January Archive

NOTE to readers: We are in process of importing all the archive of the FEI blog, which goes back to 2004. At this time the entire month of January 2008 is included in this post. If you have any questions, please send an email to blogs@financialexecutives.org and put in Subject line: Question.

Jan 29, 2008
PCAOB Adopts AS6, 'Evaluating Consistency of Financial Statements; Agrees To Move GAAP Hierarchy From Audit to Accounting Stds
Earlier today, the PCAOB voted unanimously to adopt Auditing Standard No. 6, “Evaluating Consistency of Financial Statements” (AS6). Details are in this press release, as supplemented by my notes from listening to the webcast of PCAOB's meeting, below. Here's a synopsis of key points from today's PCAOB meeting:
AS6, approved by the PCAOB board today (still subject to SEC approval as noted further below) redefines ‘restatement’ (and references, but does not define ‘materiality’), sets forth additional requirements for auditors to evaluate client’s accounting changes, error corrections and reclassifications, and requires new disclosures in the auditor’s report relating thereto. These changes in auditing standards were done to better conform with FASB Statement No. 154, “Accounting Changes and Error Corrections,” (FAS 154) issued by FASB in 2005. The focus of the new standard, as described by PCAOB board member Dan Goelzer during the PCAOB’s open meeting, is: “If there is a material effect on comparability with the prior version [of financial statements], the auditor will have the responsibility to explain the change or error correction in his/her report.” He added, “AS6 will not fundamentally alter the auditor's responsibility, but will benefit users because of disclosure by the auditor, regardless whether the change is from an error or change in accounting principle.”
Related amendments to the PCAOB's ‘interim standards’ - i.e. predecessor standards promulgated by the AICPA that had been adopted on an interim basis by the PCAOB – were also approved by the PCAOB today, concerning the auditor’s responsibilities to evaluate and report on matters relating to consistency of the financial statements.
Additionally, the PCAOB approved amendments to its ‘interim standards’ to remove the ‘GAAP Hierarchy’ from auditing literature. This action was taken in light of FASB’s proposed change to move the GAAP Hierarchy from auditing literature to accounting literature.
SEC must approve before AS6, other amendments become effective: Consistent with the policy for approval of all PCAOB standards, AS6 and the related amendments to the PCAOB's interim standards will not become effective until approved by the SEC. The effective date for this particular standard and the related amendments, as noted in PCAOB’s press release, will be 60 days following SEC approval.
“Restatements” redefined: AS6 will redefine ‘restatement’ to conform to the definition in FAS 154, said PCAOB staff during today's open board meeting. FAS 154 defines a restatement as: “the process of revising previously issued financial statements to reflect the correction of an error in those financial statements.” FAS 154 also provides guidance on when changes in accounting principle constitute correction of an error, and when changes in estimate should be reflected as a change in accounting principle. As noted in PCAOB’s earlier proposal on which the final version of AS6 will be based: “Under [FAS] 154, therefore, the term "restatement" does not refer to changes made to previously issued financial statements to reflect a change in accounting principle.”
‘Materiality’ definition untouched: PCAOB staff told the board during the open meeting that AS6 has ‘no new requirements” with respect to ‘materiality,” and that auditors should continue to apply the guidance on materiality in AU 312, Audit Risk and Materiality in Conducting an Audit, as well as SEC’s SAB 99 and SAB 108. Board member Dan Goelzer asked if AS6 would be impacted by any change in the definition of materiality that may be recommended by the SEC Advisory Committee on Improvements to Financial Reporting (CIFR). PCAOB staff replied “the definition of materiality is determined by federal securities law and case law,” adding, “I don’t think we’d have to change AS6 if the SEC changes the rules on what materiality is.”
No substantive change to client confidentiality: Goelzer supported AS6 and the related amendments to the board’s interim standards, but noted, “There is some risk we could inadvertently trigger changes in audit practice that we don’t intend.” Goelzer raised two issues in particular, and the discussion that followed essentially put on the record what the board’s intent was with respect to these changes. First, Goelzer noted some of the comment letters received on the amendments during the proposal stage questioned the PCAOB’s decision to delete from the interim standards references to AICPA Rule 301 on client confidentiality. PCAOB staff responded, “My understanding is when the board looked to adopt certain AICPA rules on a transitional basis, they did not adopt Rule 301 because they determined it was not necessary to fulfill the board’s mandate under Section 103 of the [Sarbanes-Oxley] Act.” Additionally, staff described the deletion of the reference to Rule 301 as a ‘technical change’ and basically a ‘clean-up’ change, adding: “ When we didn’t pick up Rule 301, it wasn’t because we meant to change the auditors’ obligation to maintain client confidentiality.” In an apparent reference to the debate surrounding auditor access to documents subject to attorney-client privilege and the less-established concept of auditor-client privilege, PCAOB staff continued, “There has been some controversy whether the courts should view differently disclosure of confidential information to auditors. Speaking for myself, we don’t mean to make any change, don’t interpret our action that way.” Further, staff said, “The fact that we are deleting some residual references to Rule 301 isn’t meant to make any substantive change or express our view on the auditor’s obligation with respect to confidential information.” Another staff member added, “That’s correct, there is no intent to change the auditors’ existing obligation to protect confidential information.”
Auditor’s ‘opinion’ vs. statement of ‘fact:’ Goelzer also pointed out some comment letters on the earlier proposal were concerned with deletion of a reference to AU Section 410.02 which stated the auditors’ opinion that financial statements are presented in conformity with GAAP does not require a statement of fact by the auditor, but an opinion. “Some commenters were concerned,” said Goelzer, “that deleting that [reference] may change the auditor’s responsibility or liability, on the thought that opinions can vary, facts can not,” adding, “that can be an issue in litigation.” He asked the staff why they were making this change. Staff replied, “That was not ever our intent.” They explained, “We realized the description of GAAP in AU 410 is not applicable any more, we deleted it.” In response to comments described by Goelzer, staff said, “We felt responsive to the comments, rather than putting the sentence back in as it was, that it was more appropriate to put a reference to the 4th std of reporting, which explains the auditors statement is a statement of opinion, not a statement of fact.” They repeated, “we did not intend to change” that concept. Goelzer confirmed, and the staff agreed, “the reference it is an ‘opinion,’ not fact, is still there in the auditing standards, just not in this standard.”
‘Evaluate’ vs. ‘review’ reclassifications: One change in the final version of AS6 vs. the proposed version, noted Goelzer, is the proposal said the auditor should ‘review’ reclassifications (to determine, e.g., if they are correction of an error) whereas the final standard changes the word ‘review’ to ‘evaluate.’ Staff responded the change in terminology from ‘review’ to ‘evaluate’ in this instance “doesn’t change the auditor’s responsibility, the two words are similar, but ‘evaluate’ captures the auditor’s obligation better, and is consistent with the word used throughout AS6 to ‘evaluate.’” Further, staff noted, “There have been cases where adjustments of previously issued financial statements were deemed reclassifications because they looked like reclassifications, e.g. from long term debt to short term debt.” Staff noted such a change “has ramifications on analysts’ views,” adding, “if a company were to make that kind of reclassification, this standard would require the auditor to evaluate that to make sure it is truly a reclassification, and not correction of an error.”
Change in accounting principle ‘inseparable’ from change in accounting estimate: Another change in the final rule vs. the earlier proposal noted by Goelzer relates to a comment made by GAO that a reference in the proposal to an example in AU Section 420 on changes in accounting principle vs. changes in estimate was outdated given discussion of that example (a change from straight-line to accelerated or declining balance depreciation) in FAS 154. He asked staff to explain this change. Staff replied “The classic example given in FAS 154, a change in depreciation method, e.g. from straight line to accelerated, [if it is done] not because you want to, but you found the accelerated method demonstrates consumption of that asset over time, you are making a change in principle, but doing it in response to, you have information on which to make that estimate.” He added, “It is kind of inseparable,” as to how much of the decision was purely elective vs. making the change to better reflect the current value of the depreciable asset. However, as Goelzer observed, “The bottom line is, in its final form, the standard will require the auditor to note in his/her opinion there has been a change in, e.g. depreciation.”
GAAP hierarchy: PCAOB’s press release issued today also states: “The Board has coordinated with the FASB and understands that the FASB intends to coincide the effective date of its GAAP hierarchy standard with that of the PCAOB.” The latest information currently available on FASB’s website for the GAAP Hierarchy project (last updated March, 2007) has a similar statement about coordination of the effective date of the new GAAP Hierarchy standard with related rule changes being promulgated by the PCAOB and the AICPA, and says: “In order to (1) provide a mechanism for constituents to understand the Board’s decisions during redeliberations and (2) facilitate an expeditious issuance of a final Statement upon the PCAOB’s issuance of its auditing standard that will reference the GAAP hierarchy, the staff has posted a "near-final" document [September, 2006] to the FASB website. “
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1:42 PM by Edith Orenstein

Jan 28, 2008
Lone Trader Socks It To SocGen With $7 Billion Fraud - Or Did He? And -Atkins, McKenna on Supreme Court's Stoneridge Decision
Attorneys for Jérôme Kerviel, alleged to be the ‘rogue trader’ who caused $7 billion in losses at French bank Société General (SocGen), say that Kerviel “did not commit any dishonest act, nor embezzle a single cent, and he in no way benefited from the bank’s funds.” The attorneys’ statement appeared in, “SocGen Accused of Smokescreen After Loss,” by Martin Arnold, Peggy Hollinger, and John O’Doherty in today’s Financial Times.
Kerviel’s attorneys also claim, as reported in the FT, that “SocGen wanted to ‘raise a smokescreen that would distract the public’s attention from far more substantial losses that it had made in recent months, notably in the unbelievable subprime affair.’”
SocGen’s emergency actions to close off what are described to be $75 billion in exposure last Monday may have been a major triggering event in last week’s market plunge, note Nelson D. Schwartz and Nicola Clark in their article in Saturday’s New York Times, “Société Générale’s Sales May Have Incited Market Plunge.”
But it wasn’t just Kerviel’s losses – if they even were net losses – that prompted panic at SocGen, say Kerviel’s attorneys. They further allege, as noted in the above-cited article in today’s FT, that, “the timing of the bank’s decision to close positions relating to Mr Kerviel’s trading and the manner it executed these trades ‘itself provoked the losses of €4.5bn,’ adding, ‘Mr Kerviel’s trading was in profit to the tune of €1.5bn ($2.2bn, £1.1bn) at December 31.’”
Recapping the SocGen saga, Nicola Clark and David Jolly (with additional contributions from Floyd Norris and Mark Landler at the World Economic Forum in Davos) noted in their article, “French Bank Says Rogue Trader Lost $7 Billion” in Friday’s New York Times, that “unassuming midlevel employee… Jerome Kerviel… managed to evade multiple layers of computer controls and audits for as long as a year, stacking up 4.9 billion euros [approximately $7 billion] in losses for the bank.”
A chart accompanying the NYT article showed SocGen’s $7 billion fraud as the largest reported bank fraud in history, beating Nick Leeson’s $1.4 billion fraud which brought down Barings Bank in 1995, and a number of other frauds committed over the last dozen years or so at Sumitomo Corp. ($2.6 billion), Daiwa Bank ($1.1 billion), and Allied Irish Banks ($0.7 billion).
Although the term ‘rogue trader’ appeared in many press reports, SocGen’s Jan. 24 “Message to Clients” from Chairman and CEO Daniel Bouton on the alleged fraud typified ‘bankerly understatement,’ as described by NYT’s Clark and Jolly, by referring to Kerviel as an ‘imprudent employee” responsible for committing a ‘serious internal fraud.’
How Did He Do It? Why Didn’t Controls Stop Him?
Reeling from the news about the SocGen fraud, many last week were asking how one lone mid-level employee could have accomplished so vast a fraud, and questioned why the banks’ own controls did not detect something was awry sooner.
Alistair MacDonald and Leila Abboud included a number of expert observer’s remarks on this topic in their article in Friday’s Wall Street Journal, “Vast Deception Puts Risk Controls Under Scrutiny.” For example, they quoted Chris Rexworthy of IMS consulting, a regulatory consulting firm in London, who said “The losses are too big… I don’t understand why there wouldn’t be systems in place [to] catch this.” The WSJ writers also report French Finance Minister Christine Lagarde, (now conducting one of a number of investigations into the SocGen matter) asked “How is it possible that despite the controls undertaken by the banking commission, none of these embezzlements done by this employee were detected?”
“’We can’t have a controller behind every trader at every bank in the country, at every moment,’” said Christian Noyer, governor of the Bank of France, at a news conference [Thursday],” WSJ’s MacDonald and Abboud reported. They noted that Noyer continued, “Even the best laws and the best police can’t always stop someone who is determined to defraud the system.”
Noyer was also quoted in the NYT article cited further above, “French Bank Says Rogue Trader Lost $7 Billion,” saying that SocGen’s Kerviel “breached five levels of controls’ and was ‘a computer genius.” Others commenting on the SocGen news, attending the World Economic Forum in Davos, noted in the NYT article include FINRA CEO Mary L. Schapiro (“It is quite surprising that positions of that magnitude would not have been monitored much more carefully…”), Cantor Fitzergerald CEO Howard Lutnick (“One person could engineer it – but how could one person finance it?” ) Howard Davies, former chairman of the U.K. Financial Services Authority (FSA) (“I don’t think we’ve had the full story”), and C. Ricardo Esteves, executive director of Banco Hipotecario of Argentina (“It is not credible. One person responsible for this? I just don’t believe it.”)
Yesterday (Jan. 27), SocGen published an “Explanatory Note on the Exceptional Fraud” summarizing what it has learned to date on how the fraud was executed. Some key points provided by SocGen: "In practice, the trader combined several fraudulent methods to avoid the controls in place: [F]irstly, he ensured that the characteristics of the fictitious operations limited the chances of a control: for example he chose very specific operations with no cash movements or margin call and which did not require immediate confirmation. [Second,] He misappropriated the IT access codes belonging to operators in order to cancel certain operations. [Third,] He falsified documents allowing him to justify the entry of fictitious operations. [Fourth,] He ensured that the fictitious operations involved a different financial instrument to the one he had just cancelled, in order to increase his chances of not being controlled."
The execution of the fraud is described in even more general terms in “The Loss Where No One Looked” by David Gauthier-Villars and Carrick Mollenkamp in todays’ Wall Street Journal, as follows: “Mr. Kerviel found a way to rack up a potential liability of €50 billion via a simple scheme: Making bold trades in one portfolio and then covering up those positions with a fictitious, second portfolio. That led to a neutral trading account that wouldn't draw attention. In addition, the trades were scattered on several separate balance sheets, and drawn into the massive flow of daily transactions, so the bank never realized Mr. Kerviel was vastly exceeding his risk limit. The fake trades in the second portfolio were fake trades with actual banks or clients.”
Importantly, WSJ’s Gauthier-Villars and Mollenkamp note, “Rather than betting on futures with an exchange -- a move that would trigger money flow and would have left trails -- Mr. Kerviel used forward transactions, which often don't require actual cash to exchange hands.” They add, “With this type of over-the-counter transaction, clients didn't know that they had been used to make a fake trade.” Additionally, they note, “When the bank checked Mr. Kerviel's books, the real and fictitious trades balanced out within the trader's risk limit and everything looked normal.”
Additionally, the WSJ writers note, “Several times, Mr. Kerviel's supervisors spotted mistakes in the trader's books. But Mr. Kerviel would claim it was a mistake and fix it, said Jean-Pierre Mustier, head of Société Générale's investment-banking arm.”
Kerviel Charged; What Can We Learn From The SocGen Fraud?
Earlier today, “SocGen’s Kerviel Charged with Attempted Fraud,” reported Gregory Viscusi and Heather Smith in Bloomberg.com. They note: “Kerviel, 31, admitted to hacking into computers and faking e-mails to hide trades since 2005, Paris prosecutor Jean-Claude Marin said at a press conference today, recommending the charges now be investigated by a judge.”
What can we learn from the SocGen fraud? It is still too soon to know all the details, and improvements can potentially be made to risk, control, and anti-fraud systems when those details become known.
In the meantime, a heightened awareness to the possibility of fraud may be one of the earliest lessons. Some may even see certain parallels to Enron, specifically, numerous articles on the SocGen fraud, including Friday’s NYT article cited above, noted: “This month Risk Magazine, a British publication, named SocGen ‘Equity Derivatives House of The Year,’ praising its ability to manage its risks.”
Here’s some anti-fraud resources you may want to check out:
Committee of Sponsoring Organizations of the Treadway Commission (COSO) has published studies and guidance on internal control and enterprise risk management, and currently has a project underway to publish guidance on monitoring internal control.
Financial Executives International (FEI) has a Director’s Registry which provides a source of financial experts for boards and audit committees. (Separately, on the topic of board expertise and the role of the audit committee, see article in today’s CFO.com “Audit’s Cautious Watchdogs,” by Roy Harris which quotes J. Michael Cook, former CEO of Deloitte who chairs a number of audit committees and serves on the SEC Advisory Committee on Improvements to Financial Reporting. Cook commented, as noted in the CFO.com article, that finance skill level on boards in general are 'not sufficient today.' If you are looking to source potential board members with finance skills and experience, check out FEI’s Director’s Registry!)
Association of Certified Fraud Examiners (ACFE) has many resources on the prevention and detection of fraud. Check out the cover story in the January-February issue of Fraud Magazine, “Building a Robust Fraud Prevention Program - “An Interview with Martin Biegelman, CFE, ACFE Fellow Director of Microsoft's Financial Integrity Unit.” The article was written by the magazine’s editor, Dick Carozza.
SEC’s Atkins, McKenna Partner’s McKenna, on Last Week’s Stoneridge Decision
Securities Mosaic did a thorough job of reporting on the results of the Supreme Court’s January 15 decision on Stoneridge v. Scientific Atlanta. For example, see the Securities Mosaic Spotlight report bringing together many legal sources analyzing the impact of this decision.
SEC Commissioner Paul S. Atkins published his views on “Stoneridge and the Rule of Law” in an op-ed by that name appearing in Friday’s Wall Street Journal.
“In Stoneridge,” Atkins noted, “the Supreme Court held that investors in one company cannot sue other companies for securities fraud unless those other companies did something that the plaintiffs specifically relied on when making investment decisions.” He continued, “The court warned that if it adopted the plaintiffs' concept of reliance, the ‘cause of action would reach the whole marketplace in which the issuing company does business.’ In other words, had Stoneridge gone the other way, plaintiffs would be able to reach into the pockets of customers, vendors and other firms that simply do business with companies that defraud investors.”
Following the ruling, Atkins observed, “Stoneridge sparked an outcry from those arguing that in the name of "fairness" and "justice" someone should be forced to pay if the primary wrongdoer cannot.” He added, “This outcry could lead to demands on Congress to rewrite the securities laws to give plaintiffs like those in Stoneridge what they could not get in court -- the ability to reach into a deep pocket regardless of culpability.”
“But justice is not merely finding someone who can pay,” said Atkins in his WSJ OpEd. “Exposing one company to class-action lawsuits because another company defrauded its investors is not fair or just to shareholders who shoulder the burden of class-action settlements.
He noted, “As the Supreme Court observed in Stoneridge, Congress amended the securities laws in 1995 to allow the Securities and Exchange Commission to bring actions against secondary violators that aid and abet securities fraud. Congress wisely declined to extend that right to private parties, out of concern of abusive securities litigation.”
“The SEC is well positioned to hold responsible individuals accountable by imposing injunctions, officer and director bars, disgorgement, and civil penalties,” said Atkins.
He also pointed out, “Ill-gotten gains that the SEC recovers -- along with civil penalties -- may be disbursed to aggrieved investors without the usual cut for the plaintiffs' lawyers.”
Atkins concluded, “The SEC has tremendous leverage to obtain settlements and assert novel bases of liability in court. But the SEC must resist efforts -- internal or external -- to broaden securities laws beyond their existing boundaries, even when those efforts are driven by a desire to see harmed shareholders recompensed….” adding, “The SEC has an enormous responsibility not only to enforce the securities laws as written, but also to avoid rewriting and expanding them in the process. The integrity of our capital markets and the welfare of investors depend on the adherence to the rule of law by all participants. That is the lesson of Stoneridge”
McKenna on GAO and Stoneridge
For other views on Stoneridge, and an interesting take on what Stoneridge means in the current environment in which GAO recently concluded not to recommend particular action regarding the concentration and competitiveness of audit firms, see “The GAO Report and Stoneridge – My Audacious Hope,” by Francine McKenna. (We previously covered the GAO report here.)
McKenna, formerly of various Big 4 audit firms and consulting firms, co-founded consulting firm McKenna Partners, and is author of the blog: “Re: The Auditors” in which the above cited post on GAO and Stoneridge was published Jan. 25.


12:39 PM by Edith Orenstein
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Jan 23, 2008
FASB's Herz TellsFEI NJ Chapter Change Is Coming; FASB Modifies Scope, Effective Date of FIN 48 Deferral For Private Co's
On the eve of FASB's vote to finalize its deferral of FIN 48 (Accounting for Uncertainty in Income Taxes) for private companies (discussed further below), FASB Chairman Bob Herz spoke to a packed house at a program sponsored by FEI's New Jersey Chapter.
Herz told attendees at the FEI NJ Chapter program the “breather for a while” in FASB activities is coming to an end, and said change is on the way. For details, see this review of Herz' remarks by Ellen M. Heffes, Executive Editor of Financial Executive Magazine, "FASB's Herz Says Get Ready For Change."
FASB Votes To Modify Scope, Effective Date Of Deferral of FIN 48 For Private Co's
At its board meeting earlier today (Jan. 23), the FASB voted to clarify the scope of its proposed deferral of the effective date of FIN 48 (Accounting for Uncertainty in Income Taxes) for private companies. The board also agreed to modify the effective date of the deferral, and noted early adoption of FIN 48 will still be permitted. FASB will now proceed to a ballot draft as it moves toward issuing final guidance.
The proposed deferral discussed by the board was contained in Proposed FASB Staff Position (FSP) FIN 48-b, “Effective Date of FASB Interpretation No. 48 for Nonpublic Enterprises,” released in December. Close to 50 comment letters were received by FASB on the proposed FSP, including a comment letter from Financial Executives International’s (FEI’s) Committee on Private Companies (CPC) standards subcommittee which supported the proposed deferral, and suggested some modifications.
Note: this FEI summary uses the term ‘private companies;’ technically, FASB uses the term ‘nonpublic enterprises,’ and defines the term in the proposed FSP by reference to the glossary that appears in paragraph 289 of FAS 109, Accounting for Income Taxes, which states a nonpublic enterprise is: “An enterprise other than one (a) whose debt or equity securities are traded in a public market, including those traded on a stock exchange or in the over-the-counter market (including securities quoted only locally or regionally), or (b) whose financial statements are filed with a regulatory agency in preparation for the sale of any class of securities.”
Scope clarified; practical effect same as blanket deferral, since so few adopted FIN 48 to date
In response to comment letters on the proposed FSP asking FASB to clarify the scope of the deferral (i.e., to clarify which private companies would be eligible to defer FIN 48), FASB agreed to:
“Modify the FSP to indicate that a nonpublic enterprise (except those that are a subsidiary of a public enterprise) would be eligible for the deferral unless they issued a full set of annual financial statements incorporating the recognition, measurement, and disclosure requirements of Interpretation 48.”
The wording above, agreed to by the board, was identified as ‘alternative c’ in the board handout – with the exception of the words in parenthesis, which were added at the board meeting as noted in the next section below.
One FASB board member, Donald Young, favored ‘alternative a’ which would have effectively offered what some describe as a ‘blanket deferral’ of FIN 48 for all private companies, regardless whether they had previously adopted FIN 48 or not. However, the majority of board members favored ‘alternative c’ shown above.
Young Asks, Are We Reinforcing Bad Behavior?
Young said he favored alternative ‘a’ (a blanket deferral) not only because he believed it was simpler, but because “If we go with alternative ‘c,’ if they prepared GAAP statements wrong, and didn’t do FIN 48, they get a deferral,” which he said was ‘reinforcing bad behavior.”
He contrasted that example with a company that (presumably, in good faith) tried to adopt FIN 48 in its financial statements in 2007, but “did it wrong.” Under alternative ‘c,’ he pointed out, that company would not get any ‘relief’ because they would not be entitled to the deferral. He said alternative ‘a’ was thus “more fair, and encourages better behavior by everyone in the system.” However, the majority of the board favored ‘c.’
FASB Project Manager Paul Glotzer, who serves as liaison to the FASB-AICPA joint Private Company Financial Reporting Committee (PCFRC) which formally requested FASB consider this delay, noted that as a practical matter there was not a great deal of difference between the two alternatives (‘a,’ or blanket deferral, vs. ‘c’ which the board agreed to today, shown above), because not many private companies have issued a full set of financial statements under FIN 48.
Note: since early adoption of FIN 48 is still permitted, none of the deferral alternatives discussed by FASB today, including the wording agreed to above, would have ‘required’ any private company that had previously adopted FIN 48 to reverse their entries (or ‘unadopt’ it), FASB staff observed.
“We’re Not the Policemen”
The impetus for the wording change to the scope of the deferral came from requests for clarification noted in many of the comment letters on the proposed FSP.
As noted in the FEI CPC comment letter, “our concerns with proposed FSP FIN 48-b, issued on December 19, 2007, [were] amplified following issuance of a related press release [by] FASB on January 8, 2008.”
The FASB press release stated: “The amendments contained in the proposed FSP clarify that the provisions of Interpretation 48 have been adopted if the nonpublic entity has issued financial information prepared in accordance with U.S. GAAP to third parties.”
Prior to reaching the conclusion on the modified scope wording noted above, Russell Golden, FASB’s Director of Technical Application and Implementation Activities, said, “Some comment letters said sometimes this constituent base [private companies] produces financial statements that state they are ‘in accordance with GAAP,’ but they don’t adopt new provisions [i.e., new accounting standards] until the end of year.”
He noted this raises a broader question: “[W]hat do you do with a company that produced interim GAAP, or the person they sent it to had a reasonable assumption they complied with GAAP, [should they] still get [the] deferral?”
FASB Chairman Robert Herz said, “I think that is a bigger issue.”
“A broader recommendation we heard from some in the private company arena,” said Herz, “is to make things applicable at the end of the year rather then the beginning of the year.” He said this was because private companies “rely heavily on the outside accountant, and its not until the outside accountant comes in and says, ‘by the way, this [new standard] was to be applied,” that the company moves to adopt new standards.
FASB board member Tom Linsmeier asked, “How do we know, when the outside accountant is not involved at interim, if they [the private companies’ interim financial statements] are in compliance with U.S. GAAP?”
One FASB staff member (it sounded like Russell Golden on the webcast) replied, “That’s not our role.”
Another staff member (it sounded like Paul Glotzer on the webcast) said, “It’s the role of auditors, reviewers, and compilers.” He added, “we’re not the policemen.”
Glotzer said, “We’re dealing with it [deferral] more from an operational standpoint: cost-benefit considerations involved with the ability of these entities to apply it. By giving the deferral, we’re making it so they can.”
Private subsidiaries of public companies not eligible for deferral
The next question addressed by the board was: Should private subsidiaries of a public company be eligible for the deferral for stand-alone financial statements of the private subsidiary?
Glotzer said FASB staff believe private subsidiaries of public companies “really do not need the deferral,” primarily because they would have already had to apply FIN 48 in information given to the parent company for consolidation purposes. Therefore, he said, private subsidiaries of public companies “don’t need extra time to learn about it and apply it.”
The board agreed with the staff’s recommendation, to not offer the deferral to private subsidiaries of public companies, and will modify the scope sentence as it finalizes the FSP by inserting “(except those that are a subsidiary of a public enterprise)”as shown above.
Effective date (length) of proposed deferral changed; practical effect gives more time to implement
The practical effect of another wording change agreed to by FASB will give private companies even more time to implement FIN 48, not only vs. the original effective date in FIN 48 (fiscal years beginning after Dec. 15, 2006), but also vs. the effective date in the proposed FSP (fiscal years beginning after Dec. 15, 2007), by removing any uncertainty as to whether private companies would need to include the effect of FIN 48 in interim financial statements issued during 2008.
Under the modified wording agreed to by FASB, the effective date of FIN 48 for private companies will be:“annual periods beginning after Dec. 15, 2007.”
The aim of the wording above is to make clear that private companies will not have to reflect FIN 48 in interim financial statements issued in 2008 – although they still have the option to early adopt if they wish to - but will have to be reflected by private companies when they issue annual financial statements. However, board and staff members emphasized that FIN 48 will still have to be reflected ‘as of’ the beginning of the fiscal year, when companies file those annual financial statements.
Without the wording change above, there was a view that private companies would have had to begin reporting FIN 48 in any GAAP financial statements beginning with first quarter 2008, effectively shortening the length of the deferral period.
FASB board member George Batavick, in agreeing with the above wording, said, “If I recall at the last board meeting [at which this issue was discussed], we decided we’d not issue additional guidance here, let practice develop, let the AICPA issue guidance.” Thus, he concluded, “I can’t see it being effective for private companies first quarter this year, they’ll need [more] time.”
FASB staff noted this issue was raised in one particular comment letter. Although they did not identify the author of the letter by name during the board meeting, credit goes to McGladrey & Pullen for raising this issue in their comment letter. The final wording on the effective date agreed to by FASB differs from McGladrey’s suggested wording (which was contained in the board handout), but is aimed at achieving the goal of providing a full year deferral in which FIN 48 implementation issues for private companies can be addressed.
No conforming deferral for leveraged lease FSP
The last question addressed by the board was whether to consider a conforming deferral for nonpublic entities of the effective date of FSP FAS 13-2, “Accounting for a Change or Projected Change in the Timing of Cash Flows Relating to Leveraged Lease Transactions.” The question was raised in KPMG’s comment letter, which suggested without a conforming one year deferral of the leasing FSP for private companies, it “would amount to early application of FIN 48 by such entities only to their leveraged lease transactions.”
The staff’s view, said Glotzer, was not to offer a conforming deferral to the leasing FSP. “Typically, the entities that doing this are larger, sophisticated entities who probably have been applying [FIN 48] since it was first required.”
The board agreed with the staff’s recommendation not to extend the deferral to leveraged lease transactions under FSP FAS 13-2.
At the conclusion of the meeting, the FASB board authorized its staff to proceed to drafting the final FSP.
Will additional issues be taken up during the deferral period?
Now that the deferral FSP is all but issued as final, it remains to be seen whether FASB or the PCFRC will take up issues during the deferral period raised by FEI’s CPC and others relating to the applicability and cost-benefit of FIN 48 to pass-through entities and other nonpublic entities.
The FEI CPC letter, signed by William Koch, chair of FEI CPC’s standards subcommittee, who serves as vice president and CFO at Development Dimensions, International Inc., concluded, “During the proposed delay period, we would suggest that additional consideration be given to the costs and complexities required to implement this standard for private ‘pass through’ organizations, and whether there should be a permanent delay for these organizations given the cost / benefit ratio.”

11:59 PM by Edith Orenstein
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Jan 22, 2008
New York Panel Formed By Spitzer On Modernizing Regulation Puts Its Own Spin On Principles-Based Regulation
News on the competitiveness front: New York Governor Eliot Spitzer’s ‘Commission to Modernize Regulation of Financial Services,’ (the ‘NY commission’) held its first meeting on Jan. 18. We first told you about this commission, and its members, when it was formed in May, 2007.
In brief, the NY commission is charged with modernizing regulation of financial services in New York State, including potentially combining a number of state regulatory agencies dealing with financial services (including insurance, securities and banking).
As noted in the press release issued in May, 2007 when the commission was formed: “[T]he State’s regulatory regime has failed to change with the times. Many believe the result is burdensome and inconsistent state regulation, which drives up the cost of doing business, treats functionally equivalent business activities inconsistently, and fails to effectively protect the consumer. The Commission will be charged with identifying ways in which regulatory powers could be integrated, rationalized, and changed in order to promote economic innovation and protect the consumer.”
Reports coming out of the first meeting of the NY commission, held last week, describe one their proposals as considering a move to develop “principles-based” (”New York Panel Rethinks Securities Oversight,” by Michael J. de la Merced in the Jan. 19 New York Times), or “U.K. style” regulation (“Spitzer Backs U.K. System,” by Michael MacKenzie and Jeremy Grant in the Financial Times).
Specifically, the NY commission – after learning details of the U.K. regulatory approach from Hector Sants, CEO of the U.K. Financial Services Authority (FSA), decided to propose its own ‘unique alternative’ to principles-based regulation, according to this press release issued on January 18 meeting.
Spitzer’s commission calls its alternative ‘principles-guided’ regulation, contrasting it with ‘principles-based’ regulation as follows: “Under the principles-guided approach, the principles act as guidance for interpreting existing regulations and statutes, and as key objectives for developing any future regulation.” Significantly, the press release states, “The principles guide the regulator to focus on outcomes, rather than the rules in and of themselves.”
A total of four proposals are being considered by the NY Commission, as noted in the press release:
Developing “principles-guided” regulation as a unique alternative to the principles-based approach being instituted in the United Kingdom. The new method provides the benefits of a principles-based approach, while preserving the positive elements of current regulation. Under the principles-guided approach, the principles act as guidance for interpreting existing regulations and statutes, and as key objectives for developing any future regulation. The principles guide the regulator to focus on outcomes, rather than the rules in and of themselves.
Having a single state regulator for all financial services. Similar products should not be treated differently if they are sold by different types of companies.
Instituting a risk-based approach to regulation. Examinations of financial services companies should focus on what is important and what really makes a difference.
Eliminating out-of-date rules that are unnecessarily burdensome.
“Modernizing regulation of financial services is first and foremost about keeping New York the financial capital of the world,” Spitzer stated. Recommendations coming out of the NY commission will add to the body of recommendations in the competitiveness realm issued over the past couple of years, including the report issued by New York Mayor Michael Bloomberg and Senator Charles Schumer on "Sustaining New York's and the U.S.' Global Financial Services Leadership," the report of the Committee on Capital Markets Regulation chaired by Glenn Hubbard and John Thornton and led by Harvard Law School’s Hal Scott, and the report of the U.S. Chamber of Commerce sponsored Commission on Regulation of the U.S. Capital Markets in the 21st Century.
The chair of the NY commission – Insurance Superintendent Eric Dinallo – added, “We want to offer New York as a national model of how to regulate financial services.”

10:33 AM by Edith Orenstein

Jan 21, 2008
FASB Fast-Tracks Decision on FIN 48 Deferral; SEC's Complexity Committee (CIFR) To Meet Feb. 11
The ink on the comment letters filed earlier that day was barely dry when FASB announced Friday afternoon it will add to this week’s board meeting agenda its proposal to defer the effective date of FIN 48 – Accounting for Uncertain Income Taxes – for private companies. Specifically, FASB said: “[The] Board will discuss issues raised by respondents to Proposed FSP FIN 48-b, Effective Date of FASB Interpretation No. 48 for Nonpublic Enterprises.” FASB added, “The Board also will discuss whether to issue that proposed FSP as final.” Separately, the SEC formally announced last week the next meeting of its advisory committee charged with improving financial reporting and reducing complexity, chaired by Robert Pozen, will take placed on Feb. 11, as discussed further below.
Whether these two events (the FIN 48 issue and deliberations of SEC’s complexity committee) will ever intersect is anyone's guess; although the SEC committee is by its nature more geared toward public company reporting, any of its recommendations impacting the GAAP standard setting process will also impact private companies.
FASB To Meet This Week on FIN 48 Deferral for Private Co’s
We told you last week FASB’s proposal to defer FIN 48 for private co's was controversial – not so much for why FASB was proposing the delay – which it was requested to do by the joint FASB-AICPA Private Company Financial Reporting Committee and others - but questions have arisen as to the scope of which entities would actually qualify for the delay. Some, but not all of the questions revolve around the fact that some technical language contained in the proposal, released December 19, was further ‘clarified’ (as described by some) in a press release FASB issued three weeks later. However, as confirmed by a reading of the comment letters so far – one person’s clarity is another person’s mudbath, apparently, since some wording in the press release describing the proposal was just different enough to appear to (and be described by) some as a ‘clarification’ or ‘interpretation’ of the December proposal.
On Friday, we told you that FEI’s Committee on Private Companies (CPC) standards subcommittee filed its comment letter with FASB, along with some of the key points in that letter.
The issue turns on whether one can ‘deem’ that a nonpublic entity (I’m using the term ‘private company’ interchangeably with nonpublic entity, although FASB specifically defines the term nonpublic company) has or has not adopted – or, in some cases, whether they ‘should have’ adopted - a new standard, such as FIN 48, during ‘interim’ periods (e.g., month-end or quarter-end, as opposed to year-end) for purposes of information sent to third parties at interim periods, including information sent to lenders who review compliance withdebt covenants, or others. Such information released by private companies to particular parties at interim is sometimes loosely referred to as being in conformity with Generally Accepted Accounting Principles (GAAP), since it updates previous year-end audited GAAP financial statements. However, as described in many of the comment letters (some examples cited below), the nature of ‘interim’ reporting by private companies differs substantially from interim reporting by public companies, due to the differing needs of users of private company financial information (versus, for instance, public company quarterly reporting in Form 10-Q, and related requirements for public companies to disclose the impact of standards recently issued but not yet adopted.)
The crux of the issue is that once an entity has ‘adopted’ a new standard, it generally (and in this case, as proposed by FASB to date with respect to a potential delay of FIN 48 for private companies, specifically) would not qualify for any deferral of the effective date of a new standard subsequently offered by FASB.
Another way to put this is, once an entity has ‘adopted’ an accounting standard, it generally is not allowed to ‘unadopt’ the standard. Further, in the case of FIN 48 adoption by private companies, there has been a debate over whether private companies that already adopted the standard during interim periods in 2007 in essence ‘early adopted’ it, or whether as some have claimed, those that haven’t already adopted FIN 48 during interim periods this year ‘should have’ adopted it as part of their interim reporting, and even whether nonpublic companies that failed to adopt FIN 48 at interim have an internal control weakness.
FASB and the Real World
“[FASB’s] position clearly demonstrates the Staff's lack of understanding with how financial reporting occurs in the real world,” said Crown Corporation’s Controller Craig Seitz in his comment letter.
He explained that the quarterly reporting his company provides to its lenders has not adopted the provisions of FIN 48, “although they do include tax reserves, which we believe are sufficient under FASB 109 and likely will be sufficient under FIN 48.” He continued, “These interim statements are not required to include notes to the financial statements, where much of the FIN 48 disclose would be shown.” He added, “It is important to note that our agented group of seventeen large banks are aware, and have no care whatsoever, that these interim statements are under the pre-FIN 48 guidance.”
“Based on almost 20 years of experience in both public accounting and industry,” continued Seitz, “I would think most medium to large private companies have similar requirements and have also deferred implementation of FIN 48 to their fiscal year-end, as we have. This is how private company financial reporting is done in the real world, and the users of the statements understand and accept this approach.”
Seitz warned, as did many other commenters, “For the Staff to now say at this late date that the deferral of FIN 48, which was announced over two months ago, is not available for private companies like Crown is [i]ncomprehensible.” He and others noted that as a result of communications emanating directly from FASB since the November 7 board meeting, as noted in publications with high credibility like the AICPA’s Journal of Accountancy, private companies relied on the announced plan to delay FIN 48 for them. As a result, “Implementation time has been greatly reduced,” he said.
“For many calendar yearend companies, financial statements may well be due before [FASB’s proposal] is even finalized,” noted Seitz. “In addition, forcing premature adoption of FIN 48 by private companies before the issues justifying the original deferral have been clarified makes absolutely no sense.”
He adds, “There was a reason to defer the statement for private companies. Now, the [FASB] Staff is ignoring those reasons based on insignificant technicalities that the users of the financial information don't even care about or comprehend.”
Highlights From Comment Letters Filed on FASB’s Proposal
A total of 39 comment letters were posted by FASB on Friday, the comment deadline on its proposed deferral of the effective date of FIN 48 for private companies (proposed FSP FIN 48-b). As with all such comment deadlines, (and common for SEC and PCAOB proposals as well) most comment letters arrive on or just prior to the deadline day, so it is likely additional letters will continue to arrive over the next few days. (In fact, as of 11 a.m. EST today (Jan. 21) 7 more letters have been filed/posted by FASB, bringing the total to 46 and counting.)
What is unusual is the speed with which FASB has reacted to comment letters so far, scheduling a meeting to attempt to finalize this issue on Wednesday, in response to the many commenters asking for a quick resolution so they can finalize their year-end financial reporting with or without FIN 48, depending what FASB decides.
Here’s my take on where the comment letters stand, based on my reading of the 39 comment letters posted by FASB as of Friday. (NOTE: my tally adds to 40 since I’m counting PwC twice as described below.)
3 letters ask for exemption (or repeal) Breakdown: 1 CPA (Anthony Destefano) says exempt all nonpublic co's, 1 CPA (Joseph King) says indefinitely defer FIN 48 for the following nonpublic entities pending more guidance - or exclude them permanently from FIN 48’s requirements: S-Corps, LLCs and passthroughs. 1 CFO (Tucson Tractor CFO Chris Weinell) says FASB should repeal FIN 48 for everyone.
2 letters ask for blanket deferral for all nonpublic co's, i.e., whether or not they previously adopted FIN 48. Breakdown: 1 (PwC) recommends this as 'pragmatic alternative' (although it is not their main recommendation, see below); 1 CPA (William Chambers) suggests FASB offer an 'option' to companies that previously adopted FIN 48 to be able to reverse adoption and avail themselves of deferral, along with companies that did not previously adopt FIN 48.
26 letters ask FASB to defer FIN 48 for nonpublic co's that did not previously adopt it. Many simply asked FASB to let the decision whether a company has 'adopted' the standard be determined by the company and its auditor as such decisions historically have been. Others (like FEI, Moss Adams LLP, PCFRC and PwC) laid out a slightly more detailed rubric for determining if a company previously 'adopted' FIN 48.
9 letters did not specify a preference as to scope of the deferral (i.e., as to whether FASB should offer a blanket deferral or only defer those co's that did not previously adopt), however they noted the confusion/conflicting information in circulation and, as virtually all the other commenters did, asked FASB to clarify who is entitled to the deferral ASAP.
More Highlights from the Comment File
Reading the comment file on this proposal over the weekend was almost like reading a good novel – which reminds me, when is former SEC Commissioner, now Under Secretary of Commerce Cynthia Glassman going to produce that TV show she envisioned based on the SEC, noted in this 2005 speech?
The 39 comment letters filed as of Friday give rise to tales of intrigue about conversations among parties who over the years have been described as something akin to a ‘secret society’ (more on this further below) who have alleged to have some kind of special access to FASB or other regulators. In fairness, some firms and their staff may simply be more accustomed to accessing the system. However, some in the ‘secret society’ allegedly (and in some cases, self-promoted) engaging in ‘informal conversations’ with FASB staff to arrive at ‘interpretations’ and ‘clarifications’ of what FASB (or another regulator) meant to say in a particular proposal or rule.
In this case, conversations among what are described in some of the comment letters as ‘large accounting firms’ allegedly took place with FASB staff concerning what FASB said – and may have ‘meant’ to say, in the proposed FSP to delay FIN 48 for private companies which was issued in December, which differed from the minutes of FASB’s November 7 board meeting at which FASB voted to release such a proposal, which differed from FASB’s January 8, 2008 press release describing the proposal.
For instance, Van Billet, VP and CFO of Berwind Corporation stated in his comment letter, “[W]e believe that most nonpublic companies only have access to publicly available information and have no way to connect into the informal communications between the FASB staff and the large firm practitioners and as such reasonably believe that they will qualify for the deferred effective date.”
“[I]f the current position of the FASB staff (deemed adoption of FIN 48) becomes part of the final FSP,” Billet warns, “then most nonpublic companies will be caught by surprise and thrown into a state of confusion and frustration regarding how they will comply with the adoption of FIN 48 for 2007 at a time when they are in the year end closing and audit processes for 2007.”
Billet suggests, “[B]ased on principles of fairness and timing … FASB should not adopt the FASB staffs position (deemed adoption of FIN 48).” Instead, he says, FASB should allow nonpublic companies to qualify for the deferred effective date “unless they adopted early by affirmative action (e.g., completed the internal implementation work and recorded the results into the company's financial information) the provisions of FIN 48.”
The impact of FASB’s stream of announcements on one company’s adoption and implementation plan for FIN 48, are contained in the comment letter filed by Hallmark Cards, Inc.’s Interim Corporate Controller, Brian Kurtz, together with Hallmark’s VP Tax, Kevin Hartley. They also give a fairly plain English explanation of the difference between their interim and year-end reporting processes
“It is customary for Hallmark and other nonpublic enterprises to record the effect of the adoption of new accounting pronouncements at the end of the year that it is required to do so in preparation for its annual audited financial statement process,” said Kurtz and Hartley in their letter, thus, “the effects of adoption would not be included in interim financial information provided to third parties.” They added, “these third party recipients of interim financial information are accustomed to such practices.”
With respect to FIN 48 specifically, Kurtz and Hartley explain, “During the course of 2007, Hallmark dedicated at least five full time employees to implementing the requirements of [FIN 48].”
They note implementation efforts continued “until early November 2007, when the FASB decided to propose a one-year delay of the effective date of Interpretation 48 at its November 7, 2007, Board Meeting, as followed by issuance of the proposed FSP.
However, more recently, the Hallmark exec's note they were struck by the more recent FASB press release.
“The Company's management, in consultation with its external auditor, made crucial strategic decisions to divert accounting and tax personnel from continuing the implementation of Interpretation 48 in November 2007 based on the information provided at that time regarding the proposed deferral of its effective date. Thus, Hallmark may not be able to comply with the requirements of [FIN] 48 in the remaining period before it must issue its audited financial statements,” say Hallmark’s Kurtz and Hartley. Many other comment letters made the same point.
“[FASB’s] news release is confusing and ill-timed for nonpublic entities with a calendar year-end as they are already working at high stress levels to meet annual reporting deadlines,” they add. “A requirement to comply with a highly technical and complex accounting standard whose effective date was seemingly deferred two months ago is extremely burdensome and causes undue duress… and does not adequately allow for companies to regain lost time and comply with the requirements of [FIN] 48, where these companies previously concluded the effective date had been deferred,” they conclude. Kurtz and Hartley recommend that, “The Board should allow nonpublic entities that have issued financial statements or information that did not reflect the impact of adopting Interpretation 48 subsequent to its original effective date, but prior to the deferred effective date, to defer the adoption under the proposed FSP FIN 48-b.”
In recommending what amounts to a blanket deferral for all private companies, William Chambers said, “[I]t appears that this FSP is penalizing those nonpublic enterprise that "did the right thing" and rewarding those enterprises [that] did not adopt [FIN] 48 during 2007.” He added, “I recommend the FSP be modified to provide nonpublic enterprises that have adopted [FIN] 48 the option of continuing to apply the provisions of [FIN] 48 or to restate prior interim financial statements and defer the effective date of [FIN] 48.”
Form Letters Filed by Nine Blue Cross Blue Shield Entities
Nine of the 39 comment letters filed as of Jan. 18 were essentially form letters filed by various Blue Cross Blue Shield (BCBS) and related entities, with slight variations in some. However the fact that they were essentially form letters does not dismiss the potential validity of the content.
Here is an excerpt from one, BCBS of Alabama:
“There should never be an "implied adoption" of a significant accounting standard, particularly when the adoption relates to a high profile interpretation such as FIN 48 which requires specific recognition and measurement processes, provides for a cumulative effect adjustment, and specifies significant related disclosures… The decision by the Board on November 7 to defer the effective date of FIN 48 for nonpublic enterprises was based on a number of good reasons to do so, and those same reasons continue to apply. At that time, there was a broadly held view that virtually all nonpublic enterprises would likely be eligible for the deferral. If the Board believed that nonpublic enterprises did not have sufficient time to understand and implement FIN 48 in November there is significantly less time now. A last-minute change in the eligibility rules, or at least the interpretation and application of those rules on a more restrictive basis, makes no sense and it clearly puts the nonpublic enterprises, as well as the users of their financial information, at an unfair disadvantage. There is simply no good reason to further restrict the deferral of FIN 48 for nonpublic enterprises at this time, and the Board needs to end this controversy as soon as possible.”
Capital First BCBS noted in its comment letter, after citing the board minutes from FASB’s Nov. 7 meeting at which FASB voted to propose the deferral, and citing language from the proposed FSP, added, “the ensuing discussion with independent auditors has resulted in many questions.”
Referring to the information previously released by FASB, Capital First BCBS notes: “If such releases cannot be substantially relied upon, then the FASB does a great disservice to its constituents.”
Constituents Ask For Reasonableness To Prevail
The FEI Committee on Private Companies (CPC) standards subcommittee letter, signed by CPC standards subcommittee chair Bill Koch, emphasized the need for reasonableness and transparency.
[“W]e strongly believe any decision by FASB at this point in time that would deny a deferral to private companies that had not deemed themselves to have already 'adopted' FIN 48, but would be swept into the 'adoption' camp due to wording in the proposed FSP and/or press release about having provided 'information' to third parties at interim periods, would effectively harm private companies by rushing them into adoption of a standard they had understood to be deferred for them,” said Koch in the FEI letter. Koch is the vice president & CFO, Development Dimensions International Inc
“As a practical matter, we would be concerned about the quality of any such rushed adoption, from the standpoint of preparers and auditors physical and conceptual bandwidth during busy season/year-end,” FEI CPC’s Koch continued. He noted, “[M]any if not most of the private company community believed in good faith that they had a reliable basis to put 'pencils down' on implementation of FIN 48 following FASB's November meeting, at which FASB agreed to propose a deferral of FIN 48 for private companies. They had even more basis to allocate their year-end reporting focus on items other than FIN 48 once FASB released the proposed FSP on December 19.”
Additionally, the FEI letter noted, “The notion of when standards have been 'adopted' by private companies, particularly during interim (including quarterly) periods, as opposed to year-end, is not as black and white as it is for public companies.”
Furthermore, FEI CPC standards subcommittee chair Koch noted, “[T]here appears to have been a presumption by FASB in some prior board discussions on various topics as to whether private companies need a delayed effective date for a new standard, that private companies essentially have a full year to comply with a new standard because they are not required to publish interim financials whereas public companies are required to publish interim statements (10-Qs).”
FEI's letter encouraged FASB not to ‘deem’ or ‘presume’ adoption of a standard, or to retroactively deem companies that did not adopt FIN 48 at interim as having committed an error or not being in compliance with GAAP.
“[W]e believe companies should feel free to provide information about standards to be adopted without running the risk of losing out on a potential deferral of the effective date of that standard,” said FEI CPC standards chair Koch.
“To deny a deferral to companies that tried to be transparent and provide useful information in advance of full adoption of a new standard that was expected to be adopted at year-end (in particular, a tax standard which typically involves significant emphasis on year-end review of tax position) would provide a chilling effect on good faith efforts by companies to be transparent,” he added.
FEI’s letter suggested one way to resolve the debate over the definition of ‘adoption’ of FIN 48 would be a three point test, centered on whether there was an affirmative statement as to adoption of the standard. Reasonable judgment and facts and circumstances would also be considered.
Many others are hoping reasonableness will sway the day in FASB’s meeting later this week.
BKD said in its comment letter, “The preparer and auditor communities could … determine the meaning of ‘adopted.’ We believe this approach is consistent with that historically taken by the FASB and appropriately leaves the determination of whether the Interpretation has been adopted in the hands of those ultimately responsible for the decision.”
The letter submitted by Judy O’Dell, Chair of the FASB-AICPA’s joint Private Company Financial Reporting Committee (PCFRC), after describing the current controversy over the definition of ‘adoption,’ said, “The answers to some of those questions may best be left to professional judgment.”
Some Want Not Only Deferral But Exemption, Repeal of FIN 48
Here’s a few more highlights from a couple of the comment letters that recommended FASB exempt nonpublic co’s from FIN 48, or even repeal the standard.
Joseph King, a CPA who recommended an indefinite deferral or permanent exclusion from FIN 48 for S-corps, LLCs and passthroughs, said, “I have been practicing accounting for 33 years and have been an active peer reviewer for over 17 years, including 3 terms on Kentucky's Peer Review Committee and 2 years as Committee Chair, and I support good accounting standards which improve financial reporting.”
“However,” he noted, “some standards seem to go beyond the realm of common sense for nonpublic entities and involve substantial subjectivity and additional professional time and expense for such clients.” After listing FAS 107 (fair value disclosures), FAS 142 (goodwill impairment) as among such standards (in addition to FIN 48), he says, “There needs to be more consideration given to cost and effect of accounting standards to the nonpublic sector.
“I know Enron and World Com were disasters and very embarrassing to the accounting profession,” King concludes, “but the small business and small practitioner community are unfairly suffering from the fallout.”
Tucson Tractor CFO Chris Weinell, who recommended FIN 48 be repealed for all entities, said: “I have to share my 2 cents with what I consider the most idiotic standard that FASB has ever proposed and implemented- Sorry for such strong words but what was FASB thinking?” Weinell continues, “To my understanding, there is absolutely no other liability that needs to be accrued under standards similar to those that FASB has imposed on FIN 48. Unless the foundation of accounting for uncertainty [FAS 5] has changed, which served us well since [March 1975] (and prior), liabilities should be accrued under the following circumstances […he then cites FAS 5].
“At what point did the board of FASB start to begin receiving their paychecks from the IRS?” Weinell continues. “To put public accountants at diametrically opposite points of view with their clients is ludicrous.”
He explains, “On the one hand, public accounting firms are asked by their clients to give tax advice which sometimes includes giving positions that may not be 100% clearly defined in the code but they have enough support to base their opinions. Now you want public accounting firms to prepare the roadmap for the IRS in which to challenge each and every grey area in their client's tax returns and financial statements.” Weinell states, “This will clearly lead to less information being shared between clients and their accounting firms and instead of being more transparent, financial statements over time will be less transparent. This obviously is not the goal of FIN 48.”
Like commenter King cited above, Weinell concludes, “What other profession asks its members to fall on the knife as we are doing to ourselves as a result of the Enron era? Sure there are unethical accountants and no amount of changes to accounting standards will change that for those who are unethical.”
Secret Society
If you’re interested in reading up on the ‘secret society’ referenced above, there are a couple cites in the formal record (‘proceedings’) of the SEC Advisory Committee on Smaller Public Companies (ACSPC) that you may find of interest. See the proceedings of the June 16, 2005 meeting of the ACSPC and a brief follow-on reference in the proceedings of the ACSPC meeting, held Feb. 21, 2006.
SEC ‘Complexity’ Committee to Meet Feb. 11
The references to the existence, role, and need for the ‘secret society’ may be of interest to another SEC Advisory committee formed more recently, the SEC Advisory Committee on Improvements to Financial Reporting (CIFR), chaired by Robert Pozen.
On Jan. 17, the SEC formally announced that CIFR’s next meeting will be held on Feb. 11 at 2pm, in the form of a telephonic meeting, which will be webcast.
The agenda for CIFR's Feb. 11 meeting will include: (1) discussion and deliberation of a draft progress report with developed proposals, conceptual approaches and currently identified future considerations based on the Committee’s deliberations of the Draft Decision Memorandum presented at its January 11, 2008 meeting in the areas of substantive complexity, standard setting, audit process and compliance and delivery of financial information; (2) a vote on a proposal to publish the Committee’s draft progress report in final form to the Commission and for public feedback; and (3) a discussion of next steps and planning for the next meeting. The SEC notes the public can submit written statements in advance of the meeting, requesting that such statements be received by Feb. 4.
FIN 48 Deferral Issue a Case Study in Complexity?
The FIN 48 delay for private companies matter discussed above may make for an interesting case study for CIFR, as I recall they were considering analyzing some examples of complexity and how they were handled.
FASB will likely receive kudos for quickly scheduling a meeting within days of the comment deadline to finalize the matter, (particularly if the vote goes as many are hoping, at least to offer some form of delay for private companies of FIN 48).
I am not going to place any bets, however, on precisely how FASB will decide this matter (e.g., blanket deferral, deferral for those who have not adopted.)
I recall a year ago some writers trying to call FASB’s vote on an earlier FIN 48 delay - relating to s potential delay in FIN 48 for public companies.
The day before last year’s FASB vote, Helen Shaw wrote Jan. 16 2007 in CFO.com, “FASB Delay Eases Tax Uncertainty. ”As of press time,” Shaw said, “it is all but certain that the accounting standards-setter will, at its board meeting on January 17, postpone the interpretation's implementation for one year.”
That article was followed a day later in the same publication in an article by Shaw and Marie Leone, “Tax Stunner: FASB Rejects FIN 48 Delay.”
As it moves toward deliberation on whether to delay FIN 48 for private companies later this week, FASB may be cheered by one comment letter, sent by Anthony Destefano, a CPA from New Jersey.
After asking FASB to exempt private companies from FIN 48, Destefano closed his comment letter, “Thank you again for this opportunity to comment and good luck.”

11:31 AM by Edith Orenstein
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Jan 18, 2008
FEI Sends Comments To FASB On Proposed Delay Of FIN 48 (Uncertain Income Taxes) For Private Companies
Financial Executives International's (FEI's) Committee on Private Companies (CPC), standards subcommittee filed a comment letter with the Financial Accounting Standards Board (FASB) on Proposed FASB Staff Position (FSP) No. FIN 48-b, “Effective Date of FASB Interpretation No. 48 (FIN 48) for Nonpublic Enterprises." The proposed delay that is being considered for private companies relates to FASB’s FIN 48, ‘Accounting for Uncertainty in Income Taxes.”

The FEI letter, signed by William Koch, Chair of the FEI CPC standards subcommittee, supported FASB’s proposed delay of FIN 48 for private companies, noted certain concerns, and made some recommendations to FASB to address those concerns in finalizing the FSP. Koch is VP and CFO, Development Dimensions International.

The following are the four areas of concern, on which FEI CPC provided related recommendations:
Do not deny deferral to companies that relied in good faith on promises of deferral.
FEI CPC recommended definition of ‘adopted’ for purposes of FIN 48 delay.
Do not deem private companies that failed to ‘adopt’ or provide information re: FIN 48 at interim as having committed an ‘error’ or not being in conformity with GAAP.
For private companies, that are deemed ‘pass through’ organizations for IRS purposes, the standard significantly raises cost and complexity of reporting with no material benefit.
Further details can be found in the FEI CPC comment letter.
Today (January 18) is FASB's comment deadline on this proposed FSP. FASB is posting comment letters on proposed FSP FIN 48-b here. Typically, many comment letters are filed the day of the comment deadline or shortly thereafter.

12:04 PM by Edith Orenstein

Jan 17, 2008
GAO, EU Oxera Report on Audit Concentration, and Cal Tech Wine Study; Big Six Issue Report at Global Public Policy Symposium
What do a Cal Tech wine perception study and two studies on audit firm competition and concentration have in common? The Cal Tech study, described in more detail in an online paper published Jan. 14 by the National Academy of Sciences, showed that people’s perception of the quality of wine correlated with what they were told the price of the wine was: the higher the price, the tastier the wine, subjects in the experiment reported. The verbal assessments of subjects’ level of enjoyment of the wine were backed up by scans of their neural activity, using functional magnetic resonance imaging (fMRI).
“There was a catch to the experiment, however,” explains Cal Tech in the press release linked above. “Although the subjects had been told that they would taste five different, variously priced wines, they actually had sampled only three. Wines 1 and 2 were used twice, but labeled with two different prices. For example, wine 2 was presented as the $90 wine (its actual retail price) and also as the $10 wine. When the subjects were told the wine cost $90 a bottle, they loved it; at $10 a bottle, not so much.”
And note this: “In a follow-up experiment, the subjects again tasted all five wine samples, but without any price information; this time, they rated the cheapest wine as their most preferred.”
What’s the take-away from the Cal Tech study? “Previous marketing studies have shown that it is possible to change people's reports of how good an experience is by changing their beliefs about the experience. For example…. moviegoers will report liking a movie more when they hear beforehand how good it is,” said study co-author Antonio Rangel, an associate professor of economics at Cal Tech. "Our study goes beyond that,” he added, “to show that the neural encoding of the quality of an experience is actually modulated by a variable such as price, which most people believe is correlated with experienced pleasantness."
What does Cal Tech’s wine study have to do with recent reports on audit firm concentration and competition published by the U.S. General Accountability Office (GAO), on “Audits of Public Companies: Continued Concentration in Audit Market for Large Public Companies Does Not Call for Immediate Action“ (Jan. 9, 2007) (the “GAO report”),” and a report released Oct. 2007 by the European Union’s Internal Markets Services Directorate General (DG Internal Market), conducted by research firm Oxera, on “Ownership Rules of Audit Firms and their Consequences for Audit market Concentration“ (the “Oxera report”)?
I would posit the common factor is perception vs. reality, by linking price, brand name or size to perceived quality of a product or service, including audit firms/audit services. This situation is described in the Oxera study as a perceived reputational barrier to entry for the smaller and particularly the mid-tier firms vs. the Big Four.
The Oxera (EU) Report
Oxera’s report found “higher concentration has led to higher audit fees.” Additionally, they reported, “[e]vidence showed that, while there is a degree of price sensitivity among companies, and some bargaining on fees takes place during the annual audit firm reappointment process, in general audit committee chairs focus more on quality (and reputation) than on price.”
The reported behavior of audit committee chairs favoring quality and reputation over price appears – on the surface and probably much further below - to be a reasonable cost-benefit tradeoff. If this were a television show (forgive me, Writers’ Guild) the ‘price’ of audits would play the role of ‘cost’ (incorporating, perhaps, opportunity costs arising from failure to detect errors or fraud), and ‘quality’ and ‘reputation’ (leading, possibly, to higher quality and more reliable financial reporting) would play the role of ‘benefit.’ All seems well until the ‘IBM effect’ described in the Oxera study blows in, and pure logic is at least partially pushed aside in favor of emotion.
Section 7.2.2 (Factors That Drive Auditor Selection and Favour the Big Four in Europe) and 7.2.3. (Perceptions on Suitability Between the Big Four and Mid-Tier Firms) of the Oxera report describe what is commonly referred to as an ‘IBM effect” and other perception biases among their survey participants.
Oxera found that those charged with recommending and selecting audit firms ascribe to the view commonly described as ‘no one gets fired for hiring IBM.’ With respect to the study at hand, Oxera describes this as “an outcome in which audit firms are selected on the basis that they have a credible reputation of being the ‘right’ auditors.” However, Oxera adds, “It is often only the Big Four who are perceived to benefit from this effect.”
Citing back to their prior year study, Oxera notes in the current study, “A survey asked UK audit committee chairs to rate the likelihood to rate the likelihood of considering using a mid-tier firm. Of the 50 respondents, 10 stated that they would be ‘very likely’ or ‘fairly likely’ to do so. In contrast, 35 audit committee chairs said that they were very or fairly unlikely to consider a mid-tier firm as their auditor.”
“In addition, the audit committee chairs were asked about the size of a hypothetical price reduction they would require to consider a mid-tier firm as the company’s auditor,” Oxera reports. “In reply, 37 of 40 audit committee chairs who answered this question agreed with the statement, “I would not consider a mid-tier auditor at any price.”
Some may wonder, does the above statement uncovered by the Oxera researchers seem entirely driven by logic? Or, is the statement more akin to the findings of the Cal Tech wine perception study? That is, take the Cal Tech wine study, substitute a label of “Big Four” on some of the wine bottles, ‘mid-tier’ on some, ‘other’ on the others, and see which one(s) most audit committee chairs pick.
Alternatively, place a variety of price tags on the bottles of ‘audit services’ and see which ones people pick. (If only we could bottle audit services - but that would get back to the much maligned ‘commoditization’ of audit services cited by some in the immediate pre- and post-Enron period as having contributed to a reduction in audit quality and potentially inhibiting independence by making audit services the loss leader vs. more lucrative consulting services, see related references in this Dec. 9, 2002 speech by SEC Commissioner Paul Atkins.)
Admittedly this analogy of equating price (or brand, size) with audit quality is an oversimplification, but the perceived reputation risk barrier has been noted for some time now in various studies as potentially putting a damper on the ability to increase the level of competition and reduce the concentration of audit firms. Some believe the goal of increasing competition and reducing concentration is critical to offset the risk of failure of one of the Big Four firms.
“There are a number of significant reasons why stakeholders are concerned about the current market structure for the supply and demand for audit services,” notes Oxera’s study. “These include issues relating to the level of effective choice… and the possible impact … on the underlying price and quality of the audit product to the extent that these two factors may be influenced by the level of competition in the market.”
Additionally, Oxera observes, “There are significant levels of concern about the impact of the possibility of a failure of one of the Big Four on both regulation and the capital markets.”
For related commentary, see also “Who Should Own the Auditors” by Jennifer Hughes in the Jan. 7 edition of the Financial Times. Hughes noted divergent reactions to the Oxera report from leaders of the Big Six audit firms.
“The [Oxera] report concluded that the current structure had led to a higher cost of capital for audit firms compared with similar-sized multinationals, implying that changing the ownership structure could lower this,” reports Hughes. However, she notes, “The Big Four were not convinced.”
Hughes quotes PwC partner Peter Wyman, who said: "My experience in 30-odd years of partnership, going through the globalisation process as we have, was that we were never short of capital, or being able to raise money.” He added, “These firms are not very capital-intensive, and the restraints around expansion are about finding the right people and the right clients.
She also quotes Michael Cleary, CEO of Grant Thornton UK, saying: "The focal point of our strategy is international. This means not only common systems and methodologies, and common IT platforms, but common training to create a single culture. All this requires a lot of time and money. That extra capital may be able to give us the opportunity to strengthen the firms and the network across the world."
Jeremy Newman, head of BDO Stoy Hayward, set to become head of BDO International, the fifth biggest global audit firm network, later this year, according to Hughes, stated: “Audit firms being owned by auditors is a somewhat outdated concept, and I don't have any problems in changing the ownership - and perhaps that way making capital more readily available.” However, he noted, “"Whether that's sufficient to make any difference is another question."
“More of an issue, [Newman] believes,” reported Hughes, “is getting the right people out of a pool necessarily limited by qualifications and experience. In practice, fast growth often requires poaching staff.”
GAO Report
Back in the U.S.A., the GAO report released last week observed, “While the small public company audit market is much less concentrated, the four largest accounting firms continue to audit almost all large public companies,” as noted in GAO’s summary of its study.
After surveying corporations and audit firms, and conducting additional interviews and research, GAO’s study concluded, “Given the lack of significant adverse effect of concentration in the current environment and that no clear consensus exists on how to reduce concentration, no compelling need for immediate action appears to exist.”
Further details can be found in GAO’s report, survey results, and Highlights.
Big Six Issue Report on Roundtables Held Over Past Year
In spite of any potential sibling rivalry, the six largest international audit firm networks (PwC, Deloitte, E&Y, KPMG, BDO and Grant Thornton, collectively, the “Big Six”) have banded together in recent years to show leadership on matters of mutual interest.
Earlier this week, the Big Six convened their fourth Global Public Policy Symposium (GPPS).
This years GPPS is a followup to last year's GPPS, which we reported on here, here and here, at which the Big Six released a discussion document entitled, “Global Capital Markets and the Global Economy: A Vision from the CEOs of the International Audit Network” (the ‘Vision’ paper). The purpose of the Vision paper was “to stimulate a robust dialogue on a number of critical issues confronting global capital markets.”
During the course of the past year, a series of roundtable discussions were convened by the Big Six around the globe, to discuss last year’s ‘Vision’ paper. Roundtable participants included investors, financial executives, board members, regulators, standard-setters, corporate governance experts, and audit professionals.
A report summarizing the views expressed over the course of the past year’s roundtables convened by the Big Six was released at this year’s GPPS. The report, entitled, “Global Dialogue with Capital Market Stakeholders: A Report From the CEOs of the International Audit Networks,” does not disclose the names of the participants in the roundtables, say the Big Six, because the roundtables were “not-for-attribution discussions to promote frank and candid dialogue.”
The Big Six report notes the consensus view among its global roundtable participants in four broad areas:
Global convergence: the need for consistency in financial reporting
Audit quality: the need for continuous improvement and greater consistency
Fraud Prevention and detection
The future of business reporting (including XBRL and, in a reverse from last year, some criticism of what the potential fallout could be from a move to real-time reporting)
Although finding broad support among roundtable participants for a move to one set of global accounting standards – a position which they support, note the Big Six – there was less of a common understanding of exactly what ‘principles based’ standards are.
Big Six White Paper on Principles Based Standard
To ‘advance this critical issue’ of defining what characteristics of a principles-based standard, in addition to the main report issued by the Big Six at this year’s GPPS, they also released a nine page White Paper on principles-based accounting standards, identifying six‘key elements’ of a ‘high quality, principles based standard:”
Faithful presentation of economic reality.
Responsive to users’ needs for clarity and transparency.
Consistency with a clear Conceptual Framework.
Based on an appropriately-defined scope that addresses a broad area of accounting.
Written in clear, concise and plain language.
Allows for the use of reasonable judgment
Some of the topics above are also being considered by the SEC Advisory Committee on Improvements to Financial Reporting (CIFR), chaired by Bob Pozen (thus, sometimes referred to as the ‘Pozen Committee.’)
Relating to the Big Six’ first characteristic for principles-based standards (‘faithful representation of economic reality’), one CIFR member sounded a note of caution at last week’s SEC Advisory Committee (CIFR) meeting on the challenge of trying to measure the quality or preferability of accounting treatment choices based on how well they represent economic reality
“People would like us, through the judgment framework, [a professional judgment framework being drafted by CIFR] to make GAAP something it’s not,” said Mike Cook, former Chairman and CEO of Deloitte Touche LLP, at last week’s CIFR meeting. He added, “GAAP is not economic substance, there are many areas of GAAP where it does not produce economic substance; there is ‘form vs. substance,’ but not economic substance.”
A synopsis of the Big Six 2007 GPPS report can be found in this FEI summary (downloadable by FEI members only; for information on membership, contact me at eorenstein@financialexecutives.org).
See also the website established by the Big Six which houses materials relating to the GPPS, http://www.globalpublicpolicysymposium.com/.
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6:18 AM by Edith Orenstein

Jan 15, 2008
FASB Codification Released; One Year Verification Phase Begins
Late today (Jan. 15), the Financial Accounting Standards Board (FASB) announced the release of its draft Codification, and the start of the one year 'verification' period in which FASB is "encourag[ing]... use [of] the online Codification Research System free of charge to research accounting issues and provide feedback on whether the Codification content accurately reflects existing U.S. generally accepted accounting principles."
The goal of FASB's Codification is to put all Generally Accepted Accounting Principles (GAAP) issued by various organization's over the years (including FASB, the AICPA, and FASB's Emerging Issues Task Force (EITF)) in one place, in a logically flowing topical order, and to enhance the accessibility and search capabilities through an interactive electronic platform,
A primary aim of the codification is to assist preparers and auditors in locating applicable GAAP on a particular topic, and to assist investors, regulators, and other interested parties in doing the same. This in turn is hoped to reduce some aspects of complexity in financial reporting, given that there are over 25,000 pages of U.S. GAAP, as pointed out by FASB Chairman Bob Herz at FEI's Global Financial Reporting Conference in September, and in various other venues, and as captured in the Wall Street Journal's Dec. 12, 2007 editorial: "Closing the GAAP."
"The Codification does not change GAAP; instead it reorganizes the thousands of U.S. GAAP pronouncements into roughly 90 accounting topics, and displays all topics using a consistent structure. The SEC guidance will follow a similar topical structure in separate SEC sections," says FASB.
FASB says it expects the Codification to:
Reduce the amount of time and effort required to solve an accounting research issue.
Improve usability of the literature thereby mitigating the risk of noncompliance with standards.
Provide real-time updates as new standards are released.
Assist the FASB with the research and convergence efforts required during the standard-setting process.
Become the authoritative source of literature for the completed XBRL taxonomy.
Access to the Codification is available at: http://asc.fasb.org/ . Through that link, FASB notes, "users are able to review the Codification free of charge and provide specific content-related feedback at the individual paragraph level as well as general system-related feedback." Additionally, FASB notes, "During the verification period, Codification content will be updated for changes resulting from constituent feedback and new standards."
"The FASB currently expects to approve, and make the Codification authoritative in April 2009," states the 52 page "Notice to Constituents v. 1.01" accessible at the Codification website linked above. [I got excited when I saw a 52 page document relating to the Codification, thinking, if only they could get all of GAAP down to 52 pages, that would make the Pozen Committee (SEC's Advisory Committee on Improving Financial Reporting) and a lot of other folks very happy, and it sure would smooth convergence, at least with IASB's 255 page IFRS for SMEs (Small and Medium-Sized Entities)!]
Upon becoming authoritative, the codification will supercede all existing non-SEC standards, and the superceded standards will be retained in the Codification Retrieval System for archive purposes, notes FASB.

7:02 PM by Edith Orenstein

Jan 15, 2008
Comments Due This Week on Controversial FASB, GSA-DOJ Proposals (Updated)
Controversy is swirling around a FASB proposal to defer the effective date of FIN 48, Accounting for Uncertainty in Income Taxes, with respect to private companies, on which comments are due this week. Separately, FEI's Committee on Government Business (CGB) filed a comment letter yesterday on a proposal issued by the General Services Administration (GSA) following GSA's receipt of a request from the Department of Justice (DOJ). FEI CGB recommends the GSA proposal be withdrawn. (The comment deadline on GSA's proposal was yesterday.) See details on these items below.
Controversy Swirling Over FASB Proposal to Delay FIN 48 For Private Co's
Based on discussions at FASB’s Nov. 7 board meeting and at meetings of the FASB-AICPA’s joint Private Company Financial Reporting Committee (PCFRC) leading up to issuance of FASB’s proposal, there was a broadly held view among private companies - seemingly confirmed by the issuance of Proposed FASB Staff Position (FSP) No. FIN 48-b, “Effective Date of FASB Interpretation No. 48 for Nonpublic Enterprises,” on Dec. 19, 2007 – that private companies would likely receive a one year delay in the effective date of FIN 48, moving the effective date for them from fiscal years beginning after 12/15/06 (and interim periods therein) to fiscal years beginning after 12/15/07 (and interim periods therein). The PCFRC and FEI’s Committee on Private Companies, standards subcommittee, were among those that filed comment letters requesting the delay.
(NOTE: Public companies would not be impacted by the proposed deferral, which applies only to non-public companies. We refer generically to such companies as ‘private companies,’ although FASB provides a specific definition for ‘nonpublic companies’ in the proposed FSP.)
The current controversy centers on whether private companies that provided some form of FIN 48 related information during interim periods (e.g. quarters) during 2007 to third parties such as lenders, are deemed to have ‘adopted’ FIN 48. If so, one argument goes, those companies would not be eligible for the deferral, since the proposed FSP states in its first paragraph: “Nonpublic enterprises that have already adopted the provisions of Interpretation 48 are not eligible for the deferral.” [See UPDATE below.]
However, there is another argument circulating that it would be inappropriate to ‘deem’ adoption of a standard by private companies that include FIN 48 related information, estimates or disclosures that have been internally prepared during interim periods, but the standard has not yet been formally adopted by the private company, since private companies are generally not mandated to provide formal interim reporting in the same way public companies do (i.e., public companies file 10-Qs quarterly). Thus, these people say, the private companies often don’t formally ‘adopt’ standards until they provide annual audited financial statements in accordance with GAAP – which includes full footnotes, etc. They believe private companies that voluntarily may have included some FIN 48 based information during interim periods – but had not yet formally adopted the standard – will be unfairly disadvantaged if they are not availed of the one year deferral – particularly in light of the fact that all indications from FASB and the PCFRC were that the deferral was likely to be granted.
There is also a view among some that, if the delay is not granted to these companies, they will be worse off than before, in that it will cause a rush to adopt a standard they were led to believe would be deferred for a year. [UPDATE 3pm Jan. 17: A total of 12 comment letters are posted on FASB's website so far, a day before the comment deadline, although it is not unusual for a standard-setter to receive a flurry of comment letters on, or shortly after, the deadline date.]
The comment deadline on Proposed FSP FIN 48-b is January 18. Comment letters filed so far are posted here; some believe that some letters supporting the proposal may not have been aware of the 'sleeper' issue regarding how various people are interpreting the term 'adopted' in the proposed FSP.
UPDATE 2pm: The reason why this issue may have been a 'sleeper' issue is the expansion of the scope of companies deemed to have already 'adopted' a standard through actually adopting it or ''providing information to third parties' during interim periods. This issue was raised indirectly in the last paragraph of the proposed FSP (para. 7), in a sentence about permissibility of 'early adoption' of a standard (which many private companies looking for a further delay on may not have focused on). The sentence in para. 7 states (with FASB's proposed change to this particular paragraph of existing FIN 48 underlined in bold): "Earlier adoption is permitted as of the beginning of an enterprise’s fiscal year, provided the enterprise has not yet issued financial statements or information to third parties, including financial statements or information for any interim period, for that fiscal year." It may be that even the original FIN 48 reference to "financial statements or information' was not fully focused on by the private company community and standard-setters (and perhaps some auditors) until now. The slumber has ended, however, with some audit firms promoting FASB's press release issued Jan. 8, 2008 - which has slightly stronger wording than proposed FSP FIN 48b issued three weeks earlier, on Dec. 19, 2007, and is being described by some as effectively offering an 'interpretation' of what FASB meant in the earlier FSP. Specifically, FASB's Jan. 8 press release says (highlighted words providing the caffeine punch): "Nonpublic entities that have already adopted the provisions of Interpretation 48 would not be eligible for the deferral. The amendments contained in the proposed FSP clarify that the provisions of Interpretation 48 have been adopted if the nonpublic entity has issued financial information prepared in accordance with U.S. GAAP to third parties."
UPDATE 5PM: See also, "Private Company Committee [FASB-AICPA's joint PCFRC] Says Proposal on FIN 48 Could Cause Problems," by Denise Lugo in the Jan. 11 edition of BNA's Daily Report for Executives. Lugo reported on discussion of the proposed FIN 48 deferral at PCFRC's January 10 meeting, and notes: "PCFRC member Thomas Ratcliffe said that a number of private companies that issued financial statements did not know whether or not they applied FIN 48, thus some entities may have a technical violation they know nothing about." Lugo also reported, "FASB staff member Paul Glotzer said that, according to his current count, the board had received at least two letters, and possibly four, on the issue" as of Jan. 10, and that "the majority of responses were phone calls--related to the definition of adoption--with constituents asking what it meant. For example, he asked, if a company calculated and determined its liability to be zero, did this mean it adopted FIN 48? He said another issue that constituents voiced was what to do during the interim--between when the board will vote to defer and when a formal adoption is required. "There is no answer to that yet [but this] gets more into how do you report on it," Glotzer said. He said FASB staff response to questions varied thus far from telling constituents to use their judgment to others stating perhaps illustrative examples may be warranted. Glotzer said that staff were waiting for the comment period to end before seeing how to proceed; that is, whether to propose to the board that it rewrite certain wording of the proposed amendment."
More FASB Proposals on Which Comments Due This Week; FEI CCR Responds
Other FASB proposals on which comments are due this week include Proposed FSP FAS 142-f—Determination of the Useful Life of Intangible Assets (comments due today), and Proposed FSP FAS 157-b—Effective Date of FASB Statement No. 157 [comments due today; see comment letter filed by FEI’s Committee on Corporate Reporting (CCR)]
DOJ-Initiated Proposal Issued by GSA Addresses Contractor Liability Relating to Detection and Reporting of Criminal Actions of Employees, Attorney-Client Privilege And Other Matters of “Cooperation”
Yesterday (Jan. 14) was the comment deadline on a proposed rule issued by the General Services Administration (GSA) (jointly with the Department of Defense (DOD) and NASA) entitled, “Federal AcquisitionRegulation [FAR]; FAR Case 2007–006, Contractor Compliance Program and Integrity Reporting," (the "proposed rule").
The proposed rule was issued by GSA as a result of GSA's Office of Federal Procurement Policy “receiv[ing] a request from the Department of Justice [DOJ]” on May 23, 2007.
FEI’s Committee on Government Business (CGB) filed a comment letter yesterday, recommending GSA's proposed rule be withdrawn.
“The proposed rule would require contractors and subcontractors to exercise due diligence to prevent and detect criminal conduct, to change internal control systems in some undefined way, to monitor and audit for crime detection, and to look for and report instances of “probable cause,” said the FEI CGB letter.
“We believe the proposed rule is overreaching, and essentially would “deputize” contractors and subcontractors as agents of the IG [Inspector General],” added the FEI CGB letter.
Issues surrounding waiver of attorney-client privilege and other pressures related to ‘cooperation’ with government agencies – some of which were criticized in an earlier ruling against DOJ in a tax case involving the Thompson Memo – are being resurrected in the GSA proposal, as a result of GSA receiving this request from DOJ, the FEI CGB letter continues. See FEI CGB's comment letter, which summarizes some of the major provisions of the proposal, for full details.

9:36 AM by Edith Orenstein


Jan 11, 2008
SEC Sets Its Sights on Reducing Complexity as CIFR Advisory Committee Recommendations Move Forward
Earlier today (January 11), the SEC Advisory Committee on Improvements to Financial Reporting (CIFR) unanimously adopted all proposals contained in CIFR’s Draft Decision Memo (DDM), with the exception of a proposal to make XBRL mandatory, on which there was one dissenting vote.
The 13 proposals adopted by CIFR are aimed at:
Reducing substantive complexity created by a multiplicity of guidance by reducing industry specific guidance and reducing optionality or choices among accounting treatments.
Improving the standard-setting process by focusing it more on the primary customer – the user of financial statements – and by focusing standard-setting authority at one source: FASB.
CIFR recommends a formal agenda advisory committee be formed consisting of representatives from the SEC, FASB, PCAOB and others to advise FASB on current issues and to determine which standard setter or regulator should act on certain issues or if a solution other than issuing a new standard or interpretation would suffice.
CIFR also generally agrees with the recommendations in the Financial Accounting Foundation’s (FAF’s) recent proposal to improve FASB and FAF governance and oversight, with the exception of recommending 2 at large seats on the FASB board be filled by the most qualified candidate, vs. FAF’s proposal of one at large seat and one academic seat. (The other three seats would be held by a preparer, auditor, and user of financial statements.)
Improving the audit process and compliance – by recommending that the SEC issue guidance on materiality, restatements and correction of errors. CIFR believes “Materiality should be judged based on how an error impacts the total mix of information available to a reasonable investor,” and that restatements of prior period errors (vs. correcting in the current period with disclosure) should be based on whether the restatement would impact current investment decisions of a reasonable investor.
Additionally, CIFR recommends that the SEC “issue a policy statement or adopt a safe harbor on a professional judgment framework.” CIFR also recommends ways to facilitate the disclosure of more information during what is now viewed as a ‘dark period’ between the time a company announces a restatement is pending or a matter is being investigated, and the time at which the full results of the restatement are available.
Numerous CIFR members said the professional judgment framework was a critical component in reducing complexity, without which the effectiveness of many of their other recommendations may be limited. The purpose of the framework is to influence behaviors of preparers, auditors and regulators, with a major goal of influencing more ‘respect’ of auditors and preparers judgments.
Improving delivery of financial information by mandating XBRL (phased in with largest companies first). There was a great deal of discussion about how costly auditor attestation on XBRL related information would be, and the lack of hard data on that now, as well as the fact that there is currently other information provided in annual reports and elsewhere (press releases) which is meaningful to investors, and unaudited. CIFR recommends certain XBRL information initially be ‘furrnished,’ not filed (which carries a lesser degree of liability) during the first phase of adoption of XBRL by the largest companies, and then to review the experience of the largest companies before mandating auditor attestation, changing status from ‘furnished’ to ‘filed,’ or mandating that the smallest companies file in XBRL.
SEC Division of Corporation Finance Director John White said, “I don’t see us requiring any company to provide us with XBRL tagged data until companies in the voluntary program have voluntarily chosen to provide us with information and we know the new taxonomy works, that Edgar can accept it, and that we’ve got a reader so you can read it, and until we can demonstrate all those things happen in the existing voluntary program, I don’t think you get to the point of requiring companies to do all the things you want to do.” As to SEC’s timetable for XBRL, White added, “If we were on the most aggressive schedule, we’d put out a proposal in the Spring - which I remind you goes to June 20 - that laid out a roadmap how this would happen; during the course of the summer we’d have proof of [workability of] concept I describe[d] [through the voluntary filer program], and before the Commission would adopt a proposal, you’d have to have proof it could work, adopt a final mandatory piece in the fall , which I remind you goes to December 20.” He agreed that phasing in implementation by company size would be reasonable.
Improving delivery of financial information by recommending the SEC release interpretive guidance on “the use of corporate websites for disclosures of corporate information addressing such issues as liability for information presented in a summary format, treatment of hyperlinked information from within or outside a company’s website, and clarification of the public availability of information disclosed on a reporting company website.” FEI member and past chair of FEI’s Committee on Corporate Reporting (CCR), Frank Brod, Corporate VP, Finance and Administration and Chief Accounting Officer at Microsoft Corporation, presented a demo to CIFR of web-based information being developed by Microsoft which brings together useful information for investors in various tabular formats, such as Key Performance Indicators (KPIs), which are hyperlinked to further information.
White said, “I have a team in Corp Fin reviewing this now, looking at whether we can come up with interpretive guidance along these lines.”
SEC Chief Accountant Conrad Hewitt said this topic “May lend itself to an SEC roundtable on best practices; and to users, which additional information do we need.”
Status of CIFR Recommendations
CIFR Chair Robert Pozen distinguished between the ‘developed proposals’ which were all adopted today, and the “conceptual approaches” and “matters for future consideration’ contained in the 110 page DDM.
As described in the DDM, “Developed proposals are sufficiently formed so that, shortly after approval at this meeting, they will be formally submitted to the Commission.”
Now that CIFR has approved its initial set of proposals, the next step, said Pozen, will be “to turn this into a report that isn’t geared to such a technical level or decision making level, but geared to a broader audience.”
CIFR will hold a telephonic meeting on February 11 to approve the version of the report being drafted for broader audiences, containing the proposals adopted today. Additionally, CIFR’s next in-person public meeting will be held in March, said Pozen.
Jim Kroeker, SEC Deputy Chief Accountant, who serves as the Designated Federal Officer (liaison) to CIFR, said the February 11 telephonic meeting will be open to the public in accordance with Federal Advisory Committee Act (FACA) rules. As a practical matter, the SEC will likely post a webcast link for the public to listen to the meeting
Public comment will be sought on CIFR’s report. “We will be having some town halls in the spring which we’ll announce,” Pozen said. He added that the committee thought it was “better to wait until we have a document people can focus on, then having general testimony or submissions.”
Besides town hall meetings, it is likely that CIFR will post the report approved on February 11 on the SEC website, and will invite written comment letters on its report, similar to the manner in which another recent FACA committee, the SEC Advisory Committee on Smaller Public Companies, posted its report for public comment before issuing its final report to the SEC.
Pozen reiterated CIFRs final report is due at the end of the summer.
CIFR will take up international aspects nowPozen indicated that now that the first round of recommendations have been made, subcommittee two of CIFR, led by David Sidwell, will focus further on international convergence related issues.
Sidwell said his subcommittee will focus on issues such as governance of the international standard setter (IASB), and how interpretations of global standards will be handled.
CIFR had mainly focused on FASB so far, explained Pozen, on the premise that "FASB and the IASB will both be around for a while." He added, "We aren’t in a position to judge when the IASB would fold together with FASB, we’re making a reasonable estimate [FASB] will be around for a while, whether 3, 5, or 10 years, we’re not in a position to evaluate, but my own cynicism is these things take longer than we would think."
Pozen added, "I myself am not concerned about [FASB Chairman] Bob Herz losing his job," and advised Herz, an observer at the CIFR meeting, "don’t give up your apartment in Norwalk," referencing Norwalk, CT, where FASB is headquartered.
Additional Highlights
We will report on additional highlights from the January 11 CIFR meeting. Check back to FEI's blog next week for more details.

7:51 PM by Edith Orenstein

Jan 10, 2008
Annual Report Analysis Published by FEI-FERF
In time for the 2007 annual report season, a new report published this week by the Financial Executives Research Foundation (FERF), the research affiliate of Financial Executives International (FEI), identifies and analyzes trends in last year’s annual reports.


The report, “What’s New in Financial Reporting: Financial Statement Notes from Annual Reports,” examined disclosures of the 100 largest publicly traded companies in last year’s annual reports (filed in 2007 for calendar year 2006).


Authored by Mark P. Holtzman, PhD, Assistant Professor of Accounting at the Stillman School of Business at Seton Hall University, the FERF report illustrates how companies addressed specific accounting issues recently promulgated by FASB and the SEC.


A number of trends uncovered by Holtzman noted in the FERF report include:
Most of the disclosures selected appear to have been developed specifically for a company’s own operations and industry standards, rather than “boilerplate” disclosures.
Four accounting areas were identified with a considerable variation in disclosures. The examples cited in these areas used innovative techniques to clearly address difficult accounting issues. The four areas were:
- Commitments and contingencies- Derivatives and financial instruments- Goodwill and intangibles- Revenue recognition.
Twenty-five out of 100 filers in the 2006 reporting season reported tangible asset impairments as a critical accounting policy.
Many companies report condensed consolidating cash flows statements as part of their segment disclosures, although not required by SFAS No. 131, Disclosures about Segments of an Enterprise and Related Information.
Commenting on the report, Holtzman observed, "Reporting about derivatives and financial instruments varied quite widely.” He added, “Some companies provided a lot of details to help the user understand the nature of the risk associated with derivatives and financial instruments, and how the companies use them in their businesses. Others provided much more general information that would probably not be that useful to users."
Cheryl Graziano, VP Research and Operations for FERF, said, “FERF undertook this study to provide our members with an illustration of how companies have used innovative techniques to clearly address difficult accounting concerns.”
She added, “Recent accounting issues publicized by FASB and SEC have had a direct impact on members of the financial community, and the report shows that many companies are taking action. We hope that all financial executives can utilize the report as both a quick update to summarize recent trends in the most recent annual reporting season, as well as a reference to address common accounting issues.”
The 147 page report, “What’s New in Financial Reporting: Financial Statement Notes from Annual Reports,” is available via free download by FEI members as a benefit of FEI membership. An additional benefit for FEI members is they will have access to an online database of all of the financial statement footnotes gathered for the study.
The FERF annual report study, with access to the online database, can also be purchased for $129 by nonmembers. (The cost of membership in FEI, an association of senior financial executives, is $475 annually, plus a one-time application fee of $250.) For further information about FEI or FERF, visit http://www.financialexecutives.org/ and http://www.ferf.org/ .

1:23 PM by Edith Orenstein

Jan 9, 2008
SEC Won't Object to Treatment of Certain Mortgage Modifications; Disclosures Required, States SEC Letter to AICPA, FEI
Yesterday (Jan. 8) SEC Chief Accountant Conrad Hewitt issued a letter to Sam Ranzilla, Chairman of the AICPA’s Professional Practice Committee, and Arnold C. Hanish, Chairman of Financial Executives International’s (FEI’s) Committee on Corporate Reporting (CCR), providing the views of SEC staff on accounting for modifications of subprime Adjustable Rate Mortgage (ARM) loans under Segment 2 of the "Streamlined Foreclosure and Loss Avoidance Framework for Securitized Subprime Adjustable Rate Mortgage Loans" (the "ASF Framework").
As detailed further in this FEI summary, U.S. Treasury Secretary Henry M. Paulson has supported use of the ASF Framework, to help stem the tide of mortgage defaults and foreclosures which have accelerated in the subprime mortgage market, due to steep interest rate resets and other factors.
The SEC’s January 8 letter notes questions have arisen on treatment of mortgage modifications under the ASF framework, given the requirements pertaining to servicers of Qualified Special Purpose Entities (QSPEs) under FASB Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 140).
[Update: the next 2 paragraphs of background info have been added to our original blog post. Earlier guidance from the SEC set forth in a letter last summer from SEC Chairman Christopher Cox to House Financial Services Chair Barney Frank included an attachment from the SEC Chief Accountant describing, among other things, permissible activities of QSPEs under FAS 140. The guidance in the Cox letter to Frank was characterized as 'unambiguous' by Senator Charles Schumer and he urged audit firms to "urg[e] your clients to do their part to keep our housing markets afloat, by modifying subprime loans that are at risk of default," as noted in an August 24 alert issued by the Center for Audit Quality (CAQ), affiliated with the AICPA.
However, the pace of mortgage modifications to address the subprime crisis was slower than anticipated, for a host of reasons, including not only continuing questions about accounting, but also legal and economic issues. Thus, the U.S. Treasury Department supported private-sector initiatives in coordination with legislative and regulatory initiatives to develop a broader based solution to facilitate the large number of mortgage modifications necessary to forestall default of subprime mortgages. One such initiative was the ASF framework.]
Hewitt states in his January 8 letter the SEC staff "will not object to continued status as a QSPE if Segment 2 subprime ARM loans are modified pursuant to the specific screening criteria in the ASF Framework."
"Additionally,” states the SEC letter, “given the unique nature of the contemplated modifications and other loss mitigation activities that are recommended in the ASF Framework, OCA expects registrants to provide sufficient disclosures in filings with the Commission regarding the impact that the ASF Framework has had on QSPEs that hold subprime ARM loans."
Appendix A to the SEC’s January 8 letter lists certain disclosures the SEC’s Office of Chief Accountant and Division of Corporation Finance “believe that registrants that have transferred subprime ARM loans to QSPEs should consider [providing]” in their SEC filings, including in the Management’s Discussion and Analysis (MD&A) section, and in the Notes to the Financial Statements.
Interim Guidance Only; SEC Asks FASB To Complete FAS 140 Overhaul in 2008
The purpose of the SEC’s guidance, says the letter, is to “provide interim accounting and disclosure guidance" until FASB finishes its current project addressing certain issues in FASB Statement of Financial Accounting Standards No. 140, “Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities” (FAS 140).
Among the issues to be addressed in FASB’s project, says the SEC, are issues pertaining to servicer discretion. FAS 140 requires transferors of mortgages to relinquish control over the assets transferred in order to get sale treatment, and requires that servicers of mortgages held by Qualified Special Purpose Entities (QSPEs) play a passive role with respect to those assets.
“Concurrent with the issuance of this letter, OCA has requested the FASB to immediately address the issues that have arisen in the application of the QSPE guidance in Statement 140,” says the letter. Specifically, "OCA has requested that the FASB complete its project addressing the guidance in … [FAS 140] to be effective no later than years beginning after December 31, 2008”
The SEC’s Office of Chief Accountant has sent ‘letters to industry’ such as the January 8 letter to the AICPA and FEI to help facilitate a broad dissemination of the SEC staff’s position on certain matters.
FEI, an association of over 15,000 senior financial executives, is getting the word out to its members by providing a link to the SEC’s January 8 letter in FEI’s weekly e-newsletter, FEI Express. Additionally, FEI is promoting public awareness of the letter though the FEI Financial Reporting Blog, and in this summary of the SEC letter on FEI’s website, http://www.financialexecutives.org/.
While you were out…
If you’re one of our a.m. readers and missed our post yesterday afternoon, it was on: “FASB Releasing Codification Next Week; 5 Year Goal of Moving to IFRS Reasonable, Say Panelists on FASB Webcast.” And, if you received this blog post from ‘a friend,’ sign up here to receive FEI blog emails real-time.

12:12 AM by Edith Orenstein

Jan 8, 2008
FASB Releasing Codification Next Week; 5 Year Goal of Moving to IFRS Reasonable, Say Panelists on FASB Webcast

FASB Chairman Bob Herz announced on a webcast earlier today (Jan. 8) that FASB will release its draft codification of all U.S. GAAP next week. Other highlights from FASB's webcast on global reporting are below.

Codification Coming Next Week
The release next week of FASB's codification will begin the ‘verification’ period during which FASB wants companies, auditors, investors and others to ‘test drive’ the codification and provide feedback to FASB.

“The goal of the Codification,” as described in an earlier press release issued by FASB in October, 2007, “is to simplify the organization of thousands of authoritative U.S. accounting pronouncements issued by multiple standard-setters. To achieve this goal, the FASB initiated a project to integrate and topically organize all relevant accounting pronouncements issued by the U.S. standard-setters including those of the FASB, the American Institute of Certified Public Accountants (AICPA), and the Emerging Issues Task Force (EITF).”

The length of the verification or public comment period on the draft codification will be one year, as stated in FASB’s Oct. 07 press release.

“After addressing issues raised during the constituent feedback process, the FASB expects to approve the Codification as the single authoritative source of U.S. GAAP in early 2009.”

During the verification period, “FASB will provide free online access to the FASB Accounting Standards CodificationTM research system… [which] will include features specifically designed for the Codification… constituents will be able to review the content and provide comments using a customized electronic feedback feature,” said FASB in October.

After receiving public comment during the verification phase, FASB will revise as necessary and issue the Codification as final.

“Once approved by the Board, the Codification will become the single source of authoritative U.S. GAAP, and will supersede existing FASB, AICPA, EITF, and related literature,” noted FASB’s Oct. 07 press release. When approved as final, FASB said, “only one level of authoritative GAAP will exist. All other literature will be nonauthoritative.”

Herz made his comment on the codification during this morning’s FASB webcast on,”Towards a Global Reporting System: Where Are We and Where Are We Going?” Highlights from the webcast are below.

Goal of Moving to IFRS in Five Years Reasonable
In other highlights from today’s FASB webcast, a number of panelists suggested a five year period in which the U.S. could move to IFRS would be reasonable.
Panel moderator David Reilly of the Wall Street Journal, reading questions submitted by listeners on the webcast, asked: “What is current thinking about the timeline if the SEC was going to require companies to move to IFRS?”

Peter Bridgman, SVP and Controller of PepsiCo said, “I’d go for 5 years, I wouldn’t go for significantly longer than that, if you go for 10 or 15 years, no one’s going to pay attention to that until it’s 5 years [away].”

Greg Jonas of Moody’s agreed, saying, “Something like a goal of 5 years from now is critical, so companies will make investments in infrastructure.” He added, “I would be against giving companies an option [to use U.S. GAAP or IFRS] during the intervening period,” explaining that comparability is one of the strengths of the U.S. financial reporting system, and “introducing optionality in the system is in many ways a step backwards.”

Herz noted that as a practical matter, companies had five years notice in Europe of a move to IFRS, when the IASB was first formed (after a restructuring of the predecessor IASC).

KPMG Partner Sam Ranzilla was asked what he thought about a phase-in for smaller companies.

“In our response to the Concept Release,” Ranzilla said, “we show a appetite for some sort of phase in… That makes sense to me for a lot of reasons, some similar to [the phase-in of Sarbanes-Oxley] 404.” He added he would expect any phase-in of IFRS to be a tight deadline. “ if we had 5 years between phase 1 [larger companies] and 2 [smaller companies], I don’t support that.”

Transition
Asked how he would approach a corporate wide transition to IFRS, PepsiCo’s Bridgman said he would treat it as a major project. “I’d probably look to pull a handful of people in from countries that have had experience in converting to IFRS and have them lead it.”
“In preparing the market,” Bridgman responded to a later question, “if we’re talking over, say, a 5 year time frame:
first, start talking to the market about what kind of differences they can expect, that can drive results, start educating
while still reporting in U.S. GAAP, post to some website some IFRS based information, so people can get sense of that,
switch to IFRS
Should ‘Lame Duck’ SEC Decide on IFRS Now?
WSJ's Reilly described three options which the SEC could conceivably take regarding use of IFRS by U.S. companies, with option 1 being no IFRS by U.S. companies, option 2 being permitting U.S. companies to use IFRS, and option 3 offering a period in which companies have the option to use IFRS, followed by a date certain by which IFRS would become mandatory for all.

“We at FASB and our trustees submitted a comment letter to the SEC on its Concept Release,” Herz noted. “We were in the Option 3 camp, with some caveats on that.” The caveats he described are: “We believe in this idea of getting to a single set of high quality standards across the major capital markets,” adding, “I emphasize ‘single’ and ‘high quality’ - that is the destination we should be working toward; that is what the capital markets are going to need and want, it is where most of the rest of world seems to be heading.”

Panelists noted a concern about comparability of reporting under IFRS – which are often described as more principles based than FASB standards (which are described as more ‘rules based’), including the fact that individual jurisdictions sometimes adopt their own jurisdictional version of IFRS which differs from IFRS as published by the IASB. (The SEC, in deciding to drop the IFRS ‘reconciliation’ requirement for foreign filers in November, predicated that decision on companies reporting in IFRS as published by the IASB.)

SEC’s upcoming decision whether to permit or require U.S. companies to file in IFRS will impact a much larger number of companies than the number of foreign filers impacted by SEC’s November decision to accept IFRS without reconciliation.

“Given all the issues you’ve cited” during the panel today, said Reilly - including comparability, IASB oversight and infrastructure issues, and the need for education for auditors, company financial management and investors, looking at “the risks and benefits,” and “given this is quite a large decision,” asked Reilly, “is this a decision that should be made by a lame duck SEC, missing 2 commissioners at the moment?”

Herz replied, “I am a big believer in making sure the right people have weighed in and its been carefully considered.” He said the decision does need to be made by the SEC, “but lame duck or otherwise, I think they will get 2 new commissioners in the not too distant future, I think they will get some more input, and make a careful decision on that.”

Reilly asked if Congress would need to get involved, since other regulators have U.S. GAAP based requirements, including tax requirements of the IRS, and requirements of U.S. banking regulators.

“With all due respect to our friends in Congress, I think it the SEC with input from the capital market is the right place to make the decision,” said Herz.

Bridgman agreed. “The SEC is the right place, has the expertise. I am also not in favor of calling anybody at the SEC a lame duck, when the commissioners make the decision, they’ll be committing their successors down the road,” as far as implementation.

Whither Private Companies?
Reilly asked the panel, “Do you think US GAAP will embrace a private company standard similar to IASB’s IFRS for Small and Medium Sized Entities (SMEs) initiative?”

“Numbers wise,” said Herz, “private companies using US GAAP dwarf the number of public companies in our market; while we have some differences and have a committee [the FASB-AICPA Joint Private Company Financial Reporting Committee] looking at further ones, its very important to maintain a vertically integrated reporting system.” He continued, “ if we were to go to IFRS, we would need to carefully look at what to do for private companies, including looking at what IASB doing for SMEs.”

Will There Be a FASB 5 Years From Now?
Panel moderator Reilly asked, “Is there going to be a FASB 5 years from now?

Herz replied, “There’s a chance U.S. GAAP as a separate set of standards would be eliminated, but IFRS and US. GAAP are not that different, a lot of the old IAS stds were based on US GAAP,” he noted, “and through our convergence program, we’ll continue to produce common standards for a while.”

“If you came back here 10 years from now,” Herz continued, “perhaps there’d be an FASB, but a different FASB; like in other countries around the world, in some cases they continue to do things for private companies - I’m not advocating that - they also provide implementation guidance, not standards.” He added, consistent with his remarks at an IFAC conference in December 2007, that he believes an international standard setter will need to be ‘on the ground’ in various locations around the world.

As far as where such ‘satellite’ offices of the IASB may be located (‘satellite’ was the term he used in his remarks to IFAC), he told the panel today, “I can imagine one here, maybe in the Pacific Rim, maybe one in India if that economy continues to grow.”

He added, “Consistent with the US role in the capital markets, there will continue to be a significant US role” in international standard setting.

Reilly later asked, “Would it be more efficient to merge FASB and IASB and their staff?”

Herz responded, “At some point, something like that may occur, if decision were made in this country to move to IFRS< href="http://www.financialexecutives.org/eweb/startpage.aspx?site=_fei">Financial Executives International (FEI), a leading association of over 15,000 senior financial executives, has various resources available to members and nonmembers on critical topics in financial reporting, including conferences, webcasts, national technical committees, and local chapters. PepsiCo SVP and Controller Peter Bridgman who appeared on the FASB webcast on global reporting is a member of FEI. FEI's Committee on Corporate Reporting and Committee on Private Companies have filed a number of comment letters with the SEC and IASB on IFRS related matters, and a number of FEI members appeared on the SEC's December roundtables on IFRS.
In addition to serving financial executives, FEI also has a membership category and resources for audit committee members.
For further information visit http://www.financialexecutives.org/, if you can't find what you're looking for on our website, email me at eorenstein@financialexecutives.org. Keep up with the latest financial reporting news and find out about our upcoming conferences where you can learn more about IFRS and other hot topics in financial reporting by signing up for the FEI Financial Reporting Blog, you can sign up by entering your email address here.

2:07 PM by Edith Orenstein

Jan 8, 2008
Tune in Today for Webinars on U.S. Adoption of International Accounting Standards, XBRL
Two important webcasts you may want to tune into or have a buddy tune into today:
10:30 a.m. EST FASB webcast: “Towards a Global Reporting System: Where Are We and Where Are We Going?” The panel, moderated by Wall Street Journal reporter David Reilly, includes FASB Chairman Robert Herz, PepsiCo SVP and Controller Peter Bridgman, Moodys Managing Director Greg Jonas, and KPMG Partner-in-Charge of Professional Practice, Sam Ranzilla, discussing implications of moving the U.S. toward adoption of International Financial Reporting Standards (IFRS). Sign up here for the FASB webcast, or scroll down to the “Events” section of FEI’s website which also provides a link to the FASB webcast.
12:00 noon EST FEI Webinar: XBRL and the XBRL US GAAP Public Review. As noted in SEC’s Dec. 5, 2007 press release, the SEC is ‘urging public comment’ on the U.S. GAAP taxonomy or dictionary of interactive data tags developed by XBRL-U.S. The SEC has previously announced it plans to issue a proposed rule this year to address whether/when public companies will be required to use XBRL tags, and the SEC currently has a Voluntary Filer Program (VFP) for XBRL. To learn more about the XBRL U.S. GAAP taxonomy, the SEC’s VFP, and how you can have a say in the public review of the XBRL U.S. GAAP taxonomy, join us today on the FEI-XBRL U.S. webinar: “XBRL and the XBRL US GAAP Public Review.” Sign up here.

9:13 AM by Edith Orenstein

Jan 7, 2008
Criminal Trial of AIG, Gen Re Execs, 'Pillsbury Bake-Off of Cooked Books,' Begins Today
The criminal trial of five former officers of AIG and General Re Corp in a case the Hartford Courant describes as the “Pillsbury bake-off winner of cooked books” begins today. As noted in the Hartford Courant article, “Unusual Trial Embroils Insurers” by Diane Levick, “In a highly unusual jury trial starting Monday, five former insurance executives face criminal charges in a case that seemingly is about an arcane manipulation of claim reserves.”
“The outcome of [the] trial may rest largely on the ability of federal prosecutors to keep their case simple,” say Karen Richardson and Peter Lattman in their article on the AIG GenRe trial in today’s Wall Street Journal, “Insurance Trial Goal: Keep it Simple.”
WSJ's Richardson and Lattman explain the case “Center[s] on a seven-year-old reinsurance transaction spanning two continents,” and note “the case will be laden with expert testimony by auditors and documents relating to arcane insurance and financial terms such as "loss-portfolio transfer" and "mirror-image accounting.”
As described in a related SEC Litigation Release dated Feb. 2, 2006, “The complaint… alleges that the defendants and others aided and abetted AIG’s violations of the antifraud and other provisions of the federal securities laws by helping AIG structure two sham reinsurance transactions that falsely increased AIG’s loss reserves in the fourth quarter of 2000 and first quarter of 2001 by a total of $500 million. The transactions were initiated by AIG to quell criticism by analysts concerning a reduction in the company’s loss reserves in the third quarter of 2000.”
Richardson and Lattman add, “The challenge will be proving defendants knew what they were doing was wrong and wasn't just complex accounting, all while keeping jurors' attention.” Prosecutors will need to “[o]vercom[e] the tedium inherent in an accounting-fraud case,” they say, referencing the 2006 trial of Enron’s Lay and Skilling, in which “the government's success in securing convictions was, in part, due to its ability to avoid extensive accounting arcana and to emphasize basic concepts.” They note Enron prosecutor John Hueston argued in his opening statement: “This is a simple case. It is not about accounting. It is about lies and choices."
Levick of the Hartford Courant adds that the trial of the former AIG and GenRe execs, “is setting the business world abuzz because investor idol Warren E. Buffett, chairman and chief executive of General Re's parent, Berkshire Hathaway Inc., might be called to testify.” WSJ’s Richardson and Lattman describe the possibility of Buffett’s testifying as a ‘wild card’ aspect of the trial.

9:02 AM by Edith Orenstein

Jan 4, 2008
The Subprime Mortgage Morass: Investigations Continue, Economic Impact, Accounting Questioned, What Next?
The subprime mortgage morass continues in the news with reports of an investigatory sweep by brokerage/securities regulator FINRA relating to sales of mortgage-backed securities. Separately, the subprime mess may be one trigger of an economic stimulus package President George W. Bush is reportedly to consider in meetings taking place today with Treasury Secretary Henry M. Paulson, SEC Chairman Christopher Cox, and other financial regulators.
Investigations Continue“Wall Street’s Watchdog Probes CMOs” by Kara Scannell in today’s Wall Street Journal says the Financial Industry Regulation Authority (FINRA) sent letters to “more than a dozen brokerage firms believed to be in the CMO [Collateralized Mortgage Obligation] market.”
“The letters, dated Dec. 14, were sent from Finra's enforcement division in what has been described as a "sweep" investigation, which is a broad look at industrywide practices that doesn't necessarily result in an enforcement action,” says Scannell.
“The letter asks for PowerPoint presentations, sales scripts and detailed customer-account information from June 30, 2006, through July 31, 2007.” Additionally, FINRA requested “documents, including marketing materials, a list of supervisory policies and procedures, and descriptions of how collateralized mortgage obligations were valued,” says Scannell, based on a copy of the letter she says was obtained by the Wall Street Journal.
She adds, “A spokesman for the SEC said the commission's examination division plans to conduct its own sweep examination in coordination with Finra.”
Scannell previously reported on an SEC sweep investigation into how financial firms handled mortgage-backed issues, as we noted on Dec. 21.
Economic ImpactThe subprime situation is one issue that may prompt President Bush to recommend an economic stimulus package. According to “Bush Ponders Move to Bolster Economy,” by Sheryl Gay Stolberg in today’s New York Times, “President Bush said Thursday that he was considering whether to propose a stimulus package to shore up the economy, the clearest indication yet of a growing concern inside the White House over rising oil prices, the subprime mortgage crisis and the possibility of recession. “I’m concerned about people losing their homes and paying a lot for gasoline,” Mr. Bush said in an interview with Reuters.”
A related report by Peter Baker in today’s Washington Post, “President Considers a Boost to Economy,” notes that attendees at the meeting President Bush is scheduled to have today with the interagency group on financial markets will include Fed Chairman Ben S. Bernanke, SEC Chairman Christopher Cox, CFTC Acting Director Walt Lukken, and Treasury Secretary Henry M. Paulson. “The White House has already signaled that it plans to offer additional measures to respond to the housing slump and the credit crunch, which have led to foreclosures,” reports Baker.
AccountingSeparately, Floyd Norris of the New York Times reports today on broader issues concerning accounting for off-balance sheet assets. In his article, “Now You See Those Securities, Now You Don’t,” Norris cites as an example the Dec. 31 purchase (‘bail-out,’ in his words) of $810 million in securities by Zions Bancorporation from its off-balance sheet affiliate, Lockhart Funding, resulting in a $33 million loss to Zions. Another $2.1 billion in securities held at Lockhart remains off-balance sheet at Zions, with $22 million of related unrecognized losses based on the current value of the securities. Norris notes, “Under the current accounting rules, [Zion’s] doesn’t have to take that loss. At least not yet.”
He adds, “The Financial Accounting Standards Board and the bank regulators know all about this, and they have been talking about making changes for years. But it is complicated, and nothing seems to happen.”
“We probably will get action if and when there is a good scandal,” Norris notes. “Perhaps some bank will fail even though it seemed to have plenty of capital. Then there will be expressions of shock, and calls for changing the rules to reflect economic reality. In the meantime, banks will be able to keep assets off their books — until they have to report the losses when the assets go bad.”
What Next?We asked Boston University Law School Professor Tamar Frankel, author of a textbook on Securitization as well as co-author (with Mark Fagan) of a new course on Trust and Honesty in the Real World (recently reported on in the Securities Law Prof blog carried by Securities Mosaic Blogwatch) if she had any observations on the subprime situation.
For openers, we asked her to comment on the role of regulation – accounting and legal rules – with respect to the subprime crisis. “Most if not all rules involve some discretion,” noted Frankel. She adds, “It should be also clear that a dictionary definition of the words can lead to horrendously harmful conclusions and effects. Both corporations and their accountants must ask themselves: Why is this "unclear" rule here? What is its purpose and what problem is it designed to avoid.”
“Looking for the loopholes and especially creative loopholes invariably brings about fraud on the one hand and an avalanche of rules--"dictionary" specific detailed rules that bind business and prevent flexible decision making when appropriate,” warned Frankel.
As to how to respond to the current subprime situation, Frankel observed, “There are those who suggest that the market should take care of the problems. Let us go through a recession, and let families end up on the street.” Such people argue, she says, “After all, only 3 million persons took these loans, and the low price of housing may benefit those who have the money to grab the bargains. And construction firms that might go bankrupt have always been a risky business.”
However, she notes, the impact of such a laissez faire approach is that “The problem is that our financial system suffers.”
“The sub-prime loan problems were led less by the borrowers and more by the lenders and the leaders in the financial system,” states Frankel. She adds, “The idea that banks must be regulated for "safety and soundness" must be adjusted to the fact that banks are now traders in securities and derivatives, originators of securitization and advisers to investors as well as traders with client investors.”
“Thus,” notes Frankel, “the culture of the banks has changed from safety and soundness of lending to sales, and government regulators believe that the market is the best regulator.” She concludes, “Perhaps we have to reconsider the system rather than do some patchwork."

9:46 AM by Edith Orenstein

Jan 3, 2008
IRS Issues Interim Rule on 'More Likely Than Not' Penalty Standard For Tax Preparers; Updates AMT Info.
On December 31, 2007 the IRS announced the issuance of interim guidance for implementing the expanded penalties under the ‘more likely than not’ standard applicable to tax return preparers in a law passed in May, 2007. The guidance can be found in IRS Notice 2008-13, “Guidance Under the Preparer Penalty Provisions of the Small Business and Work Opportunity Act of 2007.” Don’t ignore the provision just because of the use of the term ‘small business’ in the title of the law, since the tax return preparer implications are broader than just with respect to small business.
The AICPA had criticized the May 2007 law for imposing a higher standard of probability that an undisclosed tax position would survive challenge based on its merits with respect to the penalty standard applicable to tax return preparers (‘more likely than not’) vs. the standard applicable to the taxpayer. .
“As a result, without disclosure, a tax return preparer could be subject to a section 6694 penalty for taking a position that the taxpayer could properly take without a penalty,” said a July, 2007 AICPA Tax Section e-alert, which added, “The AICPA has opposed these changes and will continue to seek a remedy for this inconsistency in the penalty standards for the tax return preparers to avoid penalties than the standard applicable to the tax return filer.”
As described more fully in “'More Likely Than Not' Standard Becomes Rule for Preparers in Sweeping IRS Guidance” in today’s BNA Daily Report for Executives, the IRS’ interim guidance released at year-end “establish[es] that a new "more likely than not" standard for tax positions taken by their clients will be met if there is a greater-than-50 percent likelihood that the position will be upheld if challenged by IRS.” (Note: the ‘greater than 50 percent’ cite can be found in Section D on page 10 of Notice 2008-13.)
Additional points of significance noted by BNA (we have bulleted for emphasis):
“IRS said that preparers can rely in good faith without verification on information furnished by the taxpayer, or on information furnished by another adviser, tax return preparer, or third party, as allowed in Section 6694.
“They are not required to independently verify or review the items reported on tax returns, schedules, or other third-party documents to determine if they meet the reasonable belief standard.
“However, preparers must not ignore the implications of information furnished to them or actually known to them, IRS said.
“They must also make reasonable inquiries if the information furnished by another tax return preparer or third party appears to be incorrect or incomplete.
“Under the notice, preparers will not be subject to the new penalty provisions of the law unless they willfully understate tax or act in reckless or intentional disregard of the law, IRS said.”
BNA also notes the director of the AICPA’s Tax Division, Ed Karl, supports the interim guidance, but the AICPA still believes “the law passed in May is critically flawed in that it raises the preparer standard above the standard for taxpayers.”
A broader overhaul of the tax preparer penalty provisions is in the works, with the current guidance providing an interim solution to implement the existing law.
“The plan to take a fresh look at the preparer penalty regulations will be a top priority for us in 2008,” IRS Chief Counsel Don Korb said in the Dec. 31 announcement.
IRS Notice 2008-13 “solicits public comments regarding the revision of the regulatory scheme governing tax return preparer penalties in order to enable the Treasury Department and the IRS to complete their work on the overhaul of these rules by the end of 2008.”
In other year-end tax news, the IRS also issued updated guidance on December 28, 2007 on:“Alternative Minimum Tax (AMT) – How It Affects Filing Season 2008.”

9:12 AM by Edith Orenstein

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