We Go Back to the Good Old Days?
Dennis R. Beresford
I visited my pharmacy to pick up eyedrops for my two golden
retrievers. Before he would give me the prescription, the
pharmacist insisted I sign a form on behalf of Murphy and
Millie, representing that they had been apprised of their
rights under the new medical privacy rules. This ludicrous
situation is a good illustration of how complicated life has
was still shaking my head later that same day when I was
clicking mindlessly through the 150 or so channels that
my local cable TV service makes available to me. I happened
to land on The Andy Griffith Show, and the few
minutes I spent with Andy, Barney, Opie, and Aunt Bea got
me thinking about the Good Old Days. Wouldn’t it be
nice, I thought, to go back to the Good Old Days of the
profession in the early 1960s when I graduated from college?
then, accounting was really simple. The Accounting Principles
Board hadn’t issued any standards yet, and FASB didn’t
exist. So we didn’t have 880 pages listing all of
the current rules and guidance on derivative financial instruments,
for example. The totality of authoritative GAAP at that
time fit in one softbound booklet about one-third the size
of the new derivatives guidance.
those Good Old Days, the SEC had been around for quite a
while but it rarely got excited about accounting matters.
Neither mandatory quarterly reporting nor management’s
discussion and analysis (MD&A) had yet come into being,
for example. And annual report footnotes could actually
be read in an hour or so.
country had eight major accounting firms, and becoming a
partner in one was a truly big deal. Lawsuits against accounting
firms were rare, and almost none of them resulted in substantial
damages against the accountants.
short, accounting seemed more like a true profession, with
good judgment and experience key requirements for success.
course, however much we might like to return to simpler
times, it’s easier said than done. And most of us
would never give up the many benefits of progress, such
as photocopiers, personal computers, e-mail, the Internet,
and cellphones. But I think that accounting rules may have
become more complicated than necessary.
me start with a mea culpa. You may remember the famous line
from the comic strip Pogo: “We have met the
enemy, and he is us!” Well, you may be tempted to
rephrase that quote to “We have met the enemy, and
he is … Beresford!”
guilty to having led the development of 40 or so new accounting
standards over my time at FASB. A number of them had pervasive
effects on financial statements, and some have been costly
to apply. I always tried to be as practical as possible,
however, although probably few would say that I was 100%
successful in meeting that objective.
any event, more-recent accounting standards and proposals
seem to be getting increasingly complicated and harder to
apply. Even the best-intentioned accountants have difficulty
keeping up with all of the changes from FASB, the AICPA,
the SEC, the EITF, and the IASB. And some individual standards,
such as those on derivatives and variable-interest entities,
are almost impossible for professionals, let alone laypeople,
these days, companies are subject to what I’ll call
quadruple jeopardy. They have to apply GAAP as best they
can, but they are then subject to as many as four levels
of possible second-guessing of their judgments.
First, the external auditors must weigh in.
Second, the SEC will now be reviewing all public companies’
reports at least once every three years.
Third, the PCAOB will be looking at a sample of accounting
firms’ audits, and that could include any given
Finally, the plaintiff’s bar is always looking for
opportunities to challenge accounting judgments and extort
Principles Versus Detailed Rules
that all this second-guessing is what leads many companies
and auditors to ask for more-detailed accounting rules.
But we may have reached the point of diminishing returns.
In response to the complexity and sheer volume of many current
standards, some have suggested that accounting standards
should be broad principles rather than detailed rules. FASB
and the SEC have expressed support for the general notion
of a principles-based approach to accounting standards.
(It’s kind of like apple pie and motherhood: Who can
object to broad principles?) Of course, implementing such
an approach is problematic.
2002, FASB issued a proposal on this matter. And last year
the SEC reported to Congress on the same topic. Specific
things that FASB suggested could happen include the following:
Standards should always state very clear objectives.
Standards should have a clearly defined scope and there
should be few, if any, exceptions (e.g., for certain industries).
Standards should contain fewer alternative accounting
treatments (e.g., unrealized gains and losses on marketable
securities could all be run through income rather than
the various approaches used at present).
also said that a principles-based approach probably would
include less in the way of detailed interpretive and implementation
guidance. Thus, companies and auditors would be expected
to rely more on professional judgment in applying the standards.
SEC prefers to call this approach “objectives-based”
rather than “principles-based.” SEC Chief Accountant
Donald Nicolaisen recently repeated the SEC’s support
for such an approach, agreeing with the notion of clearly
identifying and articulating the objective for each standard.
Although he also suggested that objectives-based standards
should avoid bright-line tests such as lease capitalization
rules, he called for “sufficiently detailed”
implementation guidance, including real-world examples.
FASB and the SEC may have reached a meeting of the minds
on the overall notion of more general principles, they may
disagree on the key point of how much implementation guidance
to provide. FASB thinks that a principles-based approach
should include less implementation guidance and rely more
on judgment, while the SEC thinks that “sufficiently
detailed” guidance is needed, and I suspect that would
make it difficult to significantly reduce complexity in
any event, FASB recently said that it may take “several
years or more” for preparers and auditors to adjust
to a change to less detail. Meantime, little has changed
with respect to individual standards, which if anything
are becoming even harder to understand and apply.
heard FASB board members say that FASB Interpretation (FIN)
46, on variable-interest entities (VIE), is an example of
a principles-based standard. I assume they say this because
FIN 46 states an objective of requiring consolidation when
control over a VIE exists. But the definition of a VIE and
the rules for determining when control exists are extremely
difficult to understand.
recently described what it meant by the operationality of
an accounting standard. The first condition was that standards
have to be comprehensible to readers with a reasonable level
of knowledge and sophistication. This doesn’t seem
to be the case for FIN 46. Many auditors and financial executives
have told me that only a few individuals in the country
truly know how to apply FIN 46. And those few individuals
often disagree among themselves!
complications make it difficult to get decisions on many
accounting matters from an audit engagement team. Decisions
on VIEs, derivatives, and securitization transactions, to
name a few, must routinely be cleared by an accounting firm’s
national experts. And with section 404 of the Sarbanes-Oxley
Act (SOA) and new concerns about auditor independence, getting
answers is now even harder. For example, in the past, companies
would commonly consult with their auditors on difficult
accounting matters. But now the PCAOB may view this as a
control weakness, under the assumption that the company
lacks adequate internal expertise. And if auditors get too
involved in technical decisions before a complex transaction
is completed, the SEC or the PCAOB might decide that the
auditors aren’t independent, because they’re
auditing their own decisions.
things become this complicated, I wonder whether it’s
time for a new approach. Maybe we do need to go back to
the Good Old Days.
financial executives are probably more concerned about internal
controls than new accounting requirements. For the first
time, all public companies must report on the adequacy of
their internal controls over financial reporting, and outside
auditors must express their opinion on the company’s
controls. Many people have questioned whether this incredibly
expensive activity is worth the presumed benefit to investors.
one might argue that the section 404 rules are a regulatory
overreaction, shareholders should expect good internal controls.
And audit committees, as shareholders’ representatives,
must demand those good controls. So this has been by far
the most time-consuming topic at all audit committee meetings
I’ve attended in the past couple of years.
and auditors are spending huge sums this year to ensure
that transactions are properly processed and controlled.
Yet the most perfect system of internal controls and the
best audit of them might not catch an incorrect interpretation
of GAAP. A good example of this was contained in the PCAOB’s
August 2004 report on its initial reviews of the Big Four’s
audit practices. The report noted that all four firms had
missed the fact that some clients had misapplied EITF Issue
95-22. As the New York Times (August 27, 2004)
noted, “The fact that all of the top firms had been
misapplying it raised issues of just how well they know
the sometimes complicated rules.”
to a different criticism in that same PCAOB report, KPMG
noted, “Three knowledgeable informed bodies—the
firm, the PCAOB, and the SEC—had reached three different
conclusions on proper accounting, illustrating the complex
accounting issues registrants, auditors and regulators all
those who are very confident about their understanding of
the current accounting rules shouldn’t get complacent:
Fair value accounting is right around the corner, making
things even harder. In fact, it is already required in several
be clear, I’m not opposed in general to fair value
accounting. It makes sense for marketable securities, derivatives,
and probably many other financial instruments. But expanding
the fair value concept to many other assets and liabilities
is a challenge.
this sentence from FASB’s recent exposure draft on
fair value measurements: “The Board agreed that, conceptually,
the fair value measurement objective and the approach for
applying that objective should be the same for all assets
and liabilities.” In that same document, FASB said,
“Users of financial statements generally have agreed
that fair value information is relevant.”
the overall objective of moving toward a fair value accounting
model seems clear. Of course, that doesn’t necessarily
mean that we will get there soon. In fact, in the same exposure
draft the board said that it would continue to use a project-by-project
approach to decide on fair value or some other measure.
But in reality the board has been adopting a fair value
approach in most recent decisions:
SFAS 142, on goodwill, requires that impairment losses
for certain intangible assets be recognized based upon
a decline in the fair value of the asset.
SFAS 143, on asset retirement obligations, requires that
these liabilities be recorded initially at fair value
rather than what the company expects to incur.
SFAS 146, on exit or disposal activities, calls for the
fair value of exit liabilities to be recorded, not the
amount actually expected to be paid.
FIN 45, on guarantees, says that a fair value must be
recorded even when the company doesn’t expect to
have to make good on a guarantee.
value approach is also integral to other pending projects,
including the conditional asset retirement obligation exposure
draft. Under such a standard, a company might have to record
a fair value liability even when it doesn’t expect
to incur an obligation. Fair value is also key to projects
on business combination purchase procedures; differentiating
between liabilities and equity; share-based payments (stock
options); and the tremendously important revenue recognition
three major concerns about such pervasive use of fair value
accounting. First, in many cases determining fair value
in any kind of objective way will be difficult if not impossible.
Second, the resulting accounting will produce answers that
won’t benefit users of financial statements. Third,
those answers will be very difficult to explain to business
managers, with the result that accounting will be further
discredited in their minds.
approach that FASB is using for what I would call operating
liabilities is particularly troubling. Take, for example,
a company that owns and operates a facility that has some
asbestos contamination. The facility is safe and can be
operated indefinitely, but if the company wanted to sell
the property it would have to remediate that contamination.
The company has no plans to sell the property. But FASB’s
exposure draft on conditional asset retirement obligations
calls for the company to estimate and record a fair value
liability. This would be based on what someone else would
charge now to assume the obligation to clean up the problem
at some unspecified future date. The board admits that it
might be difficult to determine what the fair value would
be in this case, and companies could omit the liability
if they simply couldn’t make a reasonable estimate.
FASB and the SEC expect most companies to be able to make
a reasonable estimate, in reality I think that will be possible
only rarely. Even more important, does it really make sense
to record a liability when the company might believe that
there is only a 5% chance that it will have to be paid?
Consider how this line of reasoning might apply to litigation.
Presently, liabilities are recorded only when it’s
probable that a loss has been incurred and that a reasonable
estimate of the loss can be made. So if a company were sued
for $1 billion but there were only a 1% chance that it would
lose, nothing would be recorded. The fair value approach
would seem to call for a liability of $10 million in this
case, based on 1% of $1 billion.
might think this kind of accounting will apply only in the
distant future, but FASB is due to release its proposal
on purchase accounting procedures in the next few months,
and I understand that the proposal will require exactly
this kind of accounting.
addition to the very questionable relevance of this, I don’t
know how anyone would ever be able to reasonably determine
the 1% likelihood I assumed. How would an auditor attest
to the reliability of financial statements whose results
depend significantly on such assumptions? And where would
an auditor go to obtain objective audit evidence against
which to evaluate such assumptions?
value definitely makes sense in certain instances, but FASB
seems intent on extending the notion beyond the boundaries
of common sense. FASB also seems to have an exaggerated
notion of what companies and auditors are actually capable
of doing. Perhaps we should consider FASB’s faith
in the profession to be a compliment. Rather than feeling
complimented, however, I think that this just makes many
of us long for the Good Old Days.
Value Accounting and Revenue Recognition
asset retirement obligations and exit costs apply to only
a few companies, and even guarantees are not an everyday
issue. All companies, however, have revenues—or at
least they hope to have them. And for the past year or so,
FASB has been engaged in a complete rethinking of revenue
recognition. This, of course, was precipitated by the numerous
SEC enforcement cases on improper revenue recognition. Most
cases, however, involved failure to follow existing standards,
and most cases also resulted in premature recognition of
there’s no doubt that the current revenue accounting
rules are overly complicated, with many specific rules depending
on the type of product or service being sold. But FASB’s
current thinking would replace these rules with an asset
and liability–oriented approach based on fair value
accounting. This may well make revenue accounting even more
complicated than the detailed rules that we are at least
used to working with.
example, assume product A is being sold to a customer. It
costs $50 to produce product A and the customer has agreed
to pay a nonrefundable $100 in exchange for the company’s
promise to deliver this hot product next month. What should
the company record at month-end?
accountants would probably think first of the traditional
approach and conclude that the earnings process had not
been completed. Because product A hasn’t been completed
and shipped to the customer, the $100 credit is unearned
income. Some aggressive accountants would probably say that
the company should record the sale now because the $100
is nonrefundable. In that case the company would probably
also record a liability for the $50 cost that will be incurred
has a surprise for both. The board is presently thinking
about whether revenue for what it calls the “selling
activity”—the difference between the $100 received
and the assumed fair value of the obligation to deliver
the product—should be recorded now. This assumed fair
value would be the estimated amount that other companies
would charge to produce product A. In other words, it’s
the hypothetical amount a company would have to pay someone
else to assume the obligation to produce the product. The
company would have to make this assumption even though it
is 100% sure that it will make the product itself rather
than have someone else make it.
one could ever determine what other companies would charge,
I suspect that the amount would be higher than the $50 expected
cost, because another company probably would require a risk
premium to produce a product that it isn’t familiar
with. It would want to earn a profit as well. Let’s
assume in this case that the fair value could be determined
as $80. If so, the company would record now $20 of revenue
and profit for what FASB calls the selling activity. Next
month it would record the $80 remaining amount of revenue,
along with the $50 cost actually incurred. It’s unclear
when the company would record sales commissions, delivery
costs, and similar expenses, but I assume these would have
to be allocated somehow.
that this project was added to FASB’s agenda in large
part because of premature recognition of revenue in some
SEC cases—Enron recognized income based on the supposed
fair value of energy contracts extending 30 years into the
future—it is ironic that the project may well mandate
recognition earlier than most accountants would consider
appropriate. That kind of premature revenue recognition
is now generally prohibited, but other examples could follow,
depending on the outcome of this FASB project.
the revenue recognition project is still in an early stage
and both my understanding and the board’s positions
could change, FASB seems determined to use some sort of
fair value approach to revenue recognition in many cases.
If this happens, we will all be wishing for the Good Old
Days to return.
All That EITF Guidance Really Necessary?
early 2004, FASB’s board members began reviewing all
EITF consensus positions. A majority of board members now
have to “not disagree” with the EITF before
those positions become final and binding on companies. This
gives FASB more control over the EITF process, and it should
prevent the task force from developing positions that the
board sees as inconsistent with existing GAAP.
I think the task force has done a great deal of good over
its 20-year existence (I was a charter member), I think
it’s time to challenge whether everything that the
EITF does is necessary or even consistent with its original
purpose. Too many of the task force’s topics in recent
years can’t really be called “emerging issues.”
Rather, the task force often takes up long-standing issues
where it thinks that some limitations need to be placed
on professional judgment.
example, a couple of years ago the SEC became concerned
about the accounting for certain investments in other companies.
For years we’ve had standards that call for recognition
of losses when market value declines are “other than
temporary.” The EITF discussed this matter at eight
meetings over two years and also relied on a separate working
group of accounting experts. Earlier this year, a final
consensus position was issued. It includes a lengthy abstract
that tells companies what factors to consider, including
the following matters:
Evidence to support the ability and intent to continue
to hold the investment;
The severity of the decline in value;
How long the decline has lasted; and
The evidence supporting a market price recovery.
now we have a “detailed rule” on this matter.
Will this result in more consistency in practice? Will investors
and other users of financial statements receive better information
as a result? Is the result worth the additional effort?
after two years of effort on this project, FASB had to reconsider
the whole thing because no one had considered the effect
on debt securities held as available for sale by financial
institutions. So now the board is developing even more specifics
to deal with the unintended consequences of the rule.
I support the EITF, and I believe it has generally done
a great job. The members try to develop practical ways to
deal with current problems. Nonetheless, both the task force
and FASB may need to more carefully challenge whether all
of the EITF’s projects are really needed. If FASB
actually issued relatively broad standards, there probably
would be a need for the EITF to provide supplemental guidance
on some issues. But we now seem to have the worst of all
worlds, with quite detailed accounting standards being accompanied
by even more detailed EITF guidance.
Multitude of Challenges
intend to seem overly critical of FASB and others who are
working to improve financial reporting. It’s a tough
job, and the brickbats always outnumber the bouquets. If
I didn’t strongly
support accounting standards setting I wouldn’t have
spent 10 Qs years on the inside of the process. Still, those
years at FASB, as well as my time before and after, have
caused me to develop strong views on these issues. And I
truly do believe that standards have gotten just too complicated.
announced move to broader principles is one I fully support.
That job won’t be easy, but it has to be tried or
the sea of detail will become even deeper in the near future.
FASB needs to actually start doing this and not allow its
actions to speak otherwise. And companies, auditors, and
regulators need to support such a move and resist the temptation
to seek answers to every imaginable question. Furthermore,
companies and auditors may have to become more principled
before a principles-based approach will work.
of this process could be for the EITF to be more judicious
in what it takes on. Also, I urge FASB to reevaluate its
attitude toward fair value accounting. I believe FASB is
moving much faster in this area than preparers, auditors,
and users of financial statements can accommodate. Furthermore,
the SEC and other regulators may not yet be on board with
this new thinking.
the final analysis, we won’t be able to return to
my so-called Good Old Days. But we have to make sure that
what accounting and accountants can do is meaningful and
operational. We never want to look back and ask, “Remember
the Good Old Days, when accounting was important?”
Journal Editorial Board member Dennis R. Beresford,
CPA, was recently named the 2005 recipient of the
Gold Medal for Distinguished Service from the AICPA. He received
the award on October 26, during the fall meeting of the Institute’s
governing council in Orlando. Beresford is the Ernst &
Young Executive Professor of Accounting at the J.M. Tull School
of Accounting at the University of Georgia, Terry College
of Business. From 1987 to 1997, he was chairman of FASB. Prior
to joining FASB, he was national director of accounting standards
for Ernst & Young.ecently I visited my pharmacy to pick
up eyedrops for my two golden retrievers. Before he would
give me the prescription, the pharmacist insisted I sign a
form on behalf of Murphy and Millie, representing that they
had been apprised of their rights under the new medical privacy
rules. This ludicrous situation is a good illustration of
how complicated life has gotten.