Speech by SEC Staff:
Remarks before the 2010 AICPA National Conference on Current SEC and PCAOB Developments
Paul A. Beswick
Deputy Chief Accountant
U.S. Securities and Exchange Commission
December 6, 2010
The Securities and Exchange Commission, as a matter of policy, disclaims responsibility for any private publication or statement by any of its employees. The views expressed herein are those of the author and do not necessarily reflect those of the Commission or of the author's colleagues upon the staff of the Commission.
I would like to thank the AICPA for providing me with the opportunity to speak at the AICPA National Conference on Current SEC and PCAOB Developments. (Although, I have often wondered why FASB isn't included in the title, as we will spend a significant amount of time over the next three days discussing FASB standards.)
In considering what to say, I have previously taken the approach that I should try to be informative, but also should follow one of the principal precepts of medical ethics: do no harm. However, as a result of the efforts of one of my staff last year, I also have to consider how many tweets get posted while I am speaking. So in thinking about topics, I was reminded of when three of my friends and I were sitting in a bar and were considering the following question: Is auto racing a sport? Sorry, I guess that was last year's approach. Therefore, I thought I would spend the rest of my time talking about IFRS, Consolidation Accounting, and SEC Staff Speeches.
On October 29th, the staff issued a progress report on the status of our efforts in executing the Work Plan. Obviously there are a number of areas where the staff has not finalized our efforts. I believe it was important in certain areas that we wait until the collection of information, the analysis, and review is more complete before providing preliminary or detailed observations. As a result, in many areas our policy-type observations to date have been limited. While we considered giving you a status update for each specific area in the October update, we decided that using bar charts to illustrate our progress seemed a bit odd.
I would like to discuss the preliminary observations regarding various methods jurisdictions utilize to incorporate IFRS into their capital markets a little more. I personally found it particularly informative that very few jurisdictions were looking directly to the IASB as the mechanism for providing authoritative support for the standards followed by a jurisdiction. In talking with our foreign regulatory counterparts, other national standard setters, and others, the reasons are varied — from addressing legal requirements to the desire to maintain some level of national sovereignty. To give you an example, India is set to move to IFRS in 2011. However, they describe their approach as a convergence approach to IFRS and have indicated that they may not fully adopt IFRS if they believe an exception is warranted. This approach appears to be shared by other jurisdictions and leads to a number of thoughtful questions for the U.S. to consider for its method of incorporation.
One of the questions I frequently get asked when I am out speaking is what do I think the model looks like if the Commission decides to incorporate IFRS into the U.S. capital markets for domestic companies. Let me start with the following observation: While I am a supporter of the objective of a single set of high-quality accounting standards in concept, I have not reached a conclusion on whether, and how, the U.S. capital markets should move to IFRS. Before I lay out some of my views, let me also reiterate that these are just my current views and these views will continue to evolve as our efforts on the Work Plan continue.
So what would be a reasonable approach for the U.S.? In our October update we highlighted that the majority of jurisdictions are following either a convergence or an endorsement approach. In my opinion, if the U.S. were to move to IFRS, somewhere in between could be the right approach. I will call it a "condorsement" approach. Yes, I admit I just made up a word. And by the way, the patent is pending as we speak.
So how would this approach work? Well, to begin, U.S. GAAP would continue to exist. The IASB and the FASB would finish the major projects in their MOU. The FASB would not begin work on any major new projects in the normal course. Rather, a new set of priorities would be established where the FASB would work to converge existing U.S. GAAP to IFRS over a period of time for standards that are not on the IASB's agenda. This is not meant to be an MOU2 but rather would entail making sure that, on a standard by standard basis, existing IFRS standards are suitable for our capital markets.
At the same time, the FASB would have a process where they would consider new standards issued by the IASB for incorporation into U.S. GAAP and then integrate such standards into the U.S. codification. The ideal would be to incorporate such standards as issued by the IASB without modification. However, criteria would need to be established for FASB's consideration of endorsing or incorporating standards — for example whether incorporating a given standard is in the interests of U.S. investors or the U.S. capital markets. Sir David Tweedie has indicated in speeches that the IASB has already started thinking about their agenda after the completion of the MOU. I would expect the FASB to participate in the IFRS standard setting process much like other jurisdictions do. At the same time, I would expect that the IASB would take seriously the input of the U.S. in their deliberations.
So why consider this approach? I believe this approach is worthy of consideration and may work in the U.S. for various reasons, including the depth of the U.S. markets; the quality of our existing standards;, and, quite frankly, the existing consistency at the objectives level between many areas in U.S. GAAP and IFRS.
It is clear to me that this is in fact a method of incorporating a single set of standards into the U.S. market. But it also acknowledges our responsibility to the U.S. capital markets and provides mechanisms to ensure that the standards must be high quality prior to their incorporation. If new standards of sufficiently high quality were incorporated into U.S. GAAP, the process of creating new differences would stop. Further differences would be eliminated one by one as new high quality global solutions are achieved.
It is important to note that the calculus of moving using a "big bang" date from existing standards to an alternative set of accounting standards presents a different set of costs and benefits, and different challenges for the U.S. as compared to other jurisdictions. While our evaluation of the differences between U.S. GAAP and IFRS is ongoing, it seems clear that, in a number of major areas, the two sets of standards are consistent at the objectives level. Take, for example, PP&E, Share-Based Payments, or even Income Taxes. While I'm not at all suggesting that there are not differences, when the two bodies of standards are compared, the differences appear in many cases to be in the method of application as opposed to the objective of the standards. Requiring retroactive adoption, or even requiring new systems to be put in place prospectively on a big bang adoption date is something that requires serious consideration as to whether they're necessary. This is particularly true where the IASB may be considering modifications to their existing standards to avoid the imposition of a "two-step" change.
Further, in the U.S. we have such a wide spectrum of companies that are currently using U.S. GAAP. The cost-benefit consideration is very different for many of these companies. For example, a large Fortune 50 company has different economic considerations (both as to costs and potential benefits) as compared to a small public company in Iowa. We need to be act very deliberatively and understand fully the benefits before we create the potential for such a significant burden on U.S. companies; particularly smaller public companies and private companies.
This approach may be appealing to some as it seems to provide for a way forward in achieving the broader objective, maintains our vital interest in the U.S. capital markets, and appears to do so in a way that would manage the burden of achieving the objective to an acceptable level. If the change is gradual, and if the smaller companies can learn from the larger companies, then the cost of incorporating a global set of standards should be decreased.
However, there are a number of questions that would need to be answered under such an approach. One of the most significant questions that needs to be considered is "Should the largest companies be required or allowed to move to IFRS prior to the FASB completing its condorsement efforts?"
In any case let me reiterate that all I have done is I've outlined an idea. Don't shoot me as it is just that, an idea. But I hope it demonstrates that we are serious in considering how to achieve the broad objective, to do so in a way that maintains the protections to U.S. investors we have been afforded though our standard setting processes to date, and to do so in a way that minimizes the cost ultimately born by the U.S. investing public.
So why shouldn't we just commit right now and move? As we noted in the progress report there are still some significant areas we are considering, including the quality of the standards, and the governance and funding of the IASB. In the meantime there are some potential pitfalls that remain before the Commission makes its decision.
First and foremost, the efforts of the IASB and the FASB on the MOU projects need to result in high-quality accounting standards. If the efforts focus on meeting deadlines as opposed to producing high-quality accounting standards, it would be very difficult to see how we will end up with unified standards. I hope the Boards take the time they need to get the standards right and, if that means taking time past June 2011, I would be very supportive. Recently I was talking with an IASB Board member on the timing for completion of the MOU projects. The Board member noted that when they explain to their grandkids what they did while serving on the IASB, they hoped they could say they issued high-quality accounting standards rather than saying they issued an accounting standard by a specific date.
Another potential pitfall involves some of the sales literature and advertising I have recently observed by the larger firms that market their ability to help with the IFRS transition. I have seen advertising that creates the impression that the process will be challenging and painful. The implication is a company will not be able to convert to IFRS without outside help. I will note this type of tactic, as some have referred to them as "scare tactics", not only has the potential to put the profession in a bad light, they also reinforce some myths on the conversion to IFRS and could potentially hinder our ability to incorporate IFRS. Let's me point out that the Commission has not yet made a decision on whether to incorporate nor have there been any decisions on the best method to do so. In the staff's efforts to complete the Work Plan, we intend to consider ways to lessen the burden on converting to IFRS while at the same time protecting the interests of investors.
Turning specifically to U.S. GAAP, in June 2009, the FASB issued Statement 167 to address inadequacies with the accounting for how a company determines whether an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The FASB and the IASB continue to address matters surrounding consolidation accounting more broadly and have some difficult decisions to make regarding the treatment of voting entities and how to consider asset managers and similar structures. I am hopeful that the two Boards will be able to arrive at a single consolidation model; however, I understand the difficulty that exists in developing a comprehensive solution.
I would like to spend a couple of minutes talking about our experiences in OCA with the consolidation model for variable interest entities in ASC Topic 810, or Statement 167 if you like. The FASB has taken a more principles based approach that requires qualitative-based judgments in determining whether consolidation of a variable interest entity is required. Simply put, the principle is that a reporting entity has a controlling financial interest in an entity if it has both the power to direct the activities of the entities and rights/obligations that potentially could be significant. I think this is important to highlight because during this first year of adoption, we have encountered those who were hanging on to the quantitative approach in FIN 46(R), rather than focusing on the qualitative model of Statement 167.
While overall I think the implementation of Statement 167 has gone well, I thought I would share some of my thoughts about how to apply the principle in practice. First regarding power, we have been asked about the nature of the activities and how a registrant should consider these activities when evaluating who has power over the entity. One piece of advice I have is: when considering the activities that most significantly impact economic performance, it may not be necessary to conclude on which single activity most significantly affects economic performance but rather it may be appropriate to consider a group of activities. This will obviously depend on the structure of the entity and the purpose and design of the entity.
The other piece of advice I have regarding the evaluation of power concerns the nature of the rights that should be considered when determining who has power over those activities. The standard requires that only rights that are participating rights should be considered — and not those that are protective rights — when evaluating which party has power over the activities of the entity. The standard provides some examples of protective rights, and I would encourage registrants to consider not only those examples, but also the other examples that exist in the accounting literature when making this evaluation.
Now I would like to turn to the second part of the evaluation of control; by that I mean the requirement to identify whether a party has an obligation to absorb losses or a right to receive benefits that could potentially be significant to the variable interest entity.
We understand that some would prefer to determine whether their rights or obligations could potentially be significant to the variable interest entity based solely on a quantitative approach. However, the model doesn't accommodate that because the model is based on making a determination that must incorporate and weigh the context of the entity's purpose and design. So, questions about whether a party's rights or obligations are significant to the entity are best resolved through a qualitative framework that weighs the particular facts and circumstances of the party's rights and obligations.
Contrary to popular belief, the staff has not developed bright lines that a registrant has to satisfy when applying this aspect of the standard. It would not promote the objectives of the standard to do so.
I understand that this evaluation can be challenging in some arrangements. For example, we have heard about challenges in evaluating whether fee arrangement for a decision maker could potentially be significant, particularly where some portion of the fee is senior to most or all of the entity's other obligations and the remaining portion is subordinated. I would encourage registrants to consider all the facts and circumstances when making this determination and if you are having particular difficulty, please feel free to consult with the staff.
Later today one of the staff in OCA will provide some examples of fact patterns we have considered in evaluating whether to consolidate a variable interest entity and provide some insight into how we have thought about them.
SEC Staff Speeches
Speaking of speeches, I would like to turn to the last topic I had intended to discuss this morning. I am at times amused when I am talking with an individual and the topic of speeches comes up. In one instance, the individual asked if their speech was still being enforced more than 15 years after it was given. After a small chuckle on my part, I came to realize they were serious. The reason I had chuckled was that GAAP had changed three times since the speech was given and the principle in the accounting standard had also changed as to render the speech topic irrelevant. I informed the individual that the staff thinking on the issue had in fact changed and politely excused myself.
In light of this, I thought I would explain my view on staff speeches as my predecessors have also done in the past. In the next session you will hear from staff in my office on various accounting issues. When we develop the speech topics, we identify current issues that we have addressed in practice and explain how we considered the issue. Each of these areas represents some of the most challenging areas of accounting that individuals are currently dealing within practice. The objective of the speeches is not to provide an answer, but rather a thought process to an issue. Many of the scenarios are complex and depend on the individual facts and circumstances. All of the relevant facts and circumstances cannot fully be described within the context of a speech. Therefore, I would take the speeches as a data point providing you with insight into how we think existing GAAP should have been considered in a specific instance, but not determinative. I hope they prompt you to think about the issue, consider whether it is appropriate to consult and above all results in greater transparency in financial reporting.
Once again thank you for the opportunity to speak this morning. We will have time for questions later in the day. And yes, I believe auto racing is a sport.