Why You Should Care About This IFRS Proposal

Unless you work for a subsidiary of a foreign company reporting under International Financial Reporting Standards (IFRS), most U.S. based CPAs generally feel there is little reason to pay attention to IFRS activities. Therefore, many of you probably missed the release of a proposed change to the standard on general presentation and disclosures in a financial report in the middle of December. However, this standard is one you might want to pay attention to, because it may push the Financial Accounting Standards Board (FASB) to tackle some similar issues in the U.S. Some key highlights from the standard include:

  • Required subtotals in the Income Statement, including Operating Profit which, unless the entity is a bank or similar financial services company, will generally exclude interest expense and interest income. Even interest income on customer receivables will be excluded unless you conclude a principle function of your business is to provide customer financing.
  • The disclosure of unusual items in the footnotes to the financial statements. Unusual is defined as unusual in occurrence or unusual in amount. And the proposed disclosures allow companies to show the impact of these items on the Income Statement, so you essentially get to include the “normalization” for such items in the audited financial statements.
  • The disclosure of “management performance measures” in footnotes defined as amounts:
    • Used in public communications outside financial statements,
    • Complementing totals or subtotals specified by IFRS standards, and
    • Communicating management’s view of an aspect of an entity’s financial performance to users of financial statements.

The disclosure will include information on how the management performance measure is calculated, how it reconciles back to the most similar IFRS total or subtotal, and how management believes it (better) portrays a financial aspect of the business.

  • The movement of all interest expense into the financing section of the cash flow statement, and interest and dividends received into the investing section. This means such amounts will no longer be included in the operating section of cash flows for most (non-financial services) companies.

The standard provides a lot of opportunity for companies to better tell their stories in the financial statements, but with that comes a price. The disclosures become part of the financial statements subject to auditing procedures if an audit is obtained on the financial statements. Whether or not you want to send comments on the IFRS is your choice, but this proposed standard may be one worth taking a look at to see potential changes that FASB might consider in the future.

New Year’s Resolutions

After last year’s soapbox, I thought it would be good to get back to a simple top 10 list à la David Letterman (showing my age to those younger readers). So, without further fanfare, here is my list of resolutions all CPAs make and then quickly break each new year.

After last year’s soapbox, I thought it would be good to get back to a simple top 10 list à la David Letterman (showing my age to those younger readers). So, without further fanfare, here is my list of resolutions all CPAs make and then quickly break each new year.

10. I will take some CPE every month so that by the time my birthday or the end of the year rolls    around, I will already comply with my state’s CPE requirements.

9. I will reread my emails before I send them out to make sure they are free from silly mistakes and typos.

8. I will give timely feedback to my staff when they do something well or need to improve.

7. I will incorporate exercise into my schedule, even if it is just a 20-minute walk at lunch, each day no matter how busy I am.

6. I will say no to a new project, client or request for my time at least once a month.

5. I will not look at email at least one whole day while I am on vacation.

4. I will spend 15 minutes at the end of each day clearing my desk and planning so I can start the next day productively.

3. I will eat lunch with someone else at least twice each week. Maybe I can also hit Resolution #7 by walking to lunch with the person!

2. I will not multitask during conference calls so I know what is said and don’t have to ask people to repeat the question.

1. I will not wish ill will on the members of FASB despite having to deal with the new CECL standard!

What other resolutions do CPAs need to make and which ones do you think we will be able to keep this year?

Why Ethics CPE is Required

I recently sat through my required four hours of ethics continuing education to meet the biennial requirement for licensure in Texas. While every state requires some amount of continuing education to maintain a CPA license, some states go further and specifically require a certain portion of the continuing education hours cover ethical issues. As the instructor covered actual dilemmas faced by CPAs and actual frauds committed by CPAs and non-CPAs alike, my mind wandered a bit into why I was required to take this course in the first place. My thought was, I have high integrity; I would never do what these criminals did, and I know where and how to look for fraud. I am an internal auditor after all!

Then the stories turned to average people who started down a path that seemed appropriate. They were trying to help the company and protect people’s jobs. These people didn’t realize they were in over their head until the riptide of circumstances had pulled them so far out to sea, they could never get back to shore on their own. That is when I realized we take ethics regularly for two reasons.

First, most of us are fortunate enough to rarely be faced with true ethical dilemmas. While ethics is like riding a bike, you never completely forget, taking on those dilemmas is not for the novice and the training keeps our senses sharp for the potential situations when they arise. Second, we are there for our fellow CPAs. The requirement to think about ethics means thinking about our duty to the public and our fellow professionals. We are trusted because the whole profession is trusted. We nearly lost that trust a couple of decades ago with the Enron and WorldCom disasters. It took us years to get that trust back.

We are, once again, one of the most trusted professions in the world. If sitting through a few hours of ethics every two years means just one CPA stands up early enough to prevent a company from going off the rails and costing investors billions of dollars, then those hours of my time are well worth it.

How I Became a CPA

My story started at Thanksgiving 36 years ago. Like many, my parents had friends over for Thanksgiving dinner. While Mom and others were in the kitchen making the food, I was watching the Macy’s parade and football in the family room. One of our guests came in, an accounting professor, and started a conversation with me. I was a senior in high school, so he asked where I was thinking of going to college (early admission was not a big deal in the early ‘80s) and what I wanted to do. I told him I wasn’t sure about the college, but that I would probably work to become a doctor.

He asked why a doctor? I said because becoming a doctor is hard to do and doctors help lots of people. He then asked if I would consider a profession that would get me out of school in half the time and still help lots of people. I said sure – but what kind of profession is that? That was when I heard about the CPA profession for the first time. He told me how CPAs help take care of all sorts of investors, from people making their own investments to people participating in pension plans (remember, this was the ‘80s and lots of people had pensions) and so forth.

I quickly realized that CPAs provided the trust that greased the wheels of the economy. I figured becoming a CPA was hard, but worth the effort. I also liked math a lot and thought that is what CPAs did (OK, that is the topic of a whole different blog, but suffice it to say, I was mistaken) and didn’t mind not having to deal with knives and blood. I took the professor’s advice and decided to major in accounting.

So, during the holidays ask that high school junior or senior at your friend’s or family’s house what they plan to major in. You never know – maybe you will change the course of someone’s life.

FinREC Serving the Profession

The last Financial Reporting Executive Committee (FinREC) meeting of the year was held on November 5. The meeting covered a number of topics, including:

  • Long-duration insurance contracts
  • Current expected credit losses
  • Digital assets

I think the best way to put the proposed papers on long-duration insurance contracts is that if you are in that industry, you should pay attention; otherwise, the rest of you can take assurance that FinREC is there, so you don’t have to deal with these things. By the way, in case you are wondering, long-duration insurance contracts are things like life insurance and annuities that last many years, in some cases decades.

The current expected credit loss (CECL) topics included issues related to insurance, as well as trying to help define when information received after the balance sheet date is the result of a subsequent event or was simply a timing issue about getting information on events that occurred prior to the balance sheet date. The reason these issues matter is because the CECL standard is explicit that subsequent events are not to be considered when determining the expected losses to be included in the financial statements. By the way, you are going to have to wait for the release of the document from AICPA to find out what is a subsequent event that should be ignored and what isn’t (unless you want to dig up the SEC speech on the topic).

Finally, we continued our discussion on digital assets, which includes crypto assets like Bitcoin and Ethereum, as well as other token-based assets that represent ownership interests or other items. I’m sure you have seen by now that typical companies will need to account for crypto assets as intangible assets and not investments. But if the owning entity is an investment company following those specialized accounting rules, then crypto assets will be accounted for as investments. If that doesn’t seem fair, remember that investment companies get to treat other assets, like real estate and commodities (e.g., oil), as investments and use mark-to-market accounting on those, so unless you want to move your entire balance sheet to mark-to-market (i.e., fair value) accounting, maybe it’s not so unfair after all.

We hope you find the work of FinREC helpful. While not officially authoritative GAAP, FinREC is there to help connect the dots and provide consensus opinions about how to deal with questions that come up from new transactions or implementing new standards. We are a resource for the profession that I hope you find useful.

Better Reporting on Employees

Government “provides a tax deduction to the company that replaces a human with a robot, but offers nothing to the company that trains that worker to remain employable” – Senator Mark Warner, Virginia.

If you’re a CPA, you just cringed when you read that statement for two reasons. First, the statement is absolutely incorrect. The tax code not only allows for the deduction of the cost of training, but that cost is immediately deductible and is not required to be capitalized and recognized over a period of time like the cost of the robot. The second reason you cringed was because you realized this person’s lack of knowledge about how taxes really work is probably a good example of the majority of Congress. This is the very same Congress that is responsible for the tax law in the first place, but that is not the point of this blog.

The above quote was from an article in Harvard Business Review I recently read on “the problem of reporting employee costs as expenses instead of assets.” The writer of the article has the same misunderstanding of the difference between reporting on a cost and capitalizing something as an asset as Senator Warner has in understating how the tax code works. Simply put, slavery has been illegal in this country for over 150 years and I, for one, would like to keep it that way. That means I strongly believe employees should never be recognized as assets, but that does not mean that the goal of the article, better measurements and reporting of the most critical part of many businesses today, should not be improved.

The way to improve information on the employees is not to distort the meaning of an asset to capitalize costs. No, the way to improve information is to enhance the reporting on costs and other facts related to employees. I won’t go into all the studies about employee effects on the value of a business and business profitability. Instead, in the spirit of brevity, I will propose a few disclosures that could be combined into one simple chart. First, the disclosure should group employees based on the major employee responsibilities at the company, such as sales, customer care, retail (store) support, manufacturing, support staff (I would hate to say Finance probably goes here) and so forth. The 10% rule could be used for determining what groups need to be disclosed. Then for each group of employees, disclose the following:

  • Total number at end of period
  • Total compensation and benefits in period
  • Total improvement costs, such as training in period
  • # hired in period
  • # involuntarily terminated in period
  • # voluntarily leaving in period
  • Turnover ratio during period

Then, just like we have a whole section in the MD&A to discuss liquidity, we should have a section to discuss employees, including the value they bring to the company and how the company is working to protect and increase that value.

So what kind of reporting on employees do you think should be made by businesses?

More Revenue Reconcilliation

I recently responded to another question about revenue recognition on TXCPA Exchange that I thought everyone might benefit from seeing.

Question – I have a situation where our firm has completed all the professional services on a contract, but the client wants more work done that we have agreed to do for free and that is outside the scope of the original agreement. We have completed all the milestones in the contract and we have customer acceptance for those milestones. Would I be able to recognize the remaining milestone revenue on the contract or do I need to hold some revenue back for the free services that are outside the original scope?

Response – The situation described sounds like a potential contract modification, but, as always with the new revenue standard, the devil is in the details. The description says all of the performance obligations are done, but the client wants more work completed. Did the client approach the firm for additional work before the work was done, the day the work was done or a year after the work was done? If it was a year after, the two pieces of work are not related and we would only need to worry about the work being potentially related to a yet unsigned future contract, but I doubt that is the case given your question.

A second question is around how often these types of adjustments are made under contracts. If the firm regularly does additional work (and I do not mean more than 50% of the time, but only that it happens enough to know additional work is a possibility), then the standard would say you probably should have anticipated such a potential event and held revenue in reserve up front. Assuming that is not the case, and you determine it is a modification of a contract and not pre-work being done on a subsequent contract, we then have to deal with the contract modification section of the revenue standard. The modification is a separate contract if the scope increases; i.e., more work is being done (sounds like the case here) AND the price of the contract increases by an amount that reflects standalone selling prices of the additional work (not the case here, as the question says the work is for free). That leads us to three options under the contract modification section:

1) The new contract is a termination of the old contract and creation of a new – the key here is that the remaining services are distinct from the services previously performed. If that is the case, you take any remaining unrecognized revenue from the original contract + any new revenue (none in this case) and recognize the revenue over the remaining services to be performed.

2) The new contract is a modification of the existing contract if the remaining services are not distinct. In this case, you take the revenue from the entire initial contract + the modified contract (zero in this case) and respread the revenue over all the services to be performed and change the revenue recognized to date (potentially resulting in a decrease to revenue in this situation) and then recognize the remaining revenue as the services are performed.

3) A combination of 1 and 2, if the remaining services are a combination of the situations outlined above.

A big key to determining how to handle contract modification is determining if the additional services (or goods) are distinct. That determination is made using the same rules under step 2 for determining what performance obligations are distinct.