Accounting Is All About Numbers…NOT

I’ve heard the story so many times I’ve lost count.  It goes something like this. “I was good at math so someone recommended I consider accounting as my career.”  Or, “I decided to major in accounting because there is always a (right) answer to every problem.”  Well, I am here to tell you we’ve all been sold a bill of goods on this one that makes the jokes about buying a piece of the Brooklyn Bridge seem like child’s play.

Let me give you a couple of examples from our accounting standards on other post-retirement benefits and share-based compensation.  These two standards are difficult enough to begin with.  The “math” is some of the most complex that we deal with as accountants.  In fact it is so complex that we hire actuaries to do the math for us, but at least once you decide on the right input – the “assumptions” – there is a right answer that comes out the back end.  But therein lies the problem, what are those pesky assumptions.

Let’s look at stock based compensation.  The standard says you should use the fair value of the right granted on the grant date as the as the amount you expense over the vesting period of the award.  That sounds simple enough, but then go read up on the grant date.  It says it is the date the company and the employee reach a mutual understanding about the award.  Once again that sounds simple, but wait, maybe not.  Let’s say the Board of directors approves an allotment of 1,000 shares restricted stock based on a stock price of $25 when they approve the award because they are intended to give $25,000 in compensation to the highest rated employee in the group. So the board has approved it and we are now set and can start amortizing the cost over the vesting period, right?  Wrong!  The board hasn’t actually granted the award to a specific employee, but one to be decided at a later date.  It’s hard to have a mutual understanding if the employee doesn’t know they are getting the award.  Let’s say it takes a month for HR to figure out which employee is getting 1,000 shares because they have to wait for the performance reviews to be completed, and during that time the stock rises to $30 a share.  Now, once the employee is told they are getting the shares we finally have a mutual understanding about the award, but to the board’s surprise, that mutual understanding is for $30,000 of compensation, not $25,000 which is what they intended.  Of course it gets even worse if the Board approves the award for the top employee to be decided over the next year, then we won’t know what the value of the award is for over a year.  So much for straight answers

Now let’s talk about post-retirement benefits.  In this day and age, companies are often changing or eliminating post-retirement benefits because they simply can’t afford to provide them anymore.  Usually, the process officially starts with a plan amendment. Once again these are often approved by or at least presented to the Board for review. Under “normal” accounting thought, once the plan was legally amended you would think a company would be required to account for the change, but not so fast in the post-retirement benefit world.  Once again the need to “communicate” the change to the plan participants is required by the standard before any change is accounted for.  In the FASB’s own example, they show a plan amendment adopted in ‘X1 that is communicated to the plan participants in’X2 that is effective in ‘X3.  Even though the legal adoption is completed in ‘X1 you don’t account for it until the plan participants are told about the change in ‘X2.  And of course, there are lots of questions about what it means to communicate such changes and the words, not the numbers, are what really matter in determining if the communication has actually been made.

So accounting may ultimately be about the numbers, but its words that help you decide what the numbers are supposed to be.  Maybe it’s time we all took a refresher course on writing.

Restatement numbers go down…and up

I recently read a report that cited the overall number of public company restatements fell from 820 in 2011 to 768 to 2012, which is down from the peak in 2007 of 1,213.  The more interesting news is that large public companies – accelerated filers under SEC parlance – saw restatements increase from 202 to 245 during the same time period and in fact it is up over 50% from the 158 restatements in 2010.  The other interesting statistic is that the severity of the restatements – based on earnings impact, time frame, etc. – decreased over the same time periods.

While overall this is good news, the question that struck me was why are the biggest companies having more difficulty getting the accounting right in the first place.  The lack of “severity” of the errors leads one to believe it isn’t fraud.  So if it isn’t fraud, what is it?  I think the statistics above indicate that we might have reached the point where accounting has become so complicated that even large companies with ample resources and dedicated staff AND their auditors, generally big 4, can’t get it right all of the time.

There has been a lot of press about the FASB and AICPA attempts to reduce the complexity of accounting for private companies.  While Billy Atkinson, Chair of the PCC, and I do not see eye to eye on some private company issues, I do agree with him when he says that the maybe the private company concerns with some of the accounting standards really are concerns about the overall complexity accounting standards for everyone including public companies.

One thing most newly issued and proposed standards have in common today is the conceptual purity of the standards.  Take the initial proposal on the leasing standard.  It was clearly a great achievement of how to account for all leases as financing transactions.  We can talk about a lot of different issues with the proposal, but how about this one.  Instead of waiting for what is likely to be more than six years from when the project started to get a theoretically perfect standard on leasing in place, we could have had a workable solution to get the leasing liability on the balance sheet proposed, exposed and issued in a year if they had been less worried about being theoretically perfect and more concerned about putting something in place that gets you 95% of what was needed and 100% of an answer that would help investors understand the liability and make better investment decisions.

And another side effect of more practicable, less pure accounting – fewer restatements.  At least that is my theory.  Unfortunately, I don’t think I will ever have a chance to prove it.

Phantom AMT Accounting

A lot has been written about the (not quite so) final agreement to avert the fiscal cliff and extend existing income tax rates for most citizens of the United States.  Lost in most of the media coverage, mainstream of otherwise, was a significant development regarding the Alternative Minimum Tax (AMT).  Congress finally “permanently fixed” the AMT by upping the exemption amount and then indexing it for inflation.  At least it is as permanent as anything done in Washington these days.

The most important feature of the AMT change is that it will end the ongoing joke of extending the AMT for 1 year each year-end.  I say joke because the way the Federal Government budget (and accounting) rules worked, they only had to count the reduction in AMT revenue for the one year they extended the higher exemptions.   They were able to assume that in future years AMT revenue would be back and this would make projections of budget deficits smaller.

Let’s compare this to a couple of accounting standards those of us in the corporate world have to deal with.  The first is around accruals for vacation pay.  The standard starts off simply enough with the concept that if your vacation plan results in people earning vacation in one year that will be paid (either in the form of time or dollars if the employee leaves the company) in the next year, then you have to accrue for the vacation earned as of the end of year 1.  But the standard does not stop there.  In this case if there is no plan or even if there is, but the company makes a practice of doing something different that results in payment for unused vacation , then the company has to accrue the “substantive” practice rather than whatever the policy says in writing. A second standard that has the same concept is accounting for pensions.  In that standard, if you have a practice of giving increases in the pension benefit periodically, then the standard requires you recognize that “substantive” plan even if it is not part of the official written plan.

So, in the corporate world, if you have a practice of doing something you have to recognize the results of that recurring practice.  In Washington that rule does not apply.  There, you can ignore something everyone knows you are going to do as long as you haven’t actually put it into law. I guess we can’t call it a lie, but it certainly was misleading.  At least from now on deficit projections will be closer to reality and isn’t that the first step in dealing with a problem – recognizing what the actual problem is.

SEC Conference – SAB 74 Implications

Preparers of public company financial statements should be very familiar with the requirements of SAB 74 to disclose of the known impacts of changes in accounting standards.  Typically this disclosure is covered by the quick and dirty “the change is not expected to be material” or the “the impact of the change is not yet known.”  While the SEC doesn’t like it, that answer works for many of the standard changes that only impact disclosures or only impact a small subset of public companies.

That logic won’t work with the revenue recognition and leasing standards set to be released in 2013.  First, in responses to the FASB, many industries have made it clear that even with the changes in the revised exposure drafts the new standards will significantly impact the timing and amount of revenue and expense recognition.  Second, companies are likely to have significant information on the impact of these standards well before they are actually implemented for several reasons including the length of time to implement the standards and the likelihood that many companies will implement dual accounting processes as a way to deal with the retrospective application requirement currently proposed in the standard.

It might be acceptable to say you don’t know when the standard is issued one year and effective the next, but these standards are likely to have an implementation phase of three years of more.  The SEC might allow you to get away with “I don’t know” the first year, but they are likely to ask serious questions if you keep it up in years two and three.  I could see the SEC asking if you don’t know, or at least have a solid estimate of the impacts in years two and three, how can you say you have the proper controls in place to produce financial statements once the standard is implemented.

And it gets even better; the SAB 74 disclosure is part of your audited financial statements (note this is not forward looking information, but information on what your current financial results would look like under the new standard).  That means any estimates you give are part of what will get audited.  Most importantly that means you have to have a properly controlled process in place to come up with the estimates that can be audited. An additional implication is that once the standard is in place the amounts included in your actual financial results better be close to what you disclosed previously.  If not, there are likely to be serious questions about your controls and processes on all of your financial results, not just your SAB 74 disclosures.

Bottom line, even if the FASB gives us until 2015 or 2016 to implement the new standards, because of SAB 74 you better be ready to start disclosing some solid numbers under the new standard by the time you release your 2014 (I think we will get a pass in 2013) financial statements.  So forget about those three year implementation plans and start thinking about how to track this information starting in one year on January 2014.

IASB-FASB Fissures

It seems the fissures in the IASB-FASB relationship have continued to grow and risk becoming so fractured that the U.S. movement to IFRS may be put off indefinitely. 

The latest salvo game from IASB chairman Hans Hoogervorst.  His statement that the IASB has “broken deadlines so often that nobody believes in them anymore” seems to be purely a self assessment at first blush, but in standard setting, like politics, nothing is ever that simple.  The IASB Chairman also referred to “dysfunctional working processes and dysfunctional decision making” in his recent self assessment of the IASB.  Considering the FASB is part of that decision making process and the only standards singled out as issues where joint projects, one has to believe at least some of the criticism was squarely aimed at the FASB.

Mr. Hoogervoorst also laid down the gauntlet that the IASB would finish its conceptual framework project by September 2015.  Given that aggressive time frame, it is clear the IASB won’t have time to work with the FASB on any convergence projects once the big three – revenue recognition, leases and financial instruments are complete.  In fact, one has to wonder if the IASB will continue to work closely with the FASB to work out a single solution on those projects – in particular the leasing project – or if they will simply go their own what and effectively tell the FASB you can come along or not; we don’t care which you do.

And the IASB also seems to be getting the backing of the EU with comments from officials referring to stakeholders impressions that “we are going backwards” on accounting standards.  The EU has even raised the idea of kicking the SEC off of the monitoring board providing oversight to the IASB.  While that has not happened, if it ever does, it will be very interesting to see the SEC response.  Given the SEC’s mandate through law about accounting standards, would the SEC be willing to continuing accepting financial statements based on accounting standards they have no oversight on whatsoever?   

So it increasing looks like we may have a world of two or three (never count out the Chinese) major sets of accounting standards.  A friend on mine from Canada mentioned this is increasing starting to look like the adoption of the metric system.  The U.S. initially puts out plans to adopt the metric system, but never really gets on board with the rest of the world.  That leaves business stuck in the middle dealing with users of both systems and muddling through as best they can.

March 2012 Regional Meeting of Council

The AICPA held its four regional meetings of Council over the last couple of weeks.  Regional meetings of Council are smaller assemblies that only members of Council attend (no guests or members of the press attend). This, along with the smaller meeting size, allows for greater and more frank discussion among members of Council.  The AICPA took advantage of this opportunity to have in-depth discussions on its strategic plan down to actual implementation initiatives.

If you are like many of us buried in work these days, you might have missed the impact the JOBS Act will have on our profession.  Dodd-Frank exempted public companies with a market cap below $75M from the section 404(b)  (obviously logic evaded congress as it is precisely these small companies that are most susceptible to fraud and the most in need of controls). Congress continued to defy logic by exempting new public companies for their first 5 years of being public from 404b if their market cap is under $750M  and their revenues are under $1B.  If that wasn’t bad enough, congress also decided to get into the accounting standard setting process. Under the act, new public companies that qualify for exemption from section 404(b) will be exempt from implementing any new accounting standards if the standard includes a delay in implementation for private companies.  Most new standards today include a delay for private companies, so this in effect delays all new substantive accounting standard changes for new public companies for the same period of time.  This is congress’s first successful attempt to set accounting standards since the exchange acts of 1933 and 1934 which gave the SEC standard setting authority (which the SEC then passed to the private sector for the most part). This is a dangerous precedent and we need to be on alert for additional attempts by congress to legislate accounting standards.  As vocal as I have been about the FASB, I still see the FASB as a far superior alternative to congress setting accounting standards. 

And a word for those opposed to differential standards for private companies. Where are your voices against this set of differential standards? Congress just set up a scheme for two different sets of standards for two different classes of public companies.  This makes even less sense given the users of new public company financial statements have the exact same needs as the users of existing public company financial standards. 

The exemption also applies to auditing standards.  There is a 5 year exemption from new auditing standards for companies meeting the 404(b) exemption threshold.  This may prove to be the most contentious exemption between a new public company and it’s auditor.  Auditing standards are essentially minimum requirements for an auditor to meet when performing an audit.  An auditor can (and should) go beyond the minimum requirements depending on the audit.  My guess is the auditor will often follow all current standards regardless of the exemption, but that sets up the contention.  I can see the discussions now between the business and the auditor with the business asking why certain procedures that are costing time and money are being performed when they are not required by the older auditing standards.  Even better, can you imagine the auditing standard on the auditor’s report being changed, but the business requesting the old report format be used because they don’t want disclosures required by the new report to be included.

There were a lot more topics covered in the meeting, but in keeping with the theme that the regional meetings are more private, I won’t go into them in detail in this blog.  I will, however, continue to keep you informed of the issues through this blog as they become public over the coming months during the April AICPA Board meeting and the May AICPA Council meeting open to the public.