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Ex-FASB member would like to see changes

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Ex-FASB member would like to see changes

Revenue recognition has been a particularly heavy lift for some companies

Thursday, April 5, 2018
By Michael Cohn for

Larry Smith, who served as a member of the Financial Accounting Standards Board from 2007 until 2017, is watching some of the standards he worked on for a decade now being rolled out, but he believes the board should be doing more on performance reporting and the FASB Accounting Standards Codification.

Last July, after his second term ended with FASB, he joined FTI Consulting, where he became senior managing director of Forensic & Litigation Consulting. At FTI, he sometimes acts as an expert witness based on his experience with the accounting standards he helped write. “It can involve various types of cases that are the subject of SEC investigations, or lawsuits, or internal investigations, as to the application of accounting standards,” he told Accounting Today. “The work involves advising the company and audit committee, and/or the law firm as to how a standard was applied.”

He has also been discussing the standards with his colleagues and clients at FTI. “Most of what I’ve been doing since joining is talking with people about the new standards, what the board considered, and what the requirements are, as well as helping internally people interpret the new standards themselves,” he said.

Companies are finally implementing the revenue recognition that took effect for public companies this year while preparing for the lease accounting standard that takes effect at the end of the year. Revenue recognition has been a particularly heavy lift for some companies.

“Obviously some of the standards that we issued recently are very complex standards,” said Smith. “Revenue recognition is not an easy standard, and it wasn’t easy to write. Each of the major accounting firms has written books in excess of a thousand pages to explain how to do it. Sometimes that’s just because of the complexity of the standard itself. Sometimes it’s a result of the difficulty in how the standard was written.”

But like it or not, companies have got to grapple with both the revenue recognition and leasing standards.

“At the end of the day people better be ready for revenue since it’s now GAAP, at least for public companies,” said Smith. “I think they’re going to struggle a little bit and probably put it off, and they will be struggling mostly with disclosures. But hopefully they’ve got the nitty gritty in terms of how transactions get recorded and ironed out. In terms of the leases standard, what I’m hearing is that a majority of companies think that they are along the way in where they should be in terms of the implementation. Whether that’s true or not, it depends on what survey you look at. It really depends upon the company you’re talking to.”

Other standards that will be taking effect over the next few years include some of the financial instruments standards, such as classification and measurement, credit losses and hedging.

“With credit losses they have a little bit more time, so from a practical standpoint, a lot of companies are in the phase of trying to determine what kind of data they need in order to assess the methodologies they would use to estimate their credit losses,” said Smith. “There’s a requirement in the standard that when they share risk characteristics, you evaluate the allowance from a pooled perspective, and the standard provides several different ways that might be considered. People are beginning to assess what kind of data is available internally and externally, and then how to use that data in terms of applying it to their goals. What kind of methodology would be most appropriate to the pools that I develop, and what shared risk characteristics are the most pertinent ones to give me the best estimate for losses? There’s still time to implement that one, but hopefully companies are not taking a wait and see attitude. They’re at least compiling whatever data is available historically and making sure that they continue to compile that information for their specific portfolios.”

Some companies have chosen to adopt the hedging standard early without waiting until the official date it takes effect. “In terms of hedging, people kind of love that standard, so it’s a little bit different than the revenue recognition and the leasing standard,” said Smith. “Both the financial institutions as well as nonfinancial institutions are welcoming that standard.”

Performance Reporting

While those standards are rolling out and FASB continues to tweak some of them, Smith disagrees with the approach the board has taken on performance reporting.

“I wrote an article a little while ago where I probably didn’t make any friends there because I disagreed with a decision relative to the performance reporting standard,” he said. “Effectively what they did was they added a project as a result of their agenda consultation, which was sent out over a couple of years ago. But they waited until my replacement came on board to evaluate the input they received and make decisions relative to their agenda. Performance reporting is a project that’s been worked on, first with the [International Accounting Standards Board] back in 2002. Then both boards decided to lower the prioritization of that project because of the significance of some of the other major projects like leases, revenue recognition and financial instruments. There was a lot of pushback on both boards in terms of some interim decisions that had been made relative to changing how financial statements are presented. Both boards were considering fairly sweeping changes at that point in time.”

That all changed after performance reporting became less of a priority.

“The FASB took the project off its active agenda and then moved it to their research agenda,” said Smith. “There have been people working in the research mode now for several years trying to decide what direction that project should take, because when you talk to people, particularly users, they think that performance reporting is one of the more important things that the FASB should be addressing. There might be many preparers who don’t necessarily disagree with them. They might have different ideas about what should be done.”

But FASB is still in the research phase on that project. “The FASB staff and the FASB have been researching this and trying to decide what direction to take the project,” said Smith. “For example, they could take it in the direction of defining an operating measure or an operating income number. They could take it in a myriad of other directions. One of the things that the FASB and the staff was considering was, given the level of non-GAAP disclosures that are out there, what should the FASB be doing, if anything, to try to improve how financial statements are presented and therefore hopefully reduce the extent of non-GAAP measures that are presented? What the board finally decided after considering various alternatives was they were going to add a project to discuss how the income statement might be further disaggregated or how the lines on the income statement could be further disaggregated, to provide additional information to users of financials.”

FASB planned to discuss that matter at a recent meeting, but Smith remains skeptical about that approach. “Personally I don’t think that’s going to really be all that helpful,” he said. “From a practical standpoint I’ve been fairly vocal, at least in the last year that I was on the board and since then. I think the board should do a more comprehensive study of exactly how financial statement users are using financials in order to evaluate what changes, if any, are necessary.”

He believes there’s a need for much more fundamental change. “There are various things that have changed in financial reporting over the last 50 years,” said Smith. “Users of financial statements frequently assess information that’s released, along with earnings releases in the form of investor packages or what have you. My suspicion is that a lot of investment decisions are made based upon that information, and that the financial statements that are filed for 10-Q or 10-K purposes are more corroborating as opposed to leading investors to make decisions. I think the board should be looking at if anything should be done by the board or some of the other regulatory bodies, such as the SEC or the PCAOB, on information that is provided to investors on an earlier basis through investor packages that accompany earnings releases. That’s probably the project that I think is one of the more important ones that the board is doing, and I think they could be going about it in a different fashion.”

GAAP Codification

Smith would also like to see FASB doing more on the U.S. GAAP Accounting Standards Codification. “I would hope the FASB continues to work on improving the codification,” he said. “The codification is something that is near and dear to my heart since I was intricately involved with its creation. I always thought that what we have today was a first step. It was a major step and a great accomplishment. But at the end of the day I don’t think it’s a final step. I think the FASB could do a lot, particularly in periods of time where it’s not working on major standards. The writing and/or organization of particular topics could be greatly improved to help people who use the codification understand it better. While it’s great to have all of the literature that was previously dispersed amongst a whole bunch of individual documents together under a topical organization, sometimes the reading of the codification is not all that easy because of how it was organized. I’ve been on a soapbox since the codification was created that the FASB needs to continue to try to do its best to improve the readability and therefore the usability of the codification.”


In terms of convergence with International Financial Reporting Standards, he explained how FASB’s relationship with the International Accounting Standards Board has evolved over the years.

“I think the FASB and the IASB had great intentions and quite frankly was successful with coming up with a converged standard when it comes to revenue recognition,” said Smith. “What happened with leases, in term of us going in a slightly different direction, the one thing people should focus on is, even though our lease standards aren’t converged, they are converged in one very fundamental aspect. That is, all leases, other than short-term leases, are now on the balance sheet. That’s a major accomplishment. That being said, the FASB doing something different for what we call operating leases from what the IASB does is a reflection of just different beliefs by different people who have a responsibility in how they think financial statements can be improved. And the same thing happened with credit losses. While there are numerous similarities in what the IASB decided and what the FASB decided, there are some very fundamental differences as well. Again, those differences relate to the FASB considering the environment in which standards are implemented and reviewed, audited and regulated in the U.S., gave rise to different positions at the FASB.”

For a period of time, the two standard-setting boards were holding frequent joint meetings to try to reach consensus on a single set of global accounting standards, but eventually they drifted apart.

“We were flying over there practically every month to have joint meetings,” said Smith. “It was a great experiment, but what it showed was that when you have different boards with their own responsibilities, you’re going to get differences. That doesn’t mean that people shouldn’t work together, or try to educate one another as to what they’re thinking. That’s the effort that’s taking place right now. The FASB watches what the IASB does and they watch what we do, and the FASB consults with other standard-setters throughout the world to understand what financial reporting problems they’re wrestling with, and to make them understand the financial reporting problems the U.S. is wrestling with in order to exchange ideas and learn from one another. And hopefully that will lead to standards across the globe that are similar, but I don’t think at the end of the day that you’re ever going to get a single set of identical standards because there are cultural and regulatory differences that must be addressed in each environment.”
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