The Uneven Evolution of Accounting Standards
Davenport, Todd, American Banker
First in a series
Considering the furious pace of financial innovation, in which two days -- or two hours -- can matter, taking two years to write a roundly criticized accounting rule is disconcerting.
"Accounting has been struggling to keep up with the complexity for a long time," said Ron Lott, a senior technical adviser at the Financial Accounting Standards Board. "New types of transactions and instruments can be developed a lot faster than we can develop accounting standards" and "the best we can hope to do is stay pretty close behind."
Financial companies are particularly vulnerable, given that they are involved in some of the foggiest accounting fields: derivatives, off-balance-sheet entities, securitizations, intangible assets, and reserve methodology.
"It's gotten to the point where very few of the people who prepare financial statements -- and almost none of the people who read them -- really understand what the numbers represent anymore," said Ben Neuhausen, the national director of accounting at BDO Seidman LLP in Chicago.
"Accounting is a utilitarian discipline," Mr. Neuhausen said. "We don't create truthful portraits so we can marvel at their beauty. We create them so people can use them to make good economic decisions: invest or sell, lend or foreclose, extend credit or demand cash on delivery."
Even some sophisticated investors concede they avoid money-center banks because they do not understand their financial statements. And, mortgage banking has some of the lowest price-to-earnings multiples of any industry. Though cyclicality explains some of the discount, clear-as-mud analytics do not help.
That bad accounting can lead to inefficient capital allocation is perhaps the least of the threats. It can destroy companies and plunder investors.
A prime example of the problems facing the industry is accounting rules for off-balance-sheet instruments -- the rule that took two years to write and still causes headaches.
FASB decided to take a look at these rules after Enron Corp. collapsed in late 2001. Just over a year later the board released Financial Interpretation No. 46: "Consolidation of Variable-Interest Entities."
When an army of critics complained about the inconsistencies the interpretation created, the board spent most of 2003 revising it and released Fin 46R on Christmas Eve.
Companies and their accountants said the new rules threw the status of trust-preferred securities into doubt, complicated commercial-paper conduits, and threatened to wreak havoc on business restructurings and personal estates.
Standards setters are trying to solve some of these problems by moving away from detailed policies to more principles-based accounting.
But the evolution has been anything but easy.
"People just aren't comfortable with it," said Mr. Lott at FASB. "They want a little more detail. There are so many questions in the accounting, they want to be able to fall back on a rule sometimes."
In fact, FASB's standards are regularly fortified by pages upon pages of implementation guidance.
No standard has done more to force the issue than FAS 133: "Accounting for Derivative Instruments and Hedging Activities."
To call it a single standard is a little misleading: FAS 133 was FASB's first shot at derivatives accounting. The board later amended and clarified it through three more standards: FAS 137, FAS 138, and FAS 149. And even that was not enough.
FASB also created the Derivatives Implementation Group -- universally referred to without a trace of affection as the Dig -- to answer questions from companies trying to implement FAS 133.
At last count, the Dig had published 167 issue statements; 11 have subsequently been superseded and 63 revised. The titles advertise their page-turning quotient: "Issue A13: Whether Settlement Provisions that Require a Structured Payout Constitute Net Settlement Under Paragraph 9(a). …