Markets and financial reporting in 2013 could be summed up in one phrase: A work in progress.
For the markets, political and governmental institutions hold the key to the next 12 months. Specifically in the United States, how the Federal Reserve Board attempts to wind down its thus far five-year “quantitative easing” program will have major implications for interest rates, mergers and acquisitions and corporate growth. Globally, questions remain about Europe’s growth prospects and Chinese policymakers are attempting a “soft landing” for China’s economy.
The state of financial reporting remains just as unsettled as global rule-makers and regulators attempt to converge standards, albeit at different paces and sometimes different tracts. In fact, work on the current major convergence projects of revenue recognition, leases, insurance contracts and financial instruments will spill over into the New Year and beyond.
For attendees of Financial Executive International’s (FEI) 32nd annual Current Financial Reporting Issues conference (CFRI), any attempts to navigate 2014’s economic and financial reporting dangers will require great skill and even greater patience.
But that does not mean there is not hope.
“Even though I am a former politician, I always like to think long term,” said Hans Hoogervorst, chairman of the International Accounting Standards Board (IASB). “And long term I am very optimistic."
An Economic Warning to Start
Financial executives looking toward 2014 will face significant challenges as politics increasingly encroaches into global business and economic growth continues to remain tepid, said Rana Foroohar, Time magazine’s assistant managing editor in charge of economics and business.
Foroohar kicked-off the CFRI conference with a Monday morning keynote presentation. “It’s interesting that FEI was born out of the Great Depression and a significant time of economic upheaval,” Foroohar said. “I think that we are at a very similar turning point in the U.S.”
According to Foroohar, the largest risk to the global economy and the markets is also something that is almost completely out of the control of financial executives: Political risk. “[Among] the things that keep me up at night is not the economy, it’s politics. Political risk will play a much, much larger role in the global economic environment,” she said.
In the past politics played only a tangential part in the economy, especially during the period between the mid-1980s and 2008, which Foroohar described as the period of “Great Moderation.”
During that time, the U.S. and global economy experienced a long stretch of decreased macroeconomic volatility, she explained. That volatility came roaring back following the 2008 financial crisis as policymakers rushed into the markers to save financial institutions.
Today, government is no longer considered a savior but “actually considered a headwind” to economic growth, Foroohar stated. The Time journalist cited recent academic research put a price on government’s disruptive impact on markets. “If you strip out politics, the U.S. would have a three percent growth rather than its current two percent growth. Politics cost the U.S. two million jobs and significant economic growth,” she said.
The rest of the world is not much better off. In Europe, policymakers are stepping into the economy with even more furor as they look to backstop failing economies. “What the U.S. and Europe have in common is that central bankers have become the most important economic and political factors,” Foroohar added.
In China, the depth of the bad loans its banks may hold is another microeconomic and political risk that financial executives need to consider when planning in 2014.
“China is the biggest ‘X factor’ in the global economy. The Chinese state banks have $10 trillion in loans on the books, and 10 to 20 percent could be bad. With growth slowing, the Chinese know they need to move beyond the current model,” Foroohar said.
The coming year may see an endgame for many government-driven economies as the political forces that fueled expansion through monetary policy exhaust their ability steer the global economy with stimulus.
The biggest question, said Foroohar, concluding, is “What happens when the bond bubble bursts and interest rates rise and who is going to be found swimming with no trunks when the tide of monetary policy pulls back?”
2014: Beyond Convergence
The focus of financial reporting in the U.S. and abroad in 2013 has been on the concept of “convergence,” or aligning the accounting rules and limiting the differences between U.S. generally accepted accounting principles (GAAP) and International Financial Reporting Standards (IFRS).
Hoogervost told the audience that efforts toward global accounting convergence will continue at its current pace. “We have not seen a decisions by the SEC [U.S. Securities and Exchange Commission], and I wanted to say here very clearly that the IFRS Foundation and the IASB remain very much committed to the United States,” Hoogervorst said, referring to the SEC’s consideration of converging U.S. GAAP and IFRS.
“What is perhaps less visible to you, in the absence of any SEC decision, is that the U.S cannot escape the influence of IFRS,” the IASB chairman said, adding that the influence of IFRS in the U.S. was increasing “step by step and day by day.”
Financial Accounting Standards Board Chairman Russell Golden focused his opening remarks on how to reduce complexity and encourage the simplification of accounting regulations. “Solving complexity is, quite frankly, very complex for preparers,” he told the audience, explaining that accounting literature can either be so “dense and complicated” that it is difficult for preparers to execute. Alternatively, the FASB chairman said, they are “very clear but very costly.”
“FASB plans to address both of these issues in the coming years,” Golden said.
Both standard setters then launched into their perspectives on the progress of what they refer to as the “Big Four” convergence initiatives, including revenue recognition, leases, insurance contracts and financial instruments.
Revenue recognition saw the most agreement between the IASB and FASB leaders, although both agreed much of the hard work of implementation remains to be done. “I consider this to be an extremely well run, committed project where both boards listened to each other,” Golden said. “There are minor differences, such as interim disclosure,” he added, explaining that FASB was also working with specific industries, such as telecommunications and wireless and real estate, where the rule change could have a “substantial” impact.
Both FASB and IASB will be working with the newly created Revenue Recognition Transitional Resource Group, which will conduct public meetings in several markets to make sure preparers are ready for 2017 implementation. “We are very committed to a smooth transition,” Golden said.
The more difficult story for convergence in 2014 comes with the project around leases, with FASB’s Golden saying that U.S. companies are concerned with the complexity of rules.
“What we have heard from our stakeholders [is] that this includes unnecessary complexity,” Golden said “The argument is that we are making decisions that will require substantial judgment by companies.”
Hoogervorst agreed that there was “a lot we can do to make the model simpler,” but that he remains convinced that the proposal on leases as an “important improvement of GAAP.”
"Our investors overwhelming support putting this stuff on the balance sheet,” Hoogervorst said. “This will make for some really interesting discussions between the two boards; I hope that we can finalize our deliberations in the first quarter of next year,” the IASB chairman added.
Golden was particularly concerned about lessor accounting. “What we have heard in the U.S. on lessor accounting is that ‘if it ain’t broke, don’t fix it.’ And there are a lot of people saying that lessor accounting is not broke. We need to carefully consider how to deal with it,” he said.
“Lessor accounting has always been of secondary importance, so we will take this into consideration,” Hoogervorst replied.
On insurance accounting, the IASB chairman said that the initiative will be a significant priority in 2014. “This project is of utmost importance because most of the world does not have proper insurance standards,” Hoogervorst said. “Low rates are killing the life insurance business model.”
PCAOB, SEC Weigh In
Public Company Accounting Oversight Board (PCAOB) member Jay Hanson used prepared remarks to focus on several initiatives moving into the New Year, including the auditor’s reporting model.
The proposal would require auditors to go beyond the current pass/fail opinion regarding financial statements and whether they are fairly stated and if internal controls are effective, and would require auditors also to discuss “critical audit matters” in reports.
“It is important to understand, however, that the proposed standard does not require reporting of all information known by the auditor in which investors may have an interest. There are risks and uncertainties inherent in the financial reporting process and in business that may not be discussed as critical audit matters because the application of the accounting standards are clear, and the audit process is relatively straightforward,” Hanson explained.
“The feedback so far on the proposal has been mixed. Some commenters believe the board's approach will enhance communications by auditors and provide useful information to investors, while others have suggested the requirements do not go far enough and are not sufficiently specific to require the auditor to report information that investors want,” added Hanson.
Paul Beswick, the SEC’s chief accountant, said that the regulator continued to focus on some recent hot button topics from 2013, including several issues that remain prime fodder for private marketing “consultations,” where the regulator offers guidance.
“In term of the topics — where we are spending our time on consultations (and I doubt this will surprise anybody) [are] financial assets, principally in the accounting for loan losses, business combinations where the vast majority is related to pushdowns and revenue recognition,” Beswick said.
The number one issue for consultations in terms of revenue recognition was around the topic of gross versus net accounting, Beswick said. “Oddly, that is something that is not changing in the new revenue recognition standard. That is one of the issues that we need to think about for the EITF [Emerging Issues Task Force] to think about.”
For 2014, Beswick listed five issues that the SEC’s corporate finance chief accountant will be focusing on in the New Year. They include:
- Disclosure Overload: “Many questions revolve around whether it is okay to remove disclosure that is no longer considered relevant,” Beswick said. “I can say staff is supportive of removing non-material information and that removing it does automatically include a filling review.”
- Non-GAAP Measurers: Making sure they are clearly labeled and investors know what they are, according to Beswick.
- Metrics: Beswick explained that SEC staff is focused on clear disclosure regarding metrics, including the proper context.
- Goodwill and Segments: The SEC is looking for “robust discussions” regarding impairment.
- Stock Compensation Disclosures: In an IPO setting, Beswick said, “If you need more than a couple pages to describe what is happening, that you may be over-thinking it.
How private market practitioners implement the standards and regulations is key, and corporate controllers are preparing, although cautiously, said Pascal Desroches, senior vice president and controller for Time Warner Inc. “Candidly,” he added, “it’s hard to do anything tangible or make significant investments before you have an actual final standard and see what it says.”
That being said, controllers and other financial executives can begin “preparing” for the revenue recognition standard by laying the corporate groundwork. That includes Derosches’ plan at Time Warner of forming a cross-functional team that brings in subject matter experts from accounting, finance, information technology, tax and compensation that will all be impacted in some way by revenue recognition.
“In several of these areas there are changes at the margin and nothing significant in terms of timing of revenue recognition,” Derosches said. “But you will have to change systems and processes to be mindful of disclosure requirements.
Laying the groundwork for the new standards was something the other panelists agreed was in important step. For example, for multinationals implementing the new global standards means getting buy-in from stakeholders across borders, said Jan R. Hauser, vice president, controller and chief accounting officer for General Electric Co.
Hauser said that the language of the revenue recognition framework has been shared with GE global business controllers in each region.
“We don't have a final standard, but we do have some pro forma wording, so we asked them ‘How are you going to operationalize this standard and tell us where you understand it and don't understand it, or will [it] cause complexity?‘ ” Hauser said.
The plan also includes approaching the audit committee to explain what it will be “seeing” in the financials from the new standard, what the transition looks like and what key decisions will need to be made.
“We operate in so many different sectors, with different long-term contract and service agreements,” Hauser said “We know we have a huge task in front of us.”
Getting out ahead of the new standard is key to success in 2014, said Marsha Hunt, vice president and corporate controller for Cummins Inc.
“We are already thinking through internal education of our finance teams, especially in the operating units,” Hunt said, adding that if the 2017 implementation date stays where it is that any delay in preparation would cause significant issues.
“Start now, don’t wait,” advised Loretta Cangialosi, senior vice president and Controller at Pfizer, Inc.. “Create a cross-function team and start thinking about changes in controls within business units.”
But despite having new accounting and reporting standards to implement doesn’t mean that controllers are getting additional resources and many are finding the need to juggle regulatory and reporting priorities with cost containment.
Increasing compliance requirements doesn’t automatically mean increased budgets to implement them and financial executives need to execute the proper cost/benefit analysis, said Diana Sands, vice president of finance and corporate controller for The Boeing Co.
“How do we fund revenue recognition? How do we fund conflict minerals? There are tradeoff discussions,” Sands said. “We are satisfying compliance requirements within increasing budget constraints. These are real issues with companies.”
Sands added that it was important at that the finance staff become embedded in business lines because business owners are seeing significant price pressure on deal terms. “We are very embedded in business deals now,” Sands explained. “They are becoming more complex with much more pressure, [so] we have to make sure that we are in the front end of those deals so we understand what the financial and accounting implications are before the sales forces sign the contracts.”
Taking the lead on cost containment is also an impotent way for controllers to increase their visibility and importance to senior management, said Graeme Bottger, vice president and controller at Alcoa Inc.
“The role of the controller has expanded well beyond just reporting and control. We have so much more to offer in these other fields and that means getting involved in bigger corporate initiatives,” he said.
Bottger gave the example of a “cash sustainability” program launched by Alcoa in 2009 that was led by the controller’s office, which has been considered a significant success by stakeholders within the company.
“You can show that finance is a business partner rather than a siloed unit,” Bottger explained. ”This also works for talent development. You get people in front of senior management right up to the CEO. You can show that there is a career beyond just the blocking and tackling.”
For many controllers on the panel the key to cost containment success was a combination of proper financial forecasting and managing shared services arrangements that are currently being implemented within several corporations.
“We are focused on forecast accuracy, so we know if we have more or need to do more or less,” said Hunt, adding that forecasting includes business cycles.
“There is a lot of energy behind this,” she said.
Bottger agreed that great forecast accuracy creates controller credibility, and that a solid forecasting process can allow the financial staff to get the proper “messaging” to senior executives by using two months of actuals and one month of forecast when making presentations.
“When your final month comes in you can flex them all out and with a bit of luck you’ve got your messaging, you’ve got your presentations down and everyone is prepped up a and ready to go,” said Bottger.
But not all cost contentment programs are created equal, and some — such as newly-created shared services programs that look to leverage common processes across business units — are still in early days of showing their value.
“Candidly, it has been a bit [of] a humbling experience trying to standardize process in a shared services environment. It is costing us more that we thought and the savings are coming slower than we thought,” said Time Warner’s Desroches, explaining that shared services needs to be implemented across the enterprise in order to be useful. “It is critical that senior management mandate that this is not an opt-in.”
Alcoa’s Bottger agreed. “Once you have a shared service up and running, and running well, it should be mandatory that the business units are committed and not have an opt-in.”
Even then, some business owners will push for services outside the scope of the shared programs and controllers and other financial executives need to make sure the economics make sense.
“In some budget discussions people want gold-plated service,” said Cangialosi. “We said, ‘Okay, are you are going to fund it then?’ All of a sudden they didn't quite need the gold-plated services when they realized that they were going to have to pay for it.”
Finally, the panel agreed that beyond the financial reporting and business sense, the new generation of controllers will need a strong sense of leadership and business savvy.
“You are going to have to have the core financial and compliance mindset, but increasingly important is this business mindset,” Sands explained, adding that controllers need to have the inquisitiveness to understand the business and the creative thinking to be “problem solvers.”
“We really have to be part of the solution and work with the businesses and the organization as a whole to come up with the optimal solutions,” she added.
For Time Warner’s Desroches, it comes down to what he described as “emotional intelligence.” In our company, he said, “it really matters. Those that have emotional intelligence in our organization know how to effect change.”