In the context of a long-range project to rewrite the rules for business-performance reporting, the Financial Accounting Standards Board has decided the new system it eventually develops will no longer allow a line item for “cash equivalents.”
The category has become closely scrutinized in recent years as audit firms questioned whether companies were inappropriately including certain short-term investments with cash equivalents, says John Rieger, director of financial accounting and reporting at the Association for Financial Professionals.
Financial Accounting Standard No. 95, Statement of Cash Flows, says cash consists of currency in hand or deposits that are available on demand. Cash equivalents include any short-term, highly liquid investment that is readily convertible to cash or so near its maturity that there’s no significant risk of a change in value because of a change in interest rates. The rule says that “generally” includes investments that mature within three months.
According to Rieger, savvy treasury officers have long managed cash by using short-term investments to improve return but still maintain adequate liquidity. The inclusion of such short-term investments in the cash-equivalents category has been important because cash equivalents often are a component of total liquidity for purposes of meeting debt covenants, he says.
About two years ago, audit firms determined that auction-rate securities should not be classified as cash equivalents, Reiger says. Then about a year later, audit firms added variable-rate demand notes to the watch, determining they also should not be included in cash equivalents. AFP took exception and appealed to FASB to determine if a rule change was warranted.
Mulford
Charles Mulford, an accounting professor and director of the Georgia Tech Financial Reporting & Analysis Lab, says auction-rate securities and variable-rate demand notes skirt the definition of cash equivalents because their maturities are actually much longer than three months—as much as 20 to 30 years in some cases. They have been treated as cash equivalents nonetheless, he says, because the terms allow companies to sell them back to the issuer for a guaranteed price.
“As financing and financial engineering has gotten much more sophisticated, we’ve started seeing newer instruments that seem to fit the definition of cash equivalents, but have started to get a bit far afield from what FASB intended with FAS 95,” Mulford says. “They’re close, but they’re not exact. They technically meet the definition but they really aren’t cash equivalents.”
During a recent FASB meeting where the Board discussed the issue, FASB’s staff advocated eliminating the category because it believed it would be impossible to develop a new definition that would provide good information to investors without being overly burdensome for preparers.
Herz
Not every board member agreed, however—most notably FASB Chairman Robert Herz, who said he thought the category was worth keeping. “It seems to me it’s something analysts look at,” he said at the meeting. “It doesn’t seem right to me to just scrap the notion.”
FASB member Thomas Linsmeier said the elimination of the cash-equivalents category would simplify reporting, one of the often-stated goals of new rulemaking. “This has simplification written all over it,” he said. “If we’re looking for areas to simplify, boy this is a perfect opportunity for us.”
Board members generally agreed that a report describing only cash on hand and short-term investments would need some footnotes describing the nature of the investments and their maturities to remain useful to readers. The Board charged its staff to consider that as it continues working toward the development of a new performance-reporting model.
FASB’s plan to rewrite the overall approach to performance reporting is part of an ongoing project with the International Accounting Standards Board, and IASB recently added its support to FASB’s decision to do away with cash equivalents. The boards anticipate issuing a document of preliminary views sometime in the third quarter.
Mulford says a reporting model that makes no provision for a cash-equivalents category would simply display cash as money in the bank available for immediate liquidity and all other short-term investments would be called just that. From a reporting standpoint, it would cause companies to move numbers out of operating activities into investing activities, he explains. But from a performance standpoint, it would not create a negative effect on the appearance of liquidity for companies because analysts already consider the effect of short-term investments on liquidity.
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Olson, Niemeier Tour Asia To Discuss Regulatory Cooperation
Members of the Public Company Accounting Oversight Board recently took a trip through Asia to talk with audit regulators there about how they might increasingly cooperate or rely on one another’s work.
Olson
Chairman Mark Olson and board member Charles Niemeier attended the International Forum of Independent Audit Regulators in Tokyo to talk about issues related to cooperative oversight of public-company auditors. Olson told the forum the PCAOB would accept its invitation to join the organization. Separately, Olson and Niemeier met with their counterpart regulators in Japan, and Niemeier continued the trek to meet with regulators in China.
A few weeks earlier, Olson had met with representatives of the European Union to discuss how regulators might reach full reliance on one another’s work by 2009. Olson plans to regroup with the EU regulatory body in October to discuss their progress.
The PCAOB is keeping tabs on 760 non-U.S. audit firms from 83 different countries, all of which are registered with the PCAOB to perform audits on public companies that do business in U.S. capital markets.
Following the Tokyo forum, Olson said he was encouraged to see the number of countries taking steps to oversee public company audit firms. “The PCAOB is considering further policy guidance regarding its reliance on non-U.S. regulators,” Olson said in a statement. “The PCAOB intends to consult with these and other key jurisdictions around the world as we develop our policy guidance.”
Rhonda Schnare, the PCAOB’s director of the Office of International Affairs, said the meetings were part of the Board’s ongoing discussions regarding cooperation with other regulatory bodies. Any policy guidance the Board may be considering will focus on its implementation of PCAOB Rule 4012, which addresses its reliance on other auditor regulators, Schnare said.
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