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U.S. Securities and Exchange Commission

Speech by SEC Staff:
The Year of the Accountant

Remarks by

Lynn E. Turner

Chief Accountant,
U.S. Securities and Exchange Commission

At the SEC Institute, New York, New York

June 14 , 1999

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 Mr. Turner and do not necessarily reflect the views of the Commission or of the other members of the Commission's staff.

I have heard in a number of presentations that 1999 has been labeled as the "Year of the Accountant" at the Commission. Certainly there have been a number of new and exciting developments affecting the accounting profession in 1998 that have carried over into 1999. The focus on auditor's independence and professionalism, the earnings management initiative, and perhaps most importantly international accounting standards, are all significant issues to which the SEC and its staff are devoting substantial attention in 1999.

Dark Clouds on the Horizon

Let me begin with just a few comments about the issue of professionalism as it relates to those of us in the accounting profession. This includes CFO's, controllers and their staff and independent auditors.

When we commenced the earnings management initiative in the fall of last year, one of the Commission staff's concerns was a disturbing trend in financial reporting that if left unchecked could result in a loss of investor confidence in the quality of our markets. It had been observed too often, that certain people were pushing the envelope with accounting gimmickry that no longer reflected the reality of the businesses they were managing. Instead of managing the business and letting the numbers reflect the results of those efforts, the numbers were being managed to reflect a business that did not exist. And all of this was at the expense of the investors.

Now, some people have said that this is all much ado about nothing. That in reality the staff is blowing everything out of proportion and that the action plan outlined by Chairman Levitt is not necessary.

In my opinion that couldn't be further from the truth. Let me mention some simple facts using plain english. In the twelve months leading up to the Chairman's speech, the press had published articles with titles such as "Pick a Number, Any Number", "Speaking of Earnings - Why Managing Expectations often doesn't Work", "Accounting Abracadabra", "The Auditor's are Always the Last to Know, "10 Ways Numbers Lie", "For Better Number Earnings Try Bigger Writeoffs", and "Do Big Writeoffs Artificially Inflate Earnings?" Could it be the press was on to something? Indeed, in the first quarter of 1998, corporate write-offs, as a percentage of the reported earnings per share of the S&P's Fortune 500 stock index, surged to 11 percent of reported earnings, their highest level in the past 10 years. The Chairman of the Clarion Group, a fund manager, noted in the WSJ in June 1998 that, "[t]he quality of earnings in this market is bad and nobody cares."

Then there has been the list of companies that have publicly reported accounting problems, including Cendant, Livent, Sunbeam, Waste Management, W.R. Grace, Oxford Health Plans, Donnkenny Apparel Co., McKesson HBOC, Sensormatic and the list goes on. More alarming than the list itself, was a recent CNBC TV report on these reported accounting problems. In that report it noted that investors had lost $32 billion in certain of these alleged financial frauds. $32 billion in losses to investors, many of whom are working moms, blue collar laborers and average Joes in the work place, depending on these investments for their retirement.

In addition, a number of respected businesses have raised concerns over the quality of financial reporting and the improper managing of the numbers. One of the more recognized individuals is Warren Buffet who cited specific cases of abusive financial reporting in Berkshire Hathaway's 1998 annual report. He reported that the 1997 earnings of the fortune 500 companies totaled $324 billion dollars. He compared this to reports by R.G. Associates of Baltimore that the total charges for items such as asset writedowns, restructurings, and IPR&D charges (Website www.aaopub.com/clock/charge98.htm) amounted to a staggering $86.3 billion dollars in 1998.

Finally, during 1998, both Business Week and CFO Magazine reported on surveys by CFOs where a significant number of the respondents reported they had been asked to improperly change results. The surveys noted that a number of the respondents had succumbed to such pressures. However, as a former CFO, I am proud to note that, fortunately, despite the pressures and stress a CFO may face, many of the respondents did not improperly change the numbers.

So let me summarize, prior to the Chairman's speech the press already was focused on the issue, numerous financial frauds costing investors staggering sums were occurring, members of the business community were concerned, and financial management was under pressure to "deliver the numbers."

A Fundamental Cultural Change

As a result, one of the most important, if not the most important change Chairman Levitt called for in his speech, was a fundamental change in culture. As Lee Iacocca said in his book Talking Straight, "Symbols mean nothing if the values aren't there." Professionals involved with financial reporting can talk a good story, but everyone needs to walk the talk.

That means CFOs and their staff need to take responsibility for establishing high quality financial reporting and avoiding the lowest common denominator. I know the CFOs can deliver given their tremendous success in recent years in leading continuous change within their organizations and businesses. Auditors and the accounting profession need to live up to the expectation that Congress set for them in the Securities Act of 1933, which established their special role in ensuring transparent financial reporting through independent audits. And finally, as the third leg of a three legged stool, audit committees need to get involved and fulfill the oversight responsibilities owed to those who have entrusted them with this function, the investing public. And it is when all three legs of the stool are working together as a team, continuously improving and totally committed to excellence in financial reporting, that we instill investor confidence in the US capital markets.

But sometimes we think we are committed when we really aren't. Warren Buffet's latest annual report for Berkshire Hathaway highlights this for those of us in business. In fact, this reminds me of a story from back on the farm. A chicken and a pig were talking about commitment. The chicken said, "I'm committed to giving eggs every morning." The pig said, "Giving eggs isn't commitment its participation. Giving ham is total commitment." So I just ask you, what's it going to be, eggs or ham?

Earnings Management Initiatives

I do think most people today are delivering the ham. My experience as both a partner in one of the Big Six international accounting firms, and as a CFO, lead me to believe the vast majority of those involved with financial reporting have a high degree of integrity and honesty. I also believe this is a major reason why the financial community response to Chairman Levitt's speech regarding earnings management in September has been tremendous. Business leaders, attorneys, academics, analysts, CEOs of the major accounting firms, and the AICPA have all commended the Chairman for undertaking this bold initiative.

We at the SEC must in turn commend those in business and the accounting profession for their tremendous efforts and accomplishments in just the eight months since the Chairman's speech. Let me summarize for you a few of those accomplishments.

Audit Committees

The NYSE and NASD formed a blue ribbon committee comprised of the chairs of the exchanges, leading CFOs who are members of the FEI, managing partners from two of the five largest accounting firms, and executives of an institutional investor and of the business community.

In February, 1999, this panel proposed ten outstanding recommendations and some well thought out and invaluable best practices to the business community, accounting profession, regulators, and the exchanges. These recommendations are designed to strengthen the role and performance of audit committees. Their recommendations include: requiring audit committees to be comprised of independent board members who have a sufficient level of financial knowledge, a call for establishing a committee charter that sets forth the responsibilities of the audit committee, ongoing robust discussions between the audit committee and auditors regarding the auditor's independence, and the need for discussions between financial management, the audit committee and auditors regarding the quality of the registrant's financial reporting. I believe the SEC staff will consider carefully these recommendations and make appropriate recommendations to the full Commission.

One concern that has been raised regarding these recommendations is whether litigation will result from the implementation of the recommendations of the Blue Ribbon Committee, particularly the recommendation for disclosure of whether the audit committee believes that the financial statements are fairly presented in conformity with generally accepted accounting principles in all material respects. The Commission staff still is reviewing the Committee's recommendations and the Commission would review public comments before adopting a rule, but let me share some of my preliminary thoughts.

Although I am not a lawyer, I have discussed the possibility of increased litigation with several attorneys both inside and outside the SEC. The consensus view is that if this recommendation is adopted as written it should help rather than hinder efforts to protect audit committees and boards from unwarranted litigation.

First, the recommendation stresses that the statement regarding the audit committee's belief about whether the financial statements are in conformity with GAAP is made "in reliance on the review and discussions conducted with management and the outside auditors." The Committee's report emphasizes the point that the board will be relying on its advisers by noting, "The Committee appreciates the impracticality of having the audit committee do more than rely upon the information it receives, questions, and assesses in making this disclosure."

As a CFO, I was paid to prepare financial statements that conformed with GAAP. As an auditor, I was paid to examine the work of others and to render an opinion on whether the financial statements they prepared conformed with GAAP. In both cases, I gave expert accounting advice and counsel to audit committees and boards of directors. I am told that as legal matter outside directors on those audit committees and boards had a right to rely on my advice, and this recommendation would not change that. The express statement in the disclosure that the audit committee's belief is based on the discussions they have had with experts in accounting matters should reaffirm the working role of management and auditors and the oversight role of the audit committee.

Second, some believe that the additional discussions inherent in the recommendation will facilitate the application of the "business judgment rule" to protect audit committee members from liability. For example, Chancellor Allen, writing for the Delaware Chancery in the Caremark case, discussed the relationship between the business judgment rule and the directors' duty to attempt to assure that a good corporate information and reporting process exists. 1 His opinion states,

"....whether a judge or jury considering the matter after the fact believes a decision [by directors is] substantively wrong, of degrees of wrong extending through stupid' to egregious' or irrational', provides no ground for director liability, so long as the court determines that the process employed was either rational or employed in a good faith effort to advance corporate interests... Thus, the business judgment rule is process oriented and informed by a deep respect for all good faith board decisions." 2

A corporate process that includes the discussions recommended by the Committee, and the use of those discussions by the audit committee to form a belief about the financial statements, would appear to be in line with the rational and good faith effort to be informed and to exercise judgment that was envisioned by Chancellor Allen. 3 In short, the better informed the audit committee members become, the more likely that the business judgment rule will apply and that decisions by the audit committee about the financial statements and other matters will be protected.

Third, the recommendation states that the SEC should adopt a "safe harbor" for this disclosure. The safe harbor envisioned by the Committee would resemble the safe harbor in Item 402 of Regulation S-K for compensation committee reports. The purpose of the safe harbor is to allay any fears that the disclosure would trigger new legal standards under federal of state laws. The staff seriously is considering what kind of safe harbor might be appropriate.

Fourth, the disclosure of the audit committee's belief that the financial statements conform with GAAP is considered by many attorneys to be no more than stating expressly what is implied when the members of the board sign the Form 10-K and other documents filed with the Commission. By signing documents filed with the Commission, directors are indicating that they believe the information in that filing (including the financial statements) is accurate and complete. The Committee's report states that its recommended disclosure is consistent with this implied representation. The report states, "A formal disclosure by the audit committee as to its view of the company's financial statements that is consistent with the board's existing duty to sign the Form 10-K, will serve to raise public awareness of the importance of the audit committee's role as well as underscore its importance for audit committee members."

And finally, some believe that the adoption of this recommendation will lead to increased attention being paid to the preparation of financial statements. They believe that this not only may result in better information being included in those statements and provided to investors, but also may be convincing evidence to a jury that the financial statements have been carefully prepared.

For example, as most of you know, the main part of the recommendation – for the audit committee to discuss the quality of the accounting principles and judgments used in preparing the financial statements with management and auditors – comes from one of the recommendations of the Advisory Panel on Auditor Independence, also known as the Kirk Panel. The Kirk Panel was formed in 1994 by the Public Oversight Board, or POB, to look into ways to enhance the independence and objectivity of auditing firms. Some felt that implementation of this recommendation of the Kirk Panel would increase the exposure of board members to litigation. In response, the POB, in its report entitled "Directors, Management, and Auditors: Allies in Protecting Shareholder Interests," stated,

"The POB does not believe this will be a likely outcome. First, the Procedures recommended will reduce the possibility that the financial statements are in fact misleading, thus reducing the danger of finding directors at fault. Second, the additional steps taken by board members should be persuasive in convincing courts and juries that the financial statements were prepared with care and that every measure was taken to avoid the statements being misleading. In time, as the increased care becomes apparent, plaintiffs' attorneys should be less willing to undertake the risks involved in making claims that financial statements were faulty."

In short, based on my discussions with lawyers, and on my experiences as a CFO and auditor, I believe that adoption of a rule like the Committee recommended should not increase audit committee members' exposure to litigation because:

  • The disclosure expressly will state that the audit committee members, informing their belief about the financial statements, are relying on the review and discussions conducted with management and the auditors,

  • Those discussions may facilitate application of the business judgment rule,

  • The recommendation includes the adoption of a safe harbor,

  • The disclosure is consistent with the implied representations that currently are made when board members sign Forms 10-K, and

  • The additional discussions and steps performed by the audit committee should reduce the likelihood of the financial statements being misleading and should be useful in convincing juries and courts that every precaution was taken to prepare reliable financial statements.

Obviously, this is not an all-inclusive list of arguments supporting the adoption of the disclosure. And I am certain that as part of the comment process we will hear many equally valid and honest views that are counter to those I have mentioned.

The only statement that I can make with certainty today is that the staff recognizes that this is a serious issue and that, if the Commission publishes the Committee's recommendation for public comment, we will read your letters carefully.

International Accounting Standards

Let me switch briefly to another more global accounting topic that will affect us significantly in the future. That is the issue of international globalization of the world's capital markets and the effect of this trend on financial reporting and auditing.

The SEC's involvement in international accounting standards has been largely through the International Organization of Securities Commissions, or IOSCO. IOSCO has looked to the efforts of an existing private sector group, the International Accounting Standards Committee (IASC). In order to give you a sense of where we are – and how we got there – let me give you a brief history of this project.

  • In 1994, IOSCO reviewed the existing IASC standards and identified those that needed to be improved before IOSCO would consider endorsing those standards for use in cross-border offerings.

  • In July 1995, IOSCO and the IASC agreed on a core standards work plan, and in March 1996, the IASC announced an intention to try to complete that plan in 1998.

  • In April 1996, the Commission released a statement in support of the efforts of IOSCO and IASC. That statement articulated the key elements that will guide the SEC's assessment of the acceptability of the IASC core standards. Specifically, the Commission will consider whether the standards:

    • Constitute a comprehensive basis of accounting;

    • Are a high quality – that is, whether they result in transparency and comparability and provide for full disclosure; and

    • Can be and will be rigorously interpreted and applied.

The core standards work program identified 12 major projects, some of which involved more than one standard. In December 1998 the IASC approved the substance of the last major project in the work program, a standard on financial instrument recognition and measurement. In 1999, IOSCO and the SEC began their assessment of the completed core standards, while the IASC is working to finish two clean-up projects that remain in the core standards "to do" list.

As part of its work on the core standards project, IOSCO, as well as individual members, have been providing comments on each of the documents published by the IASC. The objective has been to provide input into the standards setting process at an early stage, rather than waiting to raise these issues when the core standards have been completed by the IASC.

Now that the main components of the core standards are completed, IOSCO will assess the status of each of the issues originally identified, as well as the standards subsequently issued by the IASC, to determine how these concerns have been addressed.

Assessment by the SEC staff is expected to overlap with and build on the IOSCO assessment.

Now let me walk through possible SEC responses.

SEC Action

The SEC currently requires foreign private issuers registered with the Commission to provide financial statements prepared in accordance with or reconciled to U.S. GAAP.

If, after assessment of the completed core standards, the SEC staff concludes that the current reconciliation requirements should be reduced or removed, the staff will need to bring a rule proposal to the Commission to amend the current filing requirements for foreign private issuers.

The Commission then would publish proposed amendments for public comment. The staff would analyze the comments received and develop final recommendations for the Commission, which then would be issued, if approved by the Commission, in an adopting release.

This procedure is mandated by U.S. law and applies to any SEC rules or regulations.

One step that is being planned, is a concept release to seek public input regarding some of the key issues that have been identified to date. Let me talk for a few moments about some of those issues.

When the Commission considers changes to its accounting and disclosure requirements, it must evaluate the impact of potential changes on capital formation, including the possible impact on the cost of capital for domestic companies and, critically, on investor protection. These basic concerns helped shape the three criteria for assessment of the completed standards identified in the SEC's April 1996 press release.

Some of the issues that will have to be considered in the SEC's assessment process include:

  • Supporting Infrastructure: Are IASC standards adequately supported so that they can be rigorously interpreted and applied?

  • Transition Issues: How should be deal with historical financial statements that apply "unimproved" IASC standards?

  • Interpretive and Application Issues: Will the IASC's focus on articulation of principles rather than application guidance create issues?

I'd like to focus today on the infrastructure issue. For a discussion of the other points, let me refer you to a Report to Congress issued by the SEC in October 1997, which addresses progress with harmonization of international accounting standards, and discusses these points in some detail. It is available on the SEC website. 4


High quality financial reporting in the United States is not just a product of high quality accounting standards. It also is dependent upon a supporting infrastructure that works to ensure that these standards are interpreted and applied in a rigorous fashion, and that issues and problems are identified and resolved rapidly. This infrastructure includes:

  • High quality auditing standards,

  • Strong audit firms with rational quality controls,

  • Profession-wide quality controls for the audit profession,

  • SEC oversight of standard setting, and

  • SEC involvement in interpretation and application through the Division of Corporation Finance review and comment process.

IASC standards are a relatively new product, many are new and have not been implemented, and there is no single group that has ownership – and responsibility – for building up the necessary infrastructure. Questions we are trying to answer include:

  • Whether preparers and auditors (and regulators) have enough training in, and experience with, IASC standards to work effectively with them.

  • Whether the standards are capable of being rigorously interpreted and applied – an issue that will be addressed, in part, by the technical assessment that IOSCO is undertaking currently.

  • Whether preparers and auditors will follow the principles and spirit of IASC standards, or try to justify diverging national practices within the IASC framework. On this point, it will be critical to see how the 16 standards that have been developed or substantially rewritten during the core standards project are applied. The IASC has tried to develop high quality standards, eliminating both explicit and implicit options wherever possible. Will financial managers and auditors live up to that challenge?

  • Whether there are auditing, quality control and auditor independence standards that will result in high quality audits on a worldwide basis. As you are probably aware, the World Bank as a user of financial statements, appropriately has raised concerns regarding this issue.

These are not easy issues, and that's why I expect the assessment process to be time consuming and thorough. Capital markets - - especially ones that are as successful as those in the United States – are not something you experiment with lightly. However, we can't let our markets be left behind by ignoring the pressures to harmonize requirements in many different areas. Instead, we must work to ensure that harmonization is accomplished at the highest quality level, and not based on a lowest common denominator.

Let me now switch our discussion to a few domestic "Hot Topics" that are the focus of the staff in their review of registrant filings.

Revenue Recognition

As one analyst summed it up, "the number of reported instances of companies improperly booking revenues has become an embarrassment to all of the accounting profession." A substantial majority of our accounting related enforcement cases involve revenue recognition. It seems as if all too often we are seeing instances of revenue recognized improperly when:

  • Delivery of the product to the end user's site has not occurred.

  • Agreements have not yet been accepted and executed by the customer.

  • The seller has to complete remaining obligations, such as installation or training.

  • The customer unilaterally can terminate or cancel the agreement.

  • A year for accounting purposes has been "extended" beyond 365 days.

  • "Just in time" arrangements exist, with FOB delivery terms, and revenue is recognized prior to arrival at the delivery destination.

  • Up front fees are recognized immediately upon receipt notwithstanding an agreement to provide services, discounts or products during an ensuing membership period.

In general, the staff has taken the position that the following criteria need to be met in order for revenue to be recognized:

  • Persuasive evidence of an agreement must exist. That means that if the agreement is not completed until the first few days of the next quarter, revenue should be deferred until it is completed, even if the product was shipped prior to quarter end.

  • Delivery must have occurred. The staff can be expected to challenge bill and hold arrangements that do not meet all of the criteria the Commission has set forth in its various enforcement releases on this issue. In addition, shipments to third party warehouses typically will raise questions as to whether revenue recognition is appropriate.

  • Collectibility of the receivable must be reasonably assured.

  • If the terms of the product sale provide for customer returns, then the vendor must be able to make reasonable and reliable estimates of product returns. This includes being able to factor in considerations for issues as channel stuffing, technological obsolescence, and changes in product lines.

The staff has seen transactions that are in substance consignment sales. Registrants and their auditors should scrutinize closely transactions that do not result in a transfer of the risks and rewards of ownership of the product to the customer, to determine if recognition of revenue is appropriate.

The staff also believes that revenues from service transactions should be recognized as the services are provided to the customer. Recognition of nonrefundable upfront fees for services should be recognized as the services are provided, not upon receipt of the fee, even if the remaining costs are accrued for.

When a vendor is providing both a service and a product, special consideration should be given to how to account for the separate components being sold.

Accounting for Goodwill

Let me now shift to some accounting issues starting with intangible assets, including goodwill. APBs 16 and 17 require that all intangibles be identified and assigned a fair value in the purchase price allocation. APB 17 requires that the recorded costs of the intangible assets acquired must be systematically amortized to income over the periods benefited.

As many of you are aware, our economy has dramatically changed since the 1960s when APB 17 was adopted. High technology and a variety of service related businesses have become much more significant components of the economy. Communications that 40 years ago were done through the "town" operator and eight party lines have been replaced with digital, fiber, wireless and e-mail systems. Each home has telephone and cable systems that give providers of media and communication services access to a mobile population. Customers differentiate based on the value added by a product or service. Manufacturing has become technology driven as competitive pressures in the marketplace require successful companies to reduce costs. Brand and customer loyalty are the focus of every CEO. Yet, products that are at the top of a market one year, are obsolete the next. And in an electronics age of communication, intangibles may very well represent the majority of the value of a company.

Registrants are required to consider the various factors described in APB 17 in determining the useful life of intangible assets, including goodwill. As a result of our changing economy and businesses, the use of a 40 year life under existing GAAP may no longer be appropriate for many companies. As well as the factors in APB 17, other factors that the staff believes are relevant in determining useful lives for goodwill include:

1. The significance of competition in the industry, the level of barriers to entry and the ability of competitors to negatively affect the profitability of the acquired business.

2. The current or expected future levels of industry consolidation.

3. The expected impact of changes in technology on product life cycles and the importance of technological innovation to future success.

4. An uncertain or changing regulatory environment.

5. Uncertain continuity of revenues dependent upon retention/departure of key employees.

6. The relative infancy of the industry.

7. The mobility of customer and employee bases, and

8. The churn rate of customers.

Some argue that if an industry, such as CPA firms, has been around at least 40 years, then a 40-year life must be acceptable. Yet, what has happened to the firms, Laventhal & Horwath, Lybrand, Ross Bros. & Montgomery, Touche Ross and others? The industry changed dramatically, and so did the businesses. There certainly was value in the customer relationships and people in these entities. However, customers and people in the firms change and the value in the future must be maintained by future operations and future expenditures. As a result, the fact an industry such as CPA firms has been in existence for 40 years or more, does not necessarily mean a 40 year life is appropriate.

The SEC staff also will challenge a registrant that merely compares its goodwill life to its peer companies. Companies should perform an analysis of the factors and assumptions as discussed above that are used in determining the appropriate useful life of goodwill in each specific acquisition. This analysis should be adequately documented when the asset is acquired and amortization begins. Then the reasonableness of the intangibles lives must be periodically reevaluated. Charges for impairment of assets whose lives were not appropriately adjusted on a timely basis may result in the need for restated financial statements.

Internal Acquisition Costs

Let me discuss some business combination issues that have surfaced. The SEC staff recently was asked whether a registrant could capitalize internal management bonuses as a cost of the acquisition in a purchase business combination pursuant to Interpretation No. 33 of APB No. 16 on costs of maintaining an acquisition department. The SEC staff believes that all internal costs associates with a business combination should be deducted as incurred, even if those costs are incremental and directly associated with the business combination.

Acquisition Loss Accruals

Another business combination issue that has been considered by the staff concerns the acquiring company assigning different amounts for certain loss accrual accounts than previously recorded by the acquiror. Staff Accounting Bulletin No. 61 (SAB 61) describes the staff's position relative to the application of Accounting Principles Board Opinion No. 16 (APB 16) to loss reserves on a loan receivable portfolio. Essentially, SAB 61 prohibits an acquiring company from adjusting an acquiror's loss reserves on a loan receivable portfolio unless the acquiring company's plans for ultimate recovery of loans acquired from the acquiror are demonstrably different from plans that have served as the basis for the acquiror's estimate of loan losses. Issues similar to loss reserves on loan receivable portfolios arise in other business combinations with other loss accrual accounts, such as allowances for bad debt reserves and obsolete and excess inventory reserves, and with contingent liabilities. The staff believes that the guidance provided in SAB 61 is analogous to other loss accrual and contingent liability balances in business combinations.

Loss Accruals

A few comments are in order for other types of loss accruals such as restructuring liabilities. Such liabilities require that there be a reasonable basis for the estimated liability that is recorded. Often this liability is based on a plan established by management. I would expect that such a plan and its key assumptions would be well documented in sufficient detail to identify and quantify all the related costs and the expected timing of the incidence of such costs, prior to the recording of the restructuring charge. I also would expect the plan to have been approved at the appropriate and necessary levels in the corporation. In addition, the plan should provide a sufficient basis to hold those responsible for its successful implementation accountable.

Since we all realize that actual results may vary from original estimates, the original liability, or loss accrual may require adjustment after it is initially established. The staff would expect a registrant to review the propriety of increasing or decreasing the liability or loss accruals pursuant to GAAP. For example, if a restructuring reserve was initially recorded based on a set of facts, and in a later period the facts changed, and therefore it was no longer probable that a loss has been incurred, then the loss accrual should be reversed on a timely basis in that period, in the proper income statement category.

Another example of this is a liability initially established for income taxes that is no longer necessary due to the settlement of a tax audit. It would be inappropriate to continue to maintain the liability in periods after the audit settlement. Amortizing immaterial amounts of the liability into income after the settlement would be indicative of inappropriate earnings management. Similarly, maintaining a loss accrual and offsetting or reducing it in a later period for a change in an unrelated item would be inappropriate.

Restructuring Charges

Restructuring charges have also been a hot topic at the SEC. The staff believes that the EITF set high standards for plan specificity when it stated in EITF 94-3, "[t]he exit plan specifically identified all significant actions to be taken to complete the exit plan". The SEC staff believes that several factors should be considered in evaluating the specificity of the plan. First, the determination of whether a particular exit plan is sufficiently detailed should include consideration of both the qualitative and quantitative aspects of the plan. The staff believes that an exit plan identifies specifically all significant actions if it is sufficiently detailed such that the company can and will use it to (1) evaluate the performance of those responsible for executing the exit plan and (2) identify and react to plan versus actual variances. That is, the staff would generally expect a company's exit plan would be at least comparable to other operating and capital budgets the company prepares in terms of the level of detail and reliability of estimates. Second, the staff believes that an exit plan would not be sufficiently detailed if it is more likely than not that either the exit plan itself, or significant actions identified within the exit plan, will be materially revised in response to events or circumstances that are likely to occur. Third, the EITF indicated that while all significant actions must be identified at the commitment date, accruals could be made only for those costs associated with specifically identified significant actions that can be reasonably estimated. The staff believes that the ability to reliably estimate encompasses both the initial development of the exit plan and its subsequent implementation.

Any need to adjust the reserves should be completed on a timely basis and should be adjusted against only the financial statement line item for which the reserve was originally recorded.

The SEC staff expects all the disclosures as required by EITF 94-3 or 95-3 to be disclosed in all periods, including interim periods, beginning with the period in which the exit plan is consummated until the exit plan is completed.

Asset Impairments

As you are all aware Statement of Financial Accounting Standards No. 121 (FASB 121) establishes the guidance for impairment of long-lived assets, certain identifiable intangibles, and goodwill related to those assets to be held and used. FASB 121 provides that when management, having the authority to approve the action, has committed to a plan to dispose of the assets, whether by sale or abandonment, the assets to be disposed of should be reported at the lower of the carrying amount or fair value less costs to sell. The staff believes that registrants also must consider the criteria in APB No. 30 and EITF 94-3 to determine if a plan is sufficiently robust to designate the assets as assets to be disposed of. The staff believes that a necessary condition of a plan to dispose of assets in use is that management have the current ability to remove the assets from operations. For instance, the staff would object if a registrant were to record an impairment of its mainframe computer if that asset cannot be taken out of service and abandoned prior to installing the new, but not yet available, mainframe computer. The operational requirement to continue to use the asset is indicative that the asset is held for use. The staff does not believe this guidance means that assets to be sold must be removed from service in order to be designated as assets held for disposal. Rather, the assets must be able to be removed from service upon identification of a buyer or receipt of an acceptable bid, but can otherwise remain in service provided the criteria in SFAS 121 has been met. If a buyer is found and an acceptable offer is received, but the assets must be retained by the seller for some period due to ongoing operational needs, the criteria for "to be disposed of" treatment has not been met.

The staff also believes that registrants must continually evaluate the appropriateness of useful lives assigned to long-lived assets, including identifiable intangible assets and goodwill. The staff does not view the recognition of an impairment charge to be a substitute for choosing the appropriate initial amortization or depreciation period or subsequently adjusting this period as company or industry conditions change.


I hope this provides you with an insight into current `developments at the Commission and within the accounting profession. I also hope it highlights current areas of focus of the SEC staff.

Thank you.

1 In re Caremark International Inc., Derivative Litigation, 698 A.2d 959, 967-968, 970 (Del. Ch. 1996).

2Id. at 967-968.

3 Id. at 968.