Analysing the Harmonisation Agenda

•July 5, 2010 • Leave a Comment

It was in February 2010, that the FASB started making is clear that the ‘grand objective’ of transforming or migrating US GAAP across to IFRS, was falling behind the envisaged time table.

It seemed that part of the urgency and momentum injected by the G20 meetings last year in creating a better global regulatory framework, had been lost for whatever reason and that the more steady and languid pace we had been used to ever since the Norwalk Agreement came into being in September 2002, was the course d’ jour again. In other words, the normal order in the world of international accounting regulation had been re-established.

The FASB also made it apparent that harmonisation in itself was not the major objective and driver as had originally been understood by practitioners and other interested parties.

However, the convergence agenda is partly being driven by concerns the SEC (Securities and Exchange Commission) have around:

• Common control transactions
• Recapitalisation transactions
• Reorganisations and
• acquisitions of minority interests

The SEC also feels that IFRS provides little guidance in certain industries such as:

• Utilities
• Insurance
• Extractive activities and
• Investment companies

We agree that the course towards international harmonisation, for the sake of capital market participants, maintaining liquidity and confidence in the systems and regulatory framework around that system should be a measured and deliberated affair.

The thrust of the SEC’s concerns were voiced by the Chairman Mary L. Schapiro’s words:
“Incorporating IFRS into our financial reporting system would involve a significant undertaking. We must carefully consider and deliberate whether such a change is in the best interest of U.S. investors and markets.”

The themes revolve around whether is serves the interests of US organisations to change to reporting on and IFRS basis, the transition arrangements and timeframes involved for both practitioners and users of the resultant Financial Information.

As all the relevant information the SEC requires to satisfy its custodial and regulatory duties was not available at the meeting in February 2010, Ms Shapiro was reluctant to comment of the feasibility of the originally envisaged road map (Norwalk Agreement) to harmonisation.

Therefore, we await further developments in order to judge the feasibility and eventual time line of the international harmonisation of Financial Reporting Standards.

EconoCountant ©2010


A dereliction of duty

•May 26, 2010 • Leave a Comment

In the last post of this blog we suggested that some follow up was due in March, yet it is almost the end of May 2010 and we have not commented further on develops at the IASB & FASB during this period.

Take heart, we are returning to focus on the issues and progress in the world of Financial Reporting Regulation, but before we continue the series, we thought that we would start a plea for a potentially different approach to Financial Regulation and Reporting.

At the heart of our argument is the fact that the raison d’être for Fair Value accounting is the objective that:

  • The objective of fair value measurement in IAS 39 is to arrive at the price at which an orderly transaction would take place between market participants at the measurement date. A forced liquidation or distress sale (ie forced transaction) at the measurement date is not an orderly transaction.
  • To meet the objective of a fair value measurement, an entity measures the fair value of financial instruments by considering all relevant market information that is available. When measuring fair value using a valuation technique, an entity maximises the use of relevant observable inputs and minimises the use of unobservable inputs.1

On the IASB’s web site the following statement on Fair Value Measurement is made:

“Guidance on measuring fair value is distributed across many IFRSs, and it is not always consistent.”

Therefore to summarise the objective of Fair Value Accounting is to report in financial statement the market values at the reporting date of financial instruments, be they financial assets or financial liabilities.

But does this not just lead to and drive further volatility in the financial reports and markets that those financial statements help inform?

So what then is a potential resolution to this apparent paradox?

Could it be that we need to embrace more holistic economic measures such as Economic Value and Value Based principles?

By Value Based principles we mean the Economic Value Added ®[EVA] tools developed by Stern Stewart & Co.

Our belief is that consistency and stability in reporting via the longer term view that EVA® fosters would be a far fairer methodology of measuring and reporting financial assets and liabilities.  Broader economic tools that takes us beyond merely ‘tracking’ fickle and unstable market transactions as a guide to valuation should be deployed to restore the stability and confidence in Financial Reporting, rather than the drive for short-term measurement and valuation techniques currently supported and endorsed by the IASB & FASB.

Tracking market values over a period of time, rather than a specific balance sheet date point in time would therefore much more accurately present the values of those financial instruments.  This objective is inherently built into the formula and calculation of Economic Profit and Economic Value Added.


Decisions pending – wait for March 2010 on further IFRS 9 developments

•February 18, 2010 • Leave a Comment

On 17 February 2010, the joint boards of the IASB & FASB met to discuss the further evolution of the classification of Financial Liabilities.

Just to clarify the distinctions.  In our previous blog post to date, the issue under discussion has been Financial Assets and the concepts around the introduction of IFRS 9 dealing specifically with Financial Assets.

The meeting of the 17th of February 2010 falls in the next category down from the graphical timeline published in the previous blog entitled Timeframe for IFRS 9 adoption.

So, if we have not managed to lose you at this stage, than means you are an ardent “IAS 39 to IFRS 9 Evolution Fan”.  The T-Shirt and button badge will be in the post to you; if you so wish!

So what was discussed on the 17th?  Well, both board’s representatives turned up, however only the IASB’s representative were there to try to make a decision.  This off course did not happen, hence the title of the post.

What was discussed: The retention of the IAS 39 measurement requirements for Financial Liabilities.  EXCEPT, I hear you ask?  Except for a proposed change to the fair value option to address the issue of ‘own credit risk.’

So a tentative decision was taken about financial liabilities to respond to the issue of how to recognise gains and losses arising from changes in an entity’s own credit risk.

Clear as mud then?  We’ll await the formal publication of the minutes of the meeting to try to make more sense of the world of IFRS 9 and Financial Instruments valuations.

Therefore, our reader scan clearly see the progression of unbundling the stated objectives of the trilogy in order to better (1) understand, (2) apply and (3) interpret pronouncements and regulations issued by the IASB and FASB.  We think more mud will be stirred in the bottom of this pond, before anyone will ever again see the fish and other animal life swimming underneath the surface….

…obviously there are more comments to follow.

The EconoCountant ©2010

Timeframes for IFRS 9 adoption

•February 16, 2010 • 1 Comment

The internet must be a marvellous thing!  The IASB published IFRS 9 Financial Instruments on 12 November 2009.  We ‘googled’ (hope that is a proper verb) “IFRS 9” this morning and found the following result:  about 3,070,000 for ifrs 9. (0.27 seconds).  Amazing result.  Moving to the Blogs search category there are about 84,395 for ifrs 9. (0.24 seconds) with theMarketSoul ©1999 – 2010 (our sister blog) appearing second on the list.  That is because the blog is posted via ‘blogspot’ and this one is published via ‘wordpress’, so we were only listed 9th, but still on page 1!

That’s enough of the self promotion stuff!

Today we address two issues in IFRS 9, namely the timeframes for adoption and defining the organisational or entity business model.  Below is the official time table from the November 2009 publication issued by the IASB (Project Summary and Feedback Statement):

Planned reform of financial instruments accounting

On page 4 of the report it clearly states:

Taking a phased approach has enabled us to provide entities with the opportunity to adopt the new requirements early for classification and measurement in 2009 year-end financial statements. Entities must apply the new requirements no later than for financial years beginning on or after 1 January 2013.

It is expected that IAS 39 will be replaced by the end of 2010, as indicated above in the time table.  At the moment IFRS 9 only deals with financial assets, and the further phases indicated in the above graphic will address financial liabilities, derecognition of financial instruments, impairment  and hedge accounting.  Therefore, by the end of 2010 we should be in a position to know exactly how to account for financial instruments in the future and entities can already start reporting on it with final adoption by 1 January 2013.  There will be transition arrangements and mechanism for reporting for early adopters and this will be addressed in future posts to this blog.

It is just worthwhile mentioning at this stage that the entire reason d’être for IAS 39 and now IFRS 9 was to converge international standards and to simplify the accounting treatment.  However, the FASB, the IASB’s counterpart in the USA has a different timetable for US GAAP convergence and the boards have expressed a concern at the risks this will impose for developing different requirements for the reporting on financial instruments.

Remember in a previous post we stated that there was a recognition that accounting for Fair Value in Financial Instruments was difficult (a) to understand, (b) apply and (c) interpret.  We should therefore be heading for a clearer principles-based approach, yet in their own admission we seem to be running towards greater risk (and therefore greater complexity).  It is interesting to note some of the dissenting voices concerns raised in a paper entitled:Reclassification of Financial Assets – Amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures”, stating that “Messrs Leisenring and Smith do not believe that amendments to standards should be made without any due process.

So is this an admission that the entire consultation process undertaken since October 2008 on IAS 39 has been flawed or that the result and outcome will be flawed because the IASB and FASB are not following a ‘due process’?

In the next article in this series we will be exploring the defining of the ‘business model’ of an entity to assist in classifying financial instrument recognition.

The EconoCountant ©2010

An update on the ‘Fair Value’ definition

•February 11, 2010 • Leave a Comment

Between 18 – 20 January 2010, the IASB and FASB met in London to discuss, amongst other things the following:

§ Financial crisis

  • Consolidation
  • Fair value measurement
  • Financial instruments: classification and measurement
  • Financial instruments: hedge accounting
  • Financial instruments with characteristics of equity

§ Financial statement presentation

§ Insurance contracts

§ Leases

§ Revenue recognition”.

The focus of this blog will be on the Fair Value measurement issue.

So, the search for a suitable definition continues (remember, this standard is already operational in the IFRS world) and the following has been decided:

“Definition of fair value

The boards tentatively decided:

• to retain the term ‘fair value’

• to define fair value as an exit price. The boards will discuss where that definition should be used in a future meeting when they address the scope of a converged fair value measurement standard.

Measuring fair value when markets become less active

The boards tentatively decided that the guidance for measuring fair value in markets that have become less active:

• pertains to when there has been a significant decline in the volume and level of activity for the asset or liability.

• focuses on whether an observed transaction price is orderly, not on the level of activity in a market.

The boards also tentatively decided that an entity should consider observable transaction prices unless there is evidence that the transaction is not orderly. If an entity does not have sufficient information to determine whether a transaction is orderly, it performs further analysis to measure fair value.”

So, to get our heads around the above jargon, let us attempt to clarify our interpretation of what it means:

  1. The phrase ‘Fair Value’ is here to stay!  No problem there
  2. Determine an exit price.  Exiting what? When? Where? How? In fairness it appears from the commentary as if this issue still requires some further work in the near future.
  3. When markets have become less active.  What would constitute a significant decline?  5%, 10%, 25%; we suppose it would be with reference to the original size of the market.  But if there were only 5 transaction in the last period, and this period there are only 4, does this 20% decline in activity levels count as a significant decline in volume?
  4. Orderly – here they appear to try to decouple the transaction flows from the size of the market; however
  5. Finally a large measure of judgement seems to be thrown in again as the entity has to determine whether a transaction is orderly or perform some further analysis to measure fair value.  Does this mean market to model again?

We will need to pick up on the further themes identified above, but not fully explained and elaborated on in this short post.

The EconoCountant ©2010

Reference material and further reading:

IFRS 9 is here! How did I miss it?

•February 6, 2010 • Leave a Comment

Yes, it is; and the press release was published back in November 2009.  So, there you have it, I took my eye off the accounting standards development radar screen and missed it.

This post makes reference to my earlier entries, see for example Comments from a lay economist on credit quake published in October 2009, and Asset bubbles: not just valuations but what and how we value published in January 2010; in which the current IAS 39 Financial Instruments: Recognition and Measurement was criticized.

In the IASB’s (International Accounting Standards Board) own words, in the preamble (Why we undertook this project) briefing to the IFRS 9 Financial Instruments documentation:

“Many users of financial statements and other interested parties have told us that the requirements in IAS 39 are difficult to understand, apply and interpret.  They have urged us to develop a new standard for the financial reporting for financial instruments that is principles-based and less complex”.

Their words, not mine.  [Lets repeat it, just for clarity:

Difficult to

(1) Understand

(2) Apply

(3) Interpret]

But it begs to ask the question:  Who are the ‘they’ referred to in the above paragraph?

The Harvard Business Review (“Fair Value Accounting for the financial crisis”, November 2009) offers a possible solution and explanation:

“But European politician have far more leverage over the International Accounting Standards Board than Congress has over the Financial Accounting Standards Board, its US counterpart.  Before a new IASB standard can go into effect in Europe, it must be ‘endorsed’ by three European bodies – the European Parliament, the European Commission, and the EU Council of Ministers.  Because of these three potential vetoes, the IASB is highly sensitive to threats from EU politicians to legislate their own accounting standards for European companies.”

Again, a quote I took directly from the Harvard Business Review, not my own words at all.

A further question the paragraph in the IASB’s documentation quoted above begs to be asked is this:

If the standard was so difficult to (1) understand, (2) apply and (3) interpret, why was it published and practitioners expected to implement it in the first place?

I thought that a ‘wide ranging consultation process’ was always adopted or, as in Sir David Tweedie’s words has “[benefiting] from unprecedented levels of consultation with stakeholders around the world, the IASB has made significant changes in its initial proposals to improve the standard, provide enhanced transparency and respond to stakeholder concerns”, only occurred in this round of the review of IAS 39?

“The new standard enhances the ability of investors and other users of financial information to understand the accounting of financial assets and reduces complexity – an objective endorsed by the Group of 20 leaders (G20) and other stakeholders internationally.”

Is it right then to return to my assertions made in October 2009 that the crisis was partly fueled by flawed International Accounting Standards?

The EconoCountant © 2010

Hello world! An EconoCountant has just landed!

•February 6, 2010 • 1 Comment

Idea Merchant is a qualified accountant (or so it states on his certificate he holds and maintains from his CCAB Chartered Institute).  He qualified in the last millennium, when accounting standards were still relatively simple, albeit not fully ‘harmonised’ by applying International Financial Reporting Standards.

He is a practitioner and keeps a keen eye on the developments, activities and pronouncements of the IASB and the FASB and therefore comments as necessary in order to promote ‘clarity of thought and interpretation’; or so he claims in any event…