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.

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.

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 AICPA.org.

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

IASB pushes mandatory effective date for IFRS 9 to 2015
InAudit.com (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.

Top 1% Pays 37% of All U.S. Income Taxes

This is not specifically an accounting issue. But with recent attention to the 1% vs 99% media frenzy, it is worth examining some facts around who pays how much tax in the U.S.

Really interesting that the top 1/10 of 1% payc about 15% of all U.S. federal taxes. That is a total of 138,000 people.

This is an article from SmartPros.

The income earned by the top 1% of Americans has declined for the second year in a row while their average tax rate has increased, according to a new Tax Foundation study. The average federal tax rate for those reporting at least $343,927 in income has increased from 22.5% in 2007 to 24.0% in 2009, while the average income for the top 1% has declined from $1.4 million to $1 million over the same period.

The Tax Foundation's analysis is based on new data from the Internal Revenue Service on individual income taxes, reporting on calendar year 2009. The amount of individual income tax paid steeply declined by $166 billion, twice the decline from 2007 to 2008. Nationally, average effective income tax rates were at their lowest levels since the IRS began tracking them in 1986. The average tax rate for returns with a positive liability went from 12.2% in 2008 to 11.1% in 2009.

"During a time of economic downturn, we expect to see significant changes in both total income reported and the share of taxes paid by those with the highest incomes," said Logan. "Unlike middle-income wage-earners whose incomes and tax liabilities are fairly steady, high-income people tend to realize significant capital gains that fluctuate wildly with the economy, causing their income tax liabilities to fluctuate as well."

In 2009, the top 1% of tax returns earned 16.9% of adjusted gross income and paid 36.7% of all federal individual income taxes. In 2008 those figures were 20.0% and 38.0%, respectively. Each year from 2005 to 2007, the top 1 percent's constantly growing share of income earned and taxes paid set a record. The 2008 reversal of this trend continued in 2009.

The study also takes a look at the very highest earners, the top 0.1 percent of tax returns, which the IRS only began singling out in recent years. In 2009, those 138,000 tax returns accounted for nearly 7.8% of adjusted gross income earned (down from almost 10% in 2008), and they paid around 17% of the nation's federal individual income taxes (down from 18.5% percent in 2008).

"The very highest income group—the top one-tenth of one percent—actually has a lower average effective income tax rate than the rest of the top 1 percent of returns because these extremely high-income returns are more likely to have income from capital gains and dividends, which are typically taxed at lower rates," said Logan. "It's worth pointing out that in the case of capital gains and dividends, however, income derived from these sources has already been taxed once by the corporate income tax, which is not included in the current study, meaning the average effective tax rate numbers can be somewhat misleading."

CFOs Like New Goodwill Impairment Shortcut

CFOs seem likely to make heavy use of FASB’s new “qualitative” option for impairment testing.



Article by David M. Katz of CFO.com


Offered the chance to enable their company to avoid the currently complex calculations of goodwill-impairment testing, corporate finance executives will seize the opportunity in droves, a soon-to-be-released survey suggests.

Last summer Duff & Phelps and the Financial Executives Research Foundation, the parent organization of Financial Executives International, asked a group of CFOs, controllers, treasurers, and other corporate finance executives if their company would take advantage of a proposed Financial Accounting Standards Board shortcut. Under the FASB plan, companies could bypass the current two-step quantitative goodwill-testing process by making — and passing — a “qualitative” assessment of their impairments.

The two hundred FEI members who responded did so resoundingly in the affirmative. Sixty-nine percent of those working for private companies and 81% at public companies expect their employers to take advantage of the option for some or all of their reporting units.

They will now get their chance: on September 15, FASB stated a final version of its rule that companies will no longer be required to calculate the fair value of their reporting units if they judge, based on a qualitative assessment, that it’s more likely than not that their fair values are more than their book values. (Goodwill impairment occurs when the fair value of goodwill in a company’s reporting unit drops below the unit’s book value, also known as its “carrying amount.”)

The new option will be effective for annual and interim goodwill-impairment tests performed for fiscal years starting after December 15, and early adoption is permitted.

Previous FASB guidance required a company to test for goodwill impairment at least once a year using a two-step process. In step one, the entity had to figure out the fair value of a reporting unit and compare the fair value with the unit’s carrying amount. If the fair value were less than the carrying amount, then the company had to perform a second step to gauge the amount of the impairment loss, if there any.

In the new guidance, FASB says a company choosing to make a qualitative assessment must base it on “such events and circumstances” as macroeconomic conditions, industry and market conditions, raw materials and labor costs, and “overall financial performance such as negative or declining cash flows.”

Gary Roland, a managing director at Duff & Phelps, says he is surprised that a higher percentage of private-company finance executives didn’t say their company would take advantage of the shortcut. After all, FASB first came up with the idea in response to a push from private companies to provide them with a simpler, cheaper testing process.

Nevertheless, Roland had expected a strong positive response from companies across the board. “There’s no surprise that certain entities would want to take advantage of this because they weren’t happy with the fees,” he says.

The survey, however, recorded just the hopes of finance executives and is only a partial reflection of how many companies will actually take advantage of the shortcut, according to the valuation consultant. “It still could be a difficult proposition,” depending upon how narrowly companies passed impairment tests in prior years and how stringent auditors are in allowing companies to take the shortcut, he adds.

Big Shot Investors Say No to IFRS

By Emily Chasan of WSJ

When SEC Chairman Mary Schapiro said in June that investors aren’t clamoring for International Financial Reporting Standards, she may have been understating things… a bit. Now, some of the biggest U.S. investor groups are letting the SEC know in no uncertain terms that it should postpone its decision on IFRS and even stop the convergence process between U.S. GAAP and IFRS.

In comment letters to the SEC this week, some big investors and analyst groups had some scathing words about IFRS, claiming, among other things, that the International Accounting Standards Board isn’t independent enough from political interference to set accounting rules for the United States.

Capital Research and Management Co, which manages over $1 trillion, wrote that U.S. GAAP was “clearer, more effective and more advanced” than IFRS in providing the information it needs to make investments. CRMC Chairman Paul Haaga wrote in the letter:

While we support the idea of a consistent set of high quality accounting standards for companies worldwide, unfortunately we do not believe IASB has been effective in achieving this objective. Moreover, IASB’s ability to achieve this objective has been gravely diminished by political influence.

CRMC, which is the investment advisor to the American Funds mutual funds, said it doesn’t expect to benefit from the more comparable reporting IFRS is supposed to provide because the standard is applied so inconsistently around the world, and urged the SEC to retain U.S. GAAP. It also said the convergence process between U.S. accounting rule makers isn’t working and should be stopped.

Investors, analysts, and others, who use financial statement, are the purported beneficiaries of a switch to IFRS, as a single set of accounting rules should make it easier to compare publicly-traded companies around the world. Many CFOs are on record saying they would bear the cost of an IFRS switch if they think investors would benefit.

But even the CFA Institute, which represents over 100,000 portfolio managers, investment analysts and advisors throughout the world expressed doubts, saying it would be “premature” for the SEC to inject IFRS into the U.S. financial system. The CFA Institute said its continued support for IFRS is not unconditional, and that the International Accounting Standards Board needs to ensure its independence and more consistent application of its rules before U.S. companies are required to use them.

After abandoning an earlier plan that would have had U.S. companies using IFRS as soon as 2014, the SEC has said it would make a decision this year about whether companies in the U.S. should move toward the international standard, which is used in more than 100 other countries around the globe.

Top Ten Most Influential Accountants

A Top Ten list from a list of 100 of the most influential accountants in the U.S., as compiled by Accounting Today.


1. Barry Melancon, President and CEO, American Institute of CPAs
2. Mary Schapiro, Chair, Securities and Exchange Commission
3. Leslie Seidman, Chair, Financial Accounting Standards Board
4. Douglas Shulman, Commissioner, Internal Revenue Service
5. James Doty, Chair, Public Company Accounting Oversight Board
6. James Kroeker, Chief accountant, Securities and Exchange Commission
7. James Metzler, Vice President of small firm interests, American Institute of CPAs
8. Hans Hoogervorst, Chair, International Accounting Standards Board
9. Mark Koziel, Vice President of firm services & global alliances, American Institute of CPAs
10. Gary Boomer, CEO, Boomer Consulting
See if you made the list of 100 by looking here.

Fix for IFRS XBRL Taxonomy Exposed

Both the U.S. GAAP and IFRS XBRL taxonomies have been revised and exposed for comment.

For those not familiar with XBRL, it is an open-source HTML-like language for tagging financial statements. Proponents claim that XBRL makes it easier for investors and analysts to compare financial results across companies and industries. XBRL is now mandated by the SEC for public companies to use in their financial filings. XBRL tags let users of financial statements electronically search for, assemble, and process data so the information can be accessed and analyzed by investors, analysts, journalists and regulators.

The 2012 U.S. GAAP Financial Reporting Taxonomy is expected to be finalized and published in early 2012. The proposed 2012 U.S. GAAP taxonomy and instructions on how to submit comments are available on FASB’s XBRL page.

As for the IFRS taxonomy, the IFRS Foundation has revised it taxonomy in response to regulators and preparers who wanted more extensions (additional sub-accounts) to the full IFRS XBRL taxonomy.

The IFRS XBRL taxonomy is used to help those filing IFRS financial statements electronically to tag the information with identification tags, also known as “concepts.” Currently, the IFRS taxonomy includes all of the core concepts included in IFRS as issued by the IASB. However, preparers often need to provide more detailed financial information than is reflected by the core IFRS concepts.

To ensure that those creating and using electronic filings do not need to create their own extensions to the IFRS taxonomy, the IFRS Foundation has created an “extension taxonomy” by analyzing and drawing from common practice. For instance, although IFRS requires the disclosure of an analysis of expenses, IFRS does not include a prescriptive listing of all of the possible categories of expenses. The common-practice taxonomy includes concepts for the most commonly used types of expenses, such as “sales and marketing.”

The interim taxonomy released on Thursday completes the first part of a project to address this issue, by providing about 350 extensions for the most common concepts used in the financial statements.

The common practice concepts are in line with IFRS requirements and will help to alleviate the burden on preparers and to increase the comparability between financial statements in accordance with IFRS that are electronically submitted.

CFOs Exit Restating Companies, Study Finds

But they overwhelmingly tend to resign rather than get fired, companies report.
Good article by David M. Katz, of CFO.com

Restatements of financial reports usually convey bad news about a company to the stock market, and CFOs, as chief stewards of financial reports, tend to like nothing less than bearing such tidings. In fact, when companies restate, their finance chiefs show a pronounced tendency to leave, new research confirms. Usually, however, it's their own decision to walk — or at least that's what the companies are reporting.

From 2005 to 2009, companies in general had a 14.88% to 19.47% chance of having a CFO departure in a given year, according to Audit Analytics, a data-research firm. But the situation changed dramatically for companies that filed a restatement. In such cases, the probability of a finance chief leaving in the period beginning three months before and ending nine months after a restatement rose to a range of 19.06% to 28.99%.

The finance chiefs mostly resigned, rather than receiving pink slips. Overall, the companies studied had a resignation rate of between 14.45% and 18.57%, while the restated companies experienced a rate from 18.06% to 27.68%. (The researchers looked at a total of 48,200 10-K filers that also filed an audit opinion over the five-year period.)

Companies rarely report that they have dismissed a CFO regardless of the reason, according to the Audit Analytics report, CFO and Auditor Departures Occurring Near the Issuance of a Restatement. Overall, companies experienced a dismissal rate ranging from 0.40% to 0.99% over the five-year period. If the companies filed a restatement, the chance of a finance chief's dismissal jumped to between 1.00% and 1.30% — a very large difference, but involving very low numbers.

"What a CFO can take out of this [study] is that the chance of getting fired and having it shot out as an 8-K disclosure really doesn't increase near the occurrence of a restatement," says Donald Whalen, the firm's director of research.



But are all those finance chiefs actually leaving on their own? While Whalen says that such information generally can't be gleaned from financial statements, he grants that CFOs threatened with dismissal might negotiate with their employer to have the move reported as a resignation. The "You can't fire me, I quit" scenario may also exist in some cases.

A company, however, has an interest in not reporting turmoil in its senior ranks. To report a resignation rather than a dismissal is usually preferable, says Whalen, because "at least it shows a better relationship than companies that come right out and say, 'Hey, we kicked this guy out.'"

CFOs might also want to take pains to avoid certain types of restatements rather than others. Restatements involving revenue recognition tend to have an especially malign effect on share prices, while those involving corporate cash flow rarely make a dent, according to Whalen.

As is the case with CFOs, companies and their auditors tend to sever relations more frequently during a restatement, according to the Audit Analytics report. For all the companies studied, the departure rate varied from 10.19% to 15.69% during the five-year period. But among those filing restatements, the departure rate rose to between 20.79% and 25.75%.

Impairment Bucket List

No, it’s not a list of cool impairments that an accountant might calculate in his lifetime, if he or she had the time and luck.

Accounting standard-setters are working on a new method of categorizing impaired financial instruments.

The recent credit crisis has advanced a need for revision of the current model as large financial institutions did not agree with existing standards. Large banks, for example, claim that the existing standards result in a “pro-cyclical” result. That means that when times were good, they accounting rules made things look better, faster. And when times were bad, things looked bas faster. Or went to hell faster, as we saw in 2009/03. The rules also impact other sectors.

Credit Crisis Effects
In 2008, banks were following a system of incurred loss reporting, meaning assets were marked down, or impaired, only once their value had demonstrably fallen. Critics said this caused catastrophic shortcomings in financial early warning systems, meaning banks were unable to build up reserves for expected losses and were woefully unprepared when asset values suddenly went into freefall.

The IASB has developed a more forward-looking set of rules for calculating impairment.

“Three-Bucket Solution”

One approach, and the major one being advocated now, is called the three-bucket approach.

One pre-IFRS problem was earnings management, when banks would set aside provisions with little justification, only to release them in lean years to plump up earnings. Critics said this made it hard for investors to get a handle on banks' true financial positions; from these concerns was born incurred loss reporting.

After the credit crisis, the accounting problem was how to permit the judgment essential for expected loss provisioning without paving the way for a potential return to earnings management.

The three-bucket approach aims to break down assets according to impairments, keeping a tighter rein on provisioning and giving analysts a clearer picture of financial health.

Into bucket one goes 'healthy' assets, those for which banks expect a reasonable return and need only make minimal provisions. Bucket two is reserved for assets with some level of impairment, but which are not completely useless, while bucket three is for assets that are undeniably 'bad'.

Throughout its life, the asset can move between buckets according to macro- and micro-economic triggers, hopefully allowing banks to make exactly the right provision at exactly the right time.

An example might be a bundle of mortgages. The bank grants the mortgages, and works out on the basis of historical data that it is likely to take an 80% return on them. It therefore makes provision for the 20% loss and the mortgage bundle sits in bucket one until a trigger makes re-evaluation necessary.

This trigger could be a macro-economic event such as falling oil prices, a contracting economy or rising unemployment. From this, the bank might deduce that a greater proportion of mortgage holders will struggle to pay and shift the asset bundle into bucket two, requiring higher provisions to be made.

For the mortgages to jump to bucket three, they must be demonstrably impaired, for example when the inhabitants of a town hit by unemployment begin defaulting on their mortgages. This is essentially an incurred loss model and would result in very high or 100% provisioning for the de-valued assets.

Unfinished business
Like all theoretical models, there is much uncertainty to be hammered out. What constitutes a bucket-moving trigger? When an asset is impaired, who decides whether the impairment is expected – therefore already provided for – or unexpected, meaning more cash should be set aside? How will auditors examine such a complicated model and will it really prevent earnings management if banks are determined to do it?

A number of question exist, and will need to be ironed out prior to implementation.

The Beginning of the End of a Single Set of High-quality, Global Accounting Standards

A year and a half ago, the G-20 leaders called on international accounting standard setters to redouble their efforts to achieve a single set of high-quality, global accounting standards through their independent standard-setting processes and complete their convergence project by June 2011.

Before we even have a converged set of global accounting standards, the EU has hammered a nail into its coffin. If the EU can decide to opt in or out of a given part of IFRS standards then the door is open to home-country versions of IFRS similar to those that have existed for years.

The European Union has refused to adopt a new accounting rule that could ease fallout from the euro zone's sovereign debt crisis on banks.

The International Accounting Standards Board (IASB), following up on pressure from policymakers at the height of the financial crisis, has eased its "fair value" or mark-to-market rule that was known as IAS 39.

The first completed part of the new IFRS 9 standard allows banks to price some government debt held on their books at cost rather than at current depressed prices.

This avoids the "cliff effect" of many banks needing to recognize large losses and top up regulatory capital buffers.

IFRS 9 would allow European banks to exclude some of the broader markets effects of the current financial crisis in Europe.

Under IFRS 9 impairments will still exist, but would be more timely.

The EU has stated that it wants to see how two other elements of IFRS 9 will be finalized before making up his mind on the complete rule.

Latest IFRS Readiness Survey from AICPA

The AICPA recently published a survey of U.S. CPAs on the subject of readiness for IFRS.

Some of the results:

• Majority of CPAs in the United States have some knowledge of IFRS


• Many CPAs have begun to develop greater expertise


• Significant movement in the readiness of U.S. CPAs for introduction of IFRS in the U.S. over the three years since 2008


• Slight reversal in readiness gains as CPAs await progress in the convergence of U.S. and international standards and a clear timeline from the SEC.


• 76% of CPAs working in public companies are delaying preparations to adopt IFRS until the SEC issues a decision, which is an inrease of 13 percent from 63% who were delaying six months ago.


• 78% of CPAs already have some knowledge of IFRS


• 53% support an SEC mandate requiring use of IFRS in the U.S.


• 23% think IFRS should be offered as a financial reporting option for public companies.


• Large majorities were unsure whether the proposed new standards and accompanying guidance in these areas would be improvements over existing standards.


• Only 16% of respondents said that they had heard of the “condorsement” model proposal.


• 50% of CPAs working for foreign-owned public companies and 39% in foreign-owned private companies have already adopted IFRS or are ready to adopt.


• 48% of CPAs working for U.S. public companies foresee a need for advanced or expert level knowledge of IFRS


• 32% have begun actively preparing for adoption.


• 18% are planning to adopt IFRS.


• 30% said the pace of change for IASB-FASB convergence is too fast; 36% said the pace is appropriate; 28% are unsure; 6% think the pace of change is too slow.


• 51% believe a 2015-16 adoption date would allow enough time for implementation; 17% said that would not be enough time, and 32% are unsure.


• 53% said they are aware of the standard for SMEs; 30% said they would consider adopting it or would advise their clients to consider adopting it, but most would only consider this if IFRS were required for public companies.
  
  

Giving a Rodent's Posterior about IFRS

I love the way that the author introduces this article:

Anyone Who Gives a Rat’s Behind About IFRS Needs to Mark July 7 on Their Calendars
By CALEB NEWQUIST

Cause there’s gonna be a roundtable.

The Securities and Exchange Commission staff announced today that it will sponsor a roundtable in July to discuss benefits or challenges in potentially incorporating International Financial Reporting Standards (IFRS) into the financial reporting system for U.S. issuers.

The July 7 event will feature three panels representing investors, smaller public companies, and regulators. The panel discussions will focus on topics such as investor understanding of IFRS and the impact on smaller public companies and on the regulatory environment of incorporating IFRS.

“We must carefully consider and deliberate whether incorporating IFRS into our financial reporting system is in the best interest of U.S. investors and markets,” said SEC Chief Accountant James Kroeker. “This roundtable will provide an excellent opportunity for investors, preparers, and regulators to provide the SEC staff with valuable information that will help the Commission in its ongoing consideration of incorporating IFRS.”

See you there. If you manage to recover from your July 4th meat sweats, that is.

XBRL and IFRS Mess

As a result of a series of missteps and lack of coordination, companies that file financial statements in the United States following IFRS may be getting a break on their first XBRL filing.

The SEC have acknowledged that it would be impossible for foreign private issuers, filing with the SEC following IFRS, to file in XBRL, because the SEC has yet to approve the XBRL taxonomy that IFRS filers should follow. Foreign private issuers (“FPI”) filing quarterly “voluntary” 10-Q filings are the first group of the third and final wave of companies coming under SEC rules to file in the XBRL for the first time.

For example a calendar year FPI in this group files its 30 June 2011 Form 10-Q on its Monday 10 August 2011 due date. The company would have until Tuesday 8 September 2011 to file its first XBRL exhibit under Form 10-Q/A. No grace period would be available for its 30 September 2011 Form 10-Q. For a FPI not filing voluntarily on domestic forms, its annual report on Form 20-F or Form 40-F for its year ended on or after 15 June 2011 will be the first SEC report required to include XBRL data. So a calendar year filer in this group would file its annual financial statements in XBRL format by its filing deadline in 2012.

To provide financial statements in XBRL according to SEC's rules, companies must follow a taxonomy approved by the SEC. A taxonomy is a list of computer-readable tags in XBRL that allows companies to tag the thousands of bits of financial data that are included in financial statements and footnote disclosures. On March 25, the IFRS Foundation finalized a 2011 IFRS taxonomy that would be followed by IFRS issuers to file in XBRL. The SEC has not yet approved that taxonomy, and hasn't said when it expects to do so. An SEC spokesman said the IFRS Foundation is still working on the taxonomy. Previously taxonomies took about five weeks for SEC approval.

The SEC has relaxed its rules for filings stating: “We are of the view that foreign private issuers that prepare their financial statements in accordance with IFRS as issued by the IASB are not required to submit to the Commission and post on their corporate websites, if any, Interactive Data Files until the Commission specifies on its website a taxonomy for use by such foreign private issuers in preparing their Interactive Data Files,” Cross and Kroeker wrote. The letter gives no indication, however, of when the SEC expects to approve the IFRS taxonomy and therefore how that might impact the date for XBRL filing requirements.

IFRS Convergence Projects Delayed

The heads of FASB and IASB announced they will take “a few additional months” beyond their June target date to complete priority joint convergence projects on revenue recognition, leases, financial instruments and insurance. This is a reasonable development, and expected by most observers. The original convergence deadlines were optimistic and some thought that inferior standards would result if the projects were rushed. A few quotes below.

David Tweedie, Chairman of the IASB
Leslie Seidman, Chairman of the FASB

David Tweedie: “...if you were listed in the United States using IFRSs you had to reconcile to US GAAP, that showed where the differences were, and what we did was try to look through our standards and if FASB had a better standard, we should take it and vice versa. That was going to take forever so in 2006, the Memorandum of Understanding (MoU) was instituted and that set out a different policy, namely that we should look at certain standards, and for each of these standards, if it was complex or out of date there was no point in trying to converge them otherwise we would just get a complex out-of-date converged standard when what we should really do is write a better one.” “...we have completed most of that program and it’s been a great success, the two sets of standards are much closer together and frankly IFRSs are much better quality than they would have been otherwise.”

Seidman: “We would never let a target date take priority over thorough and robust due process...so let me clarify any misunderstanding about the June 2011 date. It was always intended to be a target, not a deadline, and we always said that achieving the target was subject to the nature and extent of the feedback that we got on each of the exposure documents. At this point on each of the exposure documents we have received significant and very constructive feedback and we are in the process of working through those issues. The quality of the standards remains of the utmost importance. Every board member wants to issue high quality standards that we think are going to withstand the test of time.”

Tweedie: “We have been working on these now for some five years so this is hardly a rush job and what we have done, and I think this is a big change in standard-setting over the past couple of years, is we have gone out deliberately to get high quality in put in addition to that required by our due process. This extensive outreach is something that hadn’t been done to the extent that it is now. We get constant input, and we test these ideas as we finalize the standards.”

Tweedie: “...we would never release a standard before it is ready and ultimately it must be a high quality standard or you just can’t issue it.”

Seidman: “After evaluating the issues yet to be addressed we jointly concluded that, without extending the work out indefinitely, we all could benefit from a few more months to develop these standards, some of which really go to the core issues of many companies.”

Tweedie: “So as Leslie was saying there, we have decided to extend the timetable for a few additional months to enable us to check whether our conclusions will last the test of time. We are also mindful of the G20 target, we have been reminded of that many times over the last few years, and we intend to try to finish this convergence program by end of 2011. The June target has helped us to get there but at the same time it is clear that we need a little more time to check the conclusions, and to ensure that the standards are of the highest quality.”

Seidman: “Let me mention one other thing, we have yet to decide on the effective dates for these standards but we do want to reassure people that we will allow ample time for them to understand the requirements and to plan for an effective transition to the new standards once those decisions are made.”

A U.S. Viewpoint on Lease Accounting

Following is a summary of a comment letter submitted on lease acconting, as previously published in the Journal of Accountancy.

The AICPA’s Financial Reporting Executive Committee (FinREC) commented on FASB’s Proposed Accounting Standards Update, Leases. The exposure draft was developed jointly with the International Accounting Standards Board (IASB). FinREC said it supports the boards’ overall objective to develop a single approach to lease accounting and to require assets and liabilities arising under leases to be recognized in lessees’ statements of financial position. However, FinREC believes there are fundamental application issues not addressed by the ED, and revisions that need to be made to various aspects of the boards’ proposal, including those related to the right-of-use approach to lessee accounting.

The FASB proposal would result in a single “right-of-use” approach applied consistently to lease accounting for lessees and lessors. Among other changes, the approach would result in the liability for payments under all lease contracts within the scope of the standard and the right to use the underlying asset being included on the lessee’s balance sheet. The standard setters say the changes would improve the information available to investors and other financial statement users about the economics surrounding lease contracts.

Unlike FASB’s discussion paper, Leases: Preliminary Views, published in March 2009, which focused primarily on lessee accounting, the ED, Leases, would result in changes on both sides of a lease transaction. A lessor would apply either a performance obligation approach or a derecognition approach. “The majority of FinREC members do not support the boards’ hybrid (lease classification) approach to lessor accounting—instead they support the derecognition approach as the single lessor accounting model,” FinREC said in its comment letter.

The proposal includes simplified accounting for short-term leases—leases having a maximum term of 12 months or less. The simplified accounting would allow lessees to ignore the effects of interest on the recorded assets and liabilities and allow the lessee to record the liability for lease payments at the undiscounted amount for lease payments. The simplified accounting would allow the lessor not to recognize assets or liabilities arising from a short-term lease, nor derecognize any portion of the underlying asset.

In its comment letter, FinREC said, “We do not support the boards’ approach to accounting for lease renewal options and contingent rents. We believe that the lease term should be defined as the lessee’s (lessor’s) best estimate of the lease term. We believe contingent rents and expected payments under residual value guarantees should be included in the measurement of assets and liabilities based on management’s best estimate of payments to be made (received) under the lease.”

Learning IFRS

The AICPA is developing an IFRS Certificate Program. They have a number of self-study courses on IFRS in general, comparisons to U.S.GAAP, and individual topics like inventories, intangibles, impairment, EPS, etc. You can find information about the self-study courses here.

We ordered one of their self-study courses a while back. I didn't complete the course myself, but I have had good reviews from those who did.

Seven Accounting Changes That Will Affect Your 2010 Annual Report

The following is by Jim Brendel and was originally published in SmartPros.

There are a number of new rules that will have accounting and reporting implications for 2010 year end annual reports. They vary from changing the timing of financial results to adding to overall reporting expense.

Two new Financial Accounting Standards Board updates will have major impacts on accounting for sales contracts that contain multiple deliverables. What’s a multiple deliverable? Say your company sells dishwashers and also provides the installation. Under the old rules, you had to demonstrate objective evidence of “fair value” for each undelivered item in order to recognize revenue for the delivered item. If you could not establish the fair value of the installation, revenue recognition for the dishwasher could be delayed, even though the customer had paid for it.

Under the new revenue recognition rule – ASU 2009-13 – companies don’t need the “objective” proof of each service or good, they can estimate the selling price of the installation and warranty. So in our example, the vendor - say it’s Sears or Appliance Factory - can recognize the revenue of the dishwasher – alone - at the point of sale without waiting a few weeks for the installation guys to do their thing. Then they can recognize the estimated value of the installation after it is complete.

The second major revenue recognition change for 2010 reporting , ASU 2009-14, covers software enabled devices. This has also been referred to as the iPhone rule because of the large effect that it has on Apple Computers’ revenues. Although the iPhone is a piece of hardware, it depends on embedded software for its intended use. Under the old rules, this embedded software caused iPhone sales to be governed by the software revenue recognition rules, which are much more stringent than the rules related to other goods and services. As a result, Apple had to recognize all of the revenue from the sale of an iPhone over two years because it provides software updates over that period. ASU 2009-14 says that the software revenue recognition rules no longer apply to these types of software enabled devices, so they are now governed by ASU 2009-13, like other goods and services. The result of the change? Apple reported a record quarter when it elected to adopt this rule early for its first fiscal quarter 2010. Both of these new standards are effective for fiscal years beginning after June 15, 2010, but can be adopted earlier.

Five Other Changes for 2010 Reporting

Fair value disclosures. Companies will be required to provide additional disclosures about items measured at fair value in the financial statements for their 2010 financial statements. In particular, significant transfers in and out of Level 1 (quoted market price) and Level 2 (valuation based on observable markets) must be disclosed separately, along with the reasons for the changes.

Fair value items classified as Level 3 (valuations based on internal information) will require additional disclosure of purchases and sales during the year. The FASB recently decided not to exempt private companies from these requirements. Investors have said that these new disclosures will give them better insight into the quality of reported earnings, but companies can expect to spend additional time gathering and summarizing all of this information.

Consolidation of variable interest entities. Several changes to the consolidation rules for variable interest entities, also known as special purpose entities, came into effect in 2010. The new rules require a qualitative, rather than a quantitative, analysis to determine the primary beneficiary of a variable interest entity, such as a corporation formed to hold real estate and lease it to an operating company. The primary beneficiary is the company that has the power to direct the activities and obligation to absorb the losses of the variable interest entity, which it will consolidate even though it may own less than a majority of the voting interests.

XBRL. eXtensible Business Reporting Language is a data-tagging technology that standardizes the way that financial statement items are identified, and has been frequently referred to as the next generation of EDGAR. The SEC has required the largest public companies (over $5 billion in market cap) to file financial statements with XBRL tagging since June 2009.

In June 2010, the remaining large public companies (over $700 million in market cap) were first required to provide XBRL tagging in their financial statements. Starting in June 2011, all of the remaining U.S. public companies must file financial information using XBRL.

Companies will likely require outside assistance to match their accounting records with the standard XBRL classifications, and should consider an early start on this project. It can easily cost a small public company from $30,000 to $50,000 to implement.

Non-GAAP financial disclosures. Recent SEC staff interpretations allow more latitude for companies who provide non-GAAP financial disclosures, such as EBITDA, in SEC filings, as well as additional guidance in making those disclosures. These interpretations reduced the constraints on the exclusion of recurring items from the non-GAAP measure, and let companies know that management does not have to use the measure in operating the business in order to disclose it. The new interpretations can be found here. The effect of this change is mainly to provide more flexibility to companies in how they report non-GAAP measures of performance and won’t necessarily add or subtract from earnings statements.

Loss contingencies disclosures. A FASB proposal that would require more disclosures about loss contingencies, such as litigation, has been sent back for more deliberation after concerns were raised that the level of disclosure would put public companies at a disadvantage in the courtroom. However, the SEC is questioning whether companies are adequately complying with the current rule, which requires disclosure of an estimate of the possible loss or range of loss. The SEC believes that in too many cases, no disclosure is made until the case is settled because companies assert that they are not able to make accurate estimates of the potential loss. Companies should expect additional scrutiny of their disclosures in 2010 annual reports.

Developments to Watch in 2011

Short-term borrowing disclosures. In response to concerns about companies window-dressing their balance sheets by paying down lines of credit before year- end, the SEC has proposed rules that would require additional disclosures, such as fluctuating borrowing during the year and a qualitative discussion of the business reasons for the debt. These rules are expected to be finalized in the first quarter of 2011. However, the SEC has reminded companies that they expect to see a thorough discussion of liquidity and capital resources in the management’s discussion and analysis under the existing requirements.

Dodd-Frank Act. The Dodd-Frank Act is considered to be the most extensive overhaul of the U.S. financial system since the 1930s and will require the SEC to write over 100 rules and conduct numerous studies. You can follow the progress of these rules on the SEC's website.

Of particular interest to public companies are the requirements for companies to establish policies to claw back incentive compensation paid to executives in the event of a financial statement restatement and to provide disclosures regarding the ratio of CEO compensation to median employee compensation.

Convergence. While the SEC continues its consideration of whether to adopt international accounting standards (IFRS), the FASB and its international counterpart, the IASB, have their own work plan to complete 11 major projects in 2011 to converge US GAAP and IFRS. Although the effective dates of these standards have not been determined, this level of standard setting activity in such a short time is unprecedented. The two projects that are getting most of the attention are a proposal to replace all industry-specific revenue recognition guidance with one comprehensive standard, and a proposal that would require all lease obligations to be recorded on the balance sheet.

Joint Proposals Push Toward IFRS/GAAP Convergence in Issues Affecting Banks

FASB and the IASB announced moves toward convergence of IFRS and GAAP through joint proposals on offsetting transactions and impairment of financial assets.

The two main changes are 1) an exposure draft released last week on a common approach to offsetting financial assets and financial liabilities. This would end a major difference between IFRS and U.S. GAAP. 2) A supplementary document with a new impairment model for financial assets like loans managed in an open portfolio. The proposal would replace the incurred loss model with a more forward-looking expected loss model--a response to complaints in the financial crisis.

The issue with offsetting is that companies can, in some instances, report IFRS balance sheet figures that are 100 percent greater than their U.S. GAAP numbers. This is confusing to the global capital markets and the proposals would eliminate the difference.

U.S. GAAP would only net in more limited circumstances, with note disclosure of other netting arrangements in footnotes.

Offsetting/netting is required when company presents in net amounts on their balance sheet. As it stands now, financial assets and financial liabilities may show up on a balance sheet as one net amount, or as two gross amounts, depending on whether the balance sheet is in IFRS or U.S. GAAP.

The above netting arrangements cause the largest difference between balance sheets using IFRS and U.S. GAAP. Derivative assets and related liabilities are the most common area where this occurs. Balance sheets of financial institutions generally have the largest derivative positions.

The new proposed rules apply only when the right of setoff is enforceable at all times, including in default and bankruptcy, and the ability to exercise this right is unconditional—i.e. offsetting only occurs after a future event. A company must intend to settle net, i.e. with a single payment, or simultaneously. If all of these requirements are met, offsetting is mandatory. This would also change industry conventions.

The Exposure Draft is Offsetting Financial Assets and Financial Liabilities [FASB Proposed Accounting Standards Update, Balance Sheet (Topic 210): Offsetting]. Comments are due April 28.

On Impairment, changes introduce an expected loss model that is more forward-looking in accounting for credit losses, and is said to better reflect the economics of lending decisions. IFRS and U.S. GAAP currently account for credit losses using an incurred loss model, which requires evidence of a loss (known as a trigger event) before loans can be written down.

“The FASB and IASB are seeking comment on the changes, i.e. whether they agree conceptually and whether the changes can be practically applied.

Some advocate that a more forward-looking approach to loan losses would have made loan provisions show up earlier than before, and may have held off or mitigated the credit crisis by giving earlier warnings about the health of financial institutions.

Comments on the document Accounting for Financial Instruments and Revisions to the Accounting for Derivative Instruments and Hedging Activities, are due April 1.

If you need a nap, the IASB is hosting a webcast on the impairment of financial assets proposal on Friday, Feb. 4, with sessions timed for Europe and the U.S. Also “FASB in Focus” has overviews on the new rules netting on FASB’s website and another FASB in Focus on the impairment model.