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Audit & Accounting Alert Newsletter

Issue 4 | April 2014


Gerry Herter

Accounting standards resulting from the Enron collapse and the recent financial crisis have added to the undue reporting burden of small companies. The Private Company Council was formed by the FASB to relieve that burden. Our first article covers a significant step, exempting U.S. SMEs from the requirement to consolidate related entities that lease facilities to the SME.

 Meanwhile, administrative and political stumbles reveal vulnerability as the IASB pushes the world toward globally accepted financial accounting standards. Our second article details the shortcomings and the related fallout.

 Finally, the FASB’s latest installment in the comprehensive conceptual framework project focuses on financial statement disclosures. Our third article describes the approach taken to facilitate development of effective, yet practical, standards in the future.

Editor Gerald E. Herter, CPA

In This Issue 

Relief for SMEs that Lease from Related Variable Interest Entities

FASB endorses PCC proposed alternative

In response to the Enron disaster, the FASB in 2003 issued an accounting interpretation that required the consolidation of variable interest entities (VIE). The purpose of this directive, known as FIN 46(R), was to stop the abuse that allowed Enron to leave substantial obligations off of its financial statements. Though Enron technically had less than majority voting interest in certain VIEs, the company bore the risks that arose when the VIEs failed. Basically, the “form over substance” weakness of rules-based standards was exposed with devastating effect.

Unfortunately, the overreaction of the blanket requirement for consolidation called for by FIN 46(R) has caused significant unwarranted headaches for non-public SMEs. A common tax and financial strategy for an SME business owner is to acquire and maintain the business property in a separate entity from the business itself. While lenders are familiar with and agreeable to this practice, compliance with FIN 46(R) resulted in additional unneeded cost and confusion for SMEs and their lenders. Consolidation takes more time and analysis, as well as potentially causing loan covenant violations.

Consequently, many SMES opted to ignore FIN 46(R), and accepted instead a qualification of their audit report. Of course, this solution was not ideal either, since a qualified opinion casts a shadow and more confusion on the company financials.     

The FASB effectively eliminated this issue for SMEs on February 19, 2014, by endorsing a Private Company Council recommendation for alternative treatment. By complying with the following conditions, private companies can elect not to consolidate leasing VIE’s:

  1.  The private company lessee and the lessor entity are under common control
  2. The private company lessee has a leasing arrangement with the lessor entity
  3.  Substantially all of the activity between the two entities is related to the leasing activity between the lessor entity and the private company lessee
  4.  Any obligation of the lessor that is being guaranteed or collateralized by the private company lessee could, at inception of the obligation, be sufficiently collateralized by the asset(s) leased to the private company.

In developing the VIE alternative, the PCC overcame a potential snag that could have rendered the new pronouncement useless for many SMEs. The original condition d. above provided that the lessor obligation could only be collateralized by the assets leased to the lessee. Since lenders often require additional assets of the lessee to serve as collateral, the PCC answered user concerns by modifying the provision to its current form which is more practical.

If a company elects the new alternative, the VIE disclosures about the lessor entity would be replaced with:

  1.  disclosures about the amount and key terms of significant liabilities recognized by the lessor entity that expose the private company to having to provide significant financial support to the lessor entity, and
  2. a qualitative description of significant arrangements not recognized that expose the private company to having to provide significant financial support to the lessor entity.

These disclosures would be used in conjunction with other related party disclosures required of the lessor entity.

The official Accounting Standard Update that covers this issue, ASU No. 2014-07, was issued on March 20, 2014, and is effective for the 2015 calendar year, with the option of early election for 2013.

The expeditious disposition of this troublesome standard, by the FASB and PCC on behalf of private companies, validates the resolve of the Board and Council to make Financial Accounting Standards effective and useful for all parties.

For further information, see Applying Variable Interest Entity Guidance to Common Control Leasing Arrangements


New Challenges for the IASB

European Parliament concerns overshadow US vacillation on IFRS adoption

The onward push of IFRS towards dominance as the worldwide accounting standard has been reported in great detail over recent years. Though over 100 countries have signed on, a sore point has been the continued indecision on the part of the SEC.

However, the attention until now has been on the complex and thorny differences in how accounting principles should be applied in areas such as financial instruments and leases. As if that were not enough, criticism has lately expanded to seemingly mundane issues of governance. 

In the midst of the European Parliament’s (EP) debate over future funding for the IASB, Britain’s The Telegraph reported discrepancies in filings by the IFRS Foundation. A close reading indicates that the mistakes were primarily late disclosures of director changes, more an administrative technicality rather than a major indiscretion. Nevertheless, critics pounced on the revelation to bolster their allegation that IFRS were the cause of the recent financial crisis. Critics’ contention was that the fair value International Accounting Standard, established for banks to evaluate losses on potentially bad loans, led to an understatement of the risk. The IFRS Foundation has responded that there is an opposing opinion by “most of the academic evidence available, that the claim that fair value accounting exacerbated the financial crisis appears to be largely unfounded.” 

The EP ultimately approved funding of the IASB for the next six years, but indicated that each year’s allotment would be subject to satisfactory performance in the eyes of the EP. That performance may be evaluated in relation to recommendations from an examination by the European Union (EU) conducted by Commissioner Phillippe Maystadt. Maystadt was asked to determine how best to further the EU’s involvement in the development of IFRS and governance of the IASB.

One recommendation was to reform the European Financial Reporting Advisory Group (EFRAG), an advisor to the EU on how IFRS are assimilated into the EU. The IASB is asked to extend comment periods to give EFRAG more time. The IASB feels that the process and time for approving standards is extensive already, and would be hindered by further delay. Also, having the EU decide whether to endorse each standard that comes out is contrary to the global purpose of IFRS.

In addition, the Maystadt report expressed concern about the influence of the US on IFRS development. However, judging by the impasse that the FASB and IASB have reached on certain issues, the IASB has stood firm, and does not appear to be intimidated by the US. Interestingly enough, the IFRS Foundation is a US based non-profit corporation. Though originally founded in the US, the IFRS Foundation and IASB are based in London, and have an international scope.

Finally, Maystadt is also concerned that the IASB pays more attention to gaining new adopters of IFRS and the convergence process, rather than addressing issues of current users. The IASB disputes that claim as well, citing work on the Conceptual Framework and other priorities emphasized by the EU. In any event, the three year review of the work program that the IASB is required to perform will be open to all parties, so that there is broad coverage of pressing issues.

The EP is not alone in expressing concerns about funding the IASB. After the FASB’s parent organization recently pledged $3 million to the IASB, various critics in the U.S. have questioned the wisdom and propriety of the contribution. If that funding were not made, the IASB’s financial status would be further weakened.

For further information, see EP reaches last-minute agreement on IASB funding see IFRS Foundation Comments on the Maystadt Report

Shaping Financial Disclosure Standards

FASB takes another step with Conceptual Framework

An early casualty of joint FASB/IASB convergence projects, the Conceptual Framework for Financial Reporting is now being pursued separately by the two Boards. A key element of the Conceptual Framework will address financial statement disclosures. In July 2012, the FASB issued an Invitation to Comment (ITC), Disclosure Framework. The response to the ITC, covered in the February, 2013, Audit & Accounting Alert, indicated broad support for disclosure reform, but wide differences in how to achieve the goal. A debate ensued over the use of relevance versus materiality as the driving factor. The need for structure in format versus flexibility brought differing viewpoints as well. 

The broadly stated ITC also caused confusion by attempting to cover the disclosure decision making processes of both the FASB and the individual reporting entity together. Recognizing that these are separate issues, the FASB decided in June, 2013, to divide them into two parallel projects. Consequently, on March 4, 2014, the FASB issued an Exposure Draft to describe the Board’s decision making process: Conceptual Framework for Financial Reporting: Chapter 8: Notes to Financial Statements (ED). In the case of the entity’s decision making process, the FASB is conducting a field study to weigh companies’ ability “to exercise discretion over which disclosures they provide in notes to financial statements.” The results of that study along with feedback from the ITC will be used formulate that part of the framework.

The purpose of the ED is first to guide the FASB in assessing the types of information that should be taken into account when considering disclosure requirements. Then the next steps are to:

  1. Identify information to be disclosed in the notes that is likely to be helpful to those making decisions about providing resources and that would be relevant to a significant number of the organizations to which it applies,
  2.  Eliminate disclosures of certain types of future-oriented information that may have negative effects on the cash flow prospects of the reporting organization and its investors and creditors, and
  3.  Consider the costs and potential consequences of providing a disclosure in the notes.  

The ED also discusses how the disclosure criteria should be applied to interim periods.

 One of the concerns raised in the ITC was a hesitance to proceed without input from the SEC, since their regulations drive the content of public company disclosures. In December, 2013, the SEC issued a staff report recommending evaluation of disclosure requirements in order to make them more effective and efficient for companies and investors alike. The SEC indicated that the FASB would be consulted during the evaluation. In the ED, the FASB also stated its plan to coordinate with the SEC for this purpose, as well as to reduce overlapping disclosures.

As mentioned, the IASB is working separately, and has two concurrent projects underway. The IASB Conceptual Framework project considers high-level principles related to presentation and disclosure, while its Disclosure Initiative takes a more comprehensive detailed look at the concepts.

For further information, see Proposed Statement of Financial Accounting Concepts—Conceptual Framework for Financial Reporting: Chapter 8, Notes to Financial Statements

Additional A&A News 

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

  1. PCAOB’s Franzel Sees Shortage of Women among Accounting Firm Leaders
  2. GASB Declines to Delay Implementation Date of Pension Standards
  3. IASB looks to bridge gaps between Islamic, conventional accounting
  4. Defending the Usefulness of XBRL
  5. Hog Feed Company Charged in Accounting Fraud From China Operation
  6. Killing off Britain's Audit Commission is bad for the taxpayer


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]