by Glenn Cheney
Washington, D.C. - Called to Congress to testify in hearings on the Enron Corp. debacle, Edmund Jenkins, chairman of the Financial Accounting Standards Board informed United States representatives that accounting standards were not to blame.
But that doesn't mean that accounting standards couldn't be better. Even as Jenkins testified before the House Energy and Commerce Committee Subcommittee on Commerce Trade and Consumer Protection, FASB staff at the organization's Norwalk, Conn., headquarters were hammering out a proposal for a standard that would restrict the ability of companies to keep special purpose entities off their balance sheets. The board hopes to issue an exposure draft by the middle of March.
The day before Jenkins' testimony, the board added to its agenda a project to write guidelines and interpretation of its Statement 5 and possibly Statement 57. The eventual pronouncement will clarify the accounting and disclosures that should be made by a guarantor that is guaranteeing another entity's debt.
After a lengthy and detailed explanation of some of the FASB standards that should have prevented Enron's fall, Jenkins said that the board "cannot, alone, sustain the transparency necessary to maintain the vibrancy of our capital markets."
Protecting those markets, he told the subcommittee, depended on not only good standards but the good intentions of the corporate directors and officers who prepare financial reports. He called on them to "apply accounting standards in a way that is faithful not only to the language of the requirements but to the requirements' clear intent."
Jenkins also called on auditors to reject "facile arguments by a reporting entity's management that the financial statements are acceptable just because the language of the standard does not explicitly prohibit an inventive reporting technique or methodology that is intended to hide information from unsuspecting consumers."
Jenkins cited two acknowledgements by Enron that it had failed to meet accounting requirements. In one, the company issued common stock to a special purpose entity in exchange for notes receivable. Despite requirements to the contrary, the company reported the notes as assets rather than deductions from equity.
In a footnote to his prepared comments, Jenkins said that the requirements had been set in Emerging Issues Task Force Issue No. 85-1, Classifying Notes Received for Capital, and SEC Staff Accounting Bulletin No. 40, Topic 40-E, Receivables from Sales of Stock.
An Enron restatement also indicated that the assets, liabilities, gains and losses of three previously unconsolidated SPEs should have been included in the original financial statements. In a detailed answer to his own rhetorical question on what an SPE is, Jenkins cited several FASB standards that cover consolidated statements, derivatives, financial instruments, segments of enterprises and long-term obligations.
Jenkins emphasized that, as recently as 2001, FASB had issued standards that improved the transparency of business combinations, purchased goodwill and intangible assets, asset retirement obligations and impairment of long-lived assets.
He also listed projects in progress on such issues as consolidations of SPEs, determining the fair value of financial instruments and distinguishing liability instruments from equity instruments and accounting for complex instruments with debt and equity components.
The current project on SPEs is part of the consolidations project that was added to the board's agenda in November of last year. In response to the Enron crisis, the board accelerated the project in January in hopes of issuing a final statement by the middle of the year.
The exposure draft is expected to raise the percentage of an SPE that can be owned by an outside investor without the bigger owner reporting the entity's finances on its balance sheet. Currently, the bigger company can keep the SPE off the books if an outside party owns at least 3 percent of the SPE's equity. The board is expected to propose increasing that to 10 percent.
If approved as proposed, the new standard is likely to require that the outside party be the first to suffer financial loss in the event of debt or other difficulties. Under such a rule, companies are more likely to consolidate SPE finances into their balance sheets.
Jenkins quoted former Securities and Exchange Commission chief accountant Lynn Turner testifying before Congress, when he said, "New accounting rules are not needed to prevent the restatements of Enron's financial statements or improve the quality of its disclosure. Compliance with and enforcement of the accounting rules . . . would have given investors a timely and more transparent picture of the trouble the company was in."
In a rare glimmer of silver lining around the dark and swelling cloud of the Enron storm, Jenkins said, "If anything positive results from the Enron bankruptcy, it may be that this highly publicized investor and employee tragedy serves as an indelible reminder to all of us, including reporting entities, auditors and regulators, that transparent financial accounting and reporting do matter and that the lack of transparency imposes significant costs on all who participate in U.S. capital markets."
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