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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.

The Sarbanes-Oxley Act requires that all filers be reviewed at least every three years. Over the last couple years, the SEC's Division of Corporation Finance studied the filings of more than 100 foreign private issuers. Those studies resulted in comment letters on the filings, and they're available in fairly raw form at the SEC's website. They were just waiting for someone to come along and stratify them so that some conclusions could be drawn about a) the state of foreign private issuer filings, relative to GAAP or IFRS application and b) how the SEC handled the reviews.

Fortunately, someone did come along: Deloitte. They've put together a report that's available for the right price (free) which puts together some interesting observations. From their summary:

"In the comment letters we reviewed, we noted several overall themes:

  • Focus was more on the primary IFRS financial statements than on the U.S. GAAP reconciliation.
  • Presentation and disclosure were significant areas of focus across industries.
  • Recognition and measurement comments varied by industry.
  • There was a particular interest in “converged” standards.
  • Comments were geared toward understanding the judgments made and assumptions used in applying IFRSs."

That first observation is interesting - and it meshes well with the SEC's mention (in the proposing release for the IFRS/GAAP reconciliation elimination) that its first practical experience with IFRS came with its review of the FPI filings. And the fact that the focuse was more on primary IFRS financials than on the GAAP reconciliation hints at where the SEC's mind has been for the last couple of years.

On average, there were 19 comments for each filer.

The report also mentions that "certain" comments were issued on a forward-looking basis - meaning, comments were made to the effect that "something wasn't disclosed completely, but you can do it right next year." The report also mentions that a few comments required restatement.  It makes sense that the SEC wouldn't drill companies too hard - as enthusiastic as they've been about  encouraging the spread of IFRS, it wouldn't be too  wise to make it look like adoption would require restatements or a lot of head-butting with the SEC staff. Look at the corporate angst over something as  elemental as  internal controls. IFRS proponents don't want to experience that kind of wrath.

Call that a principles-based title. It gets the point across, but doesn't it make you just a little bit uneasy about the content of what you're about to read?

Well, that's perfectly normal for you to be uneasy perhaps, if you've been reading these posts for a while. But my point is that there's almost a mindless infatuation with "principles-based standards" going on in the big auditing firms. The simplification promised by moving to international accounting standards and all their "principled-ness" is coming down to the level expressed in that title.

Evidence: the Global Public Policy Symposium held in New York on Tuesday. At that conference, the Big 4 + 2, unveiled a joint presentation on "Principles-Based Accounting Standards." There's not a lot of really new thinking in it, but what's striking is the unanimity of the CEOs of those firms: they're all thinking in lockstep on the subject, all heartily endorsing IFRS. 

IFRS is a noble goal, as well as convergence of US standards with IFRS. But before blindly blaming every capital market problem on "rules-based" accounting standards, wouldn't it be a good idea to consider that IFRS is still pretty young at heart system - one that hasn't been road-tested with quite the same rigor as US GAAP?

And why do audit firms spend so much time trying to push for one system over another? Or why do they spend so much time on accounting principles in general? Shouldn't they work on auditing principles more than accounting principles? Just asking.

* * * * * * * * * * * * * * *

Thanks to the Financial Times and their accounting editor, Jennifer Hughes, for featuring in their "Accountancy" column our post about the time gap between earnings releases and 10-Qs. I hope many of their readers share our sentiments.

There are plenty of high expectations for international convergence of accounting standards. Promoters plug the portability of capital, and the fact that one language will make it easier for capital to cross borders. If the ultimate vision of future markets is that the elimination of barriers makes it all one big, happy market where capital is peddled night and day non-stop, one reporting language isn't a luxury - it's a necessity.

Markets will probably never become completely homogenous - but they're certain to look more like each other as time goes by. That means some markets will give up what differentiates them from others. And one of the unfortunate side effects of converging US accounting standards with international financial reporting standards is that, if done in pell-mell fashion, US investors might not enjoy some of the same rich disclosures to which they've become accustomed.

How so? Suppose for instance, the IASB and the FASB (with the help of the SEC) decide to converge standards on a pick-and-choose, "best of breed" basis over the next five years. Maybe the FASB standard wins; maybe the IASB standard wins. One merit sure to be a criterion: how many countries in the world already use an IASB standard that's pretty close to one used in the United States? That would tilt things in favor of the IASB standard versus the FASB standard.

For example: the benefit plan disclosures required by the IFRS standard are not as deep as what's required in the FAS 158 and 132(R) - and whenever there's stress placed on pension plans in the US, investors seem to find that there's more information they need that hasn't been supplied by the existing standards. 

Another example: there is no equivalent disclosure of "fair value hierarchy" in the IFRS standard for financial instruments. That's a disclosure that hasn't even been common yet, but you can bet in this credit/valuation environment, investors are going to keep an eagle-eye on those disclosures.

That's not the way it's planned yet. Nevertheless, as the convergence process develops, investors in the United States need to keep an eagle-eye on it - and step up to the plate if they think their interests are going to be diminished. 

After the miserable market action of the last week, it feels as though the holidays were months ago, not merely days ago. New Year's Eve will provide a lingering hangover for investors as they sort through the fourth quarter earnings reports. The sticky markets for esoteric instruments like collateralized debt obligations will make for challenging (to say the least) valuations of assets for which no readily available quotes existed on New Year's Eve. It's not even a Statement 157 world yet: that standard's effective date (recently upheld by the FASB) will be for fiscal years beginning after November 15, 2007. So the fourth quarter will not see the disclosure of fair value hierarchies for financial instruments. Starting with the March quarter however, this will be a reporting reality - one that will be of keen interest to investors, especially those investors who have holdings in the financial industry. With both sides of the balance sheets for these firms composed of mostly financial instruments, investors will want to know whether financial assets and financial liabilities are mostly Level 1, of the highest quality - or if they're mostly Level 3, the most suspect of the three levels of fair value inputs and presentation. If asset/liability presentations depend on Level 2 inputs, then investors will want to know just how Level 2 inputs were derived. Many investors view Level 2 inputs with suspicion: they wonder if logical contortions have been made to get genuine Level 3 valuations moved up a notch, out of the Level 3 dungeon. Scary - and it could happen. These are serious issues for investors. There's genuine utility to investors in the fair value hierarchy and they seem quite ready to embrace it. The big problem with the hierarchy: it isn't available to investors until the 10-Q (or 10-K, in the case of the fourth quarter) is filed. Firms aren't required to address the fair value hierarchy at the time earnings are released; there's nothing that governs the dissemination of information at earnings release time beyond Regulation. That would be a bit like regulating free speech. The only way that analysts will necessarily hear about fair value hierarchies will be when they ask about them. And there are no guarantees of a robust answer. The companies with the most to hide would be the least likely to volunteer information that would put them in an unflattering light. The time between the earnings release and the 10-Q can be considerable: a firm can be talking up (or talking down) the next quarter by the time the 10-Q is filed covering the earnings release. By the time the 10-Q is filed, the fair value hierarchy information is stale. Investment decisions have already been made. How big is the gap between earnings release and 10-Q filing? We did some digging in 10-K Wizard for the third quarter 2007 earnings releases of December year end companies and found 2,336 Item 2.02 8-Ks. We tied the dates of those "Results of Operations" 8-Ks to the filing dates of the associated 10-Qs. The table below summarizes, by sector, the gap between the time the 8-K was filed with the time the 10-Q was filed.  3Q2007: Median Days Between Filing Earnings & 10Q



Median Gap

Max Gap

Consumer Discretionary




Consumer Staples












Health Care








Information Technology


















Read More »

Last November, the SEC voted to eliminate the reconciliation that must be included in a 20-F annual report if a foreign private issuer is presenting its financial statements in accordance with International Financial Reporting Standards as published by the IASB. The official release (No. 33-8879) came to be on December 21, 2007 - with an effective date of March 4, 2008.

That gap - no pun intended - means that affected companies with years ending after November 15, 2007 but wishing to file before March 4, 2008 will still have to comply with the reconciliation as it exists today. So we may still see a few reconciliations, and still get to ponder the wideness of the GAAP in the two sets of standards in terms of recent history. It's possible though, that the SEC will work with those affected companies and possibly grant them exceptions if their differences are minor enough. Too bad investors would never get to see what might be minor differences - and what might not be minor.

In other international news, the FASB sponsored a webcast yesterday. Subject: "Towards a Global Reporting System: Where are We and Where are We Going?" Moderated by Wall Street Journal reporter Senior V-P and Controller of PepsiCo; David Reilly, the panelists included Robert Herz, Chairman of the FASB; Peter Bridgman,Greg Jonas, Managing Director of Moody’s Investors Service, and Sam Ranzilla, Partner at KPMG LLC.

You can access the archived webcast at this FASB link. I haven't listened yet, but from what I've heard, there was general agreement among the group that a fully converged system of accounting could be achieved in about five years, maybe seven. Life comes at you fast, as the commercials say.

To forgive and forget. Or something like that.

In May 2004, Lucent was hit with a $25 million penalty for improperly inflating revenue by more than $1 billion. Ten individuals were also charged with reckless and fraudulent actions; their conflicts of interests prompted them to present improper financial reporting. Their actions included post-dating of documents and side-letter arrangements with third parties. Pretty damning stuff.

Three and a half years later, the firm is nailed by the SEC once again, even though it's now part of Alcatel. This time:

"...from at least 2000 to 2003, Lucent spent over $10,000,000 for approximately 1,000 Chinese foreign officials, who were employees of Chinese state-owned or state-controlled telecommunications enterprises, to travel to the United States and elsewhere. The Commission alleges that the majority of the trips were ostensibly designed to allow the Chinese foreign officials to inspect Lucent's factories and to train the officials in using Lucent equipment. In fact, according to the complaint, during many of these trips, the officials spent little or no time in the United States visiting Lucent's facilities. Instead, they visited tourist destinations throughout the United States, such as Hawaii, Las Vegas, the Grand Canyon, Niagara Falls, Disney World, Universal Studios, and New York City... "

Having once demonstrated a lack of respect for the books-and-records and internal control provisions of federal securities laws, you might expect that the SEC would wallop Lucent for a second offense. Not so. Even though this escapade  involved "improperly recording the payments for approximately 315 trips for Chinese government officials that had a disproportionate amount of sightseeing, entertainment and leisure" - a pretty clear violation of the Foreign Corrupt Practices Act of 1977 - no individuals who arranged such trips were charged by the Commission. The penalty: a civil fine of $1.5 million, plus a fine under a non-prosecution agreement with the Department of Justice. The total bill for the second offense is only 10% of the first offense.

In other words, repeat offenders get treated better the next time they offend. A frequent offender discount, or maybe the SEC was just moved by the spirit of the season.

CFO.com's Sarah Johnson reported on the SEC's first roundtable held last week to explore the possibility of giving US companies the option of switching to International Financial Reporting Standards.

The thinking of the multinationals at the table? It was done in Europe in three years; it could be done here in three years. That's a "can-do" kind of spirit not often seen when it comes to financial reporting requirements. It's usually "can't do:" can't apply 157 in time, can't be ready for Section 404 audits, can't change computer systems to accommodate - (insert your favorite standard number here).

There's more benefit to firms in making a switch from US GAAP to IFRS than accrues to them from other reporting-type changes, so the can-do spirit is explainable. They might already be reporting chunks of their operations in IFRS and it would naturally be easier to get the whole thing on one footing.

They also might perceive IFRS as being more simple to apply because it contains less details to which they must conform - for now, at least. That may change as more companies road-test those standards.

Is it the straight-line path that many observers think it will be? Of course not. There are plenty of obstacles: the US reporting system is probably richer and more complex that the ones IFRS replaced in Europe, and adapting IFRS to that will be more difficult. There is a bank-regulation system that's based on US GAAP and auditing standards based on GAAP as well. And for years, there's been hand-wringing over a shortage of trained accountants; that's "trained" as in trained in US GAAP. There are even fewer accountants in the US experienced in IFRS.

The SEC seems hell-bent on making the choice happen. It's going to be quite a ride.

I spent Monday through Wednesday attending the largest conference devoted to current events affecting financial reporting, featuring plenty of the SEC's staff - the ones who interact with the auditors examining the year end financials. And I'm wondering: when did the SEC become afraid of its own shadow? There seemed to be an overwhelming aura surrounding the SEC presenters, a kind of self-consciousness that they be careful to not "write GAAP" in the delivery of their speeches to the audience.

When this conference first began thirty-five years ago, the intent was to bring the SEC's thinkers and doers in front of a large audience of auditors, to discuss the problems they'd seen in filings with the audience. The intent was not to "speechify GAAP" - but to get the message out as to the problems they'd seen and describe how they handled it. The goal: to identify troublesome practice issues and tamp them down before they became pervasive by presenting them to the auditors who could do something about it. That's a worthwhile service to everyone involved in the financial reporting chain, from preparers down to users and the auditors in between.

That's not writing GAAP - that's being an effective regulator. (And don't forget that writing GAAP is something that the SEC is empowered to do.) Preventing problems through effective communication has always been at the heart of this conference. And this effective communication worked quite well long before the advent of Blackberries and the internet -  accounting firms responsible for keeping their SEC knowledge current seemed to get the message quite well by the state-of-the-art information distribution means, like overnight delivery and fax machines.

Now that there's virtually instant transmission of data, including the publication of all the speeches on the SEC's website at no charge to readers, critics are complaining about the dissemination of the comments in the speeches as being unfair. Absurd.

The comments of the SEC commentators were full of reminders of current GAAP, but missed the pithiness of years past when they described fact patterns that showed how a standard was misinterpreted or misapplied, and how they expected it to be remedied if encountered in practice by members of the audience. Instead, many of the commentators offered comprehensive reminders of where trouble might occur in the application of new accounting standards, rather than reporting on the known snafus they'd seen. Instead of warning registrants and auditors about problems they'd seen, it'slike they're wish-listing problems they hope don't happen. While there's value in that approach, there might be a lot more value in what they'd done in the past. Shouldn't regulators act like regulators, instead of acting like their walking on eggshells?

EITF meeting today - not much time to write, but a couple of things for you to consider that you might not have noticed.

First, an excellent description of the above-named securities in a speech by Erik Sirri , the SEC's director of the Division of Trading and Markets. Erik explains the "concentration-despite-diversification" present in these creations, how they dissolved, and makes a couple of not so bold predictions, which are probably dead right. Like this one:

"I'm enough of a historian to know that, some number of years down the road, we or our successors likely will again be commenting on why some other product or business led to large and unexpected losses. But it will probably not be super senior ABS CDO."

Anyway, it's a good read, with more technical description of what goes on in making these things - and their markets - than you'll read in the mainstream financial press.

And there's also a very British view of the way these things work, courtesy of YouTube.




Stiff upper lip, and all that. This one has been making the rounds: I first spotted it in TheCorporateCounsel.net blog , who had gotten it from Kevin LaCroix. And I've received it from friends by e-mail too. Enjoy.

Yes, we've already had Black Friday, and today is Cyber Monday. No doubt you'll be on the receiving end of gift cards purchased sometime in the holiday shopping season, and you'll probably give a few of them, too.

There's an accounting angle to those gift cards: they're not sales for the retailers or restaurants that issue them until they're redeemed. Until the ultimate customer purchases something with them, they're just deferred revenues sitting on the right-hand side of the balance sheet. And if they never get redeemed by the giftees, they simply sit there: a lump of liability, coal in the stocking of the balance sheet.

That non-redemption can be very common. (How many of those cards do you have sitting in a desk drawer from last Christmas?)

The liabilities can be removed via journal entry, courtesy of the concept of "breakage" - meaning that the liabilities get de-recognized when management determines that a portion of the gift cards will never be cashed in. The SEC weighed in on this a few years ago when it issued SAB 101 , which ultimately became SAB 104 . Bottom line: it's not improper to de-recognize, as long as it's supportable. And from the investor point of view, the timing of any de-recognition would be noteworthy: any clean-up of the liabilities in a weak quarter might be suspicious, perhaps motivated by a desire to meet estimates.

There's no particularly noteworthy case of a company using gift card breakage to manage earnings. Maybe it's been done, but the disclosures might not be sufficient to leave a bread crumb trail. CFO.com has a good story on the concerns surrounding gift card accounting, and the Journal of Accountancy has an interesting article and study on their prevalence by Charles Owen Kile Jr., an accounting professor at Middle Tennessee State University.

Apparently gift cards aren't the only thing that recipients forget about. Here's a link to a story about something probably more valuable that people forget about as well: income tax refunds. That one is more amazing: if you bothered to send in a tax return, wouldn't you be looking forward to getting some cash back? Apparently not: the IRS says there's $110 million in unclaimed refunds outstanding.