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The definitions in Concepts Statement 6, themselves, lack clarity. FASB, Proposal: Principles-Based Approach To U.S. Standard Setting, October 21, 2002, p.6. |
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While the liabilities are relieved as the earnings process occurs, the pattern of recognition of revenue is likely to differ from its pattern when recognized using the historical view of the earnings process. Thus, while the notion of the earnings process is not inherently inconsistent with the asset/liability view, its application to revenue recognition does require refinement from the approach currently in use. |
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See, FASB Concepts Statement No. 5, "Recognition and Measurement in Financial Statements of Business Enterprises." |
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At its meeting of June 4, 2003, the FASB decided to add to its agenda a project on measurement. |
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FASB Project Updates, "Revenue Recognition," http://www.fasb.org/project/revenue_recognition.shtml. |
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FASB Project Updates, "Liabilities and Equity," http://www.fasb.org/project/liabeq.shtml. |
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FASB Project Updates, "Financial Performance Reporting by Business Enterprises," http://www.fasb.org/project/fin_reporting.shtml. |
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"FASB and IASB Agree to Work Together toward Convergence of Global Accounting Standards." FASB and IASB Joint Press Release, October 29, 2002. |
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Securities and Exhange Commission, Actions by FASB, IASB Praised, October 29, 2002. |
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FASB, Technical Plan at http://www.fasb.org/project/short-term_intl_convergence.shtml. |
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Id. |
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Examples include projects on business combinations, share-based payments, financial performance reporting, revenue recognition, and measuring financial instruments at fair value. |
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FASB, International Convergence Research Project, http://www.fasb.org/project/intl_convergence_research.shtml. |
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We believe, as noted earlier, that the IASB also must adopt a more objectives-oriented regime (as defined here) to help facilitate the convergence process. |
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Effective for 2005, companies which are listed on exchanges and markets within the European Community will be required to adopt IFRS for financial reporting purposes (with some exceptions). |
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We note, for example, that the issue of share-based payments (or stock compensation) is currently under consideration by both Boards. This is an area of the U.S. literature which is currently replete with rules because of the need to interpret the existing intrinsic value model of APB Opinion No. 25. The Boards will need to make similar decisions on when to address other such areas of the existing literature such as leases, derivatives, and derecognition of financial assets and liabilities. |
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Statement on Auditing Standards No. 69, "The Meaning of Present Fairly in Conformity With Generally Accepted Accounting Principles," AU§411.18. Although not specifically discussed, SEC rules and regulations also are Level A GAAP for public companies. |
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FASB, Statement of Financial Accounting Concepts No. 1, "Objective of Financial Reporting by Business Enterprises," November 1978. |
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We do not propose specific "levels" of the hierarchy within the authoritative literature. Rather, the authoritative literature is provided from the general to the specific. We anticipate that the appropriate bodies (i.e., PCAOB and FASB) ultimately will address the specific content and order of the GAAP hierarchy. |
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See, discussion in the previous section regarding the GAAP hierarchy. |
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The SEC staff addresses implementation questions in several ways including reviews of registrant filings, responses to "pre-clearance" submissions by registrants, and through the enforcement process. SEC staff views are sometimes communicated through announcements at EITF meetings or through Staff Accounting Bulletins. |
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See, Emerging Issues Task Force Issues Grouped by Type As of the March 20, 2003 Meeting at www.fasb.org/eitf/bytype.pdf. This total does not include other issues which were considered by the EITF but never formally added to its agenda. |
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Comments made by Sir David Tweedie at the FASB Roundtable Discussion on Principles-Based Standards, December 16, 2002. |
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See, for example, EITF Issue No. 99-17, "Accounting for Advertising Barter Transactions." |
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See, for example, comment letter of Frank H. Brod, Chairman, Committee on Corporate Reporting, Financial Executives International. |
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As we detail in the Chart in Section VI, many of the steps to adopt an objectives-oriented standard setting approach already are underway. Consistent with that, we note that more recently, the EITF has been addressing approximately half the number of issues per year as compared to its historical average number of issues per year. |
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The same holds true for guidance provided by the FASB staff. |
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For example, the EITF's international counterpart-the International Financial Reporting Interpretations Committee ("IFRIC")-uses the following guidance in determining what issues to address: a) does the issue have widespread and practical relevance; b) does the issue involve significantly divergent interpretations (either emerging or already existing in practice); and c) is the issue unrelated to a Board project that is expected to be completed in the near future (if a Board project exists that is expected to resolve the issue in a short period, the IFRIC would likely not add the issue to its agenda). Additionally, the IASB approves IFRIC conclusions before they become authoritative. |
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See, EITF Topic D-1, "Implications and Implementation of an EITF Consensus." |
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The FASB also has stated its intention to seek greater input and involvement from the investor community in the standard setting process, including additional representation on the EITF and the formation of a User Advisory Council to provide input to the Board. |
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Comments made by several representatives of the preparer community at the FASB Roundtable Discussion on Principles-Based Standards, December 16, 2002. |
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While there currently are such databases available, it is often difficult for accounting practitioners outside of major accounting firms or major companies to obtain information about content, access, and pricing about these services. |
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Conclusion based on comments made by representatives of the preparer community as well as comments made by members of the FASB at the FASB Roundtable Discussion on Principles-Based Standards, December 16, 2002. |
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It is our understanding that the staff of the FASB is currently investigating how to construct and maintain a web-enabled searchable database. |
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The Sarbanes-Oxley Act of 2002, Pub. L. No. 107-204 (2002). In particular, see Section 108(b) and Section 109 of the Act. |
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As our analysis has shown, many of the steps needed to implement an objectives-oriented standard setting approach in the U.S. are well underway. As a result, many of the costs already have been mitigated by the ongoing movement to objectives-oriented standard setting. |
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Byrnes, Nanette, "The Downside of Disclosure," Business Week, August 26, 2002, p. 102. |
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FASB, Statement of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises," November 1978, paragraph 34. |
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The complexity of certain accounting standards may go some way in explaining how the marketplace recently allowed accounting problems at major public corporations to brew for so long without an appropriate price correction. While the hints were there in some cases, few professionals-much less the average investor-tried to plumb them. |
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In particular, audit committee members are asked to participate in discussions with management and auditors about difficult accounting questions. For example, the SEC's protocol for submission of matters to the Office of the Chief Accountant asks that the registrant indicate whether the audit committee was consulted on the matter and whether the committee concurs with the company's position (see, "Guidance for Consulting with the Office of the Chief Accountant," http://www.sec.gov/info/accountants/ocasubguidance.htm). Additionally, auditors are required to discuss with the audit committee critical accounting policies used by the registrant as well as alternative applications of GAAP that are material to the company's financial statements (see, Release No. 33-8183, "Strengthening the Commission's Requirements Regarding Auditor Independence," January 28, 2003). Unless the audit committee is composed entirely of experts in financial reporting, it is difficult for members of the audit committee to properly gauge the appropriate accounting in difficult situations. |
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It is clear that strict adherence to GAAP does afford some degree of practical protection to accountants and management when they are involved in litigation. At a minimum, the ability to declare that defendants followed the rules will always constitute "good facts" for the defense. The competitive pressure on accountants to push these boundaries in order to please clients may be quite intense. |
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A recent study suggests that a rules-based approach increases earnings management through transaction structuring. See, Nelson, M., J. Elliott and R. Tarpley "Evidence from Auditors about Managers' and Auditors' Earnings Management Decisions," Accounting Review, 2002. (Interestingly, the same study indicates a reduction in earnings management obtained through management judgments.) |
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"Statement of Sir David Tweedie, Chairman, International Accounting Standards Board before the Committee on Banking, Housing and Urban Affairs of the United States Senate," Washington, D.C., February 14, 2002. |
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By informativeness, we mean the decision-usefulness of the financial reporting in terms of facilitating the assessment of the amount, timing, and uncertainty of future cash flows from an investment or credit decision. |
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As noted earlier, the term enforcement includes not just regulatory and legal enforcement mechanisms, but also, company audit committees, independent auditors, civil litigation actions, and the PCAOB. |
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Dye, R.A. and E.R. Verrechhia, "Discretion vs. Uniformity: Choices Among GAAP," Accounting Review, 1995. |
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A fundamental proposition in economics is that in a market context where there is uncertainty as to quality, consumers tend to discount all units of the good or service in question to reflect average, or expected, quality. As a consequence of this dynamic, when poor quality items (the "lemons") sell at the same price as good quality items-and all items are discounted to reflect the expectation of quality-the size of the market tends to decrease and average quality to fall, as poor quality items drive out the good. See Akerlof, G.A. "The Market for Lemons: Quality Uncertainty and the Market Mechanism." Quarterly Journal of Economics, 1970. This same dynamic can occur in financial markets, as companies with poor prospects attempt to mimic companies with good prospects through the manipulation of their accounting. In contradistinction, where good quality items (or companies) can effectively distinguish themselves from the lemons through signals to the market, this dynamic does not prevail. Such situations are called "separating equilibrium." See Spence, M. "Job Market Signaling" Quarterly Journal of Economics 1973. The key to arriving at such a separating equilibrium is that there must be a differential cost to sending the signal that indicates quality between those purveying actual quality and those attempting to mimic that quality. In the context of public reporting companies, it is enforcement that ensures that differential cost, thereby permitting companies with good prospects to effectively distinguish themselves from those without such prospects through their financial reporting. |
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As discussed subsequently, the incentives are different between rules-based and objectives-oriented standards. Under rules-based standards, management can take advantage of the "flexibility" offered by the rules since the bright-lines often provide a roadmap to engineer a desired accounting result. |
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See, for example, comment letter of Richard Levy, Senior Vice President and Controller of Wells Fargo and Company. |
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Use of a rules-based approach is only one reason that the standard setting process may be slow in responding to changes in the business environment. |
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For example, SFAS No. 13, "Accounting for Leases" has been amended and interpreted by approximately 25 Statements of Financial Accounting Standards, Interpretations, or Technical Bulletins. Additionally, another 35 EITF Issues have considered lease accounting issues. |
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There is one factor associated with an objectives-oriented regime that may work against issuing standards in a more timely fashion. As noted previously, an objectives-oriented approach bars the use of exceptions to the standards, or at least calls for minimal use of exceptions. (For ease of reference, let's call this "exception-barring.") Exceptions can play a role in the ability of a standards setting body to reach agreement. Exception-barring may, at times, preclude compromises by a standard setting body that would have helped in getting a standard issued in a timely fashion. Thus, exception-barring may, in some situations, work against the timely issuance of standards. Despite this fact, in net, we believe that objectives-oriented accounting would enhance the timeliness of the issuance of standards and would result in standards that are more durable, for the reasons outlined above. |
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We generally refer to current and potential investors and creditors by the more generic "investors," since investors may invest in either equity or debt instruments. |
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FASB, Statement of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises," November 1978. |
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As noted previously, these bright-lines also provide a roadmap to financially engineer a transaction to achieve a desired accounting result. |
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Comments made by James J. Leisenring, former member of the FASB and current member of the IASB, at the AAA/FASB Financial Issues Conference, December 7, 2002 in explaining the existence of many of the exceptions included in SFAS No. 133. |
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Some argue, for example, that the inclusion of a held-to-maturity category in the accounting for certain investments in accordance with SFAS No. 115 is an exception provided by the FASB to allow entities to avoid the earnings volatility that would result from marking-to-market those investments. See, for example, Schipper, Katherine, "Principles-Based Accounting Standards" Accounting Horizons, March 2003. |
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See, FASB, Statement of Financial Accounting Concepts No. 1, "Objectives of Financial Reporting by Business Enterprises," November 1978. The importance of the conceptual framework to standard setting is explored in greater detail in our discussion of Implementation Issues. |
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"FASB and IASB Agree to Work Together toward Convergence of Global Accounting Standards." FASB and IASB Joint Press Release, October 29, 2002. |
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See, for example, comment letter of Tim Morrison, Group Controller, Shell International. |
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Here we use IFRS to refer to both the IFRS issued by the IASB and the IAS issued by its predecessor, the IASC. |
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Schipper, Katherine, "Principles-Based Accounting Standards" Accounting Horizons, March 2003. |
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See, for example, comment letter of Jack Ciesielski, R.G. Associates, Inc. |
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It is possible that objectives-oriented accounting standards could increase the vulnerability of accounting firms to "strike" suits by plaintiffs' attorneys. That is, by requiring a different application of judgment, objectives-oriented accounting standards also could generate greater uncertainty in the outcome of any given plaintiff's case. This increased uncertainty and expected expense may result in higher settlements for suits brought by the plaintiffs' bar, some of which constitute mere nuisance suits. |
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For example, with the issuance of SFAS No. 141, discussed earlier, the FASB eliminated the illusory comparability created by pooling of interests vs. purchase accounting portrayal under APB Opinion No. 16. |
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On the opposite end of the spectrum, it is certainly true that there may be a substantial lack of comparability if standards are principles-only, because of the heavy reliance on professional judgment without a sufficient structure to cabin that judgment. |
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One recent study finds that "financial reporting is less comparable when accounting standards rely heavily on the exercise of professional judgment than when standards place fewer demands on professional judgment." See Rentfro, Randall W. and Karen L. Hooks "The Tradeoff Between Comparability in Financial Reporting and the Level of Professional Judgment in Accounting Standards," 2002. |
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For example, the application of SFAS No. 141 is effective for business combinations entered into after June 30, 2001. Thus, combinations previously reported as pooling of interests continue to receive that treatment. |
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Section 108(d) of the Act. |
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At its meeting of March 26, 2003, the FASB directed its staff to develop a proposal for a conceptual framework improvements project focusing on the selection of appropriate measurement attributes and related relevance and reliability issues. |
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While there would be one standard setter (FASB), the SEC will continue in its oversight role with respect to the standard setter. |
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At its meeting of March 26, 2003, the FASB established a near-term objective of using identical style and wording in the standards issued by the FASB and IASB on joint projects. |