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Audit & Accounting Alert Newsletter

Issue 3 | April 2012


Gerry Herter

Last month we reviewed the status of accounting standards from a private versus public, global versus local, and large versus small perspective. Over the coming months, we will look at some specific standards that are being worked out on an international basis as part of the convergence movement. Lease accounting is one of several such issues challenging rule makers that we tackle in this issue. Then we look north to see how our Canadian neighbors are faring with their move to IFRS. Finally, the AICPA has taken notice of the rise and broad impact that associations like Integra International are having on accounting firms as they address the increasingly complex world we live in. Read about what took place in New York in February when two of our own members joined representatives from the other accounting associations for an AICPA sponsored conference.

Editor Gerald E. Herter, CPA

In This Issue 

Accounting For Leases

Changes are coming with convergence, but ever so slowly

While anxiously waiting for the United States to accept IFRS, as highlighted in our last issue, the IASB and FASB have been jointly forging ahead on several fronts. The radical changes proposed to the look and feel of financial statement presentation were detailed by William Murphy, partner with Integra firm Leaf, Saltzman, Manganelli, Pfeil & Tendler, LLP, in the recently published Integra Global Update. Now we turn to the specifics of one of the rigorously contested accounting proposals: Leases.

When I started in public accounting, the Accounting Principles Board was in charge, putting out 31 APB’s over 14 years, until its replacement by the Financial Accounting Standards Board in 1973. Much more prolific, the FASB issued 168 pronouncements before incorporating all the standards into the topically oriented Codification in 2009.

Those who have been in the profession as long as I have will remember the monumental FAS 13, Accounting for Leases, the most comprehensive individual pronouncement released up until that point in 1976. FAS’s then were typically from five to fifteen pages. FAS 13 weighed in at a hefty 77 pages, and has been the holy grail of rental arrangements ever since.

A comparison of current US GAAP for lease accounting with IFRS reveals that while they are generally similar, differences arise because of the rules based approach of GAAP as contrasted with the principles basis of IFRS. There are the two categories of capital (“finance” in IFRS) and operating leases in both sets of standards. But whereas IFRS speaks in general terms, such as “major part,” substantially all,” and “immaterial” when considering whether a lease should be capitalized by a lessee, GAAP has specific rules, such as “75% of the life,” or “90% of the fair value.” Similarly for lessors, GAAP further separates capital lease classification into sales, direct financing and leveraged lease categories, while IFRS leaves them together in one general category.

The IASB and FASB started working on a joint standard back in 2006. Finally in August 2010, the initial Exposure Draft was issued. Looking to move away from the stigma of off balance sheet financing, the proposal decreed that all leases would be capitalized as “right of use assets” with corresponding “lease obligation” liabilities. The asset is recorded at the discounted present value using the lessee’s incremental borrowing rate, and is amortized on a straight-line basis while interest on the liability is amortized like a traditional loan.

The Exposure Draft provided that the lessor would record the lease under a “performance obligation approach” if risks and benefits were retained. The right to receive lease payments would be recorded as an asset along with a deferred revenue liability, present valued the same as in lessee accounting. The deferred revenue would be transferred to revenue over the term along with interest on the lease payments, while the underlying asset is depreciated. If exposure to risks and benefits were not retained, a “de-recognition” approach would be used whereby a portion of the underlying asset is removed leaving a residual asset along with a present valued lease payment receivable and liability. Gain or loss is recorded on the derecognized asset, while interest on the lease payment asset is recognized over the term.

The comment period for the Exposure Draft, ended December 2010, generated over 750 responses, indicating support for the overall goal of a unified standard, but raising a plethora of concerns about specific proposals. Consequently, many further meetings and deliberations were held. By March, 2011, a number of new provisions were being considered. Two of the significant ones were that short term leases of twelve months or less would not need to be capitalized, and that there would be two types of capital leases rather than one: finance lease (similar to a financing) and other-than-finance lease (similar to a rental). The finance lease would have expenses amortized like a loan, which front loads expenses, while the other-than-finance lease would have expenses recorded straight-line. Lessor accounting concerns proved to be more problematic, so further consideration was deferred. The changes responded to calls for less complexity and more consistency with other projects, such as revenue recognition.

Within a couple months, the Boards could not agree on technical measures for implementing the two lease model, so it was dropped for a return to the original Exposure Draft single lease model. Also, disenchantment over lessor accounting continued as the IASB preferred a single model using a derecognition approach, while the FASB held out for a model closer to current standards.

So where do things stand now with the proposed new lease standard? Along with the items mentioned, a variety of other issues have been debated. So much so, that the Boards plan to “re-expose” the Exposure Draft in the second quarter of 2012, incorporating the new thinking. While some agreement has been reached on lessor accounting, challenges still lie ahead.

Further frustration was expressed by FASB members at a late February 2012 meeting of the Boards. IASB members introduced an apparently new model for all leases where expenses would be based on consumption, which FASB members felt would distort expenses for certain leases where a straight-line model would be more appropriate. The frustration was as much for the fact that a new concept was being introduced so late in the game, on an area that had been thought to be resolved already. Still there is hope that the final joint standard will be issued by the end of the year.

For further information, see Leases - Joint Project of the FASB and the IASB

Canada Adopts IFRS

IFRS reaches North America with Canada in 2011 and Mexico in 2012

Though IFRS has already been embraced by over 120 countries, until the United States comes on board, the global set of standards will lack some level of credibility. While the SEC appears to be in the final stages of resistance before accepting the inevitable (?), Canada has moved ahead, requiring public companies to adopt IFRS for fiscal years beginning in 2011, and Mexico will follow in 2012.

Consequently, the first Canadian IFRS-based financial statements are starting to emerge. How is the conversion going?

According to Tim Kiladze, reporter for Toronto based The Globe and Mail, in a February 13, 2012 article titled Canadian bank IFRS transition was easy sailing, “After all the fanfare and hoopla around Canadian banks’ transition to International Financial Reporting Standards, it turns out the change has come and gone quite smoothly.” His point was that annual earnings were not that much different from the GAAP numbers, which were also reported. He did note, however, that book values had dropped an average of 8%, mainly from cumulative effects of recognizing pension losses and reversing securitization gains.

While the reporter has one perspective, the Ontario Securities Commission (OSC) looked at the new financial reporting landscape differently. The Office of the Chief Accountant (OCA) issued a Staff Notice (52-720) in February spelling out “levels of compliance with certain features of these standards that are ‘new’ to our capital markets.” The Notice was based on selected interim financial reports that the staff had scrutinized. The goal was to provide early guidance that companies could use to improve compliance in 2012.

The OCA focused on “…application of accounting standards that contain different recognition, measurement and disclosure requirements under IFRS…” Topics covered included 1) business combinations, 2) common control business combination transactions, 3) impairment, 4) critical judgments and sources of estimation uncertainty, and 5) going concern. Notable concerns were raised over adequacy of disclosures, areas not covered by a specific IFRS standard, and distinguishing between significant and immaterial judgments.

New disclosures required to provide readers a clear and complete picture were often not sufficiently present. In areas without a specific IFRS standard, more care should have been taken when applying the generalized IFRS accounting policies guidance, since different interpretations are more likely. For estimations and judgments, attention needed to be given to assure both that the most important assessments were covered, but that immaterial reasoning did not “clutter up” the financial statements. While full disclosure is important, the presence of excessive, obscure technical detail can distract the reader from critical matters deserving their consideration.

Though beating the US to IFRS, Canada was still late in the game compared to Europe. On the plus side, the experiences observed in Europe provided a “heads up” to the Canadians in forging ahead. The Canadian approach like Europe before it has been labeled the “big bang,” converting all at once, while the US is contemplating a “staggered” approach of gradual convergence or “condorsement.” While the gradual approach is considered less costly and less prone to mistakes in the short term, confusion may result from the longer period of a hybrid set of standards. Also, ‘big bang II” is on the way, as dozens of IFRS projects are looming in the near future, many prompted by the 2008 financial crisis.

For further information, see IFRS in Canada

Second AICPA/Firm Association Annual Meeting

Annual confab lays groundwork for future collaboration

Building on initial efforts in 2011, the AICPA recently brought representatives from accounting firm associations together to explore ways to enhance mutual opportunities for supporting each other. Integra International AAA Executive Committee Members, Don DeGrazia and Doug White attended the meeting in New York. Top AICPA executives and president, Barry Melancon, provided profession-related, legislative and international updates, as well as conducting roundtable discussions and presenting the Horizons 2025 report. While all aspects of the accounting industry were covered comprehensively, we’ll cover some of the highlights affecting audit and accounting.

In the legislative arena, several new laws and bills working their way through Congress warrant discussion. The Dodd-Frank Act of 2009, passed in the aftermath of the financial industry meltdown, among other things brought in the requirement for non-public broker dealer audits, gave shareholders a say on executive compensation, as well as setting the audit requirement of SOX 404(b) internal control reports to public companies with $75 million or more market capitalization. While this last rule had been in place for all companies from Sarbanes-Oxley, the SEC had delayed enforcement for smaller companies.

THE JOBS Act (Jumpstart Our Business Startups) working its way through Congress portends to drastically modify Dodd-Frank in an effort to stimulate the private sector. With broad congressional support, the Bill combines six previous proposals into one comprehensive action. The Act creates an “IPO On-Ramp” for “emerging growth companies.” Companies with less than $1 billion in revenue could go public without complying with SOX 404(b), and with delayed compliance with new or revised FASB standards until they reach $1 billion in revenue or five years after going public. Barry Melancon, AICPA President, SEC Chairman, Mary Shapiro, and Financial Accounting Foundation President, Teresa Polley, all vigorously oppose the legislation as inviting serious harm to investor protections.

The role and actions of the PCAOB have been the subject of debate, as discussed in the February Audit & Accounting Alert. Another area of proposed legislation addresses PCAOB disciplinary procedures. While the SEC and other governmental agencies conduct all disciplinary proceedings in public, the Sarbanes Oxley law requires that proceedings against accounting firms be conducted privately until some formal action is taken, if any. The proposed law, originally brought forth by the PCAOB chairman, would open up the PCAOB inquiries in the same manner as the other agencies.

In the international arena, the expanding opportunities for reporting on areas such as sustainability, internal control, risk management, service organization controls, XBRL and the cloud were emphasized. In this regard, the license mobility provided by MRA’s, Mutual Recognition Agreements, will facilitate practicing in these areas around the world. A Mutual Recognition Agreement between two countries works like the reciprocity agreements that allow CPA’s to practice across state lines. The United States currently has MRA’s with Canada, Mexico, Australia, New Zealand, Hong Kong and Ireland, with more in the works.

Profession-wise, Barry Melancon covered a broad spectrum of topics. A couple of those are the IIRC and the GCMA. The International Integrated Reporting Council (IIRC) is composed of governmental, private sector, academic and community leaders from across the world. As stated on the organization’s website, “Integrated Reporting is a new approach to corporate reporting that demonstrates the linkages between an organization’s strategy, governance and financial performance and the social, environmental and economic context within which it operates. By reinforcing these connections, Integrated Reporting can help business to take more sustainable decisions and enable investors and other stakeholders to understand how an organization is really performing.” The Council is in the process of developing a framework for moving forward toward this improved reporting model for the future.

The Chartered Global Management Accountant (CGMA), the new standardized designation for management accountants worldwide, was a joint effort by the AICPA and CIMA, Chartered Institute of Management Accounts. “The CGMA mission is to promote the science of management accounting on the global stage. The designation champions management accountants and the value they add to an organization,” according to Institute’s website.

While much more was covered in the AICPA/Firm Association meeting, this get together was considered a great success, and is expected to further enhance the abilities of all participating groups to help each other in addressing the myriad of opportunities and challenges facing their members.

Additional A&A News

The following links provide a selection of current articles devoted to highlighting other A&A topics currently making news.

  1. Ex-CIMA president slams institute's strategy for CGMA
  2. Investor group & AICPA affiliate challenge SOX rollback
  3. Private company reporting decision in May?
  4. CFOs Shout Down Idea of Mandatory Auditor Rotation
  5. Big Win for Accounting Profession in New Jersey Supreme Court
  6. IASB meets European accounting standard setters

Audit & Accounting Alert is a publication of Integra International intended to highlight emerging issues in the profession. The goal is to give Integra members an awareness of developments impacting the practice of Audit & Accounting, enabling them to stay on the forefront of industry trends.

Editor Gerald E. Herter  •  HMWC CPAs & Business Advisors, 17501 E. 17th Street, Suite 100, Tustin, CA 92780-7924
 •  Tel: 1 714 505-9000  •  Fax: 1 714 505-9200  •  Email: [email protected]