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The AAO Weblog covers accounting issues and current events as they relate the practice of investment analysis.

Author: Jack Ciesielski Created: 10/13/2006 2:54 PM
The AAO Weblog is a weblog published by Jack Ciesielski , dealing with accounting issues and news topics related to investment and finance.

An interesting piece by Sarah Johnson in CFO.com: if the SEC’s idea for removing the reconciliation between US GAAP and IFRS-presented financials becomes a reality, then there could be unexpected fallout for companies in the tech sector. The revenue of tech companies following US GAAP might look like it’s growing more slowly than companies following IASB standards.

If two companies have the same identical contract kind of contract, containing elements with different deliverable dates, the one following US GAAP will recognize revenue only as the components are delivered. The one following IFRS would be able to estimate the fair value of the yet-to-be delivered items and recognize the revenue up front. (That’s not too far afield from “gain-on-sale” accounting, which nobody seems to really like - once it stops working, anyway.)

Might be a case of the law of unintended consequences at work: maybe that helps pave the way to success for the SEC’s other international project, which is the concept release proposing that domestic firms get a choice between reporting in US GAAP or IFRS.

At any rate: enjoy the long holiday weekend! See you on Monday

Yesterday’s FASB meeting saw pension and OPEB standards creep back into a higher priority category than they’ve been for a while. Last year saw the the issuance of Statement 158, which put net benefit plan balances onto firm balance sheets; since then, there’s been hardly a peep about Phase 2 of the revamp of the benefit plan accounting standards.

The FASB staff proposed action on five areas (meeting handout here):

• Earnings smoothing (the expected return on assets mechanism and delayed recognition of events like market losses)

• Recognizing a single unit of cost (instead of the current stew service & interest costs, plus various amortizations and expected returns)

• Measurement of benefit obligations

• Disclosures (some would like more; others less. The staff’s proposal was that the Board should work the current derivatives disclosure project into this project)

• Getting some accounting standards - or at least disclosures requirements - worked into the accounting literature for multiemployer plans. (Currently, there’s not much accounting done for these.)

The Board seemed to agree that the issues were the right issues. Expect that they’ll keep a close watch on the IASB’s similar project which is a bit further along, and attempt to borrow what they can in an effort to keep things moving and to maintain the convergence process.

A couple days ago, it was noted in this space that Vail Resorts had some large changes in its cash from operations after putting its cash flows from its real estate operations into the right bucket of the cash flow statement.

Just a couple days later, a similar reclassification shows in the non-reliance 8-K and amended 10-Q of BCSB Bankcorp, a tiny bank in my hometown of Baltimore. (Also famous for its record-breaking baseball team.)

It seems that BCSB had classified the proceeds from the sale of loans as an operating item, when in fact they should have been properly classified as an investing inflow. It wasn’t insignificant: taking the $45.2 million of cash inflows dropped the nine-month cash from operations from $50.4 million down to $5.2 million - a 90% decrease.

It’s a good reminder: the cash from operations figure is probably the single most-viewed number on the cash flow statement - and many times analysts and investors look at it as the unvarnished truth, in comparison to net income. Not always the case, and preparer mistakes like these are one reason investors shouldn’t get overly comfortable with just one way of looking at performance in trying to understand what’s going on in a company.

The politicians are piling on the accountants.

About a month ago, Representative Barney Frank asked the SEC to look into loosening up sale criteria in Statement 140 so that lenders might be less nervous about renegotiating toxic loans. The culmination of his request: it's not managing a qualified special purpose entity if you're sure that it's going to go bust anyway. Don't worry about wrecking any sale treatment you might have reported beforehand.

Now Senator Chuck Schumer is getting in on the act. According to CFO.com, he's sent a letter to the CEOs of the Big Four auditing firms, encouraging them to do their part to resolve the subprime crisis by making sure their clients know about the new, improved interpretation of Statement 140 and encouraging them to work with their clients so that they keep housing markets afloat.

Maybe my memory is too long - but didn't we have a long period of self-flagellation over whether or not auditors were supposed to be independent of their clients, not very long ago? Here, we have a United States senator asking the audit profession to be a stimulus of the economy. What does the government want from the auditing profession - independent verification of financial reporting to instill investor confidence in markets? Or does it want them to shill for political policies because they happen to be situated at a convenient nexus in the financial reporting machinery? Let's hope its not the latter.

Interesting cash flow statement restatement from Vail Resorts filed on Friday.

The company has a real estate segment whose activities "include the planning, oversight, marketing, infrastructure improvement and development of the Company's real property holdings. In addition to the substantial cash flow generated from real estate sales, these development activities benefit the Company's mountain and lodging operations through (1) the creation of additional resort lodging which is available to guests, (2) the ability to control the architectural themes of the Company's resorts, (3) the creation of unique facilities and venues (primarily restaurant, retail and private club operations) which provide the Company with the opportunity to create new sources of recurring revenue and (4) the expansion of the Company's property management and commercial leasing operations..." according to the latest Vail Resorts 10-K.

That description sounds like a pretty active operation - something that's a day-to-day veritable beehive of real estate happenings. Yet the company had accounted for its real estate segment activities within the investing section of the cash flow statement instead of the operating section. Big difference: when restated, operating cash flows for year end (July) 2006 were 67% lower; for 2005, 33% lower; and for 2004, 15% lower. With real estate transactions requiring big lumps of investment over long periods of time, resulting in big gushing inflows later, you'd expect that the new presentation will show cash from operations in truer, spikier fashion.

The cash flow statement remains a source of restatement issues. Stay tuned.

Whoa. Will post about accounting matters later, but I need to get my head on straighter, first. Hard to focus on fair value issues or auditors or restatements when you've spent the evening before at the all-girls roller derby...

My sister-in-law coaxed me and my wife to attend the Charm City Roller Girls Sunday night match between the Night Terrors and the Junkyard Dolls and the match-up of the Speed Regime and the Mobtown Mods.

All action and theater. And '80's music wailing in the background at the Putty Hill Skateland. Gals on skates with names like Siouxsie Slaughter, Deathany, Snatch Bunny, Roxy Toxic, Flo Shizzle and my favorite ... Frenzy Lohan.

Fun stuff. I got Flo Shizzle's autograph! She was the best sprinter there; pretty incredible. More fun to watch than I expected!

Back later.

Don't let the headline scare you. The investor mood towards benefit plans is more like complacency. Plan sponsors share that complacency.

But - moods can turn on a dime on Wall Street. Just think about the subprime panic of the last few months. Complacency now could be replaced with fear later. And investors will wonder about the need to feed benefit plans, just like they did a few years ago.

(Hint: one way to feed them would be to cut share buybacks.)

You may have noticed the blogs have been a little light the last few weeks. I've spent the past month working on a study of the benefit plans in the S&P 500. Some things we've studied:

  • Funding (not bad, could be better)

  • Contributions (almost laughable)

  • What's in the wallet? (many firms' "other investments" include hedge funds & private equity - but give no clue about the riskiness. And who knows about subprime exposure?)

  • Statement 158 effects (a gouge from equity for many)

  • Underlying assumptions (more solid than usual)

    All stuff that could come back to bite at year end when remeasurement occurs. Maybe now is a good time to tune in.

    If you're an institutional investor and you've enjoyed The AAO Weblog so far, I invite you to sign up for a trial subscription to The Analyst's Accounting Observer. That invitation is also open to members of a corporate finance/accounting function. (As long as you haven't had a trial subscription before. Yes, we do keep a list.)

    Sign up now and you'll receive the report soon. And we'll check the BigDough database to see if you're an institutional investor, which is our litmus test.

  • As we move deeper into a fair value reporting environment, expect to see more debates over the ways fair value is presented. One early example can be found in Jon Weil's Bloomberg News column this morning. He examines Wells Fargo's use of fair value in presenting changes in the value of its mortgage servicing rights. Link here. Enjoy.

    A few late summer reading links...

    One of my favorite business authors, John Steele Gordon, penned a guest column in Barron's this week on the origins of accounting in the United States. Link here - $ if you don't subscribe online.

    A nice, brief history - you might not make the link between railroads and accounting without Gordon's help. But it works. Also, I strongly recommend John Steele Gordon's "An Empire of Wealth: The Epic History of American Economic Power."

    Railroads would be one of my favorite industries even if they didn't play a role in getting modern financial reporting off the ground. Plenty of business history and American history, all at the same time. I read "The Men Who Loved Trains" by Rush Loving Jr. this summer - a concise, well-paced history of the creation and demise of the Penn Central, and the subsequent creation and sale of Conrail. Loving is a former Fortune reporter and knows how to tell a story.

    I can't forget one of my favorite business historians of all time - Robert Sobel, who died in 1999. The man was a prodigious writer, appearing in Barron's and other periodicals frequently. My favorite book by Sobel: "When Giants Stumble," a chronicle of 15 classic business blunders by companies like Osborne Computer, W.R. Grace and E.J. Korvette - and the lessons to be learned from them.

    If you want a solid review of the SEC's activities in the Division of Corporation Finance for the year to date, look no further than right here.

    It's a link to a speech given by the Division's Director, John White, at a conference of the American Bar Association last week. Worth at least skimming.