The Securities and Exchange Commission Statement of Policy reaffirming the status of the Financial Accounting Standards Board as a designated private-sector standard-setter (Release Nos. 33-8221; 34-47743; IC-26028; FR-70) recognizes FASB’s financial accounting and reporting standards as “generally accepted” accounting principles for purposes of the federal securities laws.As a result, registrants are required to comply with those standards in preparing financial statements filed with the commission, unless the commission directs otherwise. The SEC has emphasized the responsibility of FASB to consider international convergence, principles-based standards, timeliness, and cost-benefit issues in pursuit of high-quality accounting standards, as appropriate in the public interest and for the protection of investors. Official positions of FASB are determined only after extensive due process and deliberations.
Increasingly, the SEC appears to be “directing otherwise.”
This has been done in the form of staff accounting bulletins, white papers that appear from accounting and auditing groups indicating consultation with the SEC, and letters to registrants with particularized demands. The problematic aspect of this development is the lack of due process that can strike at the heart of GAAP and seep into practice with virtually no due process.
A quick walk down memory lane reminds us of the potent effect of these actions. In 1999, SAB Nos. 99 on materiality, 100 on restructuring and impairment charges, and 101 on revenue recognition in financial statements dramatically altered common practice concerning each of these topics.
In 2005 and 2006, SABs 107, on guidance on Statement of Financial Accounting Standards No. 123 (revised 2004) on share-based payment, and 108, on quantifying financial statement misstatements, changed the considerations in recording stock compensation and restatements.
The problem at hand is evident from merely reading the SABs’ self-professed caveat regarding authoritative status: “The statements in the bulletin are not rules or interpretations of the commission, nor are they published as bearing the commission’s official approval; they represent interpretations and practices followed by the Division [of Corporation Finance] and the chief accountant in administering the disclosure requirements of the federal securities laws.”
What is the point of developing a transparent due process at FASB if it can be re-interpreted, overridden and trumped at the discretion of the SEC?
The lack of due process is not isolated to SABs. In April 2005, the SEC publicly overruled FASB by delaying the effective date for SFAS No. 123(R). A lack of due process was particularly evident in changes made to commission requirements detailed in its executive compensation disclosure document with respect to summary compensation tables on Dec. 22, 2006. Although comments were to be accepted for 30 days, the rule change is described as “final.”
In the early 1990s, the SEC promoted the use of current value and fair market value approaches in lieu of historical cost using such venues as its conference on market value accounting (Nov. 15, 1991). That position has affected standard-setting by FASB, leading to the current hybrid or mixed-attribute (such as historical cost for some assets and fair value for others) valuation approach.
FASB’s FAS 157 on fair value measurements (in September 2006) defines fair value as “the price that would be received to sell an asset or paid to transfer a liability in an orderly transaction between market participants at the measurement date.”
The standard addresses price, explaining: “An orderly transaction is a transaction that assumes exposure to the market for a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities; it is not a forced transaction (for example, a forced liquidation or distress sale). The transaction to sell the asset or transfer the liability is a hypothetical transaction at the measurement date, considered from the perspective of a market participant that holds the asset or owes the liability.” Attention is then accorded to the principal (or most advantageous) market, definition of an active market, and conditions in which an alternative pricing method may be used for measurement.
With the recent turbulent markets, the question arises as to whether holders of securities must reflect the existing market data, even when the thinness of such markets is recognized by both governmental agencies and market participants. Unofficial guidance, proffered as resulting from discussions with the SEC, has urged the use of market values. This is problematic in its apparent disregard for the guidance in the literature subjected to due process. Moreover, write-downs to questionable market values simply create “rainy-day cookie jars” for tomorrow when the “usual and customary” market returns.
Over the years, as hybrid measurement systems have evolved and financial instruments have become increasingly tailored, problems have erupted in various quarters of the economy.
The mid-1990s accorded attention to Orange County, Calif., the post-millennium experienced Enron, and now we have seen fallout from the subprime mortgage sector. Each of these has a commonality that concerns the value of existing holdings, relative to the value if positions are “unwound.” If the usual transaction approach is not permitted, a consequence likened to a “run on the bank” can result.
Since a transaction requires a willing buyer and seller, and it is apparent when markets become very thin that these two parties are lacking for some interim time frame, it makes little sense to force reliance on aberrant market conditions.
To analogize, consider the reports that rather than selling homes and moving, many current property owners are opting for remodeling. This is an example of how potential buyers adjust to market conditions not seen as commensurate with the value held.
Political, standard-setting, interpretation and enforcement activities blur. Consider past reports on alleged backdating, legislators’ reactions to disclosures under FASB Interpretation FIN No. 48, Accounting for Uncertainty in Income Taxes — An Interpretation of SFAS 109, and letters recently sent by the SEC seeking proprietary details on companies’ incentive arrangements.
Due process is intended to weigh costs relative to benefits and consider principles relative to rules. Care is needed to clarify whether it is to guide the measurements and disclosures of public companies, or whether FASB’s role is mere illusion.
Wanda A. Wallace, Ph.D, is the John N. Dalton Professor of Business Emerita at the College of William and Mary. She has served on FASB’s Financial Accounting Standards Advisory Council and the Comptroller General’s Government Auditing Standards Advisory Council.
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