Friday, November 27, 2009

Why Accounting Matters

Last week, we reported that two amendments relating to the Financial Accounting Standards Board were approved by the House Financial Services Committee (HFSC) during markup of its systemic risk bill. The bill, more formally called the Financial Stability Improvement Act (FSIA), is part of a broader set of bills being introduced as part of financial regulatory reform, aimed at preventing another credit crisis.

The first of the FASB-related amendments, the Perlmutter/Lucas amendment, would require the systemic risk council created under the FSIA "to review and submit comments to the Securities and Exchange Commission and any standards setting body with respect to an existing or proposed accounting principle, standard or procedure."

The second accounting-related amendment, the Garrett amendment, would require the FASB to study the impact of the minimum credit risk retention rules in the FSIA in combination with the new securitization accounting rules under FAS 166 and FAS 167 (which eliminate off-balance sheet treatment previously available under FAS 140 and FIN 46R), and that FASB "make statutory and regulatory recommendations for eliminating any negative impacts on the continued viability of the asset-backed securitization markets and on the availability of credit for new lending," and report the results within 90 days to the banking regulators and the SEC.

The ultimate fate of the FASB-related amendments approved by the HFSC is not yet known, since the full House still has to consider the entire financial regulatory reform package, as does the Senate. (See Sen. Chris Dodd's (D-CT) earlier comments on the initial version of the Perlmutter/Lucas amendment, which would have transferred oversight of FASB from the SEC to the systemic risk council. The amendment that eventually passed the HFSC was significantly softened, to require review and comment of accounting standards, but did not change the current oversight structure of FASB.) Continued focus on the financial regulatory reform legislation will take place in December.

A Civil War Over Accounting?
The battle over the Perlmutter/Lucas amendment in particular -which, as approved by the HFSC last week was significantly softened ('watered down' per's Sarah Johnson; 'gutted' per the Denver Post's Michael Riley) from its initial version proposed in March - rose to the level of Civil War in Corporate America (Ryan Grim, Huffington Post).

Some may have wondered how this level of agitation could occur in a profession that still harbors, in the eyes of some, a "milquetoast" image (Michael Riley, Denver Post).

This post attempts to provide some insight into why emotions can run so high in debates about accounting, by exploring the question of "why accounting matters." I remind you of the disclaimer which appears on the right side of this blog, which applies to the entire content of the blog, including (but not limited to) when posts have sections marked off as 'my observations' or 'my two cents.'

Cent 1 : What Accounting Is Not About: Undue Influence (Undue Pressure)
In a letter dated Nov. 5, 2009 (during the heat of the debate over the original Perlmutter/Lucas amendment, which as originally proposed in March, would have removed the SEC's oversight power over FASB, and transferred that oversight power to a Federal Accounting Oversight Board consisting of banking regulators and the SEC), SEC Chairman Mary L. Schapiro told Rep. Barney Frank (D-MA), chair of the HFSC:

I am deeply concerned about the possible consequences of changing [the current] system to one that would subject accounting standard setters to the supervision of entities with other regulatory missions. It is not that those missions are any less vital to the public interest than the mission entrusted to the SEC. It is just that they are different -- and I fear the potential consequences for our capital markets if investors come to believe that accounting standards serve any purpose other than to report the unvarnished truth. [Note: the reference to 'unvarnished truth is discussed separately later in this post.]

In closing her letter, Schapiro said: "Accounting should be about accounting, and nothing else." When I first read that closing statement, I thought it was a very powerful statement, or sound bite, if you will, but just as sound bites often convey a deeper meaning, I found myself thinking there are other interpretations about what accounting is about, and what it is not about.

Given the subject of the letter, I thought to myself, the sentence could be read to imply, "Accounting should be about accounting, and not about politics." Or, more precisely, substituting in language from the IASCF Monitoring Board's Sept. 22 statement on accounting standards and accounting standard-setting (the SEC is a member of the Monitoring Board), one could end the sentence this way: "Accounting should be about accounting, and not about undue pressures from political and corporate interests."

The word "undue" (as in "undue pressures") as used by the Monitoring Board is very significant: the group did not call for the total exclusion of dialogue with political and corporate interests; on the contrary, the Monitoring Board stated: "Interested parties must be afforded the opportunity to provide input to inform the standard setter’s evaluation of pertinent issues."

In fact, specific to the topic of fair value accounting (which some view as the driving force behind the Perlmutter/Lucas amendment) the Monitoring Board stated:
The IASB and FASB have benefitted from informative input into their financial instruments and fair value measurement standard setting initiatives from a broad range of stakeholders. The recommendations of some constituencies often contradict the strongly held views of others, reflecting the diversity of uses for and desired outcomes of financial reporting... robust participation of interested parties is an essential element of a standard setter’s transparent due process. Equipped with this input, it is the responsibility of the standard setters to evaluate the knowledge they have gained against the overarching objectives of financial reporting and the principles that reinforce those objectives, in a manner engendering independent decision-making.
Understanding the Role of Neutrality and Due Process
While we're on the subject of soundbites, some journalists over the past six months have characterized comments made by FASB and IASB board members and related advisory groups (such as the FASB-IASB Financial Crisis Advisory Group) as calling for no "meddling" by politicians (see, e.g. Politicians Accused of Meddling in Bank Rules (Floyd Norris, NYT, 7.28.09), and Europe Must Stop Its Meddling, Says FASB Chief (Mario Christodoulou, Accountancy Age 10.15.09). More recently, I've seen the word 'tinkering' used by some, in place of where 'meddling' was previously the term du jour.

Although 'meddling' or 'tinkering' are not defined in FASB's Conceptual Framework (which serves as the foundation for standard-setting), the term 'neutrality' is the operative term specified in Concepts Statement No. 2; i.e., the FASB is to exercise 'neutrality' in setting accounting standards. The IASCF Monitoring Board's Sept. 22 statement repeats the importance of neutrality.

In understanding the role of 'neutrality' and independence, of particular note is that it does not require FASB to be walled off from dialogue with outside parties, just that it act in a neutral fashion. See, e.g. Volcker Heartened by Regulators Reaction to Crisis Warns Against Isolation (Steven Burkholder, BNA Daily Report for Executives. Reproduced with permission from Daily Report for Executives, 208 DER I-4 (Oct. 30, 2009). Copyright 2009 by The Bureau of National Affairs, Inc. (800-372-1033)

More recently, BNA's Burkholder reported in, FASB Members Warm to Revised Perlmutter Amendment; SEC Supportive, that FAF spokesman Neal McGarity stated after the revised Perlmutter/Lucas amendment was approved by the HFSC:
The FAF recognizes and is respectful of the need for Congress to maintain and advance the safety and soundness of this country's financial system... The FAF does not oppose the recently adopted Perlmutter amendment because it acknowledges the due process [of accounting standard-setting] which is the backbone of the FAF mission.
The reference to 'due process' in the FAF spokesman's statement above is key, as is transparency of that due process, in engendering confidence in the process. The role of due process was also noted in the IASCF Monitoring Board's Sept. 22 statement, and in the IASB-FASB Nov. 5 joint statement, as follows:
IASCF Monitoring Board statement Sept. 22, 2009: "Visibility into the standard setting process should be sufficient to enable users to trace the evolution of the standard from thoughtful consideration of alternatives to final positions".

IASB -FASB Joint statement Nov. 5, 2009: "We aim to provide a high degree of accountability through appropriate due process, including wide engagement with
stakeholders, and oversight conducted in the public interest. We are consulting widely and will continue to draw on expertise from investors, preparers, auditors, standard-setters, regulators, and others around the world. ... We will set standards following our robust due process procedures that provide visibility into the standard-setting process and require proactive consultation to ensure communication of all points of view and the expressions of opinion at all stages of the process".
If we all were to agree on what accounting should "not" be about (i.e., that it should not be about undue influence or undue pressure), then what would we say accounting "is" about?

Cent 2: What Accounting Is About: Decision-Useful Information
Consistent with FASB's mission statement, the IASCF Monitoring Board's Sept. 22 statement defined what accounting (more generally, financial reporting) is about as follows:
We view the primary objective of financial reporting as being to provide information on an entity’s financial performance in a way that is useful for decision-making for present and potential investors. To be considered decision-useful, information provided through the application of the accounting standards must, at a minimum, be relevant, reliable, understandable and comparable.
The operative words are that financial reporting information aims at being decision-useful, by providing information that is relevant, reliable, understandable and comparable. All of these terms are longstanding fundamental concepts in FASB's Conceptual Framework (specifically, in Concepts Statement No. 2). (Note: an amendment to CON 2 was previously proposed and is set to be issued in final form 4Q2009 according to FASB's current technical plan.)

In considering the concepts noted above, people do not always agree on what 'decision-useful' means in particular contexts, and reasonable people may not always agree on how an accounting standard should be constructed to produce the most "relevant" and "reliable" information (and how to balance those two sometimes opposing forces).

For example, some people may say that fair value information is always the most relevant information ("measurement attribute"), period. Others, however, may question if fair value information in an illiquid, inactive or disorderly market, is any more relevant than information measured by some other means, such as discounted cash flow, or how much emphasis to place on 'market' quotes (e.g. broker quotes) vs. internal cash flow models, in such a market.

Thus, an 'inconvenient truth' in accounting is that, even if there were agreement among reasonable people as to which measurement attribute (e.g. 'fair value' vs. 'historic cost') is more relevant, there is not necessarily going to be universal agreement on which valuation method is most reliable to arrive at 'fair value' for all financial instruments, or how to balance relevance and reliability, in producing 'decision useful' information. You will see such debates if you review the comment letter file on the original proposal for FAS 157, and on current proposals out for comment by FASB and the IASB. It is and always has been a natural and healthy debate across all of standard-setting, as to how to develop standards that result in the most relevant and reliable information.

Since relevance and reliability, as well as understandability and comparability lead to decision usefulness, real world investing and financing decisions take place based on accounting information provided. And that is "why accounting matters."

Accounting Has Economic Consequences
Further on this topic of why accounting matters, Prof. David Albrecht was the first person to write publicly during the heated debate over the Perlmutter/Lucas amendment on the issue of why politics has historically had some role (indirect if not direct) in accounting standard-setting.

Although I disagree with Albrecht's choice of words in captioning his Nov. 18 blog post, I agree with his point that the economic impact of accounting standards has historically driven the engagement of constituents, including their elected representatives, and I urge you to look beyond the caption of his post, and read it for substance in his blog, The Summa.

Indeed, on the subject of economic consequences, in 1978 (5 years after FASB was formed, replacing a series of predecessor boards) FASB issued a call for research on, held a conference on, and produced a related report on, The Economic Consequences of Financial Accounting Standards. (Although I could not find a public link to the original 1978 report, if I recall correctly, it was inconclusive as to the role, if any, which economic considerations should play in accounting standard-setting, although views ran high in both directions; if I'm wrong, I invite blog readers to post a comment on this point.) Further reading on this topic can be found in:
Separately, I'd like to point out that Albrecht's criticism of some recent SEC statements on accounting standard-setting (in his Nov. 18 blog post) was based on part on a Reuters article reporting on SEC Commissioner Kathleen Casey's remarks at FEI's Current Financial Reporting Issues Conference on Nov. 17, which cited only a portion of Casey's remarks, which were subsequently posted on SEC's website. Refer to the full text of Casey's speech (also available on FEI's website) in which she speaks of, e.g. the need for independence and accountability:

Thus, the goal of standard setting must be to develop high-quality and unbiased accounting standards that promote transparency and that are, in turn, viewed as
credible by our markets. If, however, the standard setting process is subject to undue commercial or political pressure, market participants may lose confidence
in the financial information reported by firms. But while accounting standard setters must be independent, they must also be held accountable. The standard setting process is a delicate balancing act that highlights the importance of the Commission's oversight function. The Commission strives to ensure that this process is not compromised by inappropriate pressure and, at the same time, that the process produces high quality standards that elicit information meeting the needs of investors and other users.

Accounting as Art vs. Science, and the Role of Professional Judgment
As noted further above, SEC Chairman Mary L. Schapiro said in her Nov. 5 letter to Rep. Barney Frank:
"I fear the potential consequences for our capital markets if investors come to believe that accounting standards serve any purpose other than to report the unvarnished truth."

Although I believe the reference to 'unvarnished truth' was meant to express that investors expect accounting standards to be free from bias, the words 'unvarnished truth' trigger a visceral reaction among some in and around the accounting and auditing standard-setting profession, who believe, as stated by Prof. David Albrecht in his blog post noted above: "There is no such thing as universal accounting truth."

Indeed, the notion that information provided by accounting standards represents the absolute 'truth' has been described as an expectation gap, since accounting is replete with estimates and judgment calls. Thus, many believe accounting is more of an art, than a science.

The issue of accounting 'truth' was referenced in remarks of then-SEC Chief Accountant John C. ("Sandy") Burton in a speech in 1973 (at the time FASB was founded to replace its predecessor, the Accounting Principles Board or APB.) Significantly, Burton also refers to FASB's quasi-legislative role (and he is not the only person who has characterized it as such), provides some background on why emotions run high concerning accounting standards, and describes the nature of the relationship between the SEC and FASB. Here is an excerpt of Burton's remarks:

We at SEC are very confident that [FASB] will improve the standards of accounting measurement in a significant fashion. We believe this because we think it is institutionally more appropriately structured for dealing with problems facing it than was the old Accounting Principles Board (APB). The APB was originally designed by a committee that was convinced that research would produce Truth and that the only thing that would be needed after accounting research was done was a body to simply anoint the truth that had become apparent....

Accordingly, it was necessary to develop a body which will be more appropriately structured to perform the required quasi-legislative function than was the part-time APB....

There are a number of areas which deal with financial measurement where people are deeply involved, because their pocketbooks are deeply involved; and there is nothing more emotional than money: So that it seems very likely that as the new Board gets underway; those that find themselves ill at ease with its initial exposure drafts will probably bring the same kind of pressure to bear as they brought against the APB. And I don't think the fact that the members of the FASB are not current practitioners of accounting is going to shield them from this pressure to any great . . extent.

Nevertheless, I am optimistic that they will be able to move expeditiously....It is certainly the intent of SEC and the accounting staff of the SEC to work with the new [FASB] Board as we have worked with the APB. I have characterized our relationship [with FASB] as one of mutual nonsurprise where we both must advise
the other of how we are thinking and what we are doing.

Similarly, in a speech in 1959, then-SEC Chief Accountant Andrew Barr noted:

"Mr. May was an important witness in the hearings on the Securities Exchange Act of 1934. In these hearings his objections to a uniform system of accounting were developed after his opening remark that "The fact of the matter is that accounting, especially industrial accounting, is essentially a matter of judgment, and you cannot put judgment in strait-jackets."

Returning to the present time, but also on the subject of professional judgment, SEC Chief Accountant Jim Kroeker and Division of Corporation Finance Chief Accountant Wayne Carnall were asked in a press session at FEI's Current Financial Reporting Issues Conference about the status of the recommendation of SEC's Advisory Committee on Improvements in Financial Reporting (CIFiR) regarding establishment of a professional judgment framework. (See Recommendation 3.5 regarding a professional judgment framework in CIFiR's Final Report.)

Kroeker replied:
Regardless whether there is any more formal action on a judgment framework [that the points outlined by CIFiR are] the kinds of things we look for in the preclearance process [in the Office of the Chief Accountant], and in the Corp Fin comment process."

The points identified by CIFiR include, noted Kroeker, include whether the accounting transparently reflects the substance of the transaction, whether all relevant accounting literature was reviewed, and the consideration of alternative accounting treatments.

Further commentary on the subject of professional judgment was provided in two Fireside Chats sponsored by Deloitte, broadcast by the SEC Historical Society on Oct. 22, 2009 (featuring Deloitte Deputy CEO Robert J. Kueppers, and former SEC CIFiR and PCAOB SAG member Greg Jonas, moderated by USC Professor and former SEC Deputy Chief Accountant Zoe-Vonna Palmrose), and Oct. 28, 2009 (featuring Kueppers and former SEC Deputy Chief Accountant Scott Taub, moderated Georgetown Professor and former SEC Academic Fellow Patricia Fairfield). These two webcasts can be found under SECHS archived webcasts.

Also on the subject of professional judgment, I asked Prof. David Albrecht (author of blog post cited further above), if, given the increasing emphasis on principles-based accounting, (including, but not limited to, a potential move to IFRS) if accounting theory should be added as a required course for undergraduates majoring in accounting. (My perspective is no doubt influenced by the fact that Dr. David Solomons was my accounting theory professor.) Here is Albrecht's reply:

Should there be a theory class? Probably, as it could deal with broader issues of economics and/or reporting strategies. Will there be? No. Undergraduate and graduate accounting programs won't have any more free space in them than before.
And professors will not change their approach to teaching. [Note: Albrecht separately explained that many accounting professors still heavily rely on lecture-oriented classes vs. cases, with knowledge-oriented tests that promote short-term memorization, but not necessarily retention.]

It is interesting that you mention cases as a preferred tool or approach. I am an enlightened teaching professor. I don't use cases. I tend to use simulations and carefully constructed "what-if" types of problems. Most professors, however, would do a better job of teaching "principles" based financial accounting if they were to switch to cases.In the long run, I think that IFRS will turn into U.S. GAAP. Then we'll be back to where we started.

To wrap up this post on why accounting matters, I'd like to note remarks of then-SEC Chief Accountant Lynn Turner in a speech he gave in 2000, in which he said:

What people too are often saying when they argue that the FASB does not listen, is that the FASB did not give them the answer they wanted, that they did not "obey". In those cases, I challenge both the constituent and the FASB to sit back and say, does the standard faithfully represent the economics of the events and transactions being reported on, in a consistent, comparable and verifiable fashion?....

I believe that high quality accounting standards must be practical and operational, not only in the literature, but in the real world. In fact, I believe we must be able to apply a "litmus test" to each new accounting standard: that it must be operational at all levels, from the CFO, controller and accounting staff who have to implement the standards in practice, to the auditors who have to attest as to whether the company has correctly applied the standards, to enforcement bodies such as the SEC and similar securities regulators around the globe, who are charged with reviewing financial filings and judging whether such filings follow the standard.

Turner's remarks cited above, in a speech given nine years ago, continue to resonate today, as emotions run high over accounting standard-setting. If you'd like to read more on this particular subject, we've posted a few excerpts from past SEC speeches on accounting. (And the SEC website now has speeches posted going back to the 1930's.)

Thursday, November 19, 2009

FASB-Related Amendments (Perlmutter/Lucas; Garrett) Pass House Committee

As reported by Dow Jones Newswire's Sarah Lynch earlier today, U.S. House Panel Approves A Toned-Down Accounting Proposal. The article refers to the Perlmutter/Lucas amendment relating generally to the role that the proposed systemic risk council would play vis-a-vis accounting standard-setting. Separately, an amendment offered by Rep. Scott Garrett, which would require FASB to conduct a study relating to its new standards for securitization accounting, reportedly also passed the House Financial Services Committee today, as detailed further below.

'Toned-Down' Perlmutter/Lucas Amendment
DJ Newswire's Lynch notes in the article linked above:
The House Financial Services Committee agreed by voice vote to a much toned-down proposal Thursday that would allow a systemic risk council of regulators to offer advice about accounting rules that could pose problems to the broader marketplace.

'Toned-down' is an understatement. The amendment was virtually gutted from its original version (as detailed further below), moving from a complete overhaul of FASB oversight via the creation of a Federal Accounting Oversight Board that would take over oversight of FASB from the SEC, to what appears to be a one paragraph amendment (Amendment No. 58) that would add the following item to the list of duties of the Financial Services Oversight Council (the Council), established in the draft systemic risk bill (more formally, the Financial Stability Improvement Act):
To review and submit comments to the Securities and Exchange Commission and any standards setting body with respect to an existing or proposed accounting principle, standard or procedure.

Here's a recap of the history of the Perlmutter/Lucas amendment:
  • The original version of the amendment, co-sponsored by Rep. Ed Permutter (R-CO) and Rep. Frank Lucas (R-OK), as announced by Perlmutter on March 6 (a week before the House Financial Services Committee's March 12 hearing on mark-to-market accounting) would have created a Federal Accounting Oversight Board, transferring the SEC's oversight authority (vis-a-vis FASB) from the SEC to the FAOB. See Perlmutter's March 6 press release, and Lucas's March 11 press release.
  • In the weeks preceding Election Day, Perlmutter was expected to formally introduce the amendment to financial reform legislation being drafted by the House committee. See our Nov. 3 post, FASB Oversight Subject of Congressional Interest.
  • During early November, as the House committee's markup of the systemic risk bill approached, numerous individuals and organizations filed letters with the Chair and Ranking Member of the House Financial Services Committee, Rep. Barney Frank (D-MA) and Rep. Spencer Bachus (R-AL), respectively, to voice support or opposition to the Perlmutter/Lucas amendment, or any amendment more generally, that would impact the independence of accounting standard-setting.
  • Among those filing letters opposing change to independent standard-setting were SEC Chairman Mary L. Schapiro, FEI's Committee on Corporate Reporting, FEI's Committee on Private Companies - Standards, the AICPA, and a joint letter filed by the Center for Audit Quality, CFA Institute, and Council of Institutional Investors. (Links to these letters are in our Nov. 11 and Nov. 6 posts.)
  • Among those supporting the Perlmutter/Lucas amendment, as reported in this Nov. 16 Huffington Post article, included the American Bankers Association, Commercial Mortgage Securities Association, Council of Federal Home Loan Banks, Financial Services Roundtable, National Multi Housing Council, National Apartment Association, National Association of Home Builders, and Real Estate Roundtable.
  • By mid-November, as reported in the Huffington Post, the working draft of the Perlmutter/Lucas amendment had dialed back a bit, no longer calling for removal of the SEC's oversight authority over FASB, but still maintaining certain powers for the Financial Services Oversight Council, including the power to: "suspen[d], modif[y] or eliminat[e] such accounting principles, standards or procedures as they may apply to the stability of the financial system or the safety and soundness of financial companies, as a whole, for such duration as is reasonable and appropriate."
  • The one paragraph version of the Perlmutter/Lucas amendment approved for inclusion in the systemic risk bill by the House Financial Services Committee today, as noted above, makes no change to the SEC's formal oversight authority over the FASB, and provides no 'powers' to the Financial Services Oversight Council with respect to FASB.

The future of the Perlmutter/Lucas amendment depends in part on what the Senate decides (and as we noted last week, Sen. Chris Dodd (D-CT), Chair of the Senate Banking Committee, has said he sees no need to include in his bill anything relating to FASB independence; whether the final version of Perlmutter/Lucas will be adopted as part of the Senate version of the bill or not remains to be seen.)

My two cents
My two cents (I remind you of the disclaimer posted in the right margin of this blog): The long and short of it is, if indeed the sum-total of the Perlmutter/Lucas amendment as passed by the House committee today is the one paragraph amendment (Amendment No. 58) linked above (and if I'm wrong about that, I hope a commenter on this blog will point that out), then the final version of the Perlmutter/Lucas amendment as passed today appears to me to be pretty much motherhood and apple pie, since FASB and the IASB actively seek input from all of their constituents, financial regulators and otherwise, and the amendment calls for the systemic risk council to provide input to FASB and the SEC on accounting rules.

As noted in a Nov. 18 letter by the Financial Services Roundtable , the FSR supported the 'revised' (i.e. one paragraph) Perlmutter/Lucas amendment, because it: "leaves the current structure at the SEC in place, but provides a much-needed review if accounting principles threaten the safety and soundness of the economy."

By putting this duty for financial regulators to review and comment on FASB standards into law, it may make some people nervous, (perhaps having the provision written into law 'raises the bar' so to speak) but I believe the scaled down version of the amendment (i.e. the one paragraph version passed today) may be looked upon as a significant improvement by some, vs. the earlier, more draconian versions of the amendment which would have directly impacted FASB oversight by removing it from the SEC and placing it with a new board.

NOTE: Still to come: reconciliation of the Perlmutter/Lucas amendment in this systemic risk bill, with the Miller amendment (amendment No. 13) passed earlier by the House committee as part of the Investor Protection Act; the Miller amendment would form a Financial Reporting Forum (tasked with "meet[ing] to discuss immediate and long-term issues critical to financial reporting) - not unlike the FRF proposed by the SEC Advisory Committee on Improvements to Financial Reporting (CIFiR) - except that Miller proposes that the banking regulators be part of the FRF too, and as proposed by Miller, would require the FRF to issue an annual report, including any legislative recommendations.

In addition, I believe that the wording as agreed to today in the one-paragraph Perlmutter/Lucas amendment may transcend some of the earlier debate over whether or not accounting standard setters need to be concerned about the economic impact of their standards, including, potentially, procyclicality or systemic risk per se, or whether systemic risk is solely within the realm of government regulators.

On this point, see Prof. David Albrecht's post today in his blog, The Summa. Albrecht says: "As I blogged yesterday, it is a fact of life that accounting standards frequently have economic consequences. It is government’s responsibility to adjudicate between competing economic interests." (I may have more to say about Albrecht's posts in a future blog post as well.)

Similarly, I don't think the role of systemic risk considerations vis-a-vis investor considerations is as much an all-or-nothing issue as some may have seemingly portrayed it, particularly since the debate that takes place in standard-setting usually isn't over an extreme dichotomy like systemic risk vs. investor transparency, but over more nuanced - 'conceptual,' the standard-setters and their groupies (I place myself in the groupie category) would call it - issues, like breaking down the relevance, reliability, and understandability of particular accounting standards, principles or rules.

Reasonable people can, and do, disagree over what the most relevant or reliable information is, and how to balance those two sometimes competing needs (and other competing needs as well, including theoretical vs. practical, cost vs. benefit). Therefore, to have an all-consuming focus on whether standard-setting can straddle both systemic risk and investor protection considerations, to me, in some respects, is a red herring, like the old Miller Lite Tastes Great! Less Filling! debate.

The fundamental technical questions involved in developing accounting standards that result in information that is relevant and reliable are extremely challenging and perhaps less accessible to the general public than hyped debate pitting overarching issues of systemic risk considerations against investor transparency considerations (case in point: Huff Post's Civil War in Corporate America) but hopefully things will soon return to normal and folks can work together on the shared goal of high quality standard-setting and high quality financial reporting.

Garrett Amendment Requires FASB To Issue Study on FAS 166, 167
Separately, an amendment introduced by Rep. Scott Garrett (R-NJ) (see Garrett's Nov. 18 press release) relating to FAS 166 and FAS 167 (which amended FAS 140 and FIN 46R, removing the exception from off-balance sheet treatment for QSPEs, and changing the related consolidation rules for securitizations and asset sales) was also passed by the House Financial Services Committee, according to a Nov. 19 press release issued by the Commercial Mortgage Securities Association. As described in Garrett's press release:
This amendment would require the Financial Accounting Standards Board (FASB) to conduct a study of the combined impact by each individual asset-backed security of the new credit risk retention requirements contained in the bill and the new securitization accounting rules (FAS 166 and 167) and make statutory and regulatory recommendations for eliminating any negative impacts on the continued viability of the asset-backed securitization markets and on the availability of credit for new lending. This study would be required to be completed in 90 days and in coordination and consultation with the Office of the Comptroller of the Currency (OCC), Office of Thrift Supervision (OTS), Federal Deposit Insurance Corporation (FDIC) and the Securities and Exchange Commission (SEC).
Given that FAS 166 and FAS 167 are set to take effect on 1/1/10, there may be questions as to how feasible a study taking place over 90 days crossing year-end would be, and what any practical implications of such a study would be, combined with the fact that the Senate has not completed its markup of its version of the financial regulatory reform package, and the ultimate version that will be signed into law is not yet known. Stay tuned.

SEC Commissioner Casey's Keynote Address At FEI CFRI, Additional Conf. Highlights Posted

The closing keynote address provided by SEC Commissioner Kathleen Casey at FEI's Current Financial Reporting Issues Conference on Nov. 17 has been posted by the SEC here and is also currently posted as headline 1 on FEI's website, (Direct link to speech here.) Additional highlights from the FEI CFRI conference, by Ellen M. Heffes, Editor-in-Chief, Financial Executive Magazine, can be found here.

Tuesday, November 17, 2009

Wayne's World: Carnall Tells FEI Conf. What's In Store From Corp Fin

If you remember the old 'SEC Regs' Committee of the AICPA (now called the 'CAQ Regs' Committee, under the aegis of AICPA-affiliate, the Center for Audit Quality) you may have heard of it referred to as one of the so-called 'secret societies' in accounting. Based on remarks of SEC Division of Corp Fin Chief Accountant Wayne Carnall at an FEI conference earlier today, the SEC Regs/CAQ Reg's quarter-century-old vault is about to be opened - or rather, made more readily available, on the SEC's website, as part of an update to Corp Fin's Financial Reporting Manual.

Guidance From SEC Regs/CAQ Regs Committee To Be Incorp Into Corp Fin Fin. Reporting Manual
The term 'secret society' is a tongue-in-cheek reference to groups of experts that meet with SEC or FASB staff privately on complex issues, and a kind of mythology grows around such groups, since there is sometimes a black box aspect to the unofficial, quasi-official, or nonauthoritative guidance that is said to have arisen from such meetings.

References to 'secret societies' can be found in transcripts of two meetings of the SEC Advisory Committee on Smaller Public Companies, June 15, 2005, (in a discussion about arcane accounting rules, and the need for guidance, such as FAQs, particularly for smaller public companies) and Feb. 21, 2006 (during a discussion about 'speech GAAP,' or setting Generally Accepted Accounting Principles through speeches by SEC staff, which are not subject to FASB due process, or to SEC due process under the Administrative Procedures Act).

As an aside, SEC Chief Accountant Jim Kroeker also made a reference to 'secret societies' in his remarks at the FEI conference. Referring to FASB's Codification, issued on July 1, which brought all U.S. GAAP into one place, organized by topic, he said, "You don't have to be a member of a secret society" any more to locate guidance on a particular issue.

Carnall explained that the Corp Fin Financial Reporting Manual - written by Corp Fin staff, for Corp Fin staff, which "reflects our views on reporting issues" and "provides guidance for complying with the rules" - and was originally available only through FOIA requests until the SEC decided to make it available on, was updated for the first time in nine years a year ago. He added the Division is committed to updating it quarterly, with the next update coming in December.

With respect to updating the Manual regarding material included in SEC Regs Committee/CAQ Regs Committee minutes, Carnall said:

We meet frequently with the CAQ Regs committee; we have been meeting with them close to forever - they put [minutes] of the meetings on their website. You can have an issue dating back to a meeting in 1995, and have no idea SEC staff expressed a view on it [at a meeting with the SEC Regs/CAQ Regs committee].

We are going through the past 25 years and looking at which information is still relevant, and putting it in the [Corp Fin] Financial Reporting Manual.

There are about 780 or so distinct issues [in the SEC Regs/CAQ Regs committee material] we hope to have done some time in the spring or summer, which means by September [2010].

Coming Soon: Clarification Re: Non-GAAP Disclosures

Carnall also told attendees at the FEI conference (FEI's 28th annual Current Financial Reporting Issues Conference) that Corp Fin plans to issue something "in the near future" regarding non-GAAP disclosures. Specifically, he said:

We are looking at some guidance we have issued, FAQs, other guidance, to determine if we should modify some of our guidance to make more clear what our expectations are - you should look for that in the near future.

During a Q&A session later in the day, he added:

What we have found... a little concerning to myself and our new Division Director [Meredith Cross], we find information on a company website, [but] not in [the company's SEC] filings.

There are very limited situations where we have prohibitions [on certain non-GAAP information] - we are looking at ways we have worded our interpretations.

The overall objective is for the 10-K to be an information document, not a compliance document.

Kroeker added the requirements are, in general:

If you are using [non-GAAP disclosures], explain why they are important, and reconcile to GAAP.

During a session with the press at the conference, Carnall expanded on the reasons why the SEC staff want to issue clarifications in the area of non-GAAP disclosure. He said:

The rule is fine, we have issued FAQs, and [guidance is contained in] the Financial Reporting Manual, but there is a concern that perhaps the way we have worded them has perhaps been more restrictive than intended. People would like to provide more information, and are concerned [whether they are permitted to, based on the current guidance].... [staff is considering] whether to modify that [guidance] to make it more clear what our intent is.

Arnold Hanish, Chairman of FEI's Committee on Corporate Reporting, serving as moderator of the Q&A session with FASB and SEC staff at the conference, said: "It has been brought to my attention a recent Enforcement action was around Reg G, about inappropriate inclusion or exclusion of certain operating expenses."

Although no recent case was specified by name, Carnall referenced an earlier case, noting: "There have been a couple of Enforcement cases involving non-GAAP, the first one, Trump Casinos, highlighted unusual losses but did not highlight [unusual gains]. Rule 12b-20 of the Exchange Act [says] you cannot have a material omission."

In general, he noted, issues with non-GAAP disclosures include whether the disclosure is simply wrong, and cautioned that you 'have to tell the whole story.'

Other Areas of Focus

Carnall noted some areas of focus in Corp Fin filing reviews - noting this is not an all-inclusive list, include impairment of goodwill, income taxes, valuation allownances, APB 23/undistributed earnings, liquidity, going concern, pension assumptions, segments, and other-than-temporary-impairment (OTTI).

Another subject of Carnall's remarks was Materiality. Specifically, he said:

In preparing support why an error is not material, companies take the 8 points in SAB 99 and say 'No' ... concluding the error is not material. Companies should provide company-specific information, go well beyond the 8 bullet points [to demonstrate why an error is not material].

There's More
Kroeker reviewed various SEC rulemaking and policy initiatives, and SEC Commissioner Kathleen Casey gave the closing address at the FEI conference. (If her remarks are posted on the SEC website we will provide a link here or in a separate blog post.)

A great deal of timely information was provided at the two-day FEI Current Financial Reporting Issues Conference; you can get a flavor of a few selected highlights through our blog posts this week, and through reporting by others in attendance from the press, including the WSJ, Bloomberg, BNA, Thomson-Reuters,, Compliance Week, WebCPA, AccountingToday, Re: The Auditors, and more, but nothing compares - in terms of the quantity and quality of the experience - to being there in person. Visit FEI's website, to learn more about FEI and our upcoming events. If you join FEI by Dec. 31 as part of our Connection Through Association Campaign, you will receive complimentary registration to attend our Summit conference in Las Vegas in the spring.

Monday, November 16, 2009

Both Cost And Fair Value May Be Presented Or Disclosed, As FASB, IASB Proceed On Convergence; LIFO on IRS' List of Convergence Issues

At day one of FEI's Current Financial Reporting Issues Conference, FASB Technical Director Russell Golden noted that as FASB and the IASB work toward reconciling differences in their financial instruments projects with the hope of arriving at a converged solution, fair value and amortized cost may both end up being displayed in the financial statements or disclosed. Specifically, Golden said:
It might mean both numbers - [amortized] cost and fair value, are relevant, and will be presented, or it may be that both pieces of information are provided through disclosure, so both pieces of information are available to investors.
During a Q&A session with press that followed, IASB Board Member Patrick Finnegan said:
In the process of setting standards on a global basis, in my view, one measurement attribute cannot have primacy over the other. If you measure using historical cost, others feel fair value is more useful; [you] shouldn't have to go hunting for it, it shouldn't be buried.
FASB Chairman Robert Herz added the following significant observation about standard-setting, in response to a question raised in the press session by Michael Rapaport of
In standard-setting, you never know where you're going til you get there; the process is important - you learn a lot of things.
Finnegan concurred with Herz' observation later in the session.

In addition, Finnegan distinguished between the perception of volatility, and actual volatility, nothing: "Anything that creates the perception of volatility is unhelpful," but when it comes to actual volatility, those who argue to provide only historical cost information, "therein lies the flaw, if we suppress information in the financial statements, that we [could] somehow hold off [a financial crisis]."

Audit Firms and Convergence
Herz was asked by Francine McKenna of Re: The Auditors what he thought about the major audit firms' push for companies to move to IFRS, and how to respond to critics who may say, 'If the firms are for it [IFRS, etc.] then we probably should be against it."

Herz replied:
I think the firms are genuine in their belief [of the value of convergence] but I think they kind of rushed it... and everyone said, 'here's another [Sarbanes-Oxley] 404.' I told some of the [audit firm] leaders that ultimately, [the goal is] high quality convergence, not just [convergence] for the sake of convergence."
I'm sure Francine will include more details on this exchange in her blog, , including her unique perspective on some other highlights from the conference.

LIFO and Convergence
Another key question raised during the general session with respect to convergence related to the fact that IFRS precludes LIFO, and at the same time, the IRS in the U.S. says that the same inventory valuation procedure must be used for book and tax; therefore, if U.S. co's were to move to IFRS, they would (i.e., if no further action were taken by the IASB or the IRS, and if the SEC were to permit or mandate a move to IFRS, or if private co's were to elect to adopt IFRS or IFRS for SMEs) presumably not be permitted to use LIFO for tax purposes any longer, if they could not use it for book purposes under IFRS.

Finnegan noted that at last week's SAC (IASB Standards Advisory Council) meeting, the issue was not raised when the SAC discussed post-2011 agenda issues.

Herz indicated the LIFO issue has come up in FASB discussions with the IRS. Specifically, he said:
We meet periodically with the IRS; they have catalogued a fairly lengthy list of things that would be handled [administratively or though legislation, relating to any potential move to IFRS]; other countries do have forms of tax deductions [related to investory], there may be other ways to skin that cat; [including] if they think of some kind of phase in.
We will have other blog posts with highlights from day 1 (today) and day 2 (tomorrow) of FEI's CFRI conference. You can also follow us on twitter at, and read other's commentary on twitter posted using #feicfri.

May Be A 'Silver Lining' to Current Non-Endorsement of IFRS 9 By European Commission, IASB Board Member Says

In remarks at FEI's 28th annual Current Financial Reporting Issues (CFRI) conference earlier today, International Accounting Standards Board member Patrick Finnegan noted that the IASB's issuance of IFRS 9 (Financial Instruments) last week was met by non-endorsement by the European Commission.

According to a separate report by Duncan Wood Nov. 13 in, entitled Confusion Reigns as Europe Fails To Endorse IASB Standard, an unnamed partner at a Big Four audit firm who participated in meetings with the European Financial Reporting Advisory Group (EFRAG) - formally tasked by the EC in 2006 with "provid[ing] advice to the [European] Commission on all issues relating to the application of IFRS in the EU" - said of EFRAG's recommendation to withhold endorsement of IFRS 9: "I assume the IASB will be very unhappy."

Silver Lining
Finnegan told the FEI conference that in his view:
"If there is a silver lining [to the lack of European Commission endorsement of IFRS 9], it is that it will allow us to finish our work under the [valuable] and deliberate process with the FASB."

Finnegan was referring to the fact that the two boards had been working under different timetables to complete their versions of improved Financial Instruments standards, although the boards are aiming to reach a converged standard in this area, along with completing other major convergence projects, by June, 2011, the date reaffirmed in the Nov. 5 IASB-FASB joint statement.

The IASB had been under pressure separately from various authorities, including the G-20, to complete the first phase of its financial instruments project by the end of 2009 (resulting in issuance of IFRS 9, focusing on classification and measurement of financial instruments, on Nov. 12.)

As reported by Wood in
[EFRAG] has promised to revisit endorsement in January, but opinions are split on whether that will happen, with some observers believing the EC would prefer to wait until the second and third phases of the reform have been published. The latter course of action would massively delay a process that European politicians had previously trumpeted as one of extreme urgency. The second phase of the reform, dealing with loan loss accounting, was published last week and the comment period does not close until June, 2010.

In light of presssure directed at the IASB as noted above, they split their project to amend their Financial Instruments standard (IAS 39) in three phases. As previously reported, the IASB recently released for public comment an Exposure Draft of its proposed standard on Financial Instruments: Amortized Cost and Impairment (with comments due June 30, 2010.). The third phase will include the release of an Exposure Draft on Financial Instruments: Hedge Accounting.

In contrast, FASB has been proceeding with a unified approach to amending its Financial Instruments standard(s) - and as noted by FASB Technical Director Russell Golden at the FEI conference today - FASB expects to release an Exposure Draft on Financial Instruments for public comment (addressing measurement, recognition, impairment and hedging) early 1Q2010.

Golden explained that part of the reason the IASB and FASB boards decided to begin holding monthly joint board meetings (by videoconference or in person; previously, the boards met jointly 2-3 times a year)was, in part, to try to avoid 'leap-frogging' wherein one board is working separately on a different phase of a project than the other.

Now, said Golden, "We have asked the leading board [on a particular project] to reconsider, rethink conclusions based on what the other board has done, so they can proceed together." This move to pace convergence projects in tandem, vs. leapfrogging, will apply to convergence projects generally, not only on financial instruments. On the financial instruments project specifically, Golden said, "We may need to make some changes to FAS 157 (Fair Value Measurement), or the IASB may need to make changes," as some differences between the two approaches are significant.

We will have separate blog posts today providing additional highlights from the FEI CFRI conference, including on the subject of convergence and more. Follow the FEI blog on Twitter at; read other's commentary on the conference (and add your own) by following/using hastag #feicfri.

Thursday, November 12, 2009

IASB Releases IFRS 9-Financial Instruments (Completes 1st Phase of Project: Classification & Measurement)

Earlier today, the IASB released IFRS 9, Financial Instruments. As noted in IASB's press release, IASB is engaged in a three-phase project to replace its existing standard, IAS 39, Financial Instruments, Recognition and Measurement, with a new standard, IFRS 9, Financial Instruments. The three phases and related due process documents are listed below.
  1. Final standard, IFRS 9, Financial Instruments, issued today represents completion of the first phase of the project, focusing on Classification and Measurement of Financial Instruments. The press release notes: "The new standard enhances the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity – an objective endorsed by the Group of 20 leaders (G20) and other stakeholders internationally. IFRS 9 uses a single approach to determine whether a financial asset is measured at amortised cost or fair value, replacing the many different rules in IAS 39. The approach in IFRS 9 is based on how an entity manages its financial instruments (its business model) and the contractual cash flow characteristics of the financial assets. The new standard also requires a single impairment method to be used, replacing the many different impairment methods in IAS 39. Thus IFRS 9 improves comparability and makes financial statements easier to understand for investors and other users. Regarding liabilities, the press release notes: "the IASB decided not to finalise requirements for financial liabilities in IFRS 9 [and] expects to issue final requirements [regarding financial liabilities] during 2010."
  2. Exposure Draft issued last week on the second phase of the project: Financial Instruments: Amortized Cost and Impairment. The comment deadline on the Exposure Draft is June 30, 2010.
  3. Upcoming proposals on Financial Instruments: Hedge Accounting continue to be developed.

Archived IASB Webcast on IFRS 9
A live webcast was convened by the IASB at two separate times earlier today (11am GMT and 2pm GMT) at which questions were taken from the audience. Opening each webcast, IASB Communications Advisor Sonja Horn noted that over 1,000 people were registered for each webcast. Horn introduced Gavin Francis, Director, Capital Markets, IASB and Sue Horn, Senior Technical Consultant, IASB who walked listeners through a slide deck summarizing IFRS 9 and responded to questions from the audience. The archived webcasts have already been posted on the IASB website; (the a.m. webcast begins at approx. 16 minutes into the tape, and the p.m. webcast begins at approx. 17 minutes into the tape). Each webcast lasts approximately 45 minutes (including the Q&A) and the slides summarizing IFRS 9 can be downloaded from the webcast link. Additional information about IFRS 9 can be found on the IASB's Financial Instruments Project Page

FASB Financial Instruments Proposals Expected 1Q2010
As noted in the IASB-FASB joint statement issued on Nov. 5 reaffirming the boards' commitment to convergence by June, 2011, the discussion of progress by IASB and FASB on their respective financial instruments projects notes: "FASB has been developing proposals to replace the equivalent requirements in US GAAP, which it plans to publish for public comment in the first quarter of 2010." The joint statement details how the boards plan to address convergence issues, given that the IASB's three phase approach vs. FASB's unified approach to addressing the financial instruments project.

Learn More
Learn more about current FASB, IASB and SEC developments at FEI's 28th Annual Current Financial Reporting Issues (CFRI) conference taking place on Mon. Nov. 16-Tues. Nov. 17 at the New York Marriott Marquis in NYC. We strongly encourage you to register in advance, but on-site registration is also available. Featured speakers include FASB Chairman Robert Herz, IASB Board Member Patrick Finnegan, SEC Commissioner Kathleen Casey, SEC Chief Accountant Jim Kroeker, SEC Div. of Corp Fin Chief Accountant Wayne Carnall, and other experts.

Separately, FEI's Hall of Fame (sold out) will take place Monday evening, Nov. 16 in NYC, honoring this year's inductees to the Hall of Fame: Dennis Dammerman and Don Nicolaisen.

Also next week: FEI's IFRS Boot Camp, Wed. Nov. 18 in NYC, sponsored by Deloitte. Sign up for this one-day workshop, designed to provide financial executives with practical information, cost-effective approaches, and an overview of time-saving tools for addressing IFRS assessments and conversions in their organizations

If you're betting on a transition to IFRS, consider signing up for the 2-day IFRS Conference Dec. 2-3 in Las Vegas, offered by Executive Enterprises Institute, presented in conjunction with FEI.

Wednesday, November 11, 2009

Update On Congressional Consideration Re: FASB

Updating our post last week, FEI Committee on Corporate Reporting (CCR), SEC Chairman, Others Write Congress on Standard-Setting, earlier today, FEI's Committee on Private Companies - Standards Committee (CPC-S) submitted its own letter to Congress (see FEI CPC-S letter) on potential amendments reportedly under consideration by some members of Congress that could impact the independence of the Financial Accounting Standards Board.

The FEI CCR letter filed on Nov. 5, signed by CCR chair Arnold Hanish, stated: "CCR is concerned with recent proposals that would place accounting standards oversight under the jurisdiction of a new oversight board. Acting on such proposals to realign oversight of the Financial Accounting Standards Board (FASB), could change the objectives of financial reporting, harm U.S. capital formation, and potentially politicize the process of setting accounting standards....We urge you to reject any efforts to place accounting standard setting under a new oversight board and continue to support independent accounting standard setting in the United States."

The FEI CPC-S letter filed on Nov. 11, signed by CPC-S Chairman William Koch, stated: "We would like to express our support for the recent letter sent by [FEI CCR] and concur that accounting standard setting should remain in the private sector, by an independent accounting standard setter. Additionally, we would like to expand on CCR's points to reflect the unique observations of privately-held companies."

We noted in our post last week that a number of professional associations have filed letters with Congress against any change to FASB oversight or any tying of systemic risk considerations to the accounting standard-setting process, but an alternate view is held by the American Bankers Association as shown in their testimony at a Congressional hearing last month, linked in our Nov. 6 post.

A more colorful (and perhaps, oversimplified) description of the situation can be found in an article by Ryan Grim appearing in the Nov. 6 edition of the Huffington Post, entitled, Civil War in Corporate America: Banks Battling the Chamber on Accounting Rules. In defense of the Huffington Post, however, they do have access to information like the language of the potential amendment which Rep. Perlmutter (D-CO) was said to be considering offering as an amendment to Section 1103 of the House Financial Services Committee's discussion draft of its systemic risk bill. The Huffington Post said they confirmed with Congressional staff the language of the amendment, and the language was consistent with that circulated by the AICPA last week, along with the AICPA's comment letter to Congress arguing against the amendment. In addition, the Huffington Post posted a copy of SEC Chairman Mary L. Schapiro's letter to Rep. Frank; we had cited some excerpts of that letter in our post last week, based on reporting in BNA.

Yesterday, Sen. Chris Dodd (D-CT), Chairman of the Senate Banking Committee, commented on this issue during the Q&A that followed his press conference announcing the release of the Senate Banking Committee's Discussion Draft of the Financial Reform Bill. Asked by a member of the press whether the Senate bill contains any provision to move FASB oversight to a systemic risk council, Dodd responded:

We didn't do that in this bill. We modified FASB back a few years ago, because for years I've resisted, at various times, there's been efforts to Congressionally decide accounting standards; and just as I don't want - and I say this respectfully of our institution in which I serve - having the Congress decide Federal Reserve policy, setting accounting standards is precarious, so we have strengthened FASB to be far more independent; I'm satisfied how that works today.

You can watch a clip of Dodd's comment on YouTube here.

The House is in recess this week, and will continue with its markup of the systemic risk reform bill when it returns next week.

Links to the Senate Banking Committee's Discussion draft, press release, and summary of the Senate Banking Committee's Financial Reform bill can be found in Broc Romanek's post today in The Corporate blog.

See also: Jack Ciesielski's post earlier this week on: An Accounting Vortex, and the related post by Bill Sheridan today in the Maryland Association of CPA's Blog, CPA Success.

Hinchman Appointed FAF Director of External Relations & Communications
In other news, the Financial Accounting Foundation (FAF) - parent of the FASB and GASB, announced earlier today the appointment of Grace L. Hinchman to the position of Vice President, External Relations & Communications. Hinchman formerly served as Senior Vice President, Public Affairs and Technical Activities, at FEI. According to the FAF press release, Hinchman will be based in Washington, D.C.

Separately, the FAF announced earlier this week that the upcoming Nov. 17 FAF meeting will take place in Washington DC instead of at FAF/FASB HQ in Norwalk, CT, and the entire meeting will be closed to the public.

I wonder (and I remind you of the disclaimer on the right side of this blog ) with the FAF meeting moving to DC next week, could there be a Beer Summit in FASB's future? And who else would be on the invite list? (See, e.g.: Obama Convenes Beer Summit, by Michael O'Brien, The, 7/30/09.) More seriously...if you'd like to hear the latest news on FASB, SEC, IASB developments, join us at FEI's Current Financial Reporting (CFRI) conference in NYC next week. And follow @feiblog on Twitter for upcoming news about a tweetup Monday night.

Friday, November 6, 2009

FEI Committee on Corporate Reporting (CCR), SEC Chairman, Others Write Congress On Standard-Setting

On Nov. 5, 2009 FEI's Committee on Corporate Reporting (CCR) submitted a letter to Rep. Barney Frank and Rep. Spencer Bachus, Chair and Ranking Member, respectively of the House Financial Services Committee. The FEI CCR letter noted: "concer[n] with recent proposals that would place accounting standards oversight under the jurisdiction of a new oversight board."

One such proposal that could impact oversight of accounting standard setting is HR 1349, sponsored by Rep. Ed Perlmutter (D-CO). HR 1349 would amend the Securities Act of 1933 to remove the SEC's oversight role over FASB, and assign that oversight role instead to a Federal Accounting Oversight Board, consisting of the banking regulators, Chairman of the SEC and Chairman of the PCAOB.

As reported earlier this week, Rep. Perlmutter may offer an amendment on the Financial Stability Improvement Act (the bill relating to systemic risk regulation, to be reported as H.R. 3996) to incorporate language from HR 1349.

Following are additional points in the FEI CCR letter:
  • Acting on such proposals to realign oversight of the Financial Accounting Standards Board (FASB), could change the objectives of financial reporting, harm U.S. capital formation, and potentially politicize the process of setting accounting standards.
  • We respectfully request that accounting standards oversight should remain under the jurisdiction of the U.S. Securities and Exchange Commission, which is responsible for fair, objective, and transparent reporting for those who invest in our public companies.
  • We urge you to reject any efforts to place accounting standard setting under a new oversight board and continue to support independent accounting standard setting in the United States.
SEC Chairman States Views
SEC Chairman Mary L. Schapiro sent a letter to Rep. Frank and Rep. Bachus yesterday, reports Steve Burkholder of BNA, in his article entitled SEC Chief Schapiro Cautions Lawmakers on Proposals to Widen Oversight of FASB, Here are some highlights from Burkholder's article:
  • The chairman of the Securities and Exchange Commission is warning key congressional lawmakers at work on financial regulatory reform that efforts to change oversight of accounting standard-setting could harm the capital markets by undercutting investors' trust in financial reporting and diluting the mission of the rulemakers.
  • In sternly worded letters dated Nov. 5, Mary Schapiro wrote to the chairman and ranking minority member of the House Financial Services Committee to state that she is “deeply concerned about the possible consequences” of the potential changes.
  • ‘‘It is critical that Congress preserve the independence” of bodies such as the Financial Accounting Standards Board, Schapiro wrote ...[adding]..."[W]hile active engagement and dialogue with a broad spectrum of interested parties improves accounting standards, diluting the mission of the standard-setters does not,” the SEC chairman continued. “Accounting should be about accounting, and not about anything else.”

CII/CAQ/Chamber Letter
As previously reported, other groups that have filed letters against formation of an FAOB include a joint letter of the Council of Institutional Investors, Center for Audit Quality, and U.S. Chamber of Commerce. See, e.g. CAQ Wants Congress to Preserve SEC Oversight of FASB ( . Here are some highlights from the CII/CAQ/Chamber letter:

  • In adopting the Sarbanes-Oxley Act of 2002, Congress recognized the benefits of having
    accounting standards set by an independent body and established a process for the establishment and oversight of financial reporting policy. In doing so, Congress designated the Securities and Exchange Commission (SEC) as the primary agency with oversight over accounting standard setting, given the important role accounting standards play in the Commission’s mission to protect investors, maintain fair, orderly and efficient markets, and facilitate capital formation.
  • By placing the FASB under the jurisdiction of a structure charged with managing systemic risks to the financial markets, accounting rules will be viewed though the narrow lens of a few large companies from specific industries, rather than considerate of the applicability of financial reporting policies to over 15,000 public companies.
  • Procedure, appropriate oversight and independence are important to ensure the legitimacy of the standards-setting process, and to protect the goals of transparency, relevance, and usefulness in financial reporting that are critical to the success of the U.S. capital markets.
American Bankers Association Testimony
Another point of view is held by the American Bankers Association, which shared its views on this matter within broader testimony at an Oct. 29 hearing of the House Financial Services Committee. Following are some highlights from ABA President Edward Yingling's testimony:
  • A Systemic Risk Oversight Council could not possibly do its job if does not have oversight authority over accounting rulemaking. This is a major deficiency in the draft legislation.
  • The Financial Accounting Standards Board (FASB) should continue to function as it does today, but it should no longer report only to the Securities and Exchange Commission (SEC). The SEC’s view is simply too narrow.
  • Accounting policies contributed to the crisis, as has now been well documented, and yet the SEC is not charged with considering systemic and structural effects. Moving oversight to the systemic risk council, which includes the SEC, will address this problem.
  • Accounting policy is arcane and difficult, but it was a critical factor in turning a bubble and a recession into a full-fledged panic. If Congress does not address this issue as part of reform, it will not have addressed one of the significant causes of the problems .
Mark-up Continues Today
As shown here, the House Financial Services Committee was slated to continue its markup of the systemic risk bill beginning at 1pm today.

Thursday, November 5, 2009

FASB, IASB Reaffirm Convergence By June, 2011

Earlier today, FASB and the IASB announced the release of a 23-page joint statement which reaffirms their commitment to improve IFRS and U.S. GAAP, and to bring about their convergence through completion of the major convergence projects outlined in the FASB-IASB Memorandum of Understanding by June, 2011. The joint statement outlines plans and milestone targets that will guide completion of the major projects by the June, 2011 target date. The major convergence projects include:
  • Financial Instruments
  • Consolidations
  • Derecognition
  • Fair Value Measurement
  • Revenue Recognition
  • Leases
  • Financial Instruments with the Characteristics of Equity
  • Financial Statement Presentation
  • Other MoU Projects
  • Other Joint Projects

Strive to Align Project Timetables
In response to concerns voiced about 'leapfrogging' - i.e. when one of the two boards gets ahead of the other on a joint convergence project- the joint statement notes:

We will strive to avoid creating timeline differences like those that have complicated our efforts to improve and align standards for financial instruments and other areas. If such differences do arise, we will work together to eliminate differences between standards as soon as practicable by drawing stakeholders’ attention to each others’ proposals and reviewing our own requirements with a view to addressing differences on a timely basis.

In addition, the joint statement expresses the boards' commitment to: "Fundamental first principles about the purposes of accounting standards and the process by which the standards are determined, as set out in the statement of the Monitoring Board of the International Accounting Standards Committee Foundation, issued on 22 September 2009."

"Single Set," "Common" Set of Standards
It is interesting to note that the FASB-IASB joint statement speaks in some places of converging to a 'single' set of standards, and in other places of converging to a 'common' set of standards. To some, these terms can mean a world of difference. However, the terms are often used interchangably by many different parties. For example, here are some excerpts from the joint statement:

We are redoubling our efforts to achieve a single set of high quality standards within the context of our respective independent standard-setting processes.

Our goal is to develop together common standards that improve financial reporting in the US and internationally and that foster global comparability. Achieving such improvements is consistent with the objectives of the IASB that are set out in the Constitution of the IASC Foundation. It also fulfils the responsibility the FASB has under US law and the Securities and Exchange Commission’s 2003 Policy Statement to consider, in developing standards, whether international convergence is necessary and appropriate in the public interest and investor protection.

Presumably, once a set of 'common standards' is acheived, the next step would be to officially adopt one set (again, presumably, IFRS, which is used in over 100 countries) as the 'single' global standard. FASB Chairman Robert Herz said as much in remarks at various conferences and Congressional hearings in 2007 and 2008. For example, in testimony before the Senate Banking Committee, Securities Subcommittee, in October, 2007, Herz said:

[W]e agree with the Securities and Exchange Commission that a widely used single set of high quality international accounting standards for listed companies would benefit the global capital markets and investors. The ultimate goal, we believe, is a common, high-quality global financial reporting system that can be used for decision-making purposes across the capital markets of the world.

However, achieving the ideal system requires improvements and convergence in various elements of the infrastructure supporting the international capital markets, including a single set of common, high-quality accounting standards, a well-funded, global standard-setting organization, and a global interpretive body to handle guidance and implementation issues.

Improvements are also needed in disclosure requirements; regulatory, enforcement and corporate governance regimes; auditing standards and practices; and education of capital market participants.

Herz first acknowledged that the likely, ultimate 'single' set of accounting standards would one day be an improved version of IFRS, in remarks he gave at an FEI Global Convergence Conference in Sept., 2007, as noted by Marie Leone of in Sweeping Away GAAP, 9.28.07.

For some interesting reading on the practical aspects of convergence, see Convergence Doesn't Necessarily Mean the Same, also by Leone, published Nov. 5 in, in which she quotes D.J. Gannon of Deloitte and other experts.

Relevant, Transparent, Neutral and Comparable
Appendix B of the joint statement, Shared Goals, Values and Principles, will likely be very significant, taking on perhaps an almost equal role to the Conceptual Framework of the two boards.

The phrase 'relevant, transparent, neutral and comparable' is emphasized, in the context that:

[I]t is critically important to achieve high-quality, globally converged financial reporting standards that provide relevant, transparent, neutral, and comparable financial information, regardless of the geographical location of the entity.

High-quality accounting standards are those that foster the provision of relevant, transparent, neutral, and comparable financial information.

Some may view the only critical missing factor in that list of four factors as 'reliability,' although the decreasing emphasis on 'reliability' in favor of 'transparency' and 'relevance' has been happening for some time now in the boards' proposals to amend the conceptual framework.

FASB's Mission Statement (as described in the April 2009 edition of Facts About FASB) continues to emphasize relevance and reliability:

To accomplish its mission, FASB acts to [i]mprove the usefulness of financial reporting by focusing on the primary characteristics of relevance and reliability and on the qualities of comparability and consistency.

My two cents (I remind you of the disclaimer which appears in the right margin of this blog): The tipping of the scales with what some may perceive as more weight on relevance than reliability within the emerging revised conceptual framework, and statement of goals in today's joint statement, reflects the view of some that information about what an asset is worth today, based on what a market participant or third party would say, is more important to investors (i.e. more 'relevant') than a value based on some other valuation methodolog(ies), which may be more reliable. (Keep in mind, third party information for a nonliquid financial instrument, or a formerly liquid instrument in a disorderly or inactive market, can, in theory, be a quote from a broker who is giving a reference price, but may not necessarily actually want to buy and hold the item.) Caught in the middle, however, are preparers and auditors (not to mention members of the boards' of directors) who have legal liability for the information provided in financial reports, who may prefer keeping the historic balance between relevance and reliablity.

One Paragraph Statement By SEC Chairman
A one paragraph statement was issued by SEC Chairman Mary L. Schapiro, in recognition of the FASB-IASB joint statement, in which she said:

I am greatly encouraged by the commitment of the IASB and the FASB to provide greater transparency to the standard setting process and their convergence efforts. I believe that these efforts will result in improved financial information provided to investors.

Although brief, Schapiro's statement may help pave the way for the SEC to, as Schapiro said at a conference in September: "... speak a little later this fall about what our expectations are with respect to IFRS."

UPDATE: Regarding the status of the SEC's proposed IFRS Roadmap, Reuters' Emily Chasan reports that at a New York State Society of CPAs conference on Nov. 5, SEC Deputy Chief Accountant Julie Erhardt explained that, while commenters on the roadmap generally concurred on moving to a single set of accounting standards, there was no one clear view on how to get there. Read more in Chasan's article, Lack of Accounting Rules Consensus Vexes SEC.

G-20 Finance Ministers Meet This Week
The issuance of the joint statement by IASB and FASB, noting support of the G-20 - specifically, the G-20 Progress Report issued on Sept. 25, which "call[s] on our international accounting bodies to redouble their efforts to achieve a single set of high quality, global accounting standards within the context of their independent standard setting process; and complete their convergence project by June 2011" - comes one day ahead of the 10th anniversary meeting of the G-20 Finance Ministers and Central Bank Governors, set to take place in St. Andrews, Scotland Nov. 6 and 7. Following are some early reports relating to this week's G-20 Finance Ministers meeting:

A Deluge of G20 Meetings (FT, Nov. 4)
G-20 Will Discuss 'Bubble-Building,' Meirelles Says (Bloomberg, Nov. 3)
France Sets New Bonus Rules for Banks Ahead of G20 (DJ Newswire, Nov. 5)
Big Bank 'Living Wills' Gain Traction in G20 (Globe & Mail, Nov. 5)
Strauss-Kahn Sees G-20 Adopting Timeline, Method on Imbalances (Bloomberg, Nov. 4)

Learn More About IFRS
Learn more about IFRS at FEI's IFRS Boot Camp Nov. 18 in NYC sponsored by Deloitte. Or come to the two-day IFRS conference offered by Executive Enterprises Institute, cosponsored by FEI, Nov. 9-10 in Chicago, or Dec. 2-3 in Las Vegas. And, if you want to get an update on all the hot issues currently in the mix on the financial reporting scene, its not too late to sign up for FEI's 28th Annual Current Financial Reporting Issues (CFRI) conference, Nov. 16-17, at the Marriott Marquis in NYC. Francine McKenna of Re: The Auditors will be among press covering the event, we look forward to seeing you there!

Wednesday, November 4, 2009

Sarbanes-Oxley Exemption Passes Congressional Committee

Earlier today, the House Financial Services Committee approved an amendment that would exempt small public companies from the provisions of Sarbanes-Oxley Section 404b. The Garrett/Adler amendment, offered by Rep. Scott Garrett (R-NJ) and Rep. John Adler (D-NJ), was approved in the HFS Committee today by a vote of 37-32, as part of the Investor Protection Act (IPA). The Committee voted in turn, by a vote of 41-28, to approve the IPA. (See: Financial Services Committee Approves Investor Protection Act. )

As noted in Adler's Nov. 3 press release, the Garrett/Adler amendment would not only exempt small businesses (with less than $75 million market cap), but would require the SEC, together with the GAO, to conduct a study directed at reducing the burden of Sarbox 404b on companies with market cap between $75 million and $250 million. Additionally, the amendment calls for the study to "consider whether reducing the compliance burden or a complete exemption for these companies will encourage them to list on exchanges in the United States in their initial public offerings."

The ultimate impact of the Garrett/Adler amendment will depend on whether it remains in the IPA when voted on by the full House of Representatives, and whether it will be included in the Senate’s version of the bill and ultimately signed into law.

Sarbanes-Oxley Section 404a requires a management report on internal control. Companies of all sizes currently provide the management report on internal control. Sarbanes-Oxley Section 404b, the target of the Garrett/Adler amendment, requires an external audit of internal control. Small public companies (non-accelerated filers, generally defined by the SEC as companies with less than $75 million market cap) have not yet been subject to the Sarbox 404b requirement. As described in SEC's Oct. 2 press release issued concurrently with SEC's Sarbox cost-benefit study, the SEC granted a final deferral of the effective date of Sarbox 404b for small companies, extending the deadline to annual reports for fiscal years ending on or after June 15, 2010. See related Final Rule.

Rationale Behind The Garrett/Adler Amendment
Garrett's Oct. 28 press release explained:
Although reforms were made in 2007 to relax the guidelines for smaller companies, businesses of all sizes still report excessive compliance costs, as noted in an SEC report from September 2009. In summarizing survey responses from businesses regarding the benefits of Section 404 compliance, the SEC wrote, “[A] majority felt that the costs of compliance outweighed the benefits. This was especially true among smaller companies.
Garrett's initial proposal, cosponsored with Rep. Carolyn Maloney (D-NY) was withdrawn, as was an earlier version of Adler's amendment. According to a report in today's WSJ, Small Business Gets Break in House Financial Overhaul Bill, by Kara Scannell and Damien Paletta:

[White House Chief of Staff Rahm] Emanuel negotiated with Mr. Adler to avoid a more damaging amendment that would have exempted firms already covered by Sarbanes-Oxley, those with market caps of less than $700 million, [House Financial Services Committee Chair Barney] Frank told reporters....

"It's odd that I should be defending the White House," Mr. Garrett said. Mr. Adler said he spoke with White House Chief of Staff Rahm Emanuel three times recently about giving small businesses relief.

House Financial Services Chairman Barney Frank (D., Mass.) and Rep. Paul Kanjorski (D., Pa.) both oppose the amendment, as do left-leaning consumer-advocacy groups.
SEC Chairman Mary L. Schapiro reportedly filed a letter with the House Financial Services Committee on October 16, indicating that she “opposes an exemption,” as reported by Zachary A. Goldfarb in today's Washington Post, Small Public Companies Win Exemption from Audits. However, it is not clear if Schapiro's views changed in light of modifications made over the past week to the earlier versions of the amendments; WSJ's Scannell and Damien reported today that: "SEC Chairman Mary Schapiro said earlier this week that she didn't oppose a move, but 'I don't want to just pass the problems around the map." In related news, see also Frank Seeks House Vote in December on Financial Measures, by Michael R. Crittenden of the WSJ.

My two cents
I remind you of the disclaimer that appears in the right margin of this blog, above the blogroll. I am not going to comment on the exemption provision in the Garrett/Adler amendment, only on the provision calling for GAO and the SEC to perform a cost study. Some may question why a new cost study on Sarbox is required, when the SEC just released its cost-benefit study in September (SEC study).

Cent one: I would submit that the cost-benefit study called for under the Garrett/Adler amendment may add some valuable information. For example, there could be benefits from adding an independent party (GAO) as co-head of a cost study on Sarbox, as compared to the SEC's study published in October, in which the SEC alone studied the cost-benefit of implementation of its own rules, and those of the PCAOB (which the SEC, in turn, is responsible for approving.)

One could contrast this with the decision of Congress last year, in the Emergency Economic Stabilization Act, to call upon solely the SEC (and not GAO) to conduct a study of the impact of the fair value accounting rules, given that the SEC is responsible for oversight of the FASB that issued those rules.

Additionally, although the SEC's cost-benefit study does a good job of detailing assumptions underlying its methodology - including difficulties in obtaining certain data - it is possible further work could be done with alternative assumptions and information.

Here are some verbatim excerpts from the SEC study:

For Section 404(b) compliant companies, the largest cost component is internal labor costs— which can comprise more than 50 percent of the total compliance cost—followed by the estimated portion of total audit fees attributed to ICFR (404(b) audit fees), outside vendor fees, and non-labor cost (see Table 8). [pdf pg 7, printed pg 9, SEC study]

It is important to note that the estimates of internal labor costs presented in this report are based on an assumption about a reasonable hourly rate. The rate adopted for internal labor is $121 per hour, consistent with the rate quoted as of September, 2008 for a junior accountant cited in a report on salaries prepared by the Securities Industry and Financial Markets Association (SIFMA), to which the Commission frequently refers in its rulemakings. This is at the low end of cost estimates that are provided in the SIFMA report for accounting and related services, and above the rate of $50/hour (or $100,000 for 2000 hours) that is assumed in a series of Financial Executives International (“FEI”) reports of survey findings relating to the costs of compliance with Section 404 that date back to 2005. Although our assumed rate is within the range of reasonable estimates for evaluating the overall costs of compliance, it is not intended for use in estimating the cost to an individual company. [pdf pg 14, printed pg 12, SEC study]

Overall, on average, respondents provided estimates of audit fees that are lower than what is reported by Audit Analytics. This is consistent with the disparity between the relatively broad definition of audit fees that applies in SEC filings from which Audit Analytics collects data and the comparatively narrow definition of audit fees provided in the survey questionnaire. Moreover, the differences are significant among the medium ($75-700 million) and larger (>$700 million) companies only, precisely where the broad definition of audit fees adopted for the purpose of SEC’s filings is most likely to lead to a discrepancy relative to the narrower definition in the survey. [pdf pg 37, printed pg 35, SEC study]

The evidence on the experiences of larger companies may be useful in evaluating the extent to which additional improvements to the implementation of Section 404(b) should be undertaken before it becomes applicable to non-accelerated filers. Notwithstanding, it is important to highlight that the analysis in this report is not designed to provide compliance cost estimates for companies that have yet to comply with the relevant requirements of Section 404. [pdf pgs 3-4, printed pgs 1-2, SEC study]

Based on the above, it is possible that further analysis could be done using alternative assumptions or methodology.

Cent two: However, an alternate view could be that the cost study under the Garrett/Adler amendment, aimed at considering the impact on companies with between $75 million and $250 million market cap, could potentially undo compliance by companies that are already required to comply with Sarbox 404b, and presumably may have already integrated the 404b internal control audit into their preexisting financial statement audit.

This could be viewed by some as raising different issues than the exemption of smaller companies with less than $75 million market cap (which have yet to be required to comply with 404b) as set forth in the remainder of the Garrett/Adler amendment. As noted in some of the articles linked above, although some parties favor exemptions, some strongly object to exemptions. For additional views on this topic, see Jim Peterson's Nov. 1 post in his Re: Balance blog.