Johnson's Mark Nelson speaks to Reuters on changes to FASB standards & rules

The notion of investors as willing and educated adopters of changes to FASB reporting standards is discussed in article

Reported by Thompson Reuters, Monday, Nov. 22

Changes to Revenue Guidance Will Proceed, But at What Cost to Investors?

The FASB and IASB want to finalize the draft guidance in proposed ASU No. 1820-100 and ED No. 2010-6 in the first half of 2011. To do that, they have to stick to a busy schedule and contend with issues that are bound to complicate their efforts.

The FASB and IASB are scheduled to get an update from their research staffs regarding the work that remains on their revenue recognition project in December.

By January, the two boards will begin work in earnest on completing a final standard.

The resumption of the discussions in the new year are intended to keep the boards on schedule to meeting a June deadline for completing a final standard in both U.S. GAAP and IFRS.

But in getting to that point, the boards have to contend with a lack of support from investors, analysts, and lenders—the very audience for which financial statements are published.

“I have some real concerns that we’re making a very fundamental change in the top line that affects all companies, and potentially, we’ll have minimal user support for that,” said FASB member Lawrence Smith said during a November 17, 2010, joint meeting of the two standard-setters in Norwalk, CT.

Smith voiced his doubt during a brief presentation from the research staffs of the two boards that outlined the schedule for completing the project during the next seven months.

In recent months, the boards have engaged in an extensive outreach effort to garner feedback from public companies through the standard comment letter process; roundtables with accountants, auditors, and regulators; and one-on-one meetings with analysts and investors. The outreach parallels other efforts by the FASB and IASB on projects covered by the Memorandum of Understanding (MOU), the document that defines the process for converging U.S. accounting standards with the international board’s literature.

During several meetings, analysts who cover telecommunications companies or construction companies have given mixed views, said Kenneth Bement, the revenue recognition project manager.

“There were users… that preferred the current accounting,” Bement said. “That is a challenge with this project. It covers so many industries, and users and analysts often specialize by industry. There is a lot of support for continuing with the status quo.”

“One thing we plan on doing is looking very carefully at any potential changes to each particular industry,” Bement said. “To the extent that there is significant change to industry practice, we do plan on highlighting that to the boards and doing user outreach to make sure that it is not a change that slips under the radar but is a deliberate decision by the boards with sound reasoning.”

Smith and FASB Acting Chairman Leslie Seidman said the outreach to investors would be important in gaining support for the proposed changes.

“That is a major part of the outreach to users, the educational effort, because they don’t really understand it,” Smith said.

No one at the meeting specified what investors may want to see kept intact in the existing guidance.

But it is fairly common for analysts on Wall Street and fund managers to take public company financials and tweak them based upon their knowledge of a given industry.

“You could argue that investors have adapted the existing guidance, and they have learned to deal with what changes are there,” Mark Nelson, Landew Professor of Accounting at Cornell University's Johnson School of Management in Ithaca, NY, said in a phone interview. “Now they have to get accustomed to a new regime. It isn’t necessarily that the current rules are great, but investors are accustomed to them.”

“In many instances the investment community is more concerned about consistency within a company’s accounting, so analysts can look at trends over time,” said Edward Swanson, Durst Professor of Accounting at Texas A&M’s Mays School of Business in College Station.

Some analysts may also have a vested interested in U.S. GAAP continuing with many disparate standards for revenue recognition. Inconsistencies in financial statements can help analysts find bargains the rest of the market has overlooked.

“To the extent that the accounting has a weakness, it increases the value of the product an analyst provides by interpreting a company’s performance,” Swanson said.

As the FASB and IASB continue working on the standard, they are expected to keep talking to public and private companies and auditors.

The companies and their auditors have been concerned that the proposals released in June didn’t give enough detail on two fundamental issues—the idea of control and the manner in which some customer contracts are separated into component parts and the revenue is apportioned among the several pieces.

The comment periods for the FASB's proposed Accounting Standards Update (ASU) No. 1820-100, Revenue Recognition (Topic 605): Revenue from Contracts with Customers, and the IASB's Exposure Draft (ED) No. 2010-6, Revenue from Contracts with Customers, ended in October.

Some accountants said “the exposure draft was not sufficiently clear to help entities consistently determine when goods and services have transferred to the customer,” Glenn Brady, a senior technical manager with the IASB research staff, said in discussing the control issue.

Control addresses the point at which a seller of a product or service surrenders it to the buyer and can then record the revenue on an income statement.

“They requested a bit more clarification about when we can recognize control for construction contracts and for service contracts where there is no tangible underlying asset,” Brady said.

Businesses and auditors also want more detail on how to account for long-term or complex construction and service contracts that are broken into several pieces and produce revenue that is recorded over a series of quarters or years.

“There were concerns that the proposed guidance might be impractical and might not result in useful information,” Brady said.

Bement said the project team intends to keep testing the accounting model as it is refined to address the issues raised.

The testing may continue until the final standard is ready for release.

“One thing that makes the project unique is the breadth of its scope,” Bement said. “Certainly there is the risk of unintended consequences. As we go through redeliberations, that is something the boards will have to consider and decide, whether to test and release for external review a draft of the final standard.”

There is no comment.