FASB Again Retreats on Accounting Proposal

In another concession to public opinion and to ease transitions and merging standards with the International Accounting Standards Board (IASB), the United States-based Financial Accounting Standards Board (FASB) retreated on a controversial proposal that would require leases to be noted on corporate balance sheets.

Acknowledging that not all leases are necessarily created equal, both the FASB and IASB may now consider two categories of leases, something that would resemble today’s operating leases and capital leases, says Tammy Whitehouse of Compliance Week. The move also backs away from a proposal that would have changed the way that companies account for renewal options leading to variable lease payments. This proposal would have required companies to do a significantly higher level of projecting lease terms and renewals, raising questions about uncertainty and undue burden on companies.

This is a similar reevaluation to the fair value proposal for financial instruments, which the FASB pulled back on recently. That proposal would have required banks and other financial institutions to report most financial assets and liabilities at fair value. Like the lease accounting proposal, overwhelming negative comments from the public and investment communities, most calling it an undue stress on companies, urged the FASB to back away from the proposal.

4th Quarter Earnings Almost Complete, Appear Strong

With 4th quarter financial reporting over 95% complete, reports appear to be strong from this earnings season. Zacks Investment Research has received reports from 479 firms and is awaiting the results from the straggling 5%. The investment research company noted that typically, the early-reporting firms perform much better than those filing reports last, but that the firms reported represent almost all of the potential earnings for 4th quarter. Thus, the remaining firms are not expected to have much of a negative effect on the overall earnings in 4th quarter.

Total net income has risen a very strong 29.6% versus the same quarter one year ago. Zacks points out that significant growth came from the financial sector, which posted huge net margins. The researchers did caution that the quality of the reports versus prior years can be subject to interpretation due to the absence of mark-to-market accounting. Much of the growth might be attributed to firms setting aside fewer reserves for bad debts compared to a year ago, said Zacks.

FASB Timeline for Convergence Delayed by Fair Value Debate

One year ago, the Financial Accounting Standards Board (FASB) had set a target completion date of June 2011 for nine projects that would aid the convergence with International Accounting Standards Board (IASB) rules. The FASB has now been sending signals that this may have been an unattainable goal, targeting five projects that will adhere to this timeline, most notably fair value application of financial instruments.

The FASB originally proposed that most financial instruments be measured at fair value, noting gains and losses as a result of this application on either net income or other comprehensive income. The public comment period yielded nearly 3,000 letters – most opposed the FASB model.

Though the FASB has backed off of its fair value proposal in favor of amortized cost, revisions to accounting for financial instruments and accounting for impairment of financial instruments remain a likely area of change, as noted by Paul Munter, CPA, in his article in Financial Executive Magazine. “Closely linked to the boards’ financial instruments project are those on the projects on netting of financial instruments and derivatives and presentation of other comprehensive income,” he says. United States Generally Accepted Accounting Principles (US GAAP) and International Financial Reporting Standards (IFRS) currently differ, and will have to be equalized before a standards conversion can happen, especially on the June 2011 timeline.

Mark-to-Market for Lending Off The Table, But Not Dead Overall

The Financial Accounting Standards Board (FASB) recently rescinded its proposal to apply mark-to-market accounting to a vast array of financial instruments, an unpopular proposal from the banking industry’s perspective. But, as Bill Bradway points out in his editorial for Bank Systems & Technology, the issue is far from dead. Bradway explains that traded instruments such as actively traded loans and securities will still follow mark-to-market accounting. Loans that are held to maturity will use the amortized cost.

Generally, banks are relieved, but not free of mark-to-market entirely. Bradway explains, “Distressed real estate that is in some form of extended default (say past 90 days due) or foreclosure is still eligible for the collector’s version of mark to market. What is the property worth to a buyer?”

Bradway warns that investors will have to “raise their due diligence on banks with a meaningful basket of troubled or non performing loans.” Publicly held banks are much easier to analyze than smaller community banks in this regard, as problems on a loan portfolio level have not yet hit their default status, quickly turning the bank’s assets sour. “The broader economy will benefit simply because the biggest banks, which drive the market, will not be distracted or forced to make severe mark-to-market write downs at a critical time in this recovery’s cycle,” says Bradway.

Incoming IASB Chief Says Accounting Rule Makers Must Modernize

At the opening remarks of the European Commission conference on financial reporting, incoming International Accounting Standards Board (IASB) chairman Hans Hoogervorst said that accounting rule-setters should strive to remain independent from business but remain sensitive to the community’s concerns. Hoogervorst, who succeeds Sir David Tweedie in June, said the IASB would review its governance structure to increase transparency. “It’s very important that we develop a governance structure that is more inclusive,” he told delegates at the conference in Brussels. “At all costs we should avoid the perception that IFRS (International Financial Reporting Standards) is dominated by a small group of nations.”

One critical issue facing the board is the topic of fair value accounting, which Hoogervorst discussed. Defending the controversial accounting principle, Hoogervorst said that firms who applied fair value rules “came out of the crisis a lot better than other firms,” because the were able to “get rid of poisonous assets at a much earlier stage.”

Carmichael: Convergence, Fair Value Are Most Important FASB Tasks

Douglas Carmichael, standing member and former chief auditor of the Public Company Accounting Oversight Board (PCAOB), recently spoke to Crain’s New York Business about the upcoming challenges facing the Financial Accounting Standards Board (FASB) and the accountancy profession in general.

Carmichael recognized the steps that the Sarbanes-Oxley Act had made in making auditors more diligent, moving the spotlight away from accountants in the most recent financial crisis – something that was not the case in the Enron and WorldCom scandals. He also spoke on the FASB’s current issue of juggling convergence with the International Accounting Standards Board (IASB), replacing former chairman Robert Herz, and tackling the most important and heated issue in recent history, the proposed expansion of fair value accounting.

Carmichael said of fair value accounting, “If you move too quickly and broadly into valuing assets at their fair market value, you risk sacrificing the reliability you get valuing them at historic cost.” Skeptical of the broad application of the rule, Carmichael continued, “Anything that makes tradeoffs between relevance and reliability concerning revenue recognition worries me. That’s because in the past, we’ve seen fraudulent reporting overwhelmingly due to misapplication of principles on revenue recognition.”

Carmichael was also cautionary of a rush towards IASB convergence. “My belief is the new FASB chairman should resist pressure for convergence too quickly and only make steps that result in high-quality accounting,” he said.

Mark-to-Market Debate Nears End of Discussion Period

The Financial Accounting Standards Board (FASB) proposed accounting rule changes have brought many dire predictions from its opponents, such as loss of jobs or a new banking crisis. This opposition has brought hundreds of comment letters to the FASB, ranging from personal investors to the powerful American Bankers Association (ABA). These comment letters are being accepted through the end of September, with a series of roundtable discussions to follow in October 2010.

The FASB rule change involves the expansion of mark-to-market accounting. Proponents say the expansion of this rule would give investors a clearer picture of a bank’s financial condition, by requiring financial institutions to value loans at market value, regardless of whether or not the bank intends to sell. Banks have opposed the rule changes, saying it would discourage new loans and thus hurt the economy. In a public comment letter, James Blaine, president of the State Employees’ Credit Union in Raleigh, North Carolina, calls the proposal “Theoretically arrogant; in practice insane.”

Opponents have also cheered the resignation of former FASB chairman Robert Herz, a vocal proponent of the rule change. While his temporary replacement at the helm of the FASB, board member Leslie Seidman, has voted against the proposal, the FASB’s newest board member, Russell Golden, has not made his position known.

Bernanke “Very Cautious” About Mark-To-Market on Long Term Loans

Federal Reserve Chairman Ben Bernanke faced questioning at the hands of the Financial Crisis Inquiry Commission (FCIC) recently. Bernanke’s comments indicated some reservation about the scope of the proposed fair value accounting changes.

“I think we should do our best to get appropriate market values of assets” when they don’t have a market price, Bernanke said. “Now this is a somewhat different issue (when) you’re dealing with long-term credit in the banking book.”

“I’m in favor of accurate accounting. I think that there are sometimes problems when markets are very illiquid. The FASB tried to move in the direction of clarifying how to deal with so-called level 3 assets in illiquid markets.”

“But I’m also very cautious about applying mark-to-market accounting to the long-term loans,” he said.

The FCIC also asked about mark-to-market accounting’s relation to the financial crisis.

“I think it exacerbated it, somewhat,” said Bernanke, noting that while the nature of financial markets often move asset prices frequently, accurate valuations are a better long-term solution to eliminating the issue.

Mortgage Bankers Association Publishes Fair Value Opposition Letter to FASB

The Mortgage Bankers Association (MBA) submitted and published a comment letter to the Financial Accounting Standards Board (FASB), countering many of the assertions of the board’s proposed accounting rule changes.

The MBA stated that the application of fair value measurement to all financial instruments will “unnecessarily increase the complexity in financial statements that would adversely impact preparers, users and regulators.”

While the FASB has said in its exposure draft that application of fair value measurement will heighten transparency and understandability of financial statements, the MBA countered that notion in certain applications.

“Fair value is not the most relevant measurement for assets and liabilities for which the business strategy is to collect or pay contractual cash flows,” the MBA wrote. It suggested that amortized cost better reflects expected cash flows. “MBA especially disagrees with the notion of including in the fair value of an entity’s liabilities the change in the entity’s own creditworthiness through earnings.”

MBA concludes its position: “MBA believes qualitative along with quantitative information is more user-friendly, which is why MBA believes the current balance sheet presentation along with robust footnote disclosures is preferable.”

Experts: Herz Resignation Likely to Delay Fair-Value Rule Changes

Coming on the heels of Financial Accounting Standards Board (FASB) chairman Robert Herz’s resignation, the quick progress the organization had been making may be in jeopardy, according to some financial experts. Herz, whose resignation takes effect on October 1, 2010, left the post two years shy of when his term was scheduled to end, and in the middle of crucial changes to Generally Accepted Accounting Principles (GAAP).

John Hepp, partner in Grant Thornton’s accounting principles group and former FASB project director, spoke to CFO Magazine about the magnitude of the changes.

“The exposure drafts that are out there right now…are proposing a whole new framework for accounting,” and Herz’s retirement, according to Hepp, “is like Eisenhower resigning as the troops were landing on the beach on D-Day.”

The fair-value measurement rule aimed at banks’ financial statements (called Topic 820) was set to wrap up public comments on September 7 with a final vote expected in January 2011, but that now appears to be an unreachable goal. Herz had previously been the deciding vote on the five-member FASB, generally voting opposite of acting chairman Leslie Seidman. With the board now likely split evenly, Hepp believes the FASB will delay putting it to a final vote.

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