For RGA subscribers - 3Q2011 R3000 Fair Value (Excel Spreadsheet)

As we dive deeper into the fourth quarter reporting season, expect to be hearing more about "own credit adjustments:" the gains or losses that firms book because they exercised their option to report the value of issued debt at fair value. Why would they choose that? Maybe the nine saddest words in the English language strung together: "It seemed like a good idea at the time." Ironically, banks pleaded with FASB to give them the right to do this kind of accounting in the mid-2000’s, when the world was a less volatile place, before the financial crisis and acronyms like TARP and PIGS became part of the banking vernacular - and when worries about their own credit seemed impossible to imagine. The object may have been to create a natural hedge of an asset for which hedge accounting, through derivatives, was not possible.

It seemed like a good idea at the time. Unfortunately, the world has become a more volatile place - and firms taking the fair value option on some of their debt have had to report decreases in the value of that debt, yielding "gains" greeted only with scorn and derision from investors and financial press. While no one takes seriously the gains reported from decreases in creditworthiness, the same observers should consider any "losses" that might arise when the creditworthiness of such issuers improve. Furthermore, the "gains" are too often examined in isolation. There’s much more quarterly fair value information available than just the credit valuation adjustments to debt issuances. Looking at the fair value information in broader terms might tell a more interesting story than just "who’s making funny earnings figures." Here, we use the fair value information in more than just the typical one-dimensional analysis.

On Wall Street, nothing happens until someone changes their minds. Then, voila! Transactions occur, money changes hands, and the cash register rings. Maybe these days, there’s just a silent e-debit and e-credit to bank accounts. In any case, the first thing that happens is that someone changes their mind: they become energized to buy or sell a securities holding. Managers and investment bankers do what they can to put the best front on the face of the firm: the financial statements, a crucial source of mind-changing data.

Standard setters react to the financial innovations of bankers and managers; if there’s something on the standard setters’ agenda, it’s because investors’ needs are not currently best served. In recent years, however, the FASB has spent much time - its most valuable resource - on converging specific U.S. accounting standards with those of the IASB. This was FASB’s story for most of 2010, and it was similar in 2011. Much time was spent on major projects - financial instruments, revenue recognition and leasing are the biggest projects - but as in 2010, no major projects made the leap from proposal to required standard.

Nevertheless, the FASB managed to eke out a dozen accounting standards updates in the past year. Some will bear an impact on 2012 reporting and beyond, and others, less so. The following is a rundown of the FASB’s issuances in 2011, its plans for 2012, topped off with a look back at the accounting and business news for the year 2011.

The American Institute of Certified Public Accountants held its annual "Current SEC & PCAOB Developments Conference" in Washington, DC last week, featuring speakers from all of the accounting bodies that matter: the SEC, the FASB, the IASB and the PCAOB. It may well be the world’s biggest Christmas party for accountants, who come from all over the country to hear what the representatives of these regulators and standard-setters have on their minds about financial reporting in the current environment.

Just after 2012 begins, the preparer types at the conference will be putting together their firms’ annual 10-K filing - the thickest, juiciest shareholder communications package of the year. (Most often, it ends up being an annual exercise in compliance.) On their heels will come the auditors, paying attention to the way financial information has been compiled and presented. Both preparer-type accountants and auditors from public accounting firms invest their precious time in this conference to avoid wasting time later. If the SEC and PCAOB tell accountants of all stripes of the reporting problems they’re seeing, why ignore them? Forewarned is forearmed; understand the regulators’ concerns now, and maybe you’ll avoid comments and hung-up filings later when it’s crunch time. The conference fills up three days with financial statement intelligence for auditors and preparers to absorb - if they want to.

Investors can garner insights from this conference, too. Financial reporting problems originate inside of companies and at much lower depths of transaction detail than at the 30,000 foot level view that investors get in the financial statements. The PCAOB is charged with ensuring auditors do their job at a professional level for the benefit of investors; their overseer, the SEC, is charged with ensuring that investors receive fair disclosures. Skeptical investors should be curious about what accounting issues matter to an agency whose reason for being is simply, the investing public. It’s enough of a reason for investors to care about "what keeps the SEC busy."

Over the last couple of years, there have been precious few new proposals issued by the Financial Accounting Standards Board. The SEC’s promotion of IFRS convergence has led the FASB to devote most of its gunpowder on projects leading to standards that are more synchronized with IASB reporting standards. The results of those effort so far: a few proposals that would modify large swaths of financial reporting, like lease accounting, financial instruments and revenue recognition - all of which are in various stages of revision. There just haven’t been many other major proposals pushed out by the two-headed standard-setting beast that is the FASB and the IASB. (Call it FIASB?) That is, there haven’t been very many until the last month. The FASB has issued exposure drafts that, if enacted, would have major effects on the accounting for investment properties, investment companies, and consolidations of variable interest entities (VIEs). For good measure, the twin boards released the rewritten revenue recognition proposal last week.

The PCAOB’s standard-setting efforts primarily affect auditors, but their recent proposals should interest the investing public at large - if they care at all about the quality of the financial reporting that they consume. Last summer’s proposal on putting more information in the audit report was but one example. Now the PCAOB is proposing disclosure of the names of audit engagement partners in SEC filings, and is also floating the idea of mandatory auditor rotation, in order to bring fresh views to the audit. This report summarizes the fresh batch of proposals from the FASB and the PCAOB, and examines their relevance to investors.

Investors in firms with defined benefit pension plans always face the risk of suddenly being pushed farther back in line when it comes to being served their returns. Variability in plan assets and variability in benefit plan obligations are the reason: poor asset returns coupled with sinking interest rates always spell tough times for defined benefit plan funding. In that regard, this year’s asset returns combined with the Fed’s "Operation Twist" add up to "Operation Agony" for defined benefit pension plans. If trends continue along their current path, firms that may have anticipated moving to more realistic pension accounting might forego that decision: it could just be too painful.

Pensions aren’t the only kind of benefit plan affected by Operation Twist. Other postemployment benefit (OPEB) plans share much the same accounting model as pensions, including the calculation of a projected benefit obligation that similarly incorporates a discount rate - one that will also be affected by Operation Twist. The net OPEB obligations were even bigger than pension obligations at the end of 2010, and promise to be even bigger yet in 2011. Investors perceive them as less threatening than pension obligations because they don’t require funding. Strangely, there are a number of firms that are recognizing income from these benefit plans - without ever creating a dime of cash for investors.

A year ago, the FASB’s proposal for revamping financial instrument accounting was the burning accounting issue of the day. In the end, the FASB got singed by the fire. In the face of staunch opposition to the proposal from just about every quarter -preparers, regulators, and even investors - the FASB pulled in its horns and moved to a more IFRS-like stance, one that perpetuates amortized cost as the fundamental measure for financial instruments.

There’s a good chance that the FASB’s new-yet- old-fashioned approach may be re-exposed for comment: it’s much different than the May 2010 financial instruments proposal. One thing that’s unlikely to change are the quarterly fair value disclosures for financial instruments. In fact, they might be staked out parenthetically in the balance sheet - a much more investor-friendly treatment than their current burial in the footnotes.

Whether they’re on the face of the balance sheet or tucked into the footnotes, there’s still information in them for investors to consider. What follows here is a survey of the differences between amortized cost and fair value for the 453 non-REIT financial institutions contained in the Russell 3000.

2010 S&P 500 Executive Compensation Data  (Excel Spreadsheet)

The third quarter is looming, and a new FASB Accounting Standards Update will go into effect right from the start. It’s ASU 2011-2, “A Creditor’s Determination of Whether a Restructuring Is a Troubled Debt Restructuring.” It applies to all receivable holders, but it might give fits to mostly the financial sector firms in the second half of the year. (It doesn’t apply to changes in lease contracts, employment contracts, trade accounts receivable, or certain pooled loans.)

The ASU clarifies when a lender should apply the accounting for troubled debt restructurings, which can lead to remeasurements and recognized losses – naturally, something lenders of all stripes want to avoid. The criteria added in this standards update are judgmental and may involve probability calls about future events, but the ASU should nudge lenders towards reporting of more troubled debt restructurings (TDRs).

That might not be a bad thing. Existing accounting standards give firms the ability to offset, or to “net”, certain financial assets and financial liabilities against each other. This leaves only a net asset or liability reported on the firm’s balance sheet – and only a hint of the firm’s total exposure. For example, a firm may have a $900 billion asset owed from a derivative asset position, and it may also owe an $880 billion derivative liability to the same party. Offsetting the two amounts on the balance sheet yields a $20 billion net liability, saying little about the size of the benefits to be enjoyed or the risks taken by the firm.  

 The two accounting standard-setters have proposed a change in netting that would frequently reverse the above scenario: instead of presenting net amounts, firms would be showing their assets and liabilities on a “grossed-up” basis. This would affect U.S. banks more than any other industry group: they’ve extensively practiced the netting of derivative assets and liabilities, in contrast to banks reporting under IFRS, where netting is not the norm.

On Tuesday, the Financial Accounting Standards Board made a key decision in revising the accounting for financial instruments: it abandoned the most controversial feature of last May’s proposal for the expansion of fair value reporting for long-term receivables, like bank loans. 

The board’s decision does not eliminate the pier value categories devised in the proposal.  Those categories- fair value changes reported through net income(FV-NI), and fair value reported through other comprehensive income (FV-OCI)- will remain in the new accounting model.  Those two categories will be augmented by a third, sure to please the banking industry: amortized cost

The debt ceiling drama is temporarily behind us, replaced by the current “Rome is burning” excitement (along with“the rest of Italy, and Greece, and Portugal, and the United States is burning” drama.) The macro view of the stock market hasn’t provided participants this kind of dizzying, fear-fueled adrenaline rush since the last economic crisis.

    In complete contrast, the accounting discipline has been downright dull. No drama over restatements of financials, options backdating, adroit revenue recognition, pension plan assumptions or funding, or off-balance sheet subsidiaries - not even SEC investigations of mere muffed lease accounting. In short, the investment world now views the accounting world as it always has: a dull, occasionally necessary, discipline that’s not much fun to observe in comparison to the market - unless it’s affecting the markets.

       That’s a bit short-sighted. Accounting hasn’t been page one news for a long time: companies haven’t blown themselves up via accounting high jinks ever since Sarbanes-Oxley put more stiffness in auditors’ spines. Yet like the serene duck swimming on a pond’s surface, there’s a lot of furious paddling underneath. Now that the first half’s earnings releases are out of the way, it’s time to take a look at what the accounting ducks have been working on - and what investors will be quacking about in the second half of 2011.

     The auditor’s opinion on the financial statements have only slightly more information content than the nutrition label on a bag of potato chips. The typical “clean” opinion identifies the financial statements examined by the auditor, the auditing standards followed, and states whether or not the financials are presented fairly in conformity with accounting standards. It’s often called a “pass/fail” model: the auditor’s opinion states the financials are fairly presented (pass) or not (fail).

    For the thousands of man-hours and millions of dollars invested in the typical annual audit, that’s a pretty unsatisfying snack for investors to digest. After all, the auditing firm is inside the firm owned by the shareholders - and is privy to more facts than expressed by the standard audit opinion. The auditor is working for the shareholders - and the audit report should reflect more of the intelligence gleaned from the audit than the simple pass/fail opinion suggests has been learned.

       Think of it this way: when was the last time you actually read an audit opinion? Perhaps never, because you didn’t expect it to contain any information. The PCAOB wants to change that: after gathering opinions from its own advisory boards and conducting broad-ranging interviews, the Board has put together a proposal that could radically increase the information built into the auditor’s report. Expect resistance from both auditors and companies - and if it becomes a reality, expect higher audit fees, too.

It’s been four years since the Securities & Exchange Commission first floated the idea of permitting U.S. companies to use international financial reporting standards (IFRS) for their filings. In between 2007 and now, a two-year financial crisis distracted the SEC, the Financial Accounting Standards Board, and the International Accounting Standards Board, hobbling any plans for a quick changeover to a one-world set of standards.

    That “one-world set of standards” may have always been more ambitious than it first sounded.  Some countries have chosen to carve out parts of IFRS that they don’t see fit to adopt. Some adopting IFRS have done so with significant strings attached: for instance, reserving the right to not adopt a new IASB pronouncement if it doesn’t seem particularly relevant to that country’s constituents. While the international convergence movement has taken on a life of its own, some of the developing adoptions are more like mutations of IFRS rather than a uniformly-created single set of standards.

    Whether homogenized standards are a good idea or not, or whether countries go the full convergence route or merely adopt some form of convergence to look like they’re in the game, the SEC has committed itself to figuring out the United States’ position on adopting IFRS. The Commission’s latest effort is a staff paper explaining “condorsement” - a possible way of incorporating IFRS into the American reporting system. As you might expect from the name, it’s not a pure adoption approach to implementing IFRS.

     It’s the time of year for proxy deliveries and shareholder meetings - and plenty of rhetoric about CEO pay. This  year, the“say on pay” proxy vote, and the separate vote on the frequency of future say on pay votes, have added something to the mix for pay-watchers. Shareholder choices alone won’t bring any direct action on pay, however. If directors fail to heed shareholder displeasure through their say on compensation, the directors themselves might become liable through the courts. While that could certainly bring about change, it’s a process that could take years to produce any real differences in the size of executive compensation awards.
     Shareholders might say “no” on pay awards more often, if they stopped focusing on only the CEO and studied all of the executive pay information available to them. The proxy statement discloses the compensation of the top five officers; even though that’s only a smattering of the total executive pay, it’s uncommon for investors to look at that cost in its totality. The top five officers are part of a CEO’s cadre of trusted executives; they’re at least a part of the total management team that breathes life into the shareholders’ collective assets. Consider them to be a major input into the production of shareholder returns, with a real cost, just like raw materials or any other purchased services. One difference: managers try to keep other production costs low - but for their own costs, they’ll employ swarms of consultants to justify higher pay.
    If investors thought more about the price tag on their managers - especially in comparison to the cost of other inputs of production - they might vote “nay on pay” every chance they get. In 2010, executive pay for just the top officers recovered strongly as the financial crisis faded into the rear view mirror. Here, some perspectives on just how big the total executive pay package has become in relation to other costs that produce income and shareholder returns.

In the annual report tour, one of the usual stops made by investors is the pension plan footnote. Through various FASB edicts, the pension footnote is now so swollen in size that it’s turned into the engorged tick of the financial statement package - and causing investors to perhaps spend less time with it than they should. This report tours the most critical aspects of the pension plans of the S&P 500 companies. Pensions are like a company within the company, and affect managements’ marginal investing and financing decisions. Investors should pay attention to the pension status every year.

    Markets were quite strong for 2010. How did the pension plans fare? The short answer: so-so. There’s a slight  improvement in overall funding status, and a few firms contributed mightily to their pile of pension assets. Still, there remains a yawning gap between assets and benefit obligations for most firms.

Over here, however, is where they are reported. The basic consolidated financial statements present an American corporation’s results on a homogenous basis: investors see one number for say, net income or cash, and assume that all dollars of net income or cash are alike. Not so. There could be constraints on those amounts depending on where in the world they originated. While GAAP requires disclosures about foreign operations in terms of assets, revenues and to a lesser degree, pretax income, it doesn’t provide a feast of information for hungry investors.

The still-fresh 10-K packages don’t say much about overseas profits - but if you know where to look, they whisper about it. There’s crude information about the untaxed earnings of foreign subsidiaries in the tax footnote. Spend a little time with those figures and you can get some insight into how confusing consolidated financial statements may be, why managers dream of repatriation tax holidays, and just how dependent domestic companies may be on their foreign operations to drive earnings growth.

March 1, 2011: that’s the SEC’s 10-K deadline for “large accelerated filers” having December year ends, and it’s just days away. Ordinary“accelerated filers” - those with a public float of less than $700 million - have slightly longer to electronically heave their 10-K  filings over the SEC’s doorstep: March 16, 2011. The smallest fry of the public markets, those with public floats under $75 million, can wait until the last day of March to file their 10-Ks.

    You’re bound to be busy reading these tomes over the coming weeks, and you’d be right to wonder which ones are works of fiction, instead of presentations of facts. Only thinking critically while digesting them is going to do that for you, and the sheer size of your 10-K stack will ensure that sooner or later, you’ll be “skimming” those reports. Resist that urge as long as you can: you won’t have another chance to learn as much about a company for another year. Focus on the disclosures that are most important to you. No single magic disclosure or ratio in the annual report will always give you the most brilliant insight. The one thing the annual report offers investors is more context than usual, and a better than usual opportunity for the investor to piece together the factual mosaic tiles that describe a company and its business better than any other time of year. It’s up to the investor to make that picture come together by exercising due diligence in reading the annual reports.

Hardly a year goes by without one aspect or another of pension accounting being questioned by investors.  Some years it’s just the sheer poverty of the funds that attracts attention; other years, it’s the construction of the benefit obligations that jangles investors’ nerves.

    This year, it’s something entirely different.  Several companies have recently decided to improve their accounting for pensions and they’re taking a very conservative approach - and it’s unusual to hear “conservative” mentioned in the same breath as pension accounting.  These firms are writing off great chunks of their past losses that have been hanging around for years.  While they’re to be commended for taking the high road, their timing is splendid.  The most painful part of the change is pushed back in time to three years ago during the depths of the financial crisis -a time when they wouldn’t have dreamed of recognizing investment losses.  It also happens to set up a very pleasant earnings trend, something sure to please unquestioning investors.

Because of the dynamic nature of business and financial innovation, financial reporting changes constantly. The 2010 financial statements you’ll read in a few weeks won’t look quite the same - or have exactly the same meaning - as the financial statements you’ll read in another year or two. To get a handle on where financial reporting is going - mostly due to financial innovations and sketchy reporting already occurring - it’s wise to annually take stock of the FASB’s agenda. An accounting issue appearing on their agenda is somehow deficient in serving the FASB’s constituents, and needs repair.

    The Board probably worked more frantically than in years past, but had no monolithic standards to show for it. It issued many refinements of existing standards, but they were not the reason for the Board’s activity. What consumed the FASB in 2010: its focus on converging major standards with the International Accounting Standards Board by mid- 2011. The two boards worked furiously on those projects; for the FASB, the due process on the financial instruments at fair value project consumed a great deal of their time and resources during the year.

    Notwithstanding its engrossment with international convergence and fair value reporting, the FASB managed to issue 29 accounting  standards updates in 2010 - some with significant impacts in 2011 and beyond, others with less impact. The following is a rundown of the FASB’s major accomplishments for 2010, and a look back at the accounting news for the year 2010.

Until the fall of Lehman Brothers, nobody gave much thought to repurchase agreements - or the accounting for them. As so often is the case, once they blow up, they’re on everyone’s mind. And they’re on every available media page, too. A Google search on the phrase “Repo 105” shows three news stories in the whole calendar year before the bankruptcy examiner’s report was issued on March 11, 2010. So far in 2010, the same search yields 436 news story hits. “Repos” became interesting when Lehman blew up - and so did the accounting.

Towards the end of the year, investors start wondering about the effects of pension obligations on next year’s cash flows and capital structures. Estimated asset returns for the S&P 500 pensions is about 1% - while estimated projected benefit obligations ballooned more than 12%, fueled by current ultra-low interest rates. That unhappy confluence of returns means that underfunding for the S&P 500 plans might increase another $167 billion, or 65%. There will also be more pension fodder for investors to consider this year: the FASB has proposed disclosures that will throw light on the murky corners of multiemployer pension plans.

In late June, the IASB and the FASB announced a change in their strategy for joint accounting standards projects. The previous strategy/timeline was a virtual accounting moon shot: a series of standards revisions that would command a never-before-experienced level of cooperation and like-mindedness between the two standard-setters. The revised strategy is only slightly less demanding.

In February, we  reported on the upcoming changes in revenue recognition for firms with multiple-deliverable arrangements (Volume 19, No. 4: “Rock ’n Roll Revenue Recognition: How Growth Will Thrive.”) A re-read is recommended, but here’s the bottom line: because of two EITF consensuses effective in years beginning after 6/15/10, certain firms will find it easier to recognize revenue linked to each component of a multiple-deliverable arrangement as it’s delivered or completed, instead of recognizing revenue gradually. Some firms are going to have revenue recognition growth spurts. Adoption methods allow a choice of retrospective or prospective treatment; don’t expect consistency among companies. Prospective adopters may report juiced revenue growth rates: they’ll recognize revenue faster than before, but compare them to previous years’ revenues that reflected slower revenue recognition. Bolder comparisons result.

On March 23, President Obama signed the reconciliation bill that made the Patient Protection and Affordable Care Act a working law. One part of it immediately affected corporate financial reporting: it changed the value of deferred tax assets related to a corporate Medicare subsidy. Whenever a law is enacted that changes the value of a tax asset or liability, the change in that tax asset is recognized immediately in the period of the law’s enactment. 

The elimination of tax deductibility for the retiree drug subsidy is what’s behind the hailstorm of announced first quarter deferred tax asset writedowns. In tax years beginning after December 31, 2010, employers can be reimbursed for 28% of their retiree prescription benefits costs, provided they’re supplying benefits that are the actuarial equivalent Medicare Part D benefits. Right from the start, their pretax prescription benefit cost is 72% of what it would be without the subsidy. On top of that, they get a tax deduction for the full 100% of the benefit cost - no exclusion for the subsidy. At a 35% tax rate, the tax benefit would be 35 cents for every dollar spent. After subsidy and tax benefits, an employer’s cash cost could be just 37 cents on the dollar - for just those prescription benefits. The subsidy gives rise to a deferred tax asset because the cash tax benefits are based on the full expenditure amount.

The “double-dip” sweetener in the above scenario - deducting 100 cents of the expenditure without reducing it for the subsidy - is what gets eliminated in the law in tax years beginning after December 31, 2012. Firms will no longer earn a deduction for the portion of benefits covered by the Part D subsidy - and that means deferred tax assets attributable to those deductions have to be written down.

In our Investor’s Guide to 2009 Annual Reports (Volume 19, No. 5), we familiarized investors with new accounting issues and reminded them of ways to use accounting information to add color to their views on a particular company. Here’s an additional suggestion to consider in reviewing annual (and quarterly) reports: consider Level 3 exposure as a routine matter. When the fair value hierarchy first appeared in financial reporting in 2008, investors paid plenty of attention to Level 3 assets - mostly because they were associated with floundering financial institutions that held securities classified as Level 3. Yet Level 3 asset valuations aren’t inherently wrong; it’s just that they’re inherently pliable, depending on management intentions. What’s indisputable: because they come into play when there are no values available from active markets, the assets are inherently illiquid - and anyone  concerned with a firm’s liquidity should take into account the degree to which Level 3 securities are a part of a firm’s balance sheet.

Last week, the SEC released a statement supporting convergence of US Generally Accepted Accounting Principles (GAAP) and International Financial Reporting Standards (IFRS). While it definitely showed a commitment to the convergence process, it fell well short of a vow to require US adoption of IFRS. The Commission plans to make a decision on that in 2011, a date that’s significant for two reasons. One: at the September summit in Pittsburgh, the Group of Twenty nations requested accounting bodies to achieve convergence in accounting standards by June 2011. Two: that’s exactly what the IASB and the FASB have been doing at fever pitch ever since then, putting their efforts behind joint standards on major projects with near-Olympian vigor. If the Commission is satisfied in 2011 that IFRS adoption is a good idea, they expect that it could be implemented in 2015 or 2016. Consistent with the non-committal tone of the statement, the door remained open that early adoption might be permitted in the event of national IFRS adoption.

Last month, the FASB updated its Accounting Standards Codification, requiring firms to furnish incremental, enhanced disclosures about fair value measurements.  (Official title: Accounting Standards Update 2010-06. It updates the codification Subtopic 820-10, Fair Value Measurements and Disclosures, or what used to be called Statement 157, “Fair Value Measurements.” It was called other names as well.) The good news: the new disclosures will shed even more light on the nature of the valuations of financial instruments. The bad news: they won’t show up in 2009 annual reports; some key disclosures won’t arrive in 2010 annual reports.

Statement 167, Amendments to FASB Interpretation No. 46(R), was issued in June 2009, along with the related SFAS No. 166, Accounting for Transfers of Financial Assets – an Amendment of FASB Statement No. 140. Statement 167 was issued to allay  concerns that FIN 46(R) permitted firms to block consolidation of assets and liabilities related to variable interest entities through manipulation of quantitative assumptions. Statement 167 forced firms to use a more judgment-based analysis, on an ongoing basis, to determine whether they are the primary beneficiary of a variable interest entity; if so, a firm must consolidate the entity. Statement 166 sweeps securitization entities into Statement 167’s purview, causing them to be newly considered for consolidation.

The American Institute of Certified Public Accountants held its annual “Current SEC & PCAOB Developments Conference” in Washington, DC last week, including speakers from the SEC, the FASB, the IASB and the PCAOB. Call it “Accountant-palooza:” accountants from all parts of the country stage a homecoming of sorts to listen to what the SEC has to say about accounting issues. In a frail economy, the conference attendance exceeded 1,300; including remote locations, more than 2,300 were tuned into the SEC’s show. That’s quite a draw, especially at this time of year.

    In a matter of weeks, the accountants attending the conference will be assembling their firms’ 10-K filing - the annual exercise in communications with shareholders. (Most often, it ends up being an annual exercise in compliance.) Shortly afterwards, the auditors attending the conference will be scrutinizing the accounting records. Accountants and auditors invest their time in this conference so they don’t waste it by stepping onto land mines already mapped out by the SEC. Time is always precious, and nobody - auditors or preparers - want to waste time negotiating with SEC staff over accounting treatments covered by the Commission staff during this conference. The conference fills up three full days with “heads-ups” for auditors and preparers. Forewarned is forearmed.

    What’s in it for investors? Insight. Financial reporting problems don’t originate after financial statements are filed; they originate inside the companies and at much lower depths of transaction detail than the highly distilled levels that investors see in the finished product - the financial statements. The Commission is charged with ensuring that investors receive fair disclosures; cautious, skeptical investors should be curious about what accounting issues matter to an agency whose reason for being is - investors. That should be enough of a reason for investors to care about “what keeps the SEC busy.”

In the ensuing years since the SEC first proposed the use of International Financial Reporting Standards (IFRS) by U.S. registrants in mid-2007, there’s been no shortage of economic drama. Both the pricking of the real estate bubble and the Great Recession struck within a year; amid the financial mayhem, the international convergence of accounting standards didn’t carry quite the same urgency it did originally.

    Once relative calm was restored to the markets, however, the convergence efforts picked up steam once again. In the past twelve months, the International Accounting Standards Board and the Financial Accounting Standards Board have been issuing proposals at a blistering pace - proposals that, if they become actual standards, could have serious repercussions for the issuers of financial statements. Investors and other users would also have to deal with perhaps surprising amounts of changes. It’s reached the point where the FASB issued a discussion paper in late October for the sole purpose of taking stock of its various constituents’ views on how the Board should go about requiring the implementation of these potential standards. For instance: should they be phased in separately, or all implemented at one time? Should firms be allowed to adopt them early? How long of a grace period will be necessary?

    In an interesting coincidence of timing, the SEC also issued an update on the progress made by the Office of the Chief Accountant in deciding whether or not to permit the use of IFRS for U.S. registrants. As it stands, the Commission expects to make a decision on that in 2011. (The Commission could conceivably decide to decide later.)

    This report looks at the highlights of the two documents. For the moment, the two chief influencers on U.S accounting principles seem to be taking a breather - but they’re not finished the race, by any stretch of the imagination.

In the hit movie “The Curious Case of Benjamin Button,” the hero starts out life with the appearance and physical condition of a very aged man. As he becomes older, he becomes younger in appearance, meeting his sweetheart at a tender age for her and reuniting with her for a blissful period when they’re both in their prime. Of course, nothing that good could last forever; they continue their inverse aging paths, missing each other as they live out their days.

    Investors have been treated to a similar movie playing out over the last two decades, a movie about weirdly aging postretirement benefits obligations. These accounting creations first appeared on corporate balance sheets in 1992 among much fear and trepidation about the subsequent costs to be recognized through accrual accounting for postretirement benefits. In the time since, however, instead of becoming more detrimental to earnings, postretirement benefits costs have actually become less detrimental to earnings than ever - going from aged beasts to smooth-skinned youths. The last few years might even be a “sweetheart period,” where many firms have experienced declining postretirement benefits costs - and some firms are actually seeing negative costs.

    That sweetheart period, just as in the movie, may be coming to a close. Firms will be remeasuring their postretirement benefits obligations at year end, and it would be surprising if the Patient Protection and Affordable Care Act of 2010 didn’t start affecting those obligations. Those effects can’t be anticipated - but before they show up, investors should wonder why the existing accounting doesn’t do enough to illustrate the economics of corporate postretirement benefits plans, which cover mostly medical benefits.

The convergence movement between the FASB and the IASB has been stumbling recently over the treatment of financial instruments: the FASB pushes for more fair value reporting of financial instruments, while the IASB opts for more traditional amortized cost treatments. When it comes to other convergence projects, however, they’re moving full speed ahead, and in total lockstep. Revenue recognition is one example. Another is their joint project on lease accounting. An exposure draft released in mid-August paves the way for lease accounting that will be similar under the two standard-setters’ rules.

    The accounting won’t be too similar to what’s been in existence in the U.S. since 1976, however. Operating leases won’t operate any longer; lessee balance sheets will show assets and obligations that had always existed in an “off-balance sheet” state. That shouldn’t surprise anyone who’s familiar with the 2009 discussion paper on lessee accounting: it proposed the demise of operating leases. What really is new, however, is that this exposure draft also contains freshened accounting for lessors. Much will change for both lessees and lessors, and it will change with a big bang: there’s no gradual grandfathering transition approach contained in the exposure draft. When the standard goes into effect, there will be a catch-up that puts all firms on the same footing at the same time.

The tune changes, but the song remains the same.  You may have expected that news clip came from last week’s Wall Street Journal - but it dates back to July 16, 1992, when bankers were alleging that valuing securities at fair value would bring about the end of the economy as we know it, because banks would be too scared and too broke to lend.

    They’re singing that same song again. This time, the chorus is about the FASB proposal to put all assets and liabilities at fair value as well as simultaneously presenting corresponding amortized cost amounts. The same outcome - “we’ll bring this economy to its knees, when it can least afford it” - is being positioned by the proposal’s opponents. Their rallying cry: “Hell no, we won’t lend!”
    Don’t fall for it. Lending is a bankers’ reflex, triggered by the size of an interest rate spread. In this report, we’ll look at the S&P 500 to determine just how “bad” things could be if the proposal is implemented, and take a look at some of the canards floating around regarding the proposal.

The “revenues” line holds the single biggest number in the income statement. (Except for the occasional goodwill writedown in excess of revenues.) It’s one of the most crucial financial measures investors will ponder, and it’s often the focus of management mischief: think of the accounting chicanery to which investors have been subjected in the last decade.“Round-tripping” of contracts, done to bloat them and add to investor appeal.“Buy-and-hold” transactions where early customer purchases were not really sales at all. “Principal vs. agent” transactions where transactions were reported on a gross basis for say, a ticket price, when the real revenue earned only amounted to a commission on that gross price. And those are just a few examples.

    Maybe because it’s the single most important number in the income statement - after all, nothing happens until someone sells something - or maybe because rascally revenue recognition erupts every few years, the U.S. accounting standards dealing with revenue recognition have multiplied like rabbits. The section of the U.S. accounting standards codification covering revenue recognition is composed from more than 140 pronouncements issued over the years. Some of it is very specific to certain kinds of transactions; some of it is very specific to certain industries. Oddly, none of it contains general guidance on revenue recognition for services. Revenue recognition issues have been frequent agenda items for the FASB’s Emerging Issues Task Force, indicating that the current standards are substandard, themselves: if the accounting principles were effective, they wouldn’t need such frequent interpretation. How frequently? Two of those EITF consensuses became effective within just the last month, though their genesis began several years ago.

    Since 2002, the FASB has worked with the IASB on a joint project to improve revenue recognition standards. On the FASB side, the greatest improvement would be a comprehensive set of revenue recognition principles that don’t require constant repair and maintenance. On the IASB side, the greatest improvement would be more consistent principles that could be applied in more specific situations. For example, there’s little guidance on revenue accounting for arrangements containing multiple elements. Both sides have something to gain from this project, and developing a joint standard is a meaningful standards convergence step. Here’s how the joint proposal will work, in its current form - and how it could affect current revenue recognition practices in various industries.

    The accounting standards governing financial instruments are a rickety stack of piecemeal fixes for problems arising at different times in the history of financial reporting. What the FASB has done with a pair of proposals covering reporting of financial instruments and other comprehensive income is novel: they’ve come up with a sweeping overhaul that’s better than what it replaces, and better than the approach taken by its standard-setting counterpart, the International Accounting Standards Board.

    The financial instruments accounting proposal is the more dramatic of the two. It eliminates thefamiliar classification of financial instruments as held-to-maturity, available-for-sale, and trading, replacing them with just two: fair value and amortized cost. Both classifications earn a place on the balance sheet, and both will affect income statement presentation. Depending on the business model of the firm using them, some financial instruments may be reported on a fair value basis with changes in fair value reflected in earnings. Some financial instruments may be reported on a fair value basis, with cost basis-figured interest income (and impairments, where necessary) reported in net income. The fair value changes for such instruments would be reflected in other comprehensive income. That’s where the second FASB proposal comes into play. To give the effects of all fair value reporting equal prominence, the proposal requires that firms present a “continuous statement” of comprehensive income. No longer can firms bury the statement of comprehensive income in a stockholders’ equity schedule. Now, comprehensive income gets its due - on the same page as net income.

    The proposals provide a smorgasbord of accounting presentations: there’s something for every appetite. Regulators can tuck into the amortized cost information in setting capital requirements; cautious investors can savor fair value basis presentations; and companies can pridefully cook up their earnings presentations on an old-fashioned, net income basis - with their favorite adjustment seasonings, to boot. The presence of more information should make investors think more critically. So far, however, there’s been little support for the proposal from any quarter. Financial institutions have roundly criticized it: their financial statements would bear the most striking changes.

Consider the modern corporation to be a collection of individual minds, intangible assets, financial capital and physical resources. Without another element of production -  management - a corporation is a mere collection of disparate production inputs that don’t do anything on their own. Management essentially breathes life into those assets: acting in the interests of shareholders, it makes those various assets produce profits for shareholders’ benefit.

    Markets for production inputs are competitive and open. Utilizing the best physical and intangible resources at the lowest price and finding the cheapest capital are basic managerial tasks in bringing returns to shareholders. Managers are paid to push hard for seeking cost-effective production inputs. Naturally, they’re not of the same cost-containment mindset when it comes to the price of their own compensation - another production input.  The market for the price of management services can hardly be termed “open.” It’s as fair as a Soviet election: annually, shareholders get to approve or disapprove a compensation plan developed by consultants and approved by the board’s compensation committee, a plan built on comparisons to the pay packages of other firms. The only thing shareholders can do is vote against a proposed  plan, but they usually don’t. Occasionally, a “say on pay” vote is allowed, but they’re non-binding and thus, toothless.

    If investors thought about the cost of managerial inputs compared to the cost of other production inputs, they might nix proposals on executive compensation plans more often. While investors will concern themselves with the effect of other  costs on profitability, they don’t usually analyze the cost of managers relative to other production inputs. In this report, relevant comparisons are demonstrated. The results show that management compensation is out of proportion compared to other costs that produce shareholder benefits.

Pensions have a way of making things not safe in the workplace, on a couple levels. If you’re an employee who’s hoping for a retirement someday, they’re a wonderful thing - until the day you find out that your firm is freezing them or cutting benefits to keep the whole plan going. And in the investor workplace, pensions bring a lot of performance noise into the financials that relates more to accounting prowess rather than managerial ability. Parsing them out can be workplace pain for investors.

    Overall, pensions improved greatly in 2009 in terms of funding. 2008’s scary markets directly impacted the funded status of pensions, and 2009’s rebound did wonders for defined benefit pension plans - even if they’re not out of the woods. There’s still quite a gap from them being fully funded. One thing that’s different in 2009: the new disclosures about asset classes and fair value hierarchy provide investors with more warnings about funding adequacy than ever before.    

10-K season is in full swing. The deadline is already past for the large accelerated filers, and by month’s end, all stock market inhabitants should have their annual filings deposited in the SEC’s EDGAR archive.

    You might be overwhelmed by the sheer volume of reading you’ve got ahead of you. Before you start “skimming” way too much in an effort to get through the stacks, take a deep breath and pull back. Take time to figure out what’s really important. After all, the level of disclosure is not going to be higher any other time of the year. While there isn’t any single magic disclosure or ratio that will always save your investment - and your neck - one thing the annual report and 10-K offers investors is more context than usual. There’s a better chance than usual for the investor to separate the trees from the forest. The process: form expectations; look for support or contradiction; reconcile findings to expectations; repeat

Revenue recognition (“rev rec,” in accounting-speak) is ratcheting up and arriving earlier for some companies. Firms making their living by engaging in multiple-deliverable arrangements (contracts for a plethora of services or goods to be delivered at various times, with one price tag for all) have long hated the accounting for such deals. They’re required to parse such arrangements into identifiable pieces and recognize the revenue from each piece as it’s completed. That’s not the problem for them: it’s the accounting requirements for evidence of each piece’s selling price frequently making the disaggregation goal impossible. If disaggregation can’t be achieved, the revenue is deferred, with recognition taking place after all contract elements are delivered. Sometimes, recognition may occur ratably over the contract term.

    That retards revenue growth, making the accounting standards a target of wrath for many technology and consulting CFOs. Recently, the FASB’s Emerging Issues Task Force (EITF)greatly liberalized the requirements for objective evidence of each component’s selling price, making it much easier to achieve “componentized”revenue recognition for multiple-deliverable arrangements - and to recognize revenue faster than under the more restrictive fall-back deferral approach. The EITF also freed tangible products containing software from being accounted for under restrictive software revenue accounting methods, in many cases. The change to this new accounting was part of the reason for Apple’s recent revenue growth.

The American Institute of Certified Public Accountants held its annual “Current SEC & PCAOB Developments Conference” in Washington, DC last week, including speakers from the SEC, the FASB and the PCAOB. Accountants from all parts of America and the economy gather each year to grab year-end financial reporting advice from the SEC’s staff. Despite a still-shaky economy, the conference attendance was still well over 2,000. That’s a lot of accountants and auditors.

    Those auditors will soon be combing through client accounting records as gatekeepers in the whole financial reporting process. Time is always precious, but more so when there are reporting deadlines to be met. Auditors don’t want to waste their time - or their client’s time - arguing over a questionable accounting treatment if the SEC has already addressed it sometime during this conference. That’s one reason this conference is so well-attended. (It doesn’t hurt that it provides a huge dollop of required continuing professional education, either.) The conference provides three days’ worth of reminders for smart auditors who incorporate them into their audit plans.

    Why should investors care? Forewarned is forearmed. Investors would do well to understand issues covered at this conference as well because the SEC staff sees financial statements during their review process well before investors read annual reports. What curious investor wouldn’t want to know the SEC staff’s gripes with current reporting? The comments of these staff persons don’t predict accounting meltdowns in the making, but their comments should remind investors that firms don’t always apply generally accepted accounting principles correctly - unintentionally or not. If there’s a later revision to issued financial statements, that might be enough of a reason for investors to care about “what kept the SEC busy.”

There’s no shortage of emotional reactions on the subject of executive compensation. With the events of the past couple years fresh in the memories of investors and the general populace, executive paychecks and bonuses have been popular outlets for their rage. The focus of attention is usually on absolute pay levels, which seem absurdly high - especially in the financial sector. It’s hard to justify bonuses denominated in millions of dollars for executives whose minions came perilously close to blowing up the entire financial system, making themselves obvious targets for politicians currying favor with an angry electorate. Examined in absolute terms, executives will always appear overpaid: their paychecks are bound to be bigger than the ones of those doing the examining, so the envy factor will color judgment. Yet it may also be correct. The picture of compensation is seriously incomplete: proxy statements report the total compensation of only the top five officers, while the financial statements provide information about only the stock compensation provided to the entire employee population. Even within those constraints, investors can get a tighter grip on the fairness of executive compensation. Comparison of executive compensation to the kinds of investment spending that produces shareholder returns provides even more insight into pay fairness.

    The trio of FASB’s April turbo-standards related to fair value reporting have now been adopted by all publicly-traded companies. In brief, those standards made the recognition of other-than-temporary impairments less painful to report because firms could direct parts of the charges to other comprehensive income; made it easier for firms to employ “Level 3” reporting of asset or liability valuations; and increased the frequency of supplemental fair value reporting.

    Because they deal most directly with financial instruments, those three amendments have the greatest impact on financial institutions. In this report, the magnitude of those effects are presented for the 79 firms composing S&P 500’s financial sector.  Some findings: banks saved more than a $1 billion in regulatory capital, thanks to the sweetened other-than-temporary impairment rules; the entire S&P 500’s earnings benefitted by nearly $5 billion and over 4%; and fair value disclosures showed a surprising lack of confidence in the credit markets for the insurance industry.

Like it or not, financial accounting affects the way investors do their homework in making investment decisions - and in turn, the standard setters who generate accounting rules affect financial accounting. Investors concerned about the way accounting standards and standard setters will affect their work should be on the edge of their seats this month. While this September may not be showing its characteristic market volatility, things are rocking in accounting-land.

    Investors are suffering accounting fatigue from the ongoing (un)holy war over fair value reporting, yet they’re perpetually curious about whether U.S. accounting standards will go the way of the dodo bird if International Financial Reporting Standards become the American measure. Financial instruments proposals from the IASB and the FASB will  be a topic at this week’s Pittsburgh G-20 summit, and the discussion could define the role that fair value accounting will play in future financial  reporting - and the fate of independent U.S. accounting standards.

Executive compensation is a perennial sore spot for investors. Compensation packages designed to knit together shareholder interests and those of the managers working for them were subverted over the years by substandard accounting standards that let compensation tied to option rewards go unreported.  By the time the faulty accounting was repaired in the mid-2000’s, the damage was probably irreparable: super-size compensation packages continued to be the norm in American companies. Even though there’s complete expense recognition given to pay denominated in options, and even though there’s now a compensation effect on earnings - equity instruments for pay continue to be dispensed like water from a fire hose.

    Instead of focusing simply on the compensation of a handful of executives, investors should focus on the relationship between “incentive” compensation and other forms of deferred compensation - like pensions. Investors worry about being on the hook for contributions to sinking pension funds - but fail to consider how management stock comp largesse compares to pension funding. Investors also fail to compare firm-wide stock comp largesse to factors affecting corporate returns - factors like research and development or capital expenditures. Finally, investors fail to look at how their ownership interests are crowded out by stock comp plans. These overlooked relationships are examined for the S&P 500 in this report.

Since 1976, lease accounting by lessees has been fairly consistent - which is to say, there hasn’t been much accounting for the assets used by lessees in their operations beyond the recognition of rental expense in the income statement. That’s because FASB Statement 13, “Accounting for Leases,” divided lease reporting into capital and operating leases. The capital lease treatment results in leased assets being reported on balance sheets and depreciated, along with a related lease obligation; the operating lease treatment showed no assets or liabilities on the balance sheet, but reported lease payments as rental expense. Being a “bright line” kind of standard - one whose application depended on meeting explicit criteria - Statement 13 resulted in minimal lessee recognition of leased assets and obligations.

IFRS lease accounting standard IAS 17 is less prescriptive than its U.S. counterpart, but produced similar results: a surfeit of operating leases, and a dearth of capital (or finance, in IFRS parlance) leases. In 2006, the FASB and the IASB started work on a joint project to remedy lessor and lessee accounting; to speed the process along, they decided in July 2008 to focus only on lessee accounting as a first phase. A “discussion paper” was issued in March 2009. If the provisions of the discussion paper become a final standard, balance sheets around the world will no longer be spared from showing the assets and obligations involved in producing returns - regardless of whether assets are leased or purchased.

In April, the FASB squeezed out a trio of amendments to various fair value reporting standards, in response to Congressional coercion to “do something” about the financial crisis. The Congressional threat: if you don’t do something, we’ll legislate relief from your standards.  Those three amendments - FASB Staff Positions, or FSPs for short - become effective in the second quarter. Firms were permitted to adopt them early, in certain combinations of the standards. Because one of the FSPs blunted the reported earnings effect of writedowns of impaired securities holdings, an incentive exists for firms with shaky capital to adopt early. At least 94 firms adopted the trio of standards early; 20 of them were members of the S&P 500 financial sector. Early adoption of the FSPs spared them pain: without deploying them, the S&P 500’s financial sector would have reported half as much in earnings for 2009’s first quarter.

The Obama administration is now moving its attention away from ending the economic crisis, and is focusing on ways to fund the cure - and fund the rest of the nation’s spending, too. The administration has released its fiscal year 2010 revenue proposals, and there are some bold, ambitious plans in it for changing the way multinational firms figure their U.S. taxes. One part of the plan: reduce or eliminate foreign tax benefits that corporations have long enjoyed.

It’s still early in the horse-trading game. Companies may have to live with some dire consequences to their business models that have developed over the years, but they also might get something in return: maybe a lower marginal tax rate or increased tax benefits for new hires or investment. While foreign earnings remain the tax target of choice, however, it’s wise to figure which companies are at risk of having the biggest changes in their multinational way of life - and what consequences their investors might face aside from just higher income taxes. There are plenty of clues firms give about their foreign operations, but they’re veiled and rarely cohesive. This is a great time to get familiar with them, and in this report, we show you how to find them and evaluate them.

The pressure brought to bear on FASB to “fix mark-to-market accounting in three weeks or else” - Representative Paul Kanjorski’s message during March 12 hearings - resulted in the release of twin proposed FASB Staff Positions on St. Patrick’s Day, with a comment period ending on April Fool’s Day. For investors, there’s nothing to celebrate in these proposals; for a bank, their passage will be like owning the keys to the U.S. mint. In preparer/auditor debates over impairment, these changes will give the upper hand to preparers in valuing assets and postponing impairment recognition.

If bad news is best delivered first and in the greatest detail, then this must be 10-K season. There’s bad news aplenty out there in the market, and now an up-close-and -micro version of it is landing on your desk and seeping into your e-mail box. Yes, it’s that time of year again.

    This is the twelfth Accounting Observer heads-up on what to seek in the current batch of annual reports. Easy prediction: this year’s annual reports are going to be thicker than ever. Preparers and auditors ought to be erring on the side of caution and putting out more disclosure than ever, as reporting risks are magnified by the credit crisis. The exercise for investors remains the same: you get out of it what you put into it. There’s no single magic disclosure or ratio that’s going to save you the kind of investment agony experienced in 2008 (and so far in 2009, too.) Reading the annual reports well enough to understand the risks involved might scare the dickens out of you - but it might also lead you to the right kind of investment decisions.

    Get the most out of the annual reports: have a plan. Don’t just expect“something important” to smack you in the face if you blaze through them - figure out what’s most important first, then search for it as you read the whole thing. Be aware of how the current environment affects the company; and look for information in the accounting that either supports or contradicts what you expect. Fire up a pot of coffee, and let’s get going.

In late November, the SEC released its long-anticipated “roadmap” proposal for bringing the United States financial reporting under the umbrella of International Financial Reporting Standards (IFRS) as issued by the International Accounting Standards Board. If you accept the premise that IFRS is the financial reporting road the whole world is traveling upon, then old-fashioned U.S. GAAP is the road less traveled.

Maybe Frost had it right. Investors are better off taking the road less traveled; it could make all the difference in the world to them, if this current proposal is the only alternative. That’s not because the standards embodied in the IFRS are inherently unsound. It’s simply because the proposed plan for conversion to IFRS from GAAP is an idea that is ahead of its time. When the milestones outlined in the proposal have been completely achieved, then the conversion might really benefit investors. The proposed timetable is hardly credible, however.

Billed as a single proposal, the “Roadmap document” really contains two proposals: one allowing firms to convert to IFRS early, and a second proposal describing how the transition will take place assuming all the milestones have been accomplished. Investors who don’t plan on retiring in the next five years - and there aren’t many these days - and who also plan on using financial statements should pay attention to this proposal’s implications for them.

Want to know where financial reporting is at its worst? Check the docket of the Financial Accounting Standards Board. Investors and analysts wanting a laundry list of accounting standards needing repair - due to abuse, clever investment bankers’ innovations, or a little of both - can find one in the FASB’s "to do" list. There’s something new added each quarter. Sometimes investor information needs repair because new kinds of deals "end-run" existing standards and disclosures; sometimes standards need repair because the existing ones were poor from the start.

It’s often said that accounting is the language of business and investing - and if that’s so, an issue worthy of a place on the standard-setters’ agenda, ought to be worthy of investor note. It means that the "language of business" is in trouble, with flawed information being provided to investors.

Another reason for watching the FASB agenda: accounting proposals that become actual standards often result in changed corporate behavior. Investors should understand changes to accounting standards themselves, so they can evaluate managers’ resulting actions. Investors choosing to ignore what’s hot in accounting do so at the risk of missing new meanings in "the language of business."

The American Institute of Certified Public Accountants held its annual "Current SEC & PCAOB Developments Conference" in Washington, DC last month, with speakers from the SEC, the FASB and the PCAOB. Swarms of accountants from all parts of America gather each year to capture year-end audit advice from the SEC’s staff. Even though the economy has belted accountants as well as investment bankers, the attendance was still around 2,500.

Soon, those same auditors will be poring over client’s accounting records, playing a gatekeeper role in the financial reporting process. From the auditor’s point of view: why let a client waste their time - and yours - pursuing a shaky accounting treatment if the SEC has already described its views on it during this conference? Forewarned is forearmed; that’s one reason this conference is so well-attended. The conference is three days’ worth of warnings and reminders to wake up auditors. The smart auditors take advantage of the accounting intelligence gathered by the SEC during the year, and imparted to the audience; the not-so-smart ones skipping the conference learn things the hard way by making the mistakes brought to light by the SEC’s staff. Three days spent at this conference can pay off handsomely in terms of time saved.

What’s in it for investors? They should understand issues covered at this conference as well. The SEC staff sees financial statements in the review process long before investors read annual reports; what curious investor wouldn’t want to know what the SEC has found objectionable in their reviews? While the SEC staff comments won’t predict accounting meltdowns in the making, their comments should remind investors that some firms may either misunderstand or misapply generally accepted accounting principles. When the correction or revision arrives, the ensuing market confusion can be enough of a reason for investors to care about "what keeps the SEC busy."

The full effects of the Emergency Economic Stabilization Act of 2008 won’t be known for years. No other piece of legislation has ever had such an impact on the relationship between business and government - or between capital and ownership of capital. The line between shareholders and state has become quite blurry.

It might have an impact on the way that companies report their results to shareholders, too - and it won’t take years to find out. The EESA charged the SEC with conducting a study on "market-to-market accounting standards as provided in Statement Number 157 of the Financial Accounting Standards Board, as such standards are applicable to financial institutions, including depository institutions." The singling-out of the oft-demonized "Statement Number 157" gives hope to the banking lobby seeking to overturn fair value reporting.

Will the SEC act in the interests of shareholders and avoid any "reform" of fair value reporting? Or will it cave in to the demands of bankers who couldn’t resist their primal lending and investing urges? Politics is never a sure thing - but it’s possible to take a close look at the SEC’s responsibility under the Act and see what facts they might find as they execute their duty. How they will interpret those facts - and then act upon them - is very much an open question until January 2, when the SEC report of its findings and determinations is required to be submitted to Congress.

If 2008 ended today, there would be no tears shed on Wall Street to mourn its passing. (Except for the shorts who made the right calls on financial institutions.)

2008’s effects on the financial condition of companies in 2009 are starting to be puzzled out by Wall Street, however. When 2008 finally does end, the funded status of defined benefit pension plans on that day will have ongoing effects in 2009. Unless there’s a sudden updraft in world markets, pensions will likely be seriously underfunded. That will have consequences for 2008 balance sheets - and 2009 reported earnings and cash outflows.

Precise estimates of how funding status will affect current balance sheets and future earnings and cash flows are not possible, but investors can at least develop ranges of outcomes to help them consider exposures. Offered here: reminders on pension reporting mechanics to help one better evaluate a firm’s pension prospects.

Financial tsunami, unprecedented volatility, history-making intervention - the financial press has already exhausted its supply of clichés, and we may be in just the early innings of the game. (There’s another one for you.)

No matter what happens next, analysts and investors still have to parse the financials - and they always start parsing the minute the earnings are released. The earnings call is where, for better or worse, many snap judgments get made by investors based on scanty information. What’s left unasked in the conference calls might be the nugget or two that provides a springboard for more management discussion leading to profitable insights.

Miss your chance to ask relevant questions in the earnings calls, and you might not get another chance. In a Regulation FD world, it’s not as easy to get a straight answer to a tough question; CFOs and investor relation managers fear giving information in a way that might be deemed "selective." After a quarter like this one, the third quarter earnings calls will be more crucial than usual - and you don’t want to wait for the 10-Qs to show up. They might not even contain the information you want. Offered here: 20 questions to ask (or listen for) in third quarter earnings calls which might expose risks or reveal operating nuances that help you better understand a firm’s performance or financial status.

Last month, the sweeping changes in acquisition accounting, Statement 141 (Revised), were reviewed. One aspect of the new acquisition accounting: firms will have to change the way they account for what’s long been called "minority interests" that result from the firm taking only a partial investment in another firm. Statement 141 (R) will make firms report existing minority interests at their current fair value when there’s a change in ownership stake, as in a step acquisition.

Changes in minority interest accounting didn’t stop there. Rather than lard up the acquisition standard with new accounting for minority interests, the FASB issued a separate standard for the second-level effects of acquisition accounting. Statement 160, "Noncontrolling Interests in Consolidated Financial Statements" changes many facets of these financial statement ghosts, resulting in a treatment more comparable to international financial reporting standards. While investors don’t often pay much attention to minority interest amounts, either on the balance sheet or the income statement, the new standard will make subtle changes affecting basic calculations in return on equity, leverage ratios, and profit margins.

"Sweeping" is perhaps the best word that describes the changes in acquisition accounting coming up in a few short months. Around the turn of the century, the original Statement 141, "Business Combinations," tossed out the opaque pooling-of-interests accounting choice for merger accounting. In tandem with Statement 142, "Goodwill and Other Intangible Assets," which ended the amortization of goodwill, the last revision of acquisition accounting seemed revolutionary.

As far-reaching as those changes were, there was plenty of room for improvement in accounting for acquisitions. Four years after the 2001 standards went into effect, the FASB and the IASB jointly considered revising their respective business combination standards. The completed FASB standard, Statement 141(R), goes into effect in years beginning after December 15, 2008. Naturally, it will only affect those firms making acquisitions - so there won’t be any broad-based effects to notice immediately. Over time, however, practically all companies acquire others - and the increased transparency created by Statement 141(R) around deals will show much more about the economics of deal-making and the after-effects. The overarching theme of the new standard: more fair value reporting, at the time of an acquisition and in reporting afterwards.

It’s not the addiction it used to be. Issuing stock options as a way of rewarding employees is not as prevalent as it once was, and restricted stock compensation has moved to the forefront. When stock option issuance was at its most popular, financial reporting was seriously incomplete because the faulty accounting for stock options did not show investors all the costs of production - and at the companies where options usage was heaviest, costs were the most understated.

The required application of Statement 123(R) in 2006 changed that: it put options on the same level accounting playing field as cash and restricted stock awards. No more "stealth compensation." While many pundits expected investors to be turned off by sudden recognition of stock option compensation, the S&P index advanced almost 14% in 2006 - and the earnings of the S&P increased over 21%, despite new recognized costs. The sky didn’t fall in 2006.

The sky did fall in 2007 - but it wasn’t because of stock option accounting. Though companies now have to account for all manner of compensation, they still don’t always seem to take shareholders into consideration. This report examines trends in stock compensation for both restricted stock and options in the S&P 500.

Credit derivatives have certainly made life interesting in the last year. Perhaps the most common credit derivative is the credit default swap. They’re over-the-counter derivatives that are essentially a bet on the creditworthiness of another party. They’re not very different from an insurance relationship: one party guarantees the performance of another, for a fee.

Where credit default swaps become problematic for the entire economy: how creditworthy are the firms making the bets - the counterparties? There isn’t much public reporting of the prices of the swaps themselves, and no central clearinghouse for trades. Credit derivatives are often employed or written by non-public players like hedge funds or sovereign entities, so there isn’t much visibility into their activities. Even at the level of publicly-traded companies taking on financial responsibilities tied to these instruments, there’s an informational drought. That’s patently unfair to investors: while they might be satisfied with the liquidity and cash-generating ability of a firm in which they’ve invested, they could still be blindsided by said firm’s obligation to pay for an entirely different firm’s failure to meet its obligations. Without disclosure of such obligations, an investor would never know about such potential.

The least heavy-handed kind of regulation may be on the way: sunshine, the best disinfectant. The FASB has proposed a welter of disclosures to be effective in financial statements beginning in fiscal years ending after November 15, 2008. If the proposal goes through as planned, there could be a lot of panicky dispatching of credit derivatives in the second half of 2008 by players afraid of showing too much exposure.

Opinions vary as to the current state of the credit crisis: we’re near the end or we’re somewhere in the middle, depending on whose data you believe. Regardless of the progress made, one fact is clear: when the credit party was in full swing, it was hard for regulators to monitor all the bad loans made. That’s because they were cleared off lenders’ balance sheets as soon as they were made through the alchemy of securitization, where illiquid assets like mortgages and receivables are packaged into bond-like securities. Once those securities are dispersed through the financial system, it’s hard to tell where the damage resides. The underlying mortgages go sour, and so do the securities that may have traded many positions away from the initial securitization.

The accounting for securitizations is either simple or overly complex. If firms treat securitization transactions as secured borrowings, the accounting is simple. Should firms treat securitizations as a sale of assets, the accounting is tortured to make it fit into the concept of a sale. The sale treatment may have contributed to the current financial distress: if securitizations accounted for as sales had been more accurately accounted for as financings, balance sheet leverage might have limited securitizations of the more treacherous assets.

As so often happens with accounting standard-setting, it’s time to fix the barn door: the horse is three counties away. In January, the SEC acted schizophrenically on securitization accounting. On one hand, it promoted the continuance of the tangled accounting model in Statement 140 by giving a bye to lenders who renegotiate mortgage loans already sold in securitization transactions; on the other hand, it instructed the FASB to fix the underlying principles in Statement 140 that have caused issues. The FASB is close to issuing possible changes to Statement 140 that, if enacted, would cut the number of new securitizations earning sale treatment - but the fix is not going to be pretty or popular with either preparers or auditors. Without widespread acceptance, it’ll be hard for FASB to get the fix in place by year end.

Pension plans were at the forefront of investor attention a few years ago: the confluence of low interest rates and a multi-year bear market inflated unfunded obligations for defined benefit pension plans. The prospect of federally required contributions to those plans focused investors’ minds on them; they didn’t pay nearly as much attention to other postemployment benefit (OPEB) plans, where there’s no similar governmental push on funding. Nevertheless, the same outside forces - bear market, low interest rates - swelled unfunded OPEB obligations.

Last year, a new accounting standard (Statement 158) plopped the funded status of both kinds of benefit plans onto a sponsoring firm’s balance sheet, without changing any of the other accounting for benefits. Statement 158 couldn’t have arrived at a better time to go unnoticed: pension plans came close to the edge of being fully funded for the first time in years. In the S&P 500, the median funding ratio (assets to plan obligations) was over 94% for pension plans, the ones that can bite investors hardest. OPEB plans weren’t nearly as well-funded, but they also improved markedly. It’s too early to tell what 2008 will bring, but if the early turmoil is any indication, Statement 158’s "on-balance sheet" reporting of benefit plans might draw a lot more attention than last year. Should benefit plan funding take a giant step backwards, at least it will be a retreat from a strong position. This report shows which S&P 500 firms had the strongest and weakest benefit plans at the end of 2007.

Like a team of heart surgeons defibrillating a patient, the SEC has kick-started the moribund convergence movement between the FASB and IASB accounting standards. The first electrical jolt, administered last summer, was a proposal to eliminate the reconciliation requirement for foreign filers using full IFRS reporting. That proposal is now a rule: those foreign filers reporting on the IASB’s International Financial Reporting Standards (IFRS) no longer reconcile their earnings or stockholders’ equity to a U.S. equivalent under generally accepted accounting principles. The elimination of the requirement came about before the filing of 2007 financial statements for most firms, so there’s no up-to-date pool of firms making visible the differences between the two reporting systems.

The SEC’s second electrical shock, also administered last summer, contained even higher voltage: the Commission proposed that U.S. firms be allowed to choose between reporting under U.S. accounting standards and IFRS. While the SEC hasn’t issued a decision on that proposal yet, it would be hard pressed to let foreign filers report on an IFRS basis without reconciling to U.S. standards, while requiring domestic companies - who might be competing directly with those foreign filers - to report on the U.S. basis.

The underlying presumption in both SEC proposals: the two sets of standards aren’t all that different, and they produce pretty much the same results. It requires some imagination to accept that premise, however. This report analyzes the impact of the differences for 137 companies providing the reconciliation in 2006, and the differences can be wide. For 63% of the companies, the IFRS reporting basis increased earnings over the GAAP reporting; for 34% of the firms, IFRS reporting results were lower than GAAP results. The pattern held for return on equity: 64% of the firms showed higher ROE on IFRS compared to GAAP, while 33% reported lower return on equity on an IFRS basis.

While the data may seem old, it’s the most current available - and the results are still relevant because, save for business combination accounting, most differences between the two sets of standards remain at this time.

Once-a-year events have a special cachet that resonates with people. Usually the resonation has to do with getting people to do something, like shopping: end of car model year closeouts, for instance. Christmas. Valentine’s Day. President’s Day. Memorial Day. And so on.

There’s a once-a-year event facing investors soon, and it also has to do with shopping. It’s the arrival of the annual reports and 10-Ks. Armed with the information packed within those documents, investors can ask managements better, tougher questions. They’ve got more data to analyze, and they can question the assumptions that held them captive to management dodging all year long. In short, the once-a-year gift of annual reports and 10-Ks lets investors shop harder, and lets them base investment decisions on facts, not hunches.

To get the most out of the annual reports and 10-Ks, it helps to have a plan. Blindly trying to bulldoze through all umpteen pages of a 10-K and expecting "something important" to pop up and hit you in the face is pure magical thinking, at best. At the other extreme, believing there are just a few "most important disclosures" that will reveal the future is also pure magical thinking. A better strategy is to be aware of the overall environment; map out ways that it can affect the company under review; and look for information in the accounting that either supports or contradicts what you expect. Learn from the reading. Rinse, lather, repeat. Here’s a look at the new information in this year’s annual reports that can help you shape your thinking and expectations about your companies - and a few reminders about the perennial soft spots in financial reporting.

Investors and analysts wanting to know where accounting is in most need of repair - because of abuses, financial innovation, or some combination of both - would do well to review the FASB’s docket. Every year, there’s something new added simply because the information available to investors needs to be improved. Sometimes investor information needs improvement because new kinds of deals skirt rules around existing standards and disclosures; sometimes information needs improvement because the governing accounting standards were never very good in the first place.

So, if accounting is the language of business and investing, and an issue is important enough to make it to the standard-setters’ agenda, investors ought to pay attention. It means that the "language of business" needs repair, and there’s an information gap that affects investors.

Another incentive to watch the FASB agenda: when accounting standard proposals turn into accounting law, corporate behavior can change. When a new accounting standard improves the measure of a corporate asset or liability, managers behave differently. Investors should understand it themselves, to be able to evaluate managers’ actions. Investors choosing to ignore what’s hot in accounting do so at the risk of missing meanings in "the language of business."

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. Another goal is to reduce "diversity of practice" occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. That's only one goal, however, and not the prime reason the EITF tackles issues. While some of the issues addressed by the EITF will have more importance to users than others, many will be invisible to users. The results of some EITF consensuses are deeply woven into the financial reporting fabric. The following is a synopsis of the issues where tentative consensuses were reached at the March 15 meeting.

The American Institute of Certified Public Accountants held its annual "Current SEC & PCAOB Developments Conference" in Washington, DC last week, featuring speakers from the SEC, the FASB and the PCAOB. It’s an annual "winter carnival of accountants" from all across America who meet each year to gather year-end audit intelligence from the SEC’s staff. This year, the carnival’s attendance approached 3,000.

Over the next few months, auditors will be swarming over client’s accounting records, playing their critical role in delivering the financial reporting package to investors. As in any service endeavor, time is the most precious asset: why waste time letting a client pursue an easily challenged accounting treatment if the SEC has already described its approach to handling it? Forewarned is forearmed, and this conference provides auditors and companies with plenty of forewarning. Over a three-day span, it’s chock-full of warnings and reminders that can in the literal sense, too: the conference was beamed to the West coast and London.) In planning for accounting risks they might encounter in the audit engagement, the three days spent at this conference might pay off in a big way in terms of time saved later.

It makes sense for investors to understand issues covered at this conference too. The SEC staff sees financial statements in the review process long before investors read annual reports; investor curiosity should be aroused by what the SEC sees before the financials are made ready for prime-time. SEC staff comments don’t predict accounting disasters - but their remarks serve as a reminder that some firms may either misunderstand or misapply generally accepted accounting principles. When the correction/restatement finally comes, there’s often ensuing market confusion. That’s reason enough for investors to care about what keeps the SEC busy.

Plenty of ink has been spilled in the financial press about the coming implementation of Statement 157, "Fair Value Measurements." Most of that coverage is negative: companies have been pushing back on the standard, petitioning the FASB to delay its implementation for one more year. "Level 3" has worked its way into investment jargon, synonymous with the already-cliched "mark-to-myth" designation.

What casual observers miss: Statement 157 doesn’t appreciably expand the use of fair value measurements. What it expands, however, is the amount of disclosures surrounding fair value reporting. Without those disclosures, nobody could make clever "mark-to-myth" remarks about Level 3 assets. Another miss: fair value reporting is nothing new. In fact, before the controversial Statement 157 was issued, the FASB’s two previous statements actually expanded the use of fair value measurements - and their arrival went unheralded. That may be due to the fact that Statements 155 and 156 were elective, rather than required to be adopted by companies. Statement 159, issued after the Statement 157 demonification began, was also elective - and it’s come in for its share of criticism ever since.

This report looks at the implementation of "Statements 627" in the real world. (That’s 155 + 156 + 157 + 159.) Lessons: you don’t hear gripes about fair value reporting when firms want it. And for all the clamor about Statement 157 at the large investment banks, there’s been surprising level of adoption among the small firms.

About four years ago, contingently convertible bonds - or "CoCos" - were enormously popular because they hardly affected the issuer’s earnings per share calculations. Bearing slim coupons, they had the added benefit of rarely increasing the EPS denominator share count - at least, until the FASB’s Emerging Issues Task Force reached a consensus that such hybrid instruments should be treated as "if-converted" for purposes of EPS calculations, regardless of any contingencies needing fulfillment. That left a less popular convertible bond, known in accounting circles as "Instrument C,"as the best bet of companies trying to raise capital without affecting earnings or share count. These convertibles are low-coupon issues, and because only a portion of the convertible feature is handled on a treasury stock basis, there’s practically no effect on earnings per share for the issuer.

Money for nothing; interest for free. "I want my Instrument C!" became the rallying cry of corporate treasurers, after "CoCo bonds" became unattractive in 2004. Yet Instrument C is also a gimmicky creation designed to fall into the cracks created by a patchwork of accounting standards relating to earnings per share and convertible securities. The Emerging Issues Task Force tried unsuccessfully to improve the accounting for Instrument Cs in early 2007; failing to do so, the FASB itself took up the effort afterwards. Their solution for improving the accounting for Instrument Cs would be easily applied by issuers - and would have the effect of increasing interest expense and lowering earnings per share, all on a retrospective basis, to boot. Expect corporate resistance to their proposal - particularly from Wall Street firms that underwrite these things.

Just two short years ago, the chief accountant of the SEC laid out a "road map to convergence" for the melding of United States FASB accounting standards with the International Financial Reporting Standards (IFRS) issued by the International Accounting Standards Board. Don Nicolaisen’s road map ultimately called for the elimination of the IFRS-to-GAAP reconciliation in SEC filings by the year 2009 or sooner. "Sooner" is looking like "now:" in July, the Commission issued a proposal for the reconciliation’s current elimination. In August, the Commission issued a Concept Release to test the merits of allowing U.S. registrants to choose between FASB standards and IASB standards in preparing their financial statements - a more extensive proposal that could eventually put all accounting standards under one roof, but create surprising costs and inefficiencies along the way.

Should these two proposals become reality, the main benefit to shareholders would be an increase in investment choices on the United States exchanges: conversion to United States-style reporting, a long-standing barrier to foreign filers, would be removed. The exchanges would likely be flooded with new registrants. The question: are more choices always worth the cost? This report presents the highlights of the two proposals. It also compares 129 IFRS-to-GAAP reconciliations by foreign registrants to see if the two reporting systems currently produce similar results. The short answer: there are still plenty of major differences between them.

A few years ago, pensions were foremost in the minds of most investors as the oft-cited "perfect storm" of low interest rates and miserable asset performance swelled the unfunded obligations of pension plans. Other postemployment benefit (OPEB) plans didn’t generate nearly the same level of investor concern, despite the fact that they were also negatively affected by lower interest rates. Because OPEB plans are rarely funded, there was little cause for concern from the falling stock markets - and because OPEB plans put more discretion in the hands of the employer/sponsor than pension plans, investors shrugged. If things got bad enough, managers could always take a hard line on the plans and terminate them.

Since those dark days for benefit plans, the accounting for them has changed - neatly slicing $152 billion from the stockholders’ equity of 309 S&P 500 companies, and mostly increasing their stated leverage. The new accounting - Statement 158 - did nothing to change the way a benefit plan’s funded status would be counted; it merely put that funded status on the sponsor’s balance sheet, whether overfunded or underfunded. That funded status improved again at year end 2006 - despite declining contributions to the plans. As share buybacks increased in popularity, benefit plan contributions decreased. What might give investors pause right now: many plans have significant asset allocations to alternative investments, which might be getting rocked in the current market tumult, prompting the question of renewed contribution increases later.

FASB Interpretation No. 48, "Accounting for Uncertainty in Income Taxes," became effective on January 1 for calendar year end companies. It was preceded by much corporate angst: though it had been exposed for comment in mid-2005, and issued in final form in mid-2006, firms argued vigorously in December 2006 that they wouldn’t be able to implement the standard on such short notice. The FASB received 435 unsolicited letters in the couple months just before the January implementation deadline. It sounds like even more of a protest when you compare it to the 119 responses to the standard’s 2005 exposure draft.

If not for the last-minute corporate caterwauling, the effects of FIN 48 might not have been so highly anticipated. This review of 100 large S&P 500 companies shows that the actual balance sheet impact of the implementation was fairly light-handed. While disclosures about the amount of "tax reserves" improved significantly, effective tax rates were apparently not affected much by the new standard. It’s the disclosures yet to come, however, that might have the most impact, and that’s most likely why firms stonewalled at the bitter end. How could the disclosures be so significant? Simple: they’re likely to leave clearer clues for the Internal Revenue Service to follow in their quest for closing questionable tax practices.

Issued last February, Statement 159 gave companies immediate and unprecedented flexibility in changing the way they account for a whole slew of financial instruments - from equity method investments to debt issued by the firm itself. The standard allowed quick-footed chief financial officers to take advantage of early implementation if they adopted the standard as of the beginning of the fiscal year beginning after 11/15/06, hadn't issued financial statements for the first quarter, and completed the adoption within 120 days of the beginning of the fiscal year. Very unusual implementation criteria, indeed. That first criteria - adoption allowed for fiscal years beginning in fiscal years after 11/15/07 - made it possible for the multitude of companies with November fiscal year ends to early adopt. The only companies with November fiscal year ends adopting the standard were the banking monoliths, however. A search of first quarter 10-Qs produced only sixty firms that adopted Statement 159. Out of those who chose the fair value option, some companies found good use for the standard: better balance sheet presentation, easier hedging, and simpler accounting for investments. Others managed to find the bad parts of the standard: they gamed the transition provisions in order to bury impairment charges. The ugly upshot: Statement 159 brings good and bad reporting to the investors' table, and it's up to them to figure out whether a company is using or abusing the standard. Investors need to understand Statement 159 pitfalls before its wider application in 2008.

In 2006, after more than a decade of wrangling, investors were finally treated to earnings containing the cost of all employee stock compensation issued. Those figures included the value of stock options, long invisible in the income statement due to an exception built into accounting standards. Statement 123(R) eliminated that exception. Despite all the corporate trepidation surrounding the implementation of Statement 123(R), its effects were downright tame. Investors didn't crunch the stock prices of companies with plenty of recorded option compensation; they chose to ignore it - or were led to ignore it by those same companies. Market observers worried about the effects of stock option recognition on profits for years - but after implementation of Statement 123(R), the S&P 500's earnings still advanced a healthy 17% in 2006. Even though all manner of stock compensation is fully accounted for in financial statements now, firms still employ it readily. At the same time, valuation of stock options granted also remains a constant concern for investors. This report examines trends in stock compensation - for restricted stock and options - in the S&P 500.

Last September, the Securities & Exchange Commission's Office of the Chief Accountant issued Staff Accounting Bulletin No. 108 to provide guidance to companies in considering the materiality of known errors in financial statements issued in prior years. In most walks of adult life, it's understood: you make a mistake, you 'fess up and learn from it. Sticking with a mistake only seems to compound the consequences. So - why the need for regulatory "guidance" in deciding whether or not a financial reporting error needs a correction? Simple: after cultivating an aura of invincibility and precision ("earnings came in as targeted"), companies are loathe to admit an error for fear of looking dumb to investors. Another reason: when it comes to the plaintiff's bar, managers don't want to look like a pork chop waved in front of a coyote. Taking blame for flawed financial reporting can do that. The SEC has a ground-level view of what's under the financial statements; they know that companies have harbored errors in balance sheets for years. Issuing a Staff Accounting Bulletin on error corrections gets them aired, and gives companies some cover to get their sins cleansed "because they had to do it." SAB No. 108 has been little-noticed by investors, largely because in certain circumstances it permits the correction of errors by adjusting beginning-of-year retained earnings. It's not often that investors prowl the statement of changes in stockholders' equity, so they'll miss SAB 108 adjustments unless they notice their mention in the footnotes. There are some real differences in the way large companies and small companies have handled past errors and their corrections under SAB 108. Furthermore, investors who look at return on equity as a measure of operating performance can be misled by the SAB 108 "catch-up" treatment: error corrections that decrease equity can improve return on equity, perversely making companies with flawed reporting look like they're doing a better job with shareholder interests.

Last month, the FASB issued Statement 159 - "The Fair Value Option for Financial Assets and Financial Liabilities." The statement didn't draw much attention in the financial press. After all, it's not a standard that will torch earnings with newly-recognized expenses like Statement 123R added when it required accounting for stock compensation, or shine a light on shadowy leverage in balance sheets like Statement 158's changes in benefit plan accounting. It's an option, not a requirement; unless firms choose it, life will go on as usual for investors. And if firms choose to adopt Statement 159, investors should be s not likely that there will be many early adopters of Statement 159, investors might start seeing its application in financials as early as the first quarter of 2007.

Some investors believe that accounting information should help them "see around corners" - to let them predict disasters long before they occur. That's an admirable ambition, but a bit lofty. It's more important to see a truck bearing down on you. Flattened investors ignored many trucks over the past decade. Put another, less graphic way - don't ignore the obvious. Once a year, the obvious is on display in the annual report. It's the best chance for an investor to get a grip on whatever risks might be lurking underneath the sound-bite earnings releases of the past year, embellished with slick PowerPoint presentation slides. Read them with a healthy dose of skepticism, and you might question your beliefs about a company and its managers. You have to look for the truck; you have to assume it won't stop for you . To that end, you can't just expect to review a couple of "key disclosures" to save your hide. You have to look at the whole package - and it's not just numbers. There are more "contextual" kinds of lessons to be learned from the disclosures added to the financial reporting package over the last few years. Here's a look at the new information in this year's annual reports that will generate investor buzz and some reminders about the perennial soft spots in financial reporting.

There's an old saying in accounting circles: "Accounting is the language of business and investing." It's not just self-elevating twaddle. It's true - and if you don't think so, take a look at the pile of comment letters received by the FASB and the SEC every time they propose something that hones the information within financial statements. If an issue is important enough to make the standard-setters' docket, investors should want to know about it. Additions to FASB's agenda mean there are problems in current reporting; it means that the "language of business" needs to be fixed. Another reason for investors to take an interest: as proposed accounting standards become accounting law, corporate behavior often changes. New accounting standards often provide better measurement of some corporate activity - whether they're income taxes, stock options, health care benefits or pensions, to name a few. And once an activity is measured, or measured better than before, it starts to be managed differently. Understanding new accounting standards can t want to know what companies will do to avoid speaking "the language of business" more clearly? Then ignore the activities of the FASB.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One goal is to reduce "diversity of practice" occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users. The following is a synopsis of the issues where tentative consensuses were reached at the meeting on November 16.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One goal is to reduce "diversity of practice" occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users

The backdating maelstrom has focused even more attention on the subject of executive compensation, if that's possible. With high-profile departures at some of the firms that are subjects of investigations, it's no wonder that attention is turning onto executive option grants. The presence of above-average amounts of option grants to top executives in some of the firms being investigated also piques investor interest.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One goal is to reduce "diversity of practice" occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users. The following is a synopsis of the issues where tentative consensuses were reached at the last meeting on June 15.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One of its goals is to reduce “diversity of practice” occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users. The following is a synopsis of the issues where consensuses were reached at the last meeting on March 16.

The American Institute of Certified Public Accountants held its annual "Current SEC & PCAOB Developments Conference" in Washington, DC last week, featuring speakers from the SEC, the FASB and the PCAOB. Each year, this conference swarms with accountants from all parts of America who want to hear first-hand from the SEC's staff about accounting issues that rouse them. This year's swarm was 2,900 strong. Auditors need to know these issues: when dealing with audit clients in the next few months, forewarned is forearmed. The same goes for dealing with the SEC, too. Why waste valuable audit field time on issues that the SEC already publicly addresses at this giant venue? The conference can provide business intelligence for the conscientious auditor: it's full of "knowledge nuggets" that can put an auditor on s often ensuing market confusion. That reason alone should interest investors in what keeps the SEC busy.

In little more than a year, financial statements will bear disclosures with strange new terminology. Investors will be grappling with the meaning of things like "Level One inputs, Level Two inputs" and "Level Three inputs." What does that mean? Are they references to CFA examination results? Video game challenges? Different circles of hell? None of the above. (Although some reporting firms might conclude that they're the latter.) The answer is that they're references to a new broad-reaching accounting standard : Statement No. 157, "Fair Value Measurements." That standard will change the way many firms measure and report the fair value of assets and liabilities in their financial statements. It comes with its own warning system indicating when the reported numbers might deserve more investor skepticism: that's the message in those different "input levels." Understanding what's underneath those input level warnings is a necessary skill for investors to build before they start dealing with the warnings.

Like it or not, assumptions that are built into much of financial reporting. They're embedded in everything from accounts receivable (how much will never be collected?) to warranty expense (what will be the repair rate on cars sold?) Like it or not, firms can use assumptions to finesse earnings so they meet Wall Street expectations. And like it or not, firms are now required to report stock option compensation for the fair values of option grants - using estimates of underlying stock volatility. In the Black-Scholes model used by many firms, lowering the assumed volatility input will lower the compensation expense to hit earnings. The incentive to low-ball is high. The volatility input is not something that can be observed with great precision; it is, after all, an estimate made by management about the way the firm's stock will behave in the future. At the same time, the changes in the volatility assumption leave a trail of circumstantial evidence as to whether or not management has "grooved" the volatility input to achieve a lower option fair value and compensation expense. Like it or not, it's one more variable that analysts and investors have to consider in the full context of the financial statements. A look at the volatility inputs of the S&P 500 and Russell 2000 provides some background for determining whether or not wishful thinking is behind the input selection.

Defined benefit pension plans and other postemployment benefit (OPEB) plans inject all sorts of odd information into the operating results of companies sponsoring them. In June, we surveyed the state of employer promises for pensions and OPEBs of the S&P 500 - and looked at how balance sheets might be affected by the FASB's plans to move funding information out of the footnotes and onto corporate balance sheets. Consider that report to be a road map for navigating the balance sheet aspects of benefit plans - both present and future. This report reviews the current key assumptions underlying benefit plan reporting for the S&P 500, with a view toward the ways firms might "assume the best" to minimize the effects of the forthcoming balance sheet presentation.

Before there was option backdating, there was option vesting accelerating. It seems so 2005 now, as investors wonder what companies will be fingered next by the SEC or the US Office of the Attorney General - and for the most part, it is 2005's option compensation accounting issue. It lingered into 2006 because firms had until their fiscal year beginning after 6/15/2005 to put Statement 123(R) into effect. That awkward effective date made it possible for companies with fiscal years ending through May 2006 to "accelerate the vesting" of outstanding options and avoid recognizing the value of those options as compensation expense in earnings reported after 6/15/2005. The accelerated vesting gambit started in the summer of 2004, and it's now run its course: any firm that accelerates the vesting of employee stock options now will have to recognize the effect in earnings instead of easing it past investors through the footnotes. Vesting acceleration gave firms that ability to hide compensation expense a little longer. Investors may regard backdating as the more serious of the two option accounting transgressions but so far there are precious few details known about the extent and severity of backdating issues. Investors may tend to dismiss the acceleration of options as a non-event, yet the acceleration of options caused massive under-reporting of compensation expense. Worse: while companies may have defended their acceleration actions on the grounds that they related to only "out-of-the-money" options, some of those options have now come "into-the-money." Over $400 million of intrinsic value is now realizable by employees of just 49 firms that accelerated their "out-of-the-money" options over the last several years. No waiting, and no backdating - accelerating the vesting made it money for nothing. Speaking of backdating: some companies now in the news for backdating were accelerators as well.

"The road to hell is paved with good intentions." When it comes to stock options, truer words were never spoken - if indeed, options were ever issued with good intentions. Option plans have usually been cloaked in the guise of "alignment of management interests with shareholders." In view of the past spring's events, those appeals now appear more contrived than ever. And maybe not. In this post-Enron, post-SarbOx world, it's easy to look back at these transactions as one more example of unbridled executive greed. Some of them will be found to be just that - but it's also possible that some of these deals will be found to be less than completely malevolent. It would be surprising if every company that's being investigated or rumored to be a focus of an investigation was as guilty as they appear at the outset. Sloppy record-keeping and lack of attention to details may also play a significant role in backdating capers. The following is a look at the state of the investigations, the accounting issues surrounding backdating, and some venturing as to the endgame of the investigations

Mae West said it: "Too much of a good thing can be wonderful." That depends on your point of view. The employees receiving pension and health care benefits over the last fifty years or so would certainly agree with Mae. The employers paying them - and having to account more clearly for the amounts they promised, starting at the end of this year - would disagree with her. For them, too much of a good thing is awful. The following is a look at the state of employer promises for pensions and other postemployment benefits (OPEBs) in the S&P 500 - and also a look at how balance sheets will change if the FASB goes through with its proposal to move funding information out of the footnotes and onto corporate balance sheets

Corporate America's love affair with stock options has been winding down for years. In 2005, the passion dropped another few notches: for the S&P 500, option grants dropped 17% from 2004 levels. Fewer options were granted in 2005 than in 1995. At the same time, restricted stock continued to look like the new flame: restricted stock grants increased 22% compared to 2004 levels. Earnings misrepresentation due to suppressed reporting of stock compensation was 4% in 2005; it was 5% in 2004. One troubling trend: now facing full reporting of stock option compensation, many firms employing options are employing valuation assumptions that conveniently lower the estimated fair values of option grants - and consequently, lower their future expense. This is particularly unsettling after the wave of accelerated vestings of options observed in the past year.

In January, the FASB issued an exposure draft of a standard that could radically change the way financial statements look. By allowing firms the choice of reporting certain financial assets and liabilities at their fair values instead of their historical cost, financial statements might say more about the true state of corporate rights and responsibilities than they currently do. The downside: because it's a choice and not a mandate, firms won't be comparable to each other unless all of them decide to take the election or all of them reject the choice. One upside from the proposal: it could shore up balance sheets punctured later this year by another FASB proposal on pensions and other postemployment benefit obligations. Along with the "fair value option" proposal, the FASB has recently released Statements 155 and 156, which afford fair value treatment to certain hybrid financial instruments and servicing rights, respectively. There's a lot of commonality among those two standards and the more sweeping proposal, much of it favorable for both preparers and investors. Unfortunately, one common attribute is their "voluntary" nature.

Statement 123(R) holds the promise of putting firms' earnings on equal footing when it comes to their stock compensation reporting practices. That promise of more logical comparisons is ruined by the multitude of firms taking the low road to minimizing stock option compensation by "accelerating the vesting"of existing options. While the reporting of stock option compensation is still a mere quarterly footnote disclosure, these firms are setting the table for reduced compensation expense when Statement 123(R) finally becomes effective, which is in fiscal years beginning after 6/15/2005. When the calendar turns over, they would be charging the remaining value of their existing options against earnings - but these "accelerating firms" won't be recognizing that particular expense. Why? By accelerating the vesting of the options immediately, all of the expense is recorded in the period the vesting occurs. Voila - no stock option compensation to recognize.

The monotonous drone of media reporting about Statement 123(R) might lead one to believe it's been in effect forever. Wrong! It just feels that way - even though some firms with year-ends beginning after June 15, 2005 have been reporting under its requirements for half a year. The great deluge of Statement 123(R) reporting will be upon us when the calendar year companies begin reporting their results for the first quarter of 2006. There are still plenty of nuances surrounding the reporting under the new standard - many of them being global issues, as well as company-specific issues. They're reviewed here.

In the past year, the FASB produced very little in the way of major pronouncements - but added some significant major projects to its already-crowded agenda. The self-interested investor still needs to keep an eye on the FASB's agenda, regardless. Like it or not, the old saw is true: accounting is the language of business and investing. When something is important enough to make the agenda of the standard-setters, investors should want to know about it. Additions to FASB's agenda mean there are problems in current reporting; it means that the language of business is corrupted and needs fixing. Another reason for investors to take an interest: as proposed accounting standards leave the FASB's drafting table and become accounting law, corporate behavior can change. New accounting standards sometimes show a previous lack of managerial restraint in the use of corporate resources - think of stock options, or health care benefits. Paying attention to new accounting standards might tip off investors to a new round of corporate behavior. Want to be an informed investor? Then don't ignore the activities of the FASB. If you're in business, it helps to know the language.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One of its goals is to reduce diversity of practice occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users. The following is a synopsis of the issues where consensuses were reached at the last meeting on September 15.

The mission of the Emerging Issues Task Force is to assist the FASB in improving financial reporting through the timely identification, discussion, and resolution of financial accounting issues - as long as its results are within the framework of existing authoritative literature. One of its goals is to reduce diversity of practice occurring when preparers and auditors interpret generally accepted accounting principles differently in similar circumstances. Some of the issues addressed by the EITF will have more importance to users than others; many will be invisible to users. The following is a synopsis of the issues where consensuses were reached at the last meeting on June 15 & 16.

Since last summer, certain firms with outstanding employee stock options have tried to minimize the negative earnings impact of FASB Statement 123(R). To do this, they accelerate the vesting of the outstanding options and recognize the expense currently, while such expense is a mere footnote disclosure. Thus, there are no messy overhanging option values to amortize into earnings after implementation of 123(R). It's Expense Lite : all of the compliance with GAAP, with none of the earnings consequences. Despite an extended grace period for implementation of Statement 123(R), courtesy of the SEC, firms are still racing to accelerate outstanding options to avoid eventual consequences.

Last month's note described thevest fleece, the newest corporate fashion. Some companies with outstanding options are attempting to avoid the earnings effects of recognizing stock compensation when the time comes to implement Statement 123(R) this summer. Their gimmick: accelerating the vesting of the outstanding options so the related compensation charge is only a footnote disclosure. This clears the decks of lingering expenses related to option compensation to be recognized in earnings once Statement 123(R) goes into effect. In this note, the survey of vest fleecers is updated through the end of the first quarter of 2005.