Hedge Accounting; Auditor Market; More

The Financial Accounting Standards Board has published two new snippets of guidance on proper use of the “shortcut method” to account for hedging instruments, the latest chapter in FASB’s ongoing quest to clarify complexities in derivative accounting.

The guidance is Implementation Issue No. E23, which focuses on Paragraph 68 of Financial Accounting Standard No. 133, Accounting for Derivative Instruments and Hedging Activities. That paragraph outlines the precise conditions that must exist for a hedge to qualify for hedge accounting.

The guidance in No. E23 explains that minor differences in the trade date and settlement date of a particular instrument won’t necessarily preclude use of the shortcut method, as long as differences are within normal market conventions. It also clears up a complication created by FAS 157, Fair Value Measurement, which established a new definition for fair value that was somewhat at odds with requirements for application of the shortcut method.

Lee

Hee Lee, chairman for the North American Accounting Committee of the International Swaps and Derivatives Association, says FASB’s original draft guidance contained additional help on the shortcut method, but several provisions met with stiff resistance, especially guidance around late hedges. In the final guidance, FASB says it has tabled those issues or will address them as part of a larger project to rethink derivative accounting, which may include abolishing the shortcut method entirely.

Lee says E23 is still important for 2008 filings, especially because it squares some conflict between FAS 133 and FAS 157 over interest rate swaps. Because the FAS 157 definition of fair value focuses on exit pricing for financial assets, it trumped a shortcut requirement that an interest rate swap must have a zero fair value at inception—a concept only possible if measuring the fair value using entry or transaction pricing.

“To qualify for shortcut hedge accounting, the fair value of the swap must be zero, but now under 157 you basically shut down the shortcut by virtue of applying the 157 concept of fair value,” he says. “We urged FASB to issue E23 quickly to at least cover this particular aspect of it.”

Lee says the new guidance may help simplify some of the problems that have led to landmark restatements in recent years. Although regulators talk frequently of a desire to shift to a principles-based approach to accounting rules and enforcement, FAS 133 remains rigidly based on rules and bright lines, he says.

“A lot of these companies had to restate because they didn’t comply with the rule of the shortcut method,” he says. “They thought they complied with the spirit of it, but the (Securities and Exchange Commission) didn’t care about the spirit.”

GAO: Auditor Consolidation Is No Big Deal

A government study says concentration of audit talent among a handful of major firms doesn’t hurt competition or pricing of audit services and doesn’t compel any kind of public policy.

The Government Accountability Office published a 120-page report saying current concentration among the Big 4—Deloitte & Touche, Ernst & Young, KPMG, and PricewaterhouseCoopers—did not play a part in increased audit fees in recent years. The report says GAO research “found that factors other than concentration appeared to explain audit fee levels,” including new accounting and auditing requirements, higher costs for qualified audit personnel, and an overall increase in audit quality.

The report acknowledges, however, that the loss of a Big 4 firm would reduce auditor choice for large companies and, therefore, could affect fee competitiveness. The GAO says concentration is likely to continue in its current pattern because smaller accounting firms face various challenges in landing more public company clients and most are not interested in serving those clients anyway.

While various academic and professional groups have called for public policy to address concentration—including a blue-ribbon commission formed by the Treasury Department to study the auditing profession—the GAO says action is not warranted. “Given the lack of significant adverse effect of concentration in the current environment and that no clear consensus exists on how to reduce concentration, no compelling need for immediate action appears to exist,” the report says.

Turner

Lynn Turner, former chief accountant for the Securities and Exchange Commission and a member of the Treasury advisory committee, says the study bears further attention. The Center for Audit Quality had no comment on the study.

Prashanth Boccasam, CEO of auditing software company Approva Corp., which works with Big 4 and second-tier firms, says the market should be given time to ponder the question of firm consolidation. “Adding additional regulatory mandates will not be the right approach,” he says. “Customers will mix and match firms based on expertise, cost, and the relationships they have with partners. I don’t necessarily see that you need additional regulatory mandates to induce competition in the space. That’s going to naturally happen.”

FASB Seeks Input on Codification Research Tool

FASB is giving accountants a free, one-year test drive of its codification of U.S. Generally Accepted Accounting Principles, seeking feedback on whether the online research tool adequately organizes and accesses GAAP.

FASB is giving accountants a free, one-year test drive of its codification of U.S. Generally Accepted Accounting Principles, seeking feedback on whether the online research tool adequately organizes and accesses GAAP.

The Board developed the codification to simplify accounting research and to provide real-time updates to accounting literature as new standards are published. The codification also facilitates FASB’s own research efforts as it develops new accounting rules and seeks to harmonize them with international standards.

Ulimately, FASB expects the codification to become the authoritative source for all accounting literature for the Securities and Exchange Commission’s XBRL project, which seeks to standardize and automate financial reporting across capital markets.

For the next year, FASB wants accountants and others who research accounting literature to use the research system free of charge and provide feedback on whether the system accurately reflects GAAP for nongovernmental entities. FASB will use the feedback to modify the system before deeming the content authoritative and reliable for financial reporting purposes.

The Board has not yet determined whether it will allow free access to the codification research system beyond the verification period, or whether it may charge for access. When it is formally approved as authoritative, it will reflect all accounting standards issued by FASB, the American Institute of Certified Public Accountants, FASB’s Emerging Issues Task Force, and any related literature. It will not reflect accounting guidance published by the SEC—so that will remain a separate research exercise for accountants even after the codification is final.

Users will be able to provide feedback at the individual paragraph level, as well as the holistic system level. Content will be updated throughout the one-year verification period for changes resulting from constituent feedback and new standards.

IASB Publishes New Merger Accounting Rules

The International Accounting Standards Board has issued new rules for mergers and other business combinations, closely aligned with similar new rules FASB published in December.

IASB has published revised versions of International Financial Reporting Standard No. 3, Business Combinations, and International Accounting Standard No. 27, Consolidated and Separate Financial Statements. Both become effective July 2009. The standards are substantially similar to FASB’s own FAS 141R, Business Combinations, and FAS 160 Noncontrolling Interests in Consolidated Financial Statements.

IASB and FASB developed their standards jointly as part of the effort to converge U.S. GAAP and IFRS into a single, global rulebook. IASB was delayed in publishing its standards because it had to complete a “feedback statement” that is part of its usual rule-publishing process, to help the public see the extent to which public comment contributed to the final product.