Got Goodwill? Part 9 Impairment Hall of Fame (continued)

Recently anounced goodwill impairment charges:

Valero Energy Corp. $4.1 billion

Flextronics $5.9 billion

B/E Aerospace, Inc $300 million

U.S. Airways $622-million

Boston Scientific Corp. $2.7 billion

Colonial BancGroup $575 million

Banner Corp., $71.1 million

Quantum Corp. $350 million

Applied Micro Circuits $264 million

Lattice Semiconductor $225 million

These are in addition to the previous charges announced as noted here.

Got Goodwill? Part 8: Symantec has $7 Billion Impairment Virus

Security software maker Symantec Corp. took a $7 billion goodwill impairment charge in its December 2008 third quarter results. Symantec kept $5-billlion of goodwill on its books. About $8-billion of their goodwill before the write-down came from their acquisition of Veritas for $13.5-billion in 2004.

They completed an interim impairment analysis, meaning that they checked for impairment before being required to do so by their internal policy on testing impairment.

Symantec stated” The GAAP net loss for the third quarter of fiscal year 2009 includes a non-cash goodwill impairment charge of approximately $7 billion. Based on a combination of factors, including the current economic environment and a decline in our market capitalization, we concluded that there were sufficient indicators to require us to perform an interim goodwill impairment analysis. We have not completed the goodwill impairment analysis and expect to finalize it during the fourth quarter of fiscal year 2009. We may make an adjustment to this charge when the goodwill impairment analysis is completed.”

Got Goodwill? - Part 7 - Latest Impairment: Celestica

Celestica announced its Q4 earnings this week and disclosed that it has written off all of its remaining goodwill. Their explanation from their financial statement notes is set out below. It’s interesting from the perspective of how they describe the mechanics of the write-down:

We are required to evaluate goodwill annually or whenever events or changes in circumstances indicate that we may not recover the carrying amount. Absent any triggering events during the year, we conduct our goodwill assessment in the fourth quarter of the year to correspond with our planning cycle. We test impairment, using the two-step method, at the reporting unit level by comparing the reporting unit’s carrying amount to its fair value. To the extent a reporting unit’s carrying amount exceeds its fair value, we may have an impairment of goodwill. All of our goodwill is allocated to our Asia reporting unit.

During the fourth quarter of 2008, we performed our annual goodwill impairment assessment. Our goodwill balance prior to the impairment charge was $850.5 and was established primarily as a result of an acquisition in 2001. We completed our step one analysis using a combination of valuation approaches including a market capitalization approach, multiples approach and discounted cash flow. The market capitalization approach uses our publicly traded stock price to determine fair value. The multiples approach uses comparable market multiples to arrive at a fair value and the discounted cash flow method uses revenue and expense projections and risk-adjusted discount rates. The process of determining fair value is subjective and requires management to exercise a significant amount of judgment in determining future growth rates, discount and tax rates and other factors. The current economic environment has impacted our ability to forecast future demand and has in turn resulted in our use of higher discount rates, reflecting the risk and uncertainty in current markets. The results of our step one analysis indicated potential impairment in our Asia reporting unit, which was corroborated by a combination of factors including a significant and sustained decline in our market capitalization, which is significantly below our book value, and the deteriorating macro environment, which has resulted in a decline in expected future demand. We therefore performed the second step of the goodwill impairment assessment to quantify the amount of impairment. This involved calculating the implied fair value of goodwill, determined in a manner similar to a purchase price allocation, and comparing the residual amount to the carrying amount of goodwill. Based on our analysis incorporating the declining market capitalization in 2008, as well as the significant end market deterioration and economic uncertainties impacting expected future demand, we concluded that the entire goodwill balance of $850.5 was impaired. The goodwill impairment charge is non-cash in nature and does not affect our liquidity, cash flows from operating activities, or our compliance with debt covenants. The goodwill impairment charge is not deductible for income tax purposes and, therefore, we have not recorded a corresponding tax benefit in 2008.

Cablevision Accounting Error Case Provides SEC Insights

The recently settled SEC/Cablevision action provides a couple of insights into the SEC's practices. One insight is how the SEC settles actions involving financial statement errors that companies voluntarily bring to the SEC's attention. Another is what the SEC considers a material misstatement--in this case, 3.8% of after tax earnings. Another insight might be how easy it was for the officers of Cablevisions's subsidiary to misstate the financials.

Three former employees of Cablevision Systems Inc. were fined a total of $60,000 as a result of accounting irregularites from 2000-2003. The employees did not admit or deny wrongdoing. The three officials were the president, executive vice president and senior vice president of a subsidiary. They were dismissed in 2004, when Cablevision discovered the errors.

Cablevision is a diversified entertainment and telecommunications company with a market cap of approximately $8 billion and 2007 annual revenues of $6.5 billion.

As a result of the an income smoothing scheme the SEC's order stated that Cablevision’s financial statements for years 2000 through 2003 were materially inaccurate. The total after-tax errors were:

$15 million understatement 2000 (3.8% of earnings)
$25 million overstatement in 2001 (1.5% of earnings)
$8 million overstatement in 2002 (4.9% of earnings)
$8 million overstatement in 2003 (5.1% of earnings)

From 1999 through 2003, Cablelevision recognized certain costs as current expenses when, in fact, the costs should not have been recognized in those periods. These improper "prepays" resulted from fake invoices generated to accrue expenses earlier than when they in fact should have been. The result was that Cablevision overstated expenses in earlier periods, and understated them in later periods. This practice is generally known as "income smoothing".

In addition, from 2000 through 2003, Cablevision’s cable distribution business improperly recognized payments known as launch and marketing support paid to Cablevision by television program vendors for advertising and marketing campaigns to attract viewers to the vendors’ programs. This scheme caused Cablevision to reduce expenses in the periods in which launch support was improperly recognized and increase expenses in the periods when the launch support should have been recognized.

Improper Prepays
Cablevision’s accounting department, however, had little direct knowledge of the type of details discussed below at a business unit level. Internal accounting procedures merely called for recognition of expenses and requests for payment of expenses to be reported to the accounting department on a standardized "authorization for payment" form ("APF"), signed by the appropriate level business unit manager, with evidence of the expense, such as an invoice, attached. These controls, however, were not sufficient to prevent the manipulation of expense recognition that occurred.

Cablevision employees and managers for years were able to defeat Cablevision’s internal accounting controls using methods that were neither particularly devious nor sophisticated. For example, some employees submitted counterfeit invoices to Cablevision’s accounting department that were of noticeably poor quality, and were different in appearance from legitimate invoices. Certain Cablevision employees also asked vendors to submit false, vague or misdated invoices for services not yet provided. These invoices were used to trigger the inappropriate patments. In addition, Cablevision checks were sometimes sent to the business unit from which a counterfeit or false invoice originated, ostensibly for delivery to the vendor by an employee of the business unit. This deficient practice permitted the business unit to hold payment until the anticipated services were actually rendered.

Improper Launch Support Recognition
Beginning in the middle to late 1990s, television program vendors began providing lump-sum launch support payments to Cablevision in connection with multi-year contracts with Cablevision to carry their programs. Contract provisions concerning launch support payments were generally understood to require Cablevision to use the funds for advertising and marketing campaigns to attract viewers to the vendors’ programs. Contracts providing for large up-front payments of launch support to Cablevision were not uncommon. These contracts sometimes also required that the launch support be refunded by Cablevision if, among other things, it dropped the program.

In some cases during the relevant period, Cablevision properly recognized nonrefundable launch support as a reduction of expenses ratably over the life of the contract with the vendor and recognized refundable launch support ratably over the life of the refund period. In fact, in 2002, Cablevision publicly stated that this was how it accounted for launch support. From 2000 through the third quarter of 2003, however, Cablevision improperly accelerated the recognition of launch support received from several program vendors, rather than recognizing it ratably over the life of the contract or the refund period. This early recognition ran contrary to its general practice and its 2002 public statement, and violated GAAP’s matching principle.

For example, after the first two years of an eight-year contract, Cablevision changed its recognition for $15 million of launch support from recognition ratably over the life of the contract to immediate recognition of the remaining balance. Under the circumstances, however, Cablevision should have accounted for launch support payments ratably over the life of the contract where, as here, the contract term was fixed and there was no obligation to refund launch support. Another example involved a contract with a launch support refund period. After the first eight months of a 24 month refund period, Cablevision changed its recognition of $5 million in launch support from recognition ratably over the life of the refund period to immediate recognition of the remaining balance. Under the circumstances, however, Cablevision should have accounted for launch support ratably over the refund period specified in the contracts.

Cablevision also improperly recognized launch support early by treating a 2002 seven-year agreement to carry certain programs as if it were two agreements – one of three years, and another of seven years. As two separate agreements, Cablevision recognized $48 million in launch support over the ‘three year’ agreement ($16 million per year), and recognized $16 million in launch support over the ‘seven year’ agreement ($2 million per year). Under GAAP, however, the two agreements should have been treated as one agreement, with the result that the total $64 million in launch support should have been recognized ratably over seven years, i.e., approximately $9.14 million per year. The purported two agreements were negotiated simultaneously and dated only five days apart, and the ‘seven year’ agreement also amended the terms of the ‘three year’ agreement. Cablevision employees improperly cast the single deal as two agreements to achieve early recognition of the launch support payments.

Got Goodwill? Part 6—European Impairment Watch

European companies that adopted IFRS goodwill accounting may have their first severe year of reckoning with goodwill impairment charges this year. A few big companies will be on watch for writedowns. Vivendi has already indicated they will take a write down on its €22-billion of goodwill.

As with other markets around the world, European markets have been beaten up and lost significant value over the last six months or so.

Total goodwill reported for companies included in the Dow Jones Stoxx 600 index is about €1 trillion. This compares with a total market capitalization of around €3.5 – 4 trillion for the index., The Stoxx index represents large, mid and small capitalization companies across 18 countries of the European region: Austria, Belgium, Denmark, Finland, France, Germany, Greece, Iceland, Ireland, Italy, Luxembourg, the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland and the UK.

France Télécom (€32-billion), Vivendi (€22-billion) and Sanofi-Aventis (€43-billion) account for over 10 percent of French goodwill.

In France alone, the total amount of goodwill for companies included in the SBF 120 stock-market index reached €350 billion at the end of June, as companies have spent heavily on acquisitions over the past few years. The overall goodwill for SBF 120-listed companies compares with a total market capitalization of €841.5 billion for that index at Friday's close. The SBF 120 is a French stock market index. The index is based on the 120 most actively traded stocks listed on the Paris Bourse Paris Bourse (now Euronext Paris). The index includes all 40 stocks in the CAC 40 index (a capitalization-weighted measure of the 40 highest market caps on Euronext Paris, plus a selection of 80 additional mid-cap stocks listed on Euronext Paris.

IFRS rules require an annual impairment test. In addition, companies must test goodwill if other indicators exist. Other indicators include drops in market prices, or other indications of reductions in the present value of future cash flows from their individual cash-generating units can indicate goodwill impairment.

With information form Nathalie Boschat at the Wall Street Journal

Got Goodwill? Part 5

Impairment Hall of Fame

Tough times mean write-downs of assets including goodwill and intangibles. Following are write downs announced recently.

ConocoPhillips – oil and gas: $25.4 billion in goodwill impairments-- $7.3 billion before- and after-tax impairment related to ConocoPhillips' investment in LUKoil and additional after-tax impairments totaling $1.3 billion

Royal Bank of Scotland: $U.S. 20 to 28 billion goodwill impairment charge.

Regions Financial: $6 billion goodwill impairment in its banking reporting unit.

AMD – technology: $3.2 billion impairment to goodwill and intangibles

OfficeMax -- $1-billion impairment in goodwill and trade names

United Rentals: $1.1 billion goodwill impairment relating mostly to goodwill arising out of acquisitions made by the company between 1997 and 2000.

Brunswick Corp.--consumer brands: $1-billion goodwill impairment

JDS Uniphase: up to $744 million goodwill impairment


McMoRan Exploration - oil and gas exploration: $291.8 million impairment charges on oil and gas property, plant and equipment

Celanese – chemicals: $100 million impairment of fixed assets

Fulton Financial – banking: $90 million goodwill impairment charge

H.B. Fuller Co. - adhesives and specialty chemical products: $86.9 million goodwill and asset impairment charges mostly related to the company's 2006 acquisition of Roanoke.

Mattson Technology: $18 million against goodwill, $7 million against intangibles and $3 million against fixed assets.

Got Goodwill? Part 4

Goodwill Traps -- Establishing Reporting Units

Being slapped around by the SEC is not fun as accounting management at Sony, Johnson Controls and Caterpillar can attest. The SEC beat up those companies over their reportable segments. Goodwill and reportable segments are inextricably linked, since goodwill itested for impairment on a segment-by-segment basis.

In the 90s, Sony reported only two segments, Electronics and Entertainment. Entertainment included both Sony’s music and motion pictures divisions, which had radically different customers, cycles and operating results and presumably separate management. In 1994, Sony announced a $3.2 billion write-off related to Columbia Pictures that wiped out nearly 25% of Sony’s shareholders’ equity. Sony lost money on 17 of the 26 movies it released in 1994. Remember Cops and Robbersons? Brainscan? City Slickers II: The Legend of Curly's Gold? (I'm betting you wish you don't remember). How about Arnold Schwarzenegger's The Last Action Hero, one of the highest budget pictures in history (it bombed). Segment and MD&A disclosures prior to the write downs never showed any indication of problems. Eventually, the SEC served Sony with a "cease and desist" order.

In nailing Sony, the SEC cited their action against Caterpillar: In Caterpillar, the Commission determined that “Caterpillar's MD&A disclosures failed to adequately apprise investors of a material risk of lower earnings and did not quantify the impact of lower earnings from a Brazilian subsidiary on Caterpillar's overall results.”

The SEC again reached the end of its rope in 2001 in a speech by the Chief Accountant: “Let me warn you that our patience with deficient segment disclosure has been exhausted. Expect the staff to request an amendment, rather than suggest compliance in future filings, if components regularly reviewed by the chief operating decision maker are not presented separately.”

By 2005 they finally nailed Johnson Controls for 2002 through 2005, and forced them to revise their segment disclosures for their Automotive Group. Johnson originally had TWO segments. The SEC objected to a bloated Automotive segment, which made up 77% of Johnson’s the 2004 revenues. The SEC forced Johnson’s hand and they ultimately broke Automotive down into four segments, for a total of FIVE operating segments. In 2006, after more thought (and with the SEC looming over their thinking) decided in Q2 2006, (after an acquisition) determined that it had TEN reportable segments. None of this ever affected Johnson Controls’ goodwill, because all of their segments continued to make profits, so goodwill was never at risk. But in their two segment period, goodwill impairment in, say, their North America auto interiors division could have been covered up by a goodwill cushion in say, their European auto operations, if it had losses or other indications of impairment.

Imagine the cost in legal and accounting fees and lost time to correct the above errors. Not to mention embarrassment and career damage. Choose your segments and allocate goodwill to them carefully.

Fair Value, IFRS and Obama

Paul Volcker is the Chair of Obama’s financial advisory team and Chairman of the Trustees of the "Group of Thirty". Recently the Group of Thirty Working Group on Financial Reform published Financial Reform A Framework for Financial Stability. Volcker alsonhas an important history, as Chair of the U.S. Fed and as Chair of the IASB's oversight organization. he is thought to be a propornent of IFRS in the U.S. Below are a few comments by Volcker and an excerpt from the Fair Value section of the report. Fair Value was important enough to comprise one of 17 recommendations in the report.

Quotes from Chariman Volcker:

"The issue posed by the present crisis is crystal clear: How can we restore strong, competitive, innovative financial markets to support global economic growth without once again risking a breakdown in market functioning so severe as to put the world economies at risk? We hope that our proposals, which explicitly relate to the weaknesses that have become evident in the financial system over the last year, will be a useful contribution to the debate about needed reforms both by private financial institutions and by public authorities."

"The pervasive and deep-rooted financial crisis has amply demonstrated that our financial system is broken and it requires thorough-going repair,"

There were no representatives from the accounting community on the group that authored the report.

Excerpt from: FINANCIAL REFORM A Framework for Financial Stability

Fair Value Accounting
Recommendation 12:

a. Fair value accounting principles and standards should be reevaluated with a view to developing more realistic guidelines for dealing with less liquid instruments and distressed markets.

b. The tension between the business purpose served by regulated financial institutions that intermediate credit and liquidity risk and the interests of investors and creditors should be resolved by development of principles-based standards that better reflect the business model of these institutions, apply appropriate rigor to valuation and evaluation of intent, and require improved disclosure and transparency. These standards should also be reviewed by, and coordinated with, prudential regulators to ensure application in a fashion consistent with safe and sound operation of such institutions.

c. Accounting principles should also be made more flexible in regard to the prudential need for regulated institutions to maintain adequate credit loss reserves sufficient to cover expected losses across their portfolios over the life of assets in those portfolios. There should be full transparency of the manner in which reserves are determined and allocated.

d. As emphasized in the third report of the CRMPG, under any and all standards of accounting and under any and all market conditions, individual financial institutions must ensure that wholly adequate resources, insulated by fail-safe independent decision- making authority, are at the center of the valuation and price verification process.

Got Goodwill? Part 3

Various requirements in competing a goodwill impairment test:

• Understanding the accounting rules, related concepts, terminology and implementation issues;
• Determination of reporting units;
• Development of the reporting unit valuation model(s);
• Documentation requirements related to goodwill impairment and intangible asset
impairment testing;
• Performing market and industry research to support valuation assumptions;
• Determination of appropriate discount and capitalization rates;
• Establishing effective data collection processes to aid in regular evaluation of impairment testing;
• Reviewing valuation analysis, including valuation assumptions and calculations.

Many companies are able to provide all of the above services internally. Others may engage a CPA or valuation firm. Services offered by a valuator will be subject to the independence rules of applicable CPA Societies.C.A. Institutes and regulatory bodies such as Securities Commissions.

EU Commissioner Bashes IFRS

Charlie McCreevy, European Commissioner for Internal Market and Services had the following to say at his keynote address at the Annual Association of European Journalists (AEJ) Christmas lunch in Dublin on December 8, 2008.

"the relatively new International Accounting Standards – especially in terms of the rules on provisioning for bad debts and the valuation of assets- are commercially and prudentially flawed. They have had unintended and damaging consequences for banks operating in illiquid markets and for the markets themselves."

In his position, McCreevy would have had significant influence over EU matters relating to IFRS. However he has state that he intends to leave the Commission at the end of his current term.

Got Goodwill? Part 2

Current market conditions may require companies to revisit previous goodwill impairment calculations or provide more detailed analysis and support for their impairment tests.

Under U.S. and Canadian GAAP, the goodwill impairment test has two steps. Step One is essentially a valuation of each business that has goodwill ("reporting unit", using comparative information and/or discounted cash flows. If the value of the business is greater than its carrying value, the testing is done, and Step Two is not necessary.

Step Two is necessary if the value calculated in Step One is less than carrying value. Step Two requires valuation of the individual assets and liabilities of the business of the reporting unit, including intangible assets. This essentially means doing a purchase price allocation ("PPA") as if the business were purchased from a third party. Goodwill is always the residual amount assets have been deducted from the business value calculated in Step One. In Step Two, impairment is measured as the excess of carrying value over the calculated value of goodwill. The following diagram outlines the steps in a PPA ("Steps" are not goodwill impairment calculation steps.)

If you can't see the entire diagram click here.

[Diagram from Grant Thornton]

Once Step One has been completed, companies should make various comparisons to ensure the reasonableness of their goodwill value. One technique is to value all reporting units to arrive at a value for the company as a whole. This helps to demonstrate that value has not been shifted from one reporting unit to another to skew the result.

Another corroborating analysis is to compare the Company's market capitalization (share price times number of shares outstanding) with the total value of the company as a whole, as calculated in the above paragraph. Generally, market cap and value of the business will differ. Reasons for this difference should be explained. Differences may include control premiums, liquidity factors, and non-public information.

More later on this.

High Level Obama Advisors Disagree on IFRS

Two key advisors to Barack Obama today expressed different opinions over the SEC move to shift U.S. accounting rules to IFRS.

The clash casts some doubt on the SEC roadmap requiring large public companies to move from U.S. GAAP to IFRS by 2014.

Mary Schapiro, SEC Chair:
“I would proceed with great caution so we don’t have a race to the bottom.”. “I won’t feel bound by the [IFRS] roadmap.”

Paul Volcker, Chairman of Obama's Economic Recovery Advisory Board:
"We ought to be working toward international accounting standards and have them standard around the world under the general aegis of the International Accounting Standards Board, and there's been a lot of progress in that direction."

Volcker is a a former chairman of the International Accounting Standards Committee Foundation, IASB's parent organization. IASB determines the makeup of IFRS. Volcker is also a former chairman of the U.S. Federal Reserve Board.

Schapiro said she has concerns about the pace of the timeline, the independence of IASB, and the quality of the IFRS standards. As well, Schapiro has concerns over the lack of detail in IFRS and the additional room for interpretation, and the cost cost of the conversion to IFRS, estimated by the SEC to be up to $32 million for the largest companies adopting IFRS.

Got Goodwill?

Companies that carry goodwill on their financial statements could face a major task when completing their audited financial statements this year. The markets in general have dropped about 40 percent. Company share prices and market cap declines could be a signal goodwill impairment testing done at an interim period (many companies use July 1 or September 1) is no longer valid.

Recent market events in many cases constitute one or more indicators of impairment. Goodwill of a reporting unit must be tested for impairment between annual tests if an events or circumstances indicate a reduction in a reporting unit's fair value. Such events or circumstances include adverse changes in the business climate, an adverse action or assessment by a regulator, loss of key personnel, expectation that all or a portion of a reporting unit will be sold, testing for future recoverability of value of a assets, goodwill impairment loss in a subsidiary.

Share price/market cap declines, commodity price declines, drops in revenue, loss of market share, regulatory oversight, layoffs, and sale of assets to raise cash could all be considered impairment indicators.

Following is a chart showing a comparison of the market cap of some corporate sectors to the book value of their equity:

[Table from Mercer Capital]

The one sector where book value is higher than market cap is financials, and anyone following recent market events knows the troubles in that industry.

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There is a huge increase in the number of companies in the technology, services, industrial goods, health care, consumer goods, and basic materials sectors where book value exceeds market cap. Auditors will generally use this as a reason to ask for a recalculation of interim tests.
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This will be the first part of a few posts on this subject. More tomorrow.

Essentials for 2008 Year End Reporting

The Big 4, second-tier firms, and various other sources provide a rich offering of tools for those working in the trenches preparing 2008 financials. Here are some good ones--if you are aware of any others, please let me know:

Deloitte:
U.S.
Top 2008 Financial Reporting Developments
Highlights of the 2008 AICPA National Conference on Current SEC and PCAOB Developments
SEC Comment Letters on Domestic Issuers
IFRS Reporiting
SEC Comment Letters on Foreign Private Issuers Using IFRSs
Model financial statements, checklists, and compliance questionnaires
Deloitte: Canadian Reporting Requirements
2006 Annual Financial Reporting Document Review

PriceWaterhouseCoopers:
Reporting considerations in the current market
US GAAP Pronouncements Affecting 2008 Financial Statements (includes developments to December 31, 2008)
Canadian GAAP Pronouncements Affecting 2008 Financial Statements (includes developments to December 31, 2008)
SEC speeches, including those at the 2008 AICPA/SEC Conference
Highlights of the 2008 AICPA National Conference on Current SEC and PCAOB Developments

KPMG:
U.S.
2008 AICPA National Conference on Current SEC and PCAOB Developments
IFRS
IFRS Disclosure Checklist
Illustrative financial statements
Canada
Focus on Financial Reporting 2008 Annual Update

Ernst & Young
AICPA National Conference on current SEC and PCAOB developments

BDO Canada
Accounting Update 2008

Grant Thornton
2008 AICPA National Conference on Current SEC and PCAOB Developments
FAS 157 Resource Center

SEC
SEC Division of Corporate Finance Financial Reporting Manual--updated 2008 (formerly "Accounting Disclosure Rules and Practices")

FASB
Effective Dates of Recent FASB Documents

Canadian Institute of Chartered Accountants
Effective Dates for New Standards
IFRS Model Financial Statements from various accounting firms amd other sources

Communicating IFRS Conversion

In an article in the Canadian CA Magazine titled "Something to talk about", Chris Hicks provides an excellent summary of the communication required by enterprises that convert to IFRS. Perhaps this is a bit early for U.S. companies converting in 2014, but other countries will convert before that.

In the conversion to IFRS, preparers and investors will be best served by complete dialogue in the period leading up to 2011
In 2011 Canadian GAAP for publicly accountable enterprises will convert to international financial reporting standards (IFRS), adding Canada to the 100-plus countries that have adopted IFRS. But what about the two years leading up to the changeover — what should be communicated in management’s discussion and analysis (MD&A) and when should communications occur?

A couple of graphics illlustrate the process:

Please have a look at the full article.

U.S. IFRS Move Makes USA Today

U.S. considers costly switch to international accounting rules

In a regulatory sea change that could cost billions of dollars, thousands of U.S. companies — plus foreign corporations that do business here — will adopt global financial reporting rules within five years if regulators have their way.

The impact is likely to surpass that of the Sarbanes-Oxley Act of 2002, the tough anti-corporate fraud law of the Enron era that cost individual businesses millions of dollars in accounting fees. Whether U.S. companies like it or not, the new era of global accounting appears unstoppable, and businesses that ignore the International Financial Reporting Standards (IFRS) will fall behind.

"If companies don't prepare, if they don't start three years in advance," warns business professor Donna Street at the University of Dayton, "they're going to be in big trouble."

The long march to IFRS would be grueling and the preparations expensive to carry out. Companies would need two to three years to upgrade their communications and software systems and to train many thousands of financial professionals. Regulators, CPAs and investors would need to intensely study global accounting principles. Business schools would have to teach students the new accounting.

The U.S. Securities and Exchange Commission hopes to give companies plenty of time to adjust to IFRS. In November, the SEC issued a "road map" that could lead to regulations requiring U.S. businesses to file their financial statements using international rules by 2014, or by 2011 for companies that volunteer. The SEC is seeking public comment and has said it will decide in 2011 whether to keep that timetable.

SEC Chairman Christopher Cox has called the move "a revolutionary development" that will streamline global reporting standards and create "a true lingua franca" for accounting. Business leaders such as the U.S. Chamber of Commerce say it would help the USA compete in the world economy, leading to more cross-border commerce.

In an interview, Sir David Tweedie, chairman of the International Accounting Standards Board in London, says the growth of the global economy means "we must eventually end up with a common system of regulation, auditing and accounting."

The global financial and economic crisis, by many accounts the worst since the Great Depression, only illustrates the urgent need for universal accounting and oversight, Tweedie says.

But critics warn that global accounting could unleash a legal and regulatory nightmare, especially if the SEC moves too quickly to new standards. Add rampant corruption, poor financial practices and weak securities enforcement in many countries, and it gets worse.

"Switching to another set of accounting standards is a monumental task," says Charles Niemeier, a board member of the Public Company Accounting Oversight Board, or PCAOB, created by Sarbanes-Oxley to oversee U.S. corporate auditing. "It has the potential to be a Tower of Babel."

As the financial crisis commands Washington's attention, it's also unclear whether President-elect Barack Obama will back IFRS or shelve the issue this year. Several of his economic advisers and Cabinet choices have worked on global standards, while others favor U.S. accounting rules known as GAAP, or "Generally Accepted Accounting Principles," that have been used for decades.

The two major accounting standards organizations — the International Accounting Standards Board and the Financial Accounting Standards Board in Norwalk, Conn. — have been toiling for several years to move the USA toward global rules.

Already, the European Union and 113 nations — including Australia, China, India, Mexico and Canada — have adopted or soon plan to use international rules. The SEC already allows foreign firms that sell stock in the USA to file their financial statements here using IFRS.

"It's hard to find a trading partner of the U.S. that doesn't use IFRS," says Robert Bunting, president of the International Federation of Accountants and a partner at the Moss Adams accounting firm in Seattle.

Corporate America lags the rest of the world in global accounting. In a recent Deloitte & Touche survey of 200 CFOs and other financial professionals, only 9% said their firms used IFRS, although 42% might adopt global standards if allowed to do so earlier than 2014.

Some companies embrace switch

A handful of U.S. multinationals already use IFRS for their foreign subsidiaries. Dozens more are in the early stages, says David Kaplan, leader of international accounting consulting services at PricewaterhouseCoopers.

United Technologies, the $55 billion aerospace manufacturer in Hartford, Conn., isn't sitting still. More than 60% of the company's revenue comes from abroad, and many of its subsidiaries already use global standards.

Margaret Smyth, the company's comptroller, says that United Technologies already has a worldwide team working on international accounting rules for the entire corporation.

United Technologies is training its staff and, in a dry run, has redone its 2007 financial statements in the IFRS format, as if it were required.

While it's too early to come up with precise figures, Smyth estimates that IFRS will cost the company at least several million dollars and two years to implement. In the meantime, United Technologies has a head start over slower-moving rivals.

"We see that IFRS is inevitable, and we want to get out in front of it," Smyth says. "It's a very large and complicated project."

At first glance, a move to IFRS seems straightforward. But it encompasses a company's entire operations, including auditing and oversight, cash management, corporate taxes, technology and software, according to D.J. Gannon, a Deloitte & Touche partner.

"This is not just a technical accounting exercise," Gannon says. "Companies should look at IFRS more holistically."

The changes won't come cheaply. The SEC says that adopting IFRS will cost $32 million for each of 110 U.S. companies that may be eligible to use IFRS long before 2014. Those companies compete in industries with foreign businesses that already use global rules.

While large companies can absorb the costs, small and midsize businesses will get hit hard by higher accounting bills.

Look at Brooks Automation, a technology firm in Chelmsford, Mass., that provides products and services to semiconductor-equipment makers. About 36% of its $526 million in fiscal 2008 revenue came from growing foreign markets that continue to outpace the U.S. market.

Chief Financial Officer Martin Headley says that global accounting rules would bring dramatic changes to Brooks Automation's reporting of revenue, assets and liabilities, the cost of employee stock plans and other areas.

Headley says that switching to IFRS would cost the company "multiple millions of dollars," while bringing scant benefits. "For a company our size, that's a very significant burden," he says.

Headley, who has managed global companies for 15 years, says that "the differences in accounting standards" have never thwarted his businesses.

Global accounting also is likely to be plagued by gaping differences in business customs, financial regulations, tax laws, politics and other factors.

Early studies of European companies, which moved to IFRS three years ago, have found widely varying quality in financial statements. A 2006 report by the United Kingdom's Financial Reporting Council regulatory body found "boilerplate" and "bland and uninformative" disclosure of financial information by businesses.

Research also shows that IFRS has boosted income, investment returns and other financial measures for Europe-based companies. A Citigroup report on 73 European firms found their net income rose 23% in 2005 and 2006.

Niemeier, a former SEC chief accountant and perhaps the strongest critic of IFRS among U.S. regulators, says the international standards are wide open to "multiple interpretations and a lack of uniform enforcement."

Rules open for interpretation

Likewise, Ray Ball, a business professor at the University of Chicago, says it's unrealistic to think that the more than 100 countries embracing global accounting will use those rules in the same way.

Take the recording of a company's troubled assets — one of many accounting moves open to wide discretion. During Japan's long 1990s recession, Japanese banks and other companies were required by Japanese law to write down the lost value of loans, stocks and real estate.

But Ball says that did not happen, as the Japanese government looked the other way. "An asset worth only $200 million would be kept on the balance sheet for $1 billion," he says, "and that hurt the recovery of Japan's economy for a long time."

Tweedie and other IFRS supporters say that the benefits of global accounting rules outweigh the obstacles. Embracing global standards will save money for companies in the long run and will help them raise capital abroad. Perhaps the biggest upside: IFRS is more streamlined and less complex, with 2,500 pages of standards compared with U.S. GAAP's 25,000 pages.

Auditors note that U.S. and global standards differ in key balance-sheet practices, from when to record a company's revenue to the use of so-called fair value accounting to record long-term assets and investments.

Executives at Lenovo, the China-based technology giant that bought IBM's personal computer business in 2005, are big believers in IFRS.

Dennis Culin, Lenovo's director of business transformation, says there was healthy debate and "fear of the unknown" among some U.S.-based employees who favored U.S. accounting. But in the end, adopting IFRS was a no-brainer for a corporation doing business in 160 countries.

Now, Culin says, Lenovo is weaning itself from IBM's old "legacy" U.S. accounting system. So far, Lenovo has converted its operations in Asia and Canada to IFRS, and it's working now on Europe, then Latin America. If the USA moves to global rules, Lenovo will adapt quickly.

"We didn't want to declare ourselves a U.S. company or a Chinese company — we wanted to be a world company," Culin says. "So this version of accounting fits us."
By Edward Iwata, USA TODAY
http://www.usatoday.com/money/companies/regulation/2009-01-05-international-accounting-rule-switch_N.htm

SEC/FASB Fair Value and Impairment Changes

Jack Ciesielski has carved out a stronly-worded opinion on the FASB's suggested fast-track changes the banking industry lobbied the SEC for, i.e. more lenient rules on recognizing losses on CDOs and other securities causing the financial crisis last fall.

"There's still time to comment on the FASB's rapid-transit amendment of the impairment model embodied in EITF Issue No. 99-20. To put it in a nutshell: the existing rules will require companies having a decline in value for things like lower-rated securitizations, whether held by issuers as a retained interest or purchased outright, to look at the cash flows a marketplace participant would use in evaluating the cash flows of the instrument. The impairment charge can then be determined. The FASB would like to replace that test with a more judgment-based model embodied in Statement 115, at the request of the SEC. "

"Is it an improvement? I don't believe it is; in fact, I think it would be quite likely for impairments on securities covered by the amendment to be recognized later rather than sooner. Sure, the banks would like that - but I don't think that's giving investors timely or realistic information for investing decisions. I've put together my own comment letter, appearing below. I would recommend that even if you can send just a brief email on the subject to the FASB email-box, you should do so. Avoiding a reckoning on the values of these instruments is not the same thing as a reckoning; you'll be doing yourself a favor in the long run if firms are reporting their troubles honestly in the present. "

December 28, 2008

Russell G. Golden
FASB Technical Director
Financial Accounting Standards Board
P.O. Box 5116
Norwalk, Connecticut 06856-5116

Re: Proposed FSP EITF 99-20-a

Dear Mr. Golden:

I am writing in regard to the Proposed FSP EITF 99-20-a, “Amendments to the Impairment and Interest Income Measurement Guidance of EITF Issue No. 99-20.” I do not support the issuance of this amendment for the following reasons.

• The existing No. 99-20 impairment model embodies marketplace participant points of view in determining whether or not an impairment exists. The model is consistent with the principles of FASB’s Concept Statement No. 7, “Using Cash Flow Information and Present Value in Accounting Measurements,” and also with those contained in Statement No. 157, “Fair Value Measurements.” The information it provides investors is a faithful representation of current economic values. The impairment model embodied in Statement 115 is far less prescriptive and invokes much more preparer judgment.

This project originated because the banking industry lobbied the SEC for more lenient rules on recognizing losses on some of the worst-faring securities created during the housing boom. Moving to a Statement 115 model will not provide better information to investors than the current impairment model, and in fact, could lead to delayed recognition of impairments.

At a time when the American auditor is facing some of its most serious professional challenges since the early part of this decade, the FASB will hobble them in their dealings with clients by replacing an impairment model that currently works with one that leaves plenty of room for management discretion. Ordinarily, that wouldn’t be necessarily wrong - but given the current economic environment and the genesis of this project, it certainly portends a negative outcome regarding the information to be provided to investors.

• I believe the Board has its priorities reversed on this project. If a Level C standard (No. 99-20) produces information more consistently representative of fair values than the Level A standard (Statement 115), then it would seem that there is a problem with Statement 115.

If fair value reporting provides investors with the information they need to make investment decisions, then why should the Board engage in projects that decrease the information provided to investors?

Instead of diluting the information provided to investors by Issue No. 99-20, the Board would do better by investors - whom it is ostensibly serving, rather than preparers - to study the shortcomings of Statement 115. In fact, the whole idea of “other than temporary impairments” should be reconsidered through the expansion of fair value accounting for financial instruments. If full fair value accounting for financial instruments existed, there would be no need for artificial categorizations like “held-to-maturity” and “available-for-sale” securities - and no need for other-than-temporary impairment testing.

• The Board has engaged in a mere facade of a due process. An 11-day comment period for a project with this much potential reporting impact like this one is a mere sham.

Take into account the religious and national holidays during those eleven days and this amendment’s due process takes on the trappings of a parody.

At least the Board went through the motions of a due process, unlike the IASCF and the IASB when they amended IAS 39 last October.

In closing, I would like to support the Board in simplifying the accounting literature in trying to remove multiple impairment models and other possible redundancies in the accounting literature. There is that minor benefit to this project, but at too great a cost to investors.

I would support that notion, however, only if the actions taken were more comprehensive and not on a piecemeal basis that serve to benefit one group at the expense of investors.

That concludes my comments. If you have any questions, please don’t hesitate to contact me. Best regards.
Sincerely,

Jack Ciesielski
From the Analyst's Accounting Observer

In Depth Analysis of SEC Report on Fair Value

Joey Borson at Conrollers' Leadership Roundtable has provided a detailed analysis of the U.S. Congress mandated SEC report on Fair Value accounting. It is quoted in full below.

SEC to Critics: Back Away

In a Congressionally-mandated report issued this week, the SEC found that fair value accounting was not the cause of the ongoing financial crisis, and that neither FAS 157, nor mark-to-market accounting, should be suspended or fundamentally changed. In addition, the Commission found that:

• Though imperfect, FAS 157 and fair value disclosures provide timely, valuable information to investors, and market confidence would be hindered should either be suspended.
• Fair value accounting was not a major cause of the financial institution failures; instead, high credit losses and dramatic increases in depositor outflows (so-called "runs on the bank") were the main drivers. Indeed, fair value proved to be a good signal of the decaying asset bases of these institutions.
• Accounting standards are properly focused on the needs of the investor. Regulatory capital, while important, neither is nor should be a significant consideration of US GAAP principles-and concerns that fair valued regulatory capital requirements requires ‘deleveraging,' and is thus pro-cyclical, should be addressed to bank regulators, not accounting standard-setters.
• Improvements can be made to FAS 157, particularly around additional guidance for illiquid markets, distinctions between credit and liquidity losses, the use of managerial judgment, and a much more simplified impairment framework.

Fair Value: Reflecting, Not Causing, A Very Bad Year

While the overall fair value of financial institution assets declined in 2008, the SEC found that this was caused by the general economic downturn, and increases in credit losses and high default rates, not fair value requirements themselves.

Approximately 45% of financial institution assets are measured at fair value, of which three-quarters were held at level 2, 15% at level 1, and only 9% at level 3, the so-called "mark-to-model" tier. This distribution has held fairly constant over the course of 2008.

For a more extensive analysis of these asset classes, please see the Roundtable's brief on the subject.

Critically, though, asset impairment charges have grown significantly between 2007 and 2008-in 2007, impairment charges totaled around 1% of equity, while in the first three quarters of 2008, those charges had jumped to 8% of equity-a change that many have blamed on the requirement to fair value these assets (as opposed to holding at historical cost, where those impairments could perhaps have been minimized or pushed off).

However, the SEC found that:

"While fair value is used to measure certain assets such as trading securities and impairment losses on AFS securities, such declines in value were directionally consistent with the losses on the underlying loans and the current economic conditions, which impacted the value of these securities."

Case In Point: Bank Failures

Focusing on the most public example of the financial crisis, failed banks and financial institutions, the SEC found that "fair value accounting was not a primary underlying cause," instead; abnormally high default rates and credit losses, a decline in the overall quality of the asset base, and the resulting dramatic increases in "runs on the bank" were the main problem.

Looking at banks that failed over 2008 (and focusing on Washington Mutual, IndyMac, and Downey Saving and Loan, the three biggest failures), the SEC found:

• Most loans were accounted for on an amortized-cost basis, not a fair value basis, and so would not be impacted by FAS 157 requirements.
• The banks that failed (most notably IndyMac) did so because they focused heavily in mortgage-backed securities which both had more concentrated credit risks and losses, and unexpectedly high default rates.
• As a group, failed banks had non-performing loans that "greatly exceeded the levels experienced generally for non-failed banks of similar sizes."
• The decline in regulatory capital which ultimately crippled most failed banks was thus a result of the deterioration in bank's underlying asset base-caused mainly by credit losses, and exacerbated by increases in depositor outflows. Fair value may have reflected the lower quality assets (and, the SEC speculates, may have served as an early warning, especially if fair value had been more extensively used), but it did not cause the failures.

Ultimately, the 2008 bank crises were similar to most other historic bank failures-caused by poor business decisions, unexpectedly high credit losses, and finally, "runs on the bank" that the institutions could not survive. The instruments may have been different in this case-but the mechanisms were not.

Investors: Fair Value Is a Useful Indicator-Don't Change It

Through a series of forums and comment letters, the SEC solicited a broad range of input on fair value-and with few exceptions, most investors and preparers support fair value generally (and FAS 157 specifically) as a useful tool, and feel that suspension would decrease overall investor confidence. A few included comments, called representative by the SEC, were:

"Fair value accounting with robust disclosures provides more reliable, timely, and comparable information than amounts that would be reported under other alternative accounting approaches."
[Joint Letter: Center for Audit Quality, CFA Institute, Consumer Federation of America, Council of Institutional Investors, Investment Management Association]

"We do not believe that fair value accounting was the cause or even a contributing factor to the current credit crisis. Fair value accounting did not create the losses, but rather reflected the market conditions by initially bringing to light the impact of poor lending practices and the resulting effect on the current lack of liquidity and overall crisis in the financial markets. Fair value accounting reflects the effects of a transaction on an entity's financial statements. It does not, however, drive the underlying economic activity."
[Credit Suisse Group]

Criticisms of fair value were mainly two fold. One group criticized the implications of fair value, mainly on regulatory capital, and here the SEC's basic response was that regulatory capital was a separate issue not really related to (nor appropriately governed by) GAAP rules.

The second criticism was on the application of fair value – mainly its role in illiquid or depressed markets. Here commentators agreed that more judgment and clarification would be helpful, and the SEC points to a series of coordinated guidance issued by the major standard-setters in late September, where they stressed that market values were not intended to be the sole determination of fair value in illiquid markets, and that other criteria could, and should, be incorporated into measurements.

Overall, the preparer and investor communities support fair value, and while they believe that modifications may be needed, they neither request nor desire systemic change.

What Should the SEC Do Next?

As required by Congress, the SEC considered (and broadly rejected) a series of possible alternatives to fair value standards:

• Suspend FAS 157: While the SEC has the legislative power to suspend FAS 157, they spoke out against this step, noting that FAS 157 does not require fair value, it merely consistently defines the term, and that a suspension would lead to inconsistent definitions, disclosures, and guidance. Instead, the SEC called for more clarification of FAS 157, calling for increased guidance to ensure that their truly is a single consistent measurement framework.
• Modify Fair Value (e.g. return to historical cost): The SEC argues that fair value has generally proven to be helpful to investors, and that other methodologies have their own set of unique comparability problems (such as how historical cost can assign identical assets different values based on different purchase prices).
• Reduce Volatility through a "Rolling Average": Proponents of a "rolling average" argue that by spreading the value over a longer period of time (rather than a single point value), volatility would be reduced. However, the SEC argues that this would only lead to a debate about the proper time period for the rolling average, as well as shifting towards more prescriptive rules when the standard-setters are already committed towards a more principles-based approach.

The SEC did issue a series of tactical, and unsurprising, recommendations, including:

• FAS 157 and other fair value/mark-to-market requirements should be improved (mainly through additional guidance and disclosure) but not suspended. Fair value was not the cause of the financial crisis, and it serves as a valuable tool for investors.
• Additional measures should be taken to improve the applicability of existing fair value standards. Standard-setters need to issue more guidance around inactive, illiquid, and distressed markets, as well as promote education and training around fair value for preparers and investors.
• Readdress financial asset impairment frameworks. There are too many asset impairment frameworks, and they are not compatible with one-another, leading to significant comparability issues. A single, global model should be developed.
• Improve guidance around managerial judgment. Fair value, especially around level two and three assets and liabilities, inherently requires preparer judgment. Guidance should be issued about how to evaluate the reasonableness of accounting judgment.
• Accounting standards should continue to meet the needs of investors. Regulatory capital is important-but it's not the job of accounting standard-setters.
• Establish additional formal measures to address the operation of existing accounting standards. Implement post-adoption review processes and formal policies for situations requiring near-immediate responses. The ad hoc standard-setter responses of late September should not become the norm.
• Simplify the accounting for investing in financial assets. The IASB and FASB should work to create a single, simpler, standard.

Conclusions: Nothing Surprising

The SEC's report is not surprising, and is completely consistent with their policies and statements over the last four months. Fair value, and FAS 157, will remain US accounting policy, and while they may (and probably should) be modified on the margins, the core principles will probably survive the financial crisis intact.

Oil and Gas Disclosures: SEC Modernizes Resource Reserve Reporting

SEC Revises Energy-Reserves Rules

The Securities and Exchange Commission issued a press release on December 29, 2008 changing the way companies may disclose oil and natural-gas reserves in corporate financial reports, giving oil companies flexibility they had long sought.

Companies will be able to disclose possible and probable reserves, a break with decades-old rules that limited disclosure only to proven reserves. Rule changes include:

• Permitting use of new technologies to determine proved reserves if those technologies have been demonstrated empirically to lead to reliable conclusions about reserves volumes.
• Enabling companies to additionally disclose their probable and possible reserves to investors. Current rules limit disclosure to only proved reserves.
• Allowing previously excluded resources, such as oil sands, to be classified as oil and gas reserves. Currently these resources are considered to be mining reserves.
• Requiring companies to report the independence and qualifications of a preparer or auditor, based on current Society of Petroleum Engineers criteria.
• Requiring the filing of reports for companies that rely on a third party to prepare reserves estimates or conduct a reserves audit.
• Requiring companies to report oil and gas reserves using an average price based upon the prior 12-month period-rather than year-end prices, to maximize the comparability of reserve estimates among companies and mitigate the distortion of the estimates that arises when using a single pricing date.
  
  

Oil and gas companies have for years said the SEC's rules were outdated and didn't take into account technological advances that allow access to more reserves.

The new disclosure requirements also require companies to report the independence and qualifications of a reserves preparer or auditor; file reports when a third party is relied upon to prepare reserves estimates or conducts a reserves audit; and report oil and gas reserves using an average price based upon the prior 12-month period rather than year-end prices. The use of the average price will maximize the comparability of reserves estimates among companies and mitigate the distortion of the estimates that arises when using a single pricing date.

Related technical documents:
The full 171-page text of the proposing release to update disclosure requirements for oil and gas companies
The 16--page concept release

Including material by Siobhan Hughes at dowjones.com

Hidden Pension Fund Losses under IFRS

Many of Britain's biggest companies are preparing year-end accounts that show their pension schemes moved into surplus last year despite the collapse in world markets, which wiped hundreds of billions from their assets.

The latest figures from the pension advisers Aon Consulting show that a steep decline in the FTSE 100 over last year and a sharp drop in commercial property values has sent most final-salary schemes into crisis and pushed fund deficits to new lows. According to government figures, company pension fund deficits rose in the 12 months to November from £58bn to £155bn.

Aon Consulting warned that the figures underestimated the problem and pension funds had suffered a £226bn loss on their investments in the year to October.

However, accounting rules - which critics argue distort company pension scheme fund values - will show a rise in assets. For the top 200 companies in Britain, that will mean a £13bn surplus at the end of 2008. Aon says the top 100 firms have seen a £5bn improvement over the last year, based on current accounting rules.

Auditors must calculate deficits using the IAS19 accounting method, which assumes pension funds are invested entirely in corporate bonds and ties the value of the fund to current bond yields. Calculations under IAS19 put pension deficits at £2bn in December 2007. Figures from Aon show that a subsequent rise in bond yields turned that small deficit into a surplus of £3bn.

Marcus Hurd, of Aon, said when bond yields were low IAS19 exaggerated deficits, but now it was hiding them. In 2007, yields were 5.75% whereas last November they stood at 6.8%. He said that while a handful of schemes were heavily invested in corporate bonds, most had a mix of assets and tended to rely heavily on stockmarket investments. "They will be invested in stocks and shares, commercial property and bonds, which have all gone down in value, but the accounting rule says it is only the bond yield that counts."

In the battle over the future of company pension schemes, it is expected unions will use IAS19 to argue that employers must honour existing commitments because the accounting figures show schemes remain in a healthy state.

Union leaders have already fought several high-profile disputes over cuts in pension benefits and in most cases forced employers to backtrack. In May, workers at the Grangemouth oil refinery went on strike to keep its final-salary pension scheme open to existing members and new entrants.

Final-salary schemes typically promise to pay a retirement income worth two-thirds of a worker's last wage slip after 40 years of employment. About 80% of schemes in the UK are closed to new entrants. Unions fear employers are planning to close the remainder and may halt accruals for existing staff.

Hurd said employers and scheme trustees were well aware that the underlying assets in their funds had collapsed in value. In a report last month Aon said companies could be forced to pay up to £45bn a year for the next five years into their final-salary pension schemes to make up for the £226bn loss this year on their investments.

Article by Phillip Inman The Guardian