FASB, SEC, PCAOB Updates Key Issues
May 5, 2006
At the Fifth Annual Financial Reporting Conference at Baruch College, held on May 5, 2006, standard setters, regulators and practioners discussed several accounting and reporting issues currently affecting companies. The following is a brief summary of some key issues.
SEC on 404
Scott Taub, acting chief accountant, Securities and Exchange Commission (SEC) opened the conference. Taub's presentation covered the causes and problems with accounting complexity and focused on how to improve financial reporting.
From a standard-setting perspective, this could be accomplished by replacing complex standards (i.e. leasing), ensuring standards are prinicipals-based, and replacing standards (i.e. pensions, financial instruments) that produce information that is not transparent. He called for regulators to accept reasonable differences in judgment, stamp out accounting-motivated structures and impose requirements only when needed. Meanwhile, preparers should voluntarily improve disclosures and use professional judgment. Auditors should also use judgment, the presentation noted, should not ask for every issue to be covered in a standard or by the SEC and not to get involved with accounting-motivated transactions.
When asked about a movement toward understandable financial statement footnotes, Taub referred to the SEC's plain English rules, noting that at recent Congressional hearings, even SEC Chairman Christopher Cox has encouraged companies to write in plain English.
In the following panel discussion, Taub agreed that Sarbanes-Oxley Section 404 implementation costs were too high and admitted that the SEC cost estimates for 404 were way-off. But, he said that if companies think 404 is doing nothing for internal controls and fraud, then "you're doing it wrong." If companies believe the real risk is fraud, he continued, then they should focus on the controls that prevent and detect fraud. Taub urged companies to think about what can be done to prevent too much work and not to miss the forest from the trees. "There are no rules that say you have to test a certain percentage of controls."
Taub said that the upcoming SEC and Public Company Accounting Oversight Board (PCAOB) roundtable on May 10 would cover year accelerated filers two experiences with 404. Overall, he noted that companies have been doing a good job of trying to correct year one material weaknesses. Taub emphasized that the purpose of the roundtable is not to focus on the recommendations of the SEC Advisory Committee on Smaller Public Companies to exempt certain companies from some or all of 404 and said that the committee also made 28 other recommendations that have not been heavily publicized. (Refer to FEI Summary and June 2006 issue of Financial Executive magazine for summaries that included the other advisory committee recommendations.)
With regard to 404, Taub stated he could not support less protection for investors of smaller companies. He did not rule out changes in the future, but said the focus would clearly be on what can be done to make 404 implementable for all public companies. "Users are saying its worth the money and they're willing to pay."
Taub also discussed the move toward international convergence and the work towards getting rid of reconciliation requirements for foreign registrants. He closed with one of Cox's "top initiatives," XBRL. "We are pretty serious about this," he said, "…and are doing what we can to make it ready for prime time."
Taub was joined by Craig Olinger, deputy chief accountant at the SEC's Division of Corporation Finance and Susan Markel, chief accountant at the SEC's Division of Enforcement. Under John White, the division's new director, Olinger said the immediate focus is the 404 roundtable. Olinger said areas that are frequently covered in SEC comment letters to registrants include revenue recognition, pension disclosures, allocation issues and impairment testing related to purchase accounting, and shortcut issues related to derivatives and hedging. He also reviewed the three different possible filing deadlines for the 2006 10-Ks (60 days/75 days/90 days), which will depend on whether companies are accelerated or non-accelerated filers.
FASB Updates on Various Projects
Robert Herz, chairman, Financial Accounting Standards Board (FASB) also provided opening remarks at the beginning of the conference. In his speech, Herz spoke about accounting complexity and the need for a national initiative that would involve various constituents.
During a panel discussion on private sector developments, FASB Board Member, Leslie Seidman, gave an update on the conceptual framework project with the International Accounting Standards Board (IASB). The goal is to "get on the same page to solve problems in the future," Seidman said. She expects that a preliminary views document on the qualitative characteristics of accounting information would be released over the next month or two and emphasized that this additional step (as opposed to releasing as an exposure draft) would provide for a more thorough comment process.
Seidman also reviewed proposed significant changes regarding purchase method procedures and noncontrolling interests, which have been reaffirmed in FASB redeliberations. These include:
- Transaction costs will be expensed (not part of the assets acquired);
- In a partial acquisition, the assets acquired and liabilities assumed will be measured at 100 percent of their fair value at acquisition date, including goodwill; noncontrolling interests will be adjusted to reflect their portion of these net assets;
- Transactions involving noncontrolling interest are equity transactions, as long as still in control; and
- Gaining control is a significant economic event; therefore gain or loss on previously held interests (e.g., AFS securities) should be recognized in income. Similarly, upon a loss of control, a gain or loss should be recognized on any retained interest.
Seidman also said the FASB will become more involved in Phase B of the joint Financial Statement Presentation project with the IASB. Phase B will focus on presentation of core versus non-core business results and tackle issues such as recyclying between other comprehensive income and net income, direct vs. indirect cash flow statement and income statement buckets.
Seidman closed her presentation with a review of the progress on FASB's Uncertain Tax Positions project. The board has reaffirmed a two-step benefit recognition approach that would call for a more-likely-than-not confidence level that a position would be sustained upon an Internal Revenue Service audit that would be measured at the largest amount that is least more likely than not to be realized. In response to a question about how to measure a more-likely-than-not amount, as printed in CFO.com's web log, "Seidman implied that some of the terms - such as "cumulative probability" - were less than ideal. The issue, she said, is really whether a company can support its tax position."
In a later panel on fair value, Seidman and fellow panelists covered FASB's Fair Value Measurements and Fair Value Option projects. The measurements project, Seidman said, is intended to streamline over 40 pieces of GAAP that require fair value measurements. The approach is for companies to determine what an independent third party thinks something is worth. In response to a panelist question, she said that "Day 2" accounting once fair values are recorded are not clear, but should be addressed.
In the final panel on pensions and leases, FASB's Herz said that investors are clamoring for changes that would result in recognition of over or underfunded pension and other post employment benefits obligations. A final document, which is expected in the third quarter of 2006, would call for public companies to record the net obligation on the balance sheet for fiscal years beginning after Dec. 15, 2006. Public companies can continue to use actuarial valuations of such obligations that are dated September 30, but would have to use year-end valuations starting in 2007. (This is extended through 2008 for non-public companies). Herz added that valuation companies have told the FASB that they are ready to deal with the change in valuation dates. With regard to a project on leases, Herz said that is not yet formally on the FASB agenda, but expects it to be added later in the year once the IASB presents the project to its advisory council in June.
PCAOB on 404
During a luncheon address, PCAOB Member, Charles Niemeier spoke about how 404 has enhanced investor confidence and said that cost of capital increases for companies without clean internal controls. He said that 404 is working, but shouldn't be prohibitive. He pointed to the May 2005 SEC and PCAOB guidance, release of PCAOB inspection reports prior to the recent reporting season, and next's week May 10 roundtable, as steps that have been taken on 404.
Niemeier said he was "interested in small public company practical guidance" and referred to "constructive practical guidance" and tailored audits to fit the needs and resources of small public companies. He said that efficiencies have been driven through the inspection process, which has resulted to changes in firm methodologies that have led to improvements. He also supports the FASB adding pensions and fair value to its agenda, since both have auditing repercussions.
In the following question and answer session, Niemeier said he thinks that we are "in a good place today," and he encouraged the accounting profession to be more proactive and less focused on the past in order to remain relevant.
Prepared May 5, 2006 by Cheryl Graziano (cgraziano@FinancialExecutives.org), Vice President, Research and Operations, Financial Executives Research Foundation (FERF). This summary does not represent FEI or FERF opinion, unless specifically noted above.