From the special issue editors: fair value measurements and reporting developments, and the continued movement toward International Financial Reporting Standards.
Accounting (Standards)
Accounting (Analysis)
Casabona, Patrick A.
Gornik-Tomaszewski, Sylwia
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Name: Review of Business Publisher: St. John's University, College of Business Administration Audience: General; Trade Format: Magazine/Journal Subject: Business; Business, general Copyright: COPYRIGHT 2010 St. John's University, College of Business Administration ISSN: 0034-6454
Date: Spring, 2010 Source Volume: 30 Source Issue: 2
Geographic Scope: United States Geographic Code: 1USA United States

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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

Sylwia Gornik-Tomaszewski, DBA

The Peter J. Tobin College of Business,

St. John's University
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