In a resounding salvo aimed at pending proposals on business combinations and consolidated financial statements from the Financial Accounting Standards Board, two major financial associations - Financial Executives International and the Institute of Management Accountants - have roundly criticized not only the board's approach to those proposals, but also a broad spectrum of related issues.

A letter issued by FEI's committee on corporate reporting and the IMA's financial reporting committee offered scathing criticism of a FASB staff business combinations draft that was issued in August 2004. The correspondence subsequently went on to complain of other problems, such as the concept of fair value measurement and the increasing overall complexity and difficulty of working with FASB standards.

FEI president Colleen Sayther-Cunningham said that the letter started off as a comment on the business combinations project, but as its writers delved into the project's fundamental problems - which ended up taking months - the letter expanded to include an increased number of concepts, problems, related standards and, ultimately, the postulate that FASB's standards were beyond the understanding of most accountants.

"As we thought about all the changes in the last 10 years in standard-setting, and the complexity that has been built into the standards, and the [Sarbanes-Oxley Act] environment we're operating in, and the material weaknesses that have been disclosed, we saw that a lot of them were personnel issues," Cunningham said. "We stepped back and asked, 'Who can be an expert at implementing accounting standards these days?' People want to implement them right, but the measurements are difficult and the concepts aren't clear."

Because the FEI-IMA letter dealt broadly with a variety of concepts, standards and proposals, FASB declined to comment except to say, "FASB encourages and values input from its constituents. Board members will read and consider the content of the letter received from the FEI and the IMA."

The letter is one of the strongest of the recent calls for FASB to step back, look at the direction it is going, and grapple with the difficulty of using its standards.

"The implications of these proposals for the future shape of the financial reporting model are both profound and far-reaching," the letter stated. "Once issued as final standards, extension of these principles to similar circumstances that occur outside of a business combination is inevitable," Cunningham said.

In other words, FEI and the IMA fear that the principles within the expected business combinations proposal will eventually ripple throughout the country's generally accepted accounting principles. In fact, since FASB is working in parallel with the International Accounting Standards Board to produce, ideally, a set of unified global standards, the ripples would roll around the world.

FEI and the IMA each represent tens of thousands of corporate accountants and financial officers - the professionals who must use FASB's standards to produce financial reports.

"This is not your typical project in terms of its impact. So it's important that they get a lot of user involvement, a lot of preparer involvement, and that they thoroughly vet the issues that are being presented," said Mitch Danaher, assistant comptroller at GE and chair of the FEI-IMA business combinations working group. "I don't think that anything we've identified here is news to the FASB. They are aware of these concerns. The question is how they are going to sequence the projects as they go forward and the processes they will use to validate that the requirements are operational and responsive to user needs."

Back to basics

The FEI and IMA committees say that the problem goes back to the board's revised interpretation of its conceptual framework.

The board is planning to review and revise the framework - a project that will take several years - and the committees feel that FASB should seek public comment on any changes to its framework and resolve related issues before it implements new concepts in a statement on business combinations. Among those issues are the appropriate trigger for recognition of assets and liabilities, and the implications of relying on fair value measurement techniques for capturing uncertainty in contingencies.

Alfred King, vice chair of the Annapolis, Md.-based valuation company Marshall & Stevens, and perennial commentator on FASB issues, called the letter "a significant critique of the direction of FASB."

"This letter is a symptom of the tremendous unhappiness with the direction that FASB is going," he said. "The specifics on consolidations and fair value are interesting but somewhat arcane. But the broader picture has potential for significant impact."

King said that the board's theories are sound as theories, but can fail when put into practice. He shares one of the letter's main concerns, the treatment of accounting for contingencies. In the case of a lawsuit that has, say, a 10 percent chance of resulting in a $100 million decision against the company, FASB's proposal is likely to require it to record a liability of $10 million, even though the actual liability will be either zero or $100 million.

The letter also singles out the "economic unit model" that is at the core of the proposal on consolidated statements, pointing out that the framework does not address the concept of the economic unit, and that the board should follow its due process before implementing the model in a final standard. They claim that the economic unit is "primarily a creation of FASB" and that there is "no natural constituency that readily identifies with it," nor "any obvious intended use for the information it provides."

The letter also cited recent experience with several existing standards as evidence that the introduction of complex, fundamental changes can create significant application problems. Among the standards identified are Statements 140, on transfers of assets and extinguishment of liabilities; 143, on asset retirement obligations; and 150, on accounting for financial instruments with characteristics of both liabilities and equities.

Warning that changes in accounting business combinations would lead inexorably to changes elsewhere, and that these changes will be very difficult to undo, the board was asked to reconsider the sequence of its projects on business combinations, performance reporting and the conceptual framework.

It was also suggested that the needs of statement users should be validated. If users do not support the proposed concepts, the letter said, the board should narrow the scope of the project to "specific, identified issues with the present model for business combinations."

"A lot of the fundamental changes that are proposed in the business combinations documents are also being addressed in the conceptual framework, and we think they should deal with the framework issues first," Danaher said. "Also, there are aspects of the conclusions in these documents that affect performance reporting - what gets into the statement of earnings - and we think they ought to think about how the performance statement should look in light of these proposals before they are put into effect."

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