The Financial Accounting Standards Board’s reason for being is to establish generally accepted accounting principles (GAAP). Some parties erroneously believe that phrase means that accounting rules must be supported by at least a majority of the Board’s constituents. Rather, the phrase refers to standards that are promulgated following an extensive due process within an overall conceptual framework of good accounting. And for its 30-plus years of existence the FASB has consistently taken a leadership position in issuing new standards that result in the most meaningful financial reporting, rather than succumbing to the temptation to issue only “popular” standards.

The FASB’s new requirement to record expense for the value of employee stock options has now gone into effect, despite efforts by some parties to overturn the rule through political efforts. Numerous requests for congressional intervention or for the Securities and Exchange Commission to use its authority to override the standard also failed to stop the relatively recent accounting rulings to record derivatives at their fair value and to account for all corporate mergers by a single method. Most financial executives, auditors, analysts and other interested parties support the FASB’s independence, and feel that that it is important to keep political considerations out of the corporate reporting arena.

The support of many of those individuals and organizations, however, may be waning in light of recent actions by the FASB that they believe threaten to make financial statements less relevant and reliable. Accounting standards are becoming so complicated that even the most well-intentioned professionals have a hard time applying them. And observers also question several recent Board actions that require companies to record estimates of “fair value” in cases where markets simply don’t exist and values are nothing more than a guess.

To give them credit, Board members recognize that financial reporting requirements have become overly complicated, making accounting more difficult to apply and to understand. This recognition was acknowledged in 2003 statements by both the FASB and SEC that accounting standards need to become less complex. In a speech earlier this year, the FASB Chairman noted that one of his organization’s three strategic goals is simplification of accounting standards. Unfortunately, the Board hasn’t yet "walked the talk"—new rules continue to emerge that are just as complicated as before, if not more so. And many of those rules require use of fair value accounting in cases where most observers believe it doesn’t make sense and may not even be capable of being done.

For example, Statement 143 on asset retirements requires that a liability be recorded initially for these obligations at an estimated fair value (what a hypothetical third party would charge to retire the asset, including a risk premium and a normal profit) rather than the cost that the company actually expects to incur. And a pending proposal on merger accounting would require that liabilities be recorded for unlikely contingencies such as pending lawsuits. Thus, even when a company thinks that the odds of pending litigation resulting in damages being paid are remote, it would have to record an estimate of what a third party would require to take that “obligation” off its hands.

While it’s easy to criticize the Board for making things too complex and irrelevant to investors, the bigger challenge is finding ways to change the situation and begin moving toward actually achieving the simplification objective. Here are my suggestions:

Just Say No

Too many rules are justified by the FASB saying that it is merely responding to what companies, auditors, regulators, or others ask it to do. For example, a recent bulletin codified the fairly obvious conclusion that the grant date for employee stock options is when those options are actually granted by corporate boards. Some accounting firms had read the words of the Board’s pronouncement on this general subject and were concerned that grants weren’t official until the employee was notified, usually a short period after action by a company’s board of directors. The FASB has to resist requests like this and rely on companies and auditors to apply standards with good judgment. Of course, it is also important that neither the SEC nor the Public Company Accounting Oversight Board second-guess good faith judgments after the fact with overly legalistic readings of general standards.

Limit The Use Of Fair Value Accounting To Appropriate Circumstances

The Board needs to take a step back and consider whether the increasing use of fair values in accounting standards is leading to more useful and reliable financial reports. Moreover, it needs to realize that while fair value may sound like simplification, it actually makes accounting more complex when applied in areas where active markets don’t exist. A hopeful sign for reconsideration of this issue is a recent (but very low profile) Invitation to Comment, in which the FASB asks interested parties to weigh in on a number of issues involving uncertain assets and liabilities, such as pending litigation. This is part of a much broader project in which the Board is reconsidering its conceptual framework—the constitution that provides a context for individual accounting standards. I believe that for the process to work as it was intended, companies and others must engage the FASB in a spirited debate on these issues. I am hopeful that such debate will cause the Board to be more cautious about expanding fair value accounting beyond areas where it truly makes sense, such as for marketable securities and derivative financial instruments.

Accelerate Work On The So-Called Codification Project

Today’s accounting literature is a mishmash of pronouncements from the FASB, SEC, American Institute of CPAs, Emerging Issues Task Force and others. It has become extremely difficult to determine whether there even is guidance directly on point for a given transaction or situation. And it’s also hard in many cases to know what guidance takes precedence when more than one source arguably is relevant. A survey by the FASB in 2004 found that only 19% of accountants felt comfortable that they had identified the proper accounting guidance even when they had unlimited research time. The FASB has a major project underway to pull all of this literature together and make it much easier for accountants to find appropriate guidance. But the target completion date is several years from now and that needs to be accelerated.

A few months ago the SEC Chief Accountant commented on some of these same issues and said that a presidential commission might be needed to study the complexity issue and recommend changes. Rather than such dramatic, outside review, I believe that the FASB can address concerns by starting with the three suggestions above. If it is successful, GAAP might actually become more “generally accepted,” and also more “generally understood” as well.

The column solely reflects the views of its author, and should not be regarded as legal advice. It is for general information and discussion only, and is not a full analysis of the matters presented.

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