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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.

Hitachi's XBRL Business Unit runs a blog on all things - what else? - XBRL. One of their regular contributors, Bob Schneider, asked me a few salient questions about the acceptance of XBRL in the analyst/investor community.

I hope I came up with a few salient answers. Bob thought they were good enough to show to the XBRL community; now I'm linking it here for your perusal. Hope you find it interesting.

The "death by delay" strategy seems to live on. Probably because it's working.

On Friday, the SEC announced that they will give another year of clemency to small companies (under $75 million market capitalization) for complying with Section 404 of the Sarbanes-Oxley Act. You know, the part that has to do with making sure that internal controls are in place and working - and that auditors agree with managementthat said controls are working.

The rationale: "The extension of the Section 404(b) compliance date for smaller companies is the latest in a series of Commission efforts to help reduce unnecessary compliance costs for smaller companies while preserving important investor protections."

Ah. Internal controls, and proving that they exist, are "unnecessary compliance costs for smaller companies?"

After this extension for small firms - I think it may be the fifth or sixth - they should just come clean and make an exemption instead of dressing it up as "studying the problem." It's already a de facto exemption, on a year by year basis. 

In other news, the SEC laid the groundwork for more study of the problem. They announced the blessing from the Office of Management and Budget for a "real-world" cost-benefit study on the Act's internal control provisions, to be carried out jointly by the SEC's Office of Economic Analysis, the Office of the Chief Accountant, and the
Division of Corporation Finance. Maybe their work will provide the groundwork for a real-world exemption. The announcement said nothing about the timing of the completion of their study, but it will have to be done pretty quickly if they want to get something effective by the end of the year - concurrent with the completion of this edition of the SEC.

And in fine form, I might add. Though it's cartoon form this time.

Have a chuckle at "Green With Envy" by Merle Hazard. You remember Merle: you know, the man who brought you "H-E-D-G-E" and "In The Hamptons."

Thanks to Jon Shayne for the tip that Merle's back in action.

Last week, the SEC announced its intention to overhaul the existing disclosures required of oil and gas companies. They've been locked into a disclosure format over 25 years old, one that states reserves on a stringent, consistently-calculated basis. While that "stringent, consistently-calculated basis" provided a good platform for comparisons, it didn't take into account the improvements occurring in oil drilling and gathering technology since the 1970's.
Whatever form the new disclosure takes, it's likely oil and gas companies will show improvements in the amount of their reserves versus the levels they're showing now.

That's kind of ironic: when the disclosures were first mandated, the world was expecting oil reserves to steadily drop. Now, 25 years later, the companies will likely show increases. Hey, technology marches on.

The press release didn't mention timing of the proposed rules or how long investors will have for commenting on them. It will be interesting to see how "principles-based" the rules may be. It's also interesting that the Commission didn't bother to try and get the FASB (or the IASB) to take up this project. They simply issued their Concept Release last year and ran with it. It might have been a good joint project for the two of them - but it would probably never be completed by the end of the current SEC's administration.

Last week, I took part in the FEI Conference called "The World Is Moving To IFRS: Are You?" The keynote speaker was John White, director of the SEC's Division of Corporation Finance. While it would have been great to hear him discuss the SEC's IFRS "roadmap," it was not to be. The fact that it hasn't been released by this time leads one to believe that a rule won't be issued before the end of the SEC's current administration: it would be difficult to get a rule of this magnitude out for public comment and have it completed before the end of the year. Indeed, according to the FEI Blog, White's comments to the press after his speech indicated that "the roadmap will not be proposed rulemaking per se, although proposed rulemaking may be one of the signposts along the roadmap."

So, it may be along the lines of "speech GAAP?" Hmmm. We'll have to see how the roadmap gets positioned.

Back to the nitty-gritty. White raised the point that "...
in the coming months as the IASB continues its work, including with regard to addressing possible gaps in IFRS, I look forward to the possibility that we in the U.S. will have some involvement in the standard setting process itself. And this is just one of the reasons that it is important for U.S. companies to be able to use IFRS, and maybe even be required to use IFRS. The thought here being that, in order for the U.S. to fully input in the standard setting process for IFRS, a portion of U.S. companies should be using IFRS. To the extent appropriate, our resources can be applied as IFRS are written and be persuasive or supportive of one position or another. But U.S. views and experience would likely be more persuasive if U.S. companies were using IFRS."

A good point - but one that makes it clear that U.S. companies have to be allowed to use IFRS. And if the IASB continues its work in addressing gaps in IFRS "in the coming months," and US companies would be more persuasive in addressing them if they were using IFRS, you have to wonder if there's going to be some hurry-up optionality in allowing companies to use IFRS sooner rather than later.

While that's a logical premise, it would be awfully difficult for investors to deal with. U.S. GAAP already has many choices of accounting treatments in it, and adding a broader layer of optionality will make comparisons even more difficult for them - especially if they are unfamiliar with the IFRS choices companies make.

White mentioned that implementation "will be a key consideration for the Commission." Here are the questions he raised "that should be part of the public debate about any U.S. transition to IFRS:" 

  • Should all U.S. companies simply be mandated to start using IFRS in their SEC filings as of a certain date?
  • Should there first be a period in which U.S. companies have the option to use IFRS in their financial statements, and if so, how long should such a period be?
  • If there were such a period of optional use, would U.S. companies feel inclined to change to IFRS unless it were clear that mandated use of IFRS was in the foreseeable future?

My favorite idea (if we're convinced that IFRS is a high-quality set of standards, that is): mandate all companies to use IFRS as of a certain date, say 3 to 5 years from the date of the issued rule. No optionality in between, but be prepared to present all regularly-reported financial information on a retrospective IFRS basis when the switch gets flipped at that certain date. That would give companies ample time to develop the information as they go along; it will provide information to markets on a complete and consistent basis; and it will give investors, educators and practitioners time to evaluate their situations. 

Last Friday, the SEC settled charges with Analog Devices over fraudulent misstatement of income for the year 1998 through 2002.

As is the tradition in these cases, the company neither admitted or denied its wrongdoing - and the same goes for the CEO Jerald Fishman, who had been charged along with the company. Analog escapes with a $3 million civil penalty; Fishman, a $1 million civil penalty and a disgorgement of $450,000, plus prejudgment interest of $42,110. The disgorgement is the amount of "in-the-money" benefit that accrued to Fishman from selling stock obtained through a backdated option grant.

The amount of understated compensation expense in the period relating to three grants: $30.7 million pretax, $21.8 million aftertax. The company also had a shoddy practice of granting options just before the release of favorable public information  - and this was not a basis for the actions against the company, because the practice predated 2006 proxy disclosure rules that required disclosure of grant practices. Slimy, nonetheless.

Last Friday, the SEC signed protocols with the securities regulators of four other countries - Belgium, Bulgaria, Norway and Portugal - to share information on the application of International Financial Reporting Standards in each others' countries.

The protocols are more or less the opening up of formal channels of communication - they're not a commitment, they don't create new rights or supersede old agreements. They mostly establish an intention to cooperate between the US and the other countries. They follow a similar protocol signed about a year ago with the United Kingdom's Financial Services Authority .

It's a good thing that the SEC has decided not to travel alone on its journey to international accounting standards. These countries have had more experience in the application - or misapplication - of International Financial Reporting Standards, and there could be valuable lessons for the SEC to apply.

* * * * * * * * * *

Speaking of IFRS...

Next week, on June 5, I'll be a member of a panel on IFRS at a conference in New York City. It's sponsored by Financial Executives International and it's entitled "The World Is Moving To IFRS: Are You?"

Well, it's not like you have much of a choice any more. It also doesn't look like there's much choice if you want to attend the conference: it's sold out, but wait-listed, from what the website says. With guests like FASB's Suzanne Bielstein, the IASB's Wayne Upton and John White of the SEC, it's sold out with good reason.

Also next week: on Monday, June 2 I'll be a guest panelist on a FASB webcast on the credit crunch and fair value reporting entitled "The Crisis in the Credit Markets: Causes, Reporting Issues, and Responses." The price is right on this one: free. And you don't have to get out of your chair. I hope you'll tune in Bob Herz, Matt Schroeder (of Goldman Sachs), Ray Beier (of PricewaterhouseCoopers) and me at 2 pm next Monday.

By the end of the month, to be exact. This article from Dow Jones Newswires might mean that some SEC staffers are going to have a busy Memorial Day weekend.

In a May 9 memo to agency heads, White House Chief of Staff Josh Bolten wrote that "all rules to be finalized before the administration leaves office should be proposed by June 1, and final rules should be issued by November 1."

That means the SEC's IFRS roadmap should be published by the end of the month and completely ready to roll by November 1. The memo mentioned that "extraordinary circumstances" might make for allowances; but the June 1 deadline seems consistent with the SEC's timing all along. The White House edict might just seal it.

Statement No. 162, "The Hierarchy of Generally Accepted Accounting Principles," was issued last Thursday. It's not a standard that will drive investment decisions - but if you're an investor who's in a conversation with a CFO and the subject comes up, it might help to understand what the of "GAAP hierarchy" comes up, it might help to know a little bit about it.

Here's the background. The American Institute of CPAs had long decided what constituted the strength in various "levels" of generally accepted accounting principles because their constituents - auditors - needed a consistent policy on how to handle conflicts in accounting literature when more than one standard might be found on a single topic. Hence, there were "levels" with in the "house of GAAP," as it's frequently called. When the AICPA dictated auditing standards, it mattered that they be the ones to establish the hierarchy - but that right was removed with the establishment of the Public Company Accounting Oversight Board in 2003. The right to set accounting principles was also removed from the AICPA by the Sarbanes-Oxley Act: it required the SEC to appoint a single accounting standard setter for the establishment of accounting standards. And it picked the FASB, not the AICPA.

The FASB has now revised the standards hierarchy; it's absorbed many AICPA standards into its own domain. They didn't simply vanish along with the AICPA's authority. Here's how the new hierarchy of generally accepted accounting principles shapes up, in descending order of authority:

♦ FASB Statements of Financial Accounting Standards and Interpretations, FASB Statement 133 Implementation Issues, FASB Staff Positions, and American Institute of Certified Public Accountants (AICPA) Accounting Research Bulletins and Accounting Principles Board Opinions that are not superseded by actions of the FASB

♦ FASB Technical Bulletins and, if cleared2 by the FASB, AICPA Industry Audit and Accounting Guides and Statements of Position

♦ AICPA Accounting Standards Executive Committee Practice Bulletins that have been cleared by the FASB, consensus positions of the FASB Emerging Issues Task Force (EITF), and the Topics discussed in Appendix D of EITF Abstracts
(EITF D-Topics)

♦ Implementation guides (Q&As) published by the FASB staff, AICPA Accounting Interpretations, AICPA Industry Audit and Accounting Guides and Statements of Position not cleared by the FASB, and practices that are widely recognized and
prevalent either generally or in the industry.

The hierarchy still needs to be approved by the PCAOB to be completely effective on the auditing community. When you look at how many sources of accounting principles still exist after the clean-up, you can appreciate the calls for simplicity and the arguments made in favor of International Financial Reporting Standards. Make no mistake however: the more popular they become, the more interpretation and guidance they'll require. It wouldn't be surprising to IFRS principles grow at a rapid clip over the next few years.

Last month, subscribers to The Analyst's Accounting Observer received our report on the state of benefit plans in the S&P 500 Short version: they're in pretty good shape, but far from riskless. And we'll be monitoring them throughout the remainder of the year to assess the risks.

If you're an institutional investor and would like to take a free trial offer of the Accounting Observer, you're welcome to this report. Click here to register for the trial, and you can also register seven of your research comrades. Institutional investors only, please: if we can't find you in one of the major directories of investment research (StreetSight, BigDough), we won't honor your request.

The timing of that report was pretty fortunate: in March, the FASB proposed amping the disclosures about benefit plan assets. While we were working on the report, we got a first-hand look at the existing disclosures and their shortcomings in light of the market events of the past year. It gave us good feel for how the FASB's disclosures could benefit investors. The deadline for comments on the proposed FASB Staff Position was shortly after we completed the report, so I put together a comment letter of my own just in time for the deadline. It's available here for your reading.

The disclosures should be effective for the years ending after 12/15/08. I have no doubt that companies will vigorously oppose the proposal and at least try to stall for another year of grace. It's an iron rule of accounting standard-setting: the amount of corporate resistance is directly proportional to the amount of informational benefit a proposal will provide to investors. We'll see if it happens here.