Lease Accounting – One Step Closer
A few weeks ago, while doing research on the “then upcoming” joint Financial Accounting Standards Board (FASB) / International Accounting Standards Board (IASB) meeting that was called to try to resolve differences in approaches to accounting for lease expense as part of the project to revise lease accounting, I stumbled on a study of the economic impact of the exposure draft on leases prepared by a consulting firm that was commissioned by a coalition on several nonprofit and commercial organizations, most notably the U.S. Chamber of Commerce, and including several leading real estate industry associations.
The study’s key findings include:
- The exposure draft (ED) would increase apparent liabilities of U.S. public companies by $1.5 trillion
- In the worst case scenario, there would be a loss of 3.3 million U.S. jobs, and in the best case scenario, 190,000 jobs would be destroyed
- In the worst case, U.S. GDP would be lowered by $478.6 billion annually, and in the best case, reduced by $27.5 billion annually
- In the worst case, U.S. household earnings would decrease by $135.2 billion annually or $1,180 per household and in the best case, household earnings would be reduced by $7.8 billion or a reduction of $68 a year for the average U.S. household
After reading the study and its gloom and doom predictions, I searched the Internet and found the study headlined on a plethora of real estate industry associations’ web-sites.
My search also turned up criticism of the study which in one case indicated the belief that the doomsday predictions in the study “border not only on the ridiculous, but also the whimsical.”
Given the study’s sponsorship, among other things, I would consider its findings with a grain of salt. Make that the whole salt shaker. But it still makes for interesting bedtime reading. Don’t we all love to watch disaster movies?
Word came down from their London meeting that the FASB and IASB had come to a compromise on an approach for lessee expense accounting. The Boards tentatively agreed on a two-prong approach for expense recognition with certain leases accounted for following the approach originally outlined in the 2010 exposure draft (purchase of a right-of-use asset with separate financing), which would generally result in a greater total expense in the earlier years of the lease term and a smaller total expense in the later lease years and other leases using an approach that results in recognizing lease expense ratably over the life of the lease (straight-line method).
The right-of-use expense recognition method would be used for property in circumstances where the lease term is for the major part of the economic life of the underlying asset or the present value of fixed lease payments accounts for substantially all of the fair value of the underlying asset and for leases of assets other than property unless the lease term is an insignificant portion of the economic life of the underlying asset or the present value of the fixed lease payments is not insignificant relative to the fair value of the underlying asset. Leases other than those that don’t meet this capitalization criteria would result in total lease expense over the lease term being recognized on the straight-line method.
Further application guidance from the FASB is expected to be included in the next edition of the exposure draft presently scheduled for the 4th quarter of this year with the possibility of the project being completed in 2013.
More to come…
Gene Smith, CPA
Do As I Say, Not As I Do – FASB Style
In September 2006 the FASB published FAS 157 – Fair Value. Paragraphs 31-34 provide explicit guidance on the disclosures required for financial instruments that are measured at fair value on a recurring basis (in the case at hand, short term investments). Paragraph 32 states that disclosure of the fair value measurements as of the reporting date and the level (1, 2 or 3) within the fair value hierarchy in which the faire value measurements in their entirety fall. Paragraph 34 states “The quantitative disclosures required by this Statement shall be presented using a tabular format. (See Appendix A).” (emphasis added) Paragraph A33 of Appendix a states in part “Quantitative disclosures using a tabular format are required in all periods (interim and annual).” (emphasis added) Paragraph A34 illustrates the typical table used to present the required information in the prescribed tabular format. That table is partly reproduced below:
| Description | Total | Level 1 | Level 2 | Level 3 |
| Security 1 | $xxx | $xxx | $XX | |
| Security 2 | $xxx | $XX |
Imagine my surprise when I opened up the audited financial statements of the FASB and found the following disclosure related to the FASB’s fair value measurements:
3. Short-term investments and investment Income and Losses
Short-term investments, consisting of Level 1 money market funds which are measured at fair value, amounted to $4,514,000 and $6,009,000 as of December31, 2011 and 2010, respectively.
Furthermore, the financial statements of the Financial Accounting Foundation, the FASB’s parent, also omit the tabular presentation that I thought was required by FAS 157.
Now, we always thought that presenting a table with only one column completed looked silly, not to mention the report space wasted. But the instructions were clear, at least this auditor thought they were. Silly me.
Brian Gibney, CPA, CIRA
What Is an Accounting Principle?
| The Auditors’ Opinion Asks the Question: What Is an Accounting Principle?
Accounting is the language of business. Affairs of a business unit are communicated to management, staff and others through accounting information. Because of its extensive use by a variety of people, this information must be suitably recorded, classified, summarized and presented. In order to make this language understandable to all people, it is necessary that the accounting information be based on certain uniform standards. These standards are termed as “accounting principles.” Accounting principles are defined as those rules of action or conduct which are adopted by the accountants universally for recording accounting transactions. An accounting principle will be relevant only if it satisfies the needs of those who use it. There are three attributes that these principles must follow to be accepted. They include: 1. Usefulness:The accounting principle should provide useful information to its users; otherwise, it will not serve the purpose. 2. Objectivity:A principle will be said to be objective if it is based on facts and figures. There should not be a scope for personal bias. If the principle can be influenced by the personal bias of users, it will not be objective, and its usefulness will be limited. 3. Feasibility:The accounting principle should be practicable. The principle should be easy to use; or else, its utility will be limited. In the absence of common principles, there would be chaos. Every accountant would have his/her own principles. Not only would the utility of accountants be less, but financial statements would not even be comparable, even in the same business. Therefore, it became essential that common principles be followed for measuring business revenues and expenses. To combat this problem, the American Institute of Certified Public Accountants (AICPA) created the Committee on Accounting Procedure in 1939 to set the accounting standards, subject to Securities and Exchange Commission (SEC) regulations. This committee was replaced by the Accounting Principles Board in 1951, which was eventually replaced by the Financial Accounting Standards Board (the FASB) in 1973. The Government Accounting Standards Board (GASB) and the Public Company Accounting Oversight Board (PCAOB) also determine accounting standards in the U.S. On July 1, 2009, the FASB, approved the Accounting Standards Codification (ASC) as “the single source of authoritative U.S. accounting and reporting standards, other than guidance issued by the Securities and Exchange Commission (the SEC).” The Codification superseded all then-existing SEC accounting and reporting standards by reorganizing the existing authoritative literature. Now, only one level of authoritative U.S. GAAP exists, other than guidance issued by the SEC. All other literature is non-authoritative. |
Codification Organization
The FASB ASC reorganizes thousands of U.S. GAAP pronouncements into approximately 90 accounting topics. In addition to General Principles (Topic 105), which offers an explanation of Generally Accepted Accounting Principles (GAAP), the seven financial accounting and reporting categories are:
- Presentation (Topics 205 through 280)
- Assets (Topics 305 through 360)
- Liabilities (Topics 405 through 480)
- Equity (Topic 505)
- Revenue (Topic 605)
- Expenses (Topics 705 through 740)
- Broad transactions (Topics 805 through 860)
The above seven categories have topics, and the topics have subtopics. If needed, subtopics are divided into sections, which are numbered consistently across all subtopics. Sections provide the actual accounting guidance. An “SEC Section” is included for topics that are affected by SEC regulations.
To assist individuals with the changes this codification has brought, FASB issued the Notice to Constituents to provide information on the codification structure, style and history. In addition, the Master Glossary provides definitions of terms. Other sources of information include accounting standards updates, proposed accounting standards, other exposure documents, pre-codification standards and maintenance.
So there you have it—a brief summary of U.S. accounting principles. Next time the Auditors’ Opinion will cover another set of accounting principles known as International Financial Reporting Standards (IFRS).
Bob Van Arnum, CPA
Much has been written about the need for a single set of global accounting standards. The International Accounting Standards Board (IASB), established shortly after the Financial Accounting Standards Board, has been relentlessly pursuing this noble goal. While significant progress has been made, there is still a long way to go.
This auditor jumped on the global accounting standards bandwagon back in 2008 and immediately determined that it was only a matter of time before International Financial Reporting Standards (IFRS), as promulgated by the IASB, were adopted worldwide. After all, the idea made eminent sense. Accounting is the language of business; however, across countries and world regions, that language, and dialects within the language, differ significantly. Given the changes in the global economy in the past 25 years as a result of social, political and technological changes, it would seem logical to have all enterprises (business and non-business) speaking, not only the same language, but the same dialect. The time frame envisioned by this auditor in the phrase “matter of time” was a relatively short one – that is five to ten years.
Recently, this auditor’s enthusiasm has diminished so much so that I now have significant doubt as to whether the goal of a single set of accounting standards will ever be achieved, let alone in the near future. Consider the following:
No stabilizing legal anchor is in place
There has been praise for the IFRS Foundation, the parent of the IASB, for implementing the IFRS Foundation Monitoring Board, comprised of securities regulators from various constituent members. The purpose of the Monitoring Board is to oversee the appointment of trustees to the IFRS Foundation and monitor their performance. This places another layer of review (and expense) over the IASB’s operations but it does not provide the IASB with a legal authority to enforce accounting standards internationally.
The “IINO syndrome”
The IASB continually ballyhoos the fact that IFRS has been adopted by over 100 countries. However, approximately 40% of the adopting countries (including all of the members of the European Union) have done so with modifications of one sort or another. I refer to this as IFRS In Name Only or the “IINO syndrome”. These modifications consist of exempting certain industries or entities or excluding IFRS pronouncements believed to be inappropriate for their own public policy. In this auditor’s opinion, adoption with exception defeats the purpose of a single set of financial accounting standards.
Significant economies have yet to adopt
The world’s two largest economies, – the United States and China have yet to embrace IFRS.
In the US, both the Securities and Exchange Commission and the FASB agree, in principle, with a single set of global accounting standards. However, while the FASB has worked with the IASB to bridge the gap between US accounting standards and IFRS, it does not appear that the differences will be closed anytime soon. There remain too many differences; furthermore, recent pronouncements by the FASB have created new differences or solidified old ones.
China adopted its own set of accounting rules, similar to but not identical with IFRS, in 2007 and pledged at that time to adopt IFRS in the future. That has not happened yet and, substantial differences exist between the Chinese accounting rules and IFRS.
No enforcement mechanism
There is no global equivalent of the PCAOB to ensure that an entity’s financial statements are, in fact, prepared in accordance with IFRS and that the audit of those financial statements was conducted in accordance with internationally recognized auditing standards. The unwillingness of the Chinese to allow PCAOB inspection of Chinese auditors highlights this issue.
Inadequate funding mechanism
The IASB continues to struggle with funding. It reported a small income in 2009 sandwiched between significant losses in 2010 and 2008. For 2011 it reported a gain of 708,000 pound sterling; but that was largely due to (an apparent) one-time contribution from the EU in excess of 3.65 million pound sterling. And while the IASB rightly claims that its dependence on contributions has diminished, contributions still constitute the largest part of its revenue. Furthermore, a substantial part of those contributions come from sources within the US and China, who have not yet adopted IFRS. Most nations that have adopted IFRS contribute nothing at all towards the IASB’s operations. International accounting firms (primarily the US final four) continue to contribute a substantial amount of the IASB’s operating budget – raising the obvious questions regarding independence.
Taken together, the factors listed above, have seriously dampened this auditor’s enthusiasm for IFRS adoption. The IINO syndrome is particularly bothersome. What does one think when reading an auditor’s opinion that states, in part, “the financial statements are in full compliance with IFRS as adopted by the European Union”? What’s your opinion?
Brian Gibney, CPA, CIRA
Auditing Lessons Learned From Lance Armstrong
Even the moderate biking enthusiasts know the name Lance Armstrong. We’ve all marveled at his accomplishments in winning the Tour de France seven times. Although it comes as a disappointment that he is now being charged with using steroids to enhance his ability to compete; with the benefit of hindsight, I think there are some important lessons that can be learned by today’s auditors.
Let’s pretend that Lance Armstrong is an organization, and we’re auditing the organization. Let’s further pretend that we’re auditing the revenue related to a cycling event. Every auditor knows that historically, there have been five primary audit assertions that are evaluated when auditing the reasonableness of a set of financial statements (although in recent years, these assertions have been repackaged). These assertions are [1] existence and occurrence, [2] valuation, [3] rights and obligations, [4] completeness, and [5] disclosure. With respect to the recent allegations, the organization would be questioned as to whether it met the “rights and obligations” assertion. Did Lance Armstrong have “the right” to win seven Tour de France cycling races? How would an auditor evaluate this rights and obligations assertion for this hypothetical organization? Here are some considerations:
- Understand the Control Environment of Bicycle Racing – Auditors have a requirement when auditing an organization to understand the control environment of the organization and industry conditions affecting the organization. Some good procedures in that regard would’ve been to learn the landscape revolving around the professional cycling industry. Understanding the risks related to that industry would help the auditor design appropriate tests to address that risk.
- Be Professionally Skeptical – Just because Lance Armstrong is a famous celebrity cyclist who was married to Sheryl Crow (in this auditor’s opinion, a terrific musical artist), doesn’t mean he is necessarily honest. Auditors are required to approach their engagements with professional skepticism and corroborate with a questioning mind information that is made available to them during the audit.
- Interview Lance’s Teammates – Every audit is required to include interviews of individuals at the organization. Asking the right questions of Lance’s teammates could potentially uncover this rights and obligations issue prior to the release of these hypothetical financial statements.
- Ask Sheryl Crow – Since Sheryl Crow left the organization, (they split up in 2009), Sheryl might be able to provide useful firsthand information related to Lance’s right to win these competitive cycling races. We could also ask Sheryl for an autograph, which would also add significant value to the audit!
- Understand and Determine Implementation of Internal Controls Related to Cycling Revenue – Gaining an understanding on how the industry guarantees that blood doping does not influence its organized races would be important information to understand prior to the organization recording this revenue, and therefore, important audit information. Determining implementation of organization controls related to its recorded revenue is also generally a requirement of professional standards.
At the end of the day, the auditing lesson that we can learn from Lance Armstrong is this: When auditing a set of financial statements, think out-of-the-box and determine what might go wrong with that set of financial statements five years from now. When identifying what could potentially go wrong, assess the likelihood of the event and determine procedures that could be performed to address that risk. Thank you Lance Armstrong for this important auditing lesson. And thank you, Sheryl Crow, for eloquently reminding us that: “Every Day is a Winding Road,” so let’s do what we can to follow the curves in the audit.
Dave Dacey, CPA
Is the Economy Really Getting Better?
I just read an article in the AICPA’s CGMA magazine about the still looming economic uncertainty that we all face. I came away with one question, which was “Is our economy really doing better?”
The article indicated that executives of mid-size companies have become more cautious about the US economy – a sentiment that is reflected in hiring and expansion strategies and plans to invest in technology, according to new research.
About 52% of mid-market executives expect the US economy to grow less than 2% over the next 12 months, according to a Deloitte survey of about 528 executives whose companies generate annual revenue from $50 million to $1 billion. That was up from 42% a year earlier.
Executives showed more optimism when they were asked the same questions in September 2011: 58% expected US GDP growth to exceed 2%. Eight months later, 48% felt that optimistic.
A more cautious outlook for the economy corresponded with executives’ level of uncertainty rising.
Then, I look at the economy a little closer to home. On the street that I have lived for the past 20 years, there are two houses that are empty because their owners could not pay the mortgages. We never had one empty house on our street for this reason, let alone two. Gas and food prices are rising, while our personal income is not rising at any way near the same pace.
So, is our economy getting better? What do you think? What should be done?
Leonard Hecht, CPA
A common practice employed by government contractors, whether they are for-profit entities or not-for-profit entities, is to establish one or more related entities to provide goods and services to the entity under contract to the government. Sometimes these related entities have a legitimate business purpose. In other cases the purpose may be more sinister – that is, to enable management of the contracted entity to extract more funds from the contract than they would otherwise be entitled to.
As one example, the owners of Entity A, under contract with a government agency to provide job training under a cost reimbursement contract, establish Entity B to own the real property used by Entity A in the job training program. The rent paid to Entity B is billed to the government agency under the contract. As another example, the salaries of the senior management of Entity A are paid out of Entity B. Entity B then bills Entity A monthly for management services. In both instances contracts are drawn up between the two entities specifying the services provided and the billing rates.
Regardless of the existence of the contracts, Entity A cannot bill its government contract more for goods and services than that allowed under applicable cost principles. Billings in excess of those amounts are unallowable. The contracts between Entity A and Entity B are not arm’s-length transactions and therefore warrant increased scrutiny; an experienced auditor will go beyond the rent agreement and the inter-company service contract and request documentation for the underlying costs of Entity B. If it is subsequently determined that the government agency is paying Entity A more than the amount allowed under the applicable cost principles questioned costs may result – and the amounts could be significant. Furthermore, Entity A’s reputation with the government agency and the community at large may be irreparably damaged.
It is relatively easy to prevent potential problems from arising as a result of billings between related entities. First and foremost, it is imperative to have an understanding of the cost principles applicable to the entity and its contract. Failure to follow this basic rule will never result in anything positive. Intercompany billings must be firmly based on the underlying cost principles. Second, disclose the complete details of any such transactions to the government officials, preferably in writing. If at all possible, make the billing arrangement part of the funding contract. Verbal government approvals may not be remembered at a later date or by subsequent government officials. If a problem is later uncovered, an astute government official may re-open prior year contracts and seek reimbursement for as many periods as the law allows.
Brian Gibney, CPA, CIRA
