Accounting for change
Two changes to public company accounting took hold in 2012; the change on the test for impairment of goodwill on the balance sheet and a change in how comprehensive income is presented in the financial statements.
We expected more. After all of the hue and cry about international accounting convergence – it was predicted by most people to be a sure thing as the U.S. and international boards drove together down the ballyhooed “path to convergence,” with at least vocal support from the SEC – it hasn’t happened. Progress on the critical issues of revenue recognition and accounting for leasing slowed, but we still expect the FASB and IASB to reach agreement on final rules in the near future. What is more significant, perhaps, is what didn’t happen on convergence. In this article I will first discuss my interpretation of what actually took place in 2012, why companies should worry about it and what I believe will happen this year in public accounting rulemaking.
Before I comment on the sparring last December between the FASB (Financial Accounting Standards Board) and the IASB(International Accounting Standards Board), let’s review the changes that were implemented.
The first was the change on the test for goodwill and indefinite lived intangibles impairment. Companies used to have to undergo costly annual valuations of goodwill and certain other intangible assets, such as trademarks, licenses and distribution rights, on their books to determine whether they may have been impaired. Now companies have the option to first perform a qualitative assessment to determine whether it is likely that the fair value is less than the carrying amount. They don’t have to automatically perform a formal valuation unless some external or internal event triggers the need to revalue the asset.
The second significant change was in the presentation of comprehensive income. Instead of burying the components of other comprehensive income in the stockholders equity statement, they must be shown in a single statement with net income, or in a separate statement of comprehensive income that is consecutive with the income statement. Companies affected by this change include those that translate overseas operational results into U.S. dollars, engage in hedging, hold investments that are classified as held for sale, or have pension plans. The new rule doesn’t change the accounting for these events, just how they are presented. It is seen as more friendly to investors.
International differences surface
The two changes don’t seem like much in a year when the lack of agreement on international accounting standards dominated headlines. As work dragged along on the issues that mark the so-called “path to convergence,” the long-awaited ”“final report” by the SEC staff was released in mid-summer. The review and analysis was remarkable only in that it said very little. Staff made no recommendations to the board for adoption, but did note that adoption of IFRS in the United States is not supported by most U.S. capital markets participants. If you read between the lines, the SEC staff is not inclined to support wholesale adoption of international standards for the U.S., but other methods of achieving the goal of a single set of high quality, global accounting standards, such as a more gradual endorsement approach, may be more workable.
After the SEC report landed on desks with nothing more than a thud, the difference in opinion that was apparently simmering between the FASB and IASB came to a head at the AICPA Conference on Current SEC and PCAOB Developments in Washington in early December. Two different opinions were expressed by FASB chairman Leslie F. Seidman and IASB chairman Hans Hoogervorst. As reported in Accounting Today, Seidman, who is clearly dissatisfied with the idea of abandoning strict U.S. tests and standards for the more judgmental international model, said:
“The bottom line is that our stakeholders will demand clarity from somebody,” she added. “It’s in everyone’s best interests to have that interpretive process conducted in a transparent way, rather than individually through audit or enforcement. That doesn’t mean we want to take the judgment out of accounting. But we should try to take the judgment out of what the principle means, especially when we are introducing a new concept, such as business model or expected loss.”
Hoogervorst called for more commitment from the U.S. than he is receiving: “Already, on some issues, it is getting increasingly hard to find common solutions,” Hoogervorst said. “If we cannot achieve converged outcomes within a convergence program, then how will we maintain convergence once the program has ended? The risk of increasing divergence will be enormous. What a waste that would be.”
Seidman’s points were valid. The U.S. isn’t ready to adopt international standards, at least in part because of its litigious business environment. When it comes down to the courts, it is harder to defend a reporting decision you made using a principles-based approach when your opponent is looking at it with the benefit of hindsight. If you adhere to strict, well-defined bright line standards, you have a better chance of winning the day.
What’s ahead in 2013
Several changes that started with the convergence effort continue and may be implemented with or without total convergence. FASB’s adoption of these standards will affect U.S. companies regardless of what the IASB does. The revenue recognition project continues to move forward and while issues are still being identified and worked out, there have not been significant changes from last year’s exposure draft. Companies did win their desire to record bad debts below the net gross margin line, which is how it is treated today. After all, gross margins are a key metric for both public and private companies. All of the other revenue recognition changes reported previously look to be on track and a final standard is expected to be issued this year. The effective date remains to be seen, but is expected to take into consideration the requirement that companies adopt the new standard retrospectively.
Leasing is another big project that despite moving slowly, continues on the path to placing all leases on the balance sheet, with no distinction made between operating and capital leases. The current discussion involves the timing of recording amortization and interest expense (the original proposal would result in a front-loading effect). Expect a new exposure draft during the first half of 2013 and some indication about an effective date.
Finally, expect continued progress in the FASB’s project to place the going concern assessment on the shoulders of management, instead of solely on the auditor, where it is now. This is one more step in incorporating items that affect financial reporting that were only in the auditing standards into the accounting standards, where they rightfully belong. A similar change was made to subsequent events disclosures several years ago. We expect to see an exposure draft of this standard in mid-2013.
In conclusion, it was a relatively quiet year in accounting standard setting, with the exception of the apparent derailing of the international standards effort. Three or four years ago, convergence was a question of when it would be implemented; now it’s a question of if. Nothing is certain. Directors and commissioners change jobs and new policies can change along with them.