Sunday, November 9, 2008

Former Fed Chairman May Bring IFRS to Fore in Obama's Presidency

2009 may see the accounting profession facing a US political regime with a clear mandate to reform and regulate. Predicting accurately the form this will take is more difficult. This is partly due to senator Obama’s meagre voting record – of his three years in the Senate, more than one has been spent campaigning for president. His platform too, gives little indication of his attitudes to accounting issues, or indeed to wider corporate governance, less some populist efforts to curb CEO pay.

The difficulty inherent in predicting an Obama administration’s behaviour can be illustrated by taking the example of US GAAP convergence with International Financial Reporting Standards (IFRS). Senator Obama has appointed Paul Volcker, former Federal Reserve chairman as one of his top economic advisers, and it is expected that he will play a role in any administration.

Volcker is a man who has unequivocally expressed an ‘interest in encouraging international convergence to a single set of global accounting standards’. One would imagine that this would be a clear indication that convergence, or outright adoption of IFRS, would continue unimpeded under president Obama.

Other indicators, however, point elsewhere. Most expect Obama to make good on promises to move toward a more protectionist position, rejecting what could be seen as international interference. This, allied to the dangers of IFRS being seen as de-regulatory, could slow the process.

Some dismiss charges of a protectionist mindset in the Obama camp, and it is true that some of the more strident ‘USA first’ language has been toned down since the need to appeal to the democratic base in the primaries ended. The broader point remains, however. The potential for a democratic controlled congress pressuring a democratic president to dispense with free-trade orthodoxy has implications for the profession that go further than IFRS, extending to the US-UK tax treaty, the debate surrounding auditor consolidation, and, indeed, on efforts to manage the extra-territoriality ramifications of Sarbanes Oxley.

For accountants seeking a ray of sunshine in all this, it is possible that a democratic administration may shy away from the prevailing republican notion that the Wall Street meltdown would not have been nearly so bad were it not for the influence of mark-to-market accounting.

Unfortunately, even that possibility is likely to fall foul of the likelihood that president Obama and his top-dollar advisers will find their room to manoeuvre significantly limited by the reality of economic circumstance.
By Simon Keymer at Accountancy Age

Wednesday, November 5, 2008

CFOs: Get Rid of Mark to Market

Fair share of CFOs want end to fair-value accounting, short-selling

CFOs are not only bracing for more regulation, they apparently welcome it.

According to the most recent survey of chief financial officers conducted by Financial Executives International, an overwhelming 80% of finance chiefs felt increased regulation and oversight are needed in the financial sector to correct the current market crisis.

Not surprisingly, over a third of the CFOs surveyed want permanent restrictions placed on short-selling of all companies. Respondents also cried out for increased regulation of hedge funds and credit default swaps, as well as a reinstitution of mortgage lending standards.

What’s more, a fair percentage of finance chiefs (46%) want regulators or standards-setters to ditch mark-to-market accounting (except for publicly traded companies with no liquidity issues)

The survey also revealed that liquidity concerns still dog finance departments. Close to 70% of the nearly 300 CFOs interviewed said they anticipate access to credit will continue to tighten over the next six months. Those finance chiefs said the lack of credit will cause them to take precautionary measures and make cutbacks.

Overall, the mood of finance chiefs continues to get gloomier. FEI’s CFO optimism index on the U.S. economy fell more than seven percentage points, its largest quarterly decline since the survey began.

“Our survey shows a continued, increasing loss of confidence by these CFOs, and for the first time in several years, they are actually reporting year-over-year reductions in capital investments, technology spending and hiring,” said John Elliott, dean of the Zicklin School of Business at Baruch College, which produces the survey with FEI. Although allocations to those areas had been trending downward, “[CFOs] had continued to report planned increases in these categories through the first half of 2008,” he said.

Looking ahead, most CFOs predicted the Fed funds rate will rise to 1.62% by April 2009 and move up to 2% by next October. The Fed funds rate stood at 2% when the survey was conducted, but the Fed has since cut it to 1%.

When asked to predict the Libor/Treasury spread a year from now, 58% said that it would narrow.

“On average, CFOs responses to the third-quarter survey agreed with many of the recent economic actions taken by the government,” said Cheryl de Mesa Graziano, vice president of research and operations at FEI.
By Matthew Scott at Financial Week

Tuesday, November 4, 2008

Spreadsheet Mania and Mark to Market

Can Companies Excel at Fair Value?
Finance departments are using spreadsheets to tackle FAS 157, an approach few regard as optimum.
When FAS 157 took effect last November, many finance departments and business units faced a new accounting requirement but lacked any new technology with which to address it. To determine the fair value of a wide range of balance-sheet items, they turned to that old standby, the spreadsheet, to piece together models that they hoped would make sense to shareholders and auditors.

A year later, not much has changed. Spreadsheets are often still the starting point when trying to figure out what a portfolio of credit default swaps or a series of collateralized debt obligations would fetch on the market. That's a worrisome thought for auditors and CFOs — especially because many users construct spreadsheets so poorly that the results may be impossible to verify.

FAS 157 builds on an older rule, FAS 133, which forced companies to divulge the fair value of derivative instruments. But FAS 157 goes a major step further, telling companies how to value the assets and liabilities on their balance sheets that they mark to market. It has affected financial companies in a big way. "If the subprime crisis hadn't happened, FAS 157 would have been a 'Who cares?' kind of thing," says Jiro Okochi, CEO of Reval, a New York–based vendor that recently added a 157 module to its software for managing derivatives. "Auditors wouldn't have paid much attention."

They do now. But while FAS 157 introduced a much stronger emphasis on the methodology behind fair-value calculations, that has not inspired software that can automate that process. "I haven't seen a single solution in the marketplace that would address all the issues," says Peter Marshall, a principal in Ernst & Young's treasury advisory practice. "People are using existing systems and doing manual workarounds."

Information Vs. Data
Most people, anyway. Wesley Walton, vice president of finance at CBC Federal Credit Union, has managed to tap newer technology, in this case an analytics function contained in software from Brick & Associates that allows Walton to perform fair-value calculations. But a credit union with just $300 million in assets and one primary software vendor has an easier time of it than larger companies.

Indeed, big companies face the irony of having too much software. A large bank will typically use different applications to handle accounting for bond transfers, commercial-lending decisions, and foreign-exchange transactions, to cite just three of many activities potentially affected by FAS 157. Therefore, multiple vendors must modify their systems to handle the dictates of FAS 157.

It also isn't clear that FAS 157 can even be captured in computer code. The rule is partly intended to force companies to articulate how they arrive at valuations for illiquid securities — the so-called Level 2 assets, where there may be some observable inputs in the market; and Level 3 assets, where there is nothing comparable in the market and valuations are determined by models. Explaining valuation methods amounts to disclosure notes in financial statements, a form of information that doesn't fit neatly into the fields of a database.

Still, a database, with its central controls and its knack for forcing information into a consistent format, is ultimately where all valuation information needs to end up, according to those who understand the pressures CFOs face in tracking and accounting for hard-to-value securities. The database can be the same one a company uses for other purposes — an Oracle database with programs written in Java, for example, or a SQL Server database with programs written for Microsoft's .NET framework. "Those are all off-the-shelf," says Duff & Phelps valuation expert Joseph Pimbley. "It's not a case of a specialized firm inventing something new."

Piece by Piece
In theory, the financial assets on a company's balance sheet are ready-made for tabulation, sorting, and what-if analyses — work that software does well. So the earliest attempts to address FAS 157 have come as enhancements to asset/liability management (ALM) systems, the software used at banks and corporate treasuries.

"Many companies came out fairly promptly with a patch or upgrade" addressing FAS 157, says Denise Valentine, an analyst who covers asset-management systems for the Aite Group in Boston. British Columbia–based analytics provider FinCad and Reval are among the software firms that have added FAS 157 functionality to products that are live with clients. Bank of New York offers its clients a FAS 157 reporting package as part of its Workbench online portal of software tools.

The difficulty of addressing FAS 157 comprehensively hasn't stopped software companies from tackling individual pieces. Reval was among the first to make it easy to see which financial instruments have moved from Level 3 to Level 2. That's useful, because those assets could get a company, and its auditor, into trouble if their value later evaporated and the company had to justify their recategorization.

SAP is trying to sell banks on the idea of using its accounting for financial instruments (AFI) product to comply with fair-value requirements. Introduced three years ago for European banks, AFI functions as a financial-products subledger layer between the general-ledger and operational systems, taking data from such systems and putting it into a format that lets users value most financial instruments, while allowing some work to be done in decentralized systems.

Using AFI "doesn't have to be a big-bang major paradigm shift," says Mike Russo, a former bank CFO and regulator who is now an industry principal in SAP's financial-services group. "It basically allows you to have a single point of control."

And a single point of control is vital, says Duff & Phelps's Pimbley, especially in an era when CFOs have to aggregate the fair values of many different things and, per the demands of Sarbanes-Oxley, attest to their accuracy. This is one reason that although Pimbley endorses the use of spreadsheets for initial model development in pricing hard-to-value securities, he shudders at the idea of spreadsheets as the sole fair-value calculator.

And yet, he says, with "no game-changer out there," companies will continue to rely on spreadsheets for this delicate work. Let's hope proper controls become part of the equation.

Robert Hertzberg at

Monday, November 3, 2008

Time to Put the Brakes on the International Accounting Convergence Movement?

Jack Ciesielski is publisher of the Analyst’s Accounting Observer. His material is always worth reading and the following is an article he wrote for the Financial Times

It’s time to put the brakes on convergence
Just two months ago, there was a growing certainty that the US was on the path to adopting international accounting rules and dropping US GAAP. A roadmap for how this would happen was promised.

Now, it looks less likely – and that’s good. The events of October contain many lessons, and one of them is that it’s time to put the brakes on the international accounting convergence movement.

Accounting got caught up in the crisis as a result of fair value rules, where assets are marked to their current market price. Banks around the world have been loath to take responsibility for their own abdication of reasonable lending standards. Instead, they found the perfect villain in fair value reporting – something upon which they could blame all the pain of the credit crisis, and expect little resistance. Accountants rarely marshal much public support. Positioning accounting as a source of pain for Everyman could only help the bankers’ cause.

Politicians listened – this “solution” costs nothing, after all – and some have echoed the bankers’ refrain.

Now the SEC is holding two roundtables to debate the effects and usefulness of fair value accounting. But the International Accounting Standards Board has gone one better and hastily changed its fair value rules, and this is where the push to converge accounting rules falls down.

Uniting all countries under a single set of global accounting rules has long been the goal of the IASB, which sets the rules for 100-plus countries. US GAAP is now the only other significant set of rules.

But the IASB has now shown it is not ready to be the premier accounting standard setter in the world.

The IASB amended its rules slightly to align them with US practice by allowing an exception to fair value reporting. It did so because of political pressure. The threat it faced was that if it had not, the European Union, which follows the IASB’s rules, would have acted itself. This would have likely resulted in worse accounting rules and would almost certainly have finished the IASB’s dream of the US switching to IFRS, since the US has made it clear it will not tolerate other countries carving out chunks of the rules where they choose.

But I believe the IASB has ended that dream of US convergence itself by bowing to political pressure. The amendment was done without due process: no comments or discussion were sought from investors. Incredibly, that suspension of due process bore the blessing of the trustees who oversee the IASB.

Seeking convergence on a tiny part of the rules in this regard may seem trivial, but it is a giant step backwards. It shows that when the going got tough, the IASB waived the interests of those – the users of accounts – whom it’s supposed to serve.

Instead of converging to what is best in US standards, the IASB is adopting some of the worst features. The IASB is defining convergence downward: it is adopting an exception built into the US standard, something for which the US system is often criticised – and it is an exception bound to lead to less transparent reporting to investors. This is not what convergence is supposed to bring about.

It was the Securities and Exchange Commission that promised the roadmap on convergence. Two months later, we still have not seen it.

If it does appear, US investors should still be wary.

Instead of a rush-job convergence during the worst financial crisis since the Depression, maybe what is needed is a few more years of friendly competition between standard-setters.

The US should renew its reconciliation requirement for the registrants using IFRS, so that convergence efforts can be effectively monitored. When those reconciliations show that accounting standards are producing truly similar results consistently, then the real roadmap to convergence should be styled – one that includes protection from political pressure and the effective worldwide enforcement of accounting standards.
Jack Ciesielski is publisher of the Analyst’s Accounting Observer. This article is from the Financial Times

IASB Follows FASB; Releases Educational Material on Mark to Market: Comment

The IASB released its educational material on the application of fair value on Friday. Similar to the FASB’s release, they do not advocate a change in existing mark to market rules. Rather, they provide guidance and examples on application of existing rules. You can read the IASB's guidance here. The following article compares talks about the implications of this on the future of fair value accounting.

Undaunted: Global Fair-Value Guidance Evolves
In the face of harsh critics, the IASB releases a how-to document on fair-value accounting that tackles some thorny issues.

No accounting rules were changed, and the guidance to clarify the rules stayed the same as well — except perhaps for the addition of some new examples. Yet in some ways, the 84-page document released today by the International Accounting Standards Board speaks volumes about the future direction of fair-value accounting.

Undeterred by charges that fair-value accounting is the demon at the heart of the credit crisis, the IASB pulled together all its recent guidance on the subject into one document to answer the question of how to account for financial instruments in illiquid markets using the so-called mark-to-market methodology. The new document does not change any of the IASB's existing fair-value rules, or its proposed amendments to IFRS 7 — the fair-value disclosure rule due out in 2009. Rather, it reiterates all the principles in IAS 39, the IASB's fair-value measurement rule, and then addresses thorny practice issues, such as using transaction prices, management's estimates, and pricing service data as inputs to recalculate fair value.

The principles outlined in the guidance formalize many of the recent pronouncements made by the IASB on fair-value accounting and released piecemeal over the past few weeks. Overall, the IASB guidance is consistent with a body of guidance released by the U.S. Financial Accounting Standards Board on October 10. The U.S. guidance also provided illustrative examples, something both boards said constituents were clamoring for.

To arrive at this point, both the IASB and FASB sidestepped usual vetting periods to rush out recent fair-value guidance in response to the worsening credit crisis. Indeed, on October 9 the IASB got the go-ahead from its trustees to "accelerate" its response to the crisis, which included embracing a new clarification of FAS 157, the U.S. fair-value measurement standard.

A week earlier, FASB had reduced its public comment period for the FAS 157 guidance to just seven days, hoping to quell the controversial issue of how to measure the value of a financial asset under the rule when no market exists for the asset. FASB usually allows between one and four months — and sometimes more — to collect and digest public opinions about new guidance. But bankers, who are one of the most outspoken critics of fair-value accounting because the methodology forces their companies to write down assets to current value, needed a quick response.

For its part, the IASB's new package of information discusses all the key controversies, covering, among other topics, characteristics of an inactive market — which include a significant decline in volume and level of trading activity or significant price variations among market participants. The IASB also underscores the relevance of judgment in uncertain markets, but it makes clear that all judgment calls have to be weighed with other risk factors. Indeed, the document states that "regardless of the valuation technique used, an entity must include appropriate risk adjustments that market participants would make, such as for credit and liquidity."

Likewise, judgment must be used to determine whether a transaction is "forced," which could mean a deal is settled at a fire-sale price, and therefore the value may have to be adjusted upward. The guidance also devotes 13 pages to evaluating available market information, including transaction prices, indices, and changes in the company's own credit.

The guidance was prepared by an IASB expert advisory panel, which was set up in May 2008. The panel was put together in response to a recommendation by the Financial Stability Forum to enhance guidance of valuing financial instruments in illiquid markets, and to strengthen related valuation disclosures. The Forum comprises 26 finance and economic organizations from around the world, including central banks and national treasury departments.

Together, the IASB and FASB will move beyond the Forum's advisory group by creating a new group of advisers to deal with financial-reporting issues that emerge from the credit crunch. The boards are currently working to identify external chairs and members of the group and expect to hold three roundtables, one each in Asia, Europe, and North America.

Marie Leone at