Tuesday, July 28, 2009

The Economist on Politics and Accounting

Whenever The Economist writes about accounting, it is a good read. Here is a recent article.

Reforming finance: Accounting standards

Marks and sparks--Accountants draw up new rules for financial firms. The latest in our series

REWRITING laws in a hurry is never a great idea, but that is exactly what the International Accounting Standards Board (IASB), which sets rules for beancounters outside America, has been forced to do. One of the casualties of the credit crisis has been the idea of fair-value accounting—the practice of valuing financial assets, mainly securities, at market prices or the closest thing there is to them. The idea that accounting caused the crisis is specious, but Europe’s politicians, egged on by banks that took huge write-downs when market prices swooned, have nonetheless lashed out. The message has been pretty clear: make banks’ balance-sheets look better, or else. America’s rulemaker, the Financial Accounting Standards Board (FASB), has been excoriated by Congress and is back at the drawing-board too.

Unpleasant though the political mood music is, change is needed. The existing standards are a shambles, a patchwork of inherited rules riddled with escape clauses. They mix mark-to-market values with the more traditional practice of carrying assets at their cost and impairing them only when managers and auditors think fit. There are also several different ways of recognising losses. The result is that the balance-sheets of different banks are not always directly comparable.

IASB’s proposed solution, announced on July 14th, is to put all financial assets into two buckets. Loans and securities which share the characteristics of loans—in other words, assets that derive their value only from interest and repayment of principal—will be held at cost, provided banks can show they will hold them for the long term. Everything else, including equities, derivatives and more complicated securities, will be held at fair value. Companies will be allowed to start applying the new rules from the end of this year, and will be obliged to by 2012.

This is far simpler than the existing system. But according to one bank’s finance chief, defining the boundary between the two types of assets is likely to prove tricky. For example, IASB is likely to allow only the very top tranches of asset-backed securities to be classified as loans. That could reduce demand for tranches of nearly equivalent risk, as firms become less keen to hold them. Some insurance companies, meanwhile, are reported to be worried about holding all equities at market prices.

Any boundary will inevitably be somewhat arbitrary, however. The end result does look sensible: simple things will be held in more opaque loan books and fiddly things held at market prices. It is hard to judge whether the overall proportion of assets held at fair value will fall, but it seems highly likely. Anything else would result in an outright punch-up with some European governments.

It is this political tension which is the real problem now for standards-setters. Previous battles over accounting for pensions and share options were won in the face of great hostility. It would be hard to engage in such battles now. The best defence against politicking is to continue to merge international and American accounting into a single rulebook governed by an independent body. This is meant to happen over the next few years anyway, but American rulemakers have been dragging their heels. IASB’s pragmatic proposals may make consensus easier to reach.

Tuesday, July 21, 2009

Good Corporate Reporting Practice Examples

PWC provides a catalogue of examples of good practice in corporate reporting. The examples are accompanied by an introduction explaining why this example has been chosen as well as a detailed commentary from PWC's experts based on their corporate reporting framework.

The information is provided free of charge, but requires registration before accessing the full catalogue. Once registered, you can login each time you wish to use the good practice examples.

You can search for examples by industry, company name, country, and category or element of the corporate reporting framework. You can download and print examples in PDF format.
Access to the catalogue of good practices examples can be found in the bottom right hand corner of the page found at
this link.

Monday, July 20, 2009

Can We Simplify Financial Reporting?

Last Friday, the Global Accounting Alliance (GAA) and the AICPA held the third of three roundtable discussions about simplifying financial statement disclosures. The roundtables were held in New York, London and Beijing and had the goal of determining whether financial reporting can be made simpler and more useful.

One suggestion was to design financial statements with different levels of disclosure so that users would only get what they want. For example, the first level could be general accounting policies, followed by a level around movement within accounts, then changes in estimates and assumptions and finally forward-looking statements.

If you don’t want the full report you could just have Level 1 with collapsible sections, It was suggested that XBRL can help make that possible.

Quotable quotes:

  • It seems (in the U.S.) we’re constantly making changes. If we could step back and look at issues on a longer-term basis, it would help.
  • The profession needs to look not only at the disclosure of information, but how information is presented, because people have their own biases around how to develop financial reports
  • Companies will put additional information on their own Web sites, but not in their financial statements because of legal liability concerns. There are different liability concerns for each approach.
  • Even when companies include more information, it’s not always useful.
  • It’s not just more information, but starting a better communication document. More does not equal better.
  • Add a brief summary at the front of the financial statement to provide an overview of the bigger picture. An additional summary must be concise, candid and insightful.
  • Can we change the equation from being a compliance vs. communication exercise?
  • (Financial reporting) comes with a label. ‘Buyer beware,’...for the SME or small, small companies, it’s not something people will feel uncomfortable with given that they understand what’s in the package.
  • Companies should be allowed to focus on what’s best for them but the fundamental building blocks should be the same.
  • People confuse uniformity with consistency.
  • There may be some incremental differences from day one, but eventually a system will converge.


Friday, July 17, 2009

FASB Issues Financial Instruments Proposals

The Financial Accounting Standards Board (FASB) this week announced it will issue an exposure draft proposing that more financial instruments (including loans held by banks and held-to-maturity securities) be recognized at fair value on the balance sheet.

The proposals don't line up perfectly with what the IASB proposed earlier in the week, so this is the newest "fasb vs iasb" scenario, and next year should be interesting as to how the two proposals converge. As per an earlier post, IASB proposals focus on whether a financial instrument has "basic loan features" or is managed on a contractual yield basis. Basic loan features meant that the instrument bears market interest and repays original principal only. To put it bluntly FASB likes fair value better than IASB. The FASB proposals will result in more financial instruments at fair value than the IASB proposals.

Changes in fair value would be recognized either in net income for trading instruments or in other comprehensive income (OCI) for non-trading instruments.

Key aspects of the proposal:

  • Fair value changes on derivatives, equity securities, and hybrid instruments containing embedded derivatives requiring bifurcation under FAS 133 (i.e., those not clearly and closely related to the host contract) will be recognized in net income.
  • For all financial instruments, interest and dividends will continue to be recognized in net income.
  • Credit impairments and realized gains and losses arising from sales or settlement of financial instruments will be recognized in net income.
  • The classification of financial instruments will be determined at initial recognition with no subsequent reclassification allowed.
  • One statement of financial performance will be required, with subtotals presented for net income and OCI. However, only earnings per share for net income will be required.

While an exposure draft is planned to be released for public comment in the fourth quarter of 2009, it is possible that it will be issued sooner. At future meetings, the FASB plans to discuss related matters to be included in the exposure draft, including measurement of demand deposits, a credit impairment model based on expected losses, whether to allow nonpublic entities to measure certain financial instruments at amortized cost, and the proposed effective date and transition provisions for a final standard.

This proposal represents a significant change to the existing fair value accounting model and substantial debate is expected, including how the FASB's proposal will align with the International Accounting Standards Board's (IASB) recent exposure draft on financial instrument classification and measurement.

(content from PWC)

Thursday, July 16, 2009

Simpler Accounting for Financial Instruments

Accounting for financial instruments will be simplified from previous methods according to the recent IAS 39 Exposure Draft.

A reduction in the number of different categories from 4 to 2 and the elimination of the messy ex guidance around embedded derivatives and some of the impairment requirements, significantly streamlines this area.

The classification is an attempt to replicate the business model in FI acconting. This means that where a loan portfolio is held to generate income from interest and principal cash flows, it will be measured on that basis and not on one that looks at fair value at a point in time.

The exposure draft draws on input from the March 2008 Discussion Paper Reducing Complexity in Reporting Financial Instruments and discussions of the Financial Crisis Advisory Group.

There are still some major issues to deal with. Amortised cost measurement will be available only for instruments with ’basic loan features’ which are managed on a ‘contractual yield basis’. The latter of these is hard to define for financial instruments that sit in the middle ground between those to be held for their entire term to generate income and those to be traded for profit in the short term; that is going to be a particular concern for those who invest surplus funds temporarily. The IASB itself has not yet concluded on this point and that it’s likely that additional guidance will be required.

There’s also the question of whether equivalent changes will be made to US GAAP. The FASB is currently reviewing the requirements of its own financial instruments standards, but is at a less advanced stage of its project than the IASB. Indications are that the FASB is in a different place to the IASB and their proposals may well require more instruments to be measured at fair value.

The IASB has indicated that if the FASB does reach different conclusions, then these will be exposed for comment to the IFRS constituency.

Old model:

Held for trading
Available for sale
Amortized cost
Held to maturity

New Model:

Seven Key Differences in Adopting IFRS

A recent article in CA magazine (Canada) discussses the Seven Key Differences that public companies will need to deal in their changeover to IFRS: Given that U.S. GAAP and Canadian GAAP are virtually identical in these areas, they will be the key areas for U.S. issuers as well.

· property, plant and equipment
· revenues
· impairment of assets
· provisions

The article also identified three other topics where practice might differ fundamentally from that mandated by IFRS and that would likely affect most public entities:

· presentation of financial statements
· related parties
· leases

Check this article out—it is a high level overview tied to examples from an actual set of IFRS financials.

Wednesday, July 15, 2009

Little Economic Benefit in U.S. to Adopting IFRS: MIT Study

Back a few months this blog reported that the IFRS Roadmap calling for replacement of U.S. GAAP with IFRS by 2014 is coming under increased scrutiny. We cited a paper written by academics from Wharton, MIT, and other reputable universities discussing the implications on the U.S. economy of adopting IFRS.

The last nine months have been controversial for both U.S. GAAP and IFRS.
Political pressures have been brought against both the U.S. standards and IFRS as a result of controversy over fair value/mark to market accounting.

The specter of
political issues haunting accounting essentially could pit the SEC and the FASB against with the International Accounting Standards Board (IASB). In announcing the roadmap a few months back, the SEC called for improvements to funding and governance of the IASB. In more recent statements, the SEC has criticized IFRS as inadequate.

The same sources now argue in another paper that there are reasons to slow down the change to IFRS.

The new paper examines the economic consequences of mandatory IFRS reporting around the world. It analyzes the effects on market liquidity, and cost of capital and market value of a company's stock compared to a company's equity book value in 26 countries using a large sample of 3,100 firms that are mandated to adopt IFRS.

Some findings at the time of adoption of IFRS:

Market liquidity increases “In our firm-year analyses, the effects range in magnitude from 3% to 6% for market liquidity relative to levels prior to IFRS adoption,”

Cost of capital decreases

Equity valuations increase

However the authors find that IFRS adopters that are cross-listed on U.S. exchanges experience lower, if any, liquidity benefits. That is because “In countries like the U.S., there may be minimal room for improvement because U.S. GAAP is already considered a high-quality accounting regime.”

The authors note that while some argue that adopting IFRS in the U.S. would make it easier for investors to compare firms with those in other countries and decrease costs of reconciliations, this study provides “weak” evidence of any comparability benefits. “This is an area where more research will occur, but as of now there is no general agreement as to how large this type of benefit could be. The adoption of IFRS is a hot topic and it will take a few more years to get a full understanding of the long-term consequences.”

Capital-market benefits occur only in countries where firms have incentives to be transparent and where legal enforcement is strong, underscoring the central importance of firms' reporting incentives and countries' enforcement regimes for the quality of financial reporting.

Comparing mandatory and voluntary adopters, the capital market effects are most pronounced for firms that voluntarily switch to IFRS, both in the year when they switch and again later, when IFRS become mandatory. They however caution that the former result is likely due to self-selection, and that the latter result is a caution to attribute the capital-market effects for mandatory adopters solely or even primarily to the IFRS mandate.

Many adopting countries have made concurrent efforts to improve enforcement and governance regimes, which likely play into the findings. Consistent with this interpretation, the estimated liquidity improvements are smaller in magnitude when analyzed on a monthly basis, which is more likely to isolate IFRS reporting effects.

The paper is:
Mandatory IFRS Reporting Around the World: Early Evidence on the Economic Consequences

Tuesday, July 14, 2009

SEC Comment Letters: Goodwill Impairment

In a webcast last week, the Controllers’ Leadership Roundtable discussed SEC Comment letter activity surrounding goodwill impairment charges. Below is their summary of recent activity in this area.
SEC is hitting on three main areas.

  • Clear Identification of Impairment Recoverability Risks: If they are not doing so already, companies are going to need to ensure that they quantitatively disclose information about potential risks to revenue, operating results, and asset recoverability, so that investors have the ‘raw material’ required to judge the likelihood of future impairments. This includes explicitly addressing the economy, and the range of assumptions they used in evaluating its potential impact (and what changes in those assumptions would do to potential impairments).

  • Requiring Detailed Sensitivity Analysis: Along with identifying the range of assumptions used in their calculations, companies need to also disclose the sensitivity analyses used, so that investors and users can get a better sense of how impairment might change if certain conditions (e.g. 1% decline in revenue, 50 basis point increase in the interest rate) came to pass. This provides a check both on the validity of the impairment charges, and on the validity of management’s thought processes.

  • Managerial Judgment Process: In general, the SEC is also requiring companies to detail their impairment ‘thought process,’ including what inputs they used, and how they came to those input values. One comment letter called on firms to:

    In the interest of providing readers with a better insight into management’s judgments in accounting for goodwill and intangible assets, please consider disclosing the following:

  • The reporting unit level at which you test goodwill for impairment and your basis for that determination;

  • Sufficient information to enable a reader to understand how you apply the discounted cash flow valuation model in estimating the fair value of your reporting units and why management selected this method as being the most meaningful in preparing your goodwill impairment analyses;

  • How you determine the appropriate discount rates and attrition rates to apply in your intangible asset impairment and analysis;

  • A qualitative and quantitative description of the material assumptions used and a sensitivity analysis of those assumptions based upon reasonably likely changes; and

  • If applicable, how the assumptions and methodologies used for valuing goodwill and intangible assets in the current year have changed since the prior year, highlighting the impact of any changes.

Monday, July 13, 2009


The IASB has released IFRS accounting standards that are a simplified, compact version of International Financial Reporting Standards.

"IFRS for SMEs" is 230 pages, compared to 2500 pages for the full version of IFRS.

SME stands for small and medium-sized entities. There is no bright line size test to determine which companies can apply the standards. Instead, the SME standards can only be applied by entities that do offer their equity or debt publicly or which hold assets as a fiduciary for others (like banks, insurance companies, securities broker/dealers, and mutual funds.)

U.S. companies are free to adopt the SME rules since the American Institute of Certified Public Accountants has recognized the IASB as an accounting standard setter.

Private companies may find IFRS for SMEs is easier to apply and accordingly more cost-effective to apply tha n U.S. GAAP.

In the European Union, where accounting standards are fragmented into a multitude of home country accounting standards, the cost savings may be most significant. One major advantage could be that lenders would have one set of standards to use to evaluate financial statements in determining credit worthiness of their customers.

  • Eliminating topics not used by private companies--earnings per share, interim financial reporting, segment reporting.
  • Simpler accounting methods--financial instruments, property, plant, and equipment, intangible assets, investment property, financial instruments, investments in joint ventures, defined-benefit plans, and others.
  • Reduced disclosures

Goodwill and intangibles do not have to be tested for impairment each year. Instead, assets are valued at inception and then amortized over estimated useful life. If life cannot be estimated reliably, assets are amortized over 10 years.

Read the full IASB release here.

Worst Year Ever for Goodwill Impairments: KPMG Study

Goodwill impairments soared in 2008, doubling over 2007 levels for a surveyed group of companies.

KPMG completed the survey of approximately 1,600 public companies from January 2005 to December 2008.

Goodwill impairment charges at the companies were $340 billion in 2008, $143 billion in 2007 and $87 billion in 2006.

This result is not surprising given the current economic downturn and general financial market turmoil.

The study found that in 2008 the hardest-hit industries were banks, which accounted for about 23 percent of the total goodwill impairment charges. Materials, energy, media, and technology hardware and equipment companies were next. Other segments of the economy including pharmaceuticals and food and beverages took significant goodwill write-downs in 2008.

The largest two median goodwill impairment charge by industry were:
Banks--$411 million in 2008, from $49 million in 2007
Materials $394 million from $30 million in 2007.

Percentages of companies taking impairments by industry were:

  • Semiconductor and semiconductor equipment (31 percent)

  • Technology hardware and equipment (31 percent)

  • Media (30 percent)

  • Consumer durables and apparel (27 percent)

  • Diversified financials (25 percent)

Friday, July 10, 2009

FASB Beats Up the Banks

After a full year of contemplation and consultation, the FASB eliminated qualified special purpose entities (QSPEs).

QSPEs allow banks and other financial institutions and companies to hold asset-based securities off-balance sheet. This move will not likely have a significant impact on earnings in the banking sector, but it will affect capital levels at institutions that sold mortgage and other loans into such securities.

The previously off-balance sheet assets will now show up on the balance sheet at the start of 2010 for most institutions.

While there may be minimal differences in banks' earnings, the impacts on balance sheets will be more significant, possibly requiring banks to increase reserves.

Banks were initially upset by the timing of the initial proposal, which was put off after objections from the American bankers’ Association. The FASB says ABA lobbying will not change the current implementation date.

The ABA continues to lobby for changes to FASB's mark-to-market accounting rules and other than temporary impairment rules. The banks feel that mark-to-market accounting is not the best measurement for many transactions, advocating that the current approach works for assets expected to be sold, but not for assets that are expected to be held, among other issues. Banks have
claimed for years that mark-to-market rules force them to place unrealistically low values on illiquid or otherwise difficult to trade assets (known in mark-to-market accounting terms as "Level 3 Financial Instruments".)

Mark-to-market accounting is under
increasingly fierce attack by bankers who are lobbying hard for U.S. Congress to suspend or repeal mark to market rules. Bankers blame the rules for the current financial crisis.

Recently the FASB issued
changes to accounting rules that would allow looser mark to market accounting. The changes has sparked opposition to the changes from consumer and investor groups that who are advancing their previously expressed arguments that the rules give management (banks?) too much freedom in valuing assets in distressed or illiquid markets.

Opposition comes from such places as the Consumer Federation of America, the CFA Institute and the
FASB's Investors Technical Advisory Committee. The opposition may also have an impact on proposed changes to financial institutions' regulatory capital levels, which the banks claim are needed to ease the existing credit crunch and to avoid future credit messes like we have had in the past year.

Contrary Views on Liability Measurement

GAAP introduced in FAS 157 and elsewhere supports a view that an entity’s own credit risk is a determinant in measuring fair value of a a liability.

Some financial statement preparers don’t like the idea that a reduction in an entity’s credit rating would create a gain. How does this work?
If a company’s credit rating dropped, the likelihood that it would repay its liabilities decreases, resulting in an entry such as:

Dr Liability
Cr Gain

If later the company’s credit rating was raised, then a loss would result:

Dr Loss
Cr Liability

If an entity’s credit rating increased above the rating when the liability was set up, the liability would be carried at an amount in excess of the amount that was required to be repaid, resulting in a gain if early repayment occurred.

In June, the FASB sought comments proposed FSP Measuring Liabilities under FASB Statement
No. 157 (FSP 157-f).

The Government Relations Committee (GRC) of the Association of financial Professionals sent a comment letter to FASB to voice its concerns with the guidance.

The GRC generally supports the FASB in its efforts to issue timely guidance on fair value measurement. However the GRC takes the position that the FASB’s current model for measuring liabilities is significantly flawed for the following reasons:

  1. The inability to actually realize the fair value at the reporting date should be considered.

  2. The fair value calculation of a liability should not exceed the contractual value of the debt a company actually owes.

  3. Gains arising from a company’s own credit impairments should not be allowed.

  4. Any restrictions on a debt should be taken into consideration in subsequent measurement.

Check out the AFP's site: http://www.afponline.org/

Thursday, July 9, 2009

Accounting for Greenhouse Gases

Journal of Accountancy recently published a comprehensive article on accounting for greenhouse gases. Their summary is provided below.


Concerns over the environmental, economic and health risks posed by greenhouse gas emissions have become a frequent topic of discussion. Recent events and initiatives suggest that climate change ranks high on the U.S. political agenda.

Cap-and-trade programs have emerged globally as the most prevalent market mechanism used by countries to limit greenhouse gas emissions. In such programs, a government sets a targeted level of emissions for companies for a specified time period and uses “allowances” to assign a monetary value to pollution. Companies that emit less than their target may have excess allowances, whereas those that exceed their targets can acquire additional allowances. Companies generally can sell or purchase allowances directly with other companies, through a broker, or on an exchange.

Users of financial statements require expanded and transparent disclosure of the financial results related to pollution emissions. However, attempts by FASB and the IASB to provide definitive accounting guidance have been unsuccessful, leading to diversity in global accounting practices.

FASB and the IASB are working jointly to examine the accounting issues related to cap and- trade programs and other market-based mechanisms designed to limit emissions. A final standard is anticipated in 2010.

See the full article here.