Issues facing businesses

By: Steven Templeton, CPA, CVA, Managing Partner

International Financial Reporting Standards (IFRS)

After the Enron debacle, the American Institute of Certified Public Accountants (AICPA) assumed a leadership role in the rush toward an international set of accounting standards (IFRS).  The long and proud independent standard setting process in the United States of America is being phased out in favor of an international standard setting process with an international governing body, the International Accounting Standards Board (IASB).  So what’s the big deal?

Confusing Standards?

So will we have a single, simple, principles-based global set of accounting standards?  Not so fast, my friend!  Initially, public companies will be required to convert to IFRS while private US companies could choose to adopt IFRS for small- and mid-sized entities or could, along with not-for-profit organizations, continue to report under generally accepted accounting principles in the United States.  Bankers, investors, analysts and other users of financial statements will need to be cognizant of the differences and understand them in order to properly analyze financial statements and make useful industry comparisons.

The AICPA released results of a survey showing that more than 80% of AICPA Council members strongly support GAAP differences for U.S. private companies and not-for-profit entities from the international GAAP that will be required for U.S. public companies.  It’s safe to say that the support for a universal adoption of IFRS for public and private companies alike is weak.

Interestingly, Charles Niemeier is also more broadly challenging the conversion to IFRS. He was a member of the Public Company Accounting Oversight Board and was previously the U.S. Securities and Exchange Commission chief accountant in the Division of Enforcement and co-chair of the SEC Financial Fraud Task Force. Overall, he is not in favor of switching from U.S. GAAP to IFRS, and suggests that we continue to fix what’s broken as opposed to converting to a whole new set of less mature standards.

Convergence or Conversion?

Early on, the IFRS conversation centered around “convergence,” giving one the impression of an evolutionary process whereby US standard setters would work with the global International Accounting Standards Board (IASB) to achieve a common set of high-quality, accepted accounting principles.  As it stands today, there are broad areas of disagreement between IFRS and US GAAP and a myriad of issues addressed by US GAAP with a non-existing IFRS counterpart.  In short, US public companies are being required to convert from US GAAP, the gold standard of accounting principles, to the inferior, less developed international standards.  Rather than allow IFRS to converge with US GAAP over time, the international G-20 leaders have called for the new global set of accounting standards to be completed by June 2011, ready or not!

Here’s what Mr. Niemeier had to say about the process of converging United States generally accepted accounting principles with IFRS:

“I agree with the original goal of the International Accounting Standards Board and Financial Accounting Standards Board to enhance comparability of financial reporting by converging their standards based on quality.  Unfortunately, in the last few months the focus has changed from achieving comparability of financial reporting to establishing a set timetable to switch the U.S. to IFRS. This change de-emphasizes the quality of the standards in favor of speed, and appears to be more based in politics than in what is in the best interests of investors.  For a number of reasons, I believe that this new path has the potential of de-linking us from our current regulatory model. Instead, in my view, we need to return to a policy of convergence, where we focus on substantive milestones, not timing.”

At What Cost?

Larger public companies are beginning to assess the enormous cost and effort required to convert their transaction processing and financial reporting systems to accommodate IRFS.  If accounting is the language of business, IFRS adopter company personnel, including accounting staff, business managers, executives, and board members, must learn this new foreign language.

Barry C. Melancon, AICPA president and CEO, has called for a permanent, independent funding mechanism for the International Accounting Standards Committee Foundation, the governing body of the IASB.  In the United States, the AICPA will encourage the Securities and Exchange Commission to use part of the current levy on U.S. public companies for accounting standard setting activities as a permanent funding source for the IASB, Melancon said.

Who Will Write the Rules and Who Pays?

There will be 16 IASB standard writers of which only two will be from the United States.  Naturally, the United States will provide the super majority of the IFRS funding.

It’s Time to Get Involved.

IFRS is not an issue best left to the back office bean counters to deal with.  Now is the time for all U.S. financial system stakeholders to understand the movement toward IFRS and consider the possible ramifications, good or bad.  Interested parties should take the following steps:

  • Monitor the progress of the IFRS convergence/conversion and take appropriate action.
  • Learn: Attend relevant seminars on the subject matter
  • Share: Inform others within and without your organization to properly prepare for the transition.
  • Speak out: Let the AICPA, the SEC and others know your views on IFRS, its applicability to U.S. public and private companies, and the proposed implementation timetable.

It is our responsibility to our profession and our clients to stay abreast of this issue and do what we can to make sure that international politics do not trump good sense and that the baby is not discarded with the bathwater.

For more information on IFRS or any other accounting concerns,  please contact: info@templetonco.com

Perception and reality: shedding light on Level 3 assets

In the winter of 2007-2008, sweeping new financial reporting standards were launched – directly into the path of an unforeseen perfect storm.

Known as fair value accounting, these new rules had been years in development.  They were designed to unify global standards and provide greater transparency through market-based, rather than earlier cost-based, methods of valuation.

But no sooner had fair value gone into effect than markets worldwide all but evaporated in the worst economic crisis in over ninety years.  As asset values drifted erratically into what analysts called a “no man’s land,” accurate fair value reporting was put to the test.  And one obscure provision was taken head on by regulators.

We’re talking about Level 3 Inputs as defined by Accounting Standards Codification Topic 820: Fair Value Measurements and Disclosures (ASC 820), the least understood and thorniest area of fair value asset valuation, yet a category now critical to many organizations.

Do a quick internet search and you’ll get millions of hits on Level 3 Inputs, ranging from hard-to-follow bureaucratic explications to biased (often misinformed) broadsides in the blogosphere.  Our purpose here is to sift reality from perception and shed some light on this important area of financial reporting.

First, let’s briefly define terms.

As outlined by the ASC 820 (f/k/a Statement on Financial Accounting Standards No. 157: Fair Value Mearsument), fair value reporting provides for three distinct levels of inputs.

Level 1 Inputs, which in theory comprise the preponderance of most organizations’ portfolios, can be valued using independent observable market inputs: for example, stock prices as reported by the Wall Street Journal on a daily basis.  The idea is to peg an asset’s value to what it would fetch today – right now – in an “orderly transaction” between “willing market participants.”  Those two phrases are important.  Fair Value presumes the absence of compulsion or duress.

Level 2 Inputs don’t have readily-available market inputs, but can be accurately valued using comparable and observable data points.

Level 3 is unique.

This tier was created as a kind of “none of the above” category for perceptible yet hard-to-value assets with no observable inputs.  Generally speaking, Level 3 Inputs either are illiquid or traded so rarely there is no independent market price.  Examples might be private equity investments or certain long-term derivative contracts (typically managed by hedge funds).

To put all this in basic language:  Inputs in Levels 1 and 2 are “mark to market,” but assets in Level 3, where this is no market, are “mark to model.”

Constructing those models is what makes Level 3 asset valuation so exceedingly complex.  To meet fair value disclosure requirements, these valuations involve a combination of management forecasts, various macroeconomic and internal data, sophisticated mathematical models and other proprietary techniques – in other words, experience and specialized expertise from your accounting and audit firm.  Including a coordinated effort from both your accountant and your investment managed to insure that you have obtained full and adequate disclosure regarding those assets.

Sound accounting and audit procedure for Level 3 isn’t astrophysics, but in some respects it’s not far off either.

There’s an irony here.  While Level 3 assets are by definition hard to value, they are often precisely the types of investments one would expect in a widely (and wisely) diversified portfolio.  Many large organizations – foundations, for example – hold significant and sound assets in this fair value tier.  But in the current economic environment, Level 3 also is home to distressed assets such as complicated mortgage-backed securities for which markets seized up and have remained stagnant, making “orderly transactions” arguably impossible.

Thus Level 3 reporting is not only complex, it can be controversial.

What’s at stake for you?

Ultimately an organization’s board, investors, creditors and stakeholders comprise the real-world “jury” for any financial statement.  Credibility is the lynchpin of quality financial statements.  Our experience with a wide range of clients has shown, when done properly, Level 3 financial reporting can ensure a high degree of transparency and confidence going forward.

For more information on Level 3 assets or any other financial concerns, please contact info@templetonco.com.

About the authors:

John TempletonJohn R. Templeton, CPA, CVA

John Templeton is a Partner with Templeton and leads the firm’s Audit and Accounting Services Division. He is an experienced provider of accounting, auditing, and advisory services for private enterprises in a variety of industries including nonprofit, agriculture, manufacturing, and distribution. He is a hands-on professional who approaches each audit with focus and efficiency. He is an advocate for many of the younger members of the firm, and develops and mentors these young associates.