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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.

Yesterday, Dell released its long-simmering fiscal year 2007 10-K , including restated information for prior years. The table below, culled from the 10-K, summarizes the adjustments made by category.


                                      February 3,     January 28,     January 30,     January 31,       2006     2005     2004     2003       (in millions)     Beginning retained earnings as reported

  $ 9,174     $ 6,131     $ 3,486     $ 1,364   Revenue Recognition:


    (21 )     (9 )     (7 )     (2 ) Other

    (216 )     (217 )     (102 )     (64 )                                   Revenue Recognition

    (237 )     (226 )     (109 )     (66 )                                   Warranty Liabilities

    202       223       129       31   Restructuring Reserves

    (18 )     (18 )     (14 )     80   Other

    (45 )     (35 )     (49 )     32   (Provision) benefit for income taxes

    21       4       11       (18 )                                   Cumulative adjustments to beginning R.E.

    (77 )     (52 )    ...

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Next week, I'll be part of the New York Society of Security Analysts "14th Annual Financial Reporting Conference" to be held in their offices located at  1177 Avenue of the Americas, 2nd Floor.

It should be a good gig. On the agenda: Complexity. Fair value reporting. Performance reporting. What's going on with the FASB, as told by Chairman Bob Herz. What's going on at the PCAOB, as told by board member Charlie Niemeier.

And I'll be on hand to blather about the international reporting issues raised by the SEC in their recent proposals on International Financial Reporting Standards, along with PwC's Marie Kling.

Come out for the day, if you can make it. Hey, it'll be Thursday - the next best thing to Friday. You owe it to yourself to get the facts on these issues, don't you? I hope I see you there.

As recounted in the Wall Street Journal ($) by David Reilly, the FASB narrowly voted to oppose deferral of the effective date of Statement 157, Fair Value Measurements. It was a 4-3 vote, as close as it can get. Recall that this wound up on the Board's agenda because of some last-moment requests for deferral by Financial Executives International and the Institute of Management Accountants. 

It didn't pan out that way. The Board may consider a deferral for nonpublic companies, and it might excuse nonfinancial assets and liabilities (from a business acquisition, for example) from Statement 157's scope, at least temporarily. No word on when that will be decided.

So, it looks like analysts will be spending a lot of time next year discussing fair value ... buckets. Specifically, Level 1 (best evidence of objective fair value); Level 2 buckets (no direct observable values, but imputed from other fair values), and Level 3 buckets (mark-to-model estimated values, 'cause there are no markets for any of the things. Voodoo!)

After yesterday, the lot of the investor is displayed (profoundly) in the first of these two photos. Actually, the first photo after applying a factor of three. And it was one vote away from the second photo.

This Wednesday, the FASB will decide whether or not to delay the implementation date on Statement 157, "Fair Value Measurements." That standard was to go into effect for fiscal years beginning after November 15 - little more than a month away. As noted previously, the Committee on Corporate Repotring of Financial Executives International sent a 12-page letter a couple weeks ago requesting the FASB to delay it.

According to CFO.com, the Institute of Management Accountants has also pushed the FASB to delay the implementation. No trace of their correspondence on the internet, yet, however.

We'll know Wednesday as to whether or not there's a grace period. One chief reason cited for delaying: supporting an "exit price" as required by 157 is too new to handle. That one seems far-fetched: an exit price is one of many possible prices that exist. It's more likely that in a period of price pressure as we're seeing in the markets for some financial instruments, no one really wants the extra trimming that an exit price might provide. A better reason for postponement - though not a new one - is that the IASB is considering the adoption of 157 as a convergence move. Is that really enough of a reason?

There will be a post this morning. Later this morning.

Maxed out on Baltimore sports entertainment yesterday. First, I watched the Ravens at M&T Bank Stadium: a flawless day in the sun, and I got to see the Ravens end their touchdown drought. Kyle Boller got them across the goal line for the first time in weeks. The defense looked as good as ever. Icing on the cake: five interceptions by five different players.

Then the evening was filled with the Charm City Roller Girls Championship. Unfortunately, my favorite team - the Speed Regime - lost. Blew a 10-point lead in (what I vaguely recall as) the last minute. No kidding though - the championship match was as full of action and skill as you could wish for. And the tickets were about a tenth the price of the Ravens tickets.

Ah well. There'll be next year for the Speed Regime. And I got a Halloween souvenir: a pumpkin autographed by Mobtown Mod Roxy Toxic. Not a total loss for the evening, I guess.

Treat yourself to these Flickr pix of the CCRG, and I'll be back with a post later this morning.


At the end of August, the FASB issued an exposure draft of a Staff Position on accounting for convertibles - a particular model of convertible called Instrument C.

Those convertibles barely nick a firm's earnings per share. "But of course!" you say, "they're convertibles! They're supposed to be lower rate debt!" Yet inwardly, they contain the same kind of financing cost as much higher-coupon straight debt. You just don't see it. But of course - they're convertibles.

Convertible accounting has never accounted for much ever since APB No. 14 was issued in 1969. And these particular instruments take the gimmickry contained in convertible accounting to a new level.

The FASB has taken a bold swipe at fixing convertible accounting wih this Staff Position. If passed, it'll account for the Instrument C financing costs much more accurately than does current convertible accounting. I've prepared an outline of the proposal - on the parts of most interest to analysts - as well as an analysis of recent EITF consensuses. You can see more about the proposal in the report if you sign up for a two-month trial subscription. As always, this offer is restricted to institutional investors only, with inclusion in the BigDough investor database as a litmus test for determining who are "institutional investors."

Along the lines of the Pozen Committee to examine complexity in accounting, the Treasury Department has announced the members of a committee whose aim is to "make recommendations to encourage a more sustainable auditing profession."

According to the press release, the committee "will examine auditing industry concentration, financial soundness, audit quality, employee recruitment and retention, in addition to other topics. Treasury expects the committee to produce findings and recommendations by early summer 2008."

Well, all institutions are worthy of critiquing from time to time - just to keep them fresh. It'll be interesting to see what this committee comes  up with, because there's a lot that's going right with auditors nowadays. Encourage a more sustainable auditing profession? From the gripes one hears about audit fees, it seems like they're going to be able to sustain themselves financially, at least. Audit quality? That's a never-ending improvement process, for certain, but investor confidence hasn't been shaken lately by flawed audits. Employee recruitment and retention? That's a tough one: the accounting profession has had trouble with these twin goals for the last twenty years - it's hard for auditors and industry to retain real accounting talent when you compete with the sexiness of the finance world. (Especially after staffers have cut their teeth on public accounting.)

The committee will have its own website, if you care to monitor their activity. And they'll be "taking calls" from investors: you can register comments here for their October 15 meeting. They hope to have their work done and recommendations ready by the end of summer 2008.

Over the last few months, I've mentioned the SEC's proposal to eliminate the reconciliation of "pure" IFRS earnings and stockholders' equity amounts to their US GAAP equivalent in SEC filings.

I've also mentioned the response of the Investors Technical Advisory Committee, which got a little airplay in the New York Times yesterday.

I've drafted a letter of my own, and submitted it to the SEC on Monday. Same sentiment as the ITAC letter, with a few more examples, drawn from the report on the two SEC international proposals that I issued on Monday.

Sign up for the free two-issue trial, and you'll receive the report on the two proposals - an issue that's going to roil investors for years to come, I think. As always, this offer is restricted to institutional investors only, with inclusion in the BigDough investor database as a litmus test for determining who are "institutional investors."

There’s a good post by Edith Orenstein over at the FEI Financial Reporting Blog, covering the current events surrounding securitizations and the accounting for them. Like it or not (mostly not), there are politics aplenty ahead in the reporting for these financial Pandora’s boxes.

As reported in the Wall Street Journal ($), a 10-state task force of attorneys general and banking regulators has been formed. Their purpose: “to persuade mortgage-servicing companies and investors in mortgage-backed securities to increase the number of troubled subprime loans they restructure.” A position paper has been issued by the group, and it contains some real nuggets about the nature of securitizations and how they have contributed to the foreclosure wave. Like this one:

“Securitization has played a central role in lenders placing borrowers in unaffordable loans because it has separated the origination of a loan from its consequences. It is often repeated that no rational lender would put a borrower in a loan that the borrower cannot afford. That may well have been true in the past, when most loans were made by portfolio lenders, but is not true in today’s complicated and fractured system. While no investor would want to buy a loan that is destined to fail, many players in the current mortgage system were all too happy to originate loans without regard to the borrower’s ability to repay because when it comes time to foreclose on a loan, the originator often is long removed from the picture and does not take the loss. Thus, originators have engaged in predatory practices that a portfolio lender would never engage in, such as inflating an appraisal or inventing borrower income, because the originator can sell the loan to the secondary market...

In short, the secondary market dramatically changed the incentives for originators. Many subprime originators are no longer concerned with the terms of the loan or whether the borrower ultimately is able to afford the loan. Instead, the originators’ incentive is to close the loan as quickly as possible, no matter what, in order to be paid their origination fees, and then sell the loan to the secondary market.”

The group’s recommendation: restructure loans early and often. Pay the servicers a fee for modifications. Hire more staff with resources to actually make modifications. Forge alliances with third parties with whom borrowers are willing to work. (50% of defaulting borrowers never talk to the servicer.) The recommendations are pretty much basic common sense: do what it takes to avert problems, do it well and charge a fair price for doing it.

Nowhere did they say that the accounting shouldn’t reflect what happened - but that’s apparently not what others believe. It was noted in this space a couple weeks ago that Senator Charles Schumer was encouraging the Big Four that they should lighten up on the financial reporting of lenders who give it up for defaulting borrowers; on the letter, he also copied Cynthia Fornelli, head of the AICPA's Center for Audit Quality, just to be sure that the good news got spread even more widely. Schumer asserted that the SEC Chairman Christopher Cox "unequivocally" stated that the SEC's position on loan modifications in advance of defaults was benign and that lenders needn’t worry about losing off balance sheet status for securitizations. Frankly, the discussion by the SEC seemed more fact-and-circumstances than “unequivocal.”

If securitization issuers make modifications to loans, don’t put the obligations back on the balance sheets and don’t provide any other disclosures, it’ll make for some puzzling results later if they’re recognizing fees for reworking loans. In fact, if firms don’t discuss their activities involving renegotiations but account for them as if nothing happened, there’s going to be some very close parsing of every sentence uttered by managers of financial institutions.

The Investors Technical Advisory Committee is an advisory group composed of a dozen individuals who are associated with the investment world, usually by employment. What they share in their backgrounds is that they have some decent accounting chops.

The twelve of us have put together a comment letter to the SEC on their proposal to eliminate the IFRS-to-GAAP reconciliation requirement for foreign filers who report on a pure IFRS basis. ("Pure IFRS" means that the financials are prepared in accordance with the International Financial Reporting Standards as published by the International Accounting Standards Board. Any "country-flavored" versions of IFRS - where IFRS have been adopted with exceptions to particular standards - don't qualify for the reconciliation waiver.)

When confronted with the question of whether or not the reconciliation should continue, I think the knee-jerk reflex of many investors is that it should be trashed. There are two things wrong with this (aside from being a knee-jerk reflex in the first place):

  • As a matter of course, investors might not go to that reconciliation and immediately make a buy-sell-hold decision based on what they see in it. For those who actually read financial statements and try to understand the workings of a foreign company in the context of something they're already familiar (US GAAP), that reconciliation provides a useful environment.

  • "Then what?" Those are two of the most under-rated words in the investment world. Eliminate the reconciliation and crow that you've "simplified" the system. Then what? Will convergence of accounting standards still take place the way it should? Is there still a reason for standard setters to work together on problems if there's no visible display of what makes their results different?
In writing this letter, we asked ourselves "then what?" many times - and I think we've come up with some issues that go beyond merely looking like something has been accomplished by eliminating this reconciliation. I hope you'll take a look at it and think about the issues we've raised - and write your own letter. It would be a complete embarrassment to the US financial reporting regime to see this reconciliation be yanked - only to see it return years later once it becomes apparent that it was too early to do away with it.