U.S. GAAP should, de facto, be the standards for the entire world. Rather, the International Accounting Standards Board, whose oversight trustees I chair, is now working closely with national standard setters throughout the world to develop common solutions to the accounting challenges of the day. The aim is to find a consensus on clearly defined principles, and I am delighted that the American authorities appear sympathetic to that objective.”

In October 2002, the IASB and FASB signed a memorandum of understanding that has come to be known as the “Norwalk Agreement.” The two boards pledged to use their best efforts to (a) make their existing financial reporting standards “fully compatible as soon as is practicable” and (b) “to coordinate their future work programs to ensure that once achieved, compatibility is maintained.” “Fully compatible” was generally understood to mean that compliance with U.S. GAAP would also result in compliance with IFRS. That is, the standards would be aligned though not identical.

With the Norwalk Agreement, the boards launched a series of both short-term and longer-term convergence projects aimed at eliminating differences in the two sets of standards. The two boards agreed that where either IFRS or U.S. GAAP had the clearly preferable standard, the other board would adopt that standard. And where both boards’ standards needed improvement, the boards would work jointly on an improved standard.

The Norwalk Agreement has been updated several times since 2002, but always with the objective of two sets of standards that were converged in principle if not in words. The IFRS-U.S. GAAP convergence approach has been repeatedly endorsed by global financial leaders such as the G-20 as an important step on the path toward a single set of global accounting standards.

In November 2007 an important milestone was achieved toward use of IFRS in the United States when the SEC eliminated the requirement that a foreign issuer using IFRS must present a reconciliation of IFRS measures of profit or loss and owner’s equity to amounts that would have been reported under U.S. GAAP. In their comment letter on the SEC proposal that led to removal of the reconciliation, FASB and the Financial Accounting Foundation wrote:

Investors would be better served if all U.S. public companies used accounting standards promulgated by a single global standard setter as the basis for preparing their financial reports. This would be best accomplished by moving U.S. public companies to an improved version of International Financial Reporting Standards (IFRS).

So, where are we today after 10 years of convergence work? Some convergence projects have been completed successfully as envisioned—aligned principles even if the words differed. Others have been completed with partial success—some progress toward converged standards, but some differences remain. And some convergence projects either were discontinued or resulted in different IASB and FASB standards because, in the end, the two boards just could not agree. Some convergence projects continue to this day, including such major projects as revenue recognition, leases, and financial instruments.

At this point, it is reasonable to sit back and ask two fundamental questions about each of those convergence projects:

1. Have IFRS and U.S. GAAP been converged?

2. Even if convergence was not successfully achieved, has IFRS been improved?

The accompanying table, “Results of Convergence,” sets out my admittedly subjective views about the success of convergence and the resulting improvements to IFRS for each of the projects listed in the various agreements between the IASB and FASB. As a final thought, I would add that convergence may have been the most realistic way to initiate the use of IFRS in the United States, but such an arrangement is not sustainable in the long term. Rather, the best approach for any jurisdiction is outright adoption of IFRS. As the trustees of the IFRS Foundation said recently in the report of their 2011 Strategy Review:

As the body tasked with achieving a single set of improved and globally accepted high quality accounting standards, the IFRS Foundation must remain committed to the long-term goal of the global adoption of IFRSs as developed by the IASB, in their entirety and without modification. Convergence may be an appropriate short-term strategy for a particular jurisdiction and may facilitate adoption over a transitional period. Convergence, however, is not a substitute for adoption. Adoption mechanisms may differ among countries and may require an appropriate period of time to implement but, whatever the mechanism, it should enable and require relevant entities to state that their financial statements are in full compliance with IFRSs as issued by the IASB.

Adoption is the only way to achieve a single set of global financial reporting standards—an objective that both the IASB and FASB have publicly endorsed on many occasions.

Click here to read "Results of Convergence: A Look at the Outcome of Key Joint IASB/FASB Projects"

2012 AICPA National Conference on Current SEC and PCAOB Developments

noreply@blogger.com (Malcolm McKay) — Wed, 19 Dec 2012 22:53:00 +0000

The AICPA Conference summaries are always a source of information that will keep companies out of trouble in financial reporting.

Following is Ernst & Young's brief summary of their longer documnet.

Representatives of the SEC, the Public Company Accounting Oversight Board (PCAOB), the FASB and the IASB shared their views on various accounting, auditing, and reporting issues at the three-day AICPA National Conference on Current SEC and PCAOB Developments (Conference) in December 2012 in Washington D.C.

Highlights of their comments included:

The SEC is continuing to evaluate whether further analysis relative to whether and, if so, when and how to incorporate IFRS into the US financial reporting system is necessary. SEC officials advised stakeholders to “stay tuned.” Various SEC and FASB speakers discussed the importance of the US setting its own accounting standards while continuing to work with the IASB to improve comparability and narrow differences in the standards.
Various speakers commended the outreach performed by the FASB and IASB and their progress on the convergence projects. Several speakers focused on the need for coordination when developing implementation guidance (e.g., on revenue recognition). Speakers from the FASB stressed the need for timely interpretive guidance to help during implementation and post-implementation.
SEC and PCAOB officials stressed the importance of audit quality to the capital markets and the relevance of inspection findings, particularly findings pertaining to internal control over financial reporting (ICFR). Some inspection findings could have implications for preparers in their own evaluations of ICFR. PCAOB officials also said they are considering feedback on mandatory audit firm rotation while taking other steps to improve auditor independence, objectivity and professional skepticism.
The SEC staff discussed year-end financial statement considerations and the staff’s areas of focus in its reviews of filings, including revenue recognition disclosures, the valuation of deferred tax assets and observations related to the new fair value disclosures.
Various panelists commented on the need to evaluate disclosure requirements, particularly the dividing line between the footnotes to the financial statements and the rest of the financial reporting package (e.g., MD&A). SEC Acting Chief Accountant Paul Beswick said he plans to host a roundtable in 2013 to better understand these concerns.

EY's publication, 2012 AICPA National Conference on Current SEC and PCAOB Developments, discusses the Conference in detail.

Future of IFRS

noreply@blogger.com (Malcolm McKay) — Tue, 18 Dec 2012 22:53:00 +0000

Recently the IASB published a paper on its future priorities.

In their “feedback statement”, the IASB lists input it received from the public on the future of IFRS. They organized the responses into five broad themes from the more than 240 comment letters it received.

Provide a period of calm after a decade of almost continuous change in financial reporting.
Prioritize work on the Conceptual Framework, which would provide a consistent and practical basis for standard setting.
Make some targeted improvements in the needs of new adopters of IFRS.
Pay greater attention to the implementation and maintenance of the Standards.
Improve the way in which the IASB develops new standards, by conducting more rigorous cost-benefit analysis and problem definition earlier on in the standard-setting process.

The Board also set out five priority near-term research projects. These are:

• Emissions Trading Schemes;
• Business Combinations under Common Control;
• Discount Rates;
• Equity Method of Accounting;
• Intangible Assets; Extractive Activities; and Research & Development Activities;
• Financial Instruments with the Characteristics of Equity;
• Foreign Currency Translation;
• Non-financial Liabilities (amendments to IAS 37); and
• Financial Reporting in High Inflationary Economies.

You can read the full report here.

Disclosure Overload: FASB Project Comments

noreply@blogger.com (Malcolm McKay) — Tue, 18 Dec 2012 01:23:00 +0000

A lot of recent commentary exists on the subject of disclosure overload.

Recently the FASB has begun to focus on this topic. "Streamlining Disclosures" has become subject of various initiatives, including a recent round-table discussions this conducted by FASB and the Center for Audit Quality.

FASB has also initiated a Disclosure Framework project "to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of each entity’s financial statements. Although reducing the volume of notes to financial statements is not the primary focus, the Board hopes that a sharper focus on important information will result in reduced volume in most cases."

"Boilerplate" and non-material disclosure have been said to be "noise" that obscures the real information that readers of financial information really need.

FASB published an Invitation to Comment (ITC) on this topic last July 12. They asked stakeholders to comment on whether and how disclosures in the footnotes to financial statements can be made more effective. The comment period ended Nov. 16.

Some of the questions:

Do the decision questions in this chapter and the related indicated disclosures encompass all of the information appropriate for notes to financial statements that is necessary to assess entities’ prospects for future cash flows?
Do any of the decision questions or the related indicated disclosures identify information that is not appropriate for notes to financial statements or not necessary to assess entities’ prospects for future cash flows?

Commentors said unnecessary disclosures can prevent users from finding the information they need, obscure the real information and waste prepares' time, money, and create undesirable environmental outcomes, i.e. too much paper.

The FASB received 83 comment letters. Some comments:

Issuers should only provide relevant disclosures
Disclosures should have a narrower focus that "could be useful to investors"
Concern over the risk of litigation or regulatory action because preparers omit information previously provided.
Avoid using the term "relevance"
Watch the SEC's requirements, i.e. no point to reducing GAAP disclosures if the SEC imposes more specific requirements
"The uses of boiler plate disclosures and reliance on checklists have inundated both the public and private sector as the volume and complexity of reporting requirements have increased significantly over the years. We believe having the flexibility to apply professional judgment will substantially reduce unnecessary disclosures."
"We believe that preparers' judgment should instead be focused on what is material to the company based on a set of flexible disclosure requirements. Enabling flexibility, based upon materiality, would result in the right balance of providing relevant information while maintaining comparability."

"Disclosure overload and complexity are the two aspects of financial reporting that financial statement users and preparers, large or small, agree on: There is too much of both."

This will be interesting to watch over the next few years. Don't expect a quick reduction in disclosures for this year's 10-Ks!

500 Foreign Firms Still use U.S. GAAP U.S. Regulatory Filings

noreply@blogger.com (Malcolm McKay) — Tue, 27 Nov 2012 17:54:00 +0000

Good article by Emily Chasan of the WSJ.

The Big Number: 500

That’s the approximate number of foreign firms that use U.S. accounting standards in U.S. regulatory filings.

Some foreign companies that file financial reports with U.S. securities regulators are having trouble freeing themselves from U.S. accounting standards.

Five years ago the Securities and Exchange Commission voted to let U.S.-listed foreign companies that use International Financial Reporting Standards stop having to reconcile their financial statements with U.S. Generally Accepted Accounting Principles. But about 500 companies, or roughly half of the 1,000 foreign companies listed on a U.S. exchange, still submit their filings using the U.S. standards.

Some companies still must reconcile their home country’s accounting rules with U.S. GAAP, “but that number is shrinking in favor of companies that switch” to IFRS, Craig Olinger, deputy chief accountant in the SEC’s Division of Corporation Finance, said recently at a Financial Executives International conference.

More than 100 countries currently use IFRS. European companies, which have been using those standards since 2005, are the largest group using international rules for U.S. filings. Canada, which accounts for the biggest number of foreign SEC-registered companies, should soon have more companies using international rules for their U.S. filings after switching to IFRS last year. Some of the 340 Canadian companies that file with the SEC still reconcile their results to U.S. GAAP, Mr. Olinger said.

U.S. regulators still haven’t decided whether U.S. companies should be able to report using IFRS, and the successor to SEC Chairman Mary Schapiro will play a large role in that discussion. A widely anticipated study by the SEC’s staff earlier this year didn’t make any formal recommendations on the matter. Mr. Olinger said the SEC staff stays up to speed on trends in IFRS and performs reviews of filings in international standards at the same level that it inspects those done in U.S. GAAP

Significant vs Material

noreply@blogger.com (Malcolm McKay) — Sun, 28 Oct 2012 17:56:00 +0000

Often the terms “significant” and “material” are used interchangeably. This can course a lot of confusion. The SEC once took a company to task asking why they used this explanation of a contingency:

“You disclose...that you do not expect the ultimate conclusion of any of the proceedings to which you are a party to have a “significant adverse effect” on your financial statements and you have not disclosed the contingent liabilities associated with these claims either because they cannot be “reasonably” estimated or because such disclosure could be prejudicial to the conduct of the claims. Please revise your future filings...to more clearly confirm that you believe the ultimate conclusion of any of the proceedings to which you are a party will not have a “material” adverse effect to your results of operations, cash flows, or financial position.

Why the distinction between "material" and "significant"? To help with understanding the difference between "significnant" and "material" , the following comes from a paper on the IASB 2008 Annual Improvements Process, Comment Letter Analysis:

Significant vs Material

As mentioned above...some respondents asked for further clarification of the Board’s intentions in changing material to significant.

According to paragraph 30 of the Framework:

“Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.”

“Significant, on the other hand, is not a defined term in IFRSs but is used throughout IFRSs to denote the degree of importance or relevance, eg significant costs (IAS 16) significant increase in turnover rates (IAS 19), significant period of time (IFRS 2).”

“Some respondents questioned whether it is possible to have a material change in the number of employees that is not significant. The staff notes that it is not meaningful to say there is a ‘material’ change in the number of employees in IAS 19 since the standard does not require that number to be disclosed in the financial statements.”

Clear as mud?

US GAAP Requirement for Push Down Accounting

noreply@blogger.com (Malcolm McKay) — Sat, 01 Sep 2012 20:05:00 +0000

Had a recent comment that push down accounting wasn not mandatory under USGAAP, rather is was simply permitted in certain circumstances. In response to that previous comment, the FASB requirement for push down accounting is 805-50-S99-1. Readers of this part of the Codification will need to pay careful attention to the answer in question1, and not jump to conclusions that push down accounting is allowed (see question 2).

Following is the text of SAB Topic 5.J, New Basis of Accounting Required in Certain Circumstances.
Facts: Company A (or Company A and related persons) acquired substantially all of the common stock of Company B in one or a series of purchase transactions.

Question 1: Must Company B's financial statements presented in either its own or Company A's subsequent filings with the Commission reflect the new basis of accounting arising from Company A's acquisition of Company B when Company B's separate corporate entity is retained?

Interpretive Response: Yes. The staff believes that purchase transactions that result in an entity becoming substantially wholly owned (as defined in Rule 1-02(aa) of Regulation S-X) establish a new basis of accounting for the purchased assets and liabilities.

When the form of ownership is within the control of the parent the basis of accounting for purchased assets and liabilities should be the same regardless of whether the entity continues to exist or is merged into the parent's operations. Therefore, Company B's separate financial statements should reflect the new basis of accounting recorded by Company A upon acquisition (i.e., "pushed down" basis).

Friendly Accounting at Facebook

noreply@blogger.com (Malcolm McKay) — Fri, 01 Jun 2012 00:06:00 +0000

This post is courtesy of the Accounting Onion

U. S. Senator Carl Levin recently spoke on the Senate floor, referencing the discrepancy between tax and accounting treatment of stock options in the (then upcoming) Facebook IPO:

"According to its filings, when Facebook goes public, Mr. [Mark] Zuckerberg plans to exercise options to purchase 120 million shares of stock for 6 cents a share. Mr. Zuckerberg's shares, obviously, are going to be worth a great deal more than 6 cents, a total of about $7 million; they will apparently be worth more than 600 times as much, something in the neighborhood of $5 billion.

Here's where the tax loophole comes in. Under current law, Facebook can – perfectly legally – tell investors, the public, and regulators that the stock options he received cost the company a mere 6 cents a share – that's the expense shown on the company's books. [This is wrong – see later.] But the company can also – perfectly legally – later file a tax return claiming that those same options cost the company something close to what the shares actually sell for later on – perhaps $40 a share. And the company can take a tax deduction for that far large [sic] amount. So the books show a highly profitable company – profitable, in part, because of the relatively small expense the company shows on its books for the stock options it grants to its employees. But when it comes time to pay taxes, to pay Uncle Sam, the loophole in the tax code allows the company to take a tax deduction for a far larger expense than they show on their books. …

Now, the end result is that a profitable U.S. corporation – a success story – could end up paying no taxes at all for years, even decades."
To Levin, the Facebook IPO is a dramatic illustration of an inequitable "loophole" in the tax law. As Levin and Sherrod would have it, Facebook's tax deduction for using stock options to compensate executives – as opposed to any other form of compensation – would be essentially zero (that's probably a little dramatic on my part, but the point is the same); yet, Zuckerberg's tax liability when he exercises the options could be somewhere in the area of $3 billion.

The strong implication of Levin's narrative is that the extra amount of expenses would have wiped out every dollar of Facebook's reported net income that it had ever 'earned.' On top of that, there could be other outstanding options held by Zuckerberg and other employees extending way down the organization, which are going to have the same effect on future reported net income.

Which brings me to my second question: For all practical purposes, could Zuckerberg be taking Facebook public at this point in time with no history of profitability, perhaps negative shareholders' equity, and perhaps no hopes for earnings for some for years to come?

My inclination is to say "no," but I can only speculate. So, I will answer that question with another question: Since the FASB's rules understate the economic cost of options granted to employees, did the FASB provide a perverse incentive to Facebook to grant more options (or at terms overly favorable) to employees than it should have?

If one accepts the maxim that "what gets mismeasured gets mismanaged," then the answer to that question should be "YES." The stock option problem lies not with the tax rules that eventually recognize the full cost of the options to shareholders, but with the financial reporting rules that allowed Facebook to grant options without recording their full cost.

Surely, the senators can see that different accounting rules would have wrought different compensation policies from Facebook. Senator Levin would not have had a story to tell and Mark Zuckerberg would be a few billion dollars poorer.

Footnote: It is my distinct pleasure to provide Senator Levin (and his staff) with yet another accounting lesson. The amount of expense to be reported by Facebook is not, as the senator claims, the exercise price of the options (i.e., 6 cents per share). Assuming that the options were issued without any intrinsic value, then their "grant-date present value" (i.e., the amount upon which periodic option expense is measured) could end up being more or less than 6 cents per share. Although this technical correction to Senator Levin's story it doesn't fundamentally change the message, it once again reveals a lack of understanding that makes one question if Senator Levin has an adequate grasp on the issues.

Industry Expert: When and How to Adopt New Standards and IFRS

noreply@blogger.com (Malcolm McKay) — Thu, 26 Apr 2012 15:21:00 +0000

Bob Laux, Microsoft's accounting guru did a long and interesting interview with Bloomberg. Worth a read for his thoughts on all of the critical upcoming accounting standards changes, including timing of adoption.

In a wide-ranging interview with Bloomberg BNA, Robert Laux, senior director of financial accounting and reporting at Microsoft Corp., laid out the major issues in accounting rulemaking—with a particular focus on their potential impacts on multi-national companies. The main topics included the SEC decision on U.S. domestic use of IFRS, and top projects of the standard-setters, including revenue-recognition, financial instruments, lease accounting, and intangible assets. Steve Burkholder, a Bloomberg BNA staff correspondent, conducted the interview—an edited version of which follows.

Bloomberg BNA: The Financial Accounting Standards Board and the International Accounting Standards Board continue their long-running work to converge on a single set of accounting rules for global use.

Concurrently, many U.S. companies, audit firms, and investors await a highly-anticipated decision by the Securities and Exchange Commission on whether and, if so, how to incorporate international financial reporting standards into the reporting system for U.S. public companies.

If the SEC decides on some form of an officially prescribed use of IFRS in this country, what kind of an impact might that have on a large U.S.-based multinational company such as Microsoft?

Laux: Let me try and speculate on what may be the decision coming from the SEC although of course I don't know anything more than anybody else. The SEC had a staff paper that they produced, which talked about a dual process, if you will, of endorsement and convergence. In a speech at the AICPA's SEC [developments conference] a couple of years ago, one of the SEC staff used the word "condorsement." I think that's a good word because it aptly describes this process which is a combination of endorsement by the FASB with some convergence work. And no matter what the decision is—unless it's a decision not to go down a path of international standards (which I don't think would be the answer) —I think we need to do something to incorporate international standards in U.S. [generally accepted accounting principles, or GAAP]. If that does happen, it probably will be, in my opinion, like a condorsement [approach].

That would have quite a big impact on U.S. companies. Under this approach, the IASB will be taking on new projects and the FASB will be heavily involved, and then will have an endorsement mechanism that is given to them [the FASB] by the power of the SEC to endorse what the IASB does.

Convergence: Longer Than 5-7 Years.

Laux: I don't think that's going to have a really big impact on companies, maybe elongating the process a little bit. I think the bigger impact is on the so-called convergence area. These are like legacy accounting issues that we have in U.S. GAAP that may be in IFRS but the answers are slightly different, or there's just not IFRS guidance applicable or on point. The SEC staff paper indicated maybe a five- to seven-year time period for the FASB to look at these differences and try to incorporate the IFRS standards. However, I believe that may take longer than five to seven years— that's where there can be a somewhat big impact on companies.

Let me give you two examples. One is stock-based compensation, a joint project, but there are some differences between the U.S. GAAP and IFRS standards. One standard has to do with graded vesting and the other has to do with the way income taxes are recognized on stock-based compensation. Those can be significant differences, and if a company needs to change, that could have a significant impact.

Another issue is component depreciation, or depreciation in general.

Under IFRS, component depreciation is required. Under U.S. GAAP, it's an option that most companies do not take on—that could be a significant change. For instance, FinREC, which used to be [the Accounting Standards Executive Committee, of the American Institute of Certified Public Accountants], did a project—it's almost 10 years-plus ago—I was actually on the committee at the time–which considered having a requirement for component depreciation. Our feedback was that people were opposed to the idea.

So I think you're going to have those same kinds of discussions with these legacy differences, I call them, with U.S. GAAP versus IFRS that I think will have somewhat of an impact, to a big impact, on U.S.-based multinational companies.

Big, Tough Decision for SEC.

Laux: I think the SEC has a big, tough decision on their hands. We'll talk about that a little later in this interview. But the issue with that is— the ultimate goal—and it was in the SEC staff paper [of November 2011]—was incorporating IFRS in U.S. GAAP, with the aim to say after so many years (and I believe it's going to be more than seven years), the goal was to say that if you're in conformity with U.S. GAAP, you're also in conformity with IFRS. And that's difficult to do because of [some possible] so-called grandfathering-type of items. Maybe something could be done with what's called IFRS 1 [First-time Adoption of International Financial Reporting Standards] and the way of adopting international standards. Perhaps international standards can be slightly changed.

But some of these things that people think should be grandfathered—this is what makes it so difficult. And some would argue that, if you had these grandfathered items, then you truly do not have a global set of accounting standards if we're using different rules in the U.S. versus internationally.

I'm still a proponent of [the notion] that the world of business, of finance is international in nature, and we need to move towards a goal of having one set of high-quality global accounting standards. It's going to take us time to get there—probably a long time. And a lot of work's already been done on that.

For instance, when you bring up these grandfathering issues—yes, there are challenges and we may never get to the perfect answer. But that's not an excuse, in my opinion, for not striving to get more comparability on a global basis.

Revenue Recognition: `Going Pretty Well.'

Bloomberg BNA:As you know, one of the main standard-setting projects that the FASB and the IASB are working on is revenue recognition. How is that going, and how is the recently re-issued—and revised—proposal likely to affect companies?

Laux: I think the revenue recognition project is actually going pretty well. I'll have to go back to when it first started a number of years ago. As you know, standard-setting is difficult. People have a lot of opinions, and it takes time. But this has been on the agenda for a while now [Editor's note: It was added to FASB's and IASB's agendas in 2002]. But I remember when there were discussions of first doing this. And one of the main motivations, I believe, was to be able to converge U.S. GAAP with IFRS. U.S. GAAP has a lot of literature on revenue recognition, a lot of it [is] industry-specific. I don't know the number of references or standards on it, but people have said it's close to 200, if not over 200.

In international standards, it's really two standards and interpretations that go with them. And if you look at multiple-element arrangements, and you're not looking at the construction industry, some could argue that international accounting standards have one or two paragraphs on it.

So, this could almost be the poster child for convergence. But the point I'm trying to make is, with all that literature in U.S. GAAP, my first opinion was there's no way they're going to be able to pull this off. There's just no way that they'll come up with a general standard, or one standard, on revenue recognition. But I'll have to give the standard-setters credit here—they pretty much have been able to do that with slight disagreement with a few things in the standard. I'd also like to say that, this is probably—and I'll use the term again—poster child by the FASB staff and the IASB staff of the best way a project can be run. The staff did an outstanding job.

So, to get to your question, I think it's actually gone pretty well. The exposure draft that's out now is kind of unique, based on my experience, in that, when you have an exposure draft, you write comment letters indicating what you think about it.

Well, this exposure draft, many people and companies, including us at Microsoft are seeing it as very close to final. We are considering the implications for Microsoft, and what needs to be done? Our belief is that the rule will have a big impact on how we look at revenue recognition, when it's recognized. Also there may be more of an impact on our processes and procedures to make sure we're in compliance with the new standard.

But the point I'm trying to make is that, I think it's getting very close to what the final [standard] may look like. There is discussion on some issues. The two big issues that I know of, that people are really discussing, are the disclosure requirements and the transition provisions.

Bloomberg BNA: That's interesting, because as you know, it's been a common refrain at the FASB that sometimes the board's constituents don't follow standards during their formation as closely as they could until they see something cast in stone, or as a final standard. But this is perceived, as you say, as being close to final.

Laux: And, as you know, on the first exposure draft, there were close to a thousand comment letters, I believe. It just shows the amount that people have been engaged. Again, I'm not trying to sugar-coat it, or be self-serving, I really believe—especially in this project—the FASB and the IASB staff did a tremendous job of outreach, understanding industry-specific issues. And also outreach to users [of financial statements]. So there's been a lot of comment. And I think it's due to that we're in this shape that I described. It looks like it's close to final, in my opinion.

Resigned to On-Balance Sheet Lease Accounting.

Bloomberg BNA: Another joint FASB-IASB project with potentially big impact is leases. Basically, how is the draft standard being received? What kind of impact will that have on Microsoft? Going further, how might that impact compare with that on firms such as airlines, banks with many branches, shipping companies, and the big equipment leasers?

Laux: I think it's being received with mixed emotions. As you know, an exposure draft was issued, and the standard-setters are redeliberating the issues. We're expecting another exposure draft to come out.

I'll speak from the lessee side, because Microsoft is not a major lessee, but we're not much of a lessor, in essence. Our licensing of our software is under the revenue recognition standards. So we are a lessor in certain circumstances, but it's really on the lessee side. It's not going to have as much of an impact on Microsoft as [the planned standard would have] on the airlines, on banks with many branches, or, let's say, a grocery store chain with many locations or fast-food or restaurant chains that do a lot of leasing.

I believe people are resigned— I'm not sure resigned is the best word—but accept the fact that, in general, that leases will come on balance sheet. The SEC staff did a paper as a requirement, I believe, of [the Sarbanes-Oxley Act of 2002] to look at off-balance-sheet financing, and leases was one of the larger issues that came up. The people understand that maybe it does provide more information to users if they're on balance sheet.

I know there are still some people who are strongly in disagreement with that. But I would say, in my opinion, most people are resigned.

On the lessee side, the big issue right now is the expense recognition. And under lessee accounting—and it's really operating lease accounting—today, for the most part, in very general terms, you have straight-line rent expense. I'm renting something for $1,000 a month; I'll show $1,000 of expense a month. The way the exposure draft came out is that there would be a front-loading of that expense. I don't think we need to get into the details or the technicalities of how that occurs. It's looking at the liabilities separately from the asset, if you will. There's been a lot of feedback on that. The standard-setters are taking another look at that and it's my understanding they're doing outreach to constituents this month, to get prepared to talk about it soon—on the right way to approach this issue. So, that up-front expense recognition, instead of straight-line, could have a big impact on companies.

Let me just say, from a Microsoft perspective, as I said, we're not a big lessor. So we haven't been following it as closely as it doesn't have as much of an impact on us. But it looks like the lessor model is very complicated. I think—and I could be wrong—in that once people dig into that, you may be hearing more discourse from constituents saying, "Boy, this is pretty complicated. It may be a lot of work to actually implement in practice." And hopefully there will be discussions, if that is the case. When I look at it, and say, it's not really going to impact us to any great extreme, not in a material amount, but, boy, it looks awfully complicated, the model that's being presented for lessors.

Accounting for Financial Instruments: The Challenge Continues.

Bloomberg BNA: Another of the highest-priority projects of the FASB and IASB is financial instruments. That project has been a challenge overall. What is the outlook for convergence on that and what kind of effect would that have on banks as well as non-banking companies?

Laux: As you said, it has been a challenge overall. It's a difficult and complicated area, as you know. One of the problems, in my opinion, is that the standard-setters were starting from different points—they were leapfrogging each other,—in discussing the issue. That makes it very difficult to get one converged standard for financial instruments, when the IASB is working on something before the FASB, or vice-versa.

You can really see three areas they're working on. The first one is classification and measurement. The second one, impairment [or accounting for loan, or credit, losses]. The third one, hedging. And both the FASB and the IASB are in different spots.

This is going to be tough. You can almost look at those three components, as three separate, huge projects in and of themselves. So this shows how challenging this project is.

On recognition and measurement, what makes it even more challenging is that the IASB already has a standard out there, IFRS 9, on recognition and measurement [of financial instruments]. They delayed the effective date on it for a couple of more years —I believe, until 2015—and the European Commission has not even endorsed the standard. But there are other constituents, from what I understand, for instance, Australia, where companies have actually adopted it early. I don't have first-hand knowledge of this.

So you can see that that's a difficult proposition for the IASB. They want to work on convergence and work with the FASB, but if some of their constituents have already adopted the standard, you have to have some sympathy for the IASB and those who adopted, saying, "We adopted this. You're going to make us change again?"

But the IASB has said, in the spirit of convergence and how important this part of it is, that they would do limited reopening of IFRS 9—most of it, I believe, for the impact on insurance companies and different things like that. So, both boards are working on that issue.

The Securities Microsoft Holds: Where Are Fair Value Changes to Go?

Laux: When I'm breaking these up into these three categories: This one [on recognition and measurement], where currently the IASB rules are, and where the FASB is heading, actually would have a potentially significant impact on Microsoft.

We have a lot of investments in equity instruments—ownerships in companies, given our cash portfolio and investment portfolio. Currently under U.S. GAAP, any mark-to-market changes, fair value adjustments are shown as a component of other comprehensive income. Well, under the proposal, they would be shown as components of net income. And given the way the market moves, and our investment portfolio, we could have some potentially significant variability in net income.

We're a little concerned about that and have disagreements about the way the standard-setters are looking at, thinking about instruments. I don't think it's necessary for us to get into detail, but they're looking at both the characteristics of a financial instrument. We think that maybe the business model is really the important thing—of what companies are doing with these securities— we hold them, for the most part, for long-term strategic purposes.

Microsoft believes that a user should be informed of fair-market value changes. It's an economic event, phenomenon. But especially with the new standard on the presentation of other comprehensive income, we think it will be transparent to users. I can't speak for users. They need to speak for themselves, and can expertly speak for themselves. The volatility that goes through net income, I just fear that there may be a lot of users who will strip that out and say, that is not really what we want to see for your results for this quarter, for thinking about, predicting future share prices, and we're going to strip that out.

So it's just kind of a conundrum. Do you really want that volatility to go through the income statement? We want it to be transparent, but believe it's transparent currently in other comprehensive income.

Let me quickly go to the other two, impairment and hedging. Impairment has been difficult, as you know. The FASB and the IASB are working together and trying to come up with a converged solution. This three-bucket approach still needs a lot of meat on the bones for a lot of us to understand it, but they are working on it.

Hedging, I perceive they're even further apart. The IASB has a project that they're probably going to finalize soon, if they haven't already. And I think the finalization [involves] putting a staff draft for people to [study]. But it's really kind of a business-model type of thought process for hedging, or having hedge accounting, and it's quite different from what the FASB has been looking at or what their proposal was in their original financial instruments exposure draft [Editor's Note — That first FASB proposal was issued in May 2010]. So, they're quite a ways away in that, in my opinion.

If I go through the three [elements of the joint instruments project], I give them credit again, because they're working on trying to converge. On recognition and measurement, there's a lot of convergence there. They're working around the edges, if you will. You've heard my or Microsoft's disagreement with some of their conclusions, but the conclusions are what they are. Impairment, a little farther apart, but they're working hard on it. Hedging, I think they've got a ways to go.

Just to comment on the last part of your question. Obviously, [there would be] a significant impact on banks, financial institutions. That's their business. Just as revenue recognition is potentially going to have a significant impact on companies like Microsoft, it's just obvious that [the planned financial instruments standard] will have a big impact on financial institutions.

Financial Instruments: Potentially Big Effect on Non-Banking Firms.

Laux: The point that I try to make, however, is also that it will have a potentially big impact on non-banking companies, like Microsoft. Sometimes I get a little concerned that there's not enough attention paid to that issue. And it really goes back to the issue I discussed previously. This tentative conclusion that you've made [on investments in equity securities] could potentially have a significant impact on the variability of Microsoft's net income due to market changes. Is that really the best way to inform users of our financial statements?

And there are other sub-issues, like how complicated is the impairment model going to be? Are you making it a model based on the way financial institutions work? Or are you looking at actual non-banking companies and how they think about it, and making sure you don't make it overly complex for them? That's another one of my concerns.

At times, it feels that maybe they're just focusing too much on the banking industry and financial institutions. It's very important to them. I understand why that is, but it's important to point out that it will also have significant impacts on non-banking companies and they need to keep that in mind.

End-Dates for Key Projects, and Rules' Effective Dates.

Bloomberg BNA: For the projects we just talked about, what might be the end-dates for them, if you can prognosticate? That would be the three highest-priority projects for both boards, excluding insurance contracts, which is a topic of more immediate concern for the IASB. And what do we know about possible effective dates for the planned final standards?

Laux: Again, we're talking about revenue recognition, leases and financial instruments. I'm leaving off what some call the fourth project, insurance. On revenue recognition, I believe they're very close. The comment letters are in. Roundtables are coming up. The one at the FASB is [set for April 26]. So they are going to get that feedback, and they need to do redeliberations. [Editors' Note—He cited reported statements by FASB Chairman Leslie Seidman and by IASB Chairman Hans Hoogervorst on work plans]. And maybe the schedule [for completion of the revenue effort] is by year end. It could leak over into the beginning of calendar year 2013, in my opinion, but probably not much. I think that's close to being finalized by the end of the year, or close to the end of the year.

If we go project-by-project, and just talk about this one [revenue recognition], its effective date, a lot of people believe will be no earlier than three years from now. You need to give people at least three years to implement a standard. And the math on this—and let's say it's finalized by Jan. 1, 2013—then it would be, we believe, no earlier than January of 2016, at the earliest. In essence, both standard-setters have signaled that when they said [last year] that these standards would be effective no earlier than 2015—as we know, that schedule slipped a little bit, and I would say no earlier than 2016.

Leasing Standard: `At Least Another Year Away.'

Laux: That's a description of revenue recognition, which is the closest [to completion]. If I were prognosticating, I would say leases is at least another year away. So let's say a possibility—and this is just me guessing—of it being finalized in 2013. Let's say by Jan. 1, 2014, with maybe an effective date of 2017.

As for financial instruments, especially when you think of the three [parts of the project], there's a lot of work still to be done, so I couldn't even guess on that one.

Let me just make one final comment. We're struggling here at Microsoft, and it was actually in our comment letter on revenue recognition, and it's been a few years now, looking at what the possible implication would be if Microsoft adopted IFRS, or IASB standards. And that was in the context, as you know, if we go back three to four years, five years. It seemed at the time there was more momentum for an actual, pure adoption of the IASB standards. So, we looked at a project of what that impact would be. And, as you know from other companies, it would have been a significant undertaking.

But what we learned, when we did very high-level work, was how difficult it is to go back in history and redo the accounting for something. What the point we're making here at Microsoft is that—especially on revenue recognition, as an example—we think there could be potentially significant process, and procedural changes, system changes, that we need to make. And we think it's important that those systems and procedures and processes are in place before we make the entry.

Preparing Systems for Retrospective Application.

Laux: Let me describe this to you, because it's kind of weird to describe. It has to do with looking at the adoption technique of a standard, whether its going to be prospective or retrospective. If you go retrospective, you need to restate two years. In that context, we would like to have a system in place, prior to having to restate those two years, so that we can have parallel systems. If you do the math on that, it's more than three years, because you're talking about getting your systems in place, which, as we know in companies, is a very difficult proposition and could take up to two years. Then if you have to restate for two additional years, you're at four, close to five years.

I know the standard-setters want to get these out and get them effective. They're important standards that we need to do new accounting on. But there is that issue with the transition method. And, if there is, maybe [under] a modified prospective type of treatment, I think companies would have the ability to implement these within the time line of this three years that the standard-setters may be looking at. Even though three years sounds like a lot of time, given the requirement to do retrospective adoption and restating two additional back years, it's going to be very difficult, in my opinion, for companies to get there in a three-year time period.

SEC Staff's `Condorsement' Idea: `An Elegant Solution.'

Bloomberg BNA: These questions pertain to how the Securities and Exchange Commission might proceed on the big question of incorporation of IFRS in the U.S. reporting system. You already touched on this back in the earlier minutes of this interview. Do you have a sense of the how —if the SEC does make a definitive decision on IFRS use in this country—and the when?

Laux: Just like anyone else, I don't have any extra insight. You know that as well as I know that. I'll tell you what I would like to see, speaking personally, not for Microsoft. I am a proponent of what we discussed as "condorsement" [in] the SEC staff paper. The Financial Accounting Foundation [the parent group of the FASB and the Governmental Accounting Standards Board] has made some comments on that and, in my opinion, generally accepted what the SEC [staff] said, with some suggestions for some potential changes. But not overhauling the entire thing, or disagreeing with it.

I think it's a somewhat elegant solution. And it gets back to the issue that I'm a firm believer that the economy is world-wide in nature. We're interconnected. Just look at the contagion issues we have, where something may happen in Greece, or [elsewhere] in Europe, and the impact that could have on us in the United States.

SEC Needs to Give a Signal—`Soon.'

Laux: I strongly believe that the SEC needs to give some kind of indication of where their thinking is and needs to do it soon, just because of the uncertainty in a number of different areas. Uncertainty from a company's perspective about what we should be doing. Uncertainty from the IASB's perspective, where they have other constituents, saying, "Why all this U.S. stuff? It seems like you're ignoring us at times." (I use those terms loosely).

So, if I had my druthers, I think that the condorsement or an endorsement mechanism with further convergence on legacy-type standards that the FASB would look at is the way to go. I seriously believe that the SEC needs to come out with some indication of that within this calendar year, preferably within a couple of months. And you well know what the chief accountant at the SEC, Jim Kroeker, has indicated.

I'll go on a little bit of a tangent. I hear some people saying, well, it's an election year. While I understand that, this issue hasn't – thankfully, in my opinion – got into the presidential election debate. And I don't think it deserves to be in that debate. We have much bigger issues, in my humble opinion. I generally do not see the president and the presidential candidates on the Republican side talking about U.S. adoption of international standards. I don't think I've heard them mention it once. I would really like to see an indication from the SEC, this year, sooner rather than later. I think it's important for the U.S. It's important for the international community. It's important for the IASB.

Bloomberg BNA: Where do you think that indication might come from, if it does come from the SEC? They have their due process considerations, of course. Would it come from the commission or come from the staff?

Laux: I'm probably not the one to answer that, but I'll try to answer, based on my layman understanding of the issue. It's such an important decision, and such a big decision, that of course you have to have the commissioners weighing in on it. And I think you need to have due process.

Even the staff coming out with a paper that says, "We had the previous paper— the condorsement paper. We received feedback. And here's our current thinking that we're sharing with the commissioners and we're getting the commissioners' feedback on that." And I also think that, just like with anything else the SEC does, it will be subject to due process. Not knowing the rules of procedure like the back of my hand, when they issue something, there's always due process— that people can comment on and I think they'll encourage comment on this. I don't know the technicalities or nuances. Is it technically required that the commission actually vote to do something?

It's such a big decision, a critical decision that I think all of us would want the commissioners' opinion on it. Now it may not be a formal vote but I don't know the rules of procedure that well to definitively comment.

At FASB, Which Projects Off the Back Burner?

Bloomberg BNA: On the FASB and its potential agenda, at its March 23 meeting, the board's Financial Accounting Standards Advisory Council held lengthy breakout discussion sessions to home in on which out of the so-called "back-burner projects" should be the next major efforts of the U.S. board – that is, once the high-priority joint projects make it into the home stretch. Pension accounting and financial instruments with traits of liabilities and equity were high on the lists of a majority of participants. What do you believe should be on the FASB's new, short, must-do-next list and why?

Laux: It's a difficult issue because we have these big convergence projects and then, once they're completed, we need to look at what's going to be done next. I'll go on the assumption that a given is to complete the convergence projects, and it's really only after those, FASB will consider what's next.

Just as a sidelight, the IASB came out with an agenda consultation asking this question formally, probably similar to what FASAC discussed in their meeting. I'll give you Microsoft's comments. We did think that [financial instruments with traits of] liabilities/equities may be an issue that needs to be looked at. It's a very difficult practice issue for the standard-setters to handle. We thought that was important.

We don't have a pension here at Microsoft. So I have to tell you that it may not be high on our radar screen, so we didn't mention [accounting for pensions]. I could understand that comment, and we didn't put it in our letter to the IASB. It would not be a high-priority project for us, but the IASB is doing work on that, and the FASB is looking at it, so there could be some convergence there. I understand that.

Seeking a Better Definition of OCI.

Laux: One other one—and I'm not sure if this came out of FASAC's discussion—but what a lot of people are talking about is that the standard-setters need to become more definitive on the definition of other comprehensive income.

Bloomberg BNA: That did come out actually. That was high on the list.

Laux: It's kind of connected with the conceptual framework project. You could say that this is part of the conceptual framework project. Even, you could say, a disclosure framework project may be part of that. And I know that's on people's radar screens. We also said other comprehensive income and trying to define that. That said, that's going to be a very difficult project. Very difficult to come up with a definition, because, once you define it, you say, "Well, what about things we've done in the past that are in other comprehensive income? Do we change them? Do we put more in there?" So, I think that's a tougher project than even liabilities and equity.

For Microsoft, Intangible Assets Important.

Laux: Also on the agenda paper, when you used the term "short," I think you meant it as a small number of items. One item that we're kind of passionate about here at Microsoft is intangible assets. We believe, speaking generally, we're in an information economy. We've moved from the manufacturing economy, if you will. And we're not sure what the right [accounting policy] answer is there. I don't believe we're proponents of capitalizing a lot more intangible assets. That's kind of a double-entry thought process, if that makes sense.

Bloomberg BNA: And here you're talking about R&D, for example?

Laux: Yes, for research and development. And maybe just more information on intangible assets. What we suggested—and this would be a longer-term project—we believe it's important that, because intangible assets and intellectual capital, especially for a company like Microsoft, have a significant impact on our value—it is our most significant value driver—the accounting standards really have not kept up with that change in the economy. So we believe it's important for the standard-setters to look at that.

What we didn't want to do is prejudge what the answer is, because it could be disclosure. It could be going into areas like key performance indicators, which is difficult for the standard-setters to go in, especially in the U.S., because the SEC is the keeper, if you will, of management's discussion and analysis, not the FASB. But even in the disclosure framework project, the FASB, as a second part of that, has said that they'll look at possible integration of management's discussion and analysis with the financial statements and footnotes.

Now, of course, you need the FASB and the SEC and other constituents to cooperate. I'm a strong proponent that we need to go in that direction. To answer your question definitively, the third [topic] that we pointed out here at Microsoft is intangible assets. So, in summary, agree on liabilities and equity; understand that pensions is not an issue for us; other comprehensive income; conceptual framework; disclosure framework. And as a longer-term project, and maybe it's a research project, intangible assets.

Bloomberg BNA: You have been active for many years on the Committee of Corporate Reporting of Financial Executives International. Do you have any indication of what projects CCR would like to see the FASB tackle next?

Laux: First, I wanted to be careful [and say] I'm not speaking for FEI or the Committee on Corporate Reporting. But I'll give you my opinion from interacting with the group. I think it's somewhat similar to what was discussed at FASAC. And, as you know, there are members of FEI and the Committee on Corporate Reporting that are actually members of FASAC. For the CCR and FEI, the disclosure framework and disclosure issues are a big issue. Conceptual framework is a high[-priority] issue. There's a belief that we need to finalize and update the conceptual framework so there is a blueprint, if you will, of how to go about in setting standards and what to think about. I would say definition of other comprehensive income is important, and the FEI/CCR commented on that in their response to the proposal on the display of other comprehensive income.

I believe pension accounting is important to some CCR companies, and that would come up. So I think it's pretty consistent.

The one thing I want to add, and this also came up in the IASB's agenda paper, is with these huge convergence projects that we're working on—revenue recognition, leases and financial instruments—there's a lot of change going on. And maybe a period of calm is necessary for companies to actually implement these and make sure that they're implemented correctly and consistently, which by necessity, groups will need to talk about the right way to implement things.

Bloomberg BNA: Back when the IASB first saw its standards being adopted by the European Union countries, through the European Commission, they talked about having a "stable platform."

Laux: That's the term. So maybe we need a mini-stable platform for a number of years because what we're working on right now are just significant changes. So I would say that's another, in my opinion, another commentary that you'll hear from FEI and CCR.

Bloomberg BNA: One FASB project on which the board's chairman, Leslie Seidman, as well as the SEC staff, have mentioned recently in public discussion is the disclosure framework. The aim and primary focus of that effort are to make footnotes to the financial statements more effective. Over the years, companies have complained about what they call "disclosure overload." Do you see that disclosure overload is a problem? Do you believe the focus in that project is an appropriate focus?

Laux: I like to use a slightly different term—instead of disclosure overload, I like to use the term disclosure effectiveness. Sometimes the term disclosure overload has some baggage. People read into it and have some negative associations. When I go into disclosure overload, what I get concerned about is there's so much disclosure, that maybe the really important items that are being disclosed may be getting lost in a sea of information. In our day-to-day lives, it's almost information overload. It really gets to disclosure effectiveness. My opinion is this should be priority one.

There's a lot of complaints that some of what we're doing in financial reporting seems like a compliance exercise, not a communication exercise which we can't let happen to our profession. Our profession's responsibility to the world is to communicate transparently. That means we need a lot of work in disclosures.

I'm encouraged that the FASB has a project on their agenda. They're working with [the European Financial Reporting Advisory Group], the group that advises the European Commission. The IASB is also following this closely. I am actually a member of the Disclosure Framework Working Group. I believe it's important that the FASB is looking at it.

I believe it's also important that its not just the standard-setters looking at it but also the constituents should be heavily involved in the process. I think that is FASB's intention. I would like to see that happen sooner rather than later. So we're going to have to see, when their document [a discussion paper, scheduled for release in the second quarter] comes out, what it says. I am a little cautious that this is just such a big issue, and people were looking for significant change here. I'm not necessarily saying that there will be a decrease in disclosures, but there will be, I hope, a much more effective disclosure package. There's such a lot of expectations resting on this project so it's very, very important that constituents are intensely involved. We as preparers; users – and really the purpose of financial reporting is for the users – and, to a slightly lesser extent, but they're also involved, the auditing community, we experience this first-hand every day and have a lot of real-life experiences as preparers, users and auditors. I think we can add a lot to this project and help standard-setters really think about this issue. I think that's happening and I'd like to see more of that.

Bloomberg BNA: Wrapping up here, are there any other issues you'd like to comment on or questions you'd like to raise?

Laux: I touched on this in a couple of my comments, and I don't want to come over as self-serving or sugar-coating it. That truly is not my intention. I did an industry fellowship at the FASB, so I actually worked there for two years. And it was a great experience. I just want to give the FASB and the IASB, and the standard-setters credit. At times I don't think they get the credit they deserve in a very difficult job, and of trying to incorporate everybody's disparate and strongly held views. It was really an eye-opener for me, being on the other side and working there.

That said, at times, the standard-setters may get isolated in their theoretical world and need to really work hard on seeing what's going out in the day-to-day operations of what users are doing with the information, and what's going on at companies. They're trying hard at that. They just need to constantly try harder on that.

But the point I'm trying to make is, I just feel, and having worked there, that at times it's a thankless, very difficult job. And I just wanted to say that they deserve some credit for what they've done.

Blowing a Breaker on Financial Reporting

noreply@blogger.com (Malcolm McKay) — Tue, 06 Mar 2012 01:10:00 +0000

Great article by Teresa Iannaconi from FEI.

Financial Reporting: Disclosure Overload - Gaining Control of the Process

A team of graduate students recommended selling Enron stock three years before the company went bankrupt. What does this say about the state of financial disclosure, and would it benefit more from enhancement rather than expansion?

As standard setters, regulators and others seem to continuously call for and deliver more regulations, more standards, more transparency and more disclosure, financial executives are having difficulty keeping up with the volumes of materials that are expected from them. They believe this plethora of statements and documents that they provide to users should already comprise more than enough information, and that should solve the problems of accounting fraud and financial reporting fraud.

Indeed, many relate instances of “looking but not seeing” or “eyes wide shut.” These contradictory statements describe what happens when too many financial disclosures impair their usefulness.

A new study shows than when it comes to financial reporting, quality may be more important than quantity. The report, a joint research project published by Financial Executives Research Foundation (FERF) and KPMG LLP, delved into the effect of increased financial disclosures from 2004 to 2010. Entitled Disclosure Overload and Complexity: Hidden in Plain Sight, the report observed that more financial disclosures are not necessarily better, and recommended financial disclosure enhancement rather than expansion.

A group of students at Cornell University’s Johnson Graduate School of Management likely would agree with that recommendation. In 1998, using publicly available financial information, the students succeeded where professional investment analysts and investors failed. At that time, the students analyzed Enron Corp. and recommended selling the stock — three years before its bankruptcy. The student analysis determined that the stock was overpriced and questioned Enron’s high debt level, its earnings quality and the long-term sustainability of its business model.

The students’ research also caught the attention of author Malcolm Gladwell who discussed the research in his book, What the Dog Saw (Little, Brown and Co., New York, 2009). He devoted a chapter to the Enron implosion, entitled “Open Secrets — Enron, Intelligence and the Perils of Too Much Information.” Throughout the chapter the author notes that each party that deciphered Enron’s financial vulnerability obtained the relevant information from Enron’s publicly filed disclosures, albeit with some level of difficulty. In a discussion of Enron’s use of special purpose entities Gladwell noted, “… you can’t blame Enron for covering up the existence of its side deals. It didn’t. It disclosed them” (emphasis added).

Although Gladwell goes on to question whether the disclosure in Enron’s public documents was adequate for a complete understanding of the transactions, the discussion concludes with an observation based on a research paper, “Rethinking the Disclosure Paradigm in a World of Complexity,” authored by Steven Schwarcz, a professor at Duke Law School, which observes that increasing financial complexity has resulted in the traditional disclosure paradigm of “more is better” becoming an anachronism.

Schwarcz argues that there is no disclosure model that can adequately address the disclosure necessary to understand financial complexity. He says a regulation should be enacted that prohibits material management conflict in transactions that he characterizes as “disclosure impaired.”

Although Schwarcz is unable to identify the precise nature of a disclosure-impaired transaction or arrangement, his recommendation is founded on the concept that some activities of a business enterprise are so complicated that any approach to disclosure will provide either too little or too much disclosure to eliminate buyer-seller understanding asymmetry.

Cornell Students Cite Enron Disclosure Risk Prior to Implosion

The Cornell students were enrolled in an advanced financial statement analysis class taught by Charles M.C. Lee. The conclusions raise the obvious question: How were business students able to figure out something that sophisticated business analysts and journalists were failing to perceive and wouldn’t be able to perceive for another three years? “All the facts were hiding in plain sight,” said Lee.

The content of the Cornell students’ report presents an opportunity to develop additional understanding of the adequacy of disclosure as it existed in 1998 (pre-Enron reform) and how disclosure was approached by those who identified and those who missed the Enron warning signs.

The report provides some insight into potential paths to improved disclosure. Ultimately the question posed by the 1998 report is why was the disclosure available then adequate for this student group to reach a “right” decision, but inadequate for others to discern a seemingly hidden problem?

The students’ report generates some points to ponder:

▪ The report demonstrates extensive and in-depth analysis of the information required to be disclosed using 1998 disclosure requirements.

▪ The research and analysis utilized extensive information found outside of Enron’s public filings. For example, the report cites information about competitors, economic analysis and predictions including government data that are well beyond the information required to be disclosed by any public company.

▪ The report includes the following conclusions that, although they have been lifted from their context in the report, provide an informative backdrop for the general consideration of disclosure:

“The nature of Enron’s businesses requires a significant amount of estimates and assumptions which impact the company’s financials. Nevertheless, both in its exploration and production operations as well as in its financial services operations, Enron uses accounting methods that are in line with industry practice. After close examination and scrutiny, we have found that Enron’s financials provide an acceptable level of disclosure.” (Emphasis added.)

Disclosure Adequacy, 1998 and Now

Considering the extent that disclosure has expanded subsequent to Enron’s demise, how is it possible that the disclosure in the Enron public filings was adequate to identify its investment risks and why did only a few identify those risks on a timely basis?

Further, if it was possible to identify the risks on a timely basis using the disclosure required in 1998, what have the extensive changes in accounting and disclosure in response to Enron and similar crises accomplished?

It is inarguable that adequate financial disclosure must be provided. The 1998 analysis could not have been developed without extensive disclosure. However, as Lee said, sometimes the facts are hidden in plain sight.

The November 2011 disclosure complexity report included the results of a survey of members of Financial Executive International. Responses to Question 12 of the survey indicated that 89 percent of respondents considered the fair value disclosure requirements as a significant source of disclosure overload and complexity.

The reviews of annual reports included in the research showed an increase of 184 percent in the volume of fair value and related disclosures during the six years covered by the report. Interestingly, using a 1998 level of fair value disclosure, the students were able to derive sufficient data about the mark-to-market accounting by Enron to form an assessment of its effect on the quality of earnings. Without questioning the merits of fair value accounting, some may question the merit of the expanded footnote disclosure requirements.

There was obviously some mental process that the students at Cornell invoked that others did not. If the students could develop an understanding of an investment in Enron based on then-available information that was deemed adequate, perhaps the solution to disclosure is not to expand disclosure requirements but to find the means to enhance disclosure presentation to improve access to relevant information.

One objective of the November 2011 disclosure complexity report was to stimulate discussion and consideration of ways to streamline disclosure to improve access to relevant information.

The report listed eight recommendations, including the following two:

▪ The U.S. Securities and Exchange Commission should issue an interpretive release to address the permissibility of cross-referencing and manner of addressing immaterial items to reduce redundant and unnecessary disclosures.

▪ Summaries of significant accounting policies and discussions of newly implemented or soon to be implemented accounting policies should be streamlined to eliminate unnecessary redundancy and patently immaterial disclosures.

During the American Institute of Certified Public Accountants’ Annual Conference on Current SEC and PCAOB Developments in December 2011, presentations by the SEC’s Division of Corporation Finance staff included remarks confirming that immaterial disclosures are not required to be provided. While the remarks do not have the same force as an interpretive release, it was clear that the SEC staff’s remarks were compatible with, and reinforced the themes, of the first two recommendations.

The SEC staff comments offer a glimmer of hope in combating the disclosure challenge. A third recommendation in the November 2011 disclosure complexity report suggested using more tables and graphs to present information.

What stands out in the Cornell students’ report is that the researchers mined the available data to wring out every available piece of information that they could. Much of that information was presented in the students’ report in tables and graphs. That suggests that data was available but may have been difficult to locate or identify.

Additionally, the Cornell researchers had characteristics that distinguish them from the average investor. They were graduate students in a financial analysis course motivated by the desire to achieve an academic goal and most likely a personal knowledge goal. They also perhaps had more time to devote to this project than their employed counterparts would have had.

Disclosure for the Average Investor

A perennial question persists about the identity of the average investor: What are the characteristics of the audience to whom disclosure is directed? We appear to have gotten beyond the notion that the audience is our elderly sweet aunt and have embraced the notion that the audience should have some level of financial literacy.

Presumably, professional investment advisers and institutional investors have the same tools and capabilities as the graduate students at Cornell. There is also a large audience of investors who can generally read financial statements and footnotes but do not have the skills or motivation to devote the same level of effort as the Cornell researchers.

If disclosure is directed to that audience, the Cornell students’ report may lead us to conclude that the disclosure enhancements that are appropriate may be critical financial statement analytics. Rather than presenting more detailed information, enhanced disclosure could consist of tabular or graphical information that enables deeper financial analysis and understanding. After all is said and done, a deeper understanding is what disclosure is all about.

The Cornell students used a wide variety of information that was available 14 years ago. They used all of the basic financial statement information including an in-depth look at each of the categories of cash flow. They read and apparently understood the financial statement footnotes well enough to determine the extent to which revenue growth was coming from acquisitions and the extent to which earnings changes were derived from non-cash mark-to-market adjustments.

Returning to the theme of the disclosure complexity report, a very real possibility is that disclosure is adequate but so mired in excessive, redundant and immaterial disclosure it is difficult to find the relevant and significant information.

The Cornell research incorporated extensive information obtained from sources outside of Enron. The students obviously went to the public disclosures of Enron’s competitors and obtained and compared information including relative performance, financial position, leverage and cash flows. The research also incorporated economic and government data. This raises a very important consideration: no matter how robust a company’s disclosure may be, that disclosure must be complemented by other external data.

Prospects for Improvement — FASB’s Disclosure Framework Project

The disclosure complexity report recommends that the Financial Accounting Standards Board should accelerate consideration of its Disclosure Framework Project to establish a systematic approach to disclosure that properly balances disclosure considerations with the required cost and effort. The current FASB project agenda indicates that a discussion memorandum will be issued in the first half of 2012. Additionally, other international organizations are examining ways to improve disclosure efficiency, including the United Kingdom’s Financial Reporting Council’s Cutting Clutter project.

The efforts of standard setters and support of regulators for improvements in disclosure efficiency offer the hope that the critical disclosures that investors need to understand investment opportunities will not continue to be buried in a haystack of marginally useful or useless disclosures.

Investor Education

The accomplishment of the Cornell students may be beyond the capabilities of the average investor, but their tools are universally available. The research techniques can be replicated to a lesser degree by average investors if the relevant information is available in an accessible form that facilitates analysis.

Investor education is fertile ground for standard setters and regulators to consider in exploring a better approach to disclosure. Various organizations have undertaken programs that are characterized as investor education, but most focus on issues such as avoiding fraudulent schemes and general investment education.

A relevant question to ask is whether those initiatives go far enough. An admonition to read the financial statements and related footnotes is ineffective if the investor does not understand the richness of the data. Investor education initiatives rarely provide insight into the wealth of information that is already provided in public filings.

Instead, efforts should assist investors in understanding where and in what form information is available and how that data can be used in financial statement analysis. Disclosure policies and regulations should include consideration of information accessibility and investor education.

For many, investment decision-making is one of the most critical activities of their financial lives. Whether the user of disclosure is a professional investor or is a non-professional investor performing financial analysis for a personal portfolio, the ability to find and understand relevant information is critical.

Disclosure policies and regulations that result in indefinite expansion of detailed disclosures fail to serve users well. Standard setters, regulators and preparers all must pursue disclosure policies that enhance the ability to find and use disclosures effectively. It is also necessary to pursue initiatives that educate investors about the richness of existing disclosures and how they can be used to gain insight into the quality of potential investments.

Accessible information that is easily digestible and provides insights on significant issues in the hands of informed users must surely be the recipe for efficiency in the capital markets.

IFRS Update

noreply@blogger.com (Malcolm McKay) — Thu, 05 Jan 2012 17:17:00 +0000

Comprehensive IFRS Update, courtesy of AICPA

SEC decision on IFRS is at least a few months away
The Securities and Exchange Commission staff will need a few more months to produce a final report on International Financial Reporting Standards, SEC Chief Accountant James Kroeker said Dec. 5 at the AICPA National Conference on Current SEC and PCAOB Developments in Washington. SEC members are not expected to make a determination on the use of IFRS for reporting by U.S. public companies until the staff's work is complete.

Comment letters support IFRS, call for more convergence work: The Securities and Exchange Commission said comment letters in response to a staff paper called "Exploring a Possible Method of Incorporation," issued in May, expressed support for global accounting standards. But commenters also wanted the International Accounting Standards Board and the Financial Accounting Standards Board to make more progress on joint standards-setting projects before International Financial Reporting Standards are adopted as the U.S. standard.

AICPA advises IASB to complete work on conceptual framework
Richard Paul, chairman of the AICPA's Financial Reporting Executive Committee, advised the International Accounting Standards Board in a letter to complete its work on a conceptual framework, including a presentation and disclosure framework. This framework will guide the board as it continues to develop International Financial Reporting Standards. The letter was sent in response to a request for feedback when the IASB issued its Agenda Consultation 2011 in July.

FASB, IASB reach tentative decisions on aspects of lease accounting
The Financial Accounting Standards Board and the International Accounting Standards Board announced progress in their ongoing, high-profile convergence project on leases. Although an exposure draft hasn't been released, the boards reached tentative decisions regarding cancelable leases, and revenue recognition and disclosure for lessors with leases of investment property. They also reached an agreement on how to require banks to book losses on loans earlier than they do now. The boards will release the revised joint proposal on impairment in 2012, with the standard likely to be effective in 2015.

FASB, IASB issue new disclosure requirements on offsetting
The Financial Accounting Standards Board and the International Accounting Standards Board issued on Dec. 16 common disclosure requirements on the effect or potential effect of offsetting arrangements on a company’s financial position. The new rules will require companies to disclose gross amounts subject to rights of set-off, amounts set off in accordance with the accounting standards followed, and the related net credit exposure, according to the IASB.

Key accounting-policy decisions are mired in uncertainty
Details about whether and how International Financial Reporting Standards will be incorporated into the U.S. financial reporting system remain unclear, as Securities and Exchange Commission officials say they are still a few months away from deciding. The SEC has floated a "condorsement" approach, although the AICPA has urged the agency to give companies the option to adopt IFRS as issued by International Accounting Standards Board. Meanwhile, leaders of the Financial Accounting Standards Board and the IASB say the current convergence project model is likely to end when the priority projects are completed.

Revised FASB proposal could change revenue-recognition timing
The timing of revenue recognition for certain companies could be affected by revised accounting proposals from the Financial Accounting Standards Board and the International Accounting Standards Board. The new rules also would bring other changes, such as increased disclosure requirements. AICPA members can download an updated Revenue Recognition Accounting Brief from AICPA.org.

Amendments aim to clarify transition guidance for IFRS 10
InAudit.com (12/23)

IASB pushes mandatory effective date for IFRS 9 to 2015
InAudit.com (12/23)

How the switch to IFRS could affect M&A

The convergence of International Financial Reporting Standards and U.S. generally accepted accounting principles will have implications for the treatment of mergers and acquisitions, writes Brian Reed, CPA/CVA. For example, GAAP and IFRS take different approaches to measuring the fair value of business combinations, and in many cases, revenue is recognized sooner under IFRS. In general, IFRS offers fewer rules and less guidance.

IFRS allows banks to inflate profits, report says
Banks are using complex financial products to bolster profits under International Financial Reporting Standards, according to a report by the Adam Smith Institute that calls for changes. In particular, banks are able to recognize expectations of future income as current profits under IFRS.

IFRS rule led to misdiagnosis of financial crisis, U.K. group says
Flaws in the IAS 39 International Financial Reporting Standards rule kept U.K. and Irish banks from booking potential bad loans during the 2008 financial crisis, leading to losses totaling $236 billion, according to a report by a pension fund lobby group. The accounting rule led to misdiagnosis of the root problem as one of liquidity, rather than solvency, the report said.

Commission: U.K. local authorities handled switch to IFRS well
U.K. local authorities handled the transition to International Financial Reporting Standards well in 2010, the Audit Commission found. However, some filed late accounts because of the change, with 18 of the 457 local bodies without auditors' opinions by Oct. 31, compared with seven in 2010-11.

Ireland eyes new deadline for U.S. multinationals to use IFRS
U.S. companies operating in Ireland reportedly will have another five years before being required to prepare a second set of statements under either International Financial Reporting Standards or Irish generally accepted accounting principles, in addition to U.S. GAAP. A proposed law would allow U.S. companies to continue using U.S. GAAP until 2020. The measure is intended to encourage foreign businesses to invest in Ireland.

Official: Russia's public companies will switch to IFRS by 2013
Bloomberg (12/13)
CPA Exam to be given in South America under AICPA deal with Brazil
Accounting Today (12/9)

Discover the IFRS Certificate Program from the AICPA
The AICPA's IFRS Certificate Program is a comprehensive curriculum of online training, research tools and practice aids designed to help CPAs understand, implement and apply International Financial Reporting Standards. Courses cover revenue recognition, leases, impairment, intangible assets, inventories, EPS and more.

Top 1% Pays 37% of All U.S. Income Taxes

noreply@blogger.com (Malcolm McKay) — Tue, 01 Nov 2011 15:22:00 +0000

This is not specifically an accounting issue. But with recent attention to the 1% vs 99% media frenzy, it is worth examining some facts around who pays how much tax in the U.S.

Really interesting that the top 1/10 of 1% payc about 15% of all U.S. federal taxes. That is a total of 138,000 people.

This is an article from SmartPros.

The income earned by the top 1% of Americans has declined for the second year in a row while their average tax rate has increased, according to a new Tax Foundation study. The average federal tax rate for those reporting at least $343,927 in income has increased from 22.5% in 2007 to 24.0% in 2009, while the average income for the top 1% has declined from $1.4 million to $1 million over the same period.

The Tax Foundation's analysis is based on new data from the Internal Revenue Service on individual income taxes, reporting on calendar year 2009. The amount of individual income tax paid steeply declined by $166 billion, twice the decline from 2007 to 2008. Nationally, average effective income tax rates were at their lowest levels since the IRS began tracking them in 1986. The average tax rate for returns with a positive liability went from 12.2% in 2008 to 11.1% in 2009.

"During a time of economic downturn, we expect to see significant changes in both total income reported and the share of taxes paid by those with the highest incomes," said Logan. "Unlike middle-income wage-earners whose incomes and tax liabilities are fairly steady, high-income people tend to realize significant capital gains that fluctuate wildly with the economy, causing their income tax liabilities to fluctuate as well."

In 2009, the top 1% of tax returns earned 16.9% of adjusted gross income and paid 36.7% of all federal individual income taxes. In 2008 those figures were 20.0% and 38.0%, respectively. Each year from 2005 to 2007, the top 1 percent's constantly growing share of income earned and taxes paid set a record. The 2008 reversal of this trend continued in 2009.

The study also takes a look at the very highest earners, the top 0.1 percent of tax returns, which the IRS only began singling out in recent years. In 2009, those 138,000 tax returns accounted for nearly 7.8% of adjusted gross income earned (down from almost 10% in 2008), and they paid around 17% of the nation's federal individual income taxes (down from 18.5% percent in 2008).

"The very highest income group—the top one-tenth of one percent—actually has a lower average effective income tax rate than the rest of the top 1 percent of returns because these extremely high-income returns are more likely to have income from capital gains and dividends, which are typically taxed at lower rates," said Logan. "It's worth pointing out that in the case of capital gains and dividends, however, income derived from these sources has already been taxed once by the corporate income tax, which is not included in the current study, meaning the average effective tax rate numbers can be somewhat misleading."