Pension Pain

When the Wall Street Journal talks about accounting it is usually worth reading, so here is their take on the impact of a proposed change to accounting for pensions under IFRS.

Efforts to make pension accounting more transparent could cause corporate profits to become more volatile if gains and losses from pension assets are mingled with results from companies' business operations.

The agency for international accounting standards [the IASB] is expected to take up a proposal next year that would require companies with defined-benefit pensions to report annual changes in the value of their pension assets as part in their income statements. Under current procedures, returns on pension investments and gains and losses in pension-plan assets are accounted for in small increments over several years to keep them from skewing companies' earnings.

The change would provide a more immediate snapshot of companies' pension-plan performance. But U.S. companies, aside from Honeywell International Inc. (HON), have so far been reluctant to voluntarily change their pension accounting. Observers warn that investors could be subjected to bouncier stock prices if earnings become significantly less reliable with the addition of unpredictable gains and losses from pensions.

"If we've learned nothing else over the last three years, it's that the market isn't always rational," said Alan Glickstein, senior consultant for Towers Watson, an employee benefits consultancy. "It's not necessarily a good thing if [the accounting change] just increases earnings volatility."

If the International Accounting Standards Board--the nongovernmental agency for accounting rules used by companies outside the U.S.--adopts the change for pension accounting, observers predict the Financial Accounting Standards Board will follow suit for the sake of consistency and amend the Generally Accepted Accounting Principles used by U.S. companies.

"To the degree that a company wants to make sure that their financials are reflective of their operations, it would make sense to go through a change like this. It would add transparency to the numbers," said Daniel Holland, an analyst for research firm Morningstar Inc.

More than 340 companies in the Standard & Poor's 500 Index have defined-benefit pensions that guarantee employees pension incomes when they retire. To meet these obligations, the companies have set aside a combined $1.22 trillion that is invested in stocks, bonds and other types of investments.

Smoothing out annual gains and losses from defined-benefit pensions has come under increasing scrutiny as regulators dismantle other accounting practices used for decades to wall off pension costs and liabilities from companies' balance sheets and their profit statements.

"The pension volatility has always been there. It's just not measured today. The accounting doesn't require that it be highlighted," said David Larsen, managing director for corporate finance consulting at Duff & Phelps Corp., a financial services and investment banking advisory firm.

Honeywell is the largest U.S. company to begin using market-to-market accounting for its pension. The move is intended to put the brakes on escalating costs for Honeywell's pension. Falling interest rates on bonds used to determine companies' future pension obligations have driven up annual pension costs for all companies with defined-benefit plans. But Honeywell's expenses have been exacerbated by a decision it made in the late 1990s to use a six-year schedule for amortizing pension gains and losses on pension assets and a three-year schedule for smoothing out returns from pension investments. Most companies amortize gains and losses over 10 years or 12 years and account for investment returns over five years.

Honeywell's shorter time frame helped the company lower its pension expenses when asset values soared. But when pension-fund performance tanked in 2008, Honeywell's pension headwinds were magnified in its earnings.

Without the option of switching back to a longer amortization schedule, Honeywell will stop deferring gains and losses. The aerospace and building-systems manufacturer will recognize $5.5 billion in prior asset losses in its 2010 income statement. Going forward, Honeywell will report gains and losses in their entirety during the year they occur.

The change will increase the company's pension costs for this year to $1.61 billion, compared with $791 million under the six-year schedule. But its pension expenses are expected to plunge to $200 million in 2011.

"It takes all that old stuff and puts it behind them," said Howard Silverblatt, an analyst with Standard & Poor's investment services unit.

Once the slate is wiped clean, Honeywell aims to limit its pension expenses to about $200 million a year. Moreover, the company will attempt hold down pension-related volatility in its earnings by making pension asset values and returns more predictable than in the past.

"I can see investors having this fear that every fourth quarter there's going to be this wild swing," Chairman and Chief Executive David Cote said during a Nov. 16 conference call with analysts. "More likely than not, that is not going to happen."

In the coming years, Honeywell plans to shift more of its pension funds from equities to fixed-income investments. That will lower annual returns to 6.5% from 9%, but will lessen Honeywell's exposure to sudden swings in stock values and returns that would contribute to earnings volatility.

If mark-to-market pension accounting becomes the standard, other companies will likely change their investment mix as well, creating a profound shift in the allocation of pension funds the next decade.

"I would expect it to take a while, but pension assets would shift to less volatile securities," Morningstar's Holland said.



-By Bob Tita, Dow Jones Newswires;

Fair Value Fight between FASB, IASB heats Up with Volcker Comments

The FASB vs IASB fight has heated up substantially following comments by Paul Volcker, an advisor to Barack Obama and former chairman of the US. Federal Reserve Board, and former Chairman of the Trustees of the IFRS Foundation. The FASB wants to expand the use of fair-value accounting to all financial assets, including loans and deposits. This concept is opposed byUS bankers and also somewhat by the IASB, which prefers a milder version of fair value accounting. The battle that is shaping up between opposing forces could determine how much capital banks are required to maintain, and accordingly would determine to some extent how much leverage a bank could utilize.

The FASB proposal could result in the largest U.S. banks writing down the value of their loan portfolios.

Volcker said that treatment of financial instruments has not been resolved because of political pressure. Volcker also said “When you have global corporations operating around the world, and analysts looking at them from around the world, you want one accounting standard.”

The two accounting bodies have worked diligently toward convergence of the two different sets of accounting rules for the past five years. Disagreements are most significant around fair value rules for financial instruments, including derivatives, and rules governing what companies have to consolidate on their balance sheets. Many issues are close to being resolved.

The FASB likes a version of fair value accounting that forces loans and bank deposits to be marked to market values as is already done for banks trading books. Theis would not necessarily affect earnings, since some fair-value adjustments can be recorded in other comprehensive income which goes directly to equity.

The IASB prefers an approach that allows financial assets to stay on the books at original cost if the assets are held to maturity, i.e. for the long term. The IASB says it has no plans to re- open discussion of fair-value accounting, however the FASB and the IASB may eventually move to a middle ground.

Volcker prefers the IASB approach on valuing financial instruments. “You can’t have everything at fair value,” Volcker, said--“I’m not in favor of fair valuing bank loans because we don’t know their fair value anyway. It’s not consistent with the basic business model of commercial banks.”

In a similar episode, a few months earlier, IASB bowed to European Union demands to relax its fair-value rules, letting banks move some assets to a different part of the balance sheet so they wouldn’t have to be marked to market values.

Goldman Sachs Group Inc., the most profitable U.S. securities firm, has said that banks hide losses on loans used to generate investment-banking fees. In a Sept. 1 letter to FASB, Goldman Sachs described how banks lend at below-market rates to win equity and debt-underwriting deals, a practice known as “lend to play.” Goldman Sachs executives have argued that the firm’s practice of marking assets to market value helped it prepare for the credit contraction earlier than rivals.

Looking for Work? Try FASB or IASB

If you are an accounant with a converged accounting skillset, perhaps there are a couple of jobs youu might be interected in. Both Robert Herz, and Sir David Tweedie, respectively the chairman of the U.A. Financial Accounting Standards Board (FASB) and the head of the International Accounting Standards Board (IASB) are due to retire shortly. Despite the departures of Sir David and Mr Herz, big accounting firms and their clients still expect convergence of standards to top the agenda of their successors.

Both men have had to deal with controversial issues in financial reporting. In particular, fair value accounting for financial assets: and liabilities is a particularly cumbersome issue. In fact, the two men and their accounting bodies have butted heads over this issue, with both business people and politicialns sticking their oars in to the dispute. Recently, the FASB has taken a more principles-based approach, calling for most measurements to be at fair value. IASB has taken a two-category approach, saying that loans and loan-like equivalents held to maturity may be marked at amortised cost, whereas frequently traded instruments should be marked to market. Comments to date are leaning more toward the IASB approach, with “Big Four” accounting firms and many companies on the IASB’s side. Conjecture is that Herz’s replacement may be a pragmatic consensus-builder rather that the principles-based stalwart that herz was.

At IASB, meanwhile, the skills of a politician or diplomat may be required as the EU politicians have in some cases refused to agree to the IASB's proposed standards.

IFRS - Convergence or Adoption? Part 1

WebCPA recently published a survey of responses on IFRS adoption, quoting people of influence in the accounting profession on their thoughts on moving to IFRS.

Below is Part 1 of some of their comments.

Full convergence on rules will take time -- especially as the economic factors continue to shift (like regulating derivatives), but there needs to be general agreement on the guiding principles in the meantime.
-- Mark Albrecht, CEO, XCM Solutions

Many have underestimated the degree to which the "concepts-based" IFRS standards will migrate toward the "rules-based" structure that exists in GAAP today. In fact, the SEC issued comment letters that speak to uncertainties of this transition. We have "rules-based" standards in the U.S. today largely because of our financial reporting environment, and a change to IFRS will not necessarily change that dynamic.
-- Charles Allen, CEO, Crowe Horwath LLP

...the burden and cost of implementation during the current economy is a large hurdle for some companies. In the long term, I believe a single set of global accounting standards will be very positive.
-- Jordan Amin, Chair, National CPA Financial Literacy Commission, AICPA

The concept is good. But there are a couple real-world issues to resolve. The first is that many countries that have already adopted, or are expected to soon adopt, International Financial Reporting Standards have "country modifications" -- if this is prevalent, we do not really have common standards. A second issue is that standards must be relevant and useable -- currently, there is a legitimate question as to whether one set of standards can meet all needs of public companies, private companies, etc. and that must be resolved.
-- Rick Anderson, Chairman and CEO, Moss Adams

There seems to be worldwide consensus surrounding the need for one global set of high-quality accounting standards and that IFRS is currently best positioned to fulfill that need. However, there is much to be gained from U.S. GAAP and, as such, the convergence of U.S. GAAP and IFRS may very well best serve the needs of the global community.
-- C.E. Andrews, President, RSM McGladrey

We have indeed reached the point where global businesses, financial and capital markets are interrelated. Without a single set of standards, we will become like the Biblical Tower of Babel.
-- August Aquila, President and CEO, Aquila Global Advisors

As proposed, (IFRS is) more principle-driven than our rule-driven U.S. GAAP accounting, and thus more open to interpretation. But I think that interpretation and flexibility are necessary. The differences in the cultures and business practices of each nation have to be considered and that requires flexibility. I think that convergence will likely be the best vehicle for migration and eventual international adoption because it will allow the standards to evolve as they are practiced.
-- Andy Armanino, CEO and managing partner, Armanino McKenna

The creation of a single set of high-quality standards will benefit U.S. financial markets and public companies.
-- Erik Asgeirsson, CEO, CPA2Biz

The process is too much and too fast, especially considering the state of our economy, legal system vs. global, and the need to assure the U.S. public of due process and independence in accounting standards promulgation. The process of accounting standards convergence must slow down and acquire the broad support of the U.S. public, financial statement users, preparers, practitioners and regulators.
-- Billy Atkinson, Chairman, NASBA

I think that the political, cultural and governance challenges associated with getting global adoption of a uniform set of high-quality accounting and financial reporting standards accomplished are far more difficult to deal with than the technical accounting issues, and will likely prevent the achievement of that goal. Still the convergence goal should be pursued to the extent feasible, and any remaining differences should be identified so that financial statement users can better consider the impact of such differences.
-- Robert Attmore, Chairman, GASB

Comparability is overrated, and it's not going to happen anyway. This idea would be far superior to the status quo. All financial statements are lagging indicators anyway -- similar to timing your cookies with your smoke alarm. We have to compare any change to GAAP to the status quo, not some perfect Utopia that's never going to exist here on earth.
-- Ron Baker, Founder, VeraSage Institute

...the move to create one set of global standards recognizes that we are operating in a borderless, i.e., seamless, business environment.
-- Sheri Bango, Vice president of practice mobility and state regulatory & legislative affairs, AICPA

A single set of standards is imperative given global markets today, and IFRS is a reasonable path. With the impact of globalization and large developing economies such as China, Brazil and India, effective, meaningful comparisons between entities are absolutely critical.
-- Jon Baron, President - Americas, Workflow & Service Solutions, Thomson Reuters Tax & Accounting

U.S. GAAP was the gold standard for so many countries for so long because it was considered the highest-quality set of accounting standards anywhere. U.S. GAAP may not be flawless, but the words "prepared in accordance with U.S. GAAP" send a message to the financial statement user that the methods under which the financials were prepared have been tested and are trusted. U.S. regulators must demand that "prepared in accordance with IFRS" -- or "U.S. IFRS" if it
comes to that -- guarantees the same level of trust and reliability.

The roadmap as currently proposed does not enhance the comparability of financial information that would be achieved through convergence.
-- Joanne Barry, Executive director, NYSSCPA

While the objective of global accounting standards seems obvious and noble, there exists far too much deep and long-lasting disagreement in many basic accounting theories to make this practical and useful. For instance, "fair value accounting" has serious regulatory and financial consequences to a company and its nation, and its application may have serious unintended economic consequences. However, I am afraid that the genie is out of the bottle and continued enormous effort will still be devoted to its ultimate realization. Nevertheless, adoption of those standards will be difficult.
-- Tony Batman, Chair, CEO and president, 1st Global

Though the transition will be, and is, troublesome and costly, a single set of global accounting standards is necessary, particularly as the world is moving closer and closer to a global economy. This is clearly evident in the current recession we are experiencing in the U.S. because the entire world has been affected. Whether it will be the convergence of accounting standards or adoption of IFRS, one or the other must ultimately happen and if not now, sometime down the road.
-- Parnell Black, CEO, NACVA

While I don't think a single standard is a prerequisite for growth and prosperity, it could facilitate markets and the deployment of capital in ways that would support growth and prosperity. That is, as long as standards are not sought as end in itself -- which it sometimes feels like -- but because they would improve transparency through better disclosure and data availability, investor insight into company performance, and management accountability to markets.
-- David M. Blaszkowsky, Director, Office of Interactive Disclosure, SEC

Globalization is a reality, but a single set of global standards will take significant effort and time because of politics and world economic conditions. IFRS requires leadership, relationships and creativity in order to succeed.
-- L. Gary Boomer, CEO, Boomer Consulting Inc.

I believe that a single set of standards for publicly held companies and companies doing business worldwide is long overdue. For many years now we have been a global economy. Technology has been the single biggest contributing factor to this phenomenon. Technology has allowed companies to reach further to sell products and services than ever before.
-- James C. Bourke, Partner, WithumSmith+Brown

The accounting standard-setting process must be robust, transparent and independent, free from political interference and underpinned by appropriate due process that gives all stakeholders an opportunity to provide input.

It's important that accounting standards are not politicized but focused on providing relevant, timely and transparent information for investors and other users.
-- Beth Brooke, Global vice chair, Ernst & Young

The SEC needs to recognize that IFRS is the quality global standard and that trying to maintain a separate U.S. GAAP will not serve investors or other public stakeholders.
-- Robert Bunting, President, IFAC

The economy is definitely global in nature, and as such, it is imperative to have global accounting standards. One of the primary roles of the accounting profession is to attest to fairly presented financial statements. I believe that once a universally acceptable IFRS evolves, it will be easier for accountants to fulfill this obligation.

At this stage, once the IFRS are adopted, I believe the value generated will exceed the cost of compliance. We will be operating for a consistent framework for evaluating the health and performance of a business.
-- Peyton Burch, Director of partner programs, Deltek

Thus, in brief, the primary reason for moving toward IFRS is competitiveness. I think it will become increasingly difficult for the U.S. capital markets and U.S. organizations to compete in a world in which potentially we're the only country operating under a different set of accounting standards -- and therefore a different financial language. My concern is that if we do not now accelerate our move toward adoption, we will increasingly be less influential in the development of IFRS. There remain myriad unresolved issues related to the standard-setting process, the governance and funding of the standard-setting process, as well as serious and valid concerns about government intervention in IFRS standard-setting.
-- Stephen M. Chipman, CEO, Grant Thornton

Given the continuing evolution toward a world economy, globally recognized accounting standards are becoming more and more essential moving forward. In my opinion, this is an important development and rapid adoption is as important as ever.
-- David M. Cieslak, Principal, Arxis Technology Inc.

The shift to a global economy calls for the development of standards that make financial statements comparable across borders. The organizations involved in the process, such as the SEC, will need to take steps to ensure that companies and accounting professionals are provided with the tools to make the proper adjustments accordingly.
-- Scott Cook, Founder, Intuit

I think the goal of a single set of high-quality, fully vetted, global standards for publicly held companies is appropriate and should be pursued. However, the effort to over sell IFRS under the guise that, "Every country except the U.S. is doing it" is missing the mark and hurting the attainment of an appropriate goal of one set of standards.

The misinformation and outright hype and exaggeration of the acceptance worldwide of IFRS is not helping to convert federal and state regulators. It seems to me that before the "big sell" was made on IFRS in the U.S., much elementary work was and is required: Who is covered? What are the standards and what about the carve-outs? Why is IFRS superior to GAAP? Which entities should use IFRS? How should IFRS be developed, promulgated and monitored (there are grave sovereignty issues related to a foreign standard-setter)?
-- David Costello, President and CEO, NASBA

A single set of standards will be crucial to world commerce as our globe morphs into one overarching super-economy. I believe it's our leadership responsibility as accounting professionals to drive the effort. I'm disappointed the SEC is distracted and not setting a steady pace. The initiative has huge implications on not only the technical side, but the market dynamics of our profession. The initiative will create significant demand for our services, and cause further specialization of our profession.
-- Gale Crosley, President, Crosley+Co.

I think a single set of global accounting standards would be very good because it would bring uniformity to an already-confusing set of standards. Most companies that rely on CPA services cannot discern the differences between U.S. GAAP and global standards. A CPA promoting his or her services can more easily communicate the one set of standards to clients and prospects, especially if the client does business internationally.

I think is also incumbent on everyone who works in the accounting profession to take an active role in helping clients and the public understand the single set of standards, instead of relying on larger entities to solely communicate the information. Of course, the regulatory organizations will have to help the accounting professional understand "what" to communicate, but I think everyone should participate in this discussion.
-- Scott H. Cytron, President, Cytron & Co.

As the activities and interests of investors, lenders and companies have become increasingly global, it is crucial for the continued health of our global capital markets that a globally accepted, high-quality financial reporting framework is developed at both a domestic and international level. This is the only way to achieve fair, liquid and efficient capital markets worldwide by providing investors with information that is comparable, transparent and reliable. Given the unique concerns of the U.S. markets and standard-setters, convergence is the most likely method by which the implementation of a single set of global accounting standards is likely to occur.
-- Bob Dias, Vice president of marketing, CCH

I think that this is an important goal, as it creates a level playing field across continents and markets, which becomes more important as investors and their advisors look at investing and diversification with a more global view. Knowing that financial information is standardized makes it easier for investors to make more informed decisions.
-- Michael Di Girolamo, Managing director, Investment Advisors Division, Raymond James Financial Services

I support the creation of a single set of global accounting standards -- and truly believe IFRS is way overdue. A single set of standards will not only simplify the way companies conduct themselves, but encourage 100 percent adoption of ethical behavior. In addition, any time somewhat-disparate regulatory bodies can come together for a common cause -- even though the rules may be somewhat complicated to follow in the short term -- the public will appreciate the effort because it builds long-term trust and a much stronger economy.
-- Anton Donde, CEO, SpeedTax

A standardized set of global accounting standards is inevitable. I believe that eventually, through convergence, it will happen. It is just a matter of time. The broader concern is the potential variances based on size and type of business involved. With this consideration, I believe that there will be a difference in the development and implementation of global standards.
-- Loretta Doon, CEO, CalCPA,

To achieve the objective of a single set of global accounting standards will likely require an independent and well-funded standard-setting body that, while suitably accountable to the world's capital markets, is insulated from political interference and has an investor focus to its standard-setting activities.

There's no doubt that this is challenging -- both within a global network like KPMG's and more broadly across the profession -- but it's clearly the path we need to pursue to facilitate more efficient allocation of capital resources around the globe.
-- Timothy Flynn, Global chairman, KPMG

…there are many benefits to American investors and the markets. Such benefits include facilitating more efficient capital allocations by both companies and investors, promoting increased transparency of financial information given the principles-based nature of IFRS, reduced costs for companies (especially those operating in multiple jurisdictions), as well as protecting the long-term capital market competitiveness of U.S. capital markets.
-- Cynthia Fornelli, Executive director, Center for Audit Quality

Arriving at a single set of accounting standards is imperative; inconsistency breeds uncertainty, which in turn discourages investment and business activity.

The most obvious approach is to adopt IFRS -- after all, it's just U.S. GAAP against the rest of the world, at the moment. We would then work within the IFRS structure to get change. While IFRS is not perfect, it's better than the current uncertain standoff.
-- Christian Frederiksen, Chairman, The 2020 Group

As capital markets become increasingly global, U.S. investors have a corresponding increase in international investment opportunities. In this environment, I believe U.S. investors would benefit from an enhanced ability to compare financial information of U.S. companies with that of non-U.S. companies. The Securities and Exchange Commission has long expressed its support for a single set of high-quality global accounting standards as an important means of enhancing this comparability. Therefore, International Financial Reporting Standards will potentially provide the best common platform on which companies can report and investors can compare financial information.
-- J. Russell George, Treasury Inspector General for Tax Administration

The idea of a single set of global accounting standards is nice, especially as business today isn't and shouldn't be limited by geographic boundaries. And more principles-based than rules-based is probably good. But standards imposed by regulatory authorities for comparability aren't all that helpful to stakeholders as would be, say, reporting that meets the true needs of these stakeholders: assurance of accuracy and relevance specific to the purpose. With something as complex as accounting, judgments are almost always necessary and exceptions seem to be the rule (captured minimally, at present, in footnotes). An approach that clarifies the judgments applied and assures transparency of the judgment process is, in my humble opinion, the more important objective. Does IFRS accomplish this any better than GAAP does?
-- Michelle Golden, Founder, Golden Practices blog

On Vacation

See you in September.

Like LIFO?

Below is a very informative article from CFO.comSucking the LIFO Out of Inventory

The government sees billions of dollars in potential tax revenue sitting on the shelves of company warehouses.

Explaining accounting to Congress is never easy. But last spring, Bill Jones, vice chairman of O'Neal Industries, says he witnessed a few "aha" moments as he went door-to-door on Capitol Hill to lobby against the elimination of "last-in, first-out" (LIFO) accounting.

As Ron Travis, O'Neal's vice president of tax, explained to members of Congress why the majority of companies use LIFO, "lightbulbs started going off," recalls Jones. Until then, he says, "they thought LIFO was just a funny-sounding acronym."

LIFO allows companies to calculate the cost of goods sold based on the price of the most recently purchased ("last-in") inventory, rather than inventory that was purchased more cheaply in the past and has been sitting on the shelf. That boosts the cost of goods sold, which lowers profits — and, thus, taxable income. LIFO is particularly important to companies that have slow-moving inventory — such as industrial manufacturers and distributors — and are therefore vulnerable to rising prices. O'Neal, a manufacturer and distributor of metals and metal products, has used LIFO for 63 years, almost as long as the method has been allowed for tax purposes (the Internal Revenue Service first sanctioned it in 1939).

"We normally replace every piece of inventory we sell with a higher-priced piece of inventory," explains Travis. "Under LIFO, all of the inflation that is built into our product is not recognized for tax or book purposes."

Jones and Travis breathed a sigh of relief last year when Congress quietly dropped plans to eliminate LIFO. But it didn't take long before the funny-sounding acronym was back in the taxman's sights. The 2011 federal budget proposed by the Obama Administration again includes a provision to repeal LIFO accounting. The government estimates that the move would boost federal coffers by $59 billion over 10 years.

Even if LIFO somehow survives another year of federal budgeting, it still faces the long-term threat of being wiped out if the United States adopts international financial reporting standards (IFRS), which do not allow LIFO. That would stop companies from using LIFO entirely, because companies that use the method to reduce taxable income reported to the IRS must also use it for financial reporting, rather than potentially more-flattering methods, such as FIFO (first-in, first-out) or average cost.

A Bad Match?
Companies like LIFO because it stifles inflationary effects by matching current expenses and current sales more closely than other methods. The accounting convention "protects us from having to pay taxes on what are not really profits," contends Jones. Indeed, proponents of LIFO — 120 of which have formed the LIFO Coalition to lobby against its repeal — don't consider the methodology a tax break. "There is an economic reason for using LIFO, and that is lost on the folks in Washington," says Beatty D'Alessandro, CFO of Graybar, a distributor of electrical and industrial components that has been using LIFO since the early 1980s. Without LIFO, he says, there is a "mismatch between what it's going to cost us to put inventory back on the shelf and what we bought it for six months ago, when it may have cost less."

To understand the mismatch, consider how LIFO works: Say, for example, that a company has an industrial compressor in its inventory that it bought for $5,000. It sells the compressor for $5,500, and replaces it in inventory for $5,200. From an economic perspective, the profit is only $300, not the $500 difference between the historic and current price. LIFO allows companies to use that "last-in" price to record $300 in taxable income. The remaining $200 in income is deferred until the company shutters its business and is forced to liquidate the inventory, at which time it strips off years of "LIFO layers." The $200 — the difference between the taxable income recorded under LIFO and another methodology — is referred to as the LIFO reserve.

In a liquidation, notes O'Neal's Travis, the sell-off of old inventory generates revenue to pay the taxes. But if LIFO is simply repealed, he says, then deferred taxes will be due without the benefit of any additional revenue. "In effect, the repeal of LIFO is going after our equity," the tax director says.

Under the Obama budget proposal plan, companies would be required to "true up" their retained earnings in the year they stop using LIFO, explains Jason Cuomo, a senior analyst with Moody's Investors Service. They would then make annual cash tax payments on the profits stored in the LIFO reserve over a 10-year period, beginning in 2012.

Graybar's D'Alessandro argues that LIFO accounting is a "timing issue," rather than a tax gimmick, and emphasizes that LIFO accounting reverses itself when demand drops. "You burn through LIFO layers as you burn through your inventory," explains D'Alessandro, who notes that Graybar reached lower-cost inventory layers last year as demand slowed. At that point, profits rose under LIFO accounting and the company had to pay more in taxes. The same is true when deflation sets in, says Scott Rabinowitz, a director in PricewaterhouseCoopers's national tax practice. As the price of replacement inventory drops, taxable income increases, and so does a company's tax obligation.


A Cash-Flow Issue
Not all companies agree with the mismatch theory. Proponents of FIFO, who tend to be retailers and manufacturers of fast-moving inventory such as electronics or perishable goods, say FIFO better reflects the current value of inventories. For example, in December, packaging giant Pactiv Corp. switched from LIFO to FIFO, telling investors that the change provides "better matching of sales and expenses." Officials at the company, which makes Hefty brand plastic bags, noted that this is particularly true during periods when the price of their primary raw material, resin, is volatile.

Under FIFO, they said, "the lag between resin-price changes and selling-price changes will be reduced by approximately two months."




Moreover, not everyone agrees that LIFO elimination would be such a dire event for companies with slower-moving inventory. The elimination of LIFO "is a cash-flow issue," argues Moody's Cuomo, who co-authored a recent report on the subject. His report, which examined 176 companies rated by Moody's that use LIFO, points out that larger companies with strong cash flows likely will weather the one-time charge of converting from LIFO to FIFO or another methodology without much problem (see the chart at the end of this article). That's because for the largest companies, the charge represents a small percentage of their annual cash flow. However, smaller companies with high LIFO reserves and low cash flows could run into problems.

But some large companies say the change would still hurt. Graybar, with $4.3 billion in revenue, reported a LIFO reserve of $107 million in its most recent 10-K. Assuming a 35% tax rate, and a single payment that is not stretched out over time, D'Alessandro estimates that Graybar's tax bill would amount to $37.5 million on the day it converted from LIFO to FIFO — or a $19 million tax obligation if the company switched to average-cost accounting. More important, a switch from LIFO could mean up to 500 fewer jobs, says the CFO, who figures that, on average, salary and benefits cost the company $70,000 per person. "If we pay it in taxes, we can't pay it in wages. It is as simple as that. [LIFO repeal] is an anti-employment move," insists D'Alessandro.

The demise of LIFO also could affect a company's net operating losses — the deferred tax asset that is recorded by a company and held to offset taxable income in the future. Rabinowitz notes that taking the LIFO reserve into income could reduce the amount of NOL carryforwards.

The sting of LIFO repeal also will be felt by smaller companies that don't have robust information-technology systems, says Stephanie Anderson, a managing director at consultancy AlixPartners. That's because sorting and valuing layer after layer of LIFO inventory is a complex task. That kind of "unwinding" is mandatory before an accurate valuation can be recorded for book and tax purposes. Anderson says companies may also need to hire more cost accountants to ferret through the inventory layers.

Is the End Near?
The brightest hope for LIFO proponents is the possibility that the accounting method could yet survive. It is too early yet to tell how strong industry pushback will be on the Administration's proposed repeal, but lobbying efforts have stopped it before. Similarly, if the Securities and Exchange Commission does make IFRS the accounting system of the land, nonpublic companies won't have to use the standards. Indeed, if the IRS itself isn't the force behind a LIFO prohibition, it might even prove willing, as it has in the past, to water down conformity regulations requiring that certain methods be used consistently for both tax and financial reporting.

Perhaps the biggest wild card affecting the government's decision will be the economy. "It's always a terrible time to look at repealing LIFO," says Jones, "but right now it's just another nail in many corporate coffins."

Marie Leone is senior editor for accounting at CFO.

FASB in Midst of "Religious War" on Fair Value

This is a posting on a blog called "Finance Director" about a n article by Mario Christodoulou, Accountancy Age, 22 Jul 2010.

Attempts to bring in fair value standard "almost like a religious war" board member claims.

A member of the US accounting standard setter has likened attempts to bring in fair value to a “religious war” in a speech with regulators this week.

Lawrence Smith, board member with the Financial Accounting Standards Board (FASB), made the comment in a panel discussion with US audit regulator, the Public Company Accounting Oversight Board, in the midst of a far ranging consultation on the accounting principle.

FASB is pushing ahead with plans to bring in a full fair value measurement model which would force banks to value their financial assets at market prices. The proposals are being fought by banks who argue the rules would add volatility to balance sheets.

Smith said he is not a "fair value zealot", but was swayed to the model when he saw the effect on deposits.

"That’s what threw me over the edge," he said.

“Some people have advised us that we shouldn’t say this, but I’ll say it – fair value, to some of us, is almost like a religious war out there and we are trying to deal with that as best we can.”

FASB is attempting to harmonise its accounting rules with international standards, despite clear differences in their approach to fair value. Whereas FASB’s proposal measures assets measured at fair value, the international model allows some loans to be valued at amortised cost.

The contentious proposals was passed by a single vote, with the five-member FASB board split 3-2.

Smith’s comment will likely widen the gap between FASB’s proposal and its international counterpart, the International Accounting Standards Board (IASB). Failure to reach agreement on the standard will undermine US attempts to adopt international rules.

The US Securities and Exchange Commission is currently investigating the impact of international accounting rules on US markets. A key part of their final decision will depend on the level of convergence between US and international accounting rules, with fair value being among the most important project on the table.

Acknowledging the Obvious? US Adoption of IFRS Called “Highly Uncertain"

The newly appointed chairman of the IASB trustee group has stated that US adoption of IFRS is “highly uncertain” and furthermore, that the survival of the International Accounting Standards Board may be at stake.

Padoa-Schioppa stated that the IASB’s US convergence program may end in disappointment because of the uncertainty over US adoption.

Schioppa also noted that intervention by European governments is also a threat to IFRS/IASB because political disagreements over adoption of standards in individual countries could end up with EU governments withholding funding from the IASB.

An example of the above is the delayed implementation of IFRS 9, relating to fair values of financial instruments, which was adopted virtually everywhere but Europe.
The IASB’s funding also remains an ongoing issue. Revenues dropped last year due in part to poor foreign exchange rates but also because some US private contributors themselves faced financial difficulties.

Schioppa will conduct a review of the IASB’s scope, process, governance and financing.

G20 Slows Goals for IFRS Adoption

The G20 group of countries has dropped an accelerated timetable for adoption of IFRS by June 2011.

At the recent Toronto summitt, the G20 stated that while they continue to emphasize the importance of completing a single set of high quality improved global accounting standards, they decided to relieve pressure on convergence of US and international standards by making no reference to the urgency of the project. Earlier, the G20 had called for convergence by a June 2011 deadline.

Prior to the summit, the IASB stated that some convergence projects would not make the June 2011 cut-off point.

Retailers Must Make Major Adjustments for New Lease Accounting

Accounting rules on leases are sure to change in the near future. International and U.S. standard-setters have both introduced new proposed standards are likely to be finished in 2011 and take effect in 2013.

The New York Times quotes the SEC as stating that $1.3 trillion in leases will be added to public company balance sheets.

The standards will add significant liabilities to balance sheets and may jack up expenses as well.

All leases will be affected, including those currently classified as operating leases and fully expensed as there is no grandfathering clause when the rule takes effect.

The standards require companies to record as a liability the cost of rent over the remaining term of the lease and record as an asset their right to use the space.

This could have diverse impacts, including weakening companies in the eyes of investors and activating debt covenants with lenders.

It could also affect credit ratings. Ratings agencies say they already take into consideration rent obligations by using a multiplier on operating lease payments to arrive at an estimate of capital lease obligations. However the new standard requires significant additional disclosures that could provide readers of financial statements with additional information about corporate leases, possibly not known before, and possibly damaging to credit capacity.

The thrust of the change is part of the trend to limit off-balance-sheet activity. The standard-setters received almost 300 comment letters commenting on the proposal.

Certain companies with high debt loads may be adversely affected by adding new debt to their balance sheets. Also impacted heavily will be large retailers that may have thousands of premises leases, as well as commercial banks with multiple branches. Tracking leases and analyzing them to convert them to on-balance-sheet status may be problematic.

The standards may have the impact of persuading companies to purchase rather than lease real estate, to avoid either the ongoing administrative burden of analyzing and classifying and accounting for capitalized leases, or to have more conventional and possibly lower-cost debt on their balance sheets.

Companies may also opt for shorter leases as they will have less debt on their balance sheets that if they have longer terms.

Renewal options may become less popular. The new rules require that if a company expects to execute a renewal option, they must account for the lease as if it included the option, in many cases doubling or tripling the face/undiscounted amount of the lease liabilities and adding debt to balance sheets.

Contingent rents, based on a percentage of sales will trigger additional debt as well, based on estimated sales over a lease term. Most retailers in shopping malls fall under these types of structures. Retailers forced now to estimate sales way into the future, and to reassess these estimates at every (quarterly).

On the other side of the lease arrangements, landlords will also change their accounting. Landlords would record as a liability their obligation to provide space and record as an asset the rents they expect to receive. Under the new standard the rents will be recorded partly as interest income and partly as a reduction in the obligation to provide space.

Big Revenue Recognition Changes to Come

FASB and the IASB yesterday released a proposed accounting standard that would create one harmonized revenue recognition standard for both U.S. GAAP and IFRS.

The standard claims to simplify and standardize accounting for revenue across industries and update standards to remedy inconsistencies in current standards and practices.

In keeping with the general thrust of principles-based standards, the new proposal will require more disclosures.

The proposal also includes guidance to clarify accounting for contract costs.

On its release, the proposal was cited as one of the most important and pervasive areas in financial reporting.

According to the IASB, the proposed standard “would make it absolutely clear when revenue is recognized—and why.” The core principle was explained as “a company should recognize revenue when it transfers goods or services to a customer in the amount of consideration the company expects to receive from the customer.”

The standard is expected to impact some long-term contracts, especially those using percentage-of-completion revenue recognition.

Significant changes:
1. Revenue would be recognized only from the transfer of goods or services to a customer.
2. A company would be required to account for all distinct goods or services, which could require it to separate a contract into different units of accounting from those identified in current practice.
3. Collectibility would affect how much revenue is recognized, rather than whether revenue is recognized.
4. Greater use of estimates would be required in determining both the amount to allocate and the basis for that allocation, which would better reflect the economics of a transaction.

FASB also created a chart showing the five steps a company would follow to apply the new revenue recognition proposals; see below.

The proposal is intended to apply to all contracts to provide goods or services to customers, except leases, insurance contracts and financial instruments.

Disclosures that are new under the proposal include qualitative and quantitative information about contracts with customers, including a maturity analysis for contracts extending beyond a year, and the significant judgments and changes in judgments made in applying the proposed standard to those contracts.

The deadline for comments on the proposal is Oct. 22. The final standard is expected in the second quarter of 2011. The modified convergence timeline keeps the June 2011 target end date for projects that have the most urgent needs.

Click for the full proposal or the overview and here for the podcast.

FASB, IASB to Miss G20 Convergence Deadline

The FASB and the IASB are set to announce that they will not meet the June 30, 2011 deadline for convergence with IFRS , requested by the G20.

FASB and IASB will announce changes to their convergence work plan that will delay completion by six months and allow for greater public comment on convergence proposals.

While it is not uncommon for accounting rulemakers to reset deadlines during their standard-setting process, the June 2011 deadline had been discussed by the G20 several times and is seen as particularly important in potentially moving U.S. companies to international standards.

According to Robert Herz, chair of FASB, to issue final standards by June 2011, the two boards would have to release about 10 proposals in the next two months and rush through the public comment process.

In the past FASB and IASB have redoubled their efforts toward convergence and in some cass have fast-tracked the comment process, in May the boards received letters from corporate executive groups saying they were "extremely concerned" about the quality of responses FASB and the IASB would get on more than 10 proposals for new rules by mid-2011.

While the G20 set a mid-2011 deadline for creating a single set of high-quality accounting rules, the U.S. Securities and Exchange Commission's chief accountant has said recently that the deadline should not be met at the cost of lower-quality standards.

The areas of focus are revenue recognition, leases, financial instrument accounting and financial statement presentation.

Herz said he still expects a staggered release of proposals over the next seven to nine months, meaning most or all would be released by the end of 2011.

IFRS Risk May Be Overblown

IFRS Risk: Not What You Think

The switch from U.S. generally accepted accounting principles to international accounting standards is a hot topic. But CFOs of U.S. companies are wasting time and money managing imaginary risks while completely ignoring real ones. Article by Bruce Pounder of Leveraged Logic, from CFO.com.

Today's CFO is accustomed to managing risk. But few financial executives in the United States accurately perceive or understand the emerging risks that are associated with the global convergence of financial reporting standards (convergence). As a result, CFOs across America are wasting time and money managing imaginary risks while ignoring the real risks associated with convergence in general and International Financial Reporting Standards (IFRS) in particular.

To separate real from imagined risks, let's start by looking at some of the defining characteristics of the U.S. financial reporting environment. In the United States, as in most of the developed world, private companies outnumber public companies by a ratio of roughly 1,000 to 1. But in the United States—unlike most of the developed world—private companies have no statutory financial reporting obligations. No individual, organization, or governmental agency can unilaterally require private U.S. companies to use a particular set of financial reporting standards.

In practice, private U.S. companies frequently use U.S. generally accepted accounting principles (GAAP), and there are plenty of good reasons for doing so. But many private companies follow GAAP only up to a point, disclosing deviations in their financial statements. And other private companies use alternatives to GAAP, such as cash-basis accounting, tax-basis accounting, or some "other comprehensive basis of accounting" (OCBOA). So among private U.S. companies, diversity in financial reporting standards is the norm.

The relatively small number of public companies that exist in the United States operate in a very different environment. They are subject to statutory financial reporting obligations as determined by the Securities and Exchange Commission (SEC). The SEC has the legal authority to define the financial reporting standards that companies under its jurisdiction must or may use.

Since its inception, the SEC has relied on nongovernmental standard-setting organizations to set financial reporting standards for its regulants. Currently, the SEC looks to the Financial Accounting Standards Board (FASB) to set the financial reporting standards that the SEC requires public U.S. companies to adhere to. In some cases, the SEC has supplemented or overridden standards set by nongovernmental standard-setters, but for more than 70 years, public companies in the United States have had to use U.S. GAAP as set by the FASB and its predecessors for statutory financial reporting purposes.

IFRS and Convergence
IFRS is a specific, existing set of financial reporting standards that are developed and maintained by the International Accounting Standards Board (IASB). At the standard level, IFRS and U.S. GAAP exhibit a number of similarities-and a far greater number of differences. There are significant similarities and differences in their conceptual underpinnings as well.

As a nongovernmental organization, the IASB has no authority to compel any country to require or permit the use of IFRS. Nor does the IASB have any authority to compel any individual company to use its standards. In short, only by developing and maintaining a set of standards that at least some countries and companies perceive as being superior to alternatives (such as U.S. GAAP) has the IASB achieved widespread adoption of IFRS throughout the world.

Set-level convergence occurs when countries and/or companies stop using country-specific financial reporting standards and start using the same set of country-neutral standards, as has been the case with the adoption of IFRS outside of the United States. But standard-level convergence has also occurred in parallel with set-level convergence. Since 2002, the FASB and IASB have been working together to converge U.S. GAAP and IFRS at the standard level, and the global financial crisis has brought even greater pressure on the Boards to make further progress.

For the most part, the boards are developing new, common standards designed to replace existing standards in U.S. GAAP and IFRS. And in most cases, the standards under development differ significantly from the standards in either U.S. GAAP or IFRS today.

Imagined Risks
Many U.S. CFOs have been led to believe that their companies, at some point in the relatively near future, will be forced to switch from using U.S. GAAP, as we know it today, to using IFRS, as we know it today. On top of being concerned about the cost and effort that would likely accompany such a switch, U.S. CFOs have been bothered by the seeming uncertainty with regard to the timing of such a switch.

The responses of U.S. CFOs about their beliefs have been mixed. Some have invested time and money in voicing opposition to such a switch. Others have demanded more certainty in the timing, assuming that they'll commit resources to the switch once they get a "date certain." Still others, sensing both inevitability and imminence, have begun to study current IFRS and assess the impact of converting from current U.S. GAAP to current IFRS. But all of these represent responses to imagined risks, not real ones.

Having devoted a significant portion of my career to understanding the impact of IFRS and the phenomenon of convergence from a U.S. perspective, I am convinced that the likelihood that any U.S. company will be forced to switch from using today's version of U.S. GAAP to today's version of IFRS is absolutely zero. So to me, protesting such a switch is pointless. Insisting on knowing when the switch will take place is pointless, too. And preparing for such a switch-well, that "takes the cake" in terms of pointlessness.

What's the Evidence?
What evidence is there that U.S. companies will never be forced to switch from using U.S. GAAP as we know it today, to using IFRS as we know it today? Consider the following:
• For more than 99% of the companies in the United States (i.e., private companies), no individual, organization, or governmental agency can unilaterally require them to use any particular set of financial reporting standards. Many of those companies don't even use U.S. GAAP now. So will private U.S. companies be forced to switch from U.S. GAAP to IFRS? Absolutely not.
• For the less-than-1% of U.S. companies that fall under the jurisdiction of the SEC, the SEC has made it crystal clear that they won't even consider such a switch until there are fewer differences between U.S. GAAP and IFRS — that is, until the FASB and IASB make further substantial progress on converging the two sets of standards at the standard level. So will public U.S. companies be forced by the SEC to switch from current U.S. GAAP to current IFRS? Absolutely not. And if the SEC eventually decides to require public U.S. companies to switch from future U.S. GAAP to future IFRS, the switch will be a relatively trivial undertaking in contrast to a switch today.
•In the United States, we've generally been content to adhere to standards that everyone else in the world adheres to — as long as we set the standards. The thought of ceding global standard-setting authority to an organization that we can't "control" is, to most Americans (especially American politicians), unthinkable. So will any U.S. company be forced to follow standards set by the IASB as it is currently governed? Absolutely not.
•Investors, lenders, and other principal users of the financial statements of U.S. companies have expressed no interest in seeing those companies switch to IFRS. So are "market forces" suddenly going to compel a switch? Absolutely not.

Real Risks
Just because your company won't be forced to switch standards doesn't mean you're immune from the impact of IFRS and convergence. In fact, the real risks are far more numerous and more significant for U.S. CFOs than the imaginary risks that I've debunked. They include:

• Both U.S. GAAP and IFRS will undergo profound change as the FASB and IASB replace existing standards with common standards that bear little resemblance to current rules. Private companies that stick with U.S. GAAP, as well as public companies that are stuck with U.S. GAAP, are in for a wild ride. (If it's any consolation, so are companies that continue to use IFRS.)
• A recently formed "blue-ribbon" panel is currently examining whether it would be appropriate to decouple the standard-setting process for private U.S. companies from the standard-setting process for public U.S. companies. The likely result of the panel's efforts is that private U.S. companies will have even more and better choices of financial reporting standards beyond just future U.S. GAAP and future IFRS. A private company that fails to take advantage of new alternatives may find itself at a disadvantage to competitors that embrace them.
• With few exceptions, college accounting programs and our continuing education system for working professionals are woefully unprepared to maintain a workforce competent in U.S. GAAP given the expected pace and degree of change.
• U.S. companies subject to multiple national statutory financial reporting obligations are likely to have to adopt IFRS in addition to — not instead of — U.S. GAAP. This is a much different challenge than switching from one set of standards to the other, especially given that both U.S. GAAP and IFRS will change rapidly and profoundly in the years to come.

Bottom Line
The risk-management implications for U.S. CFOs are clear:
• Stop preparing for a switch from current U.S. GAAP to current IFRS.
• Start preparing for the roller-coaster ride that sticking with U.S. GAAP will become.
• If you work for a public company, stop worrying about when then switch from future U.S. GAAP to future IFRS will take place. If it takes place, it won't happen anytime soon and won't be nearly as big a deal as if the switch were to take place tomorrow.
• If you work for a private company, be on the lookout for additional options in financial reporting standards as they emerge.
• If your company is subject to statutory financial reporting obligations in multiple countries, get ready to start keeping a set of IFRS books in addition to keeping U.S. GAAP books.

We Knew it All Along: Rules Based = Protection

GAAP's Lawsuit Buffer

The rules-based nature of U.S. generally accepted accounting principles may actually discourage shareholder lawsuits, says a new study

The debate over whether principles-based accounting standards are better than rules-based standards has divided many accountants, and stymied regulators who want to move U.S. accounting toward less-prescriptive guidance.

One argument against that nearly decade-long push has been that moving away from bright lines and layers upon layers of rules (as is characteristic of U.S. generally accepted accounting principles) would lead to more class-action lawsuits from shareholders second-guessing companies' accounting decisions. Because standards more reliant on principles (such as international financial reporting standards, or IFRS) give users more room to make judgment calls, observers worry that adopting such standards will open companies up to more Monday-morning quarterbacking by auditors, regulators, and the plaintiffs' bar.

Indeed, it's long been assumed that adopting principles-based standards would raise companies' litigation risk. For instance, in a 2003 report encouraging a move toward more "objectives-oriented rules," the Securities and Exchange Commission said a new system would carry with it "litigation uncertainty." At the time, the commission argued that litigation exposure could be minimized by companies and their auditors properly documenting the reasoning behind their judgment calls under a principles-based system.

Now, three university professors have gathered empirical evidence suggesting that litigation is indeed an issue in the principles-versus-rules discussion. Their study, "Rules-Based Accounting Standards and Litigation," suggests that companies that violate rules-based standards have a lower likelihood of getting sued than those that are accused of violating more-principles-based standards.

The professors looked at securities class-action suits alleging GAAP violations filed between 1996 and 2005, as well as 84 restatements made during that same time frame that did not result in litigation. Rather than judge GAAP as a whole as a rules-based system, they considered the prescriptiveness of the standards mentioned in each case, based on four characteristics: level of bright-line thresholds, exceptions, implementation guidance, and detail.

The standards were measured on a "rules-based continuum" scale running from zero to four, with zero denoting the most principles-based standards and four indicating the most rules-based standards. Accordingly, the standard for contingent liabilities, which requires judgment calls, scored zero, while accounting for leases scored four.

However, the professors shied away from concluding whether the adoption of more-principles-based standards as a whole in the United States would invite more lawsuits for American companies. The unique litigation system of this country, as well as the more litigious nature of the society, makes it difficult to directly compare the U.S. system with that of Europe or beyond, they say.

Still, over time, IFRS could become more rules-based if demands for carve-outs and additional guidance continue as they have in the United States, says study co-author John McInnis, an assistant professor at the University of Texas at Austin. "Even if we adopt a more principles-based system, I'm not sure it would stay that way," he says. Rather, the professors believe their study provides a building block for U.S. regulators and other researchers to consider as the merits of adopting IFRS continue to be weighed. (The SEC plans to decide next year whether to require U.S. companies to make a switch to the global rules, starting in 2015.)

For now, apparently, GAAP and its inherent complexity give U.S. companies a defense against lawsuits by allowing them to "shield themselves behind the rules," says McInnis. "If you follow the rules, it appears that you are protected."

Shareholders have the burden of proving that a GAAP violation was intentional, not an easy task when many layers of rules provide many opportunities for mistakes. "We find that firms are less likely to be sued when they violate standards that are more rules-based, consistent with the view that the complexity of rules-based standards provides a credible 'innocent misstatement' presumption," the professors wrote.

The professors acknowledge several limitations of their research. Among them is the fact that it's not possible to observe initial shareholder claims that lawyers drop before submitting them into the court system. Also unanswerable is whether a more principles-based system would lead to fewer restatements, which often trigger shareholder lawsuits in the United States if they affect the stock price.

article by Sarah Johnson at CFO.com

"Own Credit" Liability Rules Explained

What is the own credit issue?

The accounting effect of changes in the credit risk of a financial liability is referred to “own credit”.

Changes in a financial liability’s credit risk affect the fair value of that financial liability. This means that when an entity’s creditworthiness deteriorates, the fair value of its issued debt will decrease (and vice versa). For financial liabilities measured using the fair value option, this causes a gain (or loss) to be recognized in the P&L.

Many investors find this result counter-intuitive and confusing.

This was confirmed in responses to the IASB’s June 2009 discussion paper Credit Risk in Liability Measurement and in the user questionnaire on own credit that the IASB issued as part of its outreach activities.

The IASB undertook outreach on the issue of own credit in preparation for the publication of this ED, including discussions with preparers, audit firms, regulators and investors.

What did investors tell the IASB?--Extensive input was obtained from investors, including a questionnaire to which there were more than 90 responses. Whilst there was a range of responses, in general investors confirmed that:

• P&L volatility caused by own credit does not provide useful information (except for derivatives and liabilities held for trading);
• they did not want us to develop a new measurement method; but • information on the effects of own credit can still be useful.

In response to the input received, the ED proposes a limited change that addresses the issue of own credit for financial liabilities that an entity chooses to measure at fair value by introducing a two-step approach.

The two-step approach proposed in the ED would address the P&L volatility arising from own credit as follows:
• the fair value change of liabilities under the FVO would be recognized in P&L;
• the portion of the fair value change due to own credit would be reversed out of P&L and recognized in other comprehensive income.

Current Requirement
Income statement (P&L)
Liabilities under fair value option
100 total change in fair value
100 Profit for the year
===================

Proposed Two-Step Approach
Income statement (P&L)
Liabilities under fair value option
100 Step 1 – Total change in fair value
(10) Step 2 – Change in fair value from own credit
90 Profit for the year
===================

Statement of comprehensive income
Liabilities under fair value option
10 Step 2 – Change in fair value from own credit
===================

No other changes are proposed for financial liabilities.

The current requirements for the measurement of financial liabilities would not be changed in any other way.

Importantly, the current requirements to split structured debt into a ‘vanilla’ instrument measured at amortized cost and a derivative component measured at fair value (bifurcation) would remain. As a result, those who prefer to bifurcate financial liabilities when relevant could continue to do so.

P&L volatility will no longer result from changes in own credit while information on own credit will still be available for investors.

IASB Restricts Gains form "Own Credit" Changes

Previous posts in this blog have noted that current accounting rules on financial instruments have a counter-intuitive result when a company’s credit rating is lowered. In theory, any liability should be recorded on a company’s books at the amount that is reasonably expected to be paid. If the liability is to be paid over the long-term, it should be discounted. The amount od a discounted liability on a company’s balance sheet would vary as the discount rate change. The discount rate reflects the risls associated with the liability, and as the risks increase, so does the discount rate. A higher discount rate means a lower liability. The company then reduces the liability (debit to liability) and to balance the books, requires a credit entry, which results in a gain to a company’s income statement. And that I show the counterintuitive result occurs—a drop in a company’s credit rating means a gain in earnings.

The liability treatment follows asset treatment—for example if a company thought that a debt was uncollectible, it would write the debt down to what it thought it would recover. So that the principle of fair value is maintained across the balance sheet, the same theory applies to liabilities.

The International Accounting Standards Board (IASB) has proposed changing the way banks measure their liabilities so they can no longer book the gain noted above and confuse investors after a ratings downgrade.

The IASB acknowledged that there are theoretical arguments for treating financial assets and liabilities in the same way, it is hard to defend the accounting as providing useful information when a company suffering deterioration in credit quality is able to book a corresponding gain.

The "counter intuitive" rule angered policymakers during the financial crisis when profits were being booked by banks despite ratings downgrades"

The proposal is part of an overall revamp of the IASB's fair value or marking to market rule which will be finalized by the end of this year but it is unclear when it comes into force.

HSBC Europe's biggest bank, recently reported that It had both a $5 billion hit from bad debts on U.S. home loans and asset writedowns while at the same time recording a fair value gain of $2.7 billion on its own debt during the period due to a widening in credit spreads.

Earlier in May, UBS recorded a gain of 2.1 billion Swiss francs ($2 billion) due to the widening of its own credit spread.

The debate about whether banks should allow for fair value gains on liabilities is not new, but has assumed fresh importance after a hugely volatile first quarter in credit markets, which saw bank debt trading at a discount in some cases to non-financial bonds.

Some analysts argue that if banks are taking mark-to-market losses on their assets and on hedging instruments, they should also be allowed to account for gains on their liabilities even if the underlying credit quality has not changed.

One of the practical problems with the theoretical approach noted above , however, is that a bank is unlikely to repay the debt early. A bank would usually wait until the debt matures and then buy it back at par.

AICPA Releases White Paper on Systems Impact of IFRS

The AICPA has published a white paper to provide awareness to the potential impact to an organization’s financial systems when completing an IFRS conversion project.

System Benefits of Conversion
The paper states that key benefits include opportunities to improve/ streamline business functions and processes, globally integrate the financial IT systems, and achieve consolidation/ reporting efficiency. On the other hand, there are risks associated when a company decides to convert to IFRS. Some of these risks are excessive resource spending, improper data management or migration, incomplete revisions of policies and procedures, future changes that standard setters may issue, and more.

Potential System Impacts of an IFRS Conversion
As a company prepares to convert to IFRS, the impact to information technology (IT) and financial systems should be taken into consideration during the planning phase. Representatives from the company’s IT department should be involved throughout the planning process to evaluate how the proposed accounting changes will impact the financial systems (transactional or reporting). The impact to IT and financial systems can vary depending on a company’s existing structure and environment. This may include its IT and financial systems capability/integration, industry complexity, company size, relevance of business process/transaction, internal control structure, mergers & acquisitions process, and other attributes.

If a company’s IT and financial systems are substantially integrated globally, then the degree of impact or modifications may be lower (although this is not always the case). The extent of changes may be primarily some sub-ledger configuration changes and more extensively in the general ledger and consolidation system. However, if a company has frequently acquired entities (each with unique financial systems) and has not yet integrated the acquired company systems within the organization’s infrastructure, then the degree of system impact may be quite large at the sub-ledger level as well as the internal reporting level.

XBRL and IFRS
Extensibility of XBRL taxonomies and the possibility to support additional reports that share the same underlying data are represented by XBRL taxonomies, either publicly available or developed internally. This provides opportunities for businesses to build on this standards-based data integration, reconciliation and convergence approach to support other key processes like internal reporting — business intelligence, tax compliance, management reporting — or internal auditing and controls. Another key consideration in this respect is that the implementation of this approach does not require the replacement of the existing systems; rather, it complements them by providing incremental functionalities that would otherwise require a substantial investment in the corporate IT environment.

Have a look at the white paper here.

Panel: Minimal Impact from IFRS

From CFO.com

If the Securities and Exchange Commission decides to force American companies to abandon U.S. generally accepted accounting principles in favor of international financial reporting standards, how will investors react? They will be "underwhelmed," says Aaron Anderson, director, IFRS policy and implementation at IBM. Anderson made the prediction on Tuesday at an accounting conference sponsored by Pace University's Lubin School of Business.

"When I look at the impact on IBM and compare it to whether investors will care, frankly, I don't think they will," said Anderson, one of four executives participating in a panel discussion on global accounting standards. He pointed out that if the company moves all of its financial reporting to IFRS — and some of its foreign subsidiaries are already reporting under the international standards — the change wouldn't be material in areas that investors "care about," such as service contracts and product backlog, which are "numbers that are not reported in GAAP, anyway."

Panelist Linda Mezon, chief accountant at The Royal Bank of Canada, said whether or not changing to IFRS will be material "depends on where you are coming from." RBC is "in the thick" of converting to IFRS, she said, as Canada has already mandated the switch. Using international standards to account for revenue, for example, won't produce any material differences at RBC, but likely will have a big effect on how the bank accounts for financial instruments, said Mezon.

Mezon recalled that when the European Union called for a switch to IFRS in 2005, the conversion caused banks to rework the way they booked derivatives, "so the balance sheet changed significantly" in terms of the transition adjustments. In some cases, those balance-sheet changes affected capital, she said, and "in the banking industry, capital is pretty much everything." Mezon said she is also keeping an eye on how adopting IFRS may change accounting for loan losses, an issue that will be dealt with in upcoming draft rules.

Jack Klingler, director of accounting research and IFRS implementation at Alcoa, agreed that the impact of IFRS would vary by industry. For his company, international standards pertaining to inventory valuation, research and development costs, and pensions may result in major adjustments, he said. In particular, Klingler said that Alcoa won't bless a conversion to IFRS until issues around inventory accounting are settled. Currently, Alcoa and other U.S. companies receive a tax benefit from using the last-in, first-out (LIFO) accounting method, which is banned by IFRS. Being forced to dump LIFO could cost those companies significant cash tax payments.

Alcoa executives are also concerned with understanding how hedging rules will change, said Klingler, since the company is a commodities supplier. However, "everything else will be small numbers" with respect to accounting adjustments, he said.

For international banking giant HSBC, which already adopted IFRS for its year-end 2005 consolidated financial statements, a major benefit of the accounting switch is cost reduction, said the bank's chief accountant, John McGinnis. Reporting U.S. results in IFRS would produce significant efficiencies for the bank, he said, because it would be able to "file under one set of standards."

IBM's Anderson noted that converting to IFRS would be an opportunity to take a new look at some old processes. He said IBM may be able to create new global shared-service centers for accounting by moving the whole company to IFRS, or perhaps institute accounting policies (such as a standard goodwill impairment test) that are currently impossible to implement, because subsidiaries are following local GAAPs. Such moves could lead to "greater efficiencies and stronger controls," he said.

The cost of conversion is another sticking point for companies opposing a move to IFRS. Anderson conceded that switching to international standards will require "a lot of work," but added that IBM, which has already started the process of preparing for a switch, knows "within a tight range" what it will cost — and in relative terms, "it won't be very much."

Test Your Knowledge of IFRS

This test is from the Journal of Accountancy

More than 100 countries around the world, including all major U.S. trading partners, now use or have committed to adopting IFRS. Nearly as many use international auditing and assurance standards and international ethics standards developed by independent standard-setting boards under the International Federation of Accountants. To ensure that CPAs have a basic competence in these standards, the AICPA Board of Examiners has decided to test them in three of the four sections of the exam beginning in 2011.

Although the board does not disclose specific weightings at the topic level, it has made clear that it expects exam takers to exhibit adequate competence in international standards in much the same way that they should exhibit competence in U.S. GAAP and GAAS.

The board’s decision to include international standards is not contingent on action by the SEC to require or allow U.S. public companies to report under IFRS, according to senior AICPA exam staff. Rather, it reflects the reality of the interconnectedness of world economies and its impact on organizations operating in the U.S.

Below are sample IFRS questions disclosed by the board in February.

1. Under IFRS, changes in accounting policies are
A. Permitted if the change will result in a more reliable and more relevant presentation of the financial statements.
B. Permitted if the entity encounters new transactions, events, or conditions that are substantively different from existing or previous transactions.
C. Required on material transactions, if the entity had previously accounted for similar, though immaterial, transactions under an unacceptable accounting method.
D. Required if an alternate accounting policy gives rise to a material change in assets, liabilities, or the current-year net income.

2. Under IFRS, an entity that acquires an intangible asset may use the revaluation model for subsequent measurement only if
A. The useful life of the intangible asset can be reliably determined. B. An active market exists for the intangible asset.
C. The cost of the intangible asset can be measured reliably.
D. The intangible asset is a monetary asset.

3. Under IFRS, which of the following is a criterion that must be met in order for an item to be recognized as an intangible asset other than goodwill?
A. The item’s fair value can be measured reliably.
B. The item is part of the entity’s activities aimed at gaining new scientific or technical knowledge.
C. The item is expected to be used in the production or supply of goods or services.
D. The item is identifiable and lacks physical substance.

4. An entity purchases a trademark and incurs the following costs in connection with the trademark:

One-time trademark purchase price
$100,000
One-time trademark purchase price
5,000
Nonrefundable VAT taxes
7,000
Training sales personnel on the use of the new trademark
24,000
Research expenditures associated with the purchase of the new trademark
10,500
Salaries of the administrative personnel
12,000

Applying IFRS and assuming that the trademark meets all of the applicable initial asset recognition criteria, the entity should recognize an asset in the amount of
A. $100,000
B. $115,500
C. $146,500
D. $158,500

5. Under IFRS, when an entity chooses the revaluation model as its accounting policy for measuring property, plant and equipment, which of the following statements is correct?
A. When an asset is revalued, the entire class of property, plant and equipment to which that asset belongs must be revalued.
B. When an asset is revalued, individual assets within a class of property, plant and equipment to which that asset belongs can be revalued.
C. Revaluations of property, plant and equipment must be made at least every three years.
D. Increases in an asset’s carrying value as a result of the first revaluation must be recognized as a component of profit or loss.

6. Upon first-time adoption of IFRS, an entity may elect to use fair value as deemed cost for
A. Biological assets related to agricultural activity for which there is no active market.
B. Intangible assets for which there is no active market.
C. Any individual item of property, plant and equipment.
D. Financial liabilities that are not held for trading.

7. Under IFRS, which of the following is the first step within the hierarchy of guidance to which management refers, and whose applicability it considers, when selecting accounting policies?
A. Consider the most recent pronouncements of other standard- setting bodies to the extent they do not conflict with the IFRS or the IASB Framework.
B. Apply a standard from IFRS if it specifically relates to the transaction, other event, or condition.
C. Consider the applicability of the definitions, recognition criteria, and measurement concepts in the IASB Framework.
D. Apply the requirements in IFRS dealing with similar and related issues.

8. On January 1, year 1, an entity acquires for $100,000 a new piece of machinery with an estimated useful life of 10 years. The machine has a drum that must be replaced every five years and costs $20,000 to replace. Continued operation of the machine requires an inspection every four years after purchase; the inspection cost is $8,000. The company uses the straight-line method of depreciation. Under IFRS, what is the depreciation expense for year 1?
A. $10,000
B. $10,800
C. $12,000
D. $13,200

9. On July 1, year 2, a company decided to adopt IFRS. The company’s first IFRS reporting period is as of and for the year ended December 31, year 2. The company will present one year of comparative information. What is the company’s date of transition to IFRS?
A. January 1, year 1.
B. January 1, year 2.
C. July 1, year 2.
D. December 31, year 2.

10. A company determined the following values for its inventory as of the end of its fiscal year:

Historical cost
$100,000
Current replacement cost
70,000
Net realizable value
90,000
Net realizable value less a normal profit margin
85,000
Fair value
95,000

Under IFRS, what amount should the company report as inventory on its balance sheet?
A. $70,000
B. $85,000
C. $90,000
D. $95,000

Answers: 1) A; 2) B; 3) D; 4) B; 5) A; 6) C; 7) B; 8) D; 9) A;10) C

SEC's Kroeker: Slower Covergence between GAAP, IFRS Possible

While FASB and the IASB work to complete an unprecedented 11 standards over the next 14 months, SEC Chief Accountant James Kroeker told the Journal of Accountancy this week that he would support the boards’ cutting the number of projects due in June 2011, provided there was good rationale for a delay.

“June 30, 2011, is an arbitrary deadline and it’s not one that’s been put in place by the SEC or by our road map,” said Kroeker. Citing FIN 46(R) as an example of an accelerated project that later needed to be reworked, Kroeker said that what’s most important is to ensure through the exposure process that the final standards are a “long term, sustainable solution.”

Kroeker made his comments in a JofA exclusive interview at the Pace University Lubin Forum on Contemporary Accounting Issues held Tuesday in New York.

Financial instruments and lease accounting are the two projects Kroeker suggested should remain atop the boards’ priority list. Others, such as financial statement presentation, could be completed through a more gradual process, he said.

Asked specifically about revenue recognition, Kroeker said that while he could see room for improvement to the industry-specific approach in U.S. GAAP, he didn’t see revenue recognition as the highest priority right now.

Kroeker said that although he doesn’t see convergence as the only potential path for IFRS to become sufficiently developed and consistent in application for use as the single set of accounting standards in the U.S. reporting system, convergence is “critical for these projects.”

When asked about the SEC staff’s IFRS work plan, unveiled in February, Kroeker emphasized that the SEC staff will be providing public updates on its progress, with the first report due out by October. He said that rather than setting “go or no-go” thresholds, the work plan’s intent is to compile a body of knowledge from which the SEC staff can make sound recommendations to the commission.

FASB, IASB Convergence Progress Report

The IASB and the FASB published a report detailing their progress toward convergence of U.S. GAAP andIFRS.

The two boards sped up their work on convergence last fall with the goal of making significant progress by June 2011. Instead of meeting every four months, the two boards have held 10 joint meetings totaling more than 100 hours of discussions since the fall agreement.

As of March 31, 2010, FASB and the IASB report that they have met substantially all of the milestone targets they had set for the first quarter of 2010. They are on track to publish exposure drafts this year for five major projects that would improve and achieve substantial convergence of U.S. GAAP and IFRS, including consolidations, revenue recognition, financial instruments with the characteristics of equity, and financial statement presentation.

However, on two major projects, financial instruments and insurance contracts, the two boards admitted they are at loggerheads and have reached different conclusions on some important technical issues. The boards also agreed in late March to look at lease accounting, which is a messy topic and which could affect the timing of convergence.

The revised schedule includes publication of about ten exposure drafts in the first half of 2010. Final standards are expected by 2011 for revenue recognition. leasing, insurance, debt vs equity, consolidations, and financial statement presentation.

Corrupt Regime Reform Through Accounting?

Proposed accounting rules included in a discussion paper on extractive industries may force mining and oil companies to publish how much spend in foreign countries, including payments to corrupt regimes.

The International Accounting Standards Board (IASB) yesterday released a discussion paper which may force companies involved in extractive industries to break down their costs and revenue on a country-by-country basis, and publish the figures in their financial statements.

The paper suggests investors and capital providers may want to know about the risks to reputation and income of working in resource-rich and sometimes corrupt nations.

Required disclosures are the significant components of the total benefit streams to governmentand its agencies on a country-by-country basis. At a minimum, this would include separate disclosure of:

• royalties and taxes paid in cash

• royalties and taxes paid in kind (measured in cash equivalents)

• dividends

• bonuses

• licence and concession fees.

The IASB expects that investors would want to know these amounts to assess what is at risk in each country. another benefit might be that excessive payments could disclose hidden payments otherwise considered ilegal.

The IASB must justify new accounting rules by how useful they will be for investors, capital providers and other market participants.

At the moment, multi-national mining and oil companies aggregate their costs and revenue data which makes it difficult to distil how much they pay individual governments. Breaking the data down to a “country-by-country” basis could expose corruption and provide useful market information, according to the IASB’s discussion paper.

“Generally speaking, the greater the level of corruption, the greater the investor’s concern about the integrity of the government and its commitment to honour existing terms and conditions relating to an entity’s operations in that country,” the discussion paper states.

“The disclosure of payments made to governments provides information that would be used by at least some capital providers in making their investment decisions, either by using the information to make their own assessments of investment risks and reputational risk or by providing better information to other risk analysts that advise the capital providers on investment and reputational risks.”

New Thoughts on Goodwill Impairment Testing

New thoughts on goodwill impairment testing by Marie Leone of CFO.com

Over two-thirds (68%) of U.S. public companies in the United States wrote down goodwill by taking impairment charges in 2008. Total charges were $260 billion according to a report issued by financial advisory firm Duff & Phelps and the Financial Executives Research Foundation. The report examined 2008 financial statements of nearly 6,000 publicly held companies.

As 2009 results are being filed it appears that goodwill write-downs have declined., says Greg Franceschi, who heads up the global financial reporting practice for Duff & Phelps. Since the worst of the financial crisis ended, company market values have increased and accordingly there are fewer goodwill write-offs.

However a new accounting wrinkle has surfaced related to goodwill impairments. At issue is whether companies should determine the fair value of a reporting unit — and thereby the value of the related goodwill — based on either the unit's equity value or its enterprise value. (In general, enterprise value is the sum of the fair value of debt and equity.)

The question was sparked by a December speech given by Evan Sussholz, an accounting fellow in the Office of the Chief Accountant at the Securities and Exchange Commission. In his speech, Sussholz suggested that in certain situations, using an enterprise-value measurement may provide a more economically accurate picture of the reporting unit. His suggestion left preparers and auditors clamoring for a clarification, as companies have historically applied the equity-value approach to impairment testing, says PricewaterhouseCoopers partner Larry Dodyk.

In response, the Financial Accounting Standards Board and the American Institute of Certified Public Accountants have launched efforts to figure out whether additional guidance on the subject is needed. FASB's emerging issues task force is slated to start discussing potential guidance during the second half of the year, while the AICPA is currently working on completing a practice aid, which is a sort of unofficial manual that discusses best practices and concepts that auditors and preparers may want to apply.

Under U.S. GAAP, companies must perform a goodwill impairment test at least once a year to determine if the current value of an acquired reporting unit is worth more or less than its original price. The test is a two-step process in which the company must first compare the fair value of a reporting unit with its original price — the amount the company carries on its books. If the book value exceeds the fair value, then the asset is impaired and a second step is required to measure the amount of the impairment. If the book value is lower than the unit's fair value, then the asset passes the test and nothing more is required.

The confusion over whether to use equity value or enterprise value stems from the seemingly straightforward first step of the test, because the accounting rule is unclear. Sussholz said that originally, the SEC didn't believe the selection of one approach over the other would affect the test outcome. However, since taking a closer look at the practical implications, SEC staffers have acknowledged one unanticipated situation that is a potential problem: when the book value of a reporting unit measured at the equity level is negative.

Intuitively, it might seem that a negative book value would mean a reporting unit is on the verge of bankruptcy, but that may not be the case. Dodyk explains that a single reporting-unit company, for example, may have negative shareholders' equity as a result of unrecognized assets (such as intangibles) that have significant value but don't figure into the equity equation. Heavy borrowing for a leveraged buyout could also send shareholders' equity into negative territory.

Consider what happens in an equity-value impairment test when a reporting unit's book value is negative. By definition, the fair value of common equity cannot be less than zero, because the equity is essentially a call on the company's operations. That means the fair value of a reporting unit measured at the equity level would always be greater than a negative book value, and therefore always pass step one of the impairment test. That would be the case even if significant goodwill exists and the underlying operations of the reporting unit "may be deteriorating," asserted Sussholz.

On the other hand, says Franceschi, testing for impairment at the enterprise level would include the reporting unit's debt burden, providing what Sussholz claimed was a more accurate picture of the company's financial health. To be sure, his speech opened up the possibility that another testing approach may be permitted or required.

Franceschi doesn't believe the additional guidance will cause a significant increase or decrease in goodwill write-offs. But it may require companies to rethink valuation models and approaches, especially if the guidance recommends that companies use more judgment when determining a reporting unit's fair value. "For valuation issues, you can never have something that says, 'This is the way to do it, and the only way to do it,'" he says. "There may be multiple approaches one needs to consider."

Another concern with tinkering with Topic 350 is that it may spark other changes. "Once you open the rules to the goodwill impairment test, you never know where it is going to go," says Dodyk.