It is amazing what a difference one word can make in a common question to CPAs.
The first version is “how should I account for something?” This sentence implies several things. It implies that they trust you know GAAP. It implies that they believe in your integrity. Finally, it implies that they want you to take into consideration the entire process from source data to controls to determine not only the best answer under GAAP, but also the most efficient, effective and repeatable process to get that answer month after month.
The second version is “how can I account for something?” This sentence takes us in a whole different direction. They are asking for options under GAAP. This will not only test the bounds of your knowledge, but the bounds of your integrity as well. It also implies that they are not asking for your input on the process or controls – only on researching possibilities under GAAP. This question is limiting and potentially dangerous at the same time.
So which question does your boss ask?
Gift cards are ubiquitous these days. People buy them for gifts, for loyalty points they provide and as an easier way to pay for goods and services without having to carry around cash. Originally you could only buy a gift card from the retailer or restaurant that would ultimately redeem the gift card. Now you can buy a gift card for any number of business from any number of different businesses which raises the question, when a business sells a gift card from a different business, should they book the revenue from that sale at the gross amount (the amount they sold it for) with the cost reflected as an expense or the net amount (the amount they sold it for less the amount they had to pay the other business) with no cost recorded since the cost was already recognized in the reduced revenue.
GAAP has specific rules on determining if a sale should be recorded gross or net. There several indicators to be evaluated two of which – who is the primary obligor and is there inventory risk – are given more prominence than the other indicators such as the ability to set the price and credit risk. Let’s look at these indicators as they relate to gift cards.
It would seem the seller of the gift card has discretion in setting the price. While most retailers sell a gift card for the face value, there are some like Sam’s Club that sell gift cards below face value. Really the only limit on a retailer’s ability to set the price is what the customer is willing to pay and how little profit the seller wants to make. In fact a retailer could sell a gift card as a loss leader to get people in the store to buy other goods. Credit risk also seems to reside with the seller of the gift card. If the check the customer used to pay for the gift card bounces or the credit card ends up being stolen, it is the seller that is out the money, but as I said, these two indicators are not given as much weight in today’s GAAP.
A more important indicator is inventory risk, but that can result in different evaluations depending on how the seller pays for the gift cards. If the seller buys the gift cards up front from the other business then they would certainly appear to have inventory risk. On the other hand, it seems many gift cards have no value until activated at the time of sale. If the seller doesn’t send money to the other business until the gift card is sold, then there doesn’t appear to be much inventory risk for a bunch of plastic rectangles with no value indicated on some computer server in the cloud.
The term “primary obligor” sounds intimidating, but what it really means is who does the customer see as the provider of the good or service they are buying. That’s where gift cards get tricky. Does the customer see the item they are buying as the gift card itself or as the meal or electronics it can buy from the other business? Before you answer let’s bring in some more thoughts. How many people buy gift cards to give as gifts? In their eyes are they buying the gift card itself? They certainly don’t intend on using what the gift card can buy. They intend to use the gift card itself. I can hear those of you stuck with worthless Boarders gift cards say, but the gift card is only worth something when it can be submitted in payment to the other business. That is not entirely true. There is a vibrant market for gift cards. As the seller you won’t get face value, but there clearly is a value for the gift card. So if the gift card itself has value, is it unrealistic to say the customer is buying the gift card itself and not the right to trade it for goods from some other party?
And if you think the accounting for Gift cards is fun now, wait until the new revenue standard is in effect and the indicators I discussed above are all given equal weight in evaluating whether the seller is acting as the principal or agent.
One of the most significant changes to revenue recognition on the new standard may be the elimination of the contingent, or cash, cap requirement. There are those that did not like the contingent cap requirements because they linked revenue recognition to cash payments and that did not seem to follow the spirit of accrual accounting. That view, however, seems based on believing the contingent cap requirement is in place due to a collectability issue with recognizing revenue before the cash is due from the customer. While that view may be applicable in some cases, the primary driver of the contingent cap rules is that you should not recognize revenue until delivery is complete. If the vendor is still required to provide a significant service in order to be entitled to a payment, you cannot recognize revenue under current GAAP.
In practical terms, if I need to provide wireless service in order to be entitled to a payment, I cannot and should not recognize any portion of that revenue even if today’s multi-element rules say a portion of that service charge should be allocated to a deliverable that is already completed (providing the subsidized handset), because if I don’t provide that second deliverable (the wireless service) I will never be entitled to the revenue. I acknowledge that the future service is almost always delivered and there is very little question about the ability to continue to deliver that service in the future. In fact, the business model of subsidizing wireless handsets is built upon delivering that service in the future, otherwise a business would go bankrupt very quickly selling smartphones to hundreds of dollars below cost.
The FASB has decided that if you have a contract, or even an implied contract, then the revenue from performance obligations (the new term for deliverables) is not contingent at all on the future performance because they start with the assumption that both parties will fully deliver on all elements of the contract (the vendor will provide all performance obligations and the customer will make all required payments). Given that is the way it works a significant majority of the time that assumption is not unreasonable even though it is less conservative than the previous assumption.
The result of this position is that revenue will get recorded earlier under the new standard compared to existing GAAP. It also brings into question other “conservative” elements in existing GAAP. For example, the general practice is that no matter how likely a gain contingency is under ASC 450, you simply do not record it until it is legally owed because to do so “might be to recognize revenue before its realization” (ASC 450-30-25-1). On the other hand, you recognize losses as soon as they are probable and estimable. The asymmetrical answer under ASC 450 would seem to be the opposite of the answer the FASB has come up with under the new revenue standard and I wonder if and when the Board will decide to address that difference.
I mentioned the new Financial Reporting Framework for Small and Medium Enterprises (FRF for SMEs) in last week’s blog. This week I would like to dive a little deeper into the subject and talk about how FRF for SMEs will differ from U.S. GAAP as promulgated by the FASB. The FRF for SMEs is designed to be a comprehensive basis of accounting like cash basis or tax basis so it will qualify for OCBOA (Other Comprehensive Basis of Accounting) Reporting. That means a CPA will be able to provide clients financial statements and a report (depending on the engagement agreed to with the client) and users will know exactly what they are getting.
Let’s start with some simple examples of what FRF for SMEs will contain.
- No impairment testing for goodwill. Instead, like in yesteryear, goodwill will be amortized. In this case the time period will 10 years or the same period that is used for federal tax purposes.
- No VIE Consolidation. One of the biggest complaints of SME financial statement users is the requirement to consolidate related by irrelevant enterprises. FRF for SMEs will not require their consolidation and will allow standalone entity financial statements of the relevant entity to the user.
- Lease accounting will be closely aligned with how leases are treated for tax purposes. SMEs won’t have to worry about whatever the FASB and IASB decide to come up with to complicate the accounting for leases.
- Simplified hedge a derivative accounting. Let’s face it, most SMEs don’t enter into anything strange and if they do they are usually plain vanilla currency or interest rate swaps. The accounting will coincide with the simplicity of the business operating model.
- No OCI – Most SMEs don’t do things that result in OCI anyway and it rarely has anything to do with real assets or cash flow so it won’t be required for FRF for SMEs.
The full FRF for SMEs will be about 200 pages (that’s less than the revenue recognition ED being debated currently by the FASB) and really comes down to lots of traditional things like the matching principle, conservatism and basic accrual accounting. I think one of my fellow Council members from Texas described it best when he said “It sounds a lot like GAAP before the FASB got involved.” Who knows maybe all those baby boomers nearing retirement will have an opportunity for a second career teaching all of the young CPAs the basics of plain old accrual accounting!
I attended the AICPA Council meeting last week. As expected a major topic of discussion was the FAF exposure draft on private company financial reporting, but before I get to that topic I want to list some of the AICPA’s accomplishments over the past year. The AICPA achieved record membership (372,000); Completed a major bylaw change better defining the categories of membership; Reached agreement with CIMA on forming a joint venture to issue the first Chartered Global Management Accountant credential; Successfully lobbied for the repeal of the onerous 1099 requirements and the elimination of the ability to patent income tax strategies; Resolved may problems with initial IRS proposals on Tax Preparer Registration; Completed the clarity project on auditing standards for private companies; Replaced and out of date and increasing unworkable SAS 70 regime; Successfully highlighted the CPA profession to the next generation resulting in record accounting majors and graduates; And completed an update of the vision for the CPA profession for the next 15 years. I would like to highlight two of these accomplishments before I address Private Company Financial Reporting.
The new CGMA certification for CPAs with expertise in Corporate and Management Accounting is scheduled to make its debut on January 31, 2012. The core purpose of a CGMA is to be “trusted to guide critical business decisions.” This is what CPAs in B&I do everyday, but now we will have a credential to recognize the unique nature of that service and differentiate us from non-B&I CPAs as well as other “accountants” that work in business. There are going to be additional focus areas on professional development, but it won’t be only about the individual CGMA taking the initiative. Our joint venture partner, CIMA, has extensive experience in working with employers to set up development programs for finance departments and we intend to bring this expertise into the U.S. along with the CGMA. This will not only enhance the skills of CPAs in business, but also elevate CGMAs in the minds of one of the most important influencers on our careers – our employers.
CPA Horizons 2025
The AICPA has spent time working with thousands of our members to update the Vision of the future of the CPA profession during the past year. The development has been a evolution of the existing vision rather an a revolutionary change in direction. The core purpose for CPAs remains the same, “ CPAs…Making sense of a changing and complex world.” In addition many of the core competencies such as Integrity and Objectivity remain the same. Some, however, have changed. For example, “technologically adept” is now gone as a distinct competency because the concept is so pervasive it now is really part of all of the core competencies. The final report on CPA Horizons 2025 will come out after inclusion of additional feedback from Council obtained at this meeting. Be on the lookout for it late this year.
Private Company Financial Reporting
As I reported in my last blog, FAF issued an exposure draft on private company financial reporting that did not follow the Blue Ribbon Panel recommendations. The Council was extremely disappointed in the FAF and as a result passed the following resolution at the meeting.
“Be it Further Resolved, That because the Financial Accounting Foundation’s proposal does not contain the establishment of a board under the Financial Accounting Foundation empowered to set differences in U.S. GAAP standards where appropriate for privately-held companies, which is the preference of this Council, and if the Financial Accounting Foundation’s proposal is not modified to include such a board under the Financial Accounting Foundation, this Council directs the AICPA Board of Directors to consider all options, including consideration of other independent standard-setting bodies as the standard setter for U.S. GAAP for private companies, the creation of a committee or board within the AICPA or a standard-setting body as a separate entity, to develop private company generally accepted accounting principles (PCGAAP) or comprehensive private company-specific basis of accounting that would deliver meaningful, lasting improvement to private company financial reporting consistent with the Blue Ribbon Panel recommendations.”
Just to be clear, let me repeat a statement made by our new Chair-Elect Richard Caturano. The AICPA Board, Council and members do not want to take control of private company GAAP. What we want is a separate Board under FAF as recommended by the Blue Ribbon Panel sponsored by FAF, NASBA and the AICPA, but if the FAF refuses to follow those recommendations, the AICPA Council and Board will have to act accordingly.
I just had the privilege of attending the AICPA IFRS Conference in Boston last week. There was an awesome lineup of speakers. Topics ranged from SEC enforcement of unreconciled IFRS financials to detailed discussion with FASB and IASB staff members on the leasing and revenue recognition proposals. I wanted to take a moment to highlight a few of my observations from the meeting.
- No one seems to think that SEC convergence/endorsement proposal is the best way to implement IFRS, but everyone seems resigned to the fact that it is probably the only political way to get the U.S. to IFRS over time.
- The Chairs of the IASB and FASB are not ivory tower purest. One of the highlights of the meeting was when Hans Hoorgervorst stated he really wasn’t sure what OCI (Other Comprehensive Income) was and Leslie Siedman said she did know what it was and proceeded to explain that OCI was the place to offset changes in the balance sheet that weren’t part of net income. Not exactly a principles based answer – but it is honest.
- The slow down of the MOU projects will not impact the timing of a decision from the SEC on IFRS. This was repeated several times by many speakers including representatives of the SEC, the FASB and the IASB.
- IFRS is already here in the U.S. There are many foreign subsidiaries that are already reporting and being audited under IFRS. In addition, many companies still reporting under U.S. GAAP are dealing with lots of subsidiaries (IBM reported their number is 57 and growing) keeping their books under IFRS. Users are comparing U.S. GAAP based companies with IFRS based companies every day when making investment decisions.
- Converting to IFRS will not be a simple exercise for U.S. companies. Our accounting processes are just that – very processed based. How to account for something is decided at a high level and the rest of the staff often then just does what they are told. Under IFRS, judgment will have to pushed down much further into finance organizations. This has implications on internal Controls (can we say SOX 404), the need for training on how to make decisions, not just how to process transactions, and documentation of decisions which will be much more extensive under IFRS.
- After almost 40 years, the future of the FASB is very cloudy. What will be there role in private company standards? What will be there role in public company standards? Do they even have a reason for continued existence 5 years from now?
There were many other topics covered, but I think this gives you a flavor of what was covered. One of the great things about speaking English is it is the language of business across the world. We don’t have to learn French, German, Chinese or Japanese to conduct business in the world. IFRS is no longer becoming – it is – the world wide financial language for business. While sharing many “words” with U.S. GAAP, it is a different language and even if the U.S. takes a slow road to adoption, learning the language is a must for any CPA that wants to be able to converse in the business world.
Anyone who has been following the SEC’s decision process on allowing/requiring U.S. public companies to use IFRS has heard time and again how adopting IFRS is critical to enhance the comparability of financial statements across the world. It seems likes comparability is a given – one set of global accounting standards means everyone will be accounting for the same transaction the same way – all over the world. Who can argue against the benefits of that to the investor community?
The problem is that the dream – everyone accounting for the same transaction the same way – is just that, a dream. I put forth as exhibit A, the nightmare of accounting in Europe over the value of Greek Bonds. As you know, Greece is in a little trouble and there is serious doubt about their ability to pay-off all of their debt. As a result, the level of trading in the bonds has diminished since the crisis began, but there still is trading in the bonds. That trading however indicates a price that is at a substantial discount, even lower than what some “experts” say Greece will eventually be able to pay off.
So, what should companies (mostly banks) value the Greek bonds at in their interim financial statements? Should they be valued at what they are trading for today or should they be valued at what the (experts and the) bank thinks they will eventually get back? I will be the first to tell you that there are a lot of variables in that decision, but the part that concerns me the most is that the value of the bonds seems to be determined by the country the bank is located in, not the accounting standard followed by the bank.
Yes, different banks, both using IFRS, have reported substantially different values for the bonds – and it’s not because one bank lists the bonds as held to maturity and another bank lists them as available for sale. It’s also not because the banks have different auditors – at least by name. Several of the banks with starkly different values appear to be clients of the same auditing firm. As a CPA with an understanding of how firms work, I know that a “firm” using the same name in different countries is really not the same firm. It is two (or more) firms – one from each country – that are bound together at some level internationally, but ultimately, each country (even office) of those firms has some, potentially significant, level of autonomy. Unfortunately, most investors don’t understand the intricacies of audit firm structures. If they see two opinions signed by the firm Jones & Smith, they assume that at least those financial statements should have things accounted for consistently.
So this Greek (Bond) tragedy, besides showing cracks in various aspects of the European Union, may also be showing us that moving to IFRS is not the comparability nirvana for investors that it is touted to be. There have been a lot of good debates about U.S.GAAP vs. IFRS, but until now, those on the U.S. GAAP side did not have a good response to the comparability argument. The soft underbelly of IFRS comparability has been shown for the tough old gut it is I for one am glad we didn’t rush into adopting IFRS before we had a chance to see how the supposed wonderful comparability of a single set of accounting standards really works.