UAA – ACCT 650 Seminar in Executive Uses of Accounting Dr. Fred Barbee

“History does not repeat itself, but it rhymes.” Mark Twain

“Financial reporting should be transparent, truthful and complete whether it is ‘old economy’ or ‘new economy’ accounting.” J. Edward Ketz Associate Professor of Accounting Pennsylvania State University’s Smeal College of Business as quoted in Goodbye to GAAP Industry Week March 2002

“A new model for accounting won’t be worth much if managers are opaque, misleading and deficient. The issues we face are more ethical than they are technical.” J. Edward Ketz Associate Professor of Accounting Pennsylvania State University’s Smeal College of Business as quoted in Goodbye to GAAP Industry Week March 2002

“GAAP can never stand up against bad faith. The accounting rules are merely guidelines. Any company, any company at all, that wishes to ‘game’ the rules, and can find a willing auditor, can distort economic reality for a surprisingly long period of time.” David P. Horn, Partner Tatum CFO Partners, LLP as quoted in Goodbye to GAAP Industry Week March 2002

“The rapid development of global financial markets has greatly reinforced the desirability of – indeed now demands – international consistency in accounting standards and auditing approaches.” Paul Volker, Chairman of the Trustees of the IASC Foundation, www.ifad.net

June 2001

“[. . .] by drawing on the best of US GAAP, IFRSs and other national standards, the world’s capital markets will have a set of global accounting standards that investors can trust.” Sir David Tweedie, Chairman of the IASB www.ifad.net

October 2002

“The Enron scandal shows that America can no longer take the pre-eminence of its accounting for granted.” . . . FASB and the SEC should reexamine traditional U.S. principles and possibly embrace international standards in their place.

Editorial The Economist Magazine January 19, 2002

A Short History of Accounting

This commentary is purely the rantings of this professor and does not represent the opinions of the Accounting Department, the College of Business & Public Policy, the University of Alaska, the State of Alaska or anyone else!!!

In the beginning there was nothing and darkness was upon the face of the earth for there was no accounting!

And God said, “there must be transparency! Let there be accounting!” And there was accounting and it was crude and God said, “This is not good!” And finally God could stand it no longer He said “There must be transparency! There must be a better way”! And He created Luca Pacioli and He said, “This is good!”

Luca Pacioli created the double entry bookkeeping system and he said, “This is good! Now we will have transparency!” And he was very happy.

Debits on the left! Credits on the right! Now we will balance! Now we will have transparency!

And God looked down and said, “This is better!” The accounting profession was born. Things were looking up!(?)

In the course of time (1850) a group of accountants got together and said “We must join forces! The world must know we are here!” And it was so – and the title “Certified Public Accountant” was born! And the accounting profession said, “This is good!” And God said “I’m not so sure!” And the accountants were excited and said, “Let’s form our own association!” And so they formed the Organization of Accountants (Soon to be AICPA). And they said, “This is good!”

And God said, “No comment!” Then along came the 1920s and financial scandals and corporate failures abounded. And everyone said, “This is not good!” And God said, “I thought so!” Again, in the course of time (1930s) the AICPA and the accounting profession said, “We must fill in this GAP Right!” – we must develop some rules – We need GAAP!” And it was so! And the AICPA said, “This is good!” And God said, “Yeah,

Yet again, in the course of time (?), the AICPA said, “We need our own rule-making body!” And all the accountants agreed, and it was so. The AICPA created the “Committee on Accounting Procedure” (CAP) and said, “This is definitely good!

And God simply refused to comment.

(1959) Trouble! The CAP was not filling the GAP in GAAP and the AICPA was heard to say, “We need a new rule making body – this one is broken!

And so they did! The Accounting Principles Board (APB) was created (1960) to fill the GAP in GAAP. The AICPA was excited and said, “Yes! At Last! This is good!” And God could not be found!

Finally, someone said, “Perhaps the AICPA is part of the problem! We need a new rule-making body (this one is broken) that is independent to fill the GAP in GAAP!” And it was so, and FASB was born (1973). And the accounting profession said, “This is good!” And God refused to return phone calls!

Rules! We need more rules! FASB is the answer. FASB can fill the GAP in GAAP! But alas, it was not so.

FASB tried . . .

Then came Enron! Then came WorldCom! The accounting profession was reeling – and darkness was everywhere! There was no light! There was no transparency! And darkness was everywhere!

And the accountants said, “This is really bad!”

And God just shook His head in wonder and amazement!

Then someone said, “We need a new rule making body, this one is broken! I have the answer! We need international accounting standards! The IASB should replace the FASB!” They will be able to fill the GAPs in GAAP! We will have transparency!

And God once again refused to return phone calls or respond to emails!

The End!

Com on IASB, I’ll show you a thing or two!

The FASB . . .

 Report of the Wheat Commission resulted in the demise of the APB and the creation of a new standard-setting structure . . .

 Financial Accounting Foundation  Financial Accounting Standards Board  Financial Accounting Standards Advisory Council.

Due Process . . .

 Two basic premises of FASB in setting accounting standards . . .

 Should be responsive to the needs and viewpoints of all concerned;  Should operate in full view of the public through a “due process” system.

Steps in Due Process . . .

 A topic or project is identified and placed on the Board’s agenda.

 A task force of experts is assembled to define problems, issues and alternatives related to the topic.

 Research and analysis are conducted by the FASB technical staff.

Steps in Due Process . . .

 A discussion memorandum is issued.

 A public hearing is often held, usually 60 days after release of the memorandum.

 The Board analyzes and evaluates the public response.

Steps in Due Process . . .

 The Board deliberates on the issues and prepares an exposure draft for release.

 After a 30-day (minimum) exposure period for public comment, the Board evaluates all of the responses received.

Steps in Due Process . . .

 A committee studies the exposure draft in relation to the public responses, reevaluates its position, and revises the draft if necessary.

 The full Board gives the revised draft final consideration and votes on issuance of a Standards Statement.

FASB . . .

 Passage of a new FASB Statement requires the support of 4 of the 7 Board members.

 FASB Statements are GAAP  All ARBs and APBs in effect in 1973 continue to remain in effect, until revised, or superseded by FASB.

Types of Pronouncements

 Standards and Interpretations  Financial Accounting Concepts  Technical Bulletins  Emerging Issues Task Force Statements

Emerging Issues Task Force

 Created in 1984  17 Members  11 CPA Firms  4 Companies  An SEC observer  A FASB representative

Emerging Issues Task Force

 The purpose of the EITF is to reach a consensus (15 of 17) on how to account for new and unusual financial transactions that have the potential for creating differing financial reporting practices.

FASB Due Process: An Example

Significant Events . . .

 FASB Statement No. 87  Employers’ Accounting For Pensions  FASB Statement No. 106  Employers’ Accounting for Post-Retirement Benefits Other Than Pensions

Significant Events . . .

 1974 Pensions added to FASB agenda  1975 Task force appointed  1975 Discussion Memo #1 issued  1976 Public hearing #1 held  1977 Exposure Draft #1 issued  1979 Exposure Draft #1 revised

Significant Events . . .

 1980 FASB background paper issued  1981 Discussion Memo #2 issued  1981 Public hearing #2 held  1982 Preliminary Views document issued  1983 Supplement to Discussion Memo #2 issued

Significant Events . . .

 1984 Public hearing #3 held; other postretirement benefits made a separate project  1985 Exposure Draft #2 issued  1985 Public hearing #4 held  1985 Statement No. 87 issued in December

Significant Events . . .

 1989 Exposure Draft on other post retirement benefits issued and public hearing held.

 1990 Statement No. 106 issued in December

Look at Something More Recent

FASB’s Due Process

 In August 1996, FASB put the issue of accounting for business combinations on its agenda.

FASB’s Due Process

 From 1996 through June 2001,  the Board issued four separate documents for public comment,  held over 60 public meetings, and conducted public hearings, field tests, and visits.  Analyzed & discussed more than 500 comment letters.

FASB’s Due Process

 June 1997  FASB produced a special report, Issues Associated with the FASB Project on Business Combinations, that solicited input on the scope, direction, and conduct of the project.

FASB’s Due Process

 December 1998  FASB collaborated with the G4+1, a group of international standard setters  Attempt to develop a position paper on the methods of accounting for business combinations.

Look at Something More Recent

FASB’s Due Process

 In August 1996, FASB put the issue of accounting for business combinations on its agenda.

FASB’s Due Process

 From 1996 through June 2001,  the Board issued four separate documents for public comment,  held over 60 public meetings, and conducted public hearings, field tests, and visits.  Analyzed & discussed more than 500 comment letters.

FASB’s Due Process

 June 1997  FASB produced a special report, Issues Associated with the FASB Project on Business Combinations, that solicited input on the scope, direction, and conduct of the project.

FASB’s Due Process

 December 1998  FASB collaborated with the G4+1, a group of international standard setters  Attempt to develop a position paper on the methods of accounting for business combinations.

FASB’s Due Process

 September 1999  FASB issued an Exposure Draft, Business Combinations and Intangible Assets  Constituents invited to comment

FASB’s Due Process

 February 2001  FASB issued a revised Exposure Draft, Business Combinations and Intangible Assets-Accounting for Goodwill  Constituents invited to comment

FASB’s Due Process

 May 2001  FASB concluded its redeliberations of all issues raised in comments  Board unanimously voted to issue FASB No. 141 and FASB No. 142

Come on FASB, put up your dukes!

IASC …

 Founded in 1973 by an agreement of accountancy bodies in  Australia  Canada  France  Germany  Mexico  The Netherlands  United Kingdom  United States

IASC

 Began issuing standards in 1974 known as International Accounting Standards (IAS).

 Were not always considered to be of high quality.

 Frequently known as “the lowest common denominator.”

Criticisms of IASC

 Not independent from national political pressures.

 Board meetings were not open to the public until 1999.

 Board members were appointed based on geography and not technical merit.

Criticisms of IASC

 No educational or professional criteria and no independent approval committee.

 Committee members served voluntarily on a part time basis.

IASC Restructured

 The IASC was restructured in April 2001 resulting in an organization similar to the FASB.

 The IASC became a nonprofit corporation governed by trustees that funded the activities of the new IASB (International Accounting Standards Board).

The IASB . . .

 The IASC Trustees appointed 14 IASB members.

 These members are responsible for the development and approval of new International Financial Reporting Standards (IFRS) and interpretations.

The IASB . . .

 The primary qualification for board membership is technical expertise.

 Publication of an IFRS exposure draft or interpretation requires a majority vote of the IASB.

The IASB Goal . . .

 Harmonization or convergence of accounting standards worldwide.

The IASB Goal . . .

 FASB and IASB must agree on how to settle differences between the two sets of standards.

 Then the SEC must allow listed companies to prepare financial statements in conformity with IAS.

It’s Time to Simplify Accounting Standards

Dennis R. Beresford Journal of Accountancy March 1999

FASB Statement #133

 Accounting for Derivative Instruments and Hedging Activities  Issues June 1998  Statement is 245 pages long  FASB had all five big accounting firms help in developing an educational course on the new standard.

In Addition to FASB Statements

 FASB Interpretations  FASB Technical Bulletins  FASB Staff Q&A Publications  EITF Consensus Positions  Announcements by FASB or SEC Staff Members at EITF Meetings

In Addition to FASB Statements

 AICPA Statements of Position  AICPA Practice Bulletins  AICPA Audit Guides  SEC Staff Accounting Bulletins  SEC expects public companies to follow guidelines set out in speeches by SEC accounting staff members.

The Norwalk Agreement

 Undertake a short-term project aimed at removing a variety of individual differences between U.S. GAAP and IFRS.

 Remove other differences between IRFSs and U.S. GAAP that will remain at 01/01/05, through coordination of their future work programs.

The Norwalk Agreement

 Continue progress on the joint projects that they are currently undertaking; and  Encourage their respective interpretative bodies to coordinate their activities.

The Norwalk Agreement

 Harmonization or convergence of accounting standards worldwide.

The IASB Goal . . .

 FASB and IASB must agree on how to settle differences between the two sets of standards.

 Then the SEC must allow listed companies to prepare financial statements in conformity with IAS.

IAS Vs. GAAP

Arguments Pro and Con

Arguments in Favor of IAS

 The markets want it to happen.

 For Investments  For Transparency

Arguments Against IAS

 IAS standards are not sufficiently comprehensive; that is, U.S. GAAP addresses issues not addressed by IAS.

 IASC standards are not of sufficient high quality.

 There is not an infrastructure in place sufficient to ensure the enforcement of rigorous/consistent application of IAS.

“Political” Lobbying – A Potent Force

“Political” Lobbying on Proposed Standards: A Challenge to the IASB by Stephen A. Zeff Accounting Horizons Vol. 16, No. 1, March 2002

GAAP Vs. IAS: How About a Little Competition?

Why Not Allow FASB and IASB Standards to Compete in the U.S. by Ronald A. Dye and Shyan Sunder Accounting Horizons Vol. 15, No. 3, September 2001

International Accounting Standards

Similarities and Differences: IAS, US GAAP and UK GAAP

Subject

Revenue Recognition Construction Contracts

IAS

Based on several criteria, which require the recognition of revenue when risks and rewards have been transferred and the revenue can be measured reliably.

Accounted for using the percentage-of completion method. Completed contract method prohibited.

US GAAP

Four key criteria.

In principal similar to IAS

. Detailed guidance for specific transactions.

Similar to IAS

, completed contract method permitted.

Subject

Acquired Intangible Assets

IAS

Capitalize if recognition criteria met; intangible assets must be amortized over useful life, normally no longer than 20 years. Revaluations are permitted in rare circumstances.

US GAAP

Capitalize purchased intangible assets and amortize over useful life, and review for impairment. Intangibles may also be assigned an indefinite useful life, these must not be amortized but reviewed for impairment at least annually.

Subject

Internally Generated Intangible Assets

IAS US GAAP

Expense research costs as incurred. Capitalize and amortize development costs only if stringent criteria are met.

Expense both research and development costs as incurred.

Some software and website development costs must be capitalized.

Subject IAS US GAAP

Property, Plant and Equipment Inventories Use historical cost or revalued amounts. Frequent valuations of entire classes of assets required.

Use historical cost. Revaluations are not permitted.

Carry at lower of cost and NRV. Use FIFO, LIFO (rarely used), or weighted average method to determine cost.

Similar to IAS

. More common use of LIFO.

Subject

Changes in Accounting Policies

IAS

Either restate comparatives and adjust prior year opening retained earnings, or include effect in current year income statement and provide pro-forma comparatives in the notes.

US GAAP

Generally include effect in current year income statement. Disclose pro-forma comparatives. Retrospective adjustments for specific items.

Subject IAS US GAAP

Correction of Fundamental Errors Changes in Accounting Estimates Either restate comparatives or include effect in current year income statement with pro-forma comparatives in the notes.

Report in income statement in the current period.

Restate comparatives.

Similar to IAS

Subject

Purchased Goodwill

IAS US GAAP

Capitalize and amortize over useful life, normally not longer than 20 years.

Capitalize but do not amortize. Goodwill should be tested for impairment at least annually at the reporting unit level.

International Accounting Standards

Conceptual Framework

Qualitative Characteristics of Financial Information IAS

Financial information must possess certain characteristics for it to be useful. The IAS Framework requires that financial information must be understandable, relevant, reliable, and comparable.

U.S. GAAP

A series of concept statements set out similar characteristics to IAS, with greater emphasis placed on the consistency of financial information.

Reporting Elements IAS

The IAS Framework presents five reporting elements: assets, liabilities, equity; income (includes revenues and gains) and expenses (includes losses).

Assets

are resources controlled from a past event.

Liabilities

are present obligations arising from a past event. Assets and Liabilities are recognized on the balance sheet when it is “probable” that economic benefits will flow in to, or out from the entity, and those benefits must be able to be measured reliably.

Equity

is the residual interest in the assets after deducting the liabilities of the entity.

Income

is increases in economic benefits that result in an increase in equity other than those relating to contributions from equity participants.

Expenses

are decreases in economic benefits that result in decreases in equity other than those relating to distributions to equity participants.

Reporting Elements U.S. GAAP

Reporting elements and the definition and recognition criteria are similar to IAS.

U.S. GAAP concepts statements contain additional elements:  Investments by and distributions to owners; and  Comprehensive income.

Other comprehensive income includes all changes in equity during a period, except those resulting from investments by and distributions to owners.

Historical Cost IAS

Historical cost is the main accounting convention. However, IAS permits the revaluation of intangible assets, PPE and investment property. IAS also requires fair valuation of certain categories of financial instruments and certain agricultural assets.

U.S. GAAP

Prohibits revaluations except for certain categories of financial instruments, which have to be carried at fair value.

International Accounting Standards

Financial Statements

Balance Sheet IAS

Does not prescribe a particular balance sheet format, except that IAS requires separate presentation of total assets and total liabilities. Management may use judgment regarding the form of presentation in many areas. However, as a minimum, the following items must be presented.

Assets

: PPE; Investment Property; Intangible Assets; Financial Assets; Investments accounted for using the equity method; Inventories; trade and other receivables; tax assets and cash and cash equivalents.

Equity & Liabilities

: Issued share capital and other components of shareholders’ equity; minority interests; non-current interest bearing liabilities; tax liabilities and other payables.

U.S. GAAP

Generally presented as total assets balancing to total liabilities and equities. Items presented on the face of the balance sheet are similar to IAS, but are generally presented in decreasing order of liquidity. The balance sheet detail must be sufficient to enable identification of material components

Current/Non-Current Distinction IAS

The current/noncurrent distinction is optional. When an enterprise chooses not to make this classification, assets and liabilities must be presented in the order of their liquidity. Where the distinction is adopted, assets must be classified as current assets where they are held for sale or consumption in the normal course of the operating cycle. Both assets and liabilities are classified as current where they are held for trading, or expected to be realized within twelve months of the balance sheet date. Interest bearing liabilities may be noncurrent if their original term was for more than twelve months and the documented intention is to refinance, and an agreement to refinance is completed before the financial statements are issued.

U.S. GAAP

Similar to IAS. The SEC provides guidelines for the minimum information to be included if a classified balance sheet is presented.

Income Statement IAS

IAS does not prescribe a standard format for the income statement. The entity must analyze its expenditures by function or type.

At a minimum, IAS requires presentation of the following items on the face of the income statement: Revenue; results of operating activities; finance costs, share of results of associates and joint ventures accounted for using the equity method; tax expense, profit or loss from ordinary activities; extraordinary items (if any); minority interests and net profit or loss for the period.

Income Statement U.S. GAAP

Presented in one of two formats: A

single-step format

where all expenses are classified by function and are deducted from total income to give income before tax; or A

multiple-step format

where cost of sales is deducted from sales to show gross profit, then other income and expenses are presented to give income before tax.

SEC regulations specify further line items.