Accounting at a Tipping Point:Needed--Thought Leadership

Financial Accounting and Reporting Section Meeting

January 31, 2009

Sue Haka, AAA President (suehaka@msu.edu )

The Basic Accounting We Have

Grown-up With Is At a Cross Roads or Tipping Point

At the point of significant change

• Five Signs of the Tipping Point:

• Assets/Liabilities vs. Revenue/Expense Model

• Fair Value Controversy

• “True and Fair” vs. “In Conformity With”

• IFRS

• XBRL initiative

• Four opportunities for academics:

• Research

• Participation in FASB/SEC/IASB/IMA/PCAOB/GASB decision making processes

• Classroom conversations

• Conversations with each other

I. Assets/Liabilities vs. Revenue/Expense Model

A 2003 SEC report supported the adoption of a principles-based accounting system and simultaneously rejected the revenue/expense accounting model in favor of a model focused on assets/liability accounting.

This shift to the balance sheet as the primary accounting statement is supported by standard setters[1], but has generated controversy.

[1] See the IASB-FASB joint discussion paper “Preliminary Views on Financial Statement Presentation” posted at http://go.iasb.org/FSP-DP or http://www.fasb.org/draft/DP_Financial_Statement_Presentation.pdf comment period ends April 14, 2009.

I. Assets/Liabilities vs. Revenue/Expense Model

Abandoning principles such as matching and conservatism unsettles accountants and business folks.

Some assert that the asset/liability model combined with increasing reliance on fair values will result in increased reliance on rules rather than principles based approach called for by the SEC and the IASB[1].

[1] Benston, G., M. Bromwich, and A. Wagenhoffer, “Principles-Versus Rules-Based Accounting Standards: The FASB’s Standard Setting Strategy,” ABACUS, (2) 42, 2006, pp. 165-188.

II. Continuing Fair Value Controversy

Fans maintain that fair-value accounting rules result in greater transparency for investors.

IASB Chairman David Tweedie says the "beauty of fair value accounting...is that it brought [the credit] crisis very very quickly into the open." Tweedie also said that "the disaster would be even worse“ without fair value accounting[1].

[1] “Could Bank Rules End the Fair Value Debate?” by Marie Leone and Tim Reason - CFO.com | US, November 12, 2008.

II. Continuing Fair Value Controversy

Critics such as former Federal Deposit Insurance Corp. Chief, William Isaac, argue that fair value accounting is intensifying the financial-sector crisis.

"[M]ark-to-market accounting has been extremely and needlessly destructive of bank capital in the past year, and is a major cause of the current credit crisis and economic downturn," Isaac said in his remarks. [2]

[2] “Former FDIC Chief: Fair Value Caused the Crisis” by David M. Katz - CFO.com | US October 29, 2008.

III. ‘True and Fair’ vs. ‘In Conformity With’

For the assets/liabilities model and fair values to work, auditing must play a significant role. Fair values invite manipulation and are difficult to audit.

Many advocate that the audit profession should adopt a true and fair override to encourage auditors to use professional judgment to ensure financial reporting is representationally faithful to the underlying economic substance of events.

III. ‘True and Fair’ vs. ‘In Conformity With’

• Current auditing standards, by reference to Rule 203 of the AICPA Code of Professional Conduct converts auditing to a rules based approach and has not been interpreted to allow for an override[1]. A true and fair override may also mitigate against the increasing need for rules in a principles based approach to standard setting.

[1] The rule states that ‘present fairly’ “implies that the application of officially established accounting principles almost always results in the fair presentation of financial position. The almost always qualifier has not been interpreted to allow for an override.

IV. IFRS a Growing Epidemic?

Over 100 countries require or permit IFRS

Canada: adopting in 2011 China:

convergence in 2007

Japan: convergence by 2011

Europe: 2005 adoption

USA: Adoption or convergence by 2011-2014?

Australia: convergence in 2007

Russia: IFRS adoption delayed

Chili: adopting in 2009 India:

convergence in 2011

IV. IFRS A Growing Epidemic

In November 2008 the SEC released its roadmap outlining a proposal for domestic issuers to adopt IFRS by 2014.

There is huge positive IFRS support by large public accounting firms, some academics [1] (but not others [2]) and multinational corporations.

[1] “Response to the SEC Release: Acceptance from Foreign Private Issuers of Financial Statements Prepared in Accordance with International Financial Reporting Standards without Reconciliation To U.S. GAAP File No. S7–13–07,” P. E. Hopkins et al. (AAA’s Financial Accounting and Reporting Section Financial Reporting Policy Committee) Accounting Horizons 22(2), 223 (2008).[2] “A Perspective on the SEC's Proposal to Accept Financial Statements Prepared in Accordance with International Financial Reporting Standards (IFRS) without Reconciliation to U.S. GAAP,” by AAA Financial Accounting Standards Committee, K. Jamal et al., Accounting Horizons, 22 (2), 241 (2008).

IV. IFRS a Growing Epidemic—

Many are not convinced about global accounting standards:

Charles Niemeier, an influential member of the PCAOB, said “the switch to IFRS by 2014 could squander comparability among US financial statements and impede the ability of the regulators and auditors to do their jobs”[1].

Mary Schapiro (nominee for SEC Chair) stated in congressional hearings she “will not necessarily feel bound by the existing road map that’s out for comment” and highlighted a lack of consistency in the application of IFRS, the implementation cost, and the independence of the IASB--her “greatest concern” about IFRS[2].

[1] “PCAOB Member Slams Stateside IFRS Plans,” by Penny Sukhraj, Accountancy Age, 11 Sep 2008.[2] “SEC Nominee Pledges to Revitalize Enforcement, Has concerns About IFRS” by Mathew G. Lamoreaux, Journal of Accountancy, January 16, 2009.

V. XBRL – The silent revolution:

• On Dec. 17, 2008 the SEC announced the use of XBRL will be required for the largest public companies ($5 B) as early as the second quarter of 2009 [1]

• Once in the SEC's Edgar database, every organization and individual will be able to research and benchmark each firm’s cheaply and readily available financial information

[1] http://www.xbrl.us/USGAAPPUBLICREVIEW/Pages/default.aspx

or a product of the financial excesses of the last 10 years?

Is this tipping point a coincidence?

We need your thought leadership!!

IFRS

Assets & Liabilities Model

Fair Value Accounting

True & Fair

Or

In Conformity With

XBRL

AAA long-run strategic vision focuses on Thought Leadership with three major initiatives:

• Grow membership—Going Global

• Increase the member value proposition

• Recruit and engage thought leadership through aaaCommons

Opportunities for Academics:I. Research

• Assets & Liabilities Model: implications for how the firm is managed i.e. decision making, management compensation, planning/budgeting, etc.

• Fair Value measurement: management compensation contracting and estimating fair values

• IFRS: implications for management contracting, budgeting, etc.

• XBRL: interesting data should become available (16000 tags allowing easy data collection)

Research Hive on the aaaCommons

Opportunities for Academics:

II. Participation in creating accounting used by society--– FASB, IASB, SEC, PCAOB, IMA, GASB, Congress,

etc. welcome input from academics on exposure drafts and as members of advisory groups.

III. Classroom—discussions, syllabi, cases, exercises, textbooks, etc. (shared on the commons)

• Tipping Points are affected by:

– Contagion effects (messengers)• Connectors and Thought leaders--you

– Stickiness (salient message-fundamental accounting changes)

– Context matters (current economic environment calls for engagement)

– Testing to see what works (continuous research)– “With the slightest push in just the right place—it can

be tipped” (p. 259)*

*Ideas and quote from “The Tipping Point” by Malcolm Gladwell, Little, Brown and Company: New York, 2002.

You Can Be The Difference• How our accounting tipping points are resolved

depends on us to: – Provide thought leadership

• To students, practitioners, society• Through our own activities (i.e. committee reports, blogging,

journals, textbooks, practitioner articles, editorials, etc.)– Actively advocate engagement with your Accounting

PhD students• Take discussions to the classroom• Promote an academic perspective

• Get involved:– Contact accounting leaders– Volunteer

COME TO THE ANNUAL MEETING IN AUGUST!