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By Steve Burkholder and Denise Lugo, BNA Staff Correspondents
NORWALK, Conn.—Accounting issues claimed a central place in the policy debate over how to deal with the financial crisis that gripped the U.S. and world economies in late 2008, and pressure on both the U.S. Financial Accounting Standards Board and the International Accounting Standards Board is expected to continue in the coming year.
The words “crisis” and “change” have become commonplace at the FASB, while “controversy”—though generally unspoken—also applies as the two boards cobble together responses to the unprecedented financial turmoil that continues into 2009. The boards are also moving forward on a range of changes to accounting standards designed to bring U.S. and international standards more closely in line by 2011.
Fair value accounting became a lightning rod in and around the battle over the $700 billion financial rescue bill. For the beleaguered financial industry, the stakes of that debate were high.
Fair value accounting became a lightning rod in and around the battle over the $700 billion financial rescue bill in the 110th Congress (4 APPR 853, 10/3/08). For the beleaguered financial industry, the stakes of that debate are high, as markets for financial assets—including mortgage-backed securities, and collateralized debt obligations based on mortgages—either froze up or fell through the floor in 2008.
Debate over fair value accounting and related impairment issues will continue to be a hot button issue for the FASB in 2009 as it finalizes proposals issued late in 2008 to deal with questions and problems related to existing accounting standards and considers whether to embrace fair value accounting for financial instruments more globally.
Questions on whether now is the right time for the United States to begin moving to international accounting standards issued by the IASB will also continue, as a new administration considers comments on the Securities and Exchange Commission's proposed road map to domestic adoption of international financial reporting standards.
The ongoing financial turmoil is playing out against the change in U.S. administrations. President-elect Obama assumes office Jan. 20, two weeks after the seating of the 111th Congress, marked by a firmer Democratic majority in both houses. Obama already has named his choice for the new chairman of the Securities and Exchange Commission: Mary Schapiro, a former SEC member who once headed the Commodity Futures Trading Commission. Schapiro will choose a new SEC chief accountant, an influential position in standards-setting work.
While the incoming administration has not articulated a policy on accounting issues to date, it will be asked to grapple with a host of economic and regulatory issues within the context of which accounting policy will be made. Those broader issues include potential reform of the entire financial regulatory system—in particular the role of the SEC—as well as consideration of a huge economic stimulus package and oversight of the $700 billion financial bailout package adopted late last year.
Financial Crisis Group
The FASB and IASB announced Dec. 30 the formation of a Financial Crisis Advisory Group, which will assist in developing quick accounting guidance in response to urgent financial problems and perhaps help provide political cover for such unpopular decisions as expanding use of fair value accounting.
The U.S. board already had agreed to restructure itself in response to the possibility of the United States adopting international standards. In mid-2008, the seven-member board was reduced to five members, and agenda-setting powers were newly vested in the chairman.
The IASB-FASB crisis advisory panel—which meets for the first time Jan. 20 in London—has the job of helping identify emergent problems in accounting that may warrant attention from the two boards. A second meeting of the panel is scheduled for Feb. 13 in New York.
Standards Nearing Completion
Even as the FASB seeks to issue staff guidance and new rules on hot topics rising out of the current crisis, the board is trying to push out the door a number of important standards in 2009 as it seeks to make significant progress on a host of major projects it is conducting with the IASB. Among these are projects on changes in revenue recognition, financial statement presentation, pension accounting, and the overarching conceptual framework.
In addition, the FASB plans to roll out a formal, single-source codification of all authoritative accounting pronouncements July 1. The codification represents a multiyear effort by the board.
Focus on Financial Instruments, Fair Value
Over the last few months, the FASB—at times working in tandem with the SEC staff and often on parallel tracks with the IASB—has scrambled to respond to the financial crisis with targeted, quick-turnaround guidance. The board has focused chiefly on financial instruments and, more recently, on asset impairment prescriptions. Some of that guidance has been put in place in final form or proposed in time to be effective for companies' 2008 year-end reporting.
“The standard-setting answer is a wholesale but expedited effort to redo the accounting model for financial instruments to make sure the risks and rewards of these instruments are understood by investors and regulators.”
Thomas Linsmeier, FASB member
Debate promises to intensify in the new year over the suitability of full fair value accounting for financial instruments and the timetable for a possible shift away from the mixed-attribute cost and fair value accounting.
A preview of that growing debate was offered at the FASB's Dec. 15, 2008, meeting, when Chairman Robert Herz set a course to join with the IASB for a comprehensive review of financial instrument reporting, aiming at an improved accounting and reporting model.
At that meeting, FASB member Thomas Linsmeier forcefully advocated full fair value accounting for financial instruments, a perspective with which financial institutions and others—both in the United States and Europe—have strongly objected. Linsmeier defended fair value accounting, pointing to recent research of banks' share price trends that “accounting is not the primary contributor to pro-cyclicality,” or the notion that marking assets to market prices has fed a downward spiral in values.
“The standard-setting answer is a wholesale but expedited effort to redo the accounting model for financial instruments to make sure the risks and rewards of these instruments are understood by investors and regulators,” he said. “This effort will be most effective if it concentrates on full fair value accounting for financial instruments with carefully considered required disaggregated presentation of rewards, risks, and uncertainties in these instruments in the income statement and financial statement footnotes. It is only with this type of accounting model that investors and regulators will have timely enough information to act to prevent the declines in market confidence that have led to the illiquidity problems we are now experiencing.”
“I react skeptically to calls for emergency standard-setting efforts that delay recognition of losses or have the outcome of delaying the transparent communication of the differential problems in our economy,” said the FASB member, an accounting academic who formerly taught at Michigan State University.
“To make credit markets work again, information must be provided that reduces the widespread uncertainties about banks' asset values,” he added. “This requires even more transparent and consistent reporting, not less.”
At the same meeting, FASB member Lawrence Smith offered a counterpoint, suggesting that full fair value accounting may not be the appropriate approach in every instance. “I think amortized cost does have a place” in the financial reporting model for instruments, Smith said.
Smith also cited lack of information on how preparers of financial statements arrive at fair values. He called that one of the “frustrating things in the crisis.”
Smith, a former partner at KPMG and a former FASB staff director, said that he does not necessarily believe that full fair value accounting, with changes in values recorded in profit and loss, “is the answer, but I'm willing to listen if we were to undertake such a project.” He called the rulemaking course suggested by Linsmeier a “long-term solution.”
Debate Over Due Process
Accompanying the debate about the crisis-driven guidance on fair value and impairment accounting has been emerging discord about the IASB and FASB following due process. In the last week of 2008, some of the board's more steadfast allies were especially critical of the U.S.’s board adherence to guidelines for appropriate time periods for public comment.
Concern about adequate due process for accounting rulemaking grew after the IASB—under intense pressure from the European lawmakers responding to complaints of continental banks—reluctantly suspended due process Oct. 13 and approved a bank-friendly security reclassification to align IFRS with a controversial U.S. GAAP provision (4 APPR 901, 10/17/08).
IASB Chairman David Tweedie told BNA in a Nov. 12 interview that the board had little or no choice in making the change. However, accounting rulemakers made it clear that they did not want to repeat such an episode under what the FASB chairman called circumstances in which the London-based board members “either felt or were put at the point of a gun.”
Recently, FASB has been criticized for too-quick due process. When it proposed impairment guidance Dec. 19 with a Dec. 30 comment deadline, Jack Ciesielski, president of R.G. Associates and a current member of FASB's Investors Technical Advisory Committee, fired off a comment letter objecting. “The board has engaged in a mere facade of a due process,” he said.
“Although expediency might be argued to allow any final rule to be ready for year-end financial reporting, an equal argument would question that if it's so important, doesn't it require full due process?” Janet Pegg, of Encima Global, another ITAC member and a former member of FASB's main advisory panel, asked in a Dec. 22 comment letter.
A FASB spokeswoman declined comment on the criticism Jan. 5.
FASB-IASB Memorandum of Understanding
In September, the FASB and IASB adopted a new memorandum of understanding, guiding work of the two boards to converge their accounting standards, a project intended to improve both international and U.S. standards, as well as to set the stage for a conversion of U.S. filers to international standards (4 APPR 822, 9/19/08).
The boards also agreed in 2008 to work even more closely on issues arising from the credit crisis, attempting to deflect efforts to split the two boards. They also agreed to hold a third face-to-face meeting each year in July in London, and to reserve several hours monthly for a joint video-teleconference meting at which they would discuss and resolve differences arising in their separate meetings.
Further, the boards agreed to establish a strategy group comprising members and staff of both boards that would meet monthly to discuss significant issues of mutual interest.
The MoU identified 11 areas in which standard setters are currently working jointly to develop a common, high-quality standard by 2011, including financial instruments, financial statement presentation, leases, liabilities and equity distinctions, and revenue recognition. The list will amount to a core, improved set of international financial reporting standards intended for global use.
Other areas covered by the MoU include projects where the FASB and IASB are working separately, or are at different stages, but will eventually seek a common standard. These areas include consolidations; derecognition; fair value measurement; and post-employment benefits, including pensions.
IFRS in U.S.?
Also in 2011, if it follows its proposed road map to adoption of international financial reporting standards in the United States as issued, the SEC will decide whether to require adoption of IFRS for U.S. filers starting in 2014 with largest companies, 2015 with mid-sized companies, and 2016 for small companies. The SEC decision is contingent on progress on the FASB-IASB MoU, the IASB funding/infrastructure experience, and five other milestones.
The SEC road map, if adopted also would permit early IFRS adoption for some U.S. companies if they are among the largest companies worldwide within their industry, and if their industry uses IFRS as the basis of financial reporting more than any other set of standards. Such companies could use IFRS beginning with filings for fiscal years ending on or after Dec. 15, 2009.
However, it is not clear that even large multi-national companies are anxious to move toward IFRS while withstanding the continuing economic problems. It is generally agreed that converting to IFRS will be an expensive and time-consuming process for U.S. companies, and that now may not be the time.
What's more, U.S. domestic adoption of IFRS remains uncertain under the impending leadership of Mary Schapiro, President-elect Obama's choice to lead the SEC. According to Obama, he will ask her to concentrate on securities-fraud enforcement and help lead a restructuring of financial regulation throughout the U.S. economy.
Also clouding U.S. adoption of IFRS is the fallout from the IASB's Oct. 13 decision to yield to intense European Commission pressure and allow a reclassification of certain securities from a trading status to a held-to-maturity status to remove them from fair-value accounting. The episode has cast doubt among financial report users if IFRS as promulgated by the IASB can ever be the independent, high-quality global set of standards that the SEC road map envisions.
SEC Fair Value Study
In a report issued Dec. 30, the SEC backed fair value reporting, recommending against suspension of fair value accounting standards (please see related article in this issue ), instead suggesting that existing guidance needs to be improved.
When Congress enacted the $700 billion financial bailout bill, it included a requirement that the SEC study the impact of FAS 157, Fair Value Measurement, with an emphasis on examining whether the standard and fair value accounting overall should be suspended because of a negative impact on the financial institution industry.
Bankers had asked the FASB and the SEC to hold in abeyance prescriptions for fair value measurements under FAS 157 and other accounting standards in light of distressed markets and the possibility of a pro-cyclical effect.
Instead, the 259-page report written by the SEC staff recommended improvement to existing practice. The SEC also reported “that fair value accounting did not appear to play a meaningful role in the bank failures that occurred in 2008.”
The eight improvements include reconsidering accounting for impairments and devising added guidance for arriving at the fair value of investments in inactive markets—topics that have been or are now being addressed by the FASB.
A FASB spokesman responded Jan. 5 to a BNA inquiry seeking comment from the board's chairman after the SEC report's release. “We are pleased at the support for FAS 157 expressed in the SEC report,” Neal McGarity wrote in an e-mail message. He added that the board would need more time to respond further, “given the size, scope and length of the report.”
Securitizations, Consolidations Accounting
Leading the list for scheduled final standards this year are a pair of related standards that would make major changes to problematic rules on securitizations and consolidations accounting. The amendments to Statement of Financial Accounting Standard 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and FASB Interpretation 46(R), Consolidation of Variable Interest Entities, are expected to be issued in late March or possibly early in the second quarter.
In a Dec. 2 interview with BNA (see interview with Chairman Herz in this issue), Herz cited problems in the securitizations and consolidations accounting rules that are among the many issues highlighted by the financial crisis. Dubious application of those rules—such as stretching the concept of a “qualifying special-purpose entity” under FAS 140—has led to many loans and mortgage-backed securities carried off balance sheet, the FASB chairman suggested.
The board's planned elimination of the QSPE designation, which permits sale accounting for securitized financial assets, and the related non-consolidation exception in FIN 46(R), will result in large amounts of assets being placed for the first time on company balance sheets.
The planned amendments will not be effective for calendar-year companies until Jan. 1, 2010. However, the FASB issued late last year interim rules that require more robust disclosures about such transfers of financial assets and consolidations of special investment vehicles known as variable interest entities. The beefed-up disclosure requirements are required to be effective early this year.
Other FASB Financial Instrument Projects
Other standard-setting projects expected to bear at least preliminary fruit in the new year include several pertaining to financial instruments.
The FASB and IASB continue to work on a major joint project on classifying financial instruments with traits of equity, formerly known as liabilities and equity. The boards plan to issue a draft standard on the topic in the fourth quarter of 2009. The financial instruments/equity project is part of the boards' MoU.
As for lesser, FASB-only projects on financial instruments, which are all quick turnaround projects spawned by the financial crisis, the board's timetable for releasing final guidance in the first quarter of 2009 includes: the proposed FSP on EITF 99-20-a (Please see related article), as noted above; a proposal on disclosures about certain financial instruments (FSP FAS 107-a Pleas see related article); and a planned clarification on the embedded credit derivative scope exception.
Other 2009 standard-setting projects warranting highlight include:
• FSP FAS 141(R)-a, assets and liabilities arising from contingencies in a business combination, deferred on concerns about competitive harm raised by companies and their attorneys—final rules anticipated in the first quarter of this year (Please see related article);
• FSP FAS 144-d, on reporting discontinued operations, a joint project with IASB—final, second quarter;
• leases, leading to a planned major overhaul of lease accounting and current off-balance-sheet accounting models—discussion paper with the IASB in the first quarter of this year, with final standards issued by both boards in 2011 (4 APPR 909, 10/17/08);
• separate items of guidance on going concern and subsequent events—both final rules, both in the first quarter 2009;
• loan loss disclosures—final rules in the second quarter;
• disclosure of certain loss contingencies—final, second quarter; and
• earnings per share, another joint project with the IASB—final, third quarter.
A major project on the FASB's radar this year is its joint effort with the IASB revamping the overarching conceptual framework that is intended to guide development of accounting guidance on specific topics.
Progress on the conceptual framework has been slow, in part because it is seen by some as less urgent work than modernizing accounting standards that apply, for example, to revenue recognition or financial instruments. However, some have argued that work on the conceptual framework should precede that more detailed effort. According to certain board members, without proper inroads on the conceptual framework, standard setters have little chance of completing a number of key convergence projects on the joint FASB-IASB memorandum of understanding by 2011.
IASB member Jim Leisenring has pointed out that the board cannot resolve accounting debates in a consistent manner without a conceptual framework being completed.
“I don't think you can defend a common standard process without the framework.”
Jim Leisenring, IASB member
“The failure of us to make any more progress than we are on some of our standard level projects, is because of a lack of agreement about the framework,” Leisenring said Dec. 9 at an annual conference sponsored by the American Institute of Certified Public Accountants in Washington, D.C.
“I don't think you can defend a common standard process without the framework,” he said.
The work plan for the conceptual framework envisions eight phases, A through H. So far, the FASB and IASB have issued an exposure draft for Phase A, “The Objective of Financial Reporting, and Qualitative Characteristics and Constraints of Decision-Useful Financial Reporting Information,” and a discussion paper on Phase D, “The Reporting Entity.” The FASB and IASB began redeliberations on those papers in December.
The two boards expect to issue discussion papers on Phase C, “Measurement,” and Phase B, “Elements and Recognition,” in 2009. The Phase C discussion paper is expected to be released during the first half of 2009.
According to one observer, lack of progress on the measurement aspect of the conceptual framework means that every project that entails deciding what measurement attribute to employ—such as the debate over fair value accounting—does not have a framework to help make a consistent decision about measurement attributes. There also has been a lack of progress on the “entity” phase, suggesting decisions concerning entities and consolidation will not be based on a common view.
The framework also lacks a finalized presentation and disclosure platform, and thus decisions on what and how to disclose or present in financial statements lack a framework-based backing, this observer noted. Thus, it is more likely that the boards will be idiosyncratic in decisions from project to project about measurement, disclosure, presentation, and the form of the entity, this observer said. Consequently, it is more likely the boards will reargue those issues again and again, and will not be as efficient or consistent in standard setting as they might be.
There have been various discussions and disagreements among FASB-IASB constituents regarding whether the conceptual framework should be finalized chapter-by-chapter or as one whole completed document. The FASB agreed, however, that it would not wait until the end to do revisions; rather if it has a chapter that is “finalized” and a subsequent chapter would cause it to reconsider what was written in that prior chapter, that it would, on a real-time basis, redo the “finalized” chapter.
Financial Statement Presentation
In a project that may totally revamp financial statements, the FASB and IASB Oct. 16 jointly published for public comment a discussion paper, Preliminary Views on Financial Statement Presentation (4 APPR 949, 10/31/08). The FASB and IASB discussion papers are identical except for differences in style and format. The comment period ends April 14.
While the preliminary views document is out for comment, the FASB said it will conduct a number of field tests, in which companies will voluntarily recast, to the extent practical, two years of financial statements using the new method detailed in the preliminary views document.
In addition, FASB said the Financial Accounting Standards Research Initiative will conduct a series of controlled tests aimed at evaluating investor use of financial statements prepared using the proposed presentation model.
The FASB said all these processes will allow it to learn about the costs and benefits of the proposed presentation model. Following that, the board will redeliberate the issues addressed in the discussion paper, taking into considering all of the input with the expectation of publishing an exposure draft of a proposed standard on Phase B.
The IASB and FASB have been working on a joint project since 2004 to address users' concerns that existing requirements permit too many alternative types of presentation. Users also have said that information in financial statements is highly aggregated and inconsistently presented, making it difficult to fully understand the relationship between the financial statements and the financial results of an entity.
One key objective of the project is to offer better information on future cash flows. Thus, the board is proposing to make the other comprehensive income items more clear by putting them on the face of the statement. However, that does not mean that users should concentrate more on comprehensive income than on net income, the FASB has said.
A key controversy arose over a plan by the board to get rid of the net income subtotal on the weighted comprehensive income. In response to user concerns, the FASB decided to retain a net income subtotal on the way down to comprehensive income.
The IASB and FASB Dec. 19 issued a discussion paper, Preliminary Views on Revenue Recognition in Contracts With Customers, proposing what they view as the potential key to improving the recognition of revenue (please see related article in this issue).
The joint project on revenue recognition, which the boards hope will yield a final, globally accepted standard in 2011, could have far-reaching implications for companies, auditors, and regulators, practitioners have said.
Comments on the paper and its single proposed accounting model are requested by June 19.
The FASB's advisory council, the Financial Standards Advisory Council, has said that completing the revenue recognition project is critical to U.S. adoption of IFRS since revenue is fundamental to financial statement analysis, and the existing guidance in IAS 18, Revenue, is incomplete, insufficient, and internally inconsistent, compelling some filers to resort to U.S. GAAP as a backstop.
For its part, U.S. GAAP on revenue recognition comprise numerous industry specific standards and some can produce conflicting results for economically similar transactions.
The boards are aiming to improve the existing guidance in both IFRS and U.S. GAAP by developing a single revenue model that can be applied consistently regardless of industry.
The underlying principle the boards proposed is that a company would recognize revenue when it satisfies a performance obligation by transferring goods and services to a customer as contractually agreed. Since the principle is similar to many existing requirements, the boards expect that many transactions would remain unaffected by the proposals. However, clarifying that principle and applying it consistently to all contracts with customers would improve the comparability and understandability of revenue for users of financial statements.
The discussion paper explains the proposed model and its implications and seeks views to assist the boards in further developing that model into draft standards for both IFRS and U.S. GAAP.
The FASB and IASB MoU also included a comprehensive project on postretirement benefits. However, for 2009, Phase 2 of the project will not be a priority project on the FASB's agenda.
While the FASB completed its narrowly scoped Phase 1 project in 2006, it culminated with the issuance of FAS 158, Employers' Accounting for Defined Benefit Pension and Other Postretirement Plans, and FSP FAS 158-1, Conforming Amendments to the Illustrations in FASB Statements No. 87, No. 88, and No. 106, and to the Related Staff Implementation Guides.
Like the FASB, the IASB is conducting its project in phases. This year, the IASB is expected to issue an exposure draft on Phase 1 following consideration of comments on a discussion paper issued March 2008.
Separately, on Dec. 30, the FASB issued as final, FSP FAS 132(R)-1, Employers' Disclosures About Pensions and Other Postretirement Benefits, to provide guidance on an employer's disclosures about plan assets of a defined benefit pension or other postretirement plan (please see related article in this issue).
The guidance also requires a nonpublic entity to disclose net periodic benefit cost for each annual period for which a statement of income is presented. The disclosures about plan assets required by this FSP are effective for fiscal years ending after Dec. 15, 2009.
One major initiative the FASB expects to complete in 2009 is its codification of all U.S. accounting literature, now scheduled to go live July 1.
The codification is an attempt by the board to simplify the structure of U.S. GAAP to make it more understandable and user-friendly. It will not change existing standards, but will introduce a new structure.
Currently, U.S. GAAP consists of thousands of separate FASB accounting pronouncements; under the codification, it will be divided into roughly 90 topical areas, each organized in a consistent way. In addition, current U.S. GAAP represents a collection of many kinds of accounting pronouncements issued over decades by various standard setters. These vary in format, structure, authority, and accessibility and have been criticized by preparers as confusing and difficult to navigate.
Once the codification becomes final, it will become the single source of authoritative, nongovernmental U.S. GAAP and will supersede existing FASB standards, as well as guidance issued by the AICPA, FASB's Emerging Issues Task Force, and related literature.
The codification also will include—separately, but in a similar topical structure—relevant SEC accounting guidance.
The FASB initially expected to make the codification authoritative at the end of April 2009 but recently extended the date. Prior to the July 1 launch, the board is expected to address issues raised by constituents during a yearlong verification period that began on Jan. 15, 2008.
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