Fair Value Input Sought; Restatements Up; More

To help steer the fair value ship, accounting rulemakers are reaching out to the readers of financial statements to find out if they like what they’ve seen so far in fair value accounting and where else it might be helpful in financial reporting.

The Financial Accounting Standards Board and the International Accounting Standards Board have published a joint questionnaire asking readers of financial reports to weigh in on whether current accounting standards produce the information that investors and creditors need to analyze results for companies that report some or all financial instruments at fair value.

“It is not a questionnaire on if and when financial instruments should be reported at fair value, but instead it is a questionnaire on what information would be useful to users of financial statements related to financial instruments that are reported at fair value in the financial statements,” FASB Project Manager Kevin Stoklosa says. The questionnaire marks the beginning of research to help the boards decide if they should pursue new standards addressing fair value information, he says.

The Boards acknowledge, for example, that the adoption of fair value has so far focused on recognition and measurement of financial instruments, but few disclosure requirements regarding past or projected changes in value have been enacted. The Boards want to know what else investors and creditors need to know to better understand companies’ results, but they caution respondents against unrealistic expectations.

“There are many types of information that users may find helpful in their analyses,” the Boards say in their request for information. “However, the benefit to users of that information must be balanced against the cost of preparing that information. Consequently, the Boards are interested in learning whether requiring more detailed information would improve financial analysis sufficiently to justify its cost, and if so, what types of information would be most useful.”

Both IASB and FASB require some financial instruments to be reported at fair value, such as trading securities and derivatives; IASB gives companies the option of reporting other instruments at fair value while FASB recently issued an exposure draft of a new standard—the Fair Value Option for Financial Assets and Financial Liabilities—that would expand the option to use fair value for a larger variety of financial instruments.

Meanwhile, FASB recently finalized Statement No. 155 creating new options to report certain derivatives at fair value. PricewaterhouseCoopers recently published a reminder to its clients that companies planning to select the fair value option described in FAS 155 must do so at the beginning of their fiscal year, before any interim financial statements have been issued. That means calendar-year filers must make their selections before they issue their first-quarter reports.

Research Report Says Restatements Hit Record Levels In 2005

Restatements rolled into the Securities and Exchange Commission at a record rate in 2005, with 1,295 filed for the year—one for every 12 public companies and nearly twice as many as seen in 2004—according to research by Glass Lewis & Co.

Problems unearthed by compliance with Sarbanes-Oxley’s Section 404 proved to be the biggest driver of restatements in 2005, according to Glass Lewis, but lease accounting rules and derivates caused a fair share of problems as well. The research also points to audit inspections by the Public Company Accounting Oversight Board as contributing to the record restatement wave.

Mark Grothe, the research analyst who authored the report, says the numbers should fall in 2006, but believes 750 to 1,000 restatements are still possible. “We continue to see an increase in restatements by smaller companies,” he says. “Nothing has happened at these companies (like SOX 404 at the larger companies) to ensure a greater likelihood that restatements won’t climb in the future.”

Grothe notes that 2006 restatements jumped to a fast start with a wave of restatements related to hedge accounting. “If these flavor-of-the-month issues keep popping up, the number of restatements could be just as high as in 2005. It’s still pretty early in 2006 to get a good sense of what’s going to happen,” he says.

Also on the horizon as possible cause of restatements: implementation of stock option expensing rules and year two of Section 404 reporting.

“I think the majority of companies and auditors spent the time and effort to do one major overhaul last year,” Grothe says, “but some companies and auditors that might have rushed things, just to get past year-one, may have left a lot of work to complete this year in conjunction with their year-end audits. The telling months will probably be March and April. If restatements don’t slow down then, I think we could be in for another record-breaking year in 2006.”

AICPA Proposes Rule On Audit Committee Communications

The American Institute of Certified Public Accountants is proposing to give auditors clearer instructions on what they should tell an audit committee—or whoever is in charge of governance at a client company—about what they find in an audit.

AICPA’s proposed Statement on Auditing Standard will apply only to private companies, because the Public Company Accounting Oversight Board governs audits of public companies. (The PCAOB is considering rules of its own to compel an auditor to disclose more about what it learns in the course of an audit.)

Landes

“It’s fair to say one of the areas where our profession has been criticized is where the auditor has certain information, and companies are saying after a problem is discovered, ‘If only we’d known,’ ” says Chuck Landes, vice president for AICPA. “This standard will require that communication regardless of whether the company has a formal audit committee.”

The proposed rulea and a recent PCAOB briefing paper on the topic can be found at right.