The Financial Accounting Standards Board is offering an advance preview of its work so far in sorting out the wide variety of financial instruments on the market today, and determining where they belong on the balance sheet.
FASB issued a “milestone draft” titled Proposed Classification for Single-Component Financial Instruments and Certain Other Instruments to summarize its findings to date on its comprehensive project to define the differences for accounting purposes between liabilities, equities and assets.
Beresford
While the definitions of each used to be clear-cut in accounting rules, the lines have blurred as the current generation of savvy investment professionals have created new financial instruments, said Dennis Beresford, former FASB chairman and accounting professor at the University of Georgia. In many cases, newer instruments hold characteristics consistent with more than one category on the balance sheet. “Over the last 30 to 40 years, companies have gotten creative and the instruments are not as clear cut,” he said.
Determining their proper classification is important for reporting purposes, he said, because it has significant implications for key financial ratios, like liabilities to equity. “Companies would prefer to classify as equity because it has a better effect on their ratios,” he said. “A lot of the instruments invented by Wall Street over the years are intended to take advantage of the rules and make things look like equity.”
FASB’s milestone draft says it is approaching the question by examining two criteria—ownership and ultimate settlement. “To provide the most useful information to users of financial statements regarding liquidity and ownership, the Board decided that classifications should be based on both economic characteristics and ultimate settlement, instead of just one of those factors,” the draft says.
Instruments providing direct ownership, like shares of stock, are clear equity instruments, whereas instruments requiring the company to settle an obligation at a future date, like a loan, are liabilities, Beresford said. FASB says as much in its draft, but acknowledges the definitions will get tougher when they examine financial instruments that have varying degrees of similarity to stock vs. loans. Such “multiple-component” instruments might include puttable stock, put warrants, convertible debt, prepaid contracts, and variable share forward contracts, FASB says.
The Board cautions it’s still a long way away from any definitive action on the issue. The “milestone draft,” available from the box at right, will be followed by a “preliminary views” document, then an exposure draft, before reaching a final statement or position.
European Regulators Want Extra Disclosures From Some GAAP Companies
U.S., Canadian and Japanese companies listed on European Union exchanges will have to provide additional information with their financial statements if the EU adopts the recent recommendations of the Committee of European Securities Regulators.
The Committee examined Generally Accepted Accounting Principles in the United States, Japan and Canada, comparing them to International Financial Reporting Standards now required in the European Union, and determined they are substantially equivalent except in a few areas where the EU should request more disclosure. The CESR focused attention on differences in accounting for qualifying special purpose entities and business combinations and consolidations.
Stock option accounting was on CESR’s radar, according to the Financial Executives Research Foundation, the research arm of the Financial Executives International. However, options escaped CESR’s recommendations for additional disclosure when the U.S. Financial Accounting Standards Board adopted new rules requiring their expensing.
In a July alert published for FEI members, FERF offers two notes of encouragement to U.S. companies who may see the additional disclosure recommendation as burdensome.
First, the CESR’s position is more lenient than that originally held by the EU’s Transparency Directive and Prospectus Directive, which would require non-EU based companies with listings on EU exchanges to provide IFRS-prepared financial statements beginning in January 2007. If the EU adopts the CESR’s recommendation, reporting will be significantly lighter.
Second, the CESR has taken note of ongoing efforts by U.S. and European regulators to converge accounting practices and recommends the EU watch future rulemaking to determine if the remaining differences between GAAP and IFRS are eliminated, thereby removing the need for further disclosures.
NYSE Steps Up Investor Notification Of Late Quarterly Report Filers
The New York Stock Exchange will begin in August flagging the ticker symbols of tardy quarterly filers in addition to its usual flagging of late annual report filers.
A spokesman for NYSE said the exchange notified its listed companies by letter in July to expect the flagging to begin in August. It means when a company is late filing its 10-Q, its ticker will appear with a suffix of “LF,” which is a flag to investors that the company is a late filer. “Late” as defined by the SEC generally is about five days after the filing due date, the NYSE spokesman said.
The quarterly flagging is part of a larger NYSE initiative to step up its monitoring of late filers and trigger the delisting process as necessary when companies don’t achieve compliance. NYSE initially focused its attention on late annual filers, but via the rule change comment process brought late quarterly filers onto the radar as well.
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