Get ready for More Disclosures on Variable Interest Entities

In the post Enron world, considerable ongoing attention has been given to the consolidation of variable interest entities (VIE), which are generally thinly capitalized. An amendment to FIN46(R) being issued by the FASB in June 2009 will require companies to perform periodic qualitative analysis on VIE's to determine if consolidation is necessary.

Focus is given on the amount of control a company exercises over the significant activities of the entity. This includes the right to receive benefits and the obligation to absorb losses as well as changes in risk exposure. After issuance of this new amendment, it is no long sufficient to base consolidation decisions solely quantitative analysis. A company should plan on disclosing significant judgments and assumptions used in this analysis. Effective date likely to be the beginning of 2010.

IAS 39 Fair Value – Will it be replaced?

The International Accounting Standards Board (IASB) met on May 5th to continue its work on the replacement of IAS 39, Financial Instruments: Recognition and Measurement. IAS 39 sets out requirements for recognizing and measuring financial assets, financial liabilities and some contracts to buy or sell non-financial items. IAS 39 officially was issued in 1998 and has been amended multiple times over the last 11 years.

In the KPMG 'Top Ten' of IFRS standards, IAS 39 was rated number one i.e. likely to have the most dramatic effect on reported results.

Work on this project began in 2008, with discussions dating back to 2005.

Why replace this standard? It is viewed by many as too complex. A replacement needs to improve the decision usefulness of the information for users. There is a high likelihood that it will be replaced.

At the May 5th meeting, focus was given to a possible remeasurement method based on discounted cash flows. Other possibilities being considered include amortized cost and “exit price” as defined in FAS 157.

FDIC Special Assessment Ruling Issued - OCC's John Dugan not Happy

The FDIC announced on May 22nd it's final ruling on the special assessment to bolster funds used to protect depositors. The final rule establishes a special assessment of five basis points on each FDIC-insured depository institution's assets, minus its Tier 1 capital, as of June 30, 2009. The special assessment will be assessed against assets minus Tier 1 capital rather than domestic deposits, but the assessment will be capped at 10 basis points of an institution's domestic deposits so that no institution would pay an amount higher than they would have paid under the interim rule. The special assessment will be collected September 30, 2009.

Comptroller of the Currency John C. Dugan is not too pleased with the final ruling. According to his press release shortly after the FDIC issuance, he expressed concern that the FDIC has in effect opened the door for a total of three special assessments. He indicated that “The revised special assessment in today’s final rule uses an asset-based assessment base, but if translated into the normal assessment base of domestic deposits, it results in the following totals: 7 1/3 basis points for the second quarter, and up to an additional 7 1/3 basis points each for the end of the third quarter and the end of the fourth quarter. Thus, instead of voting on a one-time special assessment today of 20 basis points, we’re voting on the ability to impose three special assessments before the end of the year totaling 22 basis points. While the second two assessments would require separate Board votes, they would not require additional public comment, and I don’t think that’s appropriate”.

He also indicated in the release that he felt that the assessment unfairly penalized larger banks and could have very negative economic consequences since it is very procyclical.

World Economy on the Mend? LIBOR Rate Declines

The London Interbank Offered Rate, better known as LIBOR, ended the week of May 22nd down 17 basis points driven not only by increased confidence in Banks, but also growing customer deposits. The LIBOR rate is derived from a survey conducted by the British Banker’s Association requesting banks to provide details regarding cost to lend to each other for 15 different periods across several currencies.

Why is LIBOR so significant? LIBOR is used to set borrowing costs on about $360 trillion of financial products globally. When LIBOR rate goes down the cost of bank borrowing is reduced.

Is this a sign that the world economy may be on the mend? Perhaps. Clearly this is a sign that credit is thawing and banks are beginning to lend to each other again.

SEC Proposal to Allow Shareholder Board of Director Nominations

Shareholders are angry. In the current economic crisis, shareholders want more power to ensure that Boards of Directors are aligned with their interests.

The SEC recognizes this and issued a proposal on May 20th for comment to allow shareholders who meet certain criteria, based primarily on percentage of shares owned, to put someone of their choosing on the shareholder proxy sent to all shareholders. The current process allows shareholders to present nominations, but only at the annual shareholder meeting. This has little to no impact due to proxy votes already having been cast by this time. In most cases, currently shareholders have no input in choosing the slate of candidates presented.

The proposal does indicate that shareholders would not be able to submit a nomination on the proxy if specifically prohibited by applicable state law or a company's charter/bylaws.

Spreadsheet Errors… more common than you think

Spreadsheets are dangerous. Very dangerous. Unlike other software development that utilizes rigid complex testing strategies worked on by a team, spreadsheets are deceptively easy to use and are typically created by a single individual.

A groundbreaking study in 1998 by Raymond R. Panko at the University of Hawaii, delves into the psychological reasons why the majority of spreadsheets contain at least 1 error, often materially significant.

Mr. Panko concludes that when complex tasks are performed, the average human error rate is approximately 5%. This error rate, he says, is fairly consistent along a wide range of complex human tasks. This error rate also does not correlate to the experience of the individual performing the task.

Several factors come into play including human nature to be overconfident when producing a spreadsheet as well as the inability to see one’s own errors.

Two suggestions, among many, to lessen the percentage of errors in a spreadsheet is to have a person other than the original creator of the spreadsheet check for errors. According to John F. Raffensperger in a different article, a creator of a spreadsheet should use a simple and well laid out design with short arcs of precedence.

The following link will lead to Mr. Panko's study and conclusions:

http://panko.shidler.hawaii.edu/SSR/Mypapers/whatknow.htm

Dynamic Provisioning – One Solution for Banking Crisis?

Regulators and Standard Setters have been working overtime to establish procedures and regulations to prevent a future meltdown based on recent lessons learned. One proposed solution from Spain? Dynamic Provisioning. Simplistically, the concept allows banks to build up capital buffers during prosperous times and then release during bad times. The concept originated in Spain in the year 2000. It is considered countercyclical, rather than procyclical, and requires a bank to set aside a provision for each new loan in case it goes bad. By countercyclical it means that Dynamic Provisioning smoothes the economic peaks and troughs. Thanks to Spain’s regulations, the country’s banks have been better able to weather the financial storm.

At a recent meeting in April of accounting standard setters in Johannesburg, the topic was discussed and the general consensus was that if Dynamic Provisioning was universally adopted, it shouldn’t flow through the profit and loss statement. Rather it should be part of a non-distributable capital reserve. It was agreed that more testing was needed.

Foreclosure Scams – OTS issues Warning to Consumers

The Office of Thrift Supervision (OTS) recently issued a warning to consumers to be on the lookout for various schemes aimed at troubled homeowners:

Three types of schemes are common:

§ Phantom help – The purported rescuer charges high fees for no work or for services that the homeowner could have easily handled or obtained free from legitimate organizations.
§ Bailout – A homeowner surrenders the title to the home after receiving a false promise that the he or she can remain as a renter and buy back the home later. The scam artist obtains possession of the home and most or all of its equity.

§ Bait and switch – Victims are told they can refinance their homes but instead sign documents transferring the titles to scam artists, while the victims remain responsible for making the mortgage payments.

Measurement of Fair Value of Liabilities - FAS157-f to the rescue!

In the latest proposed Staff Position, FSP FAS 157-f, the Financial Accounting Standards Board (FASB) is providing guidance around issues that have been raised concerning FAS 157. FAS 157 is entitled Fair Value Measurements and FAS 157-f in particular focuses on the measurement of liabilities. FAS 157 defines fair value as, “the price that would be paid to transfer a liability in an orderly transaction between market participants at the measurement date”.

Concerns addressed by this FSP:

1. Transfers to counterparties and FAS 157's assumption that these are not considered settlement of the liability.

2. Non-performance risk being the same before and after transfer when in reality the new obligor may have different risk than the transferee.

3. Lack of observable market information for many liabilities.

4. Contractual restrictions preventing a transfer and its impact on measurement.

5. Liabilities traded in the marketplace as assets.

The comment period for the proposed FSP closes June 1, 2009.

Just Around the Corner – FASB Codification Becomes a Reality

On May 1st,2009, the Financial Accounting Standards Board (FASB) issued its first weekly alert leading up to the official rollout of the Codification of accounting standards. On July 1st, 2009, the FASB Codification will become the official and only level of authoritative GAAP (nongovernmental), other than guidance issued by the SEC. Accountants, me included, have long been frustrated by the myriad of standards to sift through from different sources, such as Statements (FAS), Interpretations (FIN), Emerging Issues Task Force (EITF) and other authoritative literature. As a consequence, it is sometimes difficult to determine if all guidance on a particular topic has been reviewed or how to interpret what may be conflicting instructions from different sources. Codification is not creating new GAAP, but rather organizing existing GAAP into a structure that streamlines the research process.

I encourage you visit the link below and register for access on the FASB website to explore the new structure. It is well laid out and very easy to navigate.

http://asc.fasb.org/home

I will be discussing this topic more as we approach July 1st. Please stay tuned!

Financial Crisis Advisory Group (FCAG) Expresses Concerns

Concern was expressed in an April 29th letter intended for distribution to the leaders of the G-20 nations from the Financial Crisis Advisory Group (FCAG) regarding priorities of and pressures put upon both the FASB (Financial Accounting Standards Board) and IASB (International Accounting Standards Board) as it relates to the current financial crisis. The FCAG was recently created by the FASB and IASB as a temporary advisory group composed of senior leaders with broad international experience in financial markets. The FCAG’s major goals are to explore the standard-setting implications of the global financial crisis as well as potential changes to the global regulatory environment.

In the April 29th letter, the FCAG expressed concern about the pressures being imposed by G-20 policymakers on both the IASB and FASB to make progress on a wide range of issues, some of which are very complex. The FCAG believes the boards should focus their resources on only the commitments already made so as to not delay the most critical projects. The FCAG suggested that high priority should be given to work on the financial instrument and consolidation / derecognition projects. Valuation and off-balance sheet standards, they say, particularly need improvement. This focus, they believe, will provide the more significant, lasting global improvements.

The FCAG praised the work and cooperation of the two boards on a multitude of projects.

Swine Flu - Is your Company Prepared for the Worst?

Is the Swine Flu (H1N1) scare media hype or a real disaster on the horizon? In this day of 24/7 news cycles and endless commentary about the elections or the economy, its easy to feel overwhelmed by yet another barrage of news, this time focused on the latest confirmed Swine flu case. It’s tempting to look at the low number of cases in the US as well as the severity and believe that the whole situation is overblown. As a business leader, you may feel the risk is too small to devote significant resources to preparation. I caution against this approach. History suggests that most pandemic flu outbreaks start in the spring with relatively mild symptoms. The flu then appears to disappear during the summer months. Unfortunately, history also shows that the virus has the potential to mutate into a deadlier strain and then stage a dramatic reappearance in the fall. With this in mind, as we head into the summer months, consider this an opportunity to establish and test Continuity of Business (COB) plans.

Factors to consider:

1. How will your business operate with significant staff disruption?
2. How many key operations can be conducted remotely?
3. Do you have communication plan to coordinate staff?
4. How will the business function if key vendors are unable to meet their obligations?
5. How will communications be maintained with customers?

I encourage readers to post their own thoughts and observations as to ways to best prepare for what may be an event of historic proportions later this year.

An excellent resource on the history of the 1918 Pandemic: Flu: The Story of the Great Influenza Pandemic of 1918 & the Search for the Virus That Caused It by Gina Kolata