FEI CEO's 2006 Top 10 Financial Reporting Challenges.

As has become an annual publication "event," again this year we asked Financial Executives International President and CEO Colleen Cunningham to prepare a list of financial reporting issues she believes will be of vital interest for preparers and that will require attention during the coming year. What follows is her list for 2006.

While the regulators gave preparers a little break in standard-setting last year--as public companies complied with Section 404 of the Sarbanes-Oxley Act--the regulators have made up for it during 2005, with a plethora of new reporting requirements. Although, it was very difficult to narrow the field to 10 this year, once again, we have compiled a Top 10 Financial Reporting Challenges for next year (2006), based on our current understanding of applicable implementation dates.

1. Stock Options

During 2005, the Securities and Exchange Commission (SEC) postponed application of SFAS No. 123(R), Share-Based Payment. We don't expect any more delays--so many calendar year-end companies will have to begin expensing stock compensation in 2006.

There have been several Financial Accounting Standards Board (FASB) Staff Positions (FSPs) issued to provide additional guidance in implementing SFAS 123(R). These include guidance on determining the grant date (an understanding by employees of the terms and conditions of an award is presumed to exist at the date the award is formally approved by the company, provided certain conditions are met) and a transition election related to accounting for the tax effects of share-based payment awards (which allows a company to take a short-cut method in calculating the beginning paid-in capital pool).

2. Uncertain Tax Positions

A proposed interpretation was issued in July 2005. The interpretation was developed to address diversity in practice with respect to the accounting for tax positions taken where the ultimate outcome is uncertain. Basically, the proposal requires that a tax position recognized on the tax return be probable of being sustained under audit prior to recognition in the financial statements, and the company must assume that it will be reviewed by the taxing authorities. In order to derecognize, it must be more likely than not.

Many commenters disagreed with this proposal's "dual threshold" regarding recognition and derecognition. The FASB is currently redeliberating the proposal, but we expect to have a final statement early in 2006, with a likely implementation date later in the year.

3. Business Combinations

The International Accounting Standards Board (IASB) and FASB are jointly working on a Business Combinations project. FASB issued two Exposure Drafts (EDs) in June 2005 and held several public roundtables on the issues. Approximately 300 comment letters were received.

Once again, FASB is moving more and more towards a "fair value" model, which will impact reporting. Among the myriad of proposed major changes are that contingent assets and liabilities associated with an acquisition will be recognized at the date of the acquisition at fair value, with any subsequent changes reflected in earnings (not as an adjustment to goodwill); Intellectual Property R & D would be capitalized at date of acquisition; and all acquisition-related costs paid to third parties and restructuring charges would be expensed as incurred. A final statement is expected late in 2006, and implementation would not likely be required until 2007. However, companies really need to keep on top of this issue as the proposed changes have the potential to set the stage for other changes to existing standards.

4. Fair Value Measurements

This FASB project is intended to define fair value, establish a framework for measuring fair value and enhance fair value disclosures. An Exposure Draft was issued in 2004, with a final statement expected by the end of 2005 (not announced by press time). It applies only to pronouncements that require fair value measurements (except FAS 123(R)).

Fair value is defined as the price that would be received for an asset or paid to transfer a liability in a current transaction between marketplace participants. A fair value hierarchy distinguishes the inputs to valuation techniques, which range from quoted prices for identical assets or liabilities in an active market (Level 1) to entity inputs that are derived from extrapolation or interpolation but that are not corroborated by other observable market data (Level 5). New disclosure requirements include a tabular quantitative disclosure for all periods (interim and annual) for ongoing and periodic fair value remeasurements and qualitative disclosures about valuation techniques in annual periods.

The new disclosures are effective for fiscal years ending after Dec. 15, 2006 (therefore, 2006 reporting for calendar year-end companies); other requirements are effective for fiscal years beginning after Dec. 15, 2006 (2007 for calendar year-end companies).

5. Materiality 

As I write this list, we are anticipating a Staff Accounting Bulletin (SAB) from the SEC that would provide guidance to companies on quantifying misstatements. It is expected to include a dual methodology in determining whether a misstatement is material or not. Both a balance sheet (iron curtain method) and an income statement (rollover approach) would be required.

6. XBRL 

Both the SEC and FASB have staff dedicated to eXtensible Business Reporting Language (XBRL). The SEC had asked for voluntary reporting by companies under XBRL for 2004 reporting. Although very few companies voluntarily reported using XBRL, new SEC Chairman Christopher Cox has made technology a priority for the commission. As software providers create products that are user-friendly for preparers, we expect this project to gain more momentum in 2006.

7. Earnings Per Share

In the interest of international convergence, this specifically addresses the computation of incremental shares under the treasury stock method, the earnings-per-share effect of mandatorily convertible securities and the earnings-per-share effect of instruments that may be settled in cash or shares. A final statement is expected in early 2006, with an expected 2006 implementation date.

8. Conceptual Framework Project

The FASB's and IASB's objective in this joint project is to develop a common conceptual framework that is both complete and consistent. The idea is that this framework would provide a solid foundation for developing future accounting standards.

It has been broken down into eight phases, with a due process document from the first phase, "Objectives and Qualitative Characteristics," expected in early 2006 and the second phase, "Elements, Recognition and Definitions of Measurement Attributes," late this year.

The second phase will involve a reconsideration of CON 5, Recognition and Measurement in Financial Statements of Business Enterprises and CON 6, Elements of Financial Statements. This may result in revisions to existing definitions of elements and the concepts for recognition and derecognition (for example, FAS 5 concepts) as well as the measurement of these items (for example, weighted probability measurement concept vs. best estimate of the most likely outcome).

This is probably the most important project on the joint board's agenda because the reconstituted conceptual framework will impact all future accounting and reporting standards. It is vital that constituents stay current on this project and get involved in the comment process.

9. Complexity

Smaller public companies, large public companies, private companies, standard-setters, regulators, preparers, auditors and users have all voiced concern and growing frustration over the complexity in current standard-setting. The move towards principles-based standard-setting has been stymied by our current legal and regulatory environment.

Expect to see this frustration turn into action in 2006, as constituents work together to enable an environment where the use of professional judgment is embraced and second-guessing is minimized (OK, so maybe I am dreaming on this one!)

10. Pension Accounting

In response to the SEC's Off Balance Sheet study, issued in June 2005, as well as pressure from other constituents, in late 2005 FASB added a comprehensive project to reconsider accounting for pensions and other postretirement benefits. The project has been broken into two phases.

The first phase is expected to provide initial changes in 2006. It is expected that FASB will require that the funded or unfunded status of postretirement benefit plans, measured as the difference between the fair value of plan assets and the benefit obligation, be recognized on the balance sheet. Measurement and display in the income statement will be addressed in phase two.