Wednesday, December 19, 2012

2012 AICPA National Conference on Current SEC and PCAOB Developments

The AICPA Conference summaries are always a source of information that will keep companies out of trouble in financial reporting.

Following is Ernst & Young's brief summary of their longer documnet.
Representatives of the SEC, the Public Company Accounting Oversight Board (PCAOB), the FASB and the IASB shared their views on various accounting, auditing, and reporting issues at the three-day AICPA National Conference on Current SEC and PCAOB Developments (Conference) in December 2012 in Washington D.C.
Highlights of their comments included: 
  • The SEC is continuing to evaluate whether further analysis relative to whether and, if so, when and how to incorporate IFRS into the US financial reporting system is necessary. SEC officials advised stakeholders to “stay tuned.” Various SEC and FASB speakers discussed the importance of the US setting its own accounting standards while continuing to work with the IASB to improve comparability and narrow differences in the standards.
  • Various speakers commended the outreach performed by the FASB and IASB and their progress on the convergence projects. Several speakers focused on the need for coordination when developing implementation guidance (e.g., on revenue recognition). Speakers from the FASB stressed the need for timely interpretive guidance to help during implementation and post-implementation.
  • SEC and PCAOB officials stressed the importance of audit quality to the capital markets and the relevance of inspection findings, particularly findings pertaining to internal control over financial reporting (ICFR). Some inspection findings could have implications for preparers in their own evaluations of ICFR. PCAOB officials also said they are considering feedback on mandatory audit firm rotation while taking other steps to improve auditor independence, objectivity and professional skepticism.
  • The SEC staff discussed year-end financial statement considerations and the staff’s areas of focus in its reviews of filings, including revenue recognition disclosures, the valuation of deferred tax assets and observations related to the new fair value disclosures.
  • Various panelists commented on the need to evaluate disclosure requirements, particularly the dividing line between the footnotes to the financial statements and the rest of the financial reporting package (e.g., MD&A). SEC Acting Chief Accountant Paul Beswick said he plans to host a roundtable in 2013 to better understand these concerns.
EY's publication, 2012 AICPA National Conference on Current SEC and PCAOB Developments, discusses the Conference in detail.

Tuesday, December 18, 2012

Future of IFRS

Recently the IASB published a paper on its future priorities.

In their “feedback statement”, the IASB lists input it received from the public on the future of IFRS. They organized the responses into five broad themes from the more than 240 comment letters it received. 
  1. Provide a period of calm after a decade of almost continuous change in financial reporting.
  2. Prioritize work on the Conceptual Framework, which would provide a consistent and practical basis for standard setting.
  3. Make some targeted improvements in the needs of new adopters of IFRS.
  4. Pay greater attention to the implementation and maintenance of the Standards.
  5. Improve the way in which the IASB develops new standards, by conducting more rigorous cost-benefit analysis and problem definition earlier on in the standard-setting process. 
The Board also set out five priority near-term research projects. These are:
• Emissions Trading Schemes;
• Business Combinations under Common Control;
• Discount Rates;
• Equity Method of Accounting;
• Intangible Assets; Extractive Activities; and Research & Development Activities;
• Financial Instruments with the Characteristics of Equity;
• Foreign Currency Translation;
• Non-financial Liabilities (amendments to IAS 37); and
• Financial Reporting in High Inflationary Economies.
You can read the full report here.

Monday, December 17, 2012

Disclosure Overload: FASB Project Comments

A lot of recent commentary exists on the subject of disclosure overload.
Recently the FASB has begun to focus on this topic. "Streamlining Disclosures" has become subject of various initiatives, including a recent round-table discussions this conducted by FASB and the Center for Audit Quality.
FASB has also initiated a Disclosure Framework project "to improve the effectiveness of disclosures in notes to financial statements by clearly communicating the information that is most important to users of each entity’s financial statements. Although reducing the volume of notes to financial statements is not the primary focus, the Board hopes that a sharper focus on important information will result in reduced volume in most cases."
"Boilerplate" and non-material disclosure have been said to be "noise" that obscures the real information that readers of financial information really need.
FASB published an Invitation to Comment (ITC) on this topic last July 12. They asked stakeholders to comment on whether and how disclosures in the footnotes to financial statements can be made more effective. The comment period ended Nov. 16.

Some of the questions:
  • Do the decision questions in this chapter and the related indicated disclosures encompass all of the information appropriate for notes to financial statements that is necessary to assess entities’ prospects for future cash flows?
  • Do any of the decision questions or the related indicated disclosures identify information that is not appropriate for notes to financial statements or not necessary to assess entities’ prospects for future cash flows?
Commentors said unnecessary disclosures can prevent users from finding the information they need, obscure the real information and waste prepares' time, money, and create undesirable environmental outcomes, i.e. too much paper.  
The FASB received 83 comment letters. Some comments: 
  • Issuers should only provide relevant disclosures
  • Disclosures should have a narrower focus that "could be useful to investors"
  • Concern over the risk of litigation or regulatory action because preparers omit information previously provided. 
  • Avoid using the term "relevance" 
  • Watch the SEC's requirements, i.e. no point to reducing GAAP disclosures if the SEC imposes more specific requirements
  • "The uses of boiler plate disclosures and reliance on checklists have inundated both the public and private sector as the volume and complexity of reporting requirements have increased significantly over the years. We believe having the flexibility to apply professional judgment will substantially reduce unnecessary disclosures."
  • "We believe that preparers' judgment should instead be focused on what is material to the company based on a set of flexible disclosure requirements. Enabling flexibility, based upon materiality, would result in the right balance of providing relevant information while maintaining comparability."

  • "Disclosure overload and complexity are the two aspects of financial reporting that financial statement users and preparers, large or small, agree on: There is too much of both."

This will be interesting to watch over the next few years. Don't expect a quick reduction in disclosures for this year's 10-Ks!


Tuesday, November 27, 2012

500 Foreign Firms Still use U.S. GAAP U.S. Regulatory Filings

Good article by Emily Chasan of the WSJ.

The Big Number: 500

That’s the approximate number of foreign firms that use U.S. accounting standards in U.S. regulatory filings.

Some foreign companies that file financial reports with U.S. securities regulators are having trouble freeing themselves from U.S. accounting standards.

Five years ago the Securities and Exchange Commission voted to let U.S.-listed foreign companies that use International Financial Reporting Standards stop having to reconcile their financial statements with U.S. Generally Accepted Accounting Principles. But about 500 companies, or roughly half of the 1,000 foreign companies listed on a U.S. exchange, still submit their filings using the U.S. standards.

Some companies still must reconcile their home country’s accounting rules with U.S. GAAP, “but that number is shrinking in favor of companies that switch” to IFRS, Craig Olinger, deputy chief accountant in the SEC’s Division of Corporation Finance, said recently at a Financial Executives International conference.

More than 100 countries currently use IFRS. European companies, which have been using those standards since 2005, are the largest group using international rules for U.S. filings. Canada, which accounts for the biggest number of foreign SEC-registered companies, should soon have more companies using international rules for their U.S. filings after switching to IFRS last year. Some of the 340 Canadian companies that file with the SEC still reconcile their results to U.S. GAAP, Mr. Olinger said.

U.S. regulators still haven’t decided whether U.S. companies should be able to report using IFRS, and the successor to SEC Chairman Mary Schapiro will play a large role in that discussion. A widely anticipated study by the SEC’s staff earlier this year didn’t make any formal recommendations on the matter. Mr. Olinger said the SEC staff stays up to speed on trends in IFRS and performs reviews of filings in international standards at the same level that it inspects those done in U.S. GAAP

Sunday, October 28, 2012

Significant vs Material

Often the terms “significant” and “material” are used interchangeably. This can course a lot of confusion. The SEC once took a company to task asking why they used this explanation of a contingency:

“You disclose...that you do not expect the ultimate conclusion of any of the proceedings to which you are a party to have a “significant adverse effect” on your financial statements and you have not disclosed the contingent liabilities associated with these claims either because they cannot be “reasonably” estimated or because such disclosure could be prejudicial to the conduct of the claims. Please revise your future more clearly confirm that you believe the ultimate conclusion of any of the proceedings to which you are a party will not have a “material” adverse effect to your results of operations, cash flows, or financial position.

Why the distinction between "material" and "significant"? To help with understanding the difference between "significnant" and "material" , the following comes from a paper on the IASB 2008 Annual Improvements Process, Comment Letter Analysis:

Significant vs Material

As mentioned above...some respondents asked for further clarification of the Board’s intentions in changing material to significant.

According to paragraph 30 of the Framework:

“Information is material if its omission or misstatement could influence the economic decisions of users taken on the basis of the financial statements. Materiality depends on the size of the item or error judged in the particular circumstances of its omission or misstatement. Thus, materiality provides a threshold or cut-off point rather than being a primary qualitative characteristic which information must have if it is to be useful.”

Significant, on the other hand, is not a defined term in IFRSs but is used throughout IFRSs to denote the degree of importance or relevance, eg significant costs (IAS 16) significant increase in turnover rates (IAS 19), significant period of time (IFRS 2).”

“Some respondents questioned whether it is possible to have a material change in the number of employees that is not significant. The staff notes that it is not meaningful to say there is a ‘material’ change in the number of employees in IAS 19 since the standard does not require that number to be disclosed in the financial statements.”

Clear as mud?

Saturday, September 1, 2012

US GAAP Requirement for Push Down Accounting

Had a recent comment that push down accounting wasn not mandatory under USGAAP, rather is was simply permitted in certain circumstances. In response to that previous comment, the FASB requirement for push down accounting is 805-50-S99-1. Readers of this part of the Codification will need to pay careful attention to the answer in question1, and not jump to conclusions that push down accounting is allowed (see question 2).

Following is the text of SAB Topic 5.J, New Basis of Accounting Required in Certain Circumstances.
Facts: Company A (or Company A and related persons) acquired substantially all of the common stock of Company B in one or a series of purchase transactions.

Question 1: Must Company B's financial statements presented in either its own or Company A's subsequent filings with the Commission reflect the new basis of accounting arising from Company A's acquisition of Company B when Company B's separate corporate entity is retained?

Interpretive Response: Yes. The staff believes that purchase transactions that result in an entity becoming substantially wholly owned (as defined in Rule 1-02(aa) of Regulation S-X) establish a new basis of accounting for the purchased assets and liabilities.

When the form of ownership is within the control of the parent the basis of accounting for purchased assets and liabilities should be the same regardless of whether the entity continues to exist or is merged into the parent's operations. Therefore, Company B's separate financial statements should reflect the new basis of accounting recorded by Company A upon acquisition (i.e., "pushed down" basis).

Thursday, May 31, 2012

Friendly Accounting at Facebook

This post is courtesy of the Accounting Onion

U. S. Senator Carl Levin recently spoke on the Senate floor, referencing the discrepancy between tax and accounting treatment of stock options in the (then upcoming) Facebook IPO:

"According to its filings, when Facebook goes public, Mr. [Mark] Zuckerberg plans to exercise options to purchase 120 million shares of stock for 6 cents a share. Mr. Zuckerberg's shares, obviously, are going to be worth a great deal more than 6 cents, a total of about $7 million; they will apparently be worth more than 600 times as much, something in the neighborhood of $5 billion.

Here's where the tax loophole comes in. Under current law, Facebook can – perfectly legally – tell investors, the public, and regulators that the stock options he received cost the company a mere 6 cents a share – that's the expense shown on the company's books. [This is wrong – see later.] But the company can also – perfectly legally – later file a tax return claiming that those same options cost the company something close to what the shares actually sell for later on – perhaps $40 a share. And the company can take a tax deduction for that far large [sic] amount. So the books show a highly profitable company – profitable, in part, because of the relatively small expense the company shows on its books for the stock options it grants to its employees. But when it comes time to pay taxes, to pay Uncle Sam, the loophole in the tax code allows the company to take a tax deduction for a far larger expense than they show on their books. …

Now, the end result is that a profitable U.S. corporation – a success story – could end up paying no taxes at all for years, even decades."
To Levin, the Facebook IPO is a dramatic illustration of an inequitable "loophole" in the tax law. As Levin and Sherrod would have it, Facebook's tax deduction for using stock options to compensate executives – as opposed to any other form of compensation – would be essentially zero (that's probably a little dramatic on my part, but the point is the same); yet, Zuckerberg's tax liability when he exercises the options could be somewhere in the area of $3 billion.

The strong implication of Levin's narrative is that the extra amount of expenses would have wiped out every dollar of Facebook's reported net income that it had ever 'earned.' On top of that, there could be other outstanding options held by Zuckerberg and other employees extending way down the organization, which are going to have the same effect on future reported net income.

Which brings me to my second question: For all practical purposes, could Zuckerberg be taking Facebook public at this point in time with no history of profitability, perhaps negative shareholders' equity, and perhaps no hopes for earnings for some for years to come?

My inclination is to say "no," but I can only speculate. So, I will answer that question with another question: Since the FASB's rules understate the economic cost of options granted to employees, did the FASB provide a perverse incentive to Facebook to grant more options (or at terms overly favorable) to employees than it should have?

If one accepts the maxim that "what gets mismeasured gets mismanaged," then the answer to that question should be "YES." The stock option problem lies not with the tax rules that eventually recognize the full cost of the options to shareholders, but with the financial reporting rules that allowed Facebook to grant options without recording their full cost.

Surely, the senators can see that different accounting rules would have wrought different compensation policies from Facebook. Senator Levin would not have had a story to tell and Mark Zuckerberg would be a few billion dollars poorer.

Footnote: It is my distinct pleasure to provide Senator Levin (and his staff) with yet another accounting lesson. The amount of expense to be reported by Facebook is not, as the senator claims, the exercise price of the options (i.e., 6 cents per share). Assuming that the options were issued without any intrinsic value, then their "grant-date present value" (i.e., the amount upon which periodic option expense is measured) could end up being more or less than 6 cents per share. Although this technical correction to Senator Levin's story it doesn't fundamentally change the message, it once again reveals a lack of understanding that makes one question if Senator Levin has an adequate grasp on the issues.

Thursday, April 26, 2012

Industry Expert: When and How to Adopt New Standards and IFRS

Bob Laux, Microsoft's accounting guru did a long and interesting interview with Bloomberg. Worth a read for his thoughts on all of the critical upcoming accounting standards changes, including timing of adoption.

In a wide-ranging interview with Bloomberg BNA, Robert Laux, senior director of financial accounting and reporting at Microsoft Corp., laid out the major issues in accounting rulemaking—with a particular focus on their potential impacts on multi-national companies. The main topics included the SEC decision on U.S. domestic use of IFRS, and top projects of the standard-setters, including revenue-recognition, financial instruments, lease accounting, and intangible assets. Steve Burkholder, a Bloomberg BNA staff correspondent, conducted the interview—an edited version of which follows.

Bloomberg BNA: The Financial Accounting Standards Board and the International Accounting Standards Board continue their long-running work to converge on a single set of accounting rules for global use.

Concurrently, many U.S. companies, audit firms, and investors await a highly-anticipated decision by the Securities and Exchange Commission on whether and, if so, how to incorporate international financial reporting standards into the reporting system for U.S. public companies.

If the SEC decides on some form of an officially prescribed use of IFRS in this country, what kind of an impact might that have on a large U.S.-based multinational company such as Microsoft?

Laux: Let me try and speculate on what may be the decision coming from the SEC although of course I don't know anything more than anybody else. The SEC had a staff paper that they produced, which talked about a dual process, if you will, of endorsement and convergence. In a speech at the AICPA's SEC [developments conference] a couple of years ago, one of the SEC staff used the word "condorsement." I think that's a good word because it aptly describes this process which is a combination of endorsement by the FASB with some convergence work. And no matter what the decision is—unless it's a decision not to go down a path of international standards (which I don't think would be the answer) —I think we need to do something to incorporate international standards in U.S. [generally accepted accounting principles, or GAAP]. If that does happen, it probably will be, in my opinion, like a condorsement [approach].

That would have quite a big impact on U.S. companies. Under this approach, the IASB will be taking on new projects and the FASB will be heavily involved, and then will have an endorsement mechanism that is given to them [the FASB] by the power of the SEC to endorse what the IASB does.

Convergence: Longer Than 5-7 Years.

Laux: I don't think that's going to have a really big impact on companies, maybe elongating the process a little bit. I think the bigger impact is on the so-called convergence area. These are like legacy accounting issues that we have in U.S. GAAP that may be in IFRS but the answers are slightly different, or there's just not IFRS guidance applicable or on point. The SEC staff paper indicated maybe a five- to seven-year time period for the FASB to look at these differences and try to incorporate the IFRS standards. However, I believe that may take longer than five to seven years— that's where there can be a somewhat big impact on companies.

Let me give you two examples. One is stock-based compensation, a joint project, but there are some differences between the U.S. GAAP and IFRS standards. One standard has to do with graded vesting and the other has to do with the way income taxes are recognized on stock-based compensation. Those can be significant differences, and if a company needs to change, that could have a significant impact.

Another issue is component depreciation, or depreciation in general.

Under IFRS, component depreciation is required. Under U.S. GAAP, it's an option that most companies do not take on—that could be a significant change. For instance, FinREC, which used to be [the Accounting Standards Executive Committee, of the American Institute of Certified Public Accountants], did a project—it's almost 10 years-plus ago—I was actually on the committee at the time–which considered having a requirement for component depreciation. Our feedback was that people were opposed to the idea.

So I think you're going to have those same kinds of discussions with these legacy differences, I call them, with U.S. GAAP versus IFRS that I think will have somewhat of an impact, to a big impact, on U.S.-based multinational companies.

Big, Tough Decision for SEC.

Laux: I think the SEC has a big, tough decision on their hands. We'll talk about that a little later in this interview. But the issue with that is— the ultimate goal—and it was in the SEC staff paper [of November 2011]—was incorporating IFRS in U.S. GAAP, with the aim to say after so many years (and I believe it's going to be more than seven years), the goal was to say that if you're in conformity with U.S. GAAP, you're also in conformity with IFRS. And that's difficult to do because of [some possible] so-called grandfathering-type of items. Maybe something could be done with what's called IFRS 1 [First-time Adoption of International Financial Reporting Standards] and the way of adopting international standards. Perhaps international standards can be slightly changed.

But some of these things that people think should be grandfathered—this is what makes it so difficult. And some would argue that, if you had these grandfathered items, then you truly do not have a global set of accounting standards if we're using different rules in the U.S. versus internationally.

I'm still a proponent of [the notion] that the world of business, of finance is international in nature, and we need to move towards a goal of having one set of high-quality global accounting standards. It's going to take us time to get there—probably a long time. And a lot of work's already been done on that.

For instance, when you bring up these grandfathering issues—yes, there are challenges and we may never get to the perfect answer. But that's not an excuse, in my opinion, for not striving to get more comparability on a global basis.

Revenue Recognition: `Going Pretty Well.'

Bloomberg BNA:As you know, one of the main standard-setting projects that the FASB and the IASB are working on is revenue recognition. How is that going, and how is the recently re-issued—and revised—proposal likely to affect companies?

Laux: I think the revenue recognition project is actually going pretty well. I'll have to go back to when it first started a number of years ago. As you know, standard-setting is difficult. People have a lot of opinions, and it takes time. But this has been on the agenda for a while now [Editor's note: It was added to FASB's and IASB's agendas in 2002]. But I remember when there were discussions of first doing this. And one of the main motivations, I believe, was to be able to converge U.S. GAAP with IFRS. U.S. GAAP has a lot of literature on revenue recognition, a lot of it [is] industry-specific. I don't know the number of references or standards on it, but people have said it's close to 200, if not over 200.

In international standards, it's really two standards and interpretations that go with them. And if you look at multiple-element arrangements, and you're not looking at the construction industry, some could argue that international accounting standards have one or two paragraphs on it.

So, this could almost be the poster child for convergence. But the point I'm trying to make is, with all that literature in U.S. GAAP, my first opinion was there's no way they're going to be able to pull this off. There's just no way that they'll come up with a general standard, or one standard, on revenue recognition. But I'll have to give the standard-setters credit here—they pretty much have been able to do that with slight disagreement with a few things in the standard. I'd also like to say that, this is probably—and I'll use the term again—poster child by the FASB staff and the IASB staff of the best way a project can be run. The staff did an outstanding job.

So, to get to your question, I think it's actually gone pretty well. The exposure draft that's out now is kind of unique, based on my experience, in that, when you have an exposure draft, you write comment letters indicating what you think about it.

Well, this exposure draft, many people and companies, including us at Microsoft are seeing it as very close to final. We are considering the implications for Microsoft, and what needs to be done? Our belief is that the rule will have a big impact on how we look at revenue recognition, when it's recognized. Also there may be more of an impact on our processes and procedures to make sure we're in compliance with the new standard.

But the point I'm trying to make is that, I think it's getting very close to what the final [standard] may look like. There is discussion on some issues. The two big issues that I know of, that people are really discussing, are the disclosure requirements and the transition provisions.

Bloomberg BNA: That's interesting, because as you know, it's been a common refrain at the FASB that sometimes the board's constituents don't follow standards during their formation as closely as they could until they see something cast in stone, or as a final standard. But this is perceived, as you say, as being close to final.

Laux: And, as you know, on the first exposure draft, there were close to a thousand comment letters, I believe. It just shows the amount that people have been engaged. Again, I'm not trying to sugar-coat it, or be self-serving, I really believe—especially in this project—the FASB and the IASB staff did a tremendous job of outreach, understanding industry-specific issues. And also outreach to users [of financial statements]. So there's been a lot of comment. And I think it's due to that we're in this shape that I described. It looks like it's close to final, in my opinion.

Resigned to On-Balance Sheet Lease Accounting.

Bloomberg BNA: Another joint FASB-IASB project with potentially big impact is leases. Basically, how is the draft standard being received? What kind of impact will that have on Microsoft? Going further, how might that impact compare with that on firms such as airlines, banks with many branches, shipping companies, and the big equipment leasers?

Laux: I think it's being received with mixed emotions. As you know, an exposure draft was issued, and the standard-setters are redeliberating the issues. We're expecting another exposure draft to come out.

I'll speak from the lessee side, because Microsoft is not a major lessee, but we're not much of a lessor, in essence. Our licensing of our software is under the revenue recognition standards. So we are a lessor in certain circumstances, but it's really on the lessee side. It's not going to have as much of an impact on Microsoft as [the planned standard would have] on the airlines, on banks with many branches, or, let's say, a grocery store chain with many locations or fast-food or restaurant chains that do a lot of leasing.

I believe people are resigned— I'm not sure resigned is the best word—but accept the fact that, in general, that leases will come on balance sheet. The SEC staff did a paper as a requirement, I believe, of [the Sarbanes-Oxley Act of 2002] to look at off-balance-sheet financing, and leases was one of the larger issues that came up. The people understand that maybe it does provide more information to users if they're on balance sheet.

I know there are still some people who are strongly in disagreement with that. But I would say, in my opinion, most people are resigned.

On the lessee side, the big issue right now is the expense recognition. And under lessee accounting—and it's really operating lease accounting—today, for the most part, in very general terms, you have straight-line rent expense. I'm renting something for $1,000 a month; I'll show $1,000 of expense a month. The way the exposure draft came out is that there would be a front-loading of that expense. I don't think we need to get into the details or the technicalities of how that occurs. It's looking at the liabilities separately from the asset, if you will. There's been a lot of feedback on that. The standard-setters are taking another look at that and it's my understanding they're doing outreach to constituents this month, to get prepared to talk about it soon—on the right way to approach this issue. So, that up-front expense recognition, instead of straight-line, could have a big impact on companies.

Let me just say, from a Microsoft perspective, as I said, we're not a big lessor. So we haven't been following it as closely as it doesn't have as much of an impact on us. But it looks like the lessor model is very complicated. I think—and I could be wrong—in that once people dig into that, you may be hearing more discourse from constituents saying, "Boy, this is pretty complicated. It may be a lot of work to actually implement in practice." And hopefully there will be discussions, if that is the case. When I look at it, and say, it's not really going to impact us to any great extreme, not in a material amount, but, boy, it looks awfully complicated, the model that's being presented for lessors.

Accounting for Financial Instruments: The Challenge Continues.

Bloomberg BNA: Another of the highest-priority projects of the FASB and IASB is financial instruments. That project has been a challenge overall. What is the outlook for convergence on that and what kind of effect would that have on banks as well as non-banking companies?

Laux: As you said, it has been a challenge overall. It's a difficult and complicated area, as you know. One of the problems, in my opinion, is that the standard-setters were starting from different points—they were leapfrogging each other,—in discussing the issue. That makes it very difficult to get one converged standard for financial instruments, when the IASB is working on something before the FASB, or vice-versa.

You can really see three areas they're working on. The first one is classification and measurement. The second one, impairment [or accounting for loan, or credit, losses]. The third one, hedging. And both the FASB and the IASB are in different spots.

This is going to be tough. You can almost look at those three components, as three separate, huge projects in and of themselves. So this shows how challenging this project is.

On recognition and measurement, what makes it even more challenging is that the IASB already has a standard out there, IFRS 9, on recognition and measurement [of financial instruments]. They delayed the effective date on it for a couple of more years —I believe, until 2015—and the European Commission has not even endorsed the standard. But there are other constituents, from what I understand, for instance, Australia, where companies have actually adopted it early. I don't have first-hand knowledge of this.

So you can see that that's a difficult proposition for the IASB. They want to work on convergence and work with the FASB, but if some of their constituents have already adopted the standard, you have to have some sympathy for the IASB and those who adopted, saying, "We adopted this. You're going to make us change again?"

But the IASB has said, in the spirit of convergence and how important this part of it is, that they would do limited reopening of IFRS 9—most of it, I believe, for the impact on insurance companies and different things like that. So, both boards are working on that issue.

The Securities Microsoft Holds: Where Are Fair Value Changes to Go?

Laux: When I'm breaking these up into these three categories: This one [on recognition and measurement], where currently the IASB rules are, and where the FASB is heading, actually would have a potentially significant impact on Microsoft.

We have a lot of investments in equity instruments—ownerships in companies, given our cash portfolio and investment portfolio. Currently under U.S. GAAP, any mark-to-market changes, fair value adjustments are shown as a component of other comprehensive income. Well, under the proposal, they would be shown as components of net income. And given the way the market moves, and our investment portfolio, we could have some potentially significant variability in net income.

We're a little concerned about that and have disagreements about the way the standard-setters are looking at, thinking about instruments. I don't think it's necessary for us to get into detail, but they're looking at both the characteristics of a financial instrument. We think that maybe the business model is really the important thing—of what companies are doing with these securities— we hold them, for the most part, for long-term strategic purposes.

Microsoft believes that a user should be informed of fair-market value changes. It's an economic event, phenomenon. But especially with the new standard on the presentation of other comprehensive income, we think it will be transparent to users. I can't speak for users. They need to speak for themselves, and can expertly speak for themselves. The volatility that goes through net income, I just fear that there may be a lot of users who will strip that out and say, that is not really what we want to see for your results for this quarter, for thinking about, predicting future share prices, and we're going to strip that out.

So it's just kind of a conundrum. Do you really want that volatility to go through the income statement? We want it to be transparent, but believe it's transparent currently in other comprehensive income.

Let me quickly go to the other two, impairment and hedging. Impairment has been difficult, as you know. The FASB and the IASB are working together and trying to come up with a converged solution. This three-bucket approach still needs a lot of meat on the bones for a lot of us to understand it, but they are working on it.

Hedging, I perceive they're even further apart. The IASB has a project that they're probably going to finalize soon, if they haven't already. And I think the finalization [involves] putting a staff draft for people to [study]. But it's really kind of a business-model type of thought process for hedging, or having hedge accounting, and it's quite different from what the FASB has been looking at or what their proposal was in their original financial instruments exposure draft [Editor's Note — That first FASB proposal was issued in May 2010]. So, they're quite a ways away in that, in my opinion.

If I go through the three [elements of the joint instruments project], I give them credit again, because they're working on trying to converge. On recognition and measurement, there's a lot of convergence there. They're working around the edges, if you will. You've heard my or Microsoft's disagreement with some of their conclusions, but the conclusions are what they are. Impairment, a little farther apart, but they're working hard on it. Hedging, I think they've got a ways to go.

Just to comment on the last part of your question. Obviously, [there would be] a significant impact on banks, financial institutions. That's their business. Just as revenue recognition is potentially going to have a significant impact on companies like Microsoft, it's just obvious that [the planned financial instruments standard] will have a big impact on financial institutions.

Financial Instruments: Potentially Big Effect on Non-Banking Firms.

Laux: The point that I try to make, however, is also that it will have a potentially big impact on non-banking companies, like Microsoft. Sometimes I get a little concerned that there's not enough attention paid to that issue. And it really goes back to the issue I discussed previously. This tentative conclusion that you've made [on investments in equity securities] could potentially have a significant impact on the variability of Microsoft's net income due to market changes. Is that really the best way to inform users of our financial statements?

And there are other sub-issues, like how complicated is the impairment model going to be? Are you making it a model based on the way financial institutions work? Or are you looking at actual non-banking companies and how they think about it, and making sure you don't make it overly complex for them? That's another one of my concerns.

At times, it feels that maybe they're just focusing too much on the banking industry and financial institutions. It's very important to them. I understand why that is, but it's important to point out that it will also have significant impacts on non-banking companies and they need to keep that in mind.

End-Dates for Key Projects, and Rules' Effective Dates.

Bloomberg BNA: For the projects we just talked about, what might be the end-dates for them, if you can prognosticate? That would be the three highest-priority projects for both boards, excluding insurance contracts, which is a topic of more immediate concern for the IASB. And what do we know about possible effective dates for the planned final standards?

Laux: Again, we're talking about revenue recognition, leases and financial instruments. I'm leaving off what some call the fourth project, insurance. On revenue recognition, I believe they're very close. The comment letters are in. Roundtables are coming up. The one at the FASB is [set for April 26]. So they are going to get that feedback, and they need to do redeliberations. [Editors' Note—He cited reported statements by FASB Chairman Leslie Seidman and by IASB Chairman Hans Hoogervorst on work plans]. And maybe the schedule [for completion of the revenue effort] is by year end. It could leak over into the beginning of calendar year 2013, in my opinion, but probably not much. I think that's close to being finalized by the end of the year, or close to the end of the year.

If we go project-by-project, and just talk about this one [revenue recognition], its effective date, a lot of people believe will be no earlier than three years from now. You need to give people at least three years to implement a standard. And the math on this—and let's say it's finalized by Jan. 1, 2013—then it would be, we believe, no earlier than January of 2016, at the earliest. In essence, both standard-setters have signaled that when they said [last year] that these standards would be effective no earlier than 2015—as we know, that schedule slipped a little bit, and I would say no earlier than 2016.

Leasing Standard: `At Least Another Year Away.'

Laux: That's a description of revenue recognition, which is the closest [to completion]. If I were prognosticating, I would say leases is at least another year away. So let's say a possibility—and this is just me guessing—of it being finalized in 2013. Let's say by Jan. 1, 2014, with maybe an effective date of 2017.

As for financial instruments, especially when you think of the three [parts of the project], there's a lot of work still to be done, so I couldn't even guess on that one.

Let me just make one final comment. We're struggling here at Microsoft, and it was actually in our comment letter on revenue recognition, and it's been a few years now, looking at what the possible implication would be if Microsoft adopted IFRS, or IASB standards. And that was in the context, as you know, if we go back three to four years, five years. It seemed at the time there was more momentum for an actual, pure adoption of the IASB standards. So, we looked at a project of what that impact would be. And, as you know from other companies, it would have been a significant undertaking.

But what we learned, when we did very high-level work, was how difficult it is to go back in history and redo the accounting for something. What the point we're making here at Microsoft is that—especially on revenue recognition, as an example—we think there could be potentially significant process, and procedural changes, system changes, that we need to make. And we think it's important that those systems and procedures and processes are in place before we make the entry.

Preparing Systems for Retrospective Application.

Laux: Let me describe this to you, because it's kind of weird to describe. It has to do with looking at the adoption technique of a standard, whether its going to be prospective or retrospective. If you go retrospective, you need to restate two years. In that context, we would like to have a system in place, prior to having to restate those two years, so that we can have parallel systems. If you do the math on that, it's more than three years, because you're talking about getting your systems in place, which, as we know in companies, is a very difficult proposition and could take up to two years. Then if you have to restate for two additional years, you're at four, close to five years.

I know the standard-setters want to get these out and get them effective. They're important standards that we need to do new accounting on. But there is that issue with the transition method. And, if there is, maybe [under] a modified prospective type of treatment, I think companies would have the ability to implement these within the time line of this three years that the standard-setters may be looking at. Even though three years sounds like a lot of time, given the requirement to do retrospective adoption and restating two additional back years, it's going to be very difficult, in my opinion, for companies to get there in a three-year time period.

SEC Staff's `Condorsement' Idea: `An Elegant Solution.'

Bloomberg BNA: These questions pertain to how the Securities and Exchange Commission might proceed on the big question of incorporation of IFRS in the U.S. reporting system. You already touched on this back in the earlier minutes of this interview. Do you have a sense of the how —if the SEC does make a definitive decision on IFRS use in this country—and the when?

Laux: Just like anyone else, I don't have any extra insight. You know that as well as I know that. I'll tell you what I would like to see, speaking personally, not for Microsoft. I am a proponent of what we discussed as "condorsement" [in] the SEC staff paper. The Financial Accounting Foundation [the parent group of the FASB and the Governmental Accounting Standards Board] has made some comments on that and, in my opinion, generally accepted what the SEC [staff] said, with some suggestions for some potential changes. But not overhauling the entire thing, or disagreeing with it.

I think it's a somewhat elegant solution. And it gets back to the issue that I'm a firm believer that the economy is world-wide in nature. We're interconnected. Just look at the contagion issues we have, where something may happen in Greece, or [elsewhere] in Europe, and the impact that could have on us in the United States.

SEC Needs to Give a Signal—`Soon.'

Laux: I strongly believe that the SEC needs to give some kind of indication of where their thinking is and needs to do it soon, just because of the uncertainty in a number of different areas. Uncertainty from a company's perspective about what we should be doing. Uncertainty from the IASB's perspective, where they have other constituents, saying, "Why all this U.S. stuff? It seems like you're ignoring us at times." (I use those terms loosely).

So, if I had my druthers, I think that the condorsement or an endorsement mechanism with further convergence on legacy-type standards that the FASB would look at is the way to go. I seriously believe that the SEC needs to come out with some indication of that within this calendar year, preferably within a couple of months. And you well know what the chief accountant at the SEC, Jim Kroeker, has indicated.

I'll go on a little bit of a tangent. I hear some people saying, well, it's an election year. While I understand that, this issue hasn't – thankfully, in my opinion – got into the presidential election debate. And I don't think it deserves to be in that debate. We have much bigger issues, in my humble opinion. I generally do not see the president and the presidential candidates on the Republican side talking about U.S. adoption of international standards. I don't think I've heard them mention it once. I would really like to see an indication from the SEC, this year, sooner rather than later. I think it's important for the U.S. It's important for the international community. It's important for the IASB.

Bloomberg BNA: Where do you think that indication might come from, if it does come from the SEC? They have their due process considerations, of course. Would it come from the commission or come from the staff?

Laux: I'm probably not the one to answer that, but I'll try to answer, based on my layman understanding of the issue. It's such an important decision, and such a big decision, that of course you have to have the commissioners weighing in on it. And I think you need to have due process.

Even the staff coming out with a paper that says, "We had the previous paper— the condorsement paper. We received feedback. And here's our current thinking that we're sharing with the commissioners and we're getting the commissioners' feedback on that." And I also think that, just like with anything else the SEC does, it will be subject to due process. Not knowing the rules of procedure like the back of my hand, when they issue something, there's always due process— that people can comment on and I think they'll encourage comment on this. I don't know the technicalities or nuances. Is it technically required that the commission actually vote to do something?

It's such a big decision, a critical decision that I think all of us would want the commissioners' opinion on it. Now it may not be a formal vote but I don't know the rules of procedure that well to definitively comment.

At FASB, Which Projects Off the Back Burner?

Bloomberg BNA: On the FASB and its potential agenda, at its March 23 meeting, the board's Financial Accounting Standards Advisory Council held lengthy breakout discussion sessions to home in on which out of the so-called "back-burner projects" should be the next major efforts of the U.S. board – that is, once the high-priority joint projects make it into the home stretch. Pension accounting and financial instruments with traits of liabilities and equity were high on the lists of a majority of participants. What do you believe should be on the FASB's new, short, must-do-next list and why?

Laux: It's a difficult issue because we have these big convergence projects and then, once they're completed, we need to look at what's going to be done next. I'll go on the assumption that a given is to complete the convergence projects, and it's really only after those, FASB will consider what's next.

Just as a sidelight, the IASB came out with an agenda consultation asking this question formally, probably similar to what FASAC discussed in their meeting. I'll give you Microsoft's comments. We did think that [financial instruments with traits of] liabilities/equities may be an issue that needs to be looked at. It's a very difficult practice issue for the standard-setters to handle. We thought that was important.

We don't have a pension here at Microsoft. So I have to tell you that it may not be high on our radar screen, so we didn't mention [accounting for pensions]. I could understand that comment, and we didn't put it in our letter to the IASB. It would not be a high-priority project for us, but the IASB is doing work on that, and the FASB is looking at it, so there could be some convergence there. I understand that.

Seeking a Better Definition of OCI.

Laux: One other one—and I'm not sure if this came out of FASAC's discussion—but what a lot of people are talking about is that the standard-setters need to become more definitive on the definition of other comprehensive income.

Bloomberg BNA: That did come out actually. That was high on the list.

Laux: It's kind of connected with the conceptual framework project. You could say that this is part of the conceptual framework project. Even, you could say, a disclosure framework project may be part of that. And I know that's on people's radar screens. We also said other comprehensive income and trying to define that. That said, that's going to be a very difficult project. Very difficult to come up with a definition, because, once you define it, you say, "Well, what about things we've done in the past that are in other comprehensive income? Do we change them? Do we put more in there?" So, I think that's a tougher project than even liabilities and equity.

For Microsoft, Intangible Assets Important.

Laux: Also on the agenda paper, when you used the term "short," I think you meant it as a small number of items. One item that we're kind of passionate about here at Microsoft is intangible assets. We believe, speaking generally, we're in an information economy. We've moved from the manufacturing economy, if you will. And we're not sure what the right [accounting policy] answer is there. I don't believe we're proponents of capitalizing a lot more intangible assets. That's kind of a double-entry thought process, if that makes sense.

Bloomberg BNA: And here you're talking about R&D, for example?

Laux: Yes, for research and development. And maybe just more information on intangible assets. What we suggested—and this would be a longer-term project—we believe it's important that, because intangible assets and intellectual capital, especially for a company like Microsoft, have a significant impact on our value—it is our most significant value driver—the accounting standards really have not kept up with that change in the economy. So we believe it's important for the standard-setters to look at that.

What we didn't want to do is prejudge what the answer is, because it could be disclosure. It could be going into areas like key performance indicators, which is difficult for the standard-setters to go in, especially in the U.S., because the SEC is the keeper, if you will, of management's discussion and analysis, not the FASB. But even in the disclosure framework project, the FASB, as a second part of that, has said that they'll look at possible integration of management's discussion and analysis with the financial statements and footnotes.

Now, of course, you need the FASB and the SEC and other constituents to cooperate. I'm a strong proponent that we need to go in that direction. To answer your question definitively, the third [topic] that we pointed out here at Microsoft is intangible assets. So, in summary, agree on liabilities and equity; understand that pensions is not an issue for us; other comprehensive income; conceptual framework; disclosure framework. And as a longer-term project, and maybe it's a research project, intangible assets.

Bloomberg BNA: You have been active for many years on the Committee of Corporate Reporting of Financial Executives International. Do you have any indication of what projects CCR would like to see the FASB tackle next?

Laux: First, I wanted to be careful [and say] I'm not speaking for FEI or the Committee on Corporate Reporting. But I'll give you my opinion from interacting with the group. I think it's somewhat similar to what was discussed at FASAC. And, as you know, there are members of FEI and the Committee on Corporate Reporting that are actually members of FASAC. For the CCR and FEI, the disclosure framework and disclosure issues are a big issue. Conceptual framework is a high[-priority] issue. There's a belief that we need to finalize and update the conceptual framework so there is a blueprint, if you will, of how to go about in setting standards and what to think about. I would say definition of other comprehensive income is important, and the FEI/CCR commented on that in their response to the proposal on the display of other comprehensive income.

I believe pension accounting is important to some CCR companies, and that would come up. So I think it's pretty consistent.

The one thing I want to add, and this also came up in the IASB's agenda paper, is with these huge convergence projects that we're working on—revenue recognition, leases and financial instruments—there's a lot of change going on. And maybe a period of calm is necessary for companies to actually implement these and make sure that they're implemented correctly and consistently, which by necessity, groups will need to talk about the right way to implement things.

Bloomberg BNA: Back when the IASB first saw its standards being adopted by the European Union countries, through the European Commission, they talked about having a "stable platform."

Laux: That's the term. So maybe we need a mini-stable platform for a number of years because what we're working on right now are just significant changes. So I would say that's another, in my opinion, another commentary that you'll hear from FEI and CCR.

Bloomberg BNA: One FASB project on which the board's chairman, Leslie Seidman, as well as the SEC staff, have mentioned recently in public discussion is the disclosure framework. The aim and primary focus of that effort are to make footnotes to the financial statements more effective. Over the years, companies have complained about what they call "disclosure overload." Do you see that disclosure overload is a problem? Do you believe the focus in that project is an appropriate focus?

Laux: I like to use a slightly different term—instead of disclosure overload, I like to use the term disclosure effectiveness. Sometimes the term disclosure overload has some baggage. People read into it and have some negative associations. When I go into disclosure overload, what I get concerned about is there's so much disclosure, that maybe the really important items that are being disclosed may be getting lost in a sea of information. In our day-to-day lives, it's almost information overload. It really gets to disclosure effectiveness. My opinion is this should be priority one.

There's a lot of complaints that some of what we're doing in financial reporting seems like a compliance exercise, not a communication exercise which we can't let happen to our profession. Our profession's responsibility to the world is to communicate transparently. That means we need a lot of work in disclosures.

I'm encouraged that the FASB has a project on their agenda. They're working with [the European Financial Reporting Advisory Group], the group that advises the European Commission. The IASB is also following this closely. I am actually a member of the Disclosure Framework Working Group. I believe it's important that the FASB is looking at it.

I believe it's also important that its not just the standard-setters looking at it but also the constituents should be heavily involved in the process. I think that is FASB's intention. I would like to see that happen sooner rather than later. So we're going to have to see, when their document [a discussion paper, scheduled for release in the second quarter] comes out, what it says. I am a little cautious that this is just such a big issue, and people were looking for significant change here. I'm not necessarily saying that there will be a decrease in disclosures, but there will be, I hope, a much more effective disclosure package. There's such a lot of expectations resting on this project so it's very, very important that constituents are intensely involved. We as preparers; users – and really the purpose of financial reporting is for the users – and, to a slightly lesser extent, but they're also involved, the auditing community, we experience this first-hand every day and have a lot of real-life experiences as preparers, users and auditors. I think we can add a lot to this project and help standard-setters really think about this issue. I think that's happening and I'd like to see more of that.

Bloomberg BNA: Wrapping up here, are there any other issues you'd like to comment on or questions you'd like to raise?

Laux: I touched on this in a couple of my comments, and I don't want to come over as self-serving or sugar-coating it. That truly is not my intention. I did an industry fellowship at the FASB, so I actually worked there for two years. And it was a great experience. I just want to give the FASB and the IASB, and the standard-setters credit. At times I don't think they get the credit they deserve in a very difficult job, and of trying to incorporate everybody's disparate and strongly held views. It was really an eye-opener for me, being on the other side and working there.

That said, at times, the standard-setters may get isolated in their theoretical world and need to really work hard on seeing what's going out in the day-to-day operations of what users are doing with the information, and what's going on at companies. They're trying hard at that. They just need to constantly try harder on that.

But the point I'm trying to make is, I just feel, and having worked there, that at times it's a thankless, very difficult job. And I just wanted to say that they deserve some credit for what they've done.

Monday, March 5, 2012

Blowing a Breaker on Financial Reporting

Great article by Teresa Iannaconi from FEI.

Financial Reporting: Disclosure Overload - Gaining Control of the Process

A team of graduate students recommended selling Enron stock three years before the company went bankrupt. What does this say about the state of financial disclosure, and would it benefit more from enhancement rather than expansion?

As standard setters, regulators and others seem to continuously call for and deliver more regulations, more standards, more transparency and more disclosure, financial executives are having difficulty keeping up with the volumes of materials that are expected from them. They believe this plethora of statements and documents that they provide to users should already comprise more than enough information, and that should solve the problems of accounting fraud and financial reporting fraud.

Indeed, many relate instances of “looking but not seeing” or “eyes wide shut.” These contradictory statements describe what happens when too many financial disclosures impair their usefulness.

A new study shows than when it comes to financial reporting, quality may be more important than quantity. The report, a joint research project published by Financial Executives Research Foundation (FERF) and KPMG LLP, delved into the effect of increased financial disclosures from 2004 to 2010. Entitled Disclosure Overload and Complexity: Hidden in Plain Sight, the report observed that more financial disclosures are not necessarily better, and recommended financial disclosure enhancement rather than expansion.

A group of students at Cornell University’s Johnson Graduate School of Management likely would agree with that recommendation. In 1998, using publicly available financial information, the students succeeded where professional investment analysts and investors failed. At that time, the students analyzed Enron Corp. and recommended selling the stock — three years before its bankruptcy. The student analysis determined that the stock was overpriced and questioned Enron’s high debt level, its earnings quality and the long-term sustainability of its business model.

The students’ research also caught the attention of author Malcolm Gladwell who discussed the research in his book, What the Dog Saw (Little, Brown and Co., New York, 2009). He devoted a chapter to the Enron implosion, entitled “Open Secrets — Enron, Intelligence and the Perils of Too Much Information.” Throughout the chapter the author notes that each party that deciphered Enron’s financial vulnerability obtained the relevant information from Enron’s publicly filed disclosures, albeit with some level of difficulty. In a discussion of Enron’s use of special purpose entities Gladwell noted, “… you can’t blame Enron for covering up the existence of its side deals. It didn’t. It disclosed them” (emphasis added).

Although Gladwell goes on to question whether the disclosure in Enron’s public documents was adequate for a complete understanding of the transactions, the discussion concludes with an observation based on a research paper, “Rethinking the Disclosure Paradigm in a World of Complexity,” authored by Steven Schwarcz, a professor at Duke Law School, which observes that increasing financial complexity has resulted in the traditional disclosure paradigm of “more is better” becoming an anachronism.

Schwarcz argues that there is no disclosure model that can adequately address the disclosure necessary to understand financial complexity. He says a regulation should be enacted that prohibits material management conflict in transactions that he characterizes as “disclosure impaired.”

Although Schwarcz is unable to identify the precise nature of a disclosure-impaired transaction or arrangement, his recommendation is founded on the concept that some activities of a business enterprise are so complicated that any approach to disclosure will provide either too little or too much disclosure to eliminate buyer-seller understanding asymmetry.

Cornell Students Cite Enron Disclosure Risk Prior to Implosion

The Cornell students were enrolled in an advanced financial statement analysis class taught by Charles M.C. Lee. The conclusions raise the obvious question: How were business students able to figure out something that sophisticated business analysts and journalists were failing to perceive and wouldn’t be able to perceive for another three years? “All the facts were hiding in plain sight,” said Lee.

The content of the Cornell students’ report presents an opportunity to develop additional understanding of the adequacy of disclosure as it existed in 1998 (pre-Enron reform) and how disclosure was approached by those who identified and those who missed the Enron warning signs.

The report provides some insight into potential paths to improved disclosure. Ultimately the question posed by the 1998 report is why was the disclosure available then adequate for this student group to reach a “right” decision, but inadequate for others to discern a seemingly hidden problem?

The students’ report generates some points to ponder:

▪ The report demonstrates extensive and in-depth analysis of the information required to be disclosed using 1998 disclosure requirements.

▪ The research and analysis utilized extensive information found outside of Enron’s public filings. For example, the report cites information about competitors, economic analysis and predictions including government data that are well beyond the information required to be disclosed by any public company.

▪ The report includes the following conclusions that, although they have been lifted from their context in the report, provide an informative backdrop for the general consideration of disclosure:

“The nature of Enron’s businesses requires a significant amount of estimates and assumptions which impact the company’s financials. Nevertheless, both in its exploration and production operations as well as in its financial services operations, Enron uses accounting methods that are in line with industry practice. After close examination and scrutiny, we have found that Enron’s financials provide an acceptable level of disclosure.” (Emphasis added.)

Disclosure Adequacy, 1998 and Now

Considering the extent that disclosure has expanded subsequent to Enron’s demise, how is it possible that the disclosure in the Enron public filings was adequate to identify its investment risks and why did only a few identify those risks on a timely basis?

Further, if it was possible to identify the risks on a timely basis using the disclosure required in 1998, what have the extensive changes in accounting and disclosure in response to Enron and similar crises accomplished?

It is inarguable that adequate financial disclosure must be provided. The 1998 analysis could not have been developed without extensive disclosure. However, as Lee said, sometimes the facts are hidden in plain sight.

The November 2011 disclosure complexity report included the results of a survey of members of Financial Executive International. Responses to Question 12 of the survey indicated that 89 percent of respondents considered the fair value disclosure requirements as a significant source of disclosure overload and complexity.

The reviews of annual reports included in the research showed an increase of 184 percent in the volume of fair value and related disclosures during the six years covered by the report. Interestingly, using a 1998 level of fair value disclosure, the students were able to derive sufficient data about the mark-to-market accounting by Enron to form an assessment of its effect on the quality of earnings. Without questioning the merits of fair value accounting, some may question the merit of the expanded footnote disclosure requirements.

There was obviously some mental process that the students at Cornell invoked that others did not. If the students could develop an understanding of an investment in Enron based on then-available information that was deemed adequate, perhaps the solution to disclosure is not to expand disclosure requirements but to find the means to enhance disclosure presentation to improve access to relevant information.

One objective of the November 2011 disclosure complexity report was to stimulate discussion and consideration of ways to streamline disclosure to improve access to relevant information.

The report listed eight recommendations, including the following two:

▪ The U.S. Securities and Exchange Commission should issue an interpretive release to address the permissibility of cross-referencing and manner of addressing immaterial items to reduce redundant and unnecessary disclosures.

▪ Summaries of significant accounting policies and discussions of newly implemented or soon to be implemented accounting policies should be streamlined to eliminate unnecessary redundancy and patently immaterial disclosures.

During the American Institute of Certified Public Accountants’ Annual Conference on Current SEC and PCAOB Developments in December 2011, presentations by the SEC’s Division of Corporation Finance staff included remarks confirming that immaterial disclosures are not required to be provided. While the remarks do not have the same force as an interpretive release, it was clear that the SEC staff’s remarks were compatible with, and reinforced the themes, of the first two recommendations.

The SEC staff comments offer a glimmer of hope in combating the disclosure challenge. A third recommendation in the November 2011 disclosure complexity report suggested using more tables and graphs to present information.

What stands out in the Cornell students’ report is that the researchers mined the available data to wring out every available piece of information that they could. Much of that information was presented in the students’ report in tables and graphs. That suggests that data was available but may have been difficult to locate or identify.

Additionally, the Cornell researchers had characteristics that distinguish them from the average investor. They were graduate students in a financial analysis course motivated by the desire to achieve an academic goal and most likely a personal knowledge goal. They also perhaps had more time to devote to this project than their employed counterparts would have had.

Disclosure for the Average Investor

A perennial question persists about the identity of the average investor: What are the characteristics of the audience to whom disclosure is directed? We appear to have gotten beyond the notion that the audience is our elderly sweet aunt and have embraced the notion that the audience should have some level of financial literacy.

Presumably, professional investment advisers and institutional investors have the same tools and capabilities as the graduate students at Cornell. There is also a large audience of investors who can generally read financial statements and footnotes but do not have the skills or motivation to devote the same level of effort as the Cornell researchers.

If disclosure is directed to that audience, the Cornell students’ report may lead us to conclude that the disclosure enhancements that are appropriate may be critical financial statement analytics. Rather than presenting more detailed information, enhanced disclosure could consist of tabular or graphical information that enables deeper financial analysis and understanding. After all is said and done, a deeper understanding is what disclosure is all about.

The Cornell students used a wide variety of information that was available 14 years ago. They used all of the basic financial statement information including an in-depth look at each of the categories of cash flow. They read and apparently understood the financial statement footnotes well enough to determine the extent to which revenue growth was coming from acquisitions and the extent to which earnings changes were derived from non-cash mark-to-market adjustments.

Returning to the theme of the disclosure complexity report, a very real possibility is that disclosure is adequate but so mired in excessive, redundant and immaterial disclosure it is difficult to find the relevant and significant information.

The Cornell research incorporated extensive information obtained from sources outside of Enron. The students obviously went to the public disclosures of Enron’s competitors and obtained and compared information including relative performance, financial position, leverage and cash flows. The research also incorporated economic and government data. This raises a very important consideration: no matter how robust a company’s disclosure may be, that disclosure must be complemented by other external data.

Prospects for Improvement — FASB’s Disclosure Framework Project

The disclosure complexity report recommends that the Financial Accounting Standards Board should accelerate consideration of its Disclosure Framework Project to establish a systematic approach to disclosure that properly balances disclosure considerations with the required cost and effort. The current FASB project agenda indicates that a discussion memorandum will be issued in the first half of 2012. Additionally, other international organizations are examining ways to improve disclosure efficiency, including the United Kingdom’s Financial Reporting Council’s Cutting Clutter project.

The efforts of standard setters and support of regulators for improvements in disclosure efficiency offer the hope that the critical disclosures that investors need to understand investment opportunities will not continue to be buried in a haystack of marginally useful or useless disclosures.

Investor Education

The accomplishment of the Cornell students may be beyond the capabilities of the average investor, but their tools are universally available. The research techniques can be replicated to a lesser degree by average investors if the relevant information is available in an accessible form that facilitates analysis.

Investor education is fertile ground for standard setters and regulators to consider in exploring a better approach to disclosure. Various organizations have undertaken programs that are characterized as investor education, but most focus on issues such as avoiding fraudulent schemes and general investment education.

A relevant question to ask is whether those initiatives go far enough. An admonition to read the financial statements and related footnotes is ineffective if the investor does not understand the richness of the data. Investor education initiatives rarely provide insight into the wealth of information that is already provided in public filings.

Instead, efforts should assist investors in understanding where and in what form information is available and how that data can be used in financial statement analysis. Disclosure policies and regulations should include consideration of information accessibility and investor education.

For many, investment decision-making is one of the most critical activities of their financial lives. Whether the user of disclosure is a professional investor or is a non-professional investor performing financial analysis for a personal portfolio, the ability to find and understand relevant information is critical.

Disclosure policies and regulations that result in indefinite expansion of detailed disclosures fail to serve users well. Standard setters, regulators and preparers all must pursue disclosure policies that enhance the ability to find and use disclosures effectively. It is also necessary to pursue initiatives that educate investors about the richness of existing disclosures and how they can be used to gain insight into the quality of potential investments.

Accessible information that is easily digestible and provides insights on significant issues in the hands of informed users must surely be the recipe for efficiency in the capital markets.

Thursday, January 5, 2012

IFRS Update

Comprehensive IFRS Update, courtesy of AICPA

SEC decision on IFRS is at least a few months away
The Securities and Exchange Commission staff will need a few more months to produce a final report on International Financial Reporting Standards, SEC Chief Accountant James Kroeker said Dec. 5 at the AICPA National Conference on Current SEC and PCAOB Developments in Washington. SEC members are not expected to make a determination on the use of IFRS for reporting by U.S. public companies until the staff's work is complete.

 Comment letters support IFRS, call for more convergence work: The Securities and Exchange Commission said comment letters in response to a staff paper called "Exploring a Possible Method of Incorporation," issued in May, expressed support for global accounting standards. But commenters also wanted the International Accounting Standards Board and the Financial Accounting Standards Board to make more progress on joint standards-setting projects before International Financial Reporting Standards are adopted as the U.S. standard.

 AICPA advises IASB to complete work on conceptual framework
Richard Paul, chairman of the AICPA's Financial Reporting Executive Committee, advised the International Accounting Standards Board in a letter to complete its work on a conceptual framework, including a presentation and disclosure framework. This framework will guide the board as it continues to develop International Financial Reporting Standards. The letter was sent in response to a request for feedback when the IASB issued its Agenda Consultation 2011 in July.

FASB, IASB reach tentative decisions on aspects of lease accounting
The Financial Accounting Standards Board and the International Accounting Standards Board announced progress in their ongoing, high-profile convergence project on leases. Although an exposure draft hasn't been released, the boards reached tentative decisions regarding cancelable leases, and revenue recognition and disclosure for lessors with leases of investment property. They also reached an agreement on how to require banks to book losses on loans earlier than they do now. The boards will release the revised joint proposal on impairment in 2012, with the standard likely to be effective in 2015.

FASB, IASB issue new disclosure requirements on offsetting
The Financial Accounting Standards Board and the International Accounting Standards Board issued on Dec. 16 common disclosure requirements on the effect or potential effect of offsetting arrangements on a company’s financial position. The new rules will require companies to disclose gross amounts subject to rights of set-off, amounts set off in accordance with the accounting standards followed, and the related net credit exposure, according to the IASB.

Key accounting-policy decisions are mired in uncertainty
Details about whether and how International Financial Reporting Standards will be incorporated into the U.S. financial reporting system remain unclear, as Securities and Exchange Commission officials say they are still a few months away from deciding. The SEC has floated a "condorsement" approach, although the AICPA has urged the agency to give companies the option to adopt IFRS as issued by International Accounting Standards Board. Meanwhile, leaders of the Financial Accounting Standards Board and the IASB say the current convergence project model is likely to end when the priority projects are completed.

Revised FASB proposal could change revenue-recognition timing
The timing of revenue recognition for certain companies could be affected by revised accounting proposals from the Financial Accounting Standards Board and the International Accounting Standards Board. The new rules also would bring other changes, such as increased disclosure requirements. AICPA members can download an updated Revenue Recognition Accounting Brief from

Amendments aim to clarify transition guidance for IFRS 10 (12/23)

IASB pushes mandatory effective date for IFRS 9 to 2015 (12/23)

How the switch to IFRS could affect M&A

The convergence of International Financial Reporting Standards and U.S. generally accepted accounting principles will have implications for the treatment of mergers and acquisitions, writes Brian Reed, CPA/CVA. For example, GAAP and IFRS take different approaches to measuring the fair value of business combinations, and in many cases, revenue is recognized sooner under IFRS. In general, IFRS offers fewer rules and less guidance.

IFRS allows banks to inflate profits, report says
Banks are using complex financial products to bolster profits under International Financial Reporting Standards, according to a report by the Adam Smith Institute that calls for changes. In particular, banks are able to recognize expectations of future income as current profits under IFRS.

IFRS rule led to misdiagnosis of financial crisis, U.K. group says
Flaws in the IAS 39 International Financial Reporting Standards rule kept U.K. and Irish banks from booking potential bad loans during the 2008 financial crisis, leading to losses totaling $236 billion, according to a report by a pension fund lobby group. The accounting rule led to misdiagnosis of the root problem as one of liquidity, rather than solvency, the report said.

Commission: U.K. local authorities handled switch to IFRS well
U.K. local authorities handled the transition to International Financial Reporting Standards well in 2010, the Audit Commission found. However, some filed late accounts because of the change, with 18 of the 457 local bodies without auditors' opinions by Oct. 31, compared with seven in 2010-11.

Ireland eyes new deadline for U.S. multinationals to use IFRS
U.S. companies operating in Ireland reportedly will have another five years before being required to prepare a second set of statements under either International Financial Reporting Standards or Irish generally accepted accounting principles, in addition to U.S. GAAP. A proposed law would allow U.S. companies to continue using U.S. GAAP until 2020. The measure is intended to encourage foreign businesses to invest in Ireland.

Official: Russia's public companies will switch to IFRS by 2013
Bloomberg (12/13)
 CPA Exam to be given in South America under AICPA deal with Brazil
Accounting Today (12/9)

Discover the IFRS Certificate Program from the AICPA
The AICPA's IFRS Certificate Program is a comprehensive curriculum of online training, research tools and practice aids designed to help CPAs understand, implement and apply International Financial Reporting Standards. Courses cover revenue recognition, leases, impairment, intangible assets, inventories, EPS and more.