FASB Tries to Untangle Trio of GAAP Twists

Accounting executives now have a new roadmap for navigating Generally Accepted Accounting Principles, specifying which GAAP literature carries authority over what.

The Financial Accounting Standards Board has published Financial Accounting Standard No. 162, Hierarchy of Generally Accepted Accounting Principles, to answer criticisms that the GAAP hierarchy was better described in auditing literature than in accounting literature and that it was too complicated. “The Board believes that the GAAP hierarchy should be directed to entities because it is the entity (not its auditor) that is responsible for selecting accounting principles for financial statements that are presented in conformity with GAAP,” FASB wrote in its summary of the new hierarchy.

FAS 162 establishes that FASB standards, interpretations, and staff positions carry the highest authority, along with implementation issues related to FAS 133 (the notoriously complex standard for hedge accounting) and the accounting research bulletins and accounting principles board opinions of the American Institute of Certified Public Accountants. The next level of authority goes to FASB technical bulletins and to AICPA industry audit and accounting guides and statements of position approved by FASB.

Next in line are AICPA Accounting Standards Executive Committee practice bulletins that have been cleared by FASB, consensus positions of FASB’s Emerging Issues Task Force, and Appendix D topics of the EITF Abstracts. The lowest authority goes to implementation guides or question-and-answer documents published by FASB staff, AICPA accounting interpretations, AICPA industry audit and accounting guides, and statements of position not cleared by FASB.

FASB coordinated its statement with action by the Public Company Accounting Oversight Board to remove the GAAP hierarchy from its auditing literature. The PCAOB made those revisions in an amendment to AU Sec. 411, Meaning of Present Fairly in Conformity with GAAP, when it published Auditing Standard No. 6, Evaluating Consistency of Financial Statements, earlier this year.

The final authority on moving the hierarchy from auditing to accounting literature is the Securities and Exchange Commission, which must approve the PCAOB’s amendments for FAS 162 to become effective.

FASB doesn’t expect the new standard to result in any change in existing practice, except to direct accountants more clearly on which literature to follow where they may find conflicts. Still, it provided some transition provisions in the 26-page package of guidance, just in case.

FASB Proposals on Credit Derivatives Disclosures

FASB is crafting amendments to hedge accounting rules to require new disclosures about credit derivatives.

The Board is working on revisions to FAS 133, Accounting for Derivative Instruments and Hedging Activities, to model the kinds of disclosures that an entity currently makes when it guarantees a debt under Financial Interpretation No. 45, Guarantor’s Accounting and Disclosure Requirements for Guarantees, Including Indirect Guarantees of Indebtedness of Others. The Board is also working on amendments to FIN 45 to require additional disclosures about the current status of any guarantees, such as the credit risk of an underlying guaranteed obligation.

Ongoing turmoil in the credit markets inspired FASB to take a fresh look at the information available to investors regarding the risk an entity accepts when it takes on credit-based financial instruments, such as credit default swaps and credit spread options. The Board is expediting the guidance with a goal of having it take effect at the end of 2008. The staff is developing a draft document for the Board’s review.

Lee

FASB at first considered requiring disclosures of both the buyer and the seller of credit derivatives, but ultimately determined it will focus on requiring new disclosures from the sellers who back the underlying obligation, says Hee Lee, a partner with Ernst & Young and an adviser for the International Swaps and Derivatives Association’s North America Accounting Committee.

Lee says the Board struggled with the benefit of establishing two different disclosure frameworks, and instead chose to leverage the FIN 45 requirements, but with an additional obligation. “They want disclosure on the current status of the current credit quality of the underlying risk you are providing,” he says. “I think that will be useful to readers in terms of understanding the financial guarantee.”

FASB to Clarify Fair-Value Requirements

FASB is floating an idea for how to resolve an inconsistency in accounting literature regarding how brokers and dealers should account for their trading inventory.

The inconsistency is in the fine print of three pieces of existing accounting guidance: AICPA Audit and Accounting Guides, Brokers and Dealers in Securities, and Investment Companies, and the accounting for inventory under ARB No. 43, Inventory Pricing. The broker-dealer guide requires that entities account for inventory at fair value, while the investment company guide requires entities to report all assets at fair value. ARB 43, on the other hand, generally requires inventory to be accounted for at the lesser of cost or market value.

FASB staff is proposing guidance that would say inventories included in an entity’s trading activities should be measured at fair value, both initially and subsequently, with changes in fair value recognized in earnings. That would not have any effect on current practice for inventories included in production, retail, wholesale, or other non-trading activities, FASB says. It’s also consistent with FASB’s general move toward increasing requirements of fair-value measurement for financial assets and liabilities.

Hee Lee, an adviser to ISDA’s North America Accounting Committee, says the staff position will clarify what constitutes “trading” for purposes of determining what should be measured at fair value. “From the dealer perspective, they’re in the business of trading and they manage their positions on the basis of fair value,” he says. “They would prefer they were recorded at fair value.”

The proposal is open for comment through June 16. FASB expects to redeliberate and issue a final document in time for it to take effect for fiscal years beginning after Nov. 15.