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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.

It's been a while since I blogged anything - many projects for the day job keep me away from it. Before February slides into the past however, I'd like to share with you a "Tale of Two Cows." It's a fable about suspending mark-to-market accounting... from "Clusterstock," a site I'd never heard of before someone sent me the link.

I will not touch the name of that site.

But I will reproduce the fable here, full attribution to John Carney. Prepare to laugh. Or cry.

Talking about accounting rules is famously obscure, my-eyes-glaze over stuff. But much of what happens inside of investment banks--including all those writedowns you've heard so much about--turns on accounting rules.

Now there are reports that the SEC is planning to give banks "flexibility" on mark-to-market accounting rules. It may even suspend mark to market rules. What on earth could that mean?

Let's go to the cows.

You have two cows.

You write down on a piece of paper that the cows are worth $100 each.

You notice the cows are on fire.

Your paper still says $100.

Fortunately, mark to market has been suspended so you don't have to pay attention to the fire.

Your cows are dead from fire.

Your paper still says $100.

Fortunately, mark to market has been suspended so you don't have to pay attention to the dead cows.

You notice that you aren't getting as much milk as expected, so you adjust the model and mark the cows down to $98.

You are confident, however, that the dislocated stream of milk revenue will quickly revert to expectations.

You need to borrow some money so you ask investors for a loan against the cows. The investors tell you the cows are
dead, and you already owe them $200 dollars you borrowed to buy them in the first place. You show them the paper that says the cows are worth $98 each.

They light your paper on fire.

You ask the government to buy the dead cows at $98 each.

The government holds meetings all weekend and finally comes up with a plan to inject $45 dollars into your cattle ranch. In exchange, the government gets a right to milk generated from the cows at some point in the future. It expects you'll buy a new cow with the $45.

You have two dead cows, $45 and $200 in debt to your investors. You have no plans to buy new cows.

The question Monday was "Will the SEC extend the comment period on the IFRS Roadmap proposal?"

The answer today: yes. In this release, the SEC extends the comment period until April 20.

The SEC released its "Roadmap" proposal last November, with a deadline for responses of February 19, 2009. It's a meaty proposal: one part deals with allowing companies of a certain size to switch to IFRS reporting from GAAP reporting by the end of 2009, and one part deals with the potential phase-in of IFRS reporting in the United States for public companies if the SEC decides in 2011that it would be a good idea.

As of this writing, there are about thirty comment letters filed with the SEC, and there's a common theme: give us more time!

It's not an unreasonable request. The document is full of weighty considerations that will have effects on issuers for years to come; it's not something to be taken lightly. In the last couple weeks of 2008, the FASB issued a barrage of proposals with short deadlines, sucking away attention that preparers might have spent on the Roadmap proposal. Last but not least, it's year-end closing time for most preparers - and care in preparation of financials will probably never be more greatly needed. (Especially forfirms holding slugs of illiquid securities needing to be valued.)

Many of the companies commenting asked for an extension of the deadline until April 30. Financial Executives International, representing many CFOs and controllers, requested only an additional 45 days, which would be April 5.

If you'd like to see the comment letter of the Investors Technical Advisory Group - one letter that didn't ask for an extension - here's a link to it. A group effort of accounting analysts, the letter lays out some serious concerns with the proposal. Enjoy.

On Christmas Eve, the FASB issued another turbo-proposal on top of its controversial proposal for changing other-than-temporary impairment models for certain financial assets. This proposed FSP No. FAS 107-a, "Disclosures about Certain Financial Assets: An Amendment of FASB Statement No. 107" has a short fuse for comments, almost like the proposal amending EITF Issue No. 99-20. The comment period ends this Friday, January 15. The proposal would not change any recognition of losses like the other proposal: it's strictly a disclosure-changer. Some of it is quite an improvement, in that it would require firms with available-for-sale securities, held-to-maturity securities and loans and long-term receivables (that are not reported at fair value through earnings) to present in tabular fashion the carrying value for such assets and their fair values as well. Topping it off: they would also have to present the income from continuing operations (before taxes) as if fair value reporting had been applied to those categories of securities. Not bad at all. Investors might also appreciate net income figures and stockholders' equity figures too, but it's still a good start - and for a preparer, the proposal makes it plant one foot firmly on the road of fair value reporting. Where the proposal goes wrong: it puts the other foot on the slope on the side of the road. The proposal requires a firm to make the same disclosures on an "incurred loss basis", which is essentially amortized historical cost. In other words, financial statements prepared under the proposal as written will contain three sets of income figures, at least on a pretax basis: in the footnotes, a fair value basis and a cost basis, and in the actual income statement, the mutt-model currently in use that combines parts of both models, usually referred to as a "mixed attribute" model. apply also to Worse: the proposal asks respondents if they think the final document should have the "incurred loss" basis disclosuresthe securities that already have fair value reporting applied, in order to get to a full-strength incurred loss disclosure. This is not exactly taking a stand on the future of fair value reporting. The result of these kinds of disclosures will be very reminiscent of the period in which the original Statement 123 was in effect: investors were treated to an income statement that skipped stock compensation costs, and investors could see what the real income looked like in the footnotes. You'll have that situation again with the fair value disclosures - only to  have them offset by the incurred loss disclosures, while encouraging a flourishing Babel-like set of languages about earnings. You have to ask what good it does to add these incurred loss disclosures. They provide an aura of legitimacy to figures that will be used to take investors' attention away from what happens to a firm when all aspects of economic performance are considered - and no doubt, those who oppose fair value reporting will be encouraged to continue opposition. I've written a letter in response to the proposal, appearing below. I'd encourage you to do the same, even if you don't agree with me - and even if it's just a quick email to the FASB at this link. Be sure to put "File Reference: Proposed FSP FAS107-a" in the subject line.

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

R.G. Associates, Inc.

Investment Research/Investment Management

201 N. Charles Street, Suite 806

Baltimore, Maryland 21201

Jack T. Ciesielski, CPA, CFA                                                                                                                                                                                          Phone:(410)783-0672

President                                                                                                                                                                                                                            Fax:(410)783-0687


January 9, 2009


Mr. Russell G. Golden

FASB Technical Director

Financial Accounting Standards Board

P.O. Box 5116

Norwalk, Connecticut 06856-5116


Re: Proposed FSP FAS 107-a


Dear Mr. Golden:


              I am writing in regard to the Proposed FSP FAS 107-a, “Disclosures about Certain Financial Assets: An Amendment of FASB Statement No. 107.” I find some of the proposed disclosures to be a modest improvement over current practice. I believe that some of them are unnecessary, however, and perhaps even misleading to investors. I regard this proposal as a step backwards from the Board’s position regarding fair value reporting as stated in its basis for conclusions in Statement 133:


              “... The Board is committed to work diligently toward resolving, in a timely manner, the conceptual and practical issues related to determining the fair values of financial instruments and portfolios of financial instruments. Techniques for refining the measurement of the fair values of all financial instruments continue to develop at a rapid pace, and the Board believes that all financial instruments should be carried in the statement of financial position at fair value when the conceptual and measurement issues are resolved.1”


              Those words were written well over ten years ago, and progress has been made in the area of fair value reporting since that time, this proposal introduces more disclosure presentation of non-fair value information for certain financial instruments. The presentation of “incurred loss” information for the scoped-in financial assets and presentation...

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As part of my year-end tidying-up process (which failed again), I started thinking about the things that I used in every workday that I'd come across on the internet - either 1) websites I checked every day because they gave me ideas on better ways to get things done or) applications or programs that I found on those sites. In short, there are webtools and applications that I realized make web life (an oxymoron) more livable. I've blabbed about them to friends, and it makes sense to put them all in one place with links so they can find them easily. In no particular order, here's what made my work easier or more enjoyable in 2008: Zoho -A full-featured office productivity suite in the style of Microsoft Office, except that it's free and it's accessible on the web, no matter where you are. So are your files - nothing to download onto your computer. Very easy to use, with a Word-like word processor, Excel-like spreadsheet, Access-like database program, and so on. TechCrunch - A great blog about the tech industry; who's funding who, who's new, and who's going into the "deadpool." It's not just a good place for intelligence on the tech industry; you also find out about new web technologies that could change the way you work. (Or relax, like Lala, below.) Lifehacker - A productivity "getting things done" blog. More suggestions than you can imagine, some not always hitting the mark. But it's a great place for discovering new things on the web that make your time at the computer more productive. Some of the best stuff I've ever found came from Lifehacker, like Zoho. Lala.com - Best music site I've come across in ages. Ten cents gets you a "websong" from their 6 million song catalog,which you can play anywhere you have a computer. Eighty-nine cents gets you the downloadable mp3, and if you already bought the "websong" you pay only 79 cents. You can upload your entire collection of mp3s from your computer to Lala's server, and access your music anywhere you're using a computer. And a very nice interface. Dropbox - A way to keep your files at hand when you aren't at the office: save them to Dropbox. You can reach your files from anywhere you have a computer; no more saving to a jump drive and leaving it in the computer by accident, only to realize it when you get home. A 2GB free account gets you started; you'll want to sign up for more. Google Reader - If you use a tabbed browser and automatically open up to a dozen tabs with sites you want to check every day - stop it. Feed them all into one page in Google's reader, which neatly organizes all your daily must-read sites. Google Calendar - Just as efficient as the Google Reader. You can access it from anywhere, you can create multiple calendars for yourself (like "home" and "work"), you can share them with others in varying degrees of privacy, you can snap in calendars that are out there in the public domain (like NYSE holidays or Maryland football schedules, and you can mash them all together at one time to see where your conflicts exist. Indispensable. Jott - When you want to send yourself - or anyone else - a reminder, there's Jott. Call Jott from your cell phone and you can send yourself (or anyone else or a group) an email reminder. Jott transcribes the spoken word into email. And you can do other things with it - like call an email to your Google Calendar while you're driving and add a date. Or call an email to Zillow with an address and get a Zillow real estate report in your inbox when you return to your email. OpenOffice.org - Another Office-alike suite, but this one downloads to your computer and runs great. Particularly sweet: their version of PowerPoint. That's the stuff that comes to mind first - except for the one "helper" I found on Lifehacker that no longer exists: IWantSandy! This was a great way to manage your to-do list anddeliverables. Not worth spending time on here since it's gone, but missed nonetheless. Rael Dornfest, the creator of "Sandy," a virtual assistant, has moved on to Twitter. He's hinted that Sandy's DNA might show up in future Twitter features, and that alone made me start to toy with Twitter. Not sold on it yet, but I'll give it some time. So - enjoy these! And why not sign up for Twitter, while you're at it. Drop me a "tweet" sometime!


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There's still time to comment on the FASB's rapid-transit amendment of the impairment model embodied in EITF Issue No. 99-20. To put it in a nutshell: the existing rules will require companies having a decline in value for things like lower-rated securitizations, whether held by issuers as a retained interest or purchased outright, to look at the cash flows a marketplace participant would use in evaluating the cash flows of the instrument. The impairment charge can then be determined. The FASB would like to replace that test with a more judgment-based model embodied in Statement 115, at the request of the SEC. Is it an improvement? I don't believe it is; in fact, I think it would be quite likely for impairments on securities covered by the amendment to be recognized later rather than sooner. Sure, the banks would like that - but I don't think that's giving investors timely or realistic information for investing decisions. I've put together my own comment letter, appearing below. I would recommend that even if you can send just a brief email on the subject to the FASB email-box, you should do so. Avoiding a reckoning on the values of these instruments is not the same thing as a reckoning; you'll be doing yourself a favor in the long run if firms are reporting their troubles honestly in the present.

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


December 28, 2008


Russell G. Golden

FASB Technical Director

Financial Accounting Standards Board

P.O. Box 5116

Norwalk, Connecticut 06856-5116


Re: Proposed FSP EITF 99-20-a


Dear Mr. Golden:


              I am writing in regard to the Proposed FSP EITF 99-20-a, “Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20.” I do not support the issuance of this amendment for the following reasons.


              • The existing No. 99-20 impairment model embodies marketplace participant points of view in determining whether or not an impairment exists. The model is consistent with the principles of FASB’s Concept Statement No. 7, “Using Cash Flow Information and Present Value in Accounting Measurements,” and also with those contained in Statement No. 157, “Fair Value Measurements.” The information it provides investors is a faithful representation of current economic values. The impairment model embodied in Statement 115 is far less prescriptive and invokes much more preparer judgment.


              This project originated because the banking industry lobbied the SEC for more lenient rules on recognizing losses on  some of the worst-faring securities created during the housing boom.i Moving to a Statement 115 model will not provide better information to investors than the current impairment model, and in fact, could lead to delayed recognition of impairments.


              At a time when the American auditor is facing some of its most serious professional challenges since the early part of this decade, the FASB will hobble them in their dealings with clients by replacing an impairment model that currently works with one that leaves plenty of room for management discretion. Ordinarily, that wouldn’t be necessarily wrong - but given the current economic environment and the genesis of this project, it certainly portends a negative outcome regarding the information to be provided to investors.


              • I believe the Board has its priorities reversed on this project. If a Level C standard (No. 99-20) produces information more consistently representative of fair values than the Level A standard (Statement 115), then it would seem that there is a problem with Statement 115.


              If fair value reporting provides investors with the information they need to make investment decisions, then why should the Board engage in projects that decrease the information provided to investors?


              Instead of diluting the information provided to investors by Issue No. 99-20, the Board would do better by investors - whom it is ostensibly serving, rather than preparers - to study the shortcomings of Statement 115. In fact, the whole idea of “other than temporary impairments” should be reconsidered through the expansion of fair value accounting for financial instruments. If full fair value accounting for financial instruments existed, there would be no need for artificial categorizations like “held-to-maturity” and “available-for-sale” securities - and no need for other-than-temporary impairment testing.


              • The Board has engaged in a mere facade of a due process. An 11-day comment period for a project with this much potential reporting impact like this one is a mere sham.


              Take into account the religious and national holidays during those eleven days and this amendment’s due process takes on the trappings of a parody.


              At least the Board went through the motions of a due process, unlike the IASCF and the IASB when they amended IAS 39 last October.


              In closing, I would like to support the Board in simplifying the accounting literature in trying to remove multiple impairment models and other possible redundancies in the accounting literature. There is that minor benefit to this project, but at too great a cost to investors.


              I would support that notion, however, only if the actions taken were more comprehensive and not on a piecemeal basis that serve to benefit one group at the expense of investors.



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The SEC will convene a teleconference today of international securities regulators to "discuss urgent regulatory issues om the ongoing credit crisis."

According to the press release, the technical committee will consider "manipulative short selling" and "under-regulated or unregulated products."

With regard to the first, it will be interesting to see if we ever get some case history of what constitutes "manipulative short selling." To see just what the SEC deems to be manipulation, we'll have to wait and see what the enforcement cases show.

With regard to the second consideration, the international confab intends to "develop disclosure principles to promote transparency in OTC markets for derivatives and other financial instruments which will contribute to enhanced investor protection and mitigating systemic risk." Good idea there; late, though.

The interesting thing is the other matter to be considered: international accounting standards. The issue to address for the international regulators is to "ensure that the process of developing international accounting standards continues to take account of the interests of investors." That sounds like it could refer to the lack of independent funding of the IASB - or the dive the board had to take with regard to the fair value exception to achieve a "level playing field" (three of the more dangerous words in standard setting, by the way). In any case - it sounds like the SEC is being more cautious, at least superficially, in its pursuit of international accounting standards in the US. It could be invoking "investor interests" to give it a more graceful exit; it could weigh in the favor of the next administration if they don't like the idea. It's going to be an interesting transition at the SEC.

On Friday evening - the day before the G20 summit began in Washington - the SEC released the long-awaited roadmap for converting the United States financial reporting system to International Financial Reporting Standards. The document will have a 90 day comment period, which will begin ticking once it's recorded in the Federal Register - and that will probably take place in less than two weeks. Say it's in the register one week from the day the SEC released it: that would put the comment period's end at February 19, 2009. It's a proposal that will span two administrations - and we really don't have an idea how the new administration is going to view the proposal. When an SEC chair is named, it'll be clearer - and with the current market turmoil, you'd have to believe that President-elect Obama will not waste time on this choice. A key premise in the 165-page document: the pause for deciding. While it's encouraging companies to take the option and apply IFRS to their own reporting before it becomes a requirement, the Commission has left itself the option to stop the convergence process in 2011. It will depend on the Commission is satisfied with progress toward achieving seven milestones related to: • improvements in accounting standards; • the accountability and funding of the IASC Foundation; • the improvement in the ability to use interactive data for IFRS reporting; • education and training relating to IFRS; • limited early use of IFRS where this would enhance comparability for U.S. investors; • the anticipated timing of future rulemaking by the Commission; and • the implementation of the mandatory use of IFRS by U.S. issuers. If it's satisfied with progress in the next three years, then the Commission will proceed with requiring U.S. issuers use IFRS beginning in 2014. The declarations made at the G-20 summit will likely propel American companies down the IFRS road - so it will be critical for investors to pay attention to the roadmap. They might not like where they are at the end of the road. Some of the  declarations have very strong implications for accounting as we know it. An excerpt: 

Immediate Actions by March 31, 2009:

* The key global accounting standards bodies should work to enhance guidance for valuation of securities, also taking into account the valuation of complex, illiquid products, especially during times of stress.

* Accounting standard setters should significantly advance their work to address weaknesses in accounting and disclosure standards for off-balance sheet vehicles.

* Regulators and accounting standard setters should enhance the required disclosure of complex financial instruments by firms to market participants.

* With a view toward promoting financial stability, the governance of the international accounting standard setting body should be further enhanced, including by undertaking a review of its membership, in particular in order to ensure transparency, accountability, and an appropriate relationship between this independent body and the relevant authorities.

* Private sector bodies that have already developed best practices for private pools of capital and/or hedge funds should bring forward proposals for a set of unified best practices. Finance Ministers should assess the adequacy of these proposals, drawing upon the analysis of regulators, the expanded FSF, and other relevant bodies.

Medium-term actions:

* The key global accounting standards bodies should work intensively toward the objective of creating a single high-quality global standard.

* Regulators, supervisors, and accounting standard setters, as appropriate, should work with each other and the private sector on an ongoing basis to ensure consistent application and enforcement of high-quality accounting standards.

* Financial institutions should provide enhanced risk disclosures in their reporting and disclose all losses on an ongoing basis, consistent with international best practice, as appropriate. Regulators should work to ensure that a financial institution' financial statements include a complete, accurate, and timely picture of the firm's activities (including off-balance sheet activities) and are reported on a consistent and regular basis.

So let's read the tea leaves and see what to expect by March 31, 2009: • There will be more guidance on Level 2 and Level 3 valuations from the FASB or the SEC; • The FASB proposals for modifying Statement 140 and FIN 46R should be turned into completed standards; • The anointing of the IASB monitoring board as "good enough" to ensure independence of the IASB; • Maybe even a staff accounting bulletin from the SEC on disclosures about complex financial instruments. In the "medium-term" - whatever that is - expect the continued convergence process of the US standards with the international standards, along with the continued mutual recognition of the efforts of securities regulators around the world. There was one ominous-sounding declaration, one that didn't name fair value accounting specifically, but read between the lines in this excerpt from "Reinforcing International Cooperation:"

Medium-term actions:  * Authorities, drawing especially on the work of regulators, should collect information on areas where convergence in regulatory practices such as accounting standards, auditing, and deposit insurance is making progress, is in need of accelerated progress, or where there may be potential for progress. * Authorities should ensure that temporary measures to restore stability and confidence have minimal distortions and are...

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The election is over, and the national guessing game has begun about who will be the next Treasury secretary. Of course the attention is focused on the Treasury post: nothing is more urgent than instilling confidence in the financial system at this very moment, if any other post-election promises are to be fulfilled.

Much less focus has been placed on who will be the next SEC chairman, however. It's a given that current chairman Christopher Cox will be gone. His replacement's name, however, hasn't generated the same kind of speculative fervor as the replacement for Henry Paulson. Nevertheless, events continue to bubble at the SEC offices.

Last week, the SEC announced that John White, director of the Division of Corporation Finance, will be leaving the Commission at the end of the year. White has been a prime mover behind the SEC's plans to scrap GAAP and adopt international financial reporting standards (IFRS).

On Friday, Chairman Cox delivered a speech about international enforcement cooperation, and focused on the Commission's international efforts in subprime loan investigations. Though the topic was international in scope, there was nary a word about the forthcoming IFRS "roadmap."

Not everybody is so quiet about the pending arrival of the roadmap. Accountancy Age, a British trade journal, proclaimed that it would be released last Thursday or Friday. Maybe they're just slightly ahead of their time.

No matter - the situation at the SEC bears watching. Whoever is named to the top post may give a significant clue about the future of the Commission: will it be someone who can reinvigorate it so that it's leading those it regulates instead of mopping up a mess after it happens? Or will it be someone who will shepherd it into another agency that takes over its functions? Let's hope for the former and not the latter.

No trick, maybe all treat for financially distressed homeowners. On Halloween, news spread that JP Morgan Chase would work with homeowners holding about $70 billion of mortgages. While JP Morgan Chase didn't step into the subprime swamp when it was percolating, it inherited a large number of subprime loans from its acquisition of Washington Mutual - who wasn't shy at all about making bad loans.

Terrific idea - keep the loans whole, build customer loyalty, keep people in their houses and just maybe, help stabilize the real estate market. In short, do what you can to keep the economy going.

Investors can't help but wonder, though: what are the economic effects on the bank? They're going to give up something to keep the consumers whole. And you have to wonder about the effects that renegotiation may have on the status of any of those loans securitized by WaMu. While it's not a black-and-white area of securitization accounting in Statement 140, a renegotiation of loans in a securitization trust could be considered evidence that a genuine sale of loans never took place. To present a true picture of what exists, the sale would best be reversed with the loans being returned to the bank's balance sheet and the pass-through security being a part of the bank's debt.

There's a bye given by the SEC to such renegotiations however, from the Office of the Chief Accountant early in 2008. No need to worry about shareholder presentation of events as they exist; just move along folks, nothing to see here.

Nothing indicating yet that this is the route JP Morgan Chase is taking. It's noteworthy, though, if they spark a wave of renegotiations among other banks. One would hope that happens - but investors need to exercise skepticism about the genuineness of loan sales in securitizations. In any case, if the additional securitization disclosures proposed by the FASB for this year come to pass, investors would be best off by using them to estimate what leverage would look like in the absence of securitization sale accounting - whether or not there have been loan renegotiations.