Introduction
This issue of the Review of Business provides informative articles
on the two most important financial accounting and reporting topics
affecting the accounting profession in recent history. The first deals
with the growing use of fair value measurements for assets and
liabilities reported in financial statements, especially during the
recent credit crisis and current economic environment. The second deals
with the continued convergence of U.S. Generally Accepted Accounting
Principles (GAAP) and International Financial Reporting Standards
(IFRS), including the Security and Exchange Commission's
(SEC's) proposed roadmap for the potential mandatory use of IFRS in
financial statements prepared by U.S. issuers.
These two topics are inherently linked. Elements of fair value
accounting have been used for decades in U.S. GAAP. Although the growth
of fair value accounting has been incremental, its use has accelerated
in recent years as a means of enhancing financial statement quality,
transparency and relevance. This trend aligns with global accounting
convergence, because the use of fair value measurement is equally, if
not more, prevalent in IFRS, developed by the International Accounting
Standards Board (IASB).
The primary U.S. GAAP rules for measuring the fair value of assets
and liabilities reported in financial statements resides in the
Financial Accounting Standards Board's Accounting Standards
Codification 820 (ASC 820), Fair Value Measurements and Disclosures,
which was originally published as FASB Statement 157, Fair Value
Measurements, in September 2006. Among other things, this guidance
defines fair value, establishes a framework for measuring fair value in
U.S. GAAP and expands disclosures about fair value measurements.
Supporters of fair value accounting have argued that its
application allows users to see the underlying economic reality in a
changing environment, while carrying assets at their original costs
masks the declining values. However, there have been many complaints
about the application of fair value accounting's increased
subjectivity and uncertain valuation estimates, which have called into
question the reliability of such information. During the recent credit
crisis, these complaints escalated significantly, and additional
assertions have been made that these rules may have led to investment
values reported in financial statements that were significantly
underestimated for certain entities (i.e., financial institutions).
Many constituents have also expressed their concerns for the need
to correct the unintended consequences of fair value accounting,
especially related to determining valuations for illiquid assets in
unstable markets, and the need for enhanced transparency in the form of
more meaningful disclosures. A major area of concern relates to inherent
subjectivity and complexity in fair value valuation techniques and
assumptions used when determining the fair values of assets and
liabilities that are not traded in active and orderly financial markets,
and that rely on valuation inputs that are not observable in the market.
As a result of recommendations made by the SEC, the FASB's
Valuation Resource Group, Congressional House Subcommittee hearings, and
the European Commission, among others, both the FASB and IASB have
worked (and continue to work) arduously on improving fair value
accounting and reporting guidance. Furthermore, the FASB and IASB have a
joint project, Fair Value Measurement and Disclosure--Joint Project of
the IASB and FASB, to develop converged fair value measurement guidance
and improve the consistency and transparency of financial statements on
a global basis. The fair value project forms part of a long-term program
by the FASB and IASB to achieve convergence of U.S. GAAP and IFRS.
Several of the articles presented in this Special Issue of the
Review of Business describe the challenges recently experienced in
applying fair value accounting rules in the current economic
environment, the possible role that fair value accounting played in the
recent credit crisis the procedures and complexities involved in
auditing fair value measurements, and ethical considerations related to
fair value accounting. Also addressed are the FASB and IASB's
ongoing improvements in fair value accounting and reporting, which
reflects a pursuit of one of the most challenging and important
international accounting convergence objectives the Boards share with
one another. These efforts have led to, among other things, additional
guidance to clarify how fair value measurements for assets and
liabilities reported in financial statements should be made, especially
in inactive markets, and the additional disclosures required to make
financial statement information more translucent and meaningful to
investors and other users.
Other articles in this Special Issue of the Review of Business deal
with the growing importance of IFRS and its impact on financial
reporting systems worldwide. Over the last several years, the
world's capital markets have undergone tremendous expansion and
integration. And with that, there has been a movement away from local
country financial reporting standards toward global standards. IFRS are
now used for public reporting purposes in more than 100 countries with
others to follow over the next couple of years.
Increasing transparency in the market through a high-quality,
global set of standards has been recognized as an important objective
and a priority by governments, capital market regulators and standard
setters. In September 2009, the Group of Twenty (G-20) summit in
Pittsburgh called upon accounting standard setters to redouble their
efforts to achieve a single set of global accounting standards and to
complete their convergence project by June 2011. In response, on
November 5, 2009, the FASB and IASB issued a joint statement reaffirming
their commitment to achieving convergence of U.S. GAAP and IFRS, and
announcing plans to intensify efforts to complete several major joint
projects by the end of June 2011.
Moreover, U.S. policymakers are now considering whether IFRS should
be used in the United States. In August 2007, the SEC issued a
"concept release" asking whether U.S. public companies should
be permitted to use either IFRS or U.S. GAAP as a basis of accounting in
preparing their financial statements for reporting with the SEC.
Following this release, in 2008 the SEC issued a proposed "IFRS
roadmap" that sets forth a possible path to eventual adoption of
IFRS by all U.S. public companies. Most recently, in February 2010 the
SEC issued a statement endorsing a more specific plan to work toward
incorporation of IFRS in the U.S. financial reporting system. Over the
next year the Commission will evaluate the quality of IFRS, the
independence of IASB, investors and accountants' knowledge of IFRS
and the impact of IFRS on U.S. regulations and companies. The SEC plans
to make the final decision on the IFRS roadmap in 2011.
Year 2009 also brought interesting developments regarding
accounting for private companies. In July 2009, the IASB released IFRS
for Small and Medium-sized Entities (IFRS for SMEs). It is a
self-contained, standalone set of financial accounting and reporting
standards designated for entities that publish general-purpose financial
statements for external users, but do not have public accountability.
In the United States, there are 29 million privately held
companies, according to the U.S. Census Bureau. Many are small- and
medium-sized organizations that report to a narrower range of financial
statement users, such as lenders, venture capitalists and insurers.
Although U.S. private companies are not required to use a particular
basis of accounting in preparing financial reports, their reporting has
been largely based on what is required for public companies, that is,
U.S. GAAP.
In December 2009, the American Institute of Certified Public
Accountants (AICPA) and the Financial Accounting Foundation (FAF) have
announced the establishment of a "blue-ribbon panel" to
address how U.S. accounting standards can best meet the needs of users
of private company financial statements. The panel will provide
recommendations on the future of standard setting for private companies,
including whether separate, standalone accounting standards for private
companies are needed. Following the decision of the AICPA in May 2008 to
recognize the IASB as a standard setter, IFRS for SMEs could be an
acceptable accounting standard for U.S. companies that meet requirements
set in the standard.
Summary of Articles Presented in this Special Issue
This issue begins with an interview featuring Margaret Mulley,
Partner of Strategy & Communications and Chief Learning Officer,
Deloitte & Touche LLP and Touche, LLP, who discusses the impact that
fair value accounting and reporting and the movement to IFRS are having
on the accounting profession and business community. This includes the
impact on the preparation of financial statements, the steps accounting
firms and their clients are taking to implement this new guidance,
accounting and valuation processes needed to measure fair value,
auditing procedures, and tools professionals need to insure the accuracy
of fair value measurements and disclosures reported in financial
statements, and the education requirements and other tools needed by
accounting professionals.
The interview is followed by six articles dealing with various
aspects of fair value accounting and reporting, auditing and ethical
considerations, and the movement toward applying IFRS and its impact on
the accounting profession.
* In the first article, Fair Value Accounting and the Credit
Crisis, Patrick A. Casabona and Victoria Shoaf discuss the impact of the
increasing use of fair value accounting and reporting in financial
statements and the difficulties experienced in applying fair value
guidance in measuring the fair values of certain assets and liabilities,
especially for investments traded in inactive markets for which reliable
observable market valuation inputs are not readily available. They also
discuss the criticisms made by accounting profession constituents about
the complexity and weaknesses in fair value accounting rules, and their
possible contribution to the financial losses incurred in the credit
crisis.
This led to congressional hearings and recommendations from members
of the U.S. Congress, leaders of the G-20, the SEC, and other valuation
experts to improve and converge the fair value accounting and reporting
requirements, especially for financial instruments. As a result, the
FASB and IASB have been issuing significant new and informative guidance
to improve fair value measurements and disclosures reported in financial
statements to make them more informative, reliable and translucent.
The FASB and IASB have recently provided guidance to improve fair
value accounting and reporting in a number of areas, including
estimating the fair value of an asset or liability traded in inactive
and unstable markets; improving disclosures about the fair value of
financial instruments; assessing whether a debt security is other than
temporarily impaired; and clarifying the guidance on the fair value
measurement of liabilities, among others. In addition, the FASB and IASB
have accelerated their joint project on financial instruments, which
will reduce the complexity of the accounting and reporting for such
instruments, make the reporting more informative and translucent and to
achieve convergence in this area.
* Fair Value and Business Combinations by Nina T. Dorata and
Ignacio Perez Zaldivar examines implementation and application issues
related to ASC 805, Business Combinations, which took effect for
combinations in fiscal years after December 15, 2008. The two major
concerns related to applying this guidance include the increased
earnings volatility created by the business combination accounting
procedures, and obtaining timely and accurate fair value measurements
for assets acquired and liabilities assumed in the business combination.
Both concerns directly result from the enhanced use of a fair value
model required by the acquisition method, which requires most
acquisition-related transaction costs to be expensed in earnings, as
well as subsequent changes in fair value measurements. The two are a
vast departure from the accumulated cost model that merger and
acquisition specialists were accustomed to in the past.
The authors point out that the interaction between ASC 805, which
expands the requirements for fair value use in business combinations,
and ASC 820, Fair Value Measurements and Disclosures, which promulgates
procedures for determining fair value measurements and related
disclosures, creates boundless opportunities for valuation specialists
and experts who thrive on the nuances of fair value measurements in the
absence of active markets. The opportunities for valuation specialists
come with a price, however, as explained in the article.
* Adrian P. Fitzsimons, Jeffrey L. Satenstein, and Benjamin R.
Silliman, point out that since the credit crisis emerged in 2008, the
American Institute of CPAs (AICPA) and the Public Company Accounting
Oversight Board (PCAOB) have issued a variety of guidance dealing with
the auditing of fair value reporting. This article, Fair Value Audit
Guidance of Public and Non-Public Companies in Response to the Credit
Crisis, examines and discusses this recent guidance for both non-public
corporations and public corporations. The paper includes an audit case
that illustrates an auditor's testing for fair value of debt
securities using level-2 valuation inputs, as defined in ASC 820.
Under the new auditing guidance, the objective is to obtain
sufficient appropriate evidence about whether the recognition or
disclosure of any accounting estimates are reasonable and whether the
related disclosures in the financial statements are adequate in the
context of the applicable financial reporting framework. In addition,
the auditor would need to exercise professional judgment to determine
whether any estimates that have been identified as having high
estimation uncertainty give rise to significant risks. The paper also
examines PCAOB's new fair value auditing guidance for public
corporations. The objectives of the new guidance are to inform auditors
about potential implications of the FASB's new standard on reviews
of interim financial information and annual audits. It also addresses
audit procedures for financial statements, including integrated audits,
disclosures, and auditor reporting considerations.
* Ethics is Imperative to Effective Fair Value Reporting, by Teresa
M. Cortese-Danile, R. David Mautz, Jr., and Irene M. McCarthy, points
out that the growing use of fair value measurements in accounting has
been a source of concern for accountants and auditors, legislators,
regulators and market participants. The role of "mark to
market" accounting in possibly precipitating the near-collapse of
financial markets in 2008 has been debated by Congress, the SEC and the
PCAOB, among others. Despite recent efforts by the FASB and IASB to
improve fair value accounting and reporting, significant concern remains
about the extent to which judgment is permitted in the estimation of
fair value estimates for assets and liabilities that are traded in
inactive and disorderly markets, and where reliable market-based
valuation inputs are not available.
The authors indicate that the latitude afforded entities to assign
fair values to assets and liabilities means that the most important
"principles" in mark-to-market accounting are the ethical
principles of preparers and auditors who estimate and attest to the fair
values reported in financial statements. Thus, a high level of ethical
diligence is essential to counter managers' natural inclination to
report overly optimistic fair values when markets are inactive or
disorderly, and when observable market value inputs are not available to
estimate fair values (i.e., level-3 fair value measurements). Therefore,
the authors suggest that there must be structural changes in ethics
education and corporate culture to help mitigate the temptation to
manipulate fair values so that confidence in financial reporting is
restored.
* In the fifth article, IFRS in the United States: Challenges and
Opportunities, Sylwia Gornik-Tomaszewski and Steve Showerman discuss the
need for a single set of high quality global accounting standards to
achieve comparability and transparency of financial reporting worldwide.
To address the growing demand for such standards, FASB and IASB have
been pursuing improvement and convergence of U.S. GAAP and IFRS. In the
meantime, a global movement to IFRS has developed with well over 100
countries worldwide requiring or permitting the use of IFRS for
reporting purposes.
In the United States, important rules adopted by the SEC with
respect to foreign private issuers went into effect on March 4, 2008.
They eliminate the need for foreign private issuers who prepare
financial statements in accordance with IFRS, as issued by the IASB, to
reconcile their financial statements to U.S. GAAP. This significant
change was a major step towards the SEC's goal of having a single,
global accounting standard. Furthermore, in 2008, the Commission
proposed a roadmap that will lay out a schedule and appropriate
milestones for continuing progress toward acceptance of IFRS in the
United States. In a statement issued on February 24, 2010, the
Commission articulated its continued belief that a single set of
high-quality globally accepted accounting standards would benefit U.S.
investors. The statement is a commitment from the SEC to assess the
impact of IFRS on the U.S. reporting environment. Although no final
decisions have been made in this regard, adoption or expected adoption
of IFRS in almost all developed economies around the world have a real
impact on a growing number of U.S. companies, and on the accounting
profession itself. The article overviews current status of IFRS
worldwide and in the United States, and discusses challenges as well as
opportunities of potential U.S. GAAP to IFRS conversion from the
perspectives of preparers of financial statements, the accounting
profession and the academia.
* In the final article, IFRS for SMEs--An Option for U.S. Private
Entities? Eva K. Jermakowicz and Barry Jay Epstein evaluate the
IASB's new IFRS for Small and Medium-sized Entities (IFRS for
SMEs). The stated goal of this IFRS is to provide a simplified,
self-contained global accounting and financial reporting standard
designed to meet the financial statement needs of smaller, non-listed
entities. In the United States, FASB is also weighing development of
such a streamlined group of financial reporting requirements. The advent
of this standard follows by about a decade a similar undertaking in the
United Kingdom, where Financial Reporting Standard for Smaller Entities
(FRSSE) has been successfully implemented.
The support for the IASB's project from national accounting
standard setters throughout the world stems mostly from the widely
perceived complexity of the full IFRS, and from the compulsory statutory
requirements for financial reporting by non-public entities in many
countries, which contrasts with the absence of such requirements in the
United States. The complexity of the full IFRS (or, for that matter,
full U.S. GAAP) arguably imposes a high cost on implementing and
applying these standards. In addition, in most countries--in contrast
with the United States--SMEs are legally required to file statutory
financial statements prepared in accordance with national GAAP (or
IFRS), and to make them available to all users. Additionally, many
believe that the IFRS for SMEs may ease the transition to full IFRS for
listed companies, provide improved comparability for users of accounts,
and enhance the overall confidence in the accounts of SMEs.
This volume would not have been possible without the support and
collaboration of numerous individuals. First of all, as the guest
editors of this special issue, we would like to express our sincere
appreciation to Igor Tomic, Editor of the Review of Business, for his
support during the publication process. In addition, we would like to
thank all the reviewers for their insightful comments. All manuscripts
were technically reviewed (blind review) by academics and technical
experts in the area of fair value accounting and IFRS. Each manuscript
was revised at least twice before final acceptance.
Patrick A. Casabona, Ph.D.
The Peter J. Tobin College of Business,
St. John's University
casabonp@stjohns.edu
Sylwia Gornik-Tomaszewski, DBA
The Peter J. Tobin College of Business,
St. John's University
gornikts@stjohns.edu