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IlluminatinQ financial reportinQ: views from reQulators and the profession.

Regulators, financial statement preparers and users, auditors, and members of the private sector discussed developments in financial reporting at Baruch College's 11th Annual Financial Reporting Conference, hosted by the Robert Zicklin Center for Corporate Integrity, in New York, N.Y., on May 3, 2012. The featured speakers were Leslie F. Seidman, FASB chair; James L. Kroeker, SEC chief accountant; and Jeanette M. Franzel, a member of the Public Company Accounting Oversight Board.






Four panel sessions throughout the conference explored a variety of relevant topics. The first panel looked at current projects at the SEC, including the adoption of International Financial Reporting Standards, the commission's reaction to the Jumps= Our Business Startups Act, and recent actions taken by the Division of Enforcement. The next panel examined stan-dads-setting developments in the private sector, with a focus on recent projects from FASB, the Emerging Issues Task Force (EITF), and the Financial Reporting Executive Committee. An afternoon panel featured in-depth discussion on FASB and the International Accounting Standards Board's (IASB) convergence project, as well as on the endorsement model recently proposed by FASB. The final panel looked at the progress made by FASB and the IASB on the "big three" convergence projects--revenue recognition, leases, and financial instal-ments--representing some of the most controversial areas in accounting.

Following are edited transcripts and summaries of the speeches and panel discussions from the conference. In all cases, the speakers' comments represent their own views and are not necessarily those of their respective organizations.

Updates from FASB and the SEC

Conducting Outreach and Promoting Independence

Leslie F. Seidman was appointed FASB chair in December 2010 and has served two terms as a board member since July 2003. Prior to her appointment as chair, Seidman first served as a FASB industry fellow, later as a project manager, and then as an assistant director of research and technical activities. Before joining FASB, Seidman set accounting policies for J.P. Morgan & Co. (now JPMorgan Chase) and worked as a member of the audit staff at Ernst & Young.


SEC Chief Accountant James L. Kroeker joined the commission as deputy chief in February 2007. In his current role, he serves as principal advisor to the SEC on accounting and auditing matters. Before joining the SEC, Kroeker was an audit partner at Deloitte & Touche and represented the firm on the AICPA Accounting Standards Executive Committee. Kroeker also served as a practice fellow at FASB.

On May 3, 2012, Seidman and Kroeker kicked off Baruch College's 11th Annual Financial Reporting Conference by discussing recent developments at FASB and the SEC, respectively. The following are their edited remarks delivered at the conference.

Leslie F. Seidman

FASB Chair

What I thought I'd do in this session is focus on some important initiatives that might not be on your radar screens. Those topics fall into two broad categories: outreach and our disclosure projects. First, I want to give you some insight into the extent of outreach that FASB is doing on several of our major projects. When I use the term "outreach," what I mean is the various techniques that we use to obtain feedback and input on our proposals from a wide range of stakeholders. The reason why we do this is primarily to gather information from users--and when I use that term, I mean investors, lenders, financial statement analysts, and even donors to a nonprofit organization. We're trying to get information from them about what they need to make informed decisions about how to invest their money, and then also to discuss alternative ways of presenting that information.

We also meet with companies to understand their transactions and talk about different ways of satisfying users' needs for information in the most operational, cost-effective way. Outreach is particularly important when the boards are hearing diverse input from our stakeholders. It helps us understand why people hold their views and, therefore, it makes it easier for us to find a basis for a potential consensus. So I thought it might be enlightening to run through a few of our major projects and describe the type of outreach we're doing and how it's influencing our decisions.


Revenue Recognition

Let me start with the revenue recognition project. As you probably know, we issued a second exposure draft, jointly with the IASB, that contained a common principle for when revenue should be recognized and related application guidance. This time, we received about 350 comment letters. We held four roundtables around the world, and we have another one planned in Salt Lake City, Utah, next week. Over the last several months, we also held meetings with about 200 U.S. preparers or companies, and also about 50 investors, to discuss the revised exposure draft, identify areas of agreement, confusion, or concern; and gather ideas and information about areas that are particularly costly to implement and whether there are other alternatives that would provide comparable information at less cost. All of that input will help the board and staff to decide which issues need to be reconsidered before we finalize the proposal.

Two specific issues warrant special mention: first, the volume of the proposed disclosures, and second, the retrospective transition that we had proposed. These issues have been flagged as being very costly for preparers, but also very helpful for investors. So what we plan to do to address those issues is to hold a couple of "roll up your sleeves" workshops with both preparers and users at the same table to supplement the feedback that we've already received and talk through these issues. We hope to find a consensus about how to provide useful information, but at a more reasonable cost. The rest of the feedback will be evaluated by the board over the next few months as we redeliberate several other aspects of the exposure draft. We plan to agree on which of those areas to redeliberate during our board meeting in June.


I also want to highlight the outreach that we're doing on the leasing project. The boards have agreed and reconfirmed that leases that are greater than one year in length should be recognized on the balance sheet as an obligation at the present value of the expected lease payments, with an equivalent rate-of-use asset recognized on the balance sheet and amortized to income over time. Interest expense would be accrued based on the declining liability balance, which tends to create a front-loaded income statement pattern in total. The boards have continued to receive feedback expressing concern with the income statement effects resulting from this proposed rate-of-use model.

Many stakeholders, including preparers and some investors, do not view certain types of leases as being similar to a purchase and financing of part of an asset. Instead, they view some leases, such as a rental of office space, as an operating cost that should be recognized ratably over the period of the lease term. Many stakeholders, including government contractors and nonprofits, are concerned about the characterization of the expense as interest-based amortization, rather than rent expense, which is what it is now. Leasing is a pervasive transaction and, therefore, we want to make sure that we've carefully considered these concerns that have been raised before we move forward with another exposure draft.

We're currently discussing four alternatives with stakeholders. I'm not going to get into extreme detail here, but I do want to provide some insight into the types of alternatives we're considering and the work that's going on behind the scenes. The first alternative is Approach A, the approach that was in the original exposure draft and that I just basically described. Approach B is an interest-based amortization approach. It would use a different pattern to amortize the rate-of-use asset, but still identify interest expense in amortization, and generally would result in a total that is even or straight-line over the lease term. The rationale for this approach is that a lease is one contract that we've decided to account for in two pieces, and the rates and obligations are inextricably linked. So some people think that the better representation of the total expense should be a ratable pattern of benefit over the lease term, Approach D is based on a similar theory to Approach B, but it doesn't distinguish between interest and amortization and, therefore, is much simpler to apply. And lastly, Approach C is a new approach that would amortize the asset based on the consumption of the value of the underlying asset. It tends to have a similar front-loading effect as the original proposal, but it is dampened depending on the nature of the underlying asset.

Outreach Efforts

Over the last several weeks, we've conducted meetings with about 60 preparers and about 20 users of financial statements to gather input on these alternatives. Board members and staff from both boards are participating in these meetings to hear the input firsthand. The staff will report back to the board at our May joint meeting, which is taking place in Norwalk, and we expect to make decisions on these matters in June in London. Again, we've already decided to reexpose these conclusions and will consider the feedback from this outreach before we decide how to move forward with the final [leasing] standard, which, again, would be preceded by an exposure draft.

We're conducting very similar meetings on our impairment of financial assets project. In the interest of time, I'll just say that we have had meetings with approximately 75 stakeholders to discuss the expected loss approach. After extensive conversations, we are hearing support for that basic approach, but we're still working on the words to communicate it effectively. These meetings are very time-consuming and they clearly extend the timetables on these projects; however, we think the time is well spent and it's crucial to help the boards understand why information is important to users and how it will be used, and why it might be costly to preparers, and whether the words are being understood in the manner in which the boards have intended.

Speaking of timelines, let me clarify that the way we establish the time frames on our projects is based on a bottom-up analysis of the work that has to be done, our due process requirements, and the feedback we receive. In order to develop standards that provide improved information to the investing public in a cost-effective manner by the companies and their auditors, we're working at a deliberate pace to complete these projects as quickly as we can. In several recent communications from our organizations, we have signaled that we're unlikely to finish a couple of these standards in 2012, and we've suggested target completion dates in early to mid-2013, depending upon the project, the comment periods that we've established for these reexposures, and also--and ultimately--on the comments that we receive on these proposals.

Private Company Concerns

Let me turn to another major effort that might not be on your radar screen: the steps that we're taking to better understand and respond to the unique concerns of private companies. The first is a review being carried out by the Financial Accounting Foundation (FAF), to determine whether a different standards-setting structure is appropriate at this point in time. As you may know, the FAF issued a proposal for comment a few months ago that would establish a Private Company Standards Improvement Council (PCSIC) that would be dedicated to addressing private company issues. The trustees are planning to discuss that issue at their public meeting on May 23 in Washington, and they're expected to make a decision at that meeting about how to proceed. At the same time, FASB staff has been creating a decision-making framework for private company reporting issues, with the assistance of a resource group. The framework would be used by the board and potentially the PCSIC, depending upon the FAF's decision, to evaluate issues and determine whether there should be differences for private companies on a variety of reporting matters.

We've heard a wide range of views--at the one end, the perspective that significant changes are required, and at the other end, the view that there should be no differences in the recognition and measurement provisions for public companies versus private companies. So the purpose of this framework is to make sure that we all collectively have a common understanding of when differences might be appropriate for private companies versus public companies under U.S. Generally Accepted Accounting Principles (GAAP). We're planning to discuss this framework with our Private Company Financial Reporting Committee (PCFRC) and our Small Business Advisory Council at our meetings with those groups next week. After that, we plan to issue the draft as an invitation to comment for public input, probably in the June or July time frame.

The draft framework will not be an answer, but rather a number of factors to consider to help the board and stakeholders determine whether a difference seems warranted under the circumstances. In its current form, it includes several decision points, such as what is most relevant to most users of private company financial statements, including a series of factors to consider, as well as several questions to assess the cost and complexity of a particular accounting approach. We do not envision that the framework will become authoritative; rather, it would be a guide to the board and potentially the PCSIC to use to approach these issues with a common frame of reference. If a new council is set up, we would ultimately want their buy-in before we move forward. Several factors in the framework are aimed at assessing resource constraints and other cost-benefit issues. We have every expectation that reviewing those factors will benefit all stakeholders, not just private companies. In other words, if those efforts identify a simpler way to do something, we will obviously consider that simplification for everyone.

We're also reviewing the definition of a private company--which isn't as obvious as it might seem. We currently have at least six definitions of private companies under GAAP because, in each case, the board was attempting to solve a particular problem, such as whether to defer an effective date or to give a group of companies a scope exception. We think this framework will help us address those issues more consistently so that GAAP can be simplified with respect to the definition. We're also still evaluating some recent changes in the SEC requirements for filing and furnishing financial statements and the effect that those changes will have on the definition of a private company. We expect to issue an exposure draft of the proposed revision sometime in the next quarter or two.

Disclosure Framework Project

The last project I want to highlight is our disclosure framework project. Many stakeholders have expressed concern about what I call "disclosure overload" or "disclosure ineffectiveness." To address those concerns, FASB added a project to its agenda to improve the quality of information being disclosed and also to make the financial statements more effective overall. The staff is in the process of developing a discussion paper, which FASB plans to issue for public comment in the next few months.

The discussion paper plans to focus on three matters that could affect disclosures, both in the present and in the future. The first is a framework for the board to use in establishing future disclosure requirements that are consistent and focus on what is most important to users. Mother is how the reporting entity should evaluate which disclosures are needed under different circumstances at different points in time--in other words, a more dynamic approach to providing disclosures. That would include determining what is appropriate to disclose and also what is appropriate to no longer disclose. There appears to be an opportunity for entities with limited exposures in particular areas to reduce the volume of their notes; for example, a frozen pension plan can still generate pages and pages of disclosures. Reducing the volume in cases like that, we think, will help users focus on the more important information in the financial report. Third is how to present disclosures in ways that emphasize the newsworthy items and make a search for specific information easier. There could be a significant increase in the utility of the notes if the information most likely to influence a user's decision was emphasized in some way--for example, a better ordering of the footnotes in the financial statements. We understand that most footnotes are currently organized in the order in which we require them, and there surely seems to be an opportunity there to make the order more relevant. Another example would be tying the financial statements to the notes, and vice versa, in a manner that would facilitate a user's evaluation of financial information. There are many other possibilities that will be explored in this discussion paper.

We're also planning to begin a dialogue about the approach that should be taken to interim disclosures and also how to evaluate materiality in the context of disclosures. I know some people would like to start slashing disclosures right now to deal with the widely held perception of overload--the so-called "red pen approach." At a recent resource group meeting, however, we did receive broad support for proceeding with a framework so that we can approach this exercise with a rationale for when it might make sense to delete or modify existing requirements or to potentially add new disclosures in the future. We also plan to hold some interactive forums with preparers and users to generate interest and awareness in the framework once we issue the exposure draft or discussion paper.

James L. Kroeker

SEC Chief Accountant

I wanted to cover three topics that are things you might not necessarily think would be covered as an update. The first one is objectivity, independence, and skepticism. There's been a lot of discussion about those three words recently, but I want to talk about them in the context of existing independence requirements, and I want to talk a little bit about a financial reporting issue that is broader than just accounting--the use of non-GAAP measures. And then I want to just give some observations about some questions that I have relating to the interpretive process, both in the United States and internationally.


Independence Criteria

I thought I'd start with just a basic overview of the existing independence rules--in my personal perspective, independence is really the foundation of the value that's provided to a third-party audit. In the absence of having an independent auditor, one could really question why you need a third party at all. In fact, management would just report their own numbers if you didn't have the independence that an auditor brings to an audit. I don't want people to misinterpret that to mean that independence is the only criterion in terms of bringing high-value and high-quality audits. As one of the presenters at a recent Public Company Accounting Oversight Board (PCAOB) forum on independence stated, "An independent dud is still a dud." So you need more than independence, but it really does lay that bedrock. As I heard that, I wondered in my mind whether it was better to have an independent dud or a highly skilled person who isn't independent and is going to go along with management. You can answer for yourself who would be worse or who would provide a greater danger to audit.

The SEC's independence rules are embedded principally in Regulation S-K, and those of you in the audit profession certainly know well that there are many detailed criteria that accompany that. But I wanted to just go through a pretty simple structure that I think you could look at in our independence rules, really getting to the point that they are, in effect, a principles-based set of criteria. First and foremost, rule 2-01(b) outlines that principle: that the auditor needs to be independent in fact and needs to be viewed by a reasonable investor to be independent. I would call that independence in fact and independence in appearance.

There's an introductory note to our independence rules; it says, in addressing whether somebody is independent in fact or independent in appearance, there are really four questions you can look to for how the SEC would interpret that. First, whether there's a relationship that creates either a mutual or a conflicting set of criteria between the company and the auditor--that is, what types of investments do you have or what type of activity takes place between the two organizations. Then, the independence criteria that govern the types of services that can be provided: Is the auditor auditing their own work? Is the auditor in a position where they're acting as manager of the company or acting as an employee? Is the auditor in a position where they've placed themselves as an advocate for the company that they audit? That really is as fundamental as the independence rules.

Rule 2-01(c) goes on to provide a nonexclusive list of criteria or specifications that would be inconsistent with the principle. In some cases, it provides examples of independent situations that would be consistent with the principle. Laying that out sets a framework for addressing a couple of fact patterns that have been presented to us recently. The first is whether an independent auditor can serve as a lobbyist for the company that they audit. And if you think about lobbying in the traditional sense, you would say, "Wow, wouldn't somebody who's lobbying be placing themselves in a position to be an advocate for a company they audit?" And you can go through each of the three criteria there. The general principle in rule 2-01(b): would a reasonable investor think that an auditor who is a lobbyist for the company that they audit is independent? I think the answer to that falls out pretty easily, but in case you don't, you can go to the preliminary note. The preliminary note says that placing yourself in an advocacy position is inconsistent with that principle. If that's not clear enough for you, you can go to the nonexclusive list of examples that talks about an auditor providing expert services. There, it doesn't use the term "lobbyist," but "expert services" in the context of an administrative or regulatory proceeding; very quickly, you could say by analogy that would also address whether an auditor ought to be putting themselves in a position as an advocate.

A couple of other independence examples that we've seen recently: one is whether an auditor can enter into a relationship where they're leasing staff to the company they audit--that is, where staff auditors might go and serve as an employee of the company they audit. Again, you can go through the three criteria, but you can also go directly to the nonexclusive list that says you cannot serve as an employee of the company that you audit. And I don't think there's any confusion in that. Some auditors might say, "Well, couldn't I provide tax services because there's scope exceptions for tax services that the auditor themselves could provide?" But this rule happens to be a broader one, saying that you can't serve in any capacity as an employee. If you happen to audit the local burger chain, you can't work at night serving burgers. It's the same with tax services. You can't provide tax services as an employee of the company that you audit.

Finally, just as a quick reminder for those who are auditing or working at nonpublic companies that have an interest, at some point, in going public: the SEC and PCAOB's independence rules are different, sometimes more expansive, than the rules established by the AICPA. In an initial public offering, an auditor needs to be independent under SEC and PCAOB rules that cover all periods under audit. That can cause an impediment for companies that want to go public under the AICPA's rules. Interestingly enough, the Jumpstart Our Business Startups (JOBS) Act that was recently passed now requires only two years of financial statements for emerging growth companies, so it actually reduces the period in which you would need to be independent if you're an emerging growth company.

PCAOB Efforts

With that, let me just speak briefly about the PCAOB's work on independence, objectivity, and skepticism through a concept release that it issued last year and on which it received, at the time the initial comment period closed, more than 600 comment letters. That number is significantly in excess of that at this point. And I don't know if that's unprecedented, but I think it's a factor of about 20 times more, in terms of the ordinary number of comment letters that the PCAOB might get. So you can see that there's an extreme amount of interest in what was a concept release that principally addressed whether independence, skepticism, and objectivity would be enhanced through auditor rotation. A vast majority of respondents said they didn't believe it would.

I don't think it was necessary to stop--or even wise to stop--at that point, and I think the PCAOB has very wisely embarked. on a public outreach to solicit and draw out views more clearly. It had a two-day forum where members explored, with a number of panelists--including some luminaries like Paul Volcker, Charles A. Bowsher, and others--their views with respect to skepticism and objectivity, and it was principally a discussion about mandatory rotation. If nothing else, it has really caused people to think about ways that audit quality can be improved more broadly.

Mandatory rotation. I'll just talk about some of the discussion the panelists have brought up, or those who are commenting have brought up, with respect to the narrower issue of mandatory rotation and whether there would be an impact that actually increases audit quality. Those who say there would be a significant beneficial impact talk about things like a fresh set of eyes or whether a relationship gets too cozy over a number of years, whether the engagement partner and the engagement team would stand up to a client that had been a decades-long client of a firm and risk losing that client over an issue. And I think those are very valid questions that ought to be explored. There are others who say there might also be a benefit in promoting competition in the audit profession. When you look at that, you then also have to ask: would competition also promote audit quality? Or would greater competition actually have the potential to create a race to the bottom, either in terms of fees or other things? But really, they're all valid questions about the impact.

On the other hand, it's been relatively undisputed that audit costs would go up. As an accountant, this has been a frustrating topic to hear people talk about. I think it's relatively clear that costs would go up when you're switching auditors, both internally and externally. And those who say, "But fees might go down"--that might be a valid point as well, but you have to ask yourself, if costs go up and fees go down, somebody's bearing the cost. What would the impact on quality be if the auditor now has greater incentive either to cut corners, not hire the most diligent of staff, or do less work in earlier years to make up for that increase in cost? Is that a sustainable model, for costs to go up and fees to go down? In any natural supply-and-demand relationship, would those costs ultimately be passed on through higher fees? So we need real talk about fees or the impact on cost, whether there's the potential to reduce quality in earlier years, and then whether there would be an impact on the discretion of the audit committee from selecting the auditor that they thought was the most qualified.

One of the particular benefits that has been raised really addresses what's at the heart of why the PCAOB took on this issue: whether the volume of audit deficiencies it's seeing is a sustainable level, and whether there are actions that ought to be taken to address ways to increase audit quality. Ideas that have been brought forward as a result of this dialogue include whether mandatory retendering would have an impact on either independence or quality; whether the findings of the PCAOB have really relate to independence; whether they relate to other areas, like the role of the audit committee; or whether there's enough focus in the profession on audit quality itself.

My experience was that auditors are trained very deeply in accounting. And I think it's appropriate that, to do an audit, you've got to be an expert in accounting. But is there the same level of focus on training auditors in the core skills of auditing? Is there appropriate supervision? Do we need to revise the auditor performance standards, not just the standards governing things like the auditor's reporting model? How does an auditor actually execute auditing fair value? Do we need to take a look at the standard dealing with auditors' use of work from an expert? Not the least of the ideas is whether there is enough self-discipline within the profession. I don't have answers to these questions, but I'm very encouraged that this dialogue will continue.

Non-GAAP measures. This is an area where I've heard from many, including investors, that they're seeing an increase in the use of non-GAAP measures. I'm not here to encourage or discourage the use of non-GAAP measures, other than to say if you're using them, they need to comply. I've heard from investors that say they get significant value out of certain types of non-GAAP measures; GAAP isn't the only way to view performance. I also hear from investors that certain types of non-GAAP measures can be particularly troubling. Let me highlight one thing in the guidance: there exists guidance requiring reconciliation back to GAAP and dealing with how management uses the non-GAAP measure.

But the one piece of the guidance dealing with non-GAAP measures that is sometimes overlooked is that a non-GAAP measure can't be untrue and it can't be misleading. If it is, that's where we're not going to have a debate with you about its continued use. We're going to ask you to stop using it. In that context, we've seen some recent examples, where people are reporting performance measures that purport to be income but exclude pretty critical drivers of what generated the underlying revenue. So to purport something to be income but not include the important drivers in terms of cost that generated that revenue that causes us some concern.

I wanted to highlight another area, though, and that's pension accounting and some of the non-GAAP measures that are used there. Several companies recently have changed their basic pension accounting method from a method where you defer and amortize gains or losses--the smoothing effect is permitted under pension accounting--on pension assets that differ from expected rate of return on plan assets. They've changed from that to a method that immediately recognizes gains and losses, both actuarial and on asset return, which I think almost everyone would say is a preferable method of accounting--so that sounds like great news for investors. It'd be great if the company stopped there. A few companies that have done that have then gone on to select a non-GAAP method of disclosure for pensions that then takes out the actual return on plan assets and adds back an expected return on plan assets. Unfortunately, in doing that, they haven't then included the amortization of prior deferred losses. If you thought about this in terms of a revenue line item, it would be like a measure that says your actual revenue was $1 billion, but then you subtract that out and tell investors to look at the revenue that you expected to have. Now, I'm not saying that's misleading per se, but there must be enough disclosure around the number you're giving to investors--that is, this isn't actual performance, this is the performance you either would have hoped for or expected over a long period of time--that might be useful to an investor.

Interpretive guidance. The last area I wanted to talk about was the interpretive process--and keep in mind these are non-GAAP measures. These are interpretive issues addressed by both the Emerging Issues Task Force (El 1F) and its international counterpart, the WRS Interpretations Committee (IFRIC), over the last decade. They're non-GAAP because IFRIC includes issues that were rejected, but there was guidance provided in the rejection language.

Some of the questions we often get when we talk about International Financial Reporting Standards (IFRS) and what the SEC is thinking and what the United States is going to do--are about whether there is a sufficient interpretive process internationally to deal with interpretive issues in a U.S. environment and, quite frankly, in a global environment. It's pretty clear that IFRIC doesn't take on a significant number of issues, in terms of the percentage of issues presented to it. There were 233 total issues presented to IFRIC, and it accepted, I think in the largest year, five issues for consideration formally, and 27 issues in total. It has rejected 70 issues, which is why it's not a comparable performance measure with the EITF. There were also 83 issues that weren't added to the IFRIC agenda, but it provided rejection language for those issues. In most cases, if you look at an issue paper, it says, "What should we do with this accounting issue? View A, View B, or View C?" And then it'll say something like, "IFRIC rejected this issue because the answer is View B." And then IFRIC exposes for public comment that rejection language and sometimes modifies the rejection language, and then agrees upon that rejection language. Is that interpretive guidance or is that a rejection? Interestingly enough, these notices are actually referred to as NIFRICs, which means "not an IFRIC," and people follow NIFRIC guidance.

The total volume of interpretive guidance--if you include nonauthoritative interpretive guidance--results in IFRIC issuing significantly more guidance over the last decade than the EITF. Of course, there are other sources where GAAP was coming from, but we aren't issuing the same level of guidance that we used to through the EITF. And the EITF might have been at a pace that was really unsustainable, addressing issues that either people should have been following or that maybe we could have figured out without the BITE But it does raise some questions about what the right level of transparency is about the addition or rejection of issues. And I ask these as questions, because I don't have answers. But if issues are rejected, is it better to have rejection language? And I think there's real value to that, but if you have, should that guidance be codified? Should it go through due process? If it's rejected because there's only one answer, is that answer really the correction of an error? Because if there was only one answer before, was it just pointing out that people who hadn't followed it had an error? If in fact it's new guidance, what's the effective date? What if the NIFRIC consensus happens to be on the day of the close of a company's quarter? Does it have to adopt it this quarter, next quarter, next year?

On the other hand, rejection notices do provide a valuable source of information. Likewise, whether there are changes to the EITF that might be contemplated if the volume of guidance that they're issuing is falling off, you've got a tremendously valuable resource pool in the EITF members. I don't think the volume has anything to do with their interest or ability or, quite frankly, FASB's interest in using them. They're taking on major projects. They're probably the same people who have to comment on those FASB exposure drafts, but longer-term. If the United States was to move to some endorsement model for IFRS, could the EITF play a role in dealing with existing differences? Is there a role the EITF could play in reducing complexity? I leave those as questions. I think it's an area that bears taking a look at over time.

Questions from the Audience

Audience Member: With regard to private companies and the process that FASB is going through to try and handle some of those issues: do you see a day when FASB could actually issue standards that would say, "Here's the accounting rule for public companies, but nonpublic company users don't really need that information," and you can have a different way of measuring net income for nonpublic companies?

Seidman: That's the key question in going through this process of developing a framework. As you've seen through our actions in recent years, we have been willing to make differences for disclosures, under the primary thought process that an investor in a private company can ask for more information directly from management. The more difficult question has to do with recognition and measurement. There, we're trying to go through a process to identify whether there are any cases where there is a legitimate reason why the investor in a private company might view an accounting matter differently from an investor in a public company, other than for reasons of simplification or a practical expedient of some kind. And so this framework is going through thought processes to help guide the board's deliberations.

For example, there's stock compensation, where there's an obvious difference between the stock in a private company and the stock in a public company--so that's one where you could see that potentially there might be a different way of implementing an accounting standard. Another one might be something like one of the factors that this framework will include--can we observe that investors in private companies are routinely disregarding an item? And another issue that comes up frequently is goodwill, where there is a real question about the value to an investor in a private company of measuring goodwill, and impairments to goodwill--maybe there is a very simple way to deal with that, by writing it off up front or amortizing it over time like we used to do.

So, it's possible, but I don't want to prejudge the outcome of this developing framework.

Norman Strauss [Ernst & Young Professor-in-Residence at Baruch College]: Just for clarification on the process, is the SEC actively engaged in oversight of all of the decisions that the PCAOB makes when it issues new standards affecting auditors?

Kroeker: The staff in the Office of the Chief Accountant works very closely with the PCAOB. As an independent board, it makes its own conclusions about a particular standard. Unlike the process with FASB, which we also work closely with, FASB standards are effective immediately. PCAOB standards aren't effective until they are considered by the commission; the commission actually has a process by which it approves PCAOB standards.

Current Developments at the SEC

IFRS Work Plan, Recent Legislation, and Enforcement

The first panel at Baruch College's 11th Annual Financial Reporting Conference on May 3, 2012, featured three speakers from the SEC discussing the commission's progress with respect to the adoption of International Financial Reporting Standards (IFRS), its response to the Jumpstart Our Business Startups (JOBS) Act signed into law in April by President Obama, and the results of a range of recent cases initiated by the Division of Enforcement.


Incorporating IFRS

Paul Beswick, SEC deputy chief accountant, commenced the discussion by updating attendees on the status of the SEC's current work plan for IFRS, which SEC staff in the Office of the Chief Accountant (OCA) first began in 2010. Beswick noted that the report is currently "substantially written and we're getting close, but pinning down an exact day of when we're going to get the report out is sometimes a little challenging." In creating the report, the SEC "endeavored to take a cross section of views" and opinions, because incorporating IFRS could potentially be "the most significant accounting decision" ever made in the United States, Beswick said. After surveying constituents who would be impacted by a full adoption of IFRS, the SEC focused on endorsement mechanisms for IFRS, he stated.


Beswick provided three primary reasons why the work plan focused less on adopting IFRS in its entirety and more on the endorsement of specific IFRS standards. First, "if you think' about how IFRS is incorporated in almost every other major jurisdiction, they rely on some sort of mechanism to ensure suitability," such as the IFRS Interpretations Committee (IFRIC) in Europe, which makes recommendations to the European Commission on individual standards. Beswick pointed out the importance of the United States achieving "that same threshold of suitability and same protections that other jurisdictions have said are important." Second, the burden of conversion to IFRS would entail costs greater than the potential benefits, he said. Third, references to U.S. Generally Accepted Accounting Principles (GAAP) are "baked into thousands of pages of U.S. law, of regulatory text, and the process for getting that all updated and refocused on IFRS would have been a challenge."

SEC Observations

Spending nearly 10 years contemplating a move to IFRS and two years working on an in-depth work plan has increased the SEC's understanding of issues related to convergence. After spending "a lot of time with other jurisdictions and other regulators" and receiving "a lot of good feedback from preparers, from auditors, from investors, who have really taken the time to inform us about the implications," Beswick said that the SEC had made numerous observations, described below.

Work in progress. Beswick characterized IFRS as a "work in progress," noting that the International Accounting Standards Board (IASB) "started a little over a decade ago and had to put a system in place from scratch, and they've made a lot of progress." But significant gaps still exist, he said. For example, U.S. GAAP provides better guidance in specific areas, including extractive and rate-regulated industries, than IFRS does. This "isn't a criticism" of the IASB, however; Beswick pointed out that "they have a lot on their plate, just like FASB has a lot on its plate"

In addition, "the interpretive process is still in need of improvement," Beswick said, noting that "it's important that you get standards out--but then, over time, questions arise. And there needs to be a mechanism to deal with interpretation issues as they come up." Although the IFRS Foundation has committed to improving the process, the SEC remains unsure about whether the changes will address implementation issues.

The IASB's governance and funding are other areas considered a "work in progress," Beswick later said; however, he did note that its governance had improved after a recent constitutional review and the stability of the nonprofit's funding had improved as well, even as it continues to rely on contributions from individual large accounting firms.

Expertise of standards setters. The IASB's practice of discussing IFRS issues with national standards setters only two to three times per year might not be enough to solve existing issues, Beswick said. "If you think about these national standards setters, many of them have deep expertise in accounting and really understand the issues that are being faced in an individual jurisdiction." The IASB should "further rely on those national standards setters and really leverage the talent that exists," he stated.

Inconsistent application and enforcement. The application and enforcement of IFRS are inconsistent globally, and "while there's broad compliance, there are definitely areas that could be improved," Beswick said, calling the area of application and enforcement "one place where the regulators can have a very positive impact." For example, "staff in OCA are trying to be much more proactive in terms of identifying issues and working with other regulators," he said.

Investor education. Last, Beswick stated that investor education could be improved: "It's a very wide spectrum; there are some who do a wonderful job of following the projects and providing input, but there's a large number, that we found, who don't really follow changes in accounting." Instead, these investors learn about changes from management at a later stage in the process; thus, they don't give feedback as standards are developed and have less time to react to the resulting changes.

SEC Resources

Craig Olinger, the acting chief accountant of the SEC Division of Corporation Finance (DCF), stated that the division spends "a lot of time trying to get people to comply with the requirements." In situations where established SEC guidance doesn't necessarily apply to a filer's circumstances, he encouraged attendees to ask the DCF directly.

Olinger mentioned several other resources available to accountants, such as the recently updated financial reporting manual available on the division's website, which offers guidance on "how the division generally applies the rules and how we expect registrants to apply them" ( Another source of guidance is the SEC's series of corporation finance disclosure guidance topics, which focuses on issues "where we've got something we want to try and get the word out to the world, but it doesn't rise to the level of rule making," Olinger said ( For example, Topic 5 addresses SEC staff observations regarding disclosures of smaller financial institutions.

The JOBS Act

Next, Olinger discussed the JOBS Act, enacted on April 5, 2012; he focused on the provisions of Title 1 that are most likely to affect accountants, as well as the DCF, in the immediate future. The JOBS Act, Olinger explained, "creates this new category of filer, called 'emerging growth company,"' which must have total annual gross revenues of less than $1 billion for its most recent fiscal year and must have completed its initial registered equity offerings after December 8, 2011. Yet "there's actually no specific requirement than an emerging growth company be emerging or growing," Olinger said. "Interestingly, you could be receding and shrinking and still be one as long as your [annual revenues are] less than $1 billion."

But the act does put forth several conditions for companies seeking to shed their emerging growth company status, he said. One, for example, is if "your revenues go over $1 billion. The other is if you become a large accelerated filer." Additional conditions are met if the company issues "more than $1 billion of debt in the most recent three years," or reaches the 50th anniversary of its first public equity issuance, in which case it would drop its emerging growth status at the end of that year.

Olinger next addressed the differences between emerging growth companies and regular registrants: The audited financial statements included in a company's initial public offering (PO) registration statement can only cover two years instead of three. The selected financial data can follow the audited financials' two-year period, rather than the typical five years, as can Management's Discussion and Analysis (MD&A). Olinger noted that the act exempts emerging growth companies from some of the compensation provisions of the Dodd-Frank Wall Street Reform and Consumer Protection Act of 2010.

For executive compensation disclosures, an emerging growth company can follow smaller reporting company provisions, rather than those designed for regular companies, he said. Moreover, the act contains "a provision that allows an emerging growth company to opt into the private company transition dates for new or revised accounting standards." The SEC has received numerous questions about the definition of new or revised accounting standards. "We read it to mean standards issued or updated by FASB after the enactment date of the act," Olinger said; however, no such standards currently qualify for that status.

The JOBS Act also "creates a confidential registration statement submission process that allows the company to come in and be reviewed for a period of time before it makes its initial registration statement public," Olinger said. Once the company does make its public filling, those prior submissions would be made public.

SEC response In response to the JOBS Act, the SEC has released four related documents on its website. The first is a "quick reference guide" to the act's provisions. The remaining three documents address sets of frequently asked questions (FAQ) dealing with the confidential submission process, registration and deregistration under the Exchange Act of 1934, and a variety of Title 1 provisions, respectively.

One nugget of guidance Olinger mentioned is the expectation that the content of the confidential registration document be substantially complete, meaning that "all the major elements of the filing have to be filed; you can't come in without an audit report or without an MD&A. That's all supposed to be fully compliant as though it were being filed."

Another piece of guidance, addressing the Title 1 FAQ document, covers topics such as what total annual gross revenues mean and when a company has to meet the emerging growth company test, which is conducted at the time of its confidential submission and at the time of its initial live filing.

IFRS Registrants

Olinger added to Beswick's discussion of IFRS by pointing out that the SEC currently has 150 to 200 IFRS registrants. He predicted that "with Canada coming on for 2011, that number will go up quite a bit," and that "through the course of 2012, we expect maybe we'll have 300 more IFRS companies, so that number could go up closer to the 500 range." If this happens, IFRS will join U.S. GAAP as the two most commonly relied-upon standards in SEC filings. The SEC reviews IFRS companies on the same review schedule as domestic companies--that is, "large-cap companies and risky companies ... get reviewed annually or fairly frequently, and they all get reviewed at least once every three years." The comments issued by the SEC on IFRS tend to be similar to those issued on U.S. GAAP, such as guidance on financial instruments and business combinations, Olinger said. He concluded by briefly discussing issues relevant to foreign private issuers, which now need to file their annual reports sooner and explicitly assert IFRS compliance in order to avoid reconciliation with U.S. GAAP.


Enforcement Cases

Howard Scheck, chief accountant of the SEC Division of Enforcement, spoke next about SEC enforcement metrics and several recent enforcement cases. The division aids attorneys in accounting and auditing investigations, consulting with the OCA and the DCF "throughout all stages in the investigation and before we make our enforcement recommendation," Scheck explained. In the past year, the division charged 113 individuals, including 53 chief executive officers (CEO), chief financial officers (CFO), and chairmen, as well as internal accountants. The division is currently focusing on several areas, Scheck said, including cross-border issues, investigations related to banks, disclosures, revenue recognition, expense recognition, and audit firms' compliance programs for discovering illegal acts under the Exchange Act of 1934 section 10(a).

Scheck listed numerous additional issues encountered during SEC investigations, such as structuring transactions to achieve an accounting result, dubious materiality analyses that discount qualitative factors, and instances where an auditor might have flagged an accounting error originally in the course of the audit but then "gets comfortable with that accounting--and sometimes it's right, but sometimes it isn't. ... We're certainly going to be looking at those kinds of situations." The division also plans to look at boards of directors, audit committees, CEOs, CFOs, controllers, and a company's accounting staff because "they're the ones that have the access to the books and records, the ability to modify and alter the books and records, and, potentially, the motives to cook the books."

Scheck highlighted three recent SEC enforcement cases: Puda Coal, AutoChina, and SinoTech. AutoChina, for example, was "essentially a market-manipulation case" where the company attempted to get loans based on the value of its stock, which had a low trading volume. Because the company was receiving very unfavorable terms for the loans, it "needed to pump the volume and the price, and engaged in a pump-and-dump market manipulation," the violation cited by the SEC. Scheck also recounted several recent banking cases, including one in which Franklin Bank restructured its loans to make them look current and failed to disclose them as troubled debt restructurings. He also highlighted revenue recognition matters. In the case of Symmetry, the company engaged in "pre-booking of sales" of a "product that hadn't even been manufactured yet or shipped yet," Scheck said.

Professional Conduct

Scheck also discussed recent enforcement actions that fell under the rule 102(e) improper professional conduct provision of the SEC's Rules of Practice, aimed at auditors connected with audit deficiencies. In such cases, the division examines auditors' conduct and whether they complied with generally accepted auditing standards (GAAS). Scheck described one case in which a partner of the audit firm tried to help a company "figure out how to cook the books and how to backdate contracts--and of course we don't like that, and brought a case."

Finally, Scheck talked about cases dealing with the Exchange Act of 1934 section 10(a), which requires audit firms to have compliance programs for detecting illegal acts and discovering potential illegal acts. In one such case, incoming auditor Livingston & Haynes learned, through conversations with the previous auditor, that management might not book adjustments, and might even use fictitious transactions. Despite this and additional incriminating information that came to light, the audit firm did not take any action. Consequently, the SEC charged the auditors with a section 10(a) violation.

In response to a question from the audience about the political pressure placed on the SEC, Scheck summed up the role of the division: "We conduct our investigations objectively and we look at the evidence. We talk to the people we think we need to talk to. We get the documents we think we need to look at, try to make reasonable and fair decisions based on what we find. ... Companies come in and tell us why we shouldn't charge them, and we take their argument seriously and make the proper recommendation that we think the commission should hear and then they decide."

Current Developments in the Private Sector

Providing Guidance and Resources

The second panel of the morning session at Baruch College's 11th Annual Financial Reporting Conference on May 3, 2012, addressed standards-setting developments in the private sector. Four panelists commented on the recent and ongoing projects of three standards setters--FASB, the Emerging Issues Task Force (EITF), and the Financial Reporting Executive Committee (FinREC).


Recent FASB Projects

FASB Technical Director Susan Cosper began the discussion by updating attendees on issues that had still been in the exposure draft phase during last year's conference, such as goodwill impairment, multiemployer plans, and other comprehensive income (OCI).

Goodwill impairment "The objective was really to simplify some of the cost burdens for preparers, particularly when they were doing the goodwill impairment tests, because of the costs incurred having to do a fair value measurement," Cosper said. "What this project effectively does is put a qualitative screen in place." Effective January 1, 2012, the guidance allows an entity to first assess qualitative factors and determine whether it's more likely than not that the fair value of a reporting unit is less than its carrying amount, she said, "If it's more likely than not--which we think of as a 50% threshold--then you have to actually proceed to step one," Cosper added. "If you don't, then you can consider your test completed." Cosper said the provision reflects FASB's outreach to nonpublic entities and should alleviate some of their concerns about cost burdens.

Because this "shortcut approach" is optional for companies, some might choose not to use it, noted panelist Carlo Pippolo, a partner at Ernst & Young. He explained that "if you did an acquisition last year and it's been kind of a bumpy year since then, it may be hard to get to 'more likely than not' based on a qualitative assessment if it's a brand-new, separate reporting unit."

Multiemployer plans. Cosper then discussed FASB's multiemployer plan project "This project really arose to address some of the concerns that came out of the financial crisis related to a company's exposure to unfunded plans when they had involvement with a multiemployer plan." The project sought to improve the qualitative and quantitative disclosures about employees' participation in multiemployer plans, she said, including levels of participation and the financial health of the plan. After conducting outreach, FMB eliminated the most controversial aspect of the exposure draft--the requirement for an entity to accrue the potential withdrawal liability.

Other comprehensive income. Cosper spoke next about another recent FASB project that addressed OCI: "What this project did was to require nonowner changes to be presented in either a single, continuous statement or two separate statements of comprehensive income, and it required that changes that came out of accumulated OCI would then be shown in a separate display in the financial statements." When FASB sought feedback on the standard, it received concerns about implementing the standard, the systems needed to track these items, and the applicability of those types of disclosures to interim periods, Cosper said. FASB is considering alternatives that would alleviate some of this burden.

"I've been arguing for doing only one statement," commented Robert Laux, senior director of financial accounting and reporting at Microsoft. But a two-statement approach "might be practical, because it just gets very confusing when you see one statement going over two lines," said Richard Paul, a partner at Deloitte & Touche LLP.

FASB's Current Agenda

Cosper next turned to FASB projects currently under deliberation, such as repurchase agreements, which arose "following the concerns in the marketplace about the transparency of repurchase agreements--specifically, those that are accounted for as sales, such as repos to maturity transactions--and the market practices that have evolved surrounding the quality of the securities that are used in those types of transactions." The project will improve the guidance surrounding all repurchase agreements and promote enhanced disclosure and greater transparency, she said.

Next, Cosper spoke about the "risks and uncertainties project, formerly the going-concern project," which addresses the liquidation basis of accounting and whether FASB "should provide guidance on management's assessment of ability to assess whether an entity is a going concern, and whether there should be disclosures associated with that." She also talked briefly about a project that would establish a qualitative screen for impairment of indefinite-lived intangible assets: "I think we're hearing some of the same concerns that we heard from the goodwill project, as far as the cost-benefit question and whether auditors will actually accept a qualitative analysis. But overall, I think there's support for this particular project."

Cosper mentioned two additional reporting projects. The first is intended to provide relief from "the disclosures around the significant unobservable inputs and other disclosures required when you have a Level 3 fair value measurement." Laux later asked whether FASB is "worried about an expectation gap with this disclosure framework project, because I'm a little concerned that some might be thinking that this is the beall, end-all of the issue about disclosures." He noted that "there's a second part to this project, which is possibly integrating MD&A [management's discussion and analysis] with the financial statements, which I believe will be a much more difficult conversation--and you'll need to have leadership from the SEC and FASB, but more importantly ... you're going to have to have involvement by us as constituents."

Cosper responded that the project is "a start down the right path. It's going to take time to develop it and get it in place. ... I think disclosure redundancy is something that we need to address."

The second project seeks to define a nonpublic entity. FASB has "at least six different definitions of nonpublic entities, and we're trying to make sure we can harmonize that definition in our literature," Cosper said. "So far, the board has tentatively decided that entities that file or furnish financial statements with the SEC when issuing securities in a public market would be outside the scope" of the definition; privately held financial institutions would be included within the scope of the definition, she stated.

Yet another FASB project, focusing on financial reporting by not-for-profit entities, will revisit the guidance under Statement of Financial Accounting Standards (SFAS) 117, with an eye toward "how best to display some of the information so that it satisfies the needs of their users. The other [not-for-profit] project [on FASB's agenda] is actually a research project, and it's going to review existing best practices for not-for-profit entities to determine how communications are made [and] ... how they could better tell their story."

Joint Projects with the IASB

Cosper next spoke about several projects that FASB is working on jointly with the International Accounting Standards Board (IASB), such as the consolidations project. Although this is a joint project, the IASB finalized its standard while FASB issued an exposure draft, she said. Cosper explained the project: "The proposal rescinded the indefinite deferral in SEAS 167, or Topic 810, as it relates to reporting entities--the asset managers, if you will--and clarified whether a decision maker is a principal or an agent. And it includes the consideration of things like rights held by other parties, compensation, and exposure to variability of returns from other interests held, and each factor would be weighed based on the facts and circumstances being evaluated for consideration." A common theme expressed by commenters was the "need to have one model. They like the idea that there's not a voting interest model and a variable interest model, but just one model," which would be closer to the International Financial Reporting Standards (IFRS) model, Cosper said. FASB will address these concerns and the call for an overall principle in its redeliberation.

A second joint project that Cosper spoke about related to investment companies; it changes the criteria for determining when a company is considered an investment company and when it should apply investment company accounting, she said. The project "requires investment companies to consolidate investment companies in which they hold a controlling financial interest under Topic 810. ... It requires additional disclosures about their activities and obligations," Cosper stated. She noted that although FASB and the IASB have similar criteria for determining investment companies, the scope of the projects differs: "Under INKS, you only consider the guidance of whether you're an investment company if you're already a controlled entity, so you have to actually ... have determined that you're a controlled entity, then determine if you're an investment company; it's a bit of a carve-out from the consolidation guidance. Under our guidance, we do that first." Cosper said that as FASB deliberates, it will consider comments that the proposal was too prescriptive and that a more flexible approach based on an overall principle is needed.

The EITF's Role

Pippolo compared the EITF to the International Financial Reporting Interpretations Committee (IFRIC), its equivalent under IFRS, noting that its structure is similar to the EITF. One significant difference is that IFRIC chooses the issues on its own agenda, whereas FASB decides the EITF's agenda. If IFRIC decides to not add an item to the agenda, it issues rejection notices, Pippolo said. These notices, which IFRIC exposes to the public, sometimes actually contain guidance. He also noted that "for an IFRIC consensus to be a final standard, the IASB has to ratify that. They don't have to ratify documents for exposure, but they do have to ratify the final document."

Past EITF Projects

Pippolo then turned to three EITF issues that had come to a final consensus. The first dealt with health insurers and Accounting Standards Update (ASU) 2011-06. The issue resulted from healthcare legislation that imposed a fee on health insurers starting in 2014. Because the fee is based on a company's market share in 2013, the EITF had to decide whether the liability should be recognized in 2013 or 2014. Pippolo summed up the EH? decision: "If you don't write an insurance policy in 2014, you don't have a liability--so recognize it in 2014. But it's kind of a pay-to-play [situation], because once you write that first policy, you owe the amount, and it covers you for the year, so we decided [companies should] recognize that liability and essentially amortize it in over the year."

The second issue concerned hospitals with emergency rooms that are required to accept patients, regardless of whether they have health insurance or demonstrate the ability to pay. Because a hospital recognizes that it most likely won't collect the full amount billed, it generally recognizes revenue at a 100% contractual rate and then books a large bad debt expense for the difference that it doesn't expect to collect, Pippolo said. But he noted that "There was a lot of gnashing of teeth as to whether that met the test to be reasonably assured, [because] that's very different than the revenue recognition model in other industries." The EITF' s guidance instructed companies to "move that bad debt expense ... up as a deduction from revenue, as contra-revenue."

The final issue involved single-purpose entities that had an investment in real estate and consolidated that investment, but because the entity had defaulted on the debt funding the investment, the bank had taken operational control of the property. "If you apply the deconsolidation rules, you'd say, 'Well, I lost control, I would deconsolidate that entity,'" Pippolo said. "The problem is, that entity is, in substance, real estate--and we have a much higher threshold for derecognition of real estate from SFAS 66." FASB had previously stated that entities should apply the real estate guidance, but, in this case, it wasn't a sale. Pippolo said the EITF decision was to "treat it the same way we do a sale ... apply the real estate literature."

The EITF's Current Agenda

Pippolo also spoke about issues still on the EITF agenda, such as foreign currency translation adjustments (CTA) and discrepancies between the foreign CTA literature and the consolidation literature. Pippolo described the problem: "If you sell an entity that's part of a foreign entity but not entirely or substantially all of the foreign entity--do you derecognize CTA or not? The ETTF put out a consensus for exposure that said, 'Yes, derecognize the CTA.'" But he added that the EITF is now rethinking that decision.


He then spoke about two not-for-profit issues currently on the agenda: the first concerns non-for-profit organizations that want to immediately sell donated securities that they receive and use the cash for operations, and the second focuses on whether the threshold for a not-for-profit entity to recognize contributed services is set high enough.

Another EITF agenda item deals with assisted transactions where the Federal Deposit Insurance Corporation (FDIC) provides an indemnification of losses on loans assumed by a bank, Pippolo said. The project will try to "reconcile some of the words in the old business combination literature to figure out how to account for that indemnification asset, because there's a lack of symmetry in accounting for the loans," he stated. "If the value goes down if you take an impairment, that's recognized immediately. But if these were cred-it-impaired at the time the loans were acquired, any increases in expected cash flows get amortized in over time."

A final issue on the EITF agenda addressed joint and several liability. Pippolo described the issue through an example: "Say the panelists decide to form a joint venture and they borrow $1 million and they're all jointly and severally obligated. So in their financials ... should they each book $1 million because they're liable for $1 million, or should they book the amount they think they're going to have to pay?"

FinREC Update

Paul rounded out the panel by talking about FinREC's industry accounting guides, which he describes as general guides that detail typical transactions in a particular industry. Paul pointed out that "the guides now are nonauthoritative," but "some of the information that was in the guides that people look to actually made its way into the codification."

Another FinREC resource is technical practice aids (TPA), which are derived from questions that arise through the AICPA hotline process; however, "the volume of TPAs has gone down significantly over the past year," Pippolo noted. "I think it's because we are trying to funnel things through the standards-setting process."

Topical accounting guides are a third resource published by FinREC, Pippolo stated: 'These are topical, specific guides that really relate to an issue that was a big issue in practice historically, or one that has risen currently." Pippolo talked about three topical guides currently being developed. The first, currently out for exposure, is an inprocess research and development (IPR&D) practice guide; it has educational material about accounting guidance and valuation concepts related to IPR&D. Another guide posted for comment concerns accounting for goodwill. The third guide, which is currently being revised, focuses on valuation of private company stocks that are granted as compensation, Pippolo said.

Pippolo ended by speaking about issues on FinREC's horizon. One guide under consideration by FinREC relates to business combinations. But the challenge, he said, would be the "marrying up of the accounting guidance and educational material and valuation guidance ... and distilling it into a guide that's not going to be 4,000 pages long." Moreover, Pippolo said FinREC will continue to provide educational materials on new standards, alongside FASB and the SEC.

Driving Change to Achieve Independent and High-Quality Audits

Jeanette M. Franzel was appointed to the Public Company Accounting Oversight Board (PCAOB) in February 2012. She is a CPA, an MBA, a certified government financial manager, a certified internal auditor, and a certified management accountant. Early in her career, Franzel worked as an elementary school teacher in South America and then with a small CPA firm. Prior to joining the board, she worked at the Government Accountability Office (GAO) for 22 years, rising to the position of managing director. In this position, Franzel supervised management and auditing issues across the federal government. In addition, she oversaw the updating and issuing of the GAO's Governing Auditing Standards from 2003 to 2012. In 2010, Franzel received the International Achievement Award from the Association of Government Accountants, and, in 2011, she received both the GAO Distinguished Service Award and the AICPA Outstanding CPA in Government Award.


The following is an edited version of the keynote speech Franzel gave at Baruch College's 11th Annual Financial Reporting Conference on May 3, 2012.

Reliable and Relevant Audits

The role and relevance of audited financial statements is something that we need to think about. We've got immediate actions that we need to do now to make them relevant and reliable so that people will care about them and use them, but I think there's a longer-term issue here too, which we need to think about as a profession. I want to talk to you about the role of the PCAOB, the current initiatives and priorities of the PCAOB--and we've got some very big ones, as you know--and some legislative issues that are happening right now.

So what is the role and relevance of audited financial statements today? If you think about it, it would be a different answer than it was 20 years ago, and certainly it will be different 20 years from now. We, as a profession, have been very good about making adjustments along the way to keep things relevant and reliable. And sometimes people get excited about these things because they are controversial. We're taking on some of those topics right now, where some things have essentially been unchanged since the 1930s.

Auditors have been given an important role in the capital markets: to provide assurance to investors, owners, lenders, and others that an audited company's financial statements and disclosures fairly present the results of operations in accordance with all accounting standards. Clearly, reliable financial statements do play a key role in today's financial markets, and this is integral to the success and well-being of American households and businesses. Just look at the huge market disruptions that have happened over the last few years and the impact they have had on people's retirement accounts, college savings accounts, and household wealth in the United States. We know that when there is a major market disruption, there is a huge cost to society and to American families, so reliable financial reporting plays a very key role in helping to avoid those kinds of issues.

We're still trying to learn from the most recent financial crisis. More than half of American households invest their savings in securities to provide for retirement, education, and other goals. Fortunately, our economy proves to be resilient. We are just slowly crawling out of this most recent economic slowdown, mainly because people are willing to continue to believe in the system. People are willing to continue to save and invest. And that confidence is what is keeping things going. Then we make adjustments and try to figure out, "How can we get it right next time? How can we prevent this from happening? How do we tweak financial reporting and auditing so that we can continue to advance?" This cycle helps promote economic wealth, but again, we really need to focus on reliable financial reporting, both now and in the future.

As we approach the 10th anniversary of the Sarbanes-Oxley Act of 2002 (SOX), we've had 10 years under SOX and we've had nine years of PCAOB operations, and it seems that we have entered a period of reexamination, once again, of the role, relevance, and reliability of financial audits in protecting investors and the public interest. I think this most recent financial crisis has caused people to take a look at the role and relevance of financial statements and financial audits in the economy.

Many of the topics currently being debated have been debated over the decades--auditor independence, the role of audit committees, professional skepticism and objectivity, audit quality, and the auditor's report. We need to keep making the proper adjustments as we move into the future. "We decided decades ago on this," or "This has worked fine for the last 70 years," are really not good responses because we need to keep moving forward, and we need to keep the relevance and reliability of financial reporting in the marketplace. Even if these are some of the "same old topics," we just need to look at more recent events, figure out how to learn from them, and adjust and move on. Although we are reacting somewhat to the financial crisis, we're not in a complete crisis. This wasn't like the SOX era; this wasn't like the banking crisis in the early 1990s or the savings and loan crisis, where it was just complete crisis mode up there in Congress. So I think that, hopefully, we'll have a chance to do this in a measured, thoughtful manner.

With all of that, I think we can conclude that audited financial statements are important and will continue to be important. We need to figure out how to keep it that way and really keep the proper perspective. But with all the rapid changes in financial markets, globalization, technology, and how business is conducted across the world, this is going to dramatically impact financial reporting and financial auditing, and we all have to understand the implications on financial reporting. We, as a profession, need to realize that once you've studied for that CPA exam and learned those standards once, that's not the end. And those of you who have been in the profession for a long time, you know it requires continually learning and changing and trying to keep up with the changing standards, which is very necessary in today's world.

The PCAOB's Role and Responsibilities

As you know, SOX established the PCAOB to oversee the audits of the financial statements of public companies. We are independent, but we are congressionally created and overseen by the SEC, so it's a very unique regulatory structure by design. In July 2010, the Dodd-Frank Wall Street Reform and Consumer Protection Act amended SOX to provide the PCAOB with oversight responsibilities for audits of brokers and dealers; we are working on that right now. The bottom line, when you mix all of this together, is that our statutory mission is to oversee these audits in order to protect investors and further the public interest in the preparation of informative, accurate, and independent audit reports.

Under the act, we've got four main responsibilities. The first is to register public accounting firms that audit public companies or broker-dealers; firms cannot do these audits unless they are registered with the PCAOB. Second, establish auditing standards--those would be the PCAOB auditing standards--for these audits. Third, conduct and report on regular inspections of registered public accounting firms. Lastly, conduct investigations and disciplinary proceedings. We've got an enforcement function as well, and we heard about the SEC's enforcement function this morning.

We've got just around 2,400 registered firms. Now, not all those firms are audit issuers or broker-dealers. Between 1,000 and 1,100 of those firms actually do audits, so those are the firms that we actually inspect. Another 516 firms audit broker-dealers, and we're in the process of trying to figure out what our inspection process will be for those firms. In that category of 516 that do broker-dealers, there's a whole different range of broker-dealer type of activities (e.g., some do not have access to customer funds), so we're really trying to figure out if some of those should be exempt from inspection. The range in that industry is just amazing, and so we're figuring this out right now. We've got that category of between 1,000 and 1,100 issuers that we inspect and then this category of about 500 broker-dealer firms that we're trying to figure out what to do about, so stay tuned there.

We've basically got four categories of inspections. We have 10 firms that annually audit over 100 issuers--those are obviously big firms and those are big inspections, and we're in there every year, and we're pretty much talking to those firms year round. Firms that issue 100 or fewer audit reports are subject to inspection every three years. Last year, we did 203 of those inspections. I mentioned that the inspection program for broker-dealers is still under development. And then we've got that big category of registrants that don't audit issuers or broker-dealers, and we don't inspect them at all. So we've got the annual inspections, the every-three-years, the broker-dealers that we're still trying to figure out, and then that other category of firms that just like to send us paperwork and fees every year. It does help give us some statistics about who's out there and what they're doing.

Since it began its inspection operations, the PCAOB has conducted over 1,800 inspections of firms and reviewed over 7,800 audits in the process. We've built quite a body of knowledge about public company auditing. For firms that audit public companies, we issue inspection reports after each inspection, and they have what's called Part 1 and Part 2 to the inspection report. Part 1 is made public, and that's dealing with significant deficiencies in audits--with the names of the companies stripped out, of course. Part 2 deals with quality assurance problems within a flow, Part 2 is not made public immediately. Firms are given 12 months to come up with a remediation plan to take remediation action; if the firm takes sufficient action, then we do not publish Part 2. But sometimes we do publish Part 2. That's how that works, and it has been set up in statute that way. If you go to our website, you can find all the Part 1 reports, and then you can find those firms where we did end up issuing Part 2. Those are the firms that did not take sufficient remedial action, and then the deficiencies did get published.

Remediation is a very important part of the process, and we really work one-on-one with the firms. Our staff works with the firm's staff, and we at the board work directly with firm leadership. We have some very difficult conversations with the firms about how to staff the jobs and how to supervise the jobs. These have been very constructive discussions, where I've seen a lot of soul-searching going on in the firms for ways to fix some of these quality problems that we've been seeing, because some of them are actually quite shocking. For example, just large material areas of the audit where there really wasn't sufficient--or much or any--audit work done. How does that happen? The firms understand that that cannot continue and that it's risky and dangerous. We've been having a lot of very good conversations with the firms, where the firms are really rethinking some of the basic models for training auditors, staffing jobs, or rewarding partners.

We've also got a Division of Enforcement and Investigations, kind of similar to the SEC [Division of Enforcement], and we do take disciplinary action. Our enforcement actions are now starting to really gear up because we've had a few years of inspections going on. To date, the PCAOB has taken 49 disciplinary actions against 39 firms and 52 people. Our sanctions include censures, fines, suspensions or bars from being associated with a registered firm, and revocations of firm registrations. Sometimes, if we're initiating disciplinary proceedings against a firm, the firm will decide to dump all of its public company clients and deregister, and that's okay because they got out of the market. And then if they ever try to register with us again, we'll know about this previous issue. We've also revoked the registration of firms, barred individuals, and suspended individuals.

In my short time with the PCAOB, I have put all these categories of registration, inspection, standards, and enforcement into our basic operations--the "ordinary business" is what I would call it. It is a very heavy and varied workload, which is integral to fulfilling our mission under the law. But through that work, we really gain a lot of knowledge for really figuring out what the priorities need to be moving forward as a profession and really establishing some leadership in the profession. I think of that "bucket" as leadership and protecting investors in the public interest. Some of the concept releases that we have out on topics we're exploring would really fall under that category.

We've got a number of priorities and initiatives out there. But again, these priorities are really geared at several things. First, we want to really drive change under the current model, because we're finding some very serious audit deficiencies under current standards. Those deficiencies need to be corrected. Second, we ask ourselves whether there are issues or problems with the current model and standards that need to be updated and changed. We have a lot of standards initiatives out there. And then third, just through our normal monitoring, are there any emerging issues out there that pose some immediate risks to audited financial statements? What are those? We saw those over the last couple of years with the reverse merger issues coming out of China.

Gaps in Practice

Let's talk about the current gaps in practice; we have actually found an increase in deficiencies in the 2010 and 2011 audit cycles, and that is very disturbing. We don't know why that is; we're analyzing that and working on that. It could be because of the economic pressures that firms were facing--maybe they cut back, maybe they held fees low--but we did see a marked increase in serious audit deficiencies in our 2011 inspections of 2010 audits.

Some of these deficiencies include issues where auditors offered clean opinions even though the audit work was just not complete or not conducted. So we'll look at a specific area of an audit, and there's just not sufficient appropriate evidence there. These are pretty big issues--this isn't arguing on the margins here. Where financial information is contradicted by other evidence sitting right there in the audit files, with no explanation as to why the numbers on the financial statements would be better than this other contradictory evidence, and then where audit conclusions on material issues are just based on management views without any independent verifications, this basically means there was no audit work done. And these are on important materials of the audit; there wasn't necessarily a business failure involved.

We're just finding this by looking under the hood, and we've got to get rid of that hyper-risk, because it seems like when there's an economic cycle or pressure, these things do blow up. Those are the current gaps on the current model that we're working with firms to correct. We're working with them through our inspection process and in regular meetings as well. Our remediation staff have regular, ongoing dialogue with the finns about their remediation plans.

PCAOB Standards Setting

With regard to what we need to do with the audit model or the audit standards, maybe to improve it: that really falls into our standards-setting arena. We've got a whole lot of initiatives out there. But we do use information that we learn from our inspections and from our conversations with the fums, and through research and other issues, to determine what our standards-setting agenda is going to be. Once we have ideas on topics, we also seek advice from a wide range of stakeholders and interested parties on ways to improve audits. We have meetings with investors, auditors, representatives of public companies, the profession, and the academic community. We've got a standing advisory group, an investor advisory group, and an academic group, so we're very busy talking to a lot of people before we ever get to the point of doing a concept release or proposed standard. We also hold roundtable discussions on important topics, where we invite the public to come in and listen, and we invite speakers to come in and provide their views. And then, lastly, we do work closely with the SEC in coming up with some of our proposals. So the board really has a full agenda right now on specific proposals impacting auditing and related professional standards.

We do this through various means. The first is through concept releases. Concept releases are not proposed standards; they're discussion memorandums about certain topics. And then we also do have proposed standards. We ask for comments on all of these from the public. We read every single one of them. We analyze them to death. We have our staff--the staff that does this is absolutely wonderful--and they come in and slice and dice these things in a bunch of different ways, so that we really do have good analysis of every single comment letter that comes in. Let me talk about the two concept releases that the board is working on.

Auditor's reporting model The auditor's report is one of those things that we've been struggling with for 70 to 90 years--and really, there haven't been substantial changes to that report since the beginning, but a lot of people have questioned it over the years and there seems to be a reexamination of this around the world, not just here in the United States. In June 2011, the PCAOB issued a concept release to seek public comment on potential changes, tossing some ideas out there and getting feedback on what people think. The concept release included a discussion--and this was a little bit controversial--of a potential supplement to the auditor's report, which would provide the auditor's views on certain things, and it was referred to as the "Auditor's Discussion and Analysis." And this was really in response to people saying, "We need better information and we need more information. We just want to know what the auditor is thinking." So that was one potential proposal that we were asking about.


The other proposal is the required and expanded use of emphasis paragraphs in the auditor's report. Under current standards, it's allowed, but nobody really does it. As an auditor at the GAO, I used them all the time. It could have been the nature of the entities we were auditing, but I always found it comforting to have that tool of the emphasis paragraph. For example, when we issued our first audit opinion of the Troubled Asset Relief Program, we gave a clean opinion, but we had a bunch of emphasis paragraphs in there. These were financial instruments that were brand new; nobody had ever done this before. We basically said in the emphasis paragraph, "The results will definitely be different than what's in the financial statements, even though management followed a reasonable process," and so on and so forth.

This concept release asked about people's views on required and expanded use of emphasis paragraphs and on auditors reporting on other information outside the financial statements, and then clarifying it and tweaking some of the language in the auditor's report. This has been a very lengthy process. There were discussions with advisory groups on this in 2010. The concept release went out in 2011. And the staff is currently, based on all of the input received from the concept release, preparing a proposed standard, which they're saying will probably go out in the third quarter of 2012. And that will be a proposed standard, and we want and need your comments on it. Sometimes, depending upon the comments that come in, we will then repropose. For example, if the comments are just all over the place and it doesn't seem like we can possibly write a standard that would be generally accepted, there might even be a reproposal after that or, if not, a final standard is then drafted.

Auditor independence and audit firm rotation. This has been getting a lot of attention out there. As a result of PCAOB inspections and some of those serious issues that I mentioned, where auditors are relying on management or whatever piece of paper management gives them and not auditing it, there was some deliberation on what might be causing this and that, perhaps, it could be a lack of independence, objectivity, and professional skepticism. So the board issued a concept release last August, seeking public comment on a variety of approaches to improving auditor independence, objectivity, and professional skepticism.

As part of that concept release, the board sought comment on a rotation requirement for firms, as well as on the significant costs or risks in disruptions or benefits of doing this, under the umbrella of protecting investors and enhancing audit quality. The deadline for comments was in December, and we had received 630 comment letters as of the end of that first comment period, which is just unprecedented. And then we reopened the comment period, because we held a two-day public meeting on March 21-22. We thought by letting people come in and give additional views, we should reopen the comment period. I don't even know how many letters I've been seeing come in.

If you missed the public meeting, you can watch the webcast or listen to the podcast on our website; it is 17 hours and 12 minutes long. During those two days, we heard from 47 panelists, and I'll just give you my summary of what I heard--but we're still working on analyzing all of this, of course. In general, the panelists expressed that they believe that SOX and the PCAOB have improved the quality and reliability of financial audits. On the other hand, some people don't want any regulation or auditing standards. But it was good to hear people say, "You know, the audit committee reforms have really made a difference," and "The partner rotation reforms have really made a difference."

Another mother suggestion was changing audit firm culture and really instilling a mindset that the auditor's client is really the investor. We talked to the firms about that a lot in our one-on-one meetings, and the firms are telling us how they're trying to train their auditors with that type of a mindset. It's not the auditee sitting across the table putting pressure on you--that's not your client. The client is the investor. Employing targeted audit firm rotation in specific cases, if we see an egregious example of a nonindependent firm in a particular case, maybe that could be a case for a mandatory firm rotation. And I thought it was interesting that a firm or a company would ask us to conduct an intensive PCAOB investigation in cases where the audit tenure is long. So we received a whole host of suggestions, and I'm only mentioning a few here. We're really analyzing this, because what we're seeing is a package of actions that can be taken to help increase independence, objectivity, and professional skepticism.

During 2012, the board plans to have a few more open meetings--or at least one--and probably more than one public meeting about this issue around the country, so we can get outside of the Beltway and hear what people are thinking. Then, frankly, we need to decide what we're going to do about this. Right now, our standards-setting agenda does not have any milestones beyond holding a few more meetings this year on the issue, so stay tuned. This will be something that will be developing and that you should watch. We want your input.

Other Proposed Standards and Projects

We've got a number of proposed standards out there, as well. We have proposed standards on audits of SEC-registered brokers and dealers; we're waiting for an SEC rule to get updated before we can actually make those standards final. We have a proposed standard on audit transparency, and this really deals with listing the names of folks who worked on an audit, including other firms. We have a standard on communications with audit committees--again, just more communication of some of the audit results to audit committees, but really relying on current audit performance standards. We also have a standard on auditing related-party transactions--and this one is currently open through May 15. Again, I just want to emphasize the importance of getting feedback from you on these issues--from a wide variety of stakeholders, whether you're in academia, a firm, a preparer, or on an audit committee. We'd really like to hear from audit committee members, and we encourage you to do that.

We've also got a full range of projects that, as soon as we move out some of these current standards, we're going to be taking up, including--

* auditors' use of specialists,

* part of the audit performed by other auditors,

* assignment and documentation of firm supervisory responsibilities,

* fair value measurements,

* going concern,

* confirmation,

* quality control,

* codification of PCAOB standards, and

* subsequent events.

This is just a huge agenda right now facing the PCAOB and the profession.

I also just want to mention one legislative initiative that we've got going right now. It's pending legislation that would amend SOX to make the PCAOB disciplinary proceedings open to the public. Under current law, our disciplinary proceedings are nonpublic through the final appeal to the SEC, so the public is not aware when we are in the process of taking disciplinary action against a firm. This can cause a situation where something can be delayed from being disclosed for years. The SEC actually does have the authority to disclose its actions, and this would bring us on a par with the SEC. It is something that we're hoping can pass, and we think it would improve the process. I'm very pleased to be coming on the board during this busy time. We--the profession and everybody involved--really have a responsibility to help carry the profession into the future.

Questions from the Audience

Audience Member: I thought that that was a noble and correct point that you made, that we need to have independence and perhaps rotation, and that the client is the investor and capital provider, or lender. But the reality is that the company that is being audited cuts the check, and human nature being what it is, what are your thoughts on this? What have the studies indicated about how you untangle that difficult conflict?

Franzel: That came up during deliberation of SOX, and it came up again during our two-day hearing. There is fundamental agreement that the client-payer model has inherent conflicts built into it. There is just no doubt about that. The real question is, do we accept that? And it seems like we have, and we're going to continue to. So, if we accept that inherent conflict, then what do we do to mitigate the risks associated with that? That's where we are right now. What can be done in terms of really educating--and this really even starts with the students about--who the client is? When I was at the GAO, we worked for the taxpayers, and it was always clear to me that I was working for some interest way bigger than the agency officials sitting across the table from me. It's a mind-set, and we need to be sure we're teaching our students that mind-set. The firms need to reinforce it and train it, and partners need to be supported when they're stuck making difficult decisions, where there's a conflict between serving the auditee versus investor interest. That's something that is very important for us to continue to work on.

Audience Member: Transparency is generally a wonderful cure for problems. Is there any consideration of letting the public know of those firms, particularly the larger firms, where you have found deficiencies in their audits before they are given a year within which to make changes?

Franzel: One of the things that we asked the audit committee members during the two-day hearing was, "Are the firms sharing what's in Part 2 of that inspection report with you?" And, of course, the answer was "No," and we said, "Is that information you would like to have?" And they said "Yes." I think if there's some way that audit committee members can start asking firms about their inspection results, that can help start the dialogue. But in order to start disclosing it, and in order for us to disclose it, we would need a change in law. So for now, we're starting with building audit committee awareness that these reports are even out there and evaluating whether their auditor is qualified and independent and competent. Part of that evaluation should include PCAOB inspection results.

Status of Adopting International Standards--Should We or Shouldn't We?

the Endorsement Model and Transition Issues

The first afternoon panel at Baruch College's 11th Annual Financial Reporting Conference on May 3, 2012, focused on the adoption of International Financial Reporting Standards (11-IRS) in the United States. The panel brought together preparers, regulators, and users to discuss the endorsement approach to the ongoing convergence project between FASB and the International Accounting Standards Board (IASB), the role of U.S. standards-setting bodies under such a model, and the various transition issues that might arise during the process. Norman Strauss, the Ernst & Young Professor-in-Residence at Baruch, moderated the panel.







Adoption of IFRS

Leslie Seidman, FASB chair, began the discussion by assessing the current status of FASB's convergence project: "Several years ago, we established a memorandum of understanding with the IASB to identify the topics where we felt there was a need for improvement in standards around the world, and also cases where we felt that there was a difference between current U.S. GAAP [Generally Accepted Accounting Principles] and IFRS ... Within the last few years, though, I think we realized that initial list was a bit ambitious and, in light of all the other priorities that we were facing, it was important for us to try and identify the priority topics." FASB narrowed down the list to four convergence projects--revenue recognition, leasing, financial instruments, and insurance. "We are working very diligently," Seidman continued, "together with the IASB on a joint basis, to try and bring those projects to completion."

Mark Bielstein, a partner at KPMG, noted that most people still believe that having a common set of standards that are consistently applied and enforced around the world is a worthwhile goal. "The question is more about how to proceed," he said. "There may be some differences left--that may be okay if we're continuing to get closer and closer to that ultimate goal."

Robert Laux, senior director of financial accounting and reporting at Microsoft, said that preparers would agree that convergence is a worthy goal. But he reiterated Bielstein's point that "if you're going to have consistent standards, you need to have somewhat consistent application and enforcement--and that's going to be a very important issue. ... It just can't be that standards are similar, but the application and enforcement needs to be similar also."

Mark LaMonte, managing director of Moody's Investors Services, responded on behalf of financial statement users: "Financial statements obviously are a critical input to making investment decisions, and a critical step that investors will take in making those investment decisions will be to place one company side by side [with another] and try to make comparisons. It's very important for us to have a high degree of comparability and a single set of comparable standards. And high-quality standards certainly would be helpful for that." Although it may be impossible to truly achieve a high degree of comparability across different countries and regulatory regimes, standards setters should still work toward a goal of convergence, he added.

The Endorsement Model

Strauss asked why the popularity of the "big bang" adoption approach--the idea that everyone around the world would adopt WRS at the same time--had declined in the past several years. In many of the comments that the SEC received about the approach, concerns were raised about adopting IFRS, said James L. Kroeker, chief accountant at the SEC. Seidman later clarified this: "Broadly speaking, I would say that people were raising concerns to make sure that while we're supportive of global standards, those global standards have to work here in our environment." Kroeker cited some specific concerns--IFRS does not deal with certain issues addressed under U.S. GAAP, costs of transitioning to IFRS, and global enforcement of IFRS. "Those are pretty complex issues if you're going to say those have to be resolved" before transitioning to IFRS, he said. "That was part of the idea in the work plan: go through and figure out, is this idea that people talk about in concept ... really operational?"

Kroeker described the endorsement approach currently favored by the SEC, in which FASB would issue exposure drafts based upon each standard issued by the IASB. When the IASB finalized the standard, FASB would decide whether to incorporate that standard into U.S. GAAP, he said. "The staff paper explored a five- to seven-year time horizon where we would take those areas that are different today--and it's literally hundreds--and figure out, is the approach either moving to [i.e., converging] or not, with respect to each of those differences," Kroeker added.

Bielstein pointed out that this endorsement approach differs from convergence: "Convergence, in the past, has really talked about the IASB and FASB working together--and, in some cases, the IASB changing standards and, in other cases, FASB changing standards and coming together." Laux stated that preparers support this "elegant solution," later pointing out that the threat of non-U.S. endorsement under such a model will have an impact on the IASB, saying it would inspire "a lot of discussion at the IASB to make sure that doesn't occur; I think you change the playing field a little bit." LaMonte affirmed that users also support this approach, and Bielstein expressed his support as well, although he did warn that the "biggest drawbacks from continued joint project efforts is that that's probably not practical or workable from the IASB's standpoint ... on a long-term basis."

Seidman then spoke about FASB's position on the new model, noting that some comment letters suggested FASB "should play a strong role throughout the process, to make sure we're getting views of U.S. stakeholders, understanding what the practical implementation issues are, understanding what our investors think, and then doing any work that's necessary to identify implementation issues and making sure that guidance is ultimately provided." In this way, Seidman said that FASB would be able to address any urgent issues that arise as quickly as possible.

Furthermore, she said that some suggested FASB act as "an active standards setter on the ground, so that we can address those issues on a timely basis, ideally working with the IASB and other standards setters around the world, so as not to create new differences." But "instead of going for 100% perfection, exact words standard to standard, it would be acceptable to agree on the high-level principles in a standard and then, to the extent we need a little bit more [application guidance] in the United States, I think that is appropriate," Seidman later said. Kroeker added, "I think the essence of this is making sure FASB wouldn't be a rubber stamp--it would have to be a legitimate representative of U.S. interests."

Having a common understanding of endorsement criteria will be important, Seidman said in response to a question from Strauss about which hurdles prohibit FASB and the IASB from agreeing on numerous issues. "We think, until someone tells us otherwise, that we should be setting standards that represent an improvement in the United States, [provide] useful information to investors, and can be implemented in an operational fashion by our companies," she said. Certain standards required in the United States differ from those that appear under IFRS, she said.


Strauss asked whether letting companies choose whether to file with the SEC under U.S. GAAP or to adopt IFRS represented a viable alternative to an endorsement approach. LaMonte suggested that this idea does not have much traction in the United States because "a key element of analysis is to be able to put companies side by side and make comparisons. Any time you have options, those comparisons can become difficult."

Independence and Oversight of Standards Setters

Strauss asked Bielstein whether there are any additional benefits to the endorsement model. "It provides for more gradual and less disruptive process, in most cases; it lessens the burden of the conversion process, and I think it also provides for a more flexible transition approach," he responded. "It allows us to retain U.S. GAAP that addresses those areas that are not currently covered in MRS." Laux said that this would be a cost-beneficial method for companies; from a user perspective, LaMonte agreed with the benefits as well, pointing out that "U.S. involvement in IFRS and in global standards setting has been very, very important to the quality of what's been delivered, and if we were to isolate ourselves and not have that role, I think you would get a lower quality standard. ... I think this is good for standards around the world."

Strauss then asked panelists to delve deeper into concerns about the IASB's independence as a standards setter, given that much of its funding comes from the public accounting profession. LaMonte commented that this has long been a concern for investors because "the goals and objectives and motivations of governments can be very different and are not always aligned with the needs of investors for high-quality, transparent information. And not having an independent standards setter really does defeat that goal." U.S.. involvement in the process will encourage independence, he said.

Seidman said that, in FASB's view, "it's crucial that the whole process be conducted in the public using robust due process procedures." She added that "assuming that FASB and U.S. stakeholders have an active role throughout the process, I think that significantly increases the likelihood of an endorsement. ... It sounds so easy to say we should just endorse everything, but these are real issues we're dealing with."

Kroeker spoke about the SEC's role in the oversight of international standards, noting that, under an endorsement model in which FASB would act as a standards setter, the SEC would continue to have a one-to-one oversight relationship with FASB. In such a case, the SEC would still provide guidance if it needed to, he said. "We'd rely, in the first instance, on FASB's judgment," he later stated. "But we'd work closely, comment [on FASB releases, and] I think it'd work much the same way it does today."

Transition Issues

Seidman said that there are three categories of transition issues: "The first are the cases where we have a standard and the IASB does not, and those are the places where we think we should keep U.S. GAAP until a suitable international standard has been developed--and that could take a number of years. The second category are cases where we have differences between U.S. GAAP and IFRS, and we are aware of concerns about the IFRS standard or aware that U.S. stakeholders have already considered it and rejected it." The third category, or "bucket," is the one that "most people think about, which are the high number of remaining differences between U.S. GAAP and IFRS," she said. "There, I think we've got to do some qualitative analysis about who cares about these differences and do a cost-benefit analysis on them."


From an auditor's perspective, Bielstein commented, "if companies can do it, we can audit it. ... But I do think there are valid concerns about the potential number of changes over an extended period of constant change." He suggested potentially grouping some of the changes together in batches in order to make the process smoother.

LaMonte responded from a user perspective: "We need to be able to look at trends over time. Anything that is more of a prospective approach will make our jobs more difficult. And companies, in many cases, will have to do something to facilitate the trend analysis for investors."

Strauss asked whether it was likely that U.S. companies would respond to international proposals in the same way they currently respond to FASB proposals and whether FASB would encourage companies to send in letters to inform its decision making. Seidman replied, "I haven't really checked to see whether our companies are sending letters both to the IASB and to us. I think we could set up a mechanism where they either come in to us and we analyze them, or the letters go in to the IASB. ... I know our companies and auditors and other stakeholders in the process care a lot about financial reporting, so I can't imagine that would change."

Private companies. Next, Strauss raised the issue of nonpublic companies, asking panelists how an endorsement approach would benefit private companies that don't necessarily have foreign operations and aren't interested in international standards. Seidman pointed out that there would be no difference for private companies between international standards and the standards currently in development. "In other words, we're going to go through the same process we go through today to gather the input [and] do the cost-benefit analysis," she said. "Where I think it becomes an acute issue is dealing with the transition of legacy GAAP, where they may see no benefit to doing that whatsoever. That's where I think we'd have to be extremely careful to make sure that the cost-benefit is carefully weighed." In addition, she said, even though many U.S. private companies can currently follow the IASB's standards for small- and medium-sized entities (IFRS for SMEs), most haven't chosen to do so. "I think it's partly because it's a simplified version of IFRS, as opposed to U.S. GAAP, but also because they don't want to be the front-runners on this issue," Seidman stated. "I think they'd rather have the large, public companies go first and set the pace."

With respect to the Private Company Standards Improvement Council (PCSIC), Seidman sees it running parallel with FASB if the United States transitioned into an endorsement approach. "Just as the expectation is that they would advise us on the projects that we're working on--whether you want to call it U.S. GAAP or endorsement or the future standards of tomorrow--I would envision that this advisory council would work side by side with the board, advising us on whether there are any unique private company issues to be considered."

Acceptance of Endorsement

Strauss characterized the IASB as still waiting on FASB's decision on IFRS, after years of hying to gamer worldwide acceptance of international standards. He asked panelists what kind of feedback they've received from the IASB, in terms of what the United States should do. Kroeker pointed out that "a number [of IASB members and trustees] have given speeches about an endorsement approach, and I think there's a general acceptance of that as an idea. I'm sure they want to see how that would work flushed out, but I haven't seen any significant adverse reaction."

Strauss ended the panel by querying whether panelists thought that Congress would want to get involved in FASB's decision-making process, because it might not want to let go of that power. Kroeker opined that "our oversight committees will want to be informed, as the general public will." But ultimately, he said, "we would leave it up to [Congress] whether they want to get involved."

The Big Three Convergence Projects

Revenue Recognition, Leases, and Financial Instruments

The second afternoon panel at Baruch College's 11th Annual Financial Reporting Conference on May 3, 2012, focused on three projects integral to convergence with the International Accounting Standards Board's (IASB) International Financial Reporting Standards (IFRS): revenue recognition, leases, and financial instruments. Panelists representing auditors, preparers, regulators, and users discussed each of these issues. Norman Strauss, the Ernst & Young Professor-in-Residence at Baruch, moderated the panel.







A New Model for Revenue Recognition

FASB Technical Director Susan Cosper opened the discussion on the revenue recognition project: "Our objective on this project is to improve the accounting for revenue recognition, enhance consistency, improve transparency for users to make sure they have the information they need, and ... converge our revenue recognition standards around the globe."

Strauss asked panelists whether they felt more comfortable with the second draft of the standard than they had with the initial proposal. Paul Beswick, deputy chief accountant of the SEC's Office of the Chief Accountant, said that the commission approves of the proposal. James Barge, chief financial officer at Viacom, and Jan Hauser, a partner at PricewaterhouseCoopers, agreed that it was an improvement. Mark LaMonte, managing director of Moody's Investors Service, said that "some incremental improvements have been made from the initial proposal, and the initial proposal was a significant incremental improvement over what we have today."

Hauser said that the new model simplifies the process by breaking it down into five systematic steps. "We have so many different pieces of literature today and you look at it in very different ways; this should hopefully help us go through the process in the same way. ... I think the boards have really been trying to stick with the principles and not having too many exceptions."

Strauss summed up the five steps: First, a company would identify the contract. Second, the company would identify the separate performance obligations of the contract, viewing these as liabilities rather than deferred revenue. Third, the company would determine the price. Fourth, the company would allocate the price if there were separate performance obligations. Finally, the company would recognize revenue once the performance obligation was satisfied.

Hauser delved deeper into the meaning of a performance obligation, calling it a "promise to the customer to transfer either a good or service ... that could be stated in the contract, it could be legal, it could be explicit, or it could be implicit. It also could be based upon customary business practice." The key, she noted, will be figuring out whether each performance obligation in a contract is distinct--and this could cause application issues for companies.

Barge responded that the proposal worked from a preparer's perspective, but noted that "multielement transactions have always been complicated, have always required a great deal of judgment, and have always been difficult for everyone to deal with."

LaMonte also had some concerns: "If we can get results that are more intuitive, that more closely align with the economics of transactions and with cash flows, it'll be helpful to investors." But he noted that, with the relaxation of the current rules, "you may get more intuitive results, but you may have more discretion involved in some of the numbers, or more opportunities for manipulation."

Variable Consideration

"When you're determining the transaction price and you have variable consideration, there are basically two methodologies you can apply when the entity expects they'll be entitled to it," Cosper said, citing the expected value approach (i.e., probability-weighted) and the best-estimate approach (i.e., the most likely amount). "You need to make sure that you limit the amount that you actually recognize or record as variable consideration to the amount that you think is reasonably assured and you're going to be entitled to," she said. Beswick suggested that "people are going to gravitate to the most likely amount" approach rather than the probability-weighted approach.

Hauser commented on Strauss's concern that companies will have to perform more discounting than they currently do. "It could be very complex, particularly when one might be dealing with many elements of a contractual arrangement that span long periods of time," she said. "People understand the conceptual underpinnings of the time value of money, but have real concerns about the cost-benefit."

Strauss brought up the question of where bad debts go on the income statement. LaMonte answered that "most investors have long viewed this as a cost, as opposed to part of revenue," and he said he would like to keep it that way. Barge noted that proscribing where bad debts go doesn't make sense across all industries.

Performance Obligations

The panelists then spoke about allocating a transaction price to individual performance obligations. Hauser noted that revenue cannot be recognized until the performance obligations are satisfied, which could either be at a specific point in time, particularly when a good is transferred, or it could occur continuously.

From a user standpoint, LaMonte commented that this would "better align revenue with the economics of transactions. It'll better align revenues with cash flows. Ultimately, it will help users understand revenue more than they might today."

Strauss asked whether the current percentage-of-completion method would change under the proposal. Cosper responded that the method would disappear but contracts that "applied that type of guidance [will] likely ... be able to transfer control over time ... although [users would] have to determine the facts and circumstances of their performance obligation."

Concerns About the New Model

Strauss turned the discussion to whether companies in different industries will come across problems when they look at their facts and circumstances. Beswick responded: "Industries are working through that right now and providing feedback to both boards. And hopefully, as part of that process, the boards can come together and provide more specificity."

Strauss asked panelists about the "onerous test" for recording losses. Barge said this test represented a flaw in the proposal: "First of all, this [test] is at the performance level, which I think is way too low. I think it should be at the contract level, not at the performance level. ... But then there's a fatal flaw--and this is a big one--at the contract level." He used his own business's media networks and 10-year contracts with cable providers as an example. These contracts, he said, represent only half of the company's revenue stream; the other half comes in over time from advertising. He argued that having to put all the network's programming against just half of the revenues would not accurately represent their business model. "To me, this is dead on arrival. ... There's got to be a lot [of companies] out there that enter into long-term contracts where you have a dual revenue stream, if not a triple revenue stream, and we do not enter into these contracts to lose money."

The next topic discussed by panelists focused on the proposal's lengthy list of disclosure requirements. "Incremental disclosure around revenue is very valuable to users," LaMonte said. "Not only what's in the footnotes, but also what's in MD&A [management's discussion and analysis] will be critically important."

Transition Issues

If finalized, the new model would have a retrospective transition methodology. Cosper said that this approach "enhances comparability across companies and ensures consistency." Although Hauser agreed that a retrospective approach is the best option, she cautioned that "it's going to be very difficult" and that "there's going to have to be a practical cut that the boards make." Barge disagreed with the practicality of such an approach: "We need to remember that when you change revenue recognition, there is a knock-on effect to cost. ... I think it's much too complex to require retroactive treatment. Even though that would be ideal, I think we can deal with transparency through disclosures."

LaMonte added, "In terms of looking backward, companies are going to need to tell their story. They're going to need to explain their trends in revenues, [whether they] do that in a full retrospective manner or do that in a more practical way, through the use of pro formers--as long as they tell their story. That's what's important to us."


"We brought this project up on the agenda because the current guidance had a lot of bright-line tests and lacked comparability," Cosper said of the accounting for leases. "In the 2010 proposal, the lessee model was that of a single right of use. A lessee would initially recognize the ability to make lease payments in a corresponding right-of-use asset. That's largely where we are, tentatively, today, but that could change." She noted that the board has already made the decision to reexpose the standard, even before they have finished reexamining the proposal.


Hauser explained further: "What was originally in the proposal was a much broader view of lease term. The boards have narrowed that substantially. Originally, it looked at the renewal options that were more likely than not to occur. Now, effectively, it's really the lease term that exists and not the renewal option, unless there is a significant incentive to renew." In addition, in response to concerns and feedback, FASB has come to "a more narrow view of what variable rents need to be included in the balance sheet--so things like performance-based or usage-based contingent rents would not be included." She added that "leases that are 12 months or less could be effectively treated as we treat operating leases today."

Barge noted that preparers welcome the changes. LaMonte agreed that it's "a step in the right direction," although users will probably "end up making top-up adjustments where we put even more debt on the balance sheet for leases, above and beyond what the standard is going to bring on."

Casper addressed another concern: "The most controversial issue to date of this project is not so much the balance sheet, but it's the income statement and it's the pattern of recognition. ... The approach that the boards have taken considers all leases as financing. ... There are some users that believe [the expense] should be straight-line, like the operating leases that we have today. There are other users who do view these as financing-type transactions and think you should have this type of expense pattern." Barge criticized FASB and the IASB for pursuing different methods and approaches to minimizing the proposal's impact on the income statement.

Cosper explained FASB's perspective: "I think what we're finding [from outreach efforts] is that there is some traction for what we proposed in the ED [exposure draft], that all leases are some form of financing. ... But folks just think [the alternative approaches] are complicated. They're hard to operationalize They could even be expensive to operationalize. And so that's why in some instances ... the straight-line notion is getting some traction."

Financial Instruments

Lastly, panelists discussed three topics related to the controversial area of accounting for financial instruments: measurements, derivatives, and impairment.

Measurement Cosper provided FASB's view of the measurement approach: "What FASB is really leaning toward, particularly as it relates to financial assets, [is that] they would be classified in one of three categories, either an amortized cost category, a fair value net income category, or a fair value OCI [other comprehensive income] category, based on financial asset characteristics and the entity's business strategy."

Strauss asked LaMonte whether users are comfortable with the mixed attribute model--that is, that some financial instruments could still be carried at historical cost because they will be held to maturity and others could be carried at fair value because they will be sold much more frequently. "There is a group of users, of investors, who are very vocal about wanting fair value for everything," LaMonte responded. "My personal view is that it would create a lot of noise and be difficult for us to analyze if that were the primary measurement basis. That said, I think having fair value information is critically important, so I'm comfortable with this mixed attribute model ... but that doesn't mean I don't want fair value prominently disclosed where things are carried at amortized cost."

Derivatives. Strauss next asked whether FASB and the IASB could converge on a simpler derivative model. Hauser answered, "As it relates to the hedging aspect, the boards' proposals were really headed in differing directions. FASB's proposal was looking to keep the basic model intact but apply some simplification to the hedging model. The IASB, on the other hand, was looking at a bit more of a wholesale change and taking a look at risk strategies more broadly as they relate to hedging."


Strauss asked whether restatements for derivatives are still a "hot topic" at the SEC. Beswick answered, "It still is extremely complex. Companies are relying more and more on experts to make sure they get it right, and this is just one of the areas that has to be improved."

Impairment. The panelists then turned to impairment. Cosper explained that "the problem with SFAS [Statement of Financial Accounting Standards] 5 is, coming out of the financial crisis, it was largely criticized by being known as too little, too late--too much was reserved too late--and so the notion of a probability threshold at such a high level lent itself to an incurred loss model, as opposed to what we're considering now, which is an expected loss model."

Hauser said, "One would have to look at all reasonable and supportable information considered relevant in making this forward-looking determination or estimate. [Companies] would need to come up with a range of possible outcomes--think about the various scenarios that might occur, assess the likelihood of those scenarios, and probability-weight those scenarios." LaMonte opined that users would not prefer such an expected loss model, noting that he thinks "we can significantly improve the incurred loss model we have today, so that we would not have as much of a too-little, too-late problem."

The new model, Strauss said, would require a three-bucket approach. Hauser went into further detail: "What this really is trying to reflect is the credit deterioration over time that could occur. So what would go into bucket one would be the loan or instrument, effectively upon its initiation if it had insignificant deterioration credit since its origination and the company expects to recover substantially all its cash flows. ... If there's a deterioration, a loan can go from bucket one to bucket two, when there's more than an insignificant deterioration of credit. ... Bucket three is really somewhat similar to bucket two in terms of how the actual reserve is calculated because it's the lifetime losses, but it's done on an individual asset basis."

"I would not characterize the three-bucket approach as an expected loss approach," LaMonte commented. "I think this is an incurred loss approach on steroids, which is the better direction to go. I'm intrigued by this." He concluded by speculating: "I would expect this would help deal with some of the too-little, too-late problem. I think it would be fascinating to try to back-test this, to try to see how this would have worked in 2006 and 2007."
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Title Annotation:In Focus
Publication:The CPA Journal
Article Type:Cover story
Date:Jul 1, 2012
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