Our February column ("The demise of the drive to bring international standard-setting to the U.S.," page 16) explains why the Financial Accounting Standards Board cannot be replaced by the International Accounting Standards Board. While this is good on its own, it has also created a novel circumstance that no one else has even identified, much less analyzed.

Specifically, FASB is at long last liberated from the inferior position it has occupied since 2002. This liberation brings the opportunity, nay, the responsibility, to bring reporting standards into the 21st century. This reformation is sorely needed to serve U.S. capital markets' interests, and is long overdue because antiquated standards remain in effect despite stunning technological advances in information processing and telecommunications.

Nonetheless, many will resist progress and fight FASB each step of the way. That response must not discourage the board from improving financial reporting in the U.S. and beyond.


SUBJUGATION

Ironically, FASB entered into the so-called "Norwalk Agreement" with the IASB on Sept. 18, 2002, a mere 49 days after Sarbanes-Oxley was enacted on July 30.

What's ironic about that?

Section 109 of Sarbanes-Oxley ensures FASB's independence by requiring the Securities and Exchange Commission to authorize a single standard-setting body to produce GAAP for public filings, while the Public Company Accounting Oversight Board must fund that body's budget through a fee paid by U.S. public companies. The legislative intent was quite clear: prevent FASB from being intimidated by the possibility that they might forfeit contributions by taking controversial stands on reporting issues. The goal was to protect and empower the board by eliminating this obvious independence threat that hung over it for 29 years.

Yet only seven weeks later, FASB and the IASB signed a memorandum in which they agreed "to use their best efforts to (a) make their existing financial reporting standards fully compatible as soon as is practicable, and (b) to coordinate their future work programs to ensure that once achieved, compatibility is maintained." In effect, FASB bound itself at the hip to the IASB to craft standards that would be acceptable to both boards.

Unwittingly, FASB's members effectively sacrificed the political freedom and independence they had just gained!

Despite having been protected by Sarbanes-Oxley against financial pressure from corporate donors, FASB voluntarily put itself in the untenable position of having to concur with the IASB, which did, and still does, depend on contributions from corporations, especially those from the U.S.

In retrospect, it was a huge paradoxical setback. After being endowed with the greatest power in its life, FASB unexplainably subjugated itself to the IASB and its donors, thus plunging into an unworkable political quagmire that forced it to develop a consensus among its own seven members (not always easy) while at the same time ensuring that this consensus would be acceptable to the IASB and its constituents. This arrangement clearly constrained FASB's ability to create better standards for U.S. markets, just when they needed lots of help.


LIBERATION

FASB has now been liberated because it's clear that the SEC cannot possibly designate the IASB as the designated standard-setting body under Sarbanes-Oxley. Furthermore, it's evident that the boards are growing weary from the heavy burden of collaborating.

Thus, FASB is once again empowered to pursue what its members consider the most important issues and seek their own consensus without worrying whether it is acceptable to either donors or a majority of the IASB. After all, it can overcome any bullies because its funding is assured and it's backed by the SEC, the baddest big brother of them all.


REFORMATION

Our readers know we find little in GAAP that provides capital markets with completely useful information for rational decisions. In particular, the political process has historically produced standards that promote providers' needs, instead of users' needs. Examples abound, but off-balance-sheet financing comes to mind: Managers love it, auditors don't mind it, but users hate it.

Among our major concerns is FASB's failure to keep standards up to date. Ten years ago, we poked the board by coining the acronym "POOP" to convey that GAAP consists of Pitifully Old and Obsolete Principles.

We now offer our wishful to-do list that, if completed, would help FASB make financial reporting more relevant.

 
FASB'S TO-DO LIST

Reporting frequency. Quarterly reporting dates to the early 1930s for New York Stock Exchange companies and the early 1960s for all other public companies. Does anyone honestly believe that reporting once every three months even remotely meets today's unrelenting demands for instant access to the latest information?

Inventory. Current GAAP for inventories dates to 1946, when the Committee on Accounting Procedure faced a dilemma. If it required managers to use FIFO, the tax benefits of LIFO would be lost; if it required LIFO, inferior financial statements would be published. FASB needs to replace the CAP's weak solution of just letting managers decide.

Depreciation. Because systematic depreciation has been used since the 1830s, FASB cannot legitimately duck the question of what information about tangible assets is useful. The members must not be intimidated by auditors' hypocritical question of, "How can we audit market values?" when values for every kind of asset and liability are routinely measured and reported under GAAP.

Leases. Despite minor changes, lease accounting remains basically unaltered since 1976, when FASB embraced the false premise that companies must account differently for two kinds of leases. We anticipate that the soon-to-be-released joint exposure draft from both boards will establish that all leases convey an asset to the lessee in the form of a right to use tangible property in exchange for upfront cash and/or later payments. Likewise, the lessor's property has been affected by selling that right. Building the new standard on those concepts will lead to both superior accounting and the demise of bogus leases created to present false financial images.

Stockholders' equity. Nobody knows how old equity accounting is, but it's surely ancient and anachronistic. We favor restricting equity to common stock, thus classifying preferred shares as liabilities, in turn exposing the fallacy that banks are well-capitalized when they've issued these thinly disguised debt instruments. In addition, conversion features, employee stock options, and other derivatives are hidden away in equity, even though they're liabilities. Treasury stock accounting (from the early 1930s) leaves accountants ill-equipped to deal with today's huge buybacks.

Pensions. After studying SFAS 87 since 1985, we know straightforward is best, which means reporting each element of defined-benefit pension plans without aggregation or smoothing. Pension obligations are debt, pension funds are investments, and each should be reported separately on balance sheets. Service cost is a labor cost, interest is a financing expense, fund returns are investment income, and plan amendments and actuarial gains and losses are not usefully deferred because they affect current earnings. It's just that simple.

Cash flows. In 1987, FASB hastily decided (because of a last-minute vote change) to recommend but not require the direct method for reporting operating cash flows. Because virtually all companies use the less informative indirect method, it's time to mandate the direct method. After all, users wanted it then and still do.

Income taxes. Who can believe GAAP for income taxes is remotely useful? At a time when public policy arguments rage over who's paying a fair share, income statements report measures of tax expense that don't begin to show the favorable financial impact of deferring payments off into the future, while balance sheets grossly overstate the alleged assets and liabilities. All obscurity and games-playing can be eliminated by adopting the flowthrough method and mandating deferral information disclosures for those who still think it's useful.

Investments. Unbelievably, investments in securities have six different treatments, depending on whether they're nonmarketable, trading, available for sale, held to maturity, or subject to the equity method or consolidation. For the first five, the securities' fair value is superior information, hands down. For the last, all assets and liabilities of the acquired and acquirer should be marked to market at acquisition and revalued forever after.

 
CONSTERNATION

Efforts to reform these areas will create consternation for managers and auditors, but their outcries should not be feared or responded to. Because these people are regulated for everyone else's benefit, FASB must not accommodate them. After all, new rules are supposed to change their habits and otherwise inconvenience them! The board's new liberation puts it in the best position ever to disregard their shortsighted and self-serving comments and move forward.

 
INCORPORATION

All the recent talk about "incorporating" International Financial Reporting Standards into GAAP assumes that the former is superior to the latter.

The tables will turn if the newly empowered FASB continues to receive strong support from the SEC, gets a vision for what needs to be done, and produces high-quality standards. Specifically, we believe the IASB will be compelled to follow FASB's lead and incorporate GAAP improvements into IFRS!

 
FREEDOM

After its lost decade, FASB is now positioned like never before to produce real reforms. If its members balk, the SEC should clarify that reformation is essential.

We urge FASB members to get on with it. No more cowering at the prospect of tongue lashings from managers and auditors. No more dreading the scorn of international standard-setters who almost daily reveal that their real ambition is to become the sole global authority, even if it means no real reform at all. That message comes through loud and clear in Michael Cohn's March 8, 2012, article on AccountingToday.com that quotes IASB chair Hans Hoogervorst's appeasing promise during a speech in Mexico that the IASB will refrain from altering the status quo: "Let's fix what needs fixing, and no more."

Even though it may not be what FASB members thought they signed up for, here is their new charge: Do your duty and do it well by bringing financial accounting into the present century. As for the SEC, it should exercise its powerful oversight and help get the ball rolling.

Paul B. W. Miller is a professor at the University of Colorado at Colorado Springs and Paul R. Bahnson is a professor at Boise State University. The authors' views are not necessarily those of their institutions. Reach them at paulandpaul@qfr.biz.