"My first reaction to the direct cash-flow method was that my forehead bounced off my desk," quipped David Bond, senior vice president of finance and control for Safeway Inc., at the Financial Executives Internal financial reporting conference in New York on Tuesday. Besides getting a big laugh, he also caused many conference attendees to nod their heads in agreement.
Many of the 229 comment letters received by FASB about its discussion paper on changing the face of financial reflected similar views. That is, a new standard requiring companies to account for cash via the little-used direct cash method rather than the ubiquitous indirect method seems too costly compared to its perceived benefits.
"We don't collect this type of information [required by the direct method]," asserted Bond, a panelist at the conference. "That's not the way our ERP system is set up to do things." Steve Whaley, controller for WalMart, agreed, saying the enterprise-resource-planning system for the king of the box stores would also have to be reprogrammed to spit out financial results under the direct method.
Basically, the direct method of accounting tracks cash changes from the bottom up to arrive at net income, rather than starting with net income and making adjustments. The astronomical number of changes that would be required if FASB mandates the direct method would make the move a lot like requiring U.S. companies to use international accounting standards, noted Whaley, adding that the systems changes would have to be in place before the rule could be implemented.
When opponents of the direct method say most companies use the indirect method, they aren't exaggerating. Neri Bukspan, chief accountant, Standard and Poor's, estimated that fewer than five companies in the Fortune 500 use the direct cash-flow method. Further, a recent survey by the American Institute of Certified Public Accountants found that only six to eight companies out of 600 large public and private companies polled go direct.
Bukspan told CFO that S&P is agnostic on whether companies should use the direct or indirect method. The credit agency is more concerned with another aim of the board's financial-statement project: to develop a line-by-line reconciliation between the cash-flow statement and income statement.
FASB is expected to release an exposure draft of the new rule for public comment by the second quarter of 2010, with a final standard slated to come out in mid-2011. That means the rule would likely take effect 2012.
For his part, Bond says the project's timing is all wrong. "It may be a good idea to think about this ý but with all the other changes we have to make over the next few years, are we going to get the best bang for our buck [with the financial statement presentation project]?"
Last week, the European Union deferred the adoption of the international accounting rule known as IFRS 9, the first part of the three-part financial-instruments. The EU refused to endorse the standard until its pan-European members got a look at the remaining pieces.
IFRS 9 deals with the classification and measurement of financial assets, while the other two parts, which are currently being worked on by the International Accounting Standards Board, concern hedge accounting and impairment of financial assets.
From a practical perspective, the temporary snub from the EU isn't earth shattering, although it does nix early adoption. The rule likely won't go into effect until 2013, and IASB expects to have the other parts completed by the end of 2010, the same time the U.S. Financial Accounting Standards Board plans to finish all three parts of its standard on financial instruments.
Some executives were disappointed at the EU's decision. In a letter to the Financial Times published today, Douglas Flint, CFO of banking giant HSBC, said the EU's decision was "regrettable, noting that"while IFRS 9 does not make things perfect, it does make them better."
Whatever your opinion of the new rule, this momentary blip may portend further politicization of the accounting standard-setting process -- if the past is any guide. Indeed, last year France's Nicolas Sarkozy and Germany's Andrea Merkel lent their voices to an EU threat that lawmakers would pass their own fair-value rules if IASB didn't hurry up and publish its version.
In the United States, two legislative proposals -- one from Colorado Democrat Rep. Ed Perlmutter, the other from California Republican Rep. Gary Miller -- aim to increase the level of federal oversight over FASB. Further, a move away from U.S. GAAP and to international standards is currently in the hands of a political appointee, as CFO.com's David Katz reports today. In the past, that has spelled trouble, considering that under former SEC Chair Christopher Cox the SEC strong-armed FASB to get more say over the appointment of board members.
The year ahead will produce several significant changes to accounting rules. Whether the non-so-invisible hand of politics will be pulling the strings is another story.
Paul Volcker, a former Federal Reserve Board chairman and currently one of President Obama's economic advisors, was asked during a recent conference whether he thought the Big Four accounting firms were "too big to fail." He replied, "That's an obvious problem."
In general, being too big to fail is the notion that a company's economic reach is so vast and interconnected with the viability of so many other companies and individuals that allowing it to collapse would cause a crushing systemic financial blow to the economy. Over the past year, banks, auto makers, and financial service firms all were deemed too big to fail by the U.S. government, and as a result received federal aid to keep afloat.
Volcker, the keynote speaker at a conference sponsored by the AICPA and the IASB, noted that in its final report released last year, the U.S. Treasury Advisory Committee to the Auditing Profession questioned whether there was enough competition in the global auditing profession. He too wondered whether the PCAOB needed to have the same discussion about the auditing profession that bank regulators had had about their industry, namely that some type of "resolution process" might be needed that allowed the government to take control of bankruptcy proceedings if one of the Big Four folded.
Volcker said he didn't particularly like the idea of government intervention regarding a possible accounting firm meltdown. Yet he admitted that the auditing industry's "interdependence and consolidation" would likely require a solution of "extraordinary means."
From somewhere in the back of the room came the question: "Why are we all principles-based at conferences like this, and when we get back home, it's all rules. How do we break the cycle?"
The query momentarily stumped the otherwise highly engaged panel of experts who were assembled yesterday to speak at the AICPA's conference on international financial reporting standards. Then Deloitte CEO James Quigley broke the silence. Giving credit to the lone lawyer on the panel -- Michael Young of Willkie Farr & Gallagher -- Quigley said the answer was provided earlier in the session.
"I think Michael broke the cycle for us," said Quigley, noting that an obsession with rule compliance doesn't trump economic substance with respect to accounting treatments. "Conformity to rules doesn't necessarily get you off the hook if [the accounting treatment] doesn't have a lot of substance," opined Young.
Indeed, the panel admitted that professional judgment, which is more often used in applying so-called principles-based accounting standards than rules-based standards, can be second guessed by regulators. However, Young, who has spent 25-years litigating accounting cases, pointed out that in a case based on a principle, it's "really hard" to prove that executives or directors acted in bad faith.
Key to any good defense of an accounting judgment is documenting "good faith" attempts. If there's a tough judgment call, executives and boards should talk it out and document the discussion, advised both Young and Quigley.
"The law is, in its own slow, slow way, coming to appreciate the importance of judgments, and the law is going to have to come to grips with the fact that if it doesn't, it will stand as a significant impediment to the evolution of financial reporting," argued Young. "And I think that slowly but surely judges are starting to get that."
Why are principles-base standards considered more virtuous than a rule-based system, anyway? Young explained that rules have sharp edges that you can aim for. So companies can convolute deals and structures to stay within rule thresholds. Principles have fuzzy edges, so you have to aim for the center, and "there may be no better protection than that," mused Young.
One of the great things about this job is that we get a chance to see what our readers are thinking. Since we generally seem to attract readers of a very high intellectual caliber (there are a few exceptions), some of their off-the-cuff comments pierce through to the heart of the issue on which they're holding forth.
In a response to David McCann's article posted yesterday, which probed how much Credit Suisse's recent changes in executive compensation could revolutionize bank pay schemes overall, we received a response today from reader James McMonagle that amounts to all you'll ever need to know about the issue:
"Is Credit Suisse trying to take a pragmatic approach to pay? All banks should take a look at the pay packages of small businesses, which are always tied to performance of the whole company. If the company has a poor year, no one gets a bonus. However that ensures two things: (1) there is a company continuing next year and (2) there is a paycheck next year.
"I am amazed at the shortsightedness of these banks' compensation plans. If your bank has a bad year, your compensation plan may just bankrupt the whole thing.
"The primary goal of the small business's compensation plan is to share the wealth in good years and to get by in bad years in order to see another good year. The banks' compensation plans seems to miss the point of surviving to see another good year.
"The argument about losing skilled labor is not a valid argument because there are so many quality people currently available. If the people weren't considered a commodity by the banks, why would there be such large layoffs?
"Banks (and other groups) need a paradigm shift in their thinking about compensation to focus on surviving the hard years." Amen.
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