December 31, 2008

Bob Jensen's New Bookmarks on  December 31, 2008
Bob Jensen at Trinity University 

For earlier editions of Fraud Updates go to http://www.trinity.edu/rjensen/FraudUpdates.htm
For earlier editions of Tidbits go to http://www.trinity.edu/rjensen/TidbitsDirectory.htm
For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Site.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/.

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

Many useful accounting sites (scroll down) --- http://www.iasplus.com/links/links.htm

Accounting program news items for colleges are posted at http://www.accountingweb.com/news/college_news.html
Sometimes the news items provide links to teaching resources for accounting educators.
Any college may post a news item.

Bob Jensen's essay on the financial crisis bailout's aftermath and an alphabet soup of appendices can be found at
http://www.trinity.edu/rjensen/2008Bailout.htm

Essay

• Introductory Quotations

• The Bailout's Hidden, Albeit Noble, Agenda (for added details see Appendix Y)

• A Step Back in History Barney's Rubble

Appendix A: Impending Disaster in the U.S.

Appendix B: The Trillion Dollar Bet in 1993

Appendix C: Don't Blame Fair Value Accounting Standards This includes a bull crap case based on an article by the former head of the FDIC

Appendix D: The End of Investment Banking as We Know It

Appendix E: Your Money at Work, Fixing Others’ Mistakes (includes a great NPR public radio audio module)

Appendix F: Christopher Cox Waits Until Now to Tell Us His Horse Was Lame All Along S.E.C. Concedes Oversight Flaws Fueled Collapse And This is the Man Who Wants Accounting Standards to Have Fewer Rules

Appendix G: Why the $700 Billion Bailout Proposed by Paulson, Bush, and the Guilty-Feeling Leaders in Congress Won't Work

Appendix H: Where were the auditors? The aftermath will leave the large auditing firms in a precarious state?

Appendix I: 1999 Quote from The New York Times ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Appendix J:  Will the large auditing firms survive the 2008 banking meltdown?

Appendix K:  Why not bail out everybody and everything?

Appendix L:  The trouble with crony capitalism isn't capitalism. It's the cronies.

Appendix M:  Reinventing the American Dream

Appendix N: Accounting Fraud at Fannie Mae

Appendix O: If Greenspan Caused the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to Burst?

Appendix P:  Meanwhile in the U.K., the Government Protects Reckless Bankers

Appendix Q: Bob Jensen's Primer on Derivatives (with great videos from CBS)

Appendix R:  Accounting Standard Setters Bending to Industry and Government Pressure to Hide the Value of Dogs

Appendix S: Fooling Some People All the Time

Appendix T:  Regulations Recommendations

Appendix U: Subprime: Borne of Sleaze, Bribery, and Lies

Appendix V: Implications for Educators, Colleges, and Students

Appendix W: The End

Appendix: X: How Scientists Help Cause Our Financial Crisis

Appendix Y:  The Bailout's Hidden Agenda Details

Appendix Z:  What's the rush to re-inflate the stock market?

Personal Note from Bob Jensen

Marvene is a poor and unemployed elderly woman who lost her shack to foreclosure in 2008.
That's after Marvene stole over $100,000 when she refinanced her shack with a subprime mortgage in 2007.
Marvene wants to steal some more or at least get her shack back for free.
Both the Executive and Congressional branches of the U.S. Government want to give more to poor Marvene.
Why don't I feel the least bit sorry for poor Marvene?
Somehow I don't think she was the victim of unscrupulous mortgage brokers and property value appraisers.
More than likely she was a co-conspirator in need of $75,000 just to pay creditors bearing down in 2007.
She purchased the shack for $3,500 about 40 years ago --- http://online.wsj.com/article/SB123093614987850083.html

Marvene Halterman, an unemployed Arizona woman with a long history of creditors, took out a $103,000 mortgage on her 576 square-foot-house in 2007. Within a year she stopped making payments. Now the investors with an interest in the house will likely recoup only $15,000.
The Wall Street Journal slide show of indoor and outdoor pictures --- http://online.wsj.com/article/SB123093614987850083.html#articleTabs%3Dslideshow
Jensen Comment
The $15,000 is mostly the value of the lot since at the time the mortgage was granted the shack was virtually worthless even though corrupt mortgage brokers and appraisers put a fraudulent value on the shack. Bob Jensen's threads on these subprime mortgage frauds are at http://www.trinity.edu/rjensen/2008Bailout.htm
Probably the most common type of fraud in the Savings and Loan debacle of the 1980s was real estate investment fraud. The same can be said of the 21st Century subprime mortgage fraud. Welcome to fair value accounting that will soon have us relying upon real estate appraisers to revalue business real estate on business balance sheets --- http://www.trinity.edu/rjensen/Theory01.htm#FairValue

CEO to his accountant:  "What is our net earnings this year?"
Accountant to CEO:  "What net earnings figure do you want to report?"

The sad thing is that Lehman, AIG, CitiBank, Bear Stearns, the Country Wide subsidiary of Bank America, Fannie Mae, Freddie Mac, etc. bought these
subprime mortgages at face value and their Big 4 auditors supposedly remained unaware of the millions upon millions of valuation frauds in the investments. Does professionalism in auditing have a stronger stench since Enron?
Where were the big-time auditors? --- http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

September 30, 1999

Fannie Mae Eases Credit To Aid Mortgage Lending

By STEVEN A. HOLMES

In a move that could help increase home ownership rates among minorities and low-income consumers, the Fannie Mae Corporation is easing the credit requirements on loans that it will purchase from banks and other lenders.

The action, which will begin as a pilot program involving 24 banks in 15 markets -- including the New York metropolitan region -- will encourage those banks to extend home mortgages to individuals whose credit is generally not good enough to qualify for conventional loans. Fannie Mae officials say they hope to make it a nationwide program by next spring.

Fannie Mae, the nation's biggest underwriter of home mortgages, has been under increasing pressure from the Clinton Administration to expand mortgage loans among low and moderate income people and felt pressure from stock holders to maintain its phenomenal growth in profits.

In addition, banks, thrift institutions and mortgage companies have been pressing Fannie Mae to help them make more loans to so-called subprime borrowers. These borrowers whose incomes, credit ratings and savings are not good enough to qualify for conventional loans, can only get loans from finance companies that charge much higher interest rates -- anywhere from three to four percentage points higher than conventional loans.

''Fannie Mae has expanded home ownership for millions of families in the 1990's by reducing down payment requirements,'' said Franklin D. Raines, Fannie Mae's chairman and chief executive officer. ''Yet there remain too many borrowers whose credit is just a notch below what our underwriting has required who have been relegated to paying significantly higher mortgage rates in the so-called subprime market.'' 
Demographic information on these borrowers is sketchy. But at least one study indicates that 18 percent of the loans in the subprime market went to black borrowers, compared to 5 per cent of loans in the conventional loan market.

In moving, even tentatively, into this new area of lending, Fannie Mae is taking on significantly more risk, which may not pose any difficulties during flush economic times. But the government-subsidized corporation may run into trouble in an economic downturn, prompting a government rescue similar to that of the savings and loan industry in the 1980's.

''From the perspective of many people, including me, this is another thrift industry growing up around us,'' said Peter Wallison a resident fellow at the Americ an Enterprise Institute. ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Under Fannie Mae's pilot program, consumers who qualify can secure a mortgage with an interest rate one percentage point above that of a conventional, 30-year fixed rate mortgage of less than $240,000 -- a rate that currently averages about 7.76 per cent. If the borrower makes his or her monthly payments on time for two years, the one percentage point premium is dropped.

Fannie Mae, the nation's biggest underwriter of home mortgages, does not lend money directly to consumers. Instead, it purchases loans that banks make on what is called the secondary mark et. By expanding the type of loans that it will buy, Fannie Mae is hoping to spur banks to make more loans to people with less-than-stellar credit ratings.

 

"New Prerequisites for CPAs," by David Motz, Inside Higher Ed, December 17, 2008 --- http://www.insidehighered.com/news/2008/12/17/cpa

Business schools in New York and Pennsylvania are getting ready for a boom in accounting enrollments, following changes in state policy on the education they need.

Looking for a job? See all 122 new postings Browse all job listings: Faculty: 3,578 Administrative: 1,607 Executive: 189 FEATURED EMPLOYERS

Related stories Making Engagement Data Meaningful, Dec. 12 So Goes the Nation, Nov. 13 General Education in the City, Sept. 5 A Case Study in Case Studies, March 22, 2007 Walking on Eggshells, Aug. 15, 2006 E-mail Print

Currently, New York and Pennsylvania require that C.P.A. candidates complete a minimum of 120 credit hours — of which at least 24 must be in accounting-related subjects — and have two years’ work experience in public accounting or auditing before they can earn a license.

As of August 1, 2009 in New York and January 1, 2012 in Pennsylvania, C.P.A. candidates must have completed a minimum of 150 credits hours — of which at least 36 must be in accounting-related subjects — and one year of work experience before they can earn a license. Though these changes do not require an advanced degree beyond the existing prerequisite of a bachelors’ degree, many students seeking a C.P.A. will have to enroll in graduate studies to meet the new minimum requirement for college credit hours. As a result, many students will earn master’s degrees. Advocates of the change argue that this will boost the credibility of their C.P.A.’s and give them an increased ability to practice in other states.

Most states already have made the shift; New York and Pennsylvania are particularly significant as big states with many business programs.

To account for these forthcoming changes, colleges and universities in New York and Pennsylvania have to either expand accounting programs or identify other educational pathways for students seeking a C.P.A. license.

Baruch College of the City University of New York has a large business school, which accounts for about 80 percent of its 16,000 students. Masako Darrough, chair of the department of accountancy, said she expects more students to apply for a master’s program in order to meet the 150-credit-hour threshold. In a fifth year, qualified students at the institution can earn either a master’s degree in accounting or taxation with more than enough credits to meet the new requirement.

Still, as a third of the business school’s undergraduates major in accounting, Darrough said she is concerned that the institution will not have enough space to serve the potentially growing number of students seeking more credits.

“We will have to be more selective,” she said of the institution’s master’s programs. “We cannot expand too much because we have a hiring freeze and our classrooms are already quite full as it is. This is a big change for students as well as for us, but we’re trying to help students plan well for the future.”

The already crowded business school has had to turn away a number of students with degrees from other institutions who were seeking to take additional credits without the goal of an advanced degree, Darrough noted.

Robert Morris University, in suburban Pittsburgh, is also prepping for the change, encouraging accounting undergraduates to enroll in a program that awards an M.B.A. for an additional year of study. Frank Flanegin, head of the department of accounting and finance, said the university introduced the program as a way to help students meet the upcoming requirement change.

“There’s no mandate with this change to get another degree – an M.S. in accounting or an MBA,” Flanegin said, noting that about half of the university’s accounting majors go onto seek a C.P.A. “But why would you want to have students take additional credits without earning an additional degree? This provides our accounting majors who know what they want to do with an opportunity to fulfill the requirement.”

The first class of Pennsylvania students to be affected by the change in requirements — the class of 2012 — will begin at the institution next fall, giving the institution more time to prepare for the change.

There is, however, a certain amount of skepticism regarding the change’s benefits to the field.

“It’s going to hurt,” Flanegin said of the additional educational requirements on new accountants. “There’s already a shortage of Ph.D.’s in accounting. Part of me understands why they’re doing this. They’re trying to raise the education level. Accounting has become much more complicated. Just look at the auditors and the mess we have on Wall Street. A lot of that came from accountants. There are a lot of reasons to require more education of C.P.A.’s.”

Darrough echoed the ambivalent sentiment.

“Some people think this is an undue burden on students,” she said of the 150-credit-hour requirement. “It’s a costly process [to require additional education of CPA candidates] and some wonder if the benefits outweigh the cost.”

NASBA 2008 Update:  120 Versus 150-Credit Hour Requirement to Sit for the CPA Examination
There are now only two states that do not require 150-credits to sit for the CPA Examination, with California being the largest jurisdiction

DRAFT Education and Licensure Requirements for Certified Public Accountants: A Discussion Regarding Degreed Candidates Sitting for the Uniform CPA Examination with a Minimum of 120 Credit Hours (120-Hour Candidate) and Becoming Eligible for Licensure with a Minimum of 150 Credit Hours (150-Hour Candidate) (120/150 Discussion), Issued by the National Association of State Boards of Accountancy (NASBA) , November 2008 ---
http://snipurl.com/150nasba  [www_nasba_org] 
 http://www.nasba.org/862571B900737CED/318CD757B9F57F75862574FA00763F36/$file/120_150_Paper_Draft_November_08.pdf

The above draft has quite a lot of data and provides extensive history of the 150-Hour Rule.

For a wider history see http://en.wikipedia.org/wiki/Uniform_Certified_Public_Accountant_Examination
Part of the above Wikipedia module was out of date, so I changed the Wikipedia module on December 13, 2008.

NASBA has some learning tools at http://www.nasbatools.com/display_page

Free CPA Examination Review Course --- http://cpareviewforfree.com/
AccountingWeb Student Zone --- http://www.accountingweb.com/news/student_zone.html 

For many students, the fee-based CPA Examination Review materials and courses are likely to get better results, especially those that force students to weekly stay on track and those that have multimedia helpers and those that meet onsite as a regular class.

Accounting Institute Seminars
Becker CPA Review
Bisk-Totaltape CPA Exam Review
Conviser Duffy CPA Review (now merged with Becker)
CPA Review Twin Cities
CPAexcel CPA Exam Review
Dynasty School
Gleim Publications
Hoyle CPA Ventures
Intensive CPA Examination Review
Kaplan
Lambers
Mark's CPA Review
MicroMash
Person/Wolinsky CPA Review Courses
Rigos Professional Education
The Tutorial Group, Inc.
Wiley CPA Exam Review
Wise Guides

December 13, 2008 reply from Ron Huefner [rhuefner@acsu.buffalo.edu]

Bob:

While the NASBA report says that 48 jurisdictions require the 150 hours for CPA licensure, that does not mean, as your e-mail said, that "there are now only two states that do not". There are 54 licensing jurisdictions (50 states plus DC, Puerto Rico, Guam, and U.S. Virgin Islands) and will soon be 55 when the exam becomes active in the Commonwealth of the Northern Marianas Islands. So we have six non-150 states.

Ron

December 13, 2008 reply from Amy Dunbar [Amy.Dunbar@business.uconn.edu]

Bob,
Did you mean to refer to the licensure requirement? In Connecticut, you can sit for the exam with 120, but you need 150 to be licensed.
Amy

Bob Jensen's career helpers are at http://www.trinity.edu/rjensen/Bookbob1.htm#careers

Wouldn’t it have been helpful if we had more corporate executives and board members who’d had such training in their college years and were primed to question the fundamental assumptions of the industries in which they were engaged? Who didn’t assume that if they got a big bonus at year’s end, they must be doing everything right? Instead, we are left with an economy in near-ruin by the collective action of individuals who, I’m quite sure, got good grades, who knew how to ace the examinations on which they’d been coached, and whose long-term vision stretched no further than the end of the term. That view is great while it lasts, but, like that shiny “A” one crams for on the quiz, the substance is gone before the ink is dry.
Ralph Hexter (President of Hampshire College), "The Economic Collapse and Educational Values," Inside Higher Ed, December 18, 2008 --- http://www.insidehighered.com/views/2008/12/18/hexter

Agency Theory Question
Why do corporate executives like fair value accounting better than shareholders like fair value accounting?

Answer
Cash bonuses on the upside are not returned after the downturn that wipes out the previous unrealized paper profits.

Phantom (Unrealized) Profits on Paper, but Real Cash Outflows for Employee Bonuses and Other Compensation
Rarely, if ever, are they forced to pay back their "earnings" even in instances of earnings management accounting fraud

"On Wall Street, Bonuses, Not Profits, Were Real," by Louise Story, The New York Times, December 17, 2008 --- http://www.nytimes.com/2008/12/18/business/18pay.html?partner=permalink&exprod=permalink

"Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.

“As a result of the extraordinary growth at Merrill during my tenure as C.E.O., the board saw fit to increase my compensation each year.”

— E. Stanley O’Neal, the former chief executive of Merrill Lynch, March 2008

For Dow Kim, 2006 was a very good year. While his salary at Merrill Lynch was $350,000, his total compensation was 100 times that — $35 million.

The difference between the two amounts was his bonus, a rich reward for the robust earnings made by the traders he oversaw in Merrill’s mortgage business.

Mr. Kim’s colleagues, not only at his level, but far down the ranks, also pocketed large paychecks. In all, Merrill handed out $5 billion to $6 billion in bonuses that year. A 20-something analyst with a base salary of $130,000 collected a bonus of $250,000. And a 30-something trader with a $180,000 salary got $5 million.

But Merrill’s record earnings in 2006 — $7.5 billion — turned out to be a mirage. The company has since lost three times that amount, largely because the mortgage investments that supposedly had powered some of those profits plunged in value.

Unlike the earnings, however, the bonuses have not been reversed.

As regulators and shareholders sift through the rubble of the financial crisis, questions are being asked about what role lavish bonuses played in the debacle. Scrutiny over pay is intensifying as banks like Merrill prepare to dole out bonuses even after they have had to be propped up with billions of dollars of taxpayers’ money. While bonuses are expected to be half of what they were a year ago, some bankers could still collect millions of dollars.

Critics say bonuses never should have been so big in the first place, because they were based on ephemeral earnings. These people contend that Wall Street’s pay structure, in which bonuses are based on short-term profits, encouraged employees to act like gamblers at a casino — and let them collect their winnings while the roulette wheel was still spinning.

“Compensation was flawed top to bottom,” said Lucian A. Bebchuk, a professor at Harvard Law School and an expert on compensation. “The whole organization was responding to distorted incentives.”

Even Wall Streeters concede they were dazzled by the money. To earn bigger bonuses, many traders ignored or played down the risks they took until their bonuses were paid. Their bosses often turned a blind eye because it was in their interest as well.

“That’s a call that senior management or risk management should question, but of course their pay was tied to it too,” said Brian Lin, a former mortgage trader at Merrill Lynch.

The highest-ranking executives at four firms have agreed under pressure to go without their bonuses, including John A. Thain, who initially wanted a bonus this year since he joined Merrill Lynch as chief executive after its ill-fated mortgage bets were made. And four former executives at one hard-hit bank, UBS of Switzerland, recently volunteered to return some of the bonuses they were paid before the financial crisis. But few think others on Wall Street will follow that lead.

For now, most banks are looking forward rather than backward. Morgan Stanley and UBS are attaching new strings to bonuses, allowing them to pull back part of workers’ payouts if they turn out to have been based on illusory profits. Those policies, had they been in place in recent years, might have clawed back hundreds of millions of dollars of compensation paid out in 2006 to employees at all levels, including senior executives who are still at those banks.

A Bonus Bonanza

For Wall Street, much of this decade represented a new Gilded Age. Salaries were merely play money — a pittance compared to bonuses. Bonus season became an annual celebration of the riches to be had in the markets. That was especially so in the New York area, where nearly $1 out of every $4 that companies paid employees last year went to someone in the financial industry. Bankers celebrated with five-figure dinners, vied to outspend each other at charity auctions and spent their newfound fortunes on new homes, cars and art.

The bonanza redefined success for an entire generation. Graduates of top universities sought their fortunes in banking, rather than in careers like medicine, engineering or teaching. Wall Street worked its rookies hard, but it held out the promise of rich rewards. In college dorms, tales of 30-year-olds pulling down $5 million a year were legion.

While top executives received the biggest bonuses, what is striking is how many employees throughout the ranks took home large paychecks. On Wall Street, the first goal was to make “a buck” — a million dollars. More than 100 people in Merrill’s bond unit alone broke the million-dollar mark in 2006. Goldman Sachs paid more than $20 million apiece to more than 50 people that year, according to a person familiar with the matter. Goldman declined to comment.

Pay was tied to profit, and profit to the easy, borrowed money that could be invested in markets like mortgage securities. As the financial industry’s role in the economy grew, workers’ pay ballooned, leaping sixfold since 1975, nearly twice as much as the increase in pay for the average American worker.

“The financial services industry was in a bubble," said Mark Zandi, chief economist at Moody’s Economy.com. “The industry got a bigger share of the economic pie.”

A Money Machine

Dow Kim stepped into this milieu in the mid-1980s, fresh from the Wharton School at the University of Pennsylvania. Born in Seoul and raised there and in Singapore, Mr. Kim moved to the United States at 16 to attend Phillips Academy in Andover, Mass. A quiet workaholic in an industry of workaholics, he seemed to rise through the ranks by sheer will. After a stint trading bonds in Tokyo, he moved to New York to oversee Merrill’s fixed-income business in 2001. Two years later, he became co-president.

Skip to next paragraph

Bloomberg News Dow Kim received $35 million in 2006 from Merrill Lynch.

The Reckoning Cashing In Articles in this series are exploring the causes of the financial crisis.

Previous Articles in the Series » Multimedia Graphic It Was Good to Be a Mortgage-Related Professional . . . Related Times Topics: Credit Crisis — The Essentials

Patrick Andrade for The New York Times Brian Lin is a former mortgage trader at Merrill Lynch who lost his job at Merrill and now works at RRMS Advisors. Readers' Comments Share your thoughts. Post a Comment »Read All Comments (363) »

Even as tremors began to reverberate through the housing market and his own company, Mr. Kim exuded optimism.

After several of his key deputies left the firm in the summer of 2006, he appointed a former colleague from Asia, Osman Semerci, as his deputy, and beneath Mr. Semerci he installed Dale M. Lattanzio and Douglas J. Mallach. Mr. Lattanzio promptly purchased a $5 million home, as well as oceanfront property in Mantoloking, a wealthy enclave in New Jersey, according to county records.

Merrill and the executives in this article declined to comment or say whether they would return past bonuses. Mr. Mallach did not return telephone calls.

Mr. Semerci, Mr. Lattanzio and Mr. Mallach joined Mr. Kim as Merrill entered a new phase in its mortgage buildup. That September, the bank spent $1.3 billion to buy the First Franklin Financial Corporation, a mortgage lender in California, in part so it could bundle its mortgages into lucrative bonds.

Continued in article

How to play tricks on fair value accounting by "managing" the closing price of key securities in the portfolio
Painting the Tape (also called Banging the Close)
This occurs when a portfolio manager holding a security buys a few additional shares right at the close of business at an inflated price. For example, if he held shares in XYZ Corp on the last day of the reporting period (and it's selling at, say $50), he might put in small orders at a higher price to inflate the the closing price (which is what's reported). Do this for a couple dozen stocks in the portfolio, and the reported performance goes up. Of course, it goes back down the next day, but it looks good on the annual report.
Jason Zweig, "Pay Attention to That Window Behind the Curtain," The Wall Street Journal, December 20, 2008 --- http://online.wsj.com/article/SB122973369481523187.html?

Bob Jensen's threads on earnings management are at http://www.trinity.edu/rjensen/Theory01.htm#Manipulation

Bob Jensen's threads on fair value accounting are a http://www.trinity.edu/rjensen/Theory01.htm#FairValue

Bob Jensen's "Rotten to the Core" document --- http://www.trinity.edu/rjensen/FraudRotten.htm

"SEC Advises No Break in 'Mark' (Fair Value Accounting) Rules," by Michael R. Crittenden, The Wall Street Journal, December 31, 2008 --- http://online.wsj.com/article_email/SB123067591247143735-lMyQjAxMDI4MzMwMDYzNzA1Wj.html 

The Securities and Exchange Commission recommended against suspending fair-value accounting rules, instead suggesting improvements to deal with illiquid markets and reducing the number of models used to measure impaired assets.

In a 211-page report to U.S. lawmakers, as expected, the agency's staff Tuesday definitely recommended that fair-value and mark-to-market not be eliminated or suspended. "The abrupt elimination of fair value and market-to-market requirements would erode investor confidence," the report said.

The banking lobby has argued that financial institutions have been forced to write off as losses still-valuable assets because the market for them had dried up, creating a spiral of write-downs and asset sales.

The report said that staff found no evidence to suggest that the accounting rules had played a significant role in the collapse of U.S. financial institutions. "While the application of fair value varies among these banks...in each case studied it does not appear that the application of fair value can be considered to have been a proximate cause of the failure," the report said.

Additionally, the SEC suggests that the Financial Accounting Standards Board narrow the number of accounting models firms can use to assess the impairment for financial instruments.

Denny Beresford forwarded the above link and recommends that all accounting educators read the full 259 page SEC report that was mandated by Congress --- http://www.sec.gov/news/studies/2008/marktomarket123008.pdf

Jensen Comment
The above report makes a good case for financial asset and liability fair value accounting, but does not make a case for similar accounting of non-financial items in a going concern.

Bob Jensen's threads on fair value accounting are at http://www.trinity.edu/rjensen/theory01.htm#FairValue

Banking industry pressures to abandon fair value accounting are summarized at
http://www.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting

PKL Accounting Education Software (for a fee) --- http://www.pklsoftware.com/

Hello Professor Jensen

When you log into www.pklsoftware.com  you are at the home page of PKL. All of the products listed are currently available for a professor to choose. To view any product just click on the product button. To log into view a product, just enter Anonymous as your ID/Name and Anonymous as your Password.

All products are web-based, will run on any computer. They include:

1. Practice sets at three different levels: Middle of Financial, End of Financial, Cost, Managerial, or Intermediate

2. Work4Me Problems: Twenty individual business problems emphasizing key topics of Financial Accounting

3. Accounting Coach: Twenty-five Financial Accounting topics (algorithmic problems) that instruct, coach, teach, and test a students skills.

I would be honored if you would allow me to save you a great deal of time by joining me, at your convenience, in a short, WebEx demonstration of how our key products work for professors and their students. With a WebEx demonstration, you sit at your computer, dial into our toll-free conference call line, and you will be looking at my screen while we talk about all of the many features we now have included in our new products. This will give me the opportunity to answer all of your questions.

The professors at Trinity were very excited about what I showed them and like 95% of our demonstrations, they adopted one of our products.

A short look at a practice set, will give you a good picture of how our software works for all of the practice sets and the Work4Me problems.

Seeing how our Accounting Coach helps a student practice, learn, and then evaluate themselves on multiple Financial topics will give you another view of what we have put together.

In a nutshell, we have a great set of products, we just need to get the work out and we are working hard to do that. In two weeks we will start our Spring semester and over 550 students will be using one or more of our products.

Let me know if you like to see our work or if you would like a professor registration code for any product.

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PKL Software

Bob Jensen's threads on accounting education software are at http://www.trinity.edu/rjensen/Bookbob1.htm#software

Bob Jensen's threads on accounting software are at http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

From IAS Plus IFRS Updates --- http://www.iasplus.com/index.htm

Bob Jensen's threads on IFRS controversies are at http://www.trinity.edu/rjensen/Theory01.htm#MethodsForSetting

Selected Financial Reporting Council (FRC) Audit Reports in the United Kingdom --- http://www.frc.org.uk/
"Called to accountWith conflicts of interest rife, the auditing industry is in desperate need of independent oversight," by Prem Sikka, The Guardian, December 14, 2008 --- http://www.guardian.co.uk/commentisfree/2008/dec/14/credit-crunch-auditing

Selected PCAOB Audit Inspection Reports in the U.S. --- http://www.pcaob.org/Inspections/Public_Reports/index.aspx
It's interesting to see which firms did inadequate substantive testing (possibly due to costs of substantive testing)

2007 Inspection Report for Ernst & Young (issued April 29, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/Ernst_Young.pdf
Includes April 24, 2008 reply from Ernst & Young

2007 Inspection Report for KPMG (Issued August 12, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/KPMG_LLP.pdf
Includes July 30, 2008 reply from KPMG

2007 Inspection Report for PricewaterhouseCoopers (Issued July 27, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/PricewaterhouseCoopers-0627.pdf
Includes June 19, 2008 reply from PwC

2007 Inspection Report for Grant Thornton (Issued April 4, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/Grant_Thornton.pdf
Includes March 31, 2008 reply from Grant Thornton

2007 Inspection Report for McGladrey & Pullen (Issued April 29, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/McGladrey_Pullen.pdf
Includes April 23, 2008 reply from McGladrey & Pullen

2007 Inspection Report for Deloitte (issued May 19, 2008) ---
http://www.pcaob.org/Inspections/Public_Reports/2008/Deloitte.pdf
Includes April 30, 2008 reply from Deloitte
 

Recall that Deloitte earlier received a $1 million fine by the PCAOB

December 14, 2008 reply from Roger Debreceny [roger@DEBRECENY.COM]

Further to this, as reported by Double Entries, the PCAOB has released a summary report of four years of inspections at http://pcaob.org/News_and_Events/News/2008/12-05.aspx 

Roger

Washington, DC, December 5, 2008 – The Public Company Accounting Oversight Board today released a report summarizing the inspection findings of the eight domestic accounting firms that were subject to annual inspections over the past four years.

The PCAOB focuses its inspections on those areas of an audit likely to pose the most significant challenges for an auditor or to pose the most significant risk to investors of misstated financial statements. These include areas that are fundamental to any audit, such as testing of revenue, as well as areas that pose increasingly challenging issues in current market conditions, such as testing of fair value measurements.

The report describes deficiencies observed in these areas, as well as deficiencies in the following additional audit areas: identifying departures from generally accepted accounting principles (GAAP), auditing of management's estimates, income taxes, and internal control, performing analytical procedures and audit sampling, using the work of specialists, and assessing materiality, audit scope and audit differences.

The report also includes information on changes in the quality control systems that firms have described in remediation plans submitted in response to the first years of inspection reports. These include changes to their structure, partner evaluation processes, internal inspection programs, procedures for using the work of foreign affiliates, and processes for compliance with independence requirements.

"The Board's focus on improvements in the firms' audits and quality control systems is critical to our mission to protect investors. This report describes areas where we have found problems, and notes steps the firms have undertaken in response to certain quality control criticisms," said Mark W. Olson, PCAOB Chairman.

George Diacont, Director of the PCAOB Division of Registration and Inspections, added, " While we are encouraged by the efforts of firms to remediate quality control deficiencies that we have observed, the report highlights the need for continued focus on performing high quality audits. Even in recent years, we are seeing deficiencies in the most important and high-risk areas of the audits, where appropriate levels of care and professional skepticism are needed."

The eight domestic firms covered by this report -- that have been inspected annually for each of the past four years -- are together responsible for the audits of approximately 66 percent of all U.S.-based public companies. Four of these firms audit public companies representing 98 percent of the total U.S. market capitalization.

Each of the firms included in this report is based in the United States and has maintained more than 100 public company audit clients over the past four years. During the period covered by the report, PCAOB inspectors reviewed a selection of the firms' audits of client financial statements for 2003 to 2006.

The report is based on annual PCAOB inspections from 2004 to 2007, which included, among other things, reviews of aspects of more than 1,600 audits. Some of the information in the report has previously been reported in public portions of inspection reports on the individual firms; but the report also includes information not previously made public. Consistent with the Sarbanes-Oxley Act and the Board's Rule 4010, any otherwise nonpublic information from the PCAOB's inspection process that is included in the report does not identify the particular firm or firms to which the information relates.

The report has been posted to the PCAOB Web site at http://www.pcaobus.org/Inspections/Other/2008/12-05_Release_2008-008.pdf
It is entitled "REPORT ON THE PCAOB'S 2004, 2005, 2006, AND 2007 INSPECTIONS OF DOMESTIC ANNUALLY INSPECTED FIRMS," PCAOB Release No. 2008-008, December 5, 2008

Bob Jensen's threads on large auditing firm litigations are at http://www.trinity.edu/rjensen/Fraud001.htm

Old Fashioned Purchasing Executive Kickback Fraud:  Where were the auditors

I've had difficulty discovering what firm audited this company. Both external and internal auditors generally give more attention to the purchasing departments companies than any other department, because this department historically in companies is the source of more frauds than most any other department. In this particular company, the internal controls are blatantly out of line. I wonder who audited this company.

"Executive Stole $65M to Pay Gambling Debts," AccountingWeb, December 23, 2008 --- http://accounting.smartpros.com/x64198.xml

A Ferrari-driving vice president of Fry's Electronics Inc. who was allegedly such a heavyweight gambler that casinos chartered private planes to fly him to Las Vegas, has been arrested on charges he embezzled more than $65 million from the retailer to fuel his lavish lifestyle and pay off debts.

Ausaf Umar Siddiqui is accused by the Internal Revenue Service of concocting an incredibly profitable scheme in which he cut side deals with some of Fry's suppliers, buying their goods at higher prices than they would normally get, and buying more of them than he normally would, in exchange for kickbacks of up to 31 percent of the total sales price.

The IRS alleges in a criminal complaint filed against Siddiqui that he set up a shell company that hid $65.6 million in kickback payments from five Fry's vendors from January 2005 to November 2008. Of that amount, $17.9 million was paid to subsidiaries of Las Vegas Sands Corp., which operates the Venetian Casino Resort, according to the criminal complaint and regulatory filings. Authorities confirmed the payments went to the casino.

Siddiqui, who lives in Palo Alto, California, was ordered held on $300,000 bond Monday at a hearing in U.S. District Court in San Jose. He has been in custody since Friday, when agents arrested him at Fry's headquarters in San Jose in front of stunned co-workers. The details about his Ferrari and the private jets came out during the hearing Monday.

His home phone number is unlisted, and it was not immediately clear whether Siddiqui had a defense lawyer. A criminal complaint is one of the preliminary investigative steps for arresting someone and securing an indictment.

A Fry's spokesman did not return a phone call from The Associated Press left after-hours.

Siddiqui has not been formally charged yet with the wire-fraud allegations laid out in the criminal complaint. Arlette Lee, spokeswoman for the IRS' Criminal Investigation division, said the judge in the case has given the government 20 days to file formal charges, which she said prosecutors intend to do.

As Fry's vice president of merchandising and operations, Siddiqui pulled down a legitimate annual salary of $225,000, supervised a staff of 120 and his team was responsible for buying all the merchandise sold in Fry's 34 stores around the U.S., according to the criminal complaint. The stores are mostly located in California and Texas.

The IRS alleges Siddiqui was able to amass so much illegal money by convincing Fry's executives that he alone should be responsible for a job that is typically handled by independent contractors - the job of the sales representative that brokers deals with the suppliers and the stores for a cut of the total sales price.

The reps are kept independent so they're not seen as favoring one side or the other in sales negotiations, and their job can be lucrative if they're good at it, with commissions ranging from 3 to 8 percent of the total sales they bring in, according to the complaint.

The IRS claims Siddiqui started striking side deals with some of the suppliers, in which he would guarantee he'd keep their products stocked on Fry's shelves, in exchange for kickbacks in the form of steep commissions paid to a company he set up called PC International.

The alleged scheme unraveled when another Fry's executive walked into Siddiqui's office in October and saw spreadsheets on his desk outlining the payments and alleged kickbacks, according to the complaint. Siddiqui was not there, so the executive took the documents, contacted the IRS and handed over the evidence.

The IRS later examined Siddiqui's bank records and found that a total of $167.8 million was deposited into the bogus company's bank account. Seventy wire transfers totaling $65.6 million came from five Fry's suppliers, who were not named as defendants in the case.

Fry's Electronics Home Page --- http://www.frys.com/

Bob Jensen's Fraud Updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

Public Insurance Companies versus Mutual Insurance Companies

David Schiff, an industry gadfly and publisher of Schiff's Insurance Observer, has been warning since the late 1990s that earnings-per-share pressures would drive insurers to do dumb things. He was right. Since going public Prudential has spent $11 billion buying back shares at an average cost of $63, Schiff estimates. Those shares are now worth $19. Hartford spent $2 billion the past two years buying back stock. That's as much as the entire company is now worth. The mutuals aren't geniuses at investing--proportionally they own more mortgage securities than do public insurers, according to Etti Baranoff, a professor of insurance at Virginia Commonwealth University and former Texas insurance regulator. It's just that mutuals don't have the same incentives to boost net income. Baranoff also notes that mutuals don't have to file financials under Generally Accepted Accounting Principles. Those principles require public companies to mark down investment securities, some of them distressed and thinly traded, to current market values. The rule has given rise to $40 billion in unrealized losses as of Sept. 30. Perhaps the market has overcorrected, and shares of Hartford and Prudential are a bargain. But their mutual rivals will be snickering for quite a while.
Bernard Condon and Daniel Fisher, "Mutual Respect, Forbes, December 22, 2008 ---
http://www.forbes.com/forbes/2008/1222/036.html?partner=magazine_newsletter

Is it possible to teach this transaction from an IFRS perspective?

Denny Beresford made a helpful suggestion that one way to teach IFRS is to first look at the transaction itself and then reason out how to account for it under IFRS standards and interpretations. So here's a challenge for your advanced-level accounting students:  How would you account for this one under IFRS?

What this illustrates is the type of thing that the IASB will have to tackle all alone, without a FASB research staff, when the U.S. depends upon the IASB for its accounting standards. I don't think the IASB fully understands what it is getting into by so desperately wanting to set accounting standards for U.S. companies.

From the financial rounds blog on December 29, 2008

How Do You Use Credit Default Swaps (CDS) To Create "Synthetic Debt"?

There's been a lot of talk in recent months about "synthetic debt". I just read a pretty good explanation of synthetics in Felix Salmon's column, so I thought I'd give a brief summary of what it is, how it's used, and why.

First off, let's start with Credit Default Swaps (CDS). A CDS has a lot of similarities to an insurance policy on a bond (it's different in that the holder of the CDS needn't own the underlying bond or even suffer a loss if the bond goes into default).

The buyer (holder) of a CDS will make yearly payments (called the "premium"), which is stated in terms of basis points (a basis point is 1/100 of one percent of the notional amount of the underlying bond). The holder of the CDS gets paid if the bond underlying the CDS goes into default or if other stated events occur (like bankruptcy or a restructuring).

So, how do you use a CDS to create a synthetic bond? here's the example from Salmon's column:

Let's assume that IBM 5-year bonds were yielding 150 basis points over treasuries. In addition, Let' s assume an individual (or portfolio manager) wanted to get exposure to these bonds, but didn't think it was a feasible to buy the bonds in the open market (either there weren't any available, or the market was so thin that he's have to pay too high a bid-ask spread). Here's how he could use CDS to accomplish the same thing:
 

• First, buy $100,000 of 5-year treasuries and hold them as collateral
• Next, write a 5-year, $100,000 CDS contract
• he's receive the interest on the treasuries, and would get a 150 basis point annual premium on the CDS
   

So, what does he get from the Treasury plus writing the CDS? If there's no default, the coupons on the Treasury plus the CDS premium will give him the same yearly amount as he would have gotten if he's bought the 5-year IBM bond, And if the IBM bond goes into default, his portfolio value would be the value of the Treasury less what he would have to pay on the CDS (this amount would be the default losses on the IBM bond). So in either case (default or no default), his payoff from the portfolio would be the same payments as if he owned the IBM bond.

So why go through all this trouble? One reason might be that there's not enough liquidity in the market for the preferred security (and you'd get beaten up on the bid-ask spread). Another is that there might not be any bonds available in the maturity you want. The CDS market, on the other hand, is very flexible and extremely liquid.

One thing that's interesting about CDS is that (as I mentioned above), you don't have to hold the underlying asset to either buy or write a CDS. As a result, the notional value of CDS written on a particular security can be multiple times the actual amount of the security available.

I know of at least one hedge fund group that bought CDS as a way of betting against housing-sector stocks (particularly home builders). From what i know, they made a ton of money. But CDS can also be used to hedge default risk on securities you already hold in a portfolio.

To read Salmon's column, click here, and to read more about CDS, click here

Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad due to having turds mixed in with the chocolates, the "counterparty" who purchased the CDO will recover the value fraudulently invested in turds. On September 30, 2008 Gretchen Morgenson of The New York Times aptly explained that the huge CDO underwriter of CDOs was the insurance firm called AIG. She also explained that the first $85 billion given in bailout money by Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also explained that, unlike its casualty insurance operations, AIG had no capital reserves for paying the counterparties for the the turds they purchased from Wall Street investment banks.

"Your Money at Work, Fixing Others’ Mistakes," by Gretchen Morgenson, The New York Times, September 20, 2008 --- http://www.nytimes.com/2008/09/21/business/21gret.html

What Ms. Morgenson failed to explain, when Paulson eventually gave over $100 billion for AIG's obligations to counterparties in CDS contracts, was who were the counterparties who received those bailout funds. It turns out that most of them were wealthy Arabs and some Asians who we were getting bailed out while Paulson was telling shareholders of WaMu, Lehman Brothers, and Merrill Lynch to eat their turds.

You tube has a lot of videos about a CDS. Go to YouTube and read in the phrase "credit default swap" --- http://www.youtube.com/results?search_query=Credit+Default+Swaps&search_type=&aq=f
In particular note this video by Paddy Hirsch --- http://www.youtube.com/watch?v=kaui9e_4vXU
Paddy has some other YouTube videos about the financial crisis.

Bob Jensen’s threads on accounting for credit default swaps are under the C-Terms at
http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms

Bob Jensen's threads on CDO accounting are at http://www.trinity.edu/rjensen/theory01.htm#CDO

Bob Jensen's threads on FIN 46 are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

"Understanding Synthetics," by Felix Salman, Portfolio.com, November 28, 2008 ---
http://www.portfolio.com/views/blogs/market-movers/2008/11/28/understanding-synthetics

Over the past few days, two very smart people have asked me about a passage in Michael Lewis's cover story for Portfolio in which he talks about synthetic CDOs without actually using the term. They said that they didn't quite understand it, so I'm going to try to explain what a synthetic bond is. Once I've done that, the Lewis passage should be a lot more comprehensible.

Let's start with a simple single-credit synthetic bond. You're an investor, and looking at the credit markets, you see that IBM debt is trading at attractive levels, especially around the 5-year mark, where they yield about 150bp over Treasuries. You'd really like to buy $100 million of IBM bonds maturing in five years, but IBM isn't returning your calls (they have no desire to borrow money at these spreads), and there aren't any IBM bonds with exactly the maturity you want. What's more, even the bonds with maturities nearby are illiquid, and closely held: there's no way you can just blunder into the market and buy up that many bonds without massively skewing the market, since the overwhelming majority of the bonds are just not for sale.

So you buy a synthetic IBM five-year bond instead, taking advantage of the much more liquid CDS market. Essentially, you take the $100 million that you were going to spend on IBM bonds, and you put it into a special-purpose entity called, say, Fred. (In reality, it'll be called something really boring like Synthetic Technology Invetments Cayman III Limited, but Fred is easier to remember.) First, Fred takes the $100 million and invests it in 5-year Treasury bonds.

Next thing, Fred goes out and sells $100 million of credit protection on IBM in the CDS market, using the $100 million of Treasury bonds as collateral. The buyer of protection will pay $1.5 million per year (150 basis points) to Fred, and in return Fred promises to pay $100 million to the buyer in the event IBM defaults, less the value of IBM's bonds at the time. The buyer knows that Fred is good for the money, because it's already there, tied up in Treasury bonds.

So long as IBM doesn't default, you get not only the $1.5 million per year from the buyer of protection, but also the interest on the Treasury bonds. You wanted to buy IBM bonds yielding 150bp over Treasuries, and that's exactly what you're getting: the 150bp from the CDS counterparty, and the Treasury interest from the Treasury bonds. At maturity, assuming IBM still hasn't defaulted, you get your $100 million back, the CDS contract has expired, and Fred has no contingent liability any more.

The effect is identical to holding an IBM bond -- and you can even sell your interest in Fred, just like you could sell an IBM bond. If IBM defaults, you lose your $100 million, but you get back the value of an IBM bond -- which again is the same outcome as if you'd bought an IBM bond for $100 million and IBM defaulted.

But the key thing to note is that IBM itself is not involved in the transaction at all. It doesn't matter how few bonds IBM has issued, there can be many times that amount in synthetic IBM bonds, just so long as there are enough people out there willing to buy and sell credit protection on IBM.

And just as you can create a synthetic IBM bond, you can create a synthetic bond portfolio, made up of credit default swaps on any number of corporate names or even mortgage-backed securities. The special purpose vehicles in those cases sometimes sell protection on a lot of different names; sometimes they just sell protection on a liquid CDS index. Either way, the returns that those vehicles offer are basically the same as the returns on buying the underlying securities -- if those securities were easily available.

Now that we've understood all that, we can return to Michael Lewis's piece, where he's talking about a chap called Steve Eisman, who was buying protection in the CDS market, and is sat at dinner next to one of his counterparties, who was selling protection.

Whatever rising anger Eisman felt was offset by the man's genial disposition. Not only did he not mind that Eisman took a dim view of his C.D.O.'s; he saw it as a basis for friendship. "Then he said something that blew my mind," Eisman tells me. "He says, 'I love guys like you who short my market. Without you, I don't have anything to buy.'¿"
That's when Eisman finally got it. Here he'd been making these side bets with Goldman Sachs and Deutsche Bank on the fate of the BBB tranche without fully understanding why those firms were so eager to make the bets. Now he saw. There weren't enough Americans with shitty credit taking out loans to satisfy investors' appetite for the end product. The firms used Eisman's bet to synthesize more of them. Here, then, was the difference between fantasy finance and fantasy football: When a fantasy player drafts Peyton Manning, he doesn't create a second Peyton Manning to inflate the league's stats. But when Eisman bought a credit-default swap, he enabled Deutsche Bank to create another bond identical in every respect but one to the original. The only difference was that there was no actual homebuyer or borrower. The only assets backing the bonds were the side bets Eisman and others made with firms like Goldman Sachs. Eisman, in effect, was paying to Goldman the interest on a subprime mortgage. In fact, there was no mortgage at all. "They weren't satisfied getting lots of unqualified borrowers to borrow money to buy a house they couldn't afford," Eisman says. "They were creating them out of whole cloth. One hundred times over! That's why the losses are so much greater than the loans. But that's when I realized they needed us to keep the machine running. I was like, This is allowed?"

What Eisman is saying is that there were mortgage-backed securities, and then there were synthetic mortgage-backed securities; when the banks ran out of actual MBS to sell to investors, they sold them synthetic MBS instead. And yes, that was allowed.

There is some hyperbole here, though. While there were undoubtedly a lot of synthetic MBS issued, they weren't a large multiple of the real MBS issued, as the "one hundred times over" quote would suggest. Which is quite obvious, if you think about it: there weren't a lot of people like Steve Eisman willing to short the MBS market -- and you need them, to take the other side of the trade.

In fact, most of the synthetic MBS issued were issued by banks which kept the underlying mortgages on their own balance sheet. Rather than put the mortgages directly into a CDO and sell that to investors, they kept the mortgages themselves and bought protection from the CDO on them -- creating a synthetic CDO which mirrored (and which they could sell to hedge) their own holdings. Why did they do that? That's the story of the super-senior tranche, and will have to wait for another day.

Bob Jensen's threads on FIN 46 are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm
(Includes accounting for synthetic leases)

Question
How are for-profit universities doing relative to not-for-profit universities in the recession?

Facing projections of a 30-percent drop in its endowment, Harvard will freeze salaries for faculty members and nonunion staff members, suspend nearly all searches for tenure-track and tenured professors, and place restrictions on hiring instructional faculty members, The Harvard Crimson reported today.
Chronicle of Higher Education, December 9, 2008 ---
http://chronicle.com/news/article/5630/harvard-freezes-salaries-suspends-faculty-searches?utm_source=at&utm_medium=en

The for-profit college industry, unlike the rest of higher education, is enjoying a financial tailwind that is only likely to improve in the next couple of years. Enrollments this fall at nine major publicly traded college companies grew at a pace faster than the average annual rate of growth for the past three years, while profit margins for this year are projected to be higher than they've been since 2005. And the grim financial outlook that has led to freezes on hiring and new construction at many nonprofit colleges (like Harvard) isn't having the same effect on the for-profit sector, which accounts for about 5 percent of all postsecondary enrollments.
Goldie Blumenstyke, "Economic Downturn Is a Boon for For-Profit Colleges," Chronicle of Higher Education, December 10, 2008 --- http://chronicle.com/daily/2008/12/8330n.htm?utm_source=at&utm_medium=en
Jensen Comment
Goldie is the Chronicle of Higher Education editor who, without announcing who she worked for, took an online governmental (fund) advanced accounting course for credit from the University of Phoenix (a for-profit university). Her report on the experience is quite favorable, although she found the course to be a lot more demanding than she had expected.

My tidbit on Goldie's experience can be found at http://www.trinity.edu/rjensen/crossborder.htm

The Chronicle's Goldie Blumenstyk has covered distance education for more than a decade, and during that time she's written stories about the economics of for-profit education, the ways that online institutions market themselves, and the demise of the 50-percent rule. About the only thing she hadn't done, it seemed, was to take a course from an online university. But this spring she finally took the plunge, and now she has completed a class in government and nonprofit accounting through the University of Phoenix. She shares tales from the cy ber-classroom -- and her final grade -- in a podcast with Paul Fain, a Chronicle reporter.
Chronicle of Higher Education, June 11, 2008 (Audio) --- http://chronicle.com/media/audio/v54/i40/cyber_classroom/

• All course materials (including textbooks) online; No additional textbooks to purchase

• $1,600 fee for the course and materials

• Woman instructor with respectable academic credentials and experience in course content

• Instructor had good communications with students and between students

• Total of 14 quite dedicated online students in course, most of whom were mature with full-time day jobs

• 30% of grade from team projects

• Many unassigned online helper tutorials that were not fully utilized by Goldie

• Goldie earned a 92 (A-)

• She gave a positive evaluation to the course and would gladly take other courses if she had the time

• She considered the course to have a heavy workload

Jensen Added Comment
It wasn't mentioned, but I think Goldie took the ACC 460 course --- Click Here

ACC 460 Government and Non-Profit Accounting

Course Description

This course covers fund accounting, budget and control issues, revenue and expense recognition, and issues of reporting for both government and non-profit entities.

Topics and Objectives

Environment of Government/Non-Profit Accounting

• Compare and contrast governmental and proprietary accounting.
• Analyze the relationship between GASB and FASB.
• Analyze the relationship between a budget and a Comprehensive Annual Financial Report (CAFR).
• Determine when and how to use the modified accrual accounting method.

Fund Accounting Part I

• Distinguish between expenses and expenditures.
• Explain the effect of encumbrances on a budget.
• Apply the principles of fund accounting.
• Determine the closing process for the fund accounting cycle.
• Explain the reconciliation of government-wide financial statements with the fund statements.

Fund Accounting Part II

• Apply accounting procedures for recognizing revenues and other financial resources.
• Record interfund transfers.
• Prepare fund and non-governmental accounting entries.
• Prepare a financial statement for a governmental agency.

Overview of Not-for-Profit Accounting

• Examine the funds for different types of not-for-profit organizations.
• Compare and contrast reporting by governmental, not-for-profit, and proprietary organizations.

Current Issues in Government and Not-for-Profit Accounting

• Analyze current issues in government and not-for-profit accounting.

Bob Jensen's threads on asynchronous learning --- http://www.trinity.edu/rjensen/255wp.htm

Bob Jensen's threads on free online video courses and course materials from leading universities --- http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI

Bob Jensen's threads on assessment --- http://www.trinity.edu/rjensen/assess.htm

Bob Jensen's threads on the dark side --- http://www.trinity.edu/rjensen/000aaa/theworry.htm

Bob Jensen's threads on education technology --- http://www.trinity.edu/rjensen/000aaa/0000start.htm

IAS Plus 2008 End-of-Year Update --- http://www.iasplus.com/iasplus/0812closingout2008.pdf

Deloitte's IFRS Global Office has published an IAS Plus Update Newsletter – Closing Out 2008 (PDF 163k). The newsletter provides a high level overview of new and revised Standards and Interpretations that are effective for December 2008 and later accounting periods. Where applicable, the newsletter includes hyperlinks to past Deloitte newsletters dealing with the specific Standard or Interpretation in more detail. Those past newsletters are all available on Here on IAS Plus. As always, entities should refer to the Standards and Interpretations themselves to identify all of the changes that may affect their particular circumstances.

The IAS Plus home page is at http://www.iasplus.com/index.htm

2008 Quickbooks Update

December 12, 2008 message from Scott Bonacker [lister@BONACKERS.COM]

Hello Scott,

 

Thank you for contacting me.  Here is some information for your records.  Click on any of the hyperlinks below for more information and please let me know if you have any questions. 

The Instructor's Resource Center for QuickBooks is located at www.accountant.intuit.com/iep. Go to Register Now and enter your institution's information.  If you do not have your license number (it is a required field) you may enter "IEP" in the license number field.    This will give you full access to the fifteen lesson plans, reviews and PowerPoint presentations.  The lesson plans are for your use only.

DON'T FORGET the Educator's Corner!  Discussion forums, tools, resources and allows the sharing of curriculum from review exercises and quizzes to test questions. 

Pricing is as follows for software used for instructional purposes:    Site licenses come with a 2 year site license agreement to be filled out by the user and returned to Intuit.   Site licenses are strictly for classroom installation for instructional purposes.

NEW ! ! - QUICKBOOKS PREMIER ACCOUNTANTS EDITION IS HERE - Access other versions of QuickBooks 2009 through the Accountants Edition with the toggle feature. Click here to learn more!   The appearance and basic workflows are the same as Pro, but you will also have access to all versions of QuickBooks 2009 (Simple Start, Pro and all of the Industry Specific Versions).  

• 10 Pack $259.95 - QuickBooks 2009 Premier Accountants Edition for Windows  
• 25 Pack $399.95 - QuickBooks 2009 Premier Accountants Edition for Windows   
• 50 Pack $599.95 - QuickBooks 2009 Premier Accountants Edition for Windows   
• 2008 QuickBooks Student Guide $36.95.  The 2009 text is be $45.95, and includes a 140 day trial CD that student can install on their personal equipment.
• QuickBooks Pro Academic Version  - CLICK HERE for eligibility requirements and description 

QuickBooks Pro for their individual academic use at a special discounted price:  Bookstores can purchase four or more licenses at 15% discount direct through Intuit's Education Program.  Students can purchase independently by contacting one of Intuit's approved resellers:  Academic Superstore, (800) 817-2347 or Genesis, (800) 433-6326.

QUICKBOOKS USER CERTIFICATION   CLICK HERE for more information. Get 50% off the regular price!  Get the Training & Exam for only $49.98!  Please let me know if this is something you would like to include in your curriculum.   I will need to assign a code to your class so they receive the discount.  Initially each user will need to sign up for the certification through the web site.  Bulk pricing and sign up will come at a later date.   

 

INTEREST IN PERSONAL FINANCE AND QUICKEN?  - Go to www.quickeneducation.com for more info.

Additional Resources and Tools      

20% off Interactive CD Training! -  A great tool to help you learn and teach QuickBooks in your classroom.  Wonderful for overhead presentations.

ProSeries PowerTax Library - Free software for educators. For classroom/instructional purposes only. Click here to view the License Agreement

Ordering Information

FAX or email - DO NOT MAIL - Purchase Orders and State Tax Exempt Certificate to 520-844-6412 or education@intuit.com

The Intuit payment address that will appear on your invoice is Intuit Inc., PO Box 513340, Los Angeles, CA 90051-3340

Credit card and EFT orders are also accepted

If you have any questions, please feel free to contact me.  

LISA SCHWARTZ - INTUIT EDUCATION PROGRAM   - TUCSON, AZ   

(866) 570-3843 - Fax 520-844-6412

education@intuit.com - www.accountant.intuit.com/iep

Bob Jensen's threads on accounting education software are at http://www.trinity.edu/rjensen/Bookbob1.htm#software

Bob Jensen's threads on accounting software in general are at http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

For Educators
Bob Jensen's threads on tools and tricks of the trade are at http://www.trinity.edu/rjensen/000aaa/thetools.htm

"So you want a new desktop accounting package?" by David Carter, AccountingWeb, June 5, 2007 --- http://www.accountingweb.com/cgi-bin/item.cgi?id=103569

David does not mention my oft-preferred alternative of a Webledger system (such as NetSuite) that can be accessed at a range of needs and sizes and prices with some huge advantages over installing accounting software on your own hardware --- at http://www.trinity.edu/rjensen/Webledger.htm

Bob Jensen's helpers on accounting software alternatives are http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

February 6, 2008 message from CHRISTINE KLOEZEMAN [ckloezem@PRODIGY.NET]

At Glendale Community College in California we teach our Financial Accounting and Basic Accounting without a computerized accounting program. I have previously included both a tutorial computerized accounting program and later a commercial accounting program. It took too much time out of the class that meets 5 hours a week.

Instead we have a Computerized Accounting class that uses Quickbooks Pro that is required for the Accounting AA. We also have Payroll accounting that uses Quickbooks pro. We were using Business Works (lower version of MAS 2000) but Quickbooks was suggested by our Advisory Committee. We also have a Advanced Computerized Accounting class that teaches Peachtree and others. We also require students to take Excel to get both a certificate and an AA.

Christy

February 6, 2008 message from Carol Flowers [cflowers@OCC.CCCD.EDU]

We have the financial /managerial accounting class meeting 5 hours per week and using epacks. However, we have a "computerized accounting" course that stands alone and is required for an AA degree. In that course, the student completes an integrated accounting package and also excel. We also offer stand alone courses in Quickbooks, Payroll and MAS 90/200.

We have found that our population learns the concepts better with pen and paper (for lack of a better word) and then we use the Computerized Accounting to re-enforce their principles while exposing them to industry software and excel.

June 7, 2007 message from Ray Slager [slgr@CALVIN.EDU]

I wonder if anyone is currently using commercial software in their courses. I tried to use QuickBooks at one time but the company makes it very difficult to use. First of all it must be loaded on each computer - not on the network. Secondly it needs to be updated each quarter for the payroll module to work and of course the entire package must be "upgraded" every two or three years. Does anyone know if this is still the case?

Does anyone use other commercial software that is easier to administer? I currently am using MYOB and find it very easy to use. I currently am looking at their latest version and think it is very promising. It can be loaded on a file server and comes in a "10 pack" - good for use on 10 computers for about $300.

Ray Slager
Calvin College

June 7, 2007 reply from Davidson, Dee (Dawn) [dgd@MARSHALL.USC.EDU]

We use Peachtree and get the software free for the network. Use this link. http://www.peachtree.com/training/educational_partnerships.cfm 

Find the license and application forms. Fax them to Peachtree and the software CD will be mailed to you. They send you last year's version - we just received 2006 - but the changes are very minimal year to year. Each spring we send in the forms and get a new CD to be installed on the network for the following school year. We develop our own exercises, but they also have education material available. Hope that helps.

dee davidson
Leventhal School of Accounting
Marshall School of Business
University of Southern California
(213)740-5018 tel (213) 747-2815 fax
dgd@marshall.usc.edu 

June 7, 2007 reply from Formosa, Jim [Jim.Formosa@NSCC.EDU]

We are using QuickBooks but are looking at Microsoft's accounting software for small business. We have the same problems you describe with QuickBooks.

Jim Formosa, MS, CPA
Certified Senior WebCT Trainer
Associate Professor of Accounting
Nashville Community College
615-353-3420 FAX 615-356-1213

June 7, 2007 reply from Fisher, Paul [PFisher@ROGUECC.EDU]

I have found that Peachtree is much better. I am running an older version, but it does not seem to matter. Peachtree provides an educational version that does not lock the student out after 25 visits, and does not have the payroll deadfall. It also has a "tutorial"

embedded that makes it almost textbook free if you are willing to produce class handouts. I am going to be attempting Timberlake for a construction program. Anyone have experience in that?

Paul

June 7, 2007 reply from Prachyl, Cheryl L [cprachyl@UTA.EDU]

I use Peachtree. They provide a free educational site license. The educational version is one year behind the currently marketed version, but I don't find that to be a problem.

I tried using Quickbooks for one semester but we had no money in our budget to purchase the software. We got a donation to the department for a one year site license but we had problems with the installation in our labs.

I have found that Peachtree works well. It also can reinforce the "cycle" approach to business through the navigation aids.

Cheryl Prachyl
University of Texas at Arlington

June 7, 2007 reply from Leslie Kren [lkren@UWM.EDU]

I use SAP in my cost management courses. SAP is the leading ERP system and using it in the classroom provides exposure to the 'big systems' most of our students see in practice. The startup cost for me was quite high several years ago, but now the SAP University Alliance is quite active and provides summer workshops and substantial assistance with instructional materials to interested faculty.

Leslie Kren, PhD, CPA
Associate Professor
Lubar School of Business
University of WI - Milwaukee
3202 N. Maryland Milwaukee, WI 53201
414 229-6075 fax: 414 229-6957
lkren@uwm.edu
http://www.uwm.edu/~lkren/ 

"A Conspiracy Theory Debunked:  The long-running KPMG tax-shelter case ends with a whimper," The Wall Street Journal, December 20, 2008 --- http://online.wsj.com/article/SB122973258821422991.html?mod=djemEditorialPage

What started as the "largest criminal tax-fraud case in history" ended this week with a whimper -- one acquittal and three partial convictions for four defendants in the long-running KPMG tax-shelter case. The Justice Department had charged 19 people back in 2005. Two pleaded guilty, while 13 had their charges dismissed after federal Judge Lewis Kaplan found the government had violated their Fifth and Sixth Amendment rights by coercing KPMG into denying them legal assistance, among other offenses.

The remaining four stood trial this fall. David Greenberg, who was jailed for five months after the government argued he was a flight risk if permitted to post bail, was acquitted on all counts. The other three were convicted on some tax evasion charges while acquitted on others. No one was convicted on the original, underlying conspiracy charge.

Justice may consider this as a partial vindication, and it is certainly a setback for the three defendants who now face possible jail time on the tax evasion charges. But the fact that the government could not prove its case for a criminal conspiracy calls into question the premise of the entire prosecution. We argued from the beginning that prosecuting tax advisers for selling tax shelters that had never been found illegal in a court of law had an Alice-in-Wonderland quality. This aggressive legal theory produced, in turn, the government misconduct that ultimately led to the dismissals. Now a jury has found that the conspiracy alleged by the government never existed.

Without a conspiracy, even the convictions the government did secure look dubious and could be overturned on appeal. Whether those convictions stand up or not, there are at least 14 innocent people whose lives were turned upside down and careers ruined by overreaching prosecutors. No moral victory can give back what was taken from them by this regrettable, and abusive, episode.

Jensen Comment
The criminal case fell apart for complicated reasons, but that did not exonerate KPMG as a firm nor return its $456 million settlement reached with the IRS.

December 20, 2008 reply from Robert B Walker [walkerrb@ACTRIX.CO.NZ]

The inability to secure convictions is certainly a set-back, but we, as accountants, need to consider the morality of our conduct, particularly in view of what has happened in the last year.

Bankers, lawyers and accountants are afforded a privileged position in society perhaps in the order set out at the beginning of this sentence. Bankers have the right, writ large now, for public support in the wake of their failings. Lawyers have the right to represent in court. Accountants have the right to audit or, at least, some do as audit is concentrated in fewer and fewer hands. These rights are provided by society. Yet these same people occupying a privileged position seem to think it their right to engage in practices to the detriment of those very people who provided them with the privilege in the first place.

I like to think that there was a golden age of responsibility, probably mythical, in which professionals had a mystical view of their role. A role in which they understood that they stood in the role of trustee of the status of the professions. In the manner of a never ending relay race the current profession assumed the baton from their predecessors and cherished it until time to pass it to their successors. This sense of awe grew from a veneration of the discipline they practiced – in our case it was, and should be again, a reverence for the process of double entry.

I suspect that taxation has played a central role in the erosion of the golden age. As accountants, lawyer and bankers saw it as their place to take a hostile stance towards the revenue gathering agencies, gradually any sense of awe towards the rule of law diminished. This was replaced by the cult of the individual in which naked self interest replaced any sense of responsibility to the wider community. Self interest is a doctrine empty of any sense of right or wrong. Even Francis Fukuyama in his book ‘The End of History’ understood that in the supposed defeat of socialism (Russian communism) by western liberalism (American capitalism) that there would be a psychological vacancy which he proposed, at the end of the book, to fill with the thought of Friedrich Nietzsche.

I my analysis the words of Lao Tzu in the Tao Te Ching have great resonance.

When the people lack a proper sense of awe, then some awful visitation will descend upon them. (verse LXXII)

Well it happened, didn’t it?

Bob Jensen's threads on KPMG are at http://www.trinity.edu/rjensen/Fraud001.htm#KPMG
These include many of the details in this complicated case.

"Highlights of Accounting Systems Research:  Keep up with the latest findings on the impacts of IT investments," by Cynthia Bolt-Lee and Janette Moody, Journal of Accountancy, December 2008 --- http://www.journalofaccountancy.com/Issues/2008/Dec/Highlightsof+ccountingSystemsResearch.htm

This article is the fourth in a series reviewing research relevant to practicing accountants. Previous articles covered auditing, management accounting and tax. Recent, top-ranked journals that cover accounting and information technology systems were examined to determine results containing practical implications.

Jensen Comment
This article reviews a very, very small subset of AIS research, and I would hardly call the articles the "latest findings" since most of them date back two or more years. But in nevertheless is nice to have a summary appearing in a practitioner journal.

Here are some more current articles on AIS:

A Discovery-Learning Classroom Case on Accounting Data Transmission Systems David R. Fordham Journal of Information Systems - Teaching Notes 22(2), 1 (2008) (7 pages)

Modeling an Object-Oriented Accounting System with Computer-Aided Software Engineering Alan S. Levitan, Jian Guan, and Andrew T. Cobb Journal of Information Systems - Teaching Notes 22(2), 8 (2008) (8 pages)

KaDo: An Advanced Enterprise Modeling, Database Design, Database Implementation, and Information Retrieval Case for the Accounting Information Systems Class Guido L. Geerts and Kinsun Tam Journal of Information Systems - Teaching Notes 22(2), 16 (2008) (22 pages)

Introducing Students to the Integrated Audit with “Auditing Alchemy, Inc.” Ulric J. Gelinas, Jr., David L. Schwarzkopf, and Jay C. Thibodeau Journal of Information Systems - Teaching Notes 22(2), 38 (2008) (16 pages) 

Modeling a Business Process and Querying the Resulting Database: Analyzing RFID Data to Develop Business Intelligence A. Faye Borthick, Paul L. Bowen, and Gregory J. Gerard Journal of Information Systems - Teaching Notes 22(2), 54 (2008) (33 pages)

 

Bob Jensen's sadly neglected threads on ERP in academia --- http://www.trinity.edu/rjensen/245glosap.htm

Bob Jensen's somewhat neglected threads on XBRL --- http://www.trinity.edu/rjensen/XBRLandOLAP.htm

500 Largest Corporations Registered by the SEC Must Markup Financial Statements with XBRL Tags

December 17, 2008 message from Neal Hannon [nhannon@GMAIL.COM]

Some of the largest U.S. companies will have to file their financial reports next year using technology designed to make it easier for investors to read and analyze the data under a rule adopted by U.S. Securities and Exchange Commission on Wednesday. The SEC voted 4-1 to require 500 of the largest public companies to begin filing their financial reports using the technology known as XBRL, or extensible business reporting language, by mid-2009. The SEC voted, also by 4-1, in favor of requiring mutual funds to file their risk and return information using XBRL to make it easier for investors to analyze the performance, risk and fees of thousands of funds. Mutual funds will be required to file the data using the electronic tags by Jan. 1, 2011."

Pop the champange and throw the confetti! XBRL is finally mandatory for SEC filings starting with quarters and years ending after June 15, 2009. Although the final rule details will not be official until published in the Federal Register, we did learn today that XBRL filings will be required and that liability on the XBRL will be phased in over a two year period. In other words, the XBRL filing of G.E. for the second quarter of 2011, two years after the first filing in 2009, will carry "as filed" status. The one discenting vote, from commissioner Aguilar, was an objection to the push back on liability. Commissioner Aguilar wanted full liability on XBRL filings as of June 15, 2009.

Bob Jensen's threads on XBRL --- http://www.trinity.edu/rjensen/XBRLandOLAP.htm

2008 TurboTax Boycott Begins and Wins
Tax Software Boycott of TurboTax Begins:  I'll Bet You Can't Find the Hidden Fees Disclosed on the TurboTax Website

Users are not complaining about the functionality of TurboTax. The problem, as they see it, is with pricing changes. For the first time, TurboTax producer Intuit started charging users an additional $9.95 for each additional return whether they print or e-file. Also, readers complain that the 2008 software costs more at checkout, jumping from $44.95 to $59.95. (However, when AccountingWEB went on Amazon, the software could be had at the discounted price of $54.99.) . . . One reviewer seemed to be issuing a battle cry by writing, "Time to start the boycott." Another reviewer had criticism of a more personal nature: "You should fire the person who came up with pay to print!" Of the 182 product reviews as of the evening of December 9, 2008, 171 of them were one-star reviews and only five were five-stars, the highest rating. Of the five five-star ratings, one user named Fernando Ortega said TurboTax is still the best, pointing out that he doesn't have to enter all of his personal information and previous returns manually.
"TurboTax turmoil: Online reviews pan the top selling software," AccountingWeb, December 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=106620

H&R Block did not raise the software fee and has no additional user fee --- http://newsblaze.com/story/2008120913262200003.mwir/topstory.html
I shifted to TaxCut years ago and have never regretted doing so --- http://www.hrblock.com/taxes/products/software/index.html
Maybe it's just me, but I prefer to buy TaxCut in the box at Wal-Mart so that I have a CD for each year to file away. I prefer not to download the software directly, although download updates are free and easy to install.

Jensen Comment
It has been popular in the past for a person to file his or her tax return and then use the same software for filing the tax returns of children or parents. No longer will this be possible for free from TurboTax. Presumably the add-on fee has to be paid when spouses file separate returns rather than a joint return. Turbo Tax along with other popular tax software for individuals does participate in the Free File Alliance for taxpayers having less than $54,000 adjusted gross income. This is only  free tax software for the Federal Return, but the accompanying TurboTax State Return costs $26 so all is not free if you need to file both a State and Federal Return using Turbo Tax.

The new additional return fee irks taxpayers in 2008 just like the TurboTax activation fee in 2003 really irked taxpayers --- http://www.pcmag.com/article2/0,1895,821308,00.asp

What irks me is how hard it is at the TurboTax Web site about this $9.95 additional return fee. It's almost like TurboTax is playing a game to make it easier to drop the fee if the boycott really becomes serious.

Another thing that irks me with the TurboTax Web site is that it highlights that users can get a free edition of TurboTax and allows users to start filling in the information. Then it suddenly springs on the purchase fee along the way for users who will have an adjusted gross income above $54,000 after they have started preparing their return. This essentially wastes their time if they decide not to order the Turbo Tax software for $59 directly from TurboTax. For example, someone who decides to pay $54 from Amazon essentially has to start over preparing the return. I think hiding the $54,000 AGI maximum is highly unethical on the part of the TurboTax Website.

TaxACT  has its standard 1040 product free for download. The deluxe is $7.95 and software for Federal and State combined is $16/95.
The standard only allows one return, with the others you can do multiple returns. E-file is free --- http://www.taxact.com/
Low income filers can get a free download of the TaxACT software. I would use this software if it was possible to buy the CD at Wal-Mart. I think Wal-Mart only sells TaxCut and TurboTax CD boxes and manuals.

I really like the tax preparation hand book and forms that the IRS mails out automatically to some taxpayers and not others. My trick is to print my tax return from the TaxCut software, Then I replace the top two pages with an inked-in 1040 form as if I computed my taxes by hand. Then I mail our return. I think if I filed a computer-printed return in total or e-filed, I would not necessarily receive my handbook automatically each year from the IRS. I could be wrong about this, but the one year that I filed a total computer-printed tax return, the IRS did not mail me the handbook. It's possible to get the handbook for free, but this way I don't have to bother asking for the handbook. By the way, you should file the IRS handbook with your CD so that if the IRS raises questions a couple of years later you have the hand book available for that particular year if needed.

December 17, 2008 Update on Intuit's Reversal
"Intuit responds to TurboTax customer revolt," Accounting Web, December 17, 2008 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=106668

Responding to market pressure and consumer outrage, Intuit has reversed its original position and announced that customers using its best-selling TurboTax software can prepare and print multiple returns at no additional cost. Also, free e-filing is included with five Federal returns.

"We're responding to changing market conditions and customer feedback," said Dan Maurer, general manager of Intuit's consumer division. "We believe this better positions TurboTax in the marketplace with an even stronger value proposition for consumers. It's one more way we help make it easier for TurboTax customers to keep more money in their pockets."

Last week, AccountingWEB reported that 171 online product reviewers on Amazon.com had panned TurboTax with one-star ratings (as of this writing, the number is at 276). The reason? For the first time, Intuit had started charging users an additional $9.95 for each additional return whether they print or e-file. Also, reviewers complained that the 2008 version of the software costs more than last year's model, from $44.95 to $59.95.

After the Intuit changes were put in place, one Amazon reviewer gave TurboTax a five-star rating and declared, "We won, you can print unlimited returns for free."

Under the headline, "Intuit Finds Customer Complaints Too Taxing to Endure," the Washington Post reported the company would refund any preparation fees customers had already paid and an upcoming update to TurboTax software would "remove any mention of the $9.95 additional-return fee."

TurboTax guarantees taxpayers will get their biggest possible refund. TurboTax customers also benefit from many features, such as built-in guidance for more than 350 possible deductions. Intuit's product line includes QuickBooks and Quicken.

Bob Jensen's tax helpers are at http://www.trinity.edu/rjensen/Bookbob1.htm#010304Taxation

Small Business Helpers from Smart Stops on the Web, Journal of Accountancy, December 2008 --- http://www.journalofaccountancy.com/Issues/2008/Dec/SmartStops.htm

SMALL OFFICE / HOME OFFICE

GET YOUR BUSINESS OFF THE GROUND
www.business.gov
Known as “The Official Business Link to the U.S. Government,” this site is a virtual one-stop shop for information on running a small business. Operated by the Small Business Administration, this Smart Stop offers guides on starting and managing a business, government contracting, taxes and a host of other topics. There’s also a helpful tool to determine what types of federal, state and local licenses and permits are needed for a variety of businesses, along with contact information for the appropriate agencies. There’s even a separate section filled with information tailored for home-based businesses, which the SBA says account for more than half of U.S. businesses.

FEEL RIGHT AT HOME
www.2minutecommute.com
This blog offers commentary and advice for people who work out of their homes. Recent postings included advice on feeling secure in an insecure economy, a video review of telephone headsets, and an alert about “business opportunity” scams. The site also looks at how to avoid the isolation of working from home by co-working, or sharing space with a group of other self- employed professionals. Postings can be viewed by subject, such as “Business Ideas” or “Financing.”

MAKE YOUR SMALL BUSINESS WORK
www.esmalloffice.com
This Smart Stop offers articles and weekly columns for the small business owner. It features a “Business Guide” with dozens of how-to articles offering advice on everything from writing a press release to analyzing profitability. Other articles are grouped into topics including “Starting Your Business,” “Managing Your Money” and “Government Resources.” The site licenses content from providers such as Commerce Clearing House, the Edward Lowe Foundation and the Kauffman Foundation. You can also sign up to receive a free monthly e-newsletter.

GENERAL INTEREST

GET A CREDIT CLUE
www.controlyourcredit.gov
Way more fun than a lecture, the U.S. Treasury’s interactive site features The Bad Credit Hotel game, which provides information on keeping up a good credit score. The premise is to solve a mystery in a creepy hotel, with the goal of racking up enough credit tips to get to room 850—the perfect credit score—and unlock bonus information. Along the way, you collect clues on debt management, credit history and credit cards by clicking through to different rooms and clicking on key objects in each room. After collecting enough clues, players get to enjoy the secret perks found in room 850.

Bob Jensen's small business helpers  --- http://www.trinity.edu/rjensen/Bookbob1.htm#SmallBusiness

Congratulations to KPMG's Bernie Milano, Champion of Raising Support for Minority Doctoral Students in Accounting
Journal of Accountancy, December 2008 --- http://www.journalofaccountancy.com/Issues/2008/Dec/MilanoReceivesPresidentsAward.htm

Bernard J. Milano, president and trustee of the KPMG Foundation, received Beta Alpha Psi’s President’s Award, the organization’s highest honor. Milano was BAP president from 1999 to 2000. Stephanie Bryant, director of the University of South Florida’s School of Accountancy and BAP’s 2007–2008 international president, presented the award during a lunch at the BAP national convention in Anaheim, Calif.

Bryant said that under Milano’s leadership, BAP broadened its scope beyond accounting students to include finance and information systems students and led the creation of the annual Community Service Day in which volunteer members work to improve towns and cities. Milano also helped find funding for BAP’s superior chapter model, which awards cash to chapters with high levels of volunteer and professional activity.

Beta Alpha Psi is an honorary organization for accounting and financial information students and professionals.

You can read more about Bernie and the KPMG Foundation fellowships for minority doctoral students --- Click Here

"Feed the Pig" is the AICPA's terrible name for its free site for helping people with personal finances
 http://www.aicpa.org/financialliteracy/FeedThePig/

"New Feed the Pig Cirriculum Targets Younger Audience, Journal of Accountancy, December 2008 --- http://www.journalofaccountancy.com/Issues/2008/Dec/NewFTPTargetsYoungerAudience.htm

Bob Jensen's helpers for personal finance are at http://www.trinity.edu/rjensen/Bookbob1.htm#InvestmentHelpers

"A Model Curriculum for Education in Fraud and Forensic Accounting," by Mary-Jo Kranacher, Bonnie W. Morris, Timothy A. Pearson, and Richard A. Riley, Jr., Issues in Accounting Education, November 2008. pp. 505-518  (Not Free) --- Click Here

There are other articles on fraud and forensic accounting in this November edition of IAE:

Incorporating Forensic Accounting and Litigation Advisory Services Into the Classroom Lester E. Heitger and Dan L. Heitger, Issues in Accounting Education 23(4), 561 (2008) (12 pages)]

West Virginia University: Forensic Accounting and Fraud Investigation (FAFI) A. Scott Fleming, Timothy A. Pearson, and Richard A. Riley, Jr., Issues in Accounting Education 23(4), 573 (2008) (8 pages)

The Model Curriculum in Fraud and Forensic Accounting and Economic Crime Programs at Utica College George E. Curtis, Issues in Accounting Education 23(4), 581 (2008) (12 pages)

Forensic Accounting and FAU: An Executive Graduate Program George R. Young, Issues in Accounting Education 23(4), 593 (2008) (7 pages)

The Saint Xavier University Graduate Program in Financial Fraud Examination and Management William J. Kresse, Issues in Accounting Education 23(4), 601 (2008) (8 pages)

Also see

Bob Jensen's Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm
Bob Jensen's threads on fraud --- http://www.trinity.edu/rjensen/Fraud.htm

Accounting Theory Controversy

"The 'Preliminary Views on Financial Statement Presentation": Seven Years of Deliberation for This?" by Tom Selling, The Accounting Onion, December 7, 2008 --- http://accountingonion.typepad.com/theaccountingonion/2008/12/the-preliminary.html?cid=141712056

December 9, 2008 reply from Bob Jensen

Hi Tom,

Thank you for this thought-provoking article.

Two of the things that confuse me are as follows:

At the top "Largest Possible Entity" you've illustrated balance sheet and income statement items to be additive. I think there are huge covariances that need to be accounted for. For example, it would seem that as an asset "Knowledge" has a huge covariance with the other balance sheet items.

At the top "Largest Possible Entity" there may be some interest in the balance sheet by politicians, but it would seem that investors would only be interested in that piece of the rock that they can invest in however that piece of the rock is defined and accounted for for purposes of making portfolio investment decisions.

Bob Jensen

Bob Jensen's threads http://www.trinity.edu/rjensen/theory01.htm

From The Wall Street Journal Accounting Weekly Review on December 4, 2008

UAW Gives Concessions to Big Three
by Alex P. Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike Spector
The Wall Street Journal
Dec 04, 2008
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC
 

TOPICS: Accounting, Budgeting, Cash Flow

SUMMARY: In preparation for presenting revised turnaround plans to Congress, Detroit's Big Three automakers have negotiated concessions from the United Auto Workers' union to delay cash payments for post-employment health benefits and to suspend the jobs bank program.

CLASSROOM APPLICATION: Questions focus on the cash budgeting implications of the negotiations with UAW and the requests for Congressional aid, asking students to differentiate cash flow problems from profitability issues.

QUESTIONS: 
1. (Introductory) Describe the need for cash by each of Detroit's Big Three automakers. How do these companies determine the cash that will be needed over the next 3 months to one year?

2. (Introductory) Why is the UAW negotiating terms of its contracts with the Big Three Detroit automakers? Are the industry labor contracts up for renewal? In your answer, comment on the union's relationship to all three major U.S. automobile producers.

3. (Advanced) "...The union [will] allow the companies to delay billions of dollars in payments into funds that will cover health-care cost for retired workers." Will this concession actually reduce the expense associated with providing post-employment health-care benefits? What help will it provide to the automakers?

4. (Introductory) "The union also will suspend a controversial 'jobs bank' program..." What is this program? How will suspending it help the Big Three weather the current crisis?

5. (Advanced) Ford Motor Co. is asking for a line of credit from Congress, while General Motors and Chrysler are asking for low-cost federal loans. If they are granted, what benefit will these plans provide? Will these government supports help to return the auto manufacturers to profitability?

6. (Advanced) "The Detroit makers insist bankruptcy isn't an option" but others disagree. What can be done through bankruptcy to help ensure that companies can emerge through this process?

7. (Advanced) What is an Altman Z score? What factors enter into this model? In your answer, be sure to define the term "Z score".

8. (Introductory) Why do you think Congress is particularly interested in an academic's view on this matter of support for the automakers?

9. (Introductory) Chrysler "is not viable in its current configuration" according to a former Chrysler executive, Jerome B. York. Why not? What has changed about his company's configuration? What about today's global economy has impacted this company?
 

Reviewed By: Judy Beckman, University of Rhode Island

 

"UAW Gives Concessions to Big Three:  Banking Chairman Dodd Is Tapped to Develop Rescue Package in Senate That Could Top $25 Billion," by Alex P. Kellogg, Matthew Dolan, Greg Hitt, Jeffrey McCracken and Mike Spector, The Wall Street Journal, December 4, 2008 --- http://online.wsj.com/article/SB122832097499675993.html?mod=djem_jiewr_AC

The United Auto Workers union Wednesday offered two major concessions to the Big Three auto makers, as Democratic leaders in the Senate intensified efforts to find compromise legislation that would throw a financial lifeline to the industry.

Late Wednesday, Senate Banking Chairman Christopher Dodd was tapped to develop a consensus rescue package that could be brought to the Senate floor next week. The Connecticut Democrat, who convenes a hearing Thursday on the industry's latest appeal for assistance, is to focus on legislation that would effectively create a bridge loan for the industry, by diverting funds from an existing loan program originally intended to help the industry retool to meet higher fuel economy standards. The senator would impose much tougher conditions on the aid than a bipartisan bill developed in the Senate last month, congressional aides said.

The goal of the initiative would be for the Senate to move ahead of the House, where deep divisions exist on the issue. The final cost of the package could exceed the $25 billion originally sought by lawmakers last month. And to fund the measure the senator is also expected to consider drawing on the $700 billion government pool created to rescue financial markets, to form a dual-source of funding for the automakers, congressional aides said.

Behind the moves is Senate Majority Leader Harry Reid, the Nevada Democrat who pressed Sen. Dodd Wednesday to move forward. Mr. Reid is trying to break a stalemate between Congress and White House on the issue. Sen. Reid declared that a Democratic-backed bill -- which would solely draw on the $700 billion market rescue fund -- couldn't pass Congress, signaling to rank-and-file Democrats that compromise would be needed to avoid another collapse of legislative efforts to help the industry.

The maneuvering comes as the Detroit companies are set to make a second appeal to Congress for a bailout, and underscores the importance of the UAW's willingness to consider additional concessions.

Two weeks after insisting his union had already done enough to help the car makers, UAW President Ron Gettelfinger said the union would allow the companies to delay billions of dollars in payments into funds that will cover health-care costs for retired workers. The union also will suspend a "jobs bank" program under which workers continue to collect most of their wages after they are laid off.

"We're willing to take an extra step here," Mr. Gettelfinger said at a news conference after meeting with UAW leadership in Detroit.

The union move comes amid increasing concern about the future of General Motors Corp., Ford Motor Co. and Chrysler LLC, and whether the written restructuring plans they submitted to Congress on Tuesday go far enough to return the companies to financial health. Lawmakers gave a cautious welcome to the turnaround plans, but significant opposition remains to giving the companies a bailout.

On Wednesday, Ford Chief Executive Alan Mulally said he was "very concerned" about the fate of GM and Chrysler after each told Congress it needed an immediate cash infusion to survive. GM said it needs $4 billion this month, and a total of $18 billion; Chrysler said it needs $7 billion by the end of the month.

"Each revelation by our competitors has been of growing concern," Mr. Mulally said in an interview with The Wall Street Journal. Ford has greater cash reserves than GM and Chrysler, and asked the government to extend a $9 billion credit line that it would tap only if the U.S. recession proves worse than expected or one of its competitors fails.

Mr. Mulally, along with the CEOs of GM and Chrysler and Mr. Gettelfinger, are due to testify Thursday and Friday before House and Senate committees on how they intend to use low-cost federal loans to reorganize. They appeared last month but lawmakers were unconvinced that they had sound recovery strategies and told them to submit new plans by Dec. 2.

If the House and Senate panels are persuaded by the new plans, lawmakers could reconvene next week to consider legislation to provide funds.

Car-industry representatives held a briefing for more than 100 congressional aides Wednesday. Their response was generally positive, with little of the hostility displayed by lawmakers last month when the CEOs of the three makers first testified before Congress, said one person in attendance.

Rep. Brad Sherman (D., Calif.), a critic of the Detroit auto companies, said the new plans were a big improvement. "The original plan was, 'We flew here on our jets, we have enough room on each jet for the cash, so where's the cash?'" Mr. Sherman said. "This is way better than that."

Continued in article

Bob Jensen's threads on the bailout of automobile companies and other non-financial companies are at
http://www.trinity.edu/rjensen/2008Bailout.htm#Everybody

In these hard times, how many going concern doubts will force auditors to shift from going concern GAAP to exit value GAAP with going concern doubts expressed in the audit opinions? Also will broken markets for toxic securities, how will exit values be estimated?

From The Wall Street Journal's Accounting Weekly Review on December 12, 2008

AIG Faces $10 Billion in Losses on Bad Bets
by Serena Ng, Carrick mollenkamp, and Michael Siconolfi
The Wall Street Journal
Dec 10, 2008
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB122887203792493481.html?mod=djem_jiewr_AC
 

TOPICS: Accounting, Derivatives, Disclosure, Financial Accounting

SUMMARY: While the article states that AIG faces a potential additional $10 billion in losses on speculative derivatives, the figure actually represents the underlying notional amount of the derivative. AIG responded to the front page article. Their response is listed as a related article. It references disclosure explaining the $10 billion underlying notional amount on page 117 of the 10-Q for the quarter ended September 30, 2008.

CLASSROOM APPLICATION: The article covers issues related to complex derivative transactions.

QUESTIONS: 
1. (Introductory) With respect to derivative securities, what is an underlying notional amount? Give an example of a notional amount in the context of a specific derivative security.

2. (Advanced) The headline of the article says that AIG faces $10 billion losses on trades. AIG responded in the related article to say that the $10 billion is an underlying notional amount on derivative securities. Is it possible that AIG will face an additional $10 billion in payments related to this amount?

3. (Introductory) What is the difference between using derivative securities to speculate and using them for hedging? In your answer, define these two terms.

4. (Advanced) "The $10 billion...stems from...AIG's exposure to speculative investments...which were essentially bets on the performance of bundles of derivatives linked to subprime mortgages, commercial real-estate bonds and corporate bonds." Based on the description in the article, why are these speculative investments not "covered" by the government bailout assistance given to AIG?

5. (Advanced) In the related article, AIG refers to disclosures on page 117 of its 10-Q filing for the quarter ended September 30, 2008. Refer to the disclosures on that page. What events cause AIG to incur losses and cash payments to counterparties on these securities? Does this description change your answer to question 2?
 

Reviewed By: Judy Beckman, University of Rhode Island
 

RELATED ARTICLES: 
AIG Responds to Wall Street Journal Story
by WSJBlog
Dec 10, 2008
Online Exclusive

"AIG Faces $10 Billion in Losses on Bad Bets," The Wall Street Journal, by Serena Ng, Carrick mollenkamp, and Michael Siconolfi, The Wall Street Journal, December 10, 2008 --- http://online.wsj.com/article/SB122887203792493481.html?mod=djem_jiewr_AC

American International Group Inc. owes Wall Street's biggest firms about $10 billion for speculative trades that have soured, according to people familiar with the matter, underscoring the challenges the insurer faces as it seeks to recover under a U.S. government rescue plan.

The details of the trades go beyond what AIG has explained to investors about the nature of its risk-taking operations, which led to the firm's near-collapse in September. In the past, AIG has said that its trades involved helping financial institutions and counterparties insure their securities holdings. The speculative trades, engineered by the insurer's financial-products unit, represent the first sign that AIG may have been gambling with its own capital.

The soured trades and the amount lost on them haven't been explicitly detailed before. In a recent quarterly filing, AIG does note exposure to speculative bets without going into detail. An AIG spokesman characterizes the trades not as speculative bets but as "credit protection instruments." He said that exposure has been fully disclosed and amounts to less than $10 billion of AIG's $71.6 billion exposure to derivative contracts on debt pools known as collateralized debt obligations as of Sept. 30.

AIG's financial-products unit, operating more like a Wall Street trading firm than a conservative insurer selling protection against defaults on seemingly low-risk securities, put billions of dollars of the company's money at risk through speculative bets on the direction of pools of mortgage assets and corporate debt. AIG now finds itself in a position of having to raise funds to pay off its partners.

The fresh $10 billion bill is particularly challenging because the terms of the current $150 billion rescue package for AIG don't cover those debts. The structure of the soured deals raises questions about how the insurer will raise the funds to pay the debts. The Federal Reserve, which lent AIG billions of dollars to stay afloat, has no immediate plans to help AIG pay off the speculative trades.

The outstanding $10 billion bill is in addition to the tens of billions of taxpayer money that AIG has paid out over the past 16 months in collateral to Goldman Sachs Group Inc. and other trading partners on trades called credit-default swaps. These instruments required AIG to insure trading partners, known on Wall Street as counterparties, against any losses in their holdings of securities backed by pools of mortgages and other assets. With the value of those mortgage holdings plunging in the past year and increasing the risk of default, AIG has been required to put up additional collateral -- often cash payments.

AIG's problem: The rescue plan calls for a company funded largely by the Federal Reserve to buy about $65 billion in troubled CDO securities underlying the credit-default swaps that AIG had written, so as to free AIG from its obligations under those contracts. But there are no actual securities backing the speculative positions that the insurer is losing money on. Instead, these bets were made on the performance of pools of mortgage assets and corporate debt, and AIG now finds itself in a position of having to raise funds to pay off its partners because those assets have fallen significantly in value.

The Fed first stepped in to rescue AIG in mid-September with an $85 billion loan when the collateral demands from banks and losses from other investments threatened to send the firm into bankruptcy court. A bankruptcy filing would have created losses and problems for financial institutions and policyholders all over the world that were relying AIG to insure them against the unexpected.

By November, AIG had used up a large chunk of the government money it had borrowed to meet counterparties' collateral calls and began to look like it would have difficulty repaying the loan. On Nov. 10 the government stepped in again with a revised bailout package. This time, the Treasury said it would pump $40 billion of capital into AIG in exchange for interest payments and proceeds of any asset sales, while the Fed agreed to lend as much as $30 billion to finance the purchases of AIG-insured CDOs at market prices.

The $10 billion in other IOUs stems from market wagers that weren't contracts to protect securities held by banks or other investors against default. Rather, they are from AIG's exposures to speculative investments, which were essentially bets on the performance of bundles of derivatives linked to subprime mortgages, commercial real-estate bonds and corporate bonds.

These bets aren't covered by the pool to buy troubled securities, and many of these bets have lost value during the past few weeks, triggering more collateral calls from its counterparties. Some of AIG's speculative bets were tied to a group of collateralized debt obligations named "Abacus," created by Goldman Sachs.

The Abacus deals were investment portfolios designed to track the values of derivatives linked to billions of dollars in residential mortgage debt. In what amounted to a side bet on the value of these holdings, AIG agreed to pay Goldman if the mortgage debt declined in value and would receive money if it rose.

As part of the revamped bailout package, the Fed and AIG formed a new company, Maiden Lane III, to purchase CDOs with a principal value of $65 billion on which AIG had written credit-default-swap protection. These CDOs currently are worth less than half their original values and had been responsible for the bulk of AIG's troubles and collateral payments through early November.

Fed officials believed that purchasing the underlying securities from AIG's counterparties would relieve the insurer of the financial stress if it had to continue making collateral payments. The plan has resulted in banks in North America and Europe emerging as winners: They have kept the collateral they previously received from AIG and received the rest of the securities' value in the form of cash from Maiden Lane III.

The government's rescue of AIG helped prevent many of its policyholders and counterparties from incurring immediate losses on those traditional insurance contracts. It also has been a double boon to banks and financial institutions that specifically bought protection on now shaky mortgage securities and are effectively being made whole on those positions by AIG and the Federal Reserve.

Some $19 billion of those payouts were made to two dozen counterparties just between the time AIG first received federal government assistance in mid-September and early November when the government had to step in again, according to a confidential document and people familiar with the matter. Nearly three-quarters of that went to French bank Société Générale SA, Goldman, Deutsche Bank AG, Crédit Agricole SA's Calyon investment-banking unit, and Merrill Lynch & Co. Société Générale, Calyon and Merrill declined to comment. A Goldman spokesman says the firm's exposure to AIG is "immaterial" and its positions are supported by collateral.

As of Nov. 25, Maiden Lane III had acquired CDOs with an original value of $46.1 billion from AIG's counterparties and had entered into agreements to purchase $7.4 billion more. It is still in talks over $11.2 billion.

Bob Jensen's threads on previous AIG accounting fraud --- http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

Bob Jensen's threads on the AIG bailout of 2008 --- http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

Big Bang IFRS as shown at http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

 The roaring SEC-FASB (read that Cox-Herz) Enterprise for replacing domestic accounting standards such as U.S. and Canadian GAAP is analogous to letting the Federation  govern the world. Both the U.N. and the International Accounting Standards Board have lofty intentions, but multinational politics in the Federation is a nightmare to behold.

A November 3, 2008 clarification of my position of the controversy of replacing U.S. accounting standards with international accounting standards

Notwithstanding Shaum Sunder’s excellent argument against an IASB monopoly and my preference for bright line rules, I’ve viewed all along that “resistance is futile” in trying to prevent the ultimate replacement of U.S. domestic accounting standards with international standards.

At this point I’m merely trying to prevent both a premature Big Bang (Mary Barth’s wording) or a bunch of Little Bangs (Pat Walter’s wording) prematurely. By prematurely, I mean having at least until 2018 to evolve into this in an orderly manner for business firms, auditors, accounting educators, textbook writers, students, and CPA examiners. Cox is rushing this thing too fast at the SEC, and I think the FASB is trying to avoid having to rewrite FASB standards, interpretations, and guidelines to be consistent with IFRS.

I think we’ve given the FASB sufficient resources to rewrite U.S. GAAP in an evolutionary manner that will greatly enrich the illustrations and implementation guidelines that are sorely lacking in the present IASB standards. In other words I would like to have FASB Standards and a greatly improved FASB Codification Database after 2018 even if IFRS is virtually written into U.S. GAAP. And yes, I will concede to removing most of the bright line rules! Sigh!

I also think the U.S. should maintain its leverage by not fully committing to IFRS until the IASB is better able to handle the enormous U.S. economy in terms of a better IASB infrastructure, greatly increased IASB research funds, many more IASB full-time members, and a demonstration that it is not under the thumb of the EU politicians and bankers.

I also agree fully with Mary Barth that our academy’s accounting researchers worldwide should play a greater role in making IFRS better able handle its eventual monopoly on all accounting standards for the free world.

I would also like time to let the smell to dissipate concerning how Chris Cox, while Director of the SEC, abused his authority by trying for force international standards down our throats too suddenly in a chaotic Big Bang.

November 26, 2008 message from david.raggay@ifrs-consultants.com

Forget IFRS for a moment if you will – let us pretend that they don’t exist. Are you of the opinion that rules lead to transactions and events being more faithfully represented than principles?

If no, would you support a gradual move from current US GAAP to principles-based US GAAP in a manner that allows proper acclimatization by all stakeholders?

David

November 27, 2008 reply from Bob Jensen

Hi David,

I have argued over and over that rules in many instances lead to greater consistency, easier enforcement, and better safety. My classic examples are traffic rules. The principle “reduce speed in a school zone” just does not work well when some drivers think that reducing speed from 55 mph to 40 mph meets the “principle.” Parents of school children are ever so grateful for bright-line signs posted setting maximum speed to something like 20 mph in school zones.

In the U.S. over the past four decades, we’ve seen where enormous clients that auditing firms cannot afford to lose have been bullying auditors to points where auditors exercised poor judgments about accounting “principles.” My best example here is when CEO Frank Raines bullied KPMG to violate FAS 133 rules about hedge accounting for heterogeneous macro hedges. As a result of the rules, the government caught Fannie Mae and KPMG. KPMG got fired from the audit and Frank Raines got fired from Fannie Mae and was required to pay over a million dollars in fines.

Had there only been a “principle” about macro hedging without some bright line rules, chances are that both Raines and KPMG would still be misleading investors at Fannie Mae, because they could argue that they just applied different “judgment” about accounting principles vis-à-vis what judgments other firms and auditors might apply in the same circumstances. It was the Three-Percent rule (now a 10 % Rule in FIN 46) that essentially brought down both Enron and Andersen. Without such a bright line rule, Enron might still be gouging electric power companies, Andersen might still be performing terrible audits, and Andy Fastow might be the new Secretary of the U.S. Treasury.

My point is that enormous clients are prone to bullying auditors in the U.S. and, without some of the bright line rules in such areas as revenue realization, hedge accounting, and SPE accounting (that 10% rule today), the bad guys would still be cooking the books in the U.S. instead of having to pay up in court --- http://www.trinity.edu/rjensen/Fraud001.htm 

Obviously, no accounting standards can be exclusively principles-based (IFRS has some bright line rules) or rules-based (U.S. GAAP leaves a lot of leeway for professional judgment in most standards). I think what you’ve overlooking, David, is the history of bright line rules in U.S. GAAP.

Bright line rules typically were introduced when business firms were abusing the privilege of judgment. These abuses led to many inconsistencies such as when Boeing said it sold an airliner to Eastern Airlines, but Eastern Airlines reported in was only renting the airliner from Boeing. These abuses also misled investors and led to a lot of unearned bonuses because principles-based standards led to greater ability to manage earnings to the penny just to get a bonus (as in the case of Franklin Raines at Fanney Mae).

Sure it’s easy to point to some bright line rules that have not worked well such as the FAS 13 bright line rules separating operating leases from capital leases. It’s easier to generate a “principle” that there can be no operating leases and make every lease a capital lease. But this is more than just a “principle.” This is a harsh bright line rule that simply sets the bar for operating leases at zero.

Of course doing away with operating leases entirely is not necessarily a good thing in theory. There is a difference when there’s zero chance of ever being an owner after decades of paying rent under an operating lease such as when a bookstore rents a 1,000 square-foot shop in the Galleria Shopping Mall. The Galleria has no intention whatsoever of ever passing ownership title to a mere 1,000 square feet in a million square-foot mall. The firm that leases the entire million square feet mall itself, however, may well become the owner of the Galleria Mall under a true capital lease after making lease payments for 30 years and then paying an ending one dollar to own the mall.

Hence there is a difference between the book store’s lease (never a chance to own) and the mall lease allows the lessee to purchase the mall for a dollar after 30 years of paying rent. Standards that consider the book store lease and the mall’s lease as equivalents is not necessarily correct in “principle.”

My threads on rules-based versus principles-based standards are at http://www.trinity.edu/rjensen/theory01.htm#Principles-Based 
Neither basis for accounting standards is perfect in every instance, but I hate accounting standards that give greater flexibility to enormous clients to bully auditors and manage earnings to maximize bonuses rather than shareholder value.

What a more gradual convergence to test principles-based standards slower in the U.S. business environment to see where they are allowing run-away earnings management and financial reporting manipulation. This would allow the U.S. to pressure the IASB to insert some bright line rules, before the U.S. buys into IFRS entirely, where the most egregious earnings management is being attempted under principles-based standards.

Bob Jensen

Tom Selling explains the timing of the the SEC issuance of the IFRS Roadmap in "G-20 Conference Provides Cover for the SEC to Issue Its IFRS Roadmap," The Accounting Onion Blog on November 15, 2008 --- http://accountingonion.typepad.com/

November 16, 2008 letter from Bob Jensen to Tom Selling

Hi Tom,

Thanks for providing a link to the Roadmap for unconditional surrender of U.S. GAAP. We lost the war, but resistance was futile from the time Chris Cox took over as the Director of the SEC. I surrendered some time ago but was hoping for 2018 rather than 2014 --- http://www.trinity.edu/rjensen/Theory01.htm#MethodsForSetting
I think the U.S. could've bargained for more, especially for a better infrastructure and funding of the IASB and a much larger permanent research staff at the IASB.

Like everything else associated with IFRS, this SEC Roadmap is an illustration of being “Principles Based.” The milestones are very soft with no bright lines --- http://www.sec.gov/rules/proposed/2008/33-8982.pdf

The SEC Roadmap sets 2014 as the date of unconditional surrender, but leaves the door very slightly ajar for delays in this date depending upon whether certain “milestones” are met. But true to principles-based standards there are no definitive benchmarks for accomplishing the milestones. To me these milestones are more for show than for real. It’s best to assume 2014 is a done deal. Educators and CPA examiners and CPA review courses and students are going to be in a state of turmoil. As for the publishers --- they’re probably dancing in the streets. Cox just killed the used book market. Cox just killed the CPA exam review materials.

This will affect textbooks at all levels. LIFO has to be expunged from Principles textbooks. Fair value fantasies have to be added to the textbooks. All the bright line rules in Intermediate and Advanced accounting textbooks have to be plucked out and replaced by IFRS principles-based replacements. All basic and financial accounting instructors have to be retooled --- http://www.trinity.edu/rjensen/Theory01.htm#FairValue

Training firms (including the AICPA, IMA, and large accounting firms) are dancing in the streets. Virtually all business firms that have public accounting audits as well has the public accounting audit firms themselves will have to spend hundreds of millions of dollars on hurried training.

Let’s conclude by admitting we’ve been Coxed into 2014 this in the waning days before Chris Cox gets fired or is forced to resign. He abused his authority in this just like he abused his authority in deciding not to monitor Wall Street’s Investment Banks before their collapse (Cox admits he made a grave mistake here) --- http://www.trinity.edu/rjensen/2008Bailout.htm#SEC

I’m willing to surrender unconditionally but not until 2018. However, I doubt that anything short of nuclear war will slow down this Herz-Cox Express Train. Sadly, the Big Four that really got us into this roadmap (Cox is just a front) may not be around in 2014 to enjoy their successful lobbying effort --- http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

My threads on this whole IFRS convergence mess are at http://www.trinity.edu/rjensen/Theory01.htm#MethodsForSetting

Bob Jensen

November 16, 2008 reply from Neal Hannon [nhannon@GMAIL.COM]

Hi Tom,

As pointed out by the FEI financial blog, the chairman of the FAF has sent a FAF letter to President Bush, G-20 prior to the G-20 summit asking him to preserve accounting standard setting. Here are a few highlights from the letter:

In a letter posted on the Financial Accounting Standards Board (FASB) website today, Robert Denham, President of the board of Trustees of the Financial Accounting Foundation (FAF) (which oversees the FASB), sent a letter to U.S. President George W. Bush on Nov. 13, asking President Bush to share the letter with members of the G-20 attending the Summit on Financial Markets and the World Economy taking place today and tomorrow in Washington, DC. Following are some of the points in the FAF letter to President Bush, G-20:

We understand that current issues relating to international accounting standards will be discussed at this [G20] meeting as part of a comprehensive examination of the global financial crisis. The FAF believes that the complex task of setting accounting standards is best done by the experts who comprise the FASB and International Accounting Standards Board (IASB). We are very concerned about recent efforts in the United States and abroad that contemplate political solutions to perceived flaws in certain accounting standards. Political pressures have been brought to bear on the IASB to urgently review and revise its standards, particularly relating to 'mark-to-market' (fair value) accounting. The IASB has already departed from its normal due process to make one such revision in response to this pressure and is being asked by the European Commission to further review its standards for certain financial instruments and to complete its deliberations in time for year-end financial reporting. High-quality accounting standards are best achieved when the standard-setting process is independent and free of political influence. We believe that any legislative outcome that would permit accounting standards to be overturned through a political process will create uncertainty, greatly undermine investor confidence, and dangerously compromise the credibility of financial reporting at a time when the capital markets are under great duress and in need of greater transparency. We encourage the G-20 to support independent standard setting via a robust due process free from political interference. This support will do more to restore confidence in the capital markets than legislating accounting standards in a way that reduces the reliability and transparency of financial information presently available to investors. How can giving an understaffed, under-funded, politically influenced board be a good thing for international accounting, let alone US accounting? The Wall Street Journal (see http://online.wsj.com/article/SB122662346962726733.html  ), in an editorial about the G-20 summit talked about the push for a new international regulator (a natural follow-on to global IFRS) in the following terms: Given the dominant American role in global finance, a new international regulator is one more way for the Lilliputians to tie down Gulliver. We're all for nations working together for common standards that improve business efficiency across borders. But Europe has all too often used its regulatory standards to punish American companies -- witness its antitrust assaults on Microsoft and GE.

Seems to me that there is an abundance of scepticism to harness against giving up on FASB as the US accounting standard setter.

Neal

SEC Director Chris Cox --- Good Riddance in Spite of a Relatively Good Enforcement Year
Why “Good Riddance?”

On September 27, 2008 I added the following appendix to my essay at http://www.trinity.edu/rjensen/2008Bailout.htm

"The SEC in 2008: A Very Good Year? A terrific one, the commission says, tallying a fiscal-year record in insider-trading cases, and the second-highest number of enforcement cases overall. But what would John McCain say?" by Stephen Taub and Roy Harris, CFO.com, October 22, 2008 --- http://www.cfo.com/article.cfm/12465408/c_12469997

Sadly, Chris Cox will leave office with both U.S. capital markets and the U.S. financial accounting/auditing systems in disarray. It's not so much that he's a bad person. It's just that he was too trusting of the oligopolies when allowing them free hand in policing themselves. That did not work all well as we're now writing into the histories of disasters.

As a departing (hopefully soon) Director of the SEC, the legacy of Chris Cox will not be commendable in spite of a record number of successful recent SEC court cases against financial fraud. John McCain announced during his campaign that, if elected President of the U.S., one of his first acts would be to fire Chris Cox. In spite of some great leadership against specific targets of fraud, Chris Cox failed to see the dangers in allowing oligopolies to control two industries. In the case of Wall Street, Commissioner Cox decided not to exercise the SEC's power and responsibility of oversight of investment banks. And Wall Street investment bankers took advantage of lax SEC oversight to a point of self-destruction.

In the case of the accounting industry, Chris Cox decided to allow the oligopoly of the largest international accounting firms to dictate, for all U.S. accounting firms and U.S. industry, abandonment of our rich heritage of U.S. accounting principles in favor of an incomplete set (compared to U.S. GAAP standards) of international accounting standards (IFRS). Although this might be a commendable goal in a couple of decades after the International Accounting Standards Board has the resources and infrastructure and standards in place to take on the giant U.S. economy, the large-firm oligopoly seemingly moved too quickly to make this transition. Possibly the large accounting firms rushed us into IFRS this year because they had Chris Cox under their thumbs. Tom Selling on October 8, 2008 now reveals some of the politics being played by the big firms in this regard and predicts that the new SEC Director will not be so favorably inclined toward a rush to abandon U.S. accounting standards.

"Speaking Out Against IFRS Adoption? Welcome to the "Loud Minority," by Tom Selling, The Accounting Onion, October 8, 2008 --- http://accountingonion.typepad.com/ 
As I mentioned in a previous post, PCAOB member Charles Niemeier delivered a tour de force critique of U.S. efforts to adopt IFRS, at a recent New York State Society of CPAs (NYSSCPA) educational event. To its credit, the NYSSCPA's e-zine covered Niemeier's remarks a few days later. On the other hand, the PCAOB sure took its sweet time (weeks) to post the text of his speech on its website.

Perhaps one reason the PCAOB appears to have dragged its feet is that Niemeier was equally critical, if not more so, of two other "global initiatives" in the financial reporting arena: "reliance on non-U.S. regimes for auditor oversight, and converging U.S. auditing standards to those developed by the International Federation of Accountants." These thoughts were completely overlooked in the NYSSCPA's coverage, and given short shrift by almost everyone else it seems. Evidently, few care whether the PCAOB willingly gores its own ox; but opposing IFRS adoption is like standing between hungry pigs and their troughs.

IASC to Niemeier: You're Loud and We're Right ('Cuz We Said So)

With respect to IFRS adoption, NYSSCPAs' coverage of Niemeier was fair, and gets kudos from me for reporting this key reaction:

"'The impression I got and the reaction from the audience was: it's about time somebody said something about this,' said conference Chair George I. Victor, who is also immediate past chair of the NYSSCPA's Accounting and Auditing Oversight Committee. 'It's David and Goliath and David stood up to Goliath here. Just about everybody in the room agreed with most if not all, of what he said.'" [emphasis supplied]

You can bet that a Goliath would want the last word, and preferably with no David to contend with. So, the NYSSCPA accommodated Goliath a week later in the person of Philip Laskawy, vice-chairman of the International Accounting Standards Committee Foundation (IASCF), new chairman of Fannie Mae, and former head of Ernst & Young (1994 – 2001). Not all of the questions posed to Laskawy were softballs; however, there can be no denying that numerous disingenuous answers were allowed to prevail with nary a token of protest.

If a straight-shooting David were present, maybe the encounter would have gone something like this:

NYSSCPA: The 22 trustees of the IASCF are responsible for the governance, oversight and funding of IASB and the rigorous application of International Financial Reporting Standards (IFRS). Philip A. Laskawy retired as the chairman and CEO of Ernst & Young in 2001, a position he had held since 1994. In addition to his service as a trustee, he currently serves on the boards of several U.S. and foreign-based companies and non-profits.

David: Another pertinent fact, which may affect your assessment of Mr. Laskawy's credibility, is that he presided over E&Y during a time when, as evidenced by unprecedented sanctions, E&Y committed some of the most blatant independence violations by an international firm since the enactment of the federal securities laws:

[In 2004, an] SEC administrative law judge fined E&Y $2.164 million (including $1.7 million disgorgement) and bars the firm from accepting any new clients in the U.S. for six months, after finding that the firm acted improperly by auditing PeopleSoft Inc. -- a company with which it had a profitable business relationship. … According to The New York Times, the administrative law judge said the firm "committed repeated violations of its auditor independence standards by conduct that was reckless, highly unreasonable and negligent." (Floyd Norris, "Big Auditing Firm Gets 6-Month Ban on New Business," April 17, 2004) … The SEC alleged that E&Y violated the auditor independence requirements in connection with E&Y's audits of PeopleSoft Inc.'s financial statements from 1994 through 2000. … [Available at http://www.crocodyl.org/wiki/ernst_young; emphasis supplied]

NYSSCPA: More than one study has reported that companies show higher earnings under IFRS versus GAAP. Can anything be done to smooth the contradictory data investors will be relying upon as IFRS is phased in for more companies in the years ahead?

Goliath: I have no basis of knowing whether any of those studies are right or wrong. Anyway, that gets adjusted in the market place, but more importantly you'll be able to compare two companies from different countries who are in the same business to see how they're doing.

David: It sounds like you're not even interested in knowing the answer to these questions. Evidently, the numerous studies cited by Niemeier, and by Professor Teri Yohn in her testimony to Congress amount to an inconvenient truth you would prefer to ignore. Yes, I know you're Goliath, so I'll humor you and pretend that the totality of research on this topic is actually inconclusive. How can you say on the one hand that the market adjusts for differences in accounting, rendering differences between IFRS and GAAP inconsequential; and then say on the other hand that market participants will benefit from enhanced comparability! You seem to be saying that accounting doesn't matter now, but it will when everyone adopts IFRS.

NYSSCPA: Are you concerned that comparability across companies will decrease if the U.S. conducts a phased-in transition to IFRS?

Goliath: Nope. U.S. companies aren't comparable anyway, because GAAP changes so darn much. And, I don't think there have been any examples where it's been that impactful on stock prices. Even today, investors are not using GAAP earnings necessarily as a way of determining their recommendations on companies.

David: Once again, the evidence contradicts your wishful thinking. Those same folks I just mentioned cite evidence that investors do prefer GAAP, and GAAP is more closely associated with stock prices – i.e., investors putting their money where their mouth is.

Besides, lack of comparability due to changes in GAAP is way overstated; all significant changes to GAAP require retroactive restatements to assure comparability over earlier periods. Also, are you actually saying that once the U.S. takes the plunge on IFRS, there will be the equivalent of world peace, and for the first time since the days of the Old Testament, accounting standards won't change? Unless that's what you are saying, then IFRS won't result in comparability either; you have just thrown comparability, your biggest selling point for global accounting convergence, under the bus.

NYSSCPA: If the transition goes as expected, the U.S. will be basically giving up control of financial standards to an international body by 2016. We're surprised more people haven't been talking about it.

Goliath: You really would have to ask them.

David: "You really would have to ask them" is exactly what the IASCF and SEC should be doing more often and more better – if the goal of U.S. adoption of IFRS is to make a change that investors actually want and can benefit from. Instead of blatantly shilling for IFRS, Goliaths should be spending their time looking for real answers. For example, figure out how to encourage broad-based investor feedback so that rigorous studies by impartial investigators can provide reliable answers to high-stakes questions.

NYSSCPA: We're also surprised that you haven't gotten more comment letters on the constitution review from stakeholders who would want to weigh in on the oversight of IASB. What's your opinion on that? Do you think all the stakeholders are really paying attention at this point, or maybe it's too far off?

Goliath: With most things in life there's a very loud minority, and Charles Niemeier truly is part of that minority—very small—who make a lot of noise, but the vast silent majority just goes about and does its thing, and I think that's what's happening here. And by the way, I don't think the presidential election is going to affect the transition to IFRS.

David: I don't know which insult makes me want to shoot you with my slingshot more: your arrogant disrespect of a man of obvious intelligence and integrity; or channeling Richard Nixon and Spiro Agnew with their infamous Vietnam-era "silent majority" ("vast," no less) schtick. Either way, there can be no denying Niemeier is in the company of some other very smart people: among them, Ed Trott, former FASB member is now speaking out about the questionable political agendas motivating the SEC's proposed roadmap and the EU's adoption of IFRS; Floyd Norris of the New York Times doing pretty much the same; and Shyam Sunder of Yale, who believes that U.S. adoption of IFRS would lead to a mandated monopoly, thereby creating more chaos than order to accounting standards. And, don't forget the reaction of Niemeier's audience at the NYSSCPA program: it sounds like he is the one preaching to the majority choir.

As to "loud," that better describes the Big Four et. al., and the AICPA with their unabashed promotion of their own self-interest. Now that current events are forcing the SEC to refocus on investor protection, the long-awaited document proposing a "roadmap" to IFRS seems to have disappeared (along with my 401(k) account). That seems to have had no effect on your rhetoric – or that of your former firm. I received an invitation from E&Y to watch a webcast on IFRS 2 (share-based payment) with the following come on:

"International Financial Reporting Standards (IFRS) is becoming the dominant language of financial reporting worldwide. With the pending release of the SEC's proposed IFRS Roadmap, IFRS adoption in the US is almost official. The question now remains a matter of when will adoption be required and how will companies make the transition. For many, the key will be early preparation and these businesses are developing their transition plans now." [bold and italics in original; underline is mine]

Given recent events, that sounds awfully loud to me! Other work prevented me from watching the webcast, but I'm betting that there was more of the same hyperbole: probably some useful tips designed to lead to fees for assisting management should they desire to re-engineer their own compensation schemes to get the most out of IFRS in their financial statements. But wait. I forgot that, according to you, the "market adjusts" for these things. I'm also betting that a lot of investors' money will be headed out the window when management figures out how to manage its compensation under IFRS.

As to the outcome of the elections, don't be surprised if "loud minority" leader Niemeier becomes the next SEC chair! Even though he is a Republican, and Barack Obama is the likely victor, Niemeier has the integrity, experience and profile that the SEC desperately needs at this critical juncture. With three Democrats and a Republican chair who owes nothing to his party, IFRS adoption in the U.S. will be history.

The bottom line, Goliath, is that the footnotes to Niemeier's speech by themselves were more compelling and interesting than what essentially boils down to your blind eye, blind faith or vested interest responses for the sole objective of selling IFRS. My father taught me to watch out for people, like you and the SEC's John White, who weave "truly" into pompous rhetoric like "loud minority" and "vast silent majority." The reliability of such utterances are usually anything but.

And by the way, I'm sure you're going to do a truly great job for me at Fannie Mae.

At least six accounting professors have been trying to actively derail the current SEC Chairman's abusing of his power to rush the replacement of rule-laced U.S. accounting standards with mushy "principles-based" international standards that allow business firms much greater flexibility (read that "subjective judgment") in accounting for earnings and risk. But our efforts to derail or at least postpone the Cox-Herz IFRS Express Train are utterly futile --- http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

As Chairman of the SEC, Christopher Cox should've instead been paying more attention to preventing fraud and preventing the Men in Black (bankers) from bullying their auditors into understating their bad debt reserves for faltering mortgaged-backed securities (e.g., at Bear Stearns) and sinking credit default swaps (e.g., at AIG). Mixing the metaphor here, we might say that Nero was fiddling while Rome was burning.

Bob Jensen's threads on this unconditional surrender of U.S. GAAP are at http://www.trinity.edu/rjensen/Theory01.htm#MethodsForSetting

All is not well in the House of IFRS

"Global Accounting Standards? Not So Fast," SmartPros, November 13, 2008 --- http://accounting.smartpros.com/x63796.xml

Too Much Interfering

IASB Chairman Sir David Tweedie told a group of British members of Parliament that he considered resigning his post after going toe to toe with the European Commission [EC] over the use of fair value accounting methods and warned that further interference in accounting rules could destroy the effort to adopt a unified set of standards, according to a story in the Financial Times on Nov. 12. The IASB reportedly agreed to the change only to avoid a worse alternative -- the EC's threat to carve out sections of the IFRS relating to fair value practices.

The CFA Institute's Centre for Financial Market Integrity opposes the IASB's change, calling it a step backward because it doesn't improve the quality of financial reporting. The CFA would like to see a broader application of fair value into categories where it's currently not required, such as loans and receivables, says Patrick Finnegan, director of the Financial Reporting Policy Group at the Centre.

"If you think we have problems with transparency of balance sheets now, just wait for what's coming [under IFRS]," warns Kenneth Scott, a senior research fellow at the Hoover Institution and a professor at Stanford University's law school. Reclassification of financial assets "doesn't add anything to asset value. It just fixes the books."

It's odd that something promoted as beneficial to investors should be called into question for potentially lowering the quality of reporting standards and in turn, preventing investors from analyzing what a company's assets are really worth.

The key difference between U.S. Generally Accepted Accounting Principles [GAAP] and IFRS is that U.S. standards are based on explicit rules while the international standards' reliance on principles gives companies more room to use their judgment in deciding how to recognize revenue and other key metrics. Adoption of IFRS would also probably trigger a big tax hike for U.S. companies, which would no longer be able to use the last-in-first-out [LIFO] inventory accounting method, which doesn't exist under the international standards. The LIFO method assumes that goods purchased most recently are sold first and that the remaining items have been purchased at earlier periods, yielding a lower gross profit during high-inflation periods than the first-in-first-out accounting method.

Don't Sue Me

The debate over switching to accounting standards based on something less explicit than rules comes down to questions about whether the less explicit standard will provide adequate protection against lawsuits, says James Leisenring, director of technical activities in research at the FASB. "You can't understand the debate about gratuitous vs. obligatory guidance [within IFRS] until you understand the litigation system in the U.S.," where companies are more concerned about getting sued than in other parts of the world, he says. "What it's really about is safe harbors. What [IFRS skeptics] really want to know is 'If I do it in a particular way, am I home free or not?'"

The explicit rules under GAAP may appear to offer safety, but the downside is there are so many of them that the odds of missing one or two are greater, he says. From Leisenring's perspective, the big accounting firms that are drawn to IFRS believe they'll get sued less since it will be harder to point to their mistakes. White agrees that some companies like the freedom allowed under IFRS to interpret standards to suit their convenience, which undercuts auditors' ability to prohibit certain accounting choices.

The most strident critics of migration to IFRS argue that the primary goal of the SEC and U.S. Treasury Dept. is attracting capital to U.S. markets, rather than ensuring that the highest quality accounting standards prevail. While attracting more capital to the U.S. "is a valid business objective, it's not clear we can do that by going to international financial reporting standards," says Ashwinpaul Sondhi, president of A.C. Sondhi Associates in Maplewood, N.J., who has served on CFA Institute committees.

Paul Miller, a professor of accounting at the University of Colorado, would prefer to have competing standards, since the only standards all countries would be able to agree on would be very weak ones. He also believes a unified set of standards, rather than being helpful, would stifle much-needed innovation given that most of the existing accounting standards are more than 60 years old. (This is also consistent with Shayum Sunder's research paper --- http://profalbrecht.wordpress.com/2008/10/08/shyam-sunder-ifrs-critic/ )

Loss of Information

Some investment advisers, including Sondhi, believe investors have already lost valuable information with the SEC's elimination last year of the reconciliation between GAAP and the non-U.S. GAAP standards used in foreign companies' financial reports. "Reconciliation gave me information and told me about [non U.S. companies'] cash flow generating ability that I didn't have from their financial statements alone," Sondhi says.

The fact that many analysts in the U.S. and overseas used to rely on the reconciliation suggests they found the differences between GAAP and foreign standards very useful, says Sondhi. He agrees that competition between different sets of standards might result in better information. "I don't know that either side has achieved a level of standard setting that would lead me to say we can do with one," he says.

Many investment professionals, however, support migrating to a single set of standards, as long as they are of the highest quality. Finnegan at the CFA Institute questions whether the IASB and the FASB can act truly independently given the pressure each has been subjected to by regulators over the past several months as a result of the financial crisis. "When you have that kind of pressure and intervention, you have the possibility of movement to lower-quality standards that's going to appease certain interests at any one point in time, and that's not healthy," he says.

Criticism of fair value accounting has been no less vehement in the U.S. The SEC has resisted pressure to suspend the standard, but Section 132 of the TARP gives the SEC broad authority to suspend the use of SFAS 157 by issuer class or category of transaction [BusinessWeek.com, 10/14/08].

Who Feeds the Watchdogs?

The fact that IASB is funded by corporate contributions also compromises its independence, critics say. Until 2003, the FASB was funded under the same arrangement for 30 years. That changed with the passage of Sarbanes-Oxley, which required the board to be funded by mandatory contributions from the Public Company Accounting Oversight Board [PCAOB], which Congress created to provide better regulatory oversight of the accounting industry.

Miller at the University of Colorado says a better source of funding for a standards board would be stock exchanges, which could charge a fee to buyers and sellers who use the exchanges to do transactions and presumably are users of financial statements. "I would far rather see money going to an international board from users of financial standards than those who prepare them," he says.

Another concern is whether the SEC would continue to have regulatory oversight if U.S. companies adopt IFRS. Says Miller: "The big issue is that sending it offshore diminishes our control, and in a time of crisis where accounting has played a part, I don't think it's especially wise to create a new system that diminishes U.S. control over accounting standards."

Continued in article

December 18, 2008 reply from David A E Raggay [david.raggay@IFRS-CONSULTANTS.COM]

Is that to say that FASB is beyond political (and other) interference?

David

December 18, 2008 reply from Bob Jensen

Hi David,

Of course the FASB is not beyond politics. But it was successfully formed to further distance standard setting from politics. In fact the FASB was formed because a very serious threat from Moss and Medcalf that the SEC would become the U.S. accounting standard body, thereby giving the executive and legislative branches of government more control over accounting standards and appointments of standard setters --- http://www.trinity.edu/rjensen/theory01.htm#AccountingHistory

Moss and Metcalf came very close to removing the accounting profession from standard setting. The FASB was intended to be an in-between “independent” standard setting body. There are many times when the FASB really demonstrated independence under threatened legislation to overturn such standards as FAS 123-R and FAS 133 (both of which Silicon Valley lobbyists fought hard to overthrow). The SEC, however, has always had powers to overturn the FASB, and it did so with oil and gas accounting after the drilling industry put the SEC in a vice. That episode served to illustrate how political standard setting would’ve become in the hands of the SEC. To it’s credit, the SEC has mostly distanced itself from such standard overrides for more than three decades.

If I were to criticize FASB independence it might be that the powers on the Board were and still are heavily influenced by executive partner alumni of the largest accounting firms whose alumni generally led the FASB. I don’t want to imply ethics violations in this regard. I do want to imply that the most powerful FASB members had close ties with research partners in their former CPA firms. I think that the research going on within the big firms caught the attention of the FASB more than any other input to FASB deliberations. In many, many instances this was a good thing since our academy utterly and shamefully failed the FASB.

After 1933, the AICPA and the SEC seriously attempted to generate accounting standards, enforce accounting standards, and provide academic justification for promulgated standards.

• ASRs of the SEC
• In a 3-2 vote the SEC followed George O. May's efforts to mandate external audits of securities traded across state lines in the U.S.
• 1939-1959 A.D.: Accounting standards were generated by the AICPA's Committee on Accounting Procedure (CAP) that issued Accounting Research Bulletins (51 ARBs) --- but the tendency was to overlook controversial issues such as off-balance sheet financing, public disclosure of management forecasts, price-level accounting, current cost accounting, and exit value accounting.  Controversial items avoided by the CAP included management compensation accounting, pension accounting, post-employment benefits accounting, and off balance sheet financing (OBSF).  The CAP did very little to restrain diversity of reporting.
• 1960-1972 A.D.:  Accounting standards in the U.S. were generated by the AICPA's Accounting Principles Board (APB) that had more members than the CAP and a mandate to attack more controversial reporting issues.  The APB attacked some controversial issues but often failed to resolve their own disputes on such issues as pooling versus purchase accounting for mergers.  
• 1972-???? A.D.  Accounting standards in the U.S. were, and still are, being generated by the Financial Accounting Standards Board (FASB) that has seven members, including required members from industry, academe, and financial analysts in addition to members from public accountancy.  FASB members must divorce themselves from previous income ties and work full time for the FASB.  The formation of the FASB was a desperation move by CPA's to stave off threatened takeover of accounting standards by the Federal Government (there were the Moss and Metcalf bills to do just that under pending legislation in the U.S. House and Senate).  Unlike the CAP and APB, the FASB has a full-time research staff and has issued highly controversial standards forcing firms to abide by pension accounting rules, capitalization of many leases, and booking of many previous OBSF items (capital leases, pensions, post-employment benefits, income tax accounting, derivative financial instruments, pooling accounting, etc.).  The road has been long and hard on some other issues where attempts to issue new standards (e.g., expensing of dry holes in oil and gas accounting and booking of employee stock options) have been thwarted by highly-publicized political pressuring by corporations.

History of the U.S. Financial Accounting Standards Board (FASB) and earlier accounting standard setting in the United States --- http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

The funding history of the FASB is interesting in itself until government funds started flowing because of the Sarbanes-Oxley legislation. Like the IASB, some funding came from sales of publications, but the FASB also had a seeded endowment. Since the big accounting firms want IFRS so desperately in a rushed time frame, I think these international firms should also give millions for an endowment of IASB research and publication and Website communications.

As far as our academy goes, most faculty listened to the accountics researchers who attempted to divert academic thinking away from standards setting.

Academic Accounting Researchers Dropped Out and Failed the FASB
Demski’s (1973 around the time the FASB was being formed) article, ‘‘The General Impossibility of Normative Accounting Standards,’’ reinforced academic reluctance to weigh in on how practice ‘‘ought’’ to proceed. What quantitative, management accountants read into Demski’s article was that the accounting standard-setting process was hopelessly and inevitably pointless— impossible, even—and that it did not deserve any further effort from them. Academicians began backing off from involvement in standard setting, which caused further separation of teaching from research, but also exacerbated the separation of research from practice. In fact, polls revealed that the most quantitative journals—thus, those least accessible to practitioners—were perceived to have the highest status in the academy (Benjamin and Brenner 1974).
Glenn Van Wyhe, "A History of U.S. Higher Education in Accounting, Part II: Reforming Accounting within the Academy," Issues in Accounting Education, Vol. 22, No. 3 August 2007, Page 481.

 

Professor Demski continues to steer us away from the clinical side of the accountancy profession by saying we should avoid that pesky “vocational virus.” (See below).

The (Random House) dictionary defines "academic" as "pertaining to areas of study that are not primarily vocational or applied , as the humanities or pure mathematics." Clearly, the short answer to the question is no, accounting is not an academic discipline.
Joel Demski, "Is Accounting an Academic Discipline?" Accounting Horizons, June 2007, pp. 153-157

Statistically there are a few youngsters who came to academia for the joy of learning, who are yet relatively untainted by the vocational virus. I urge you to nurture your taste for learning, to follow your joy. That is the path of scholarship, and it is the only one with any possibility of turning us back toward the academy.
Joel Demski, "Is Accounting an Academic Discipline? American Accounting Association Plenary Session" August 9, 2006 --- http://www.trinity.edu/rjensen//theory/00overview/theory01.htm

Too many accountancy doctoral programs have immunized themselves against the “vocational virus.” The problem lies not in requiring doctoral degrees in our leading colleges and universities. The problem is that we’ve been neglecting the clinical needs of our profession. Perhaps the real underlying reason is that our clinical problems are so immense that academic accountants quake in fear of having to make contributions to the clinical side of accountancy as opposed to the clinical side of finance, economics, and psychology --- http://www.trinity.edu/rjensen/theory01.htm#DoctoralPrograms

My honest opinion is that many leading accountics researchers are not avoiding the clinical side of accounting out of snobbery. The problem is that clinical research in accountancy is much more difficult than economics and behavioral research. Clinical problems in accountancy are systemic and intractable.

See my tidbit on “Accounting for Business Firms versus Accounting for Vegetables”
--- http://www.trinity.edu/rjensen/FraudConclusion.htm#BadNews

 

Bob Jensen's threads on the IFRS convergence mess are at http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

Commentary on a TAR Paper by Mary Barth

Mary Barth is a former partner at Arthur Andersen, a distinguished professor of accounting at Stanford University, one of the very best accountancy researchers in the world, a long-time member of the International Accounting Standards Board (IASB), a strong advocate of fair value accounting, and a leading advocate of replacing U.S. GAAP with IFRS international standards ---
https://gsbapps.stanford.edu/facultybios/biomain.asp?id=37912109

Actually some leading nations did not adopt IFRS with a "big bang." For example, Canada and Australia are working toward converting domestic accounting standards to be consistent with IFRS standards. This will eventually have the same result as a big bang transition, but the process is more evolutionary and leaves in place domestic standards where there are no IFRS standards covering certain transactions because the IASB has either not taken up those issues or cannot agree on a solution at the present time.

The FASB has for years been working with the IASB to develop new or revised consistency between some FASB standards and IASB standards. The FASB, like virtually all accounting educators, was somewhat taken aback when the Director of the SEC in 2008 announced that the slower cooperative and evolutionary joint effort by the FASB and IASB was going to be replaced by an abrupt big bang adoption of IFRS like it or not.

"Global Financial Reporting: Implications for U.S.," by Mary Barth, The Accounting Review, Vol. 83, No. 5, September 2008 ---
Not free at http://www.atypon-link.com/AAA/doi/pdfplus/10.2308/accr.2008.83.5.1159

This paper identifies challenges and opportunities created by global financial reporting for the education and research activities of U.S. academics. Relating to education, after overviewing the relation between global financial reporting and U.S. GAAP, it offers suggestions for topics to be covered in global financial reporting curricula and clarifies common misunderstandings about the concepts underlying financial reporting. Relating to research, it explains how and why research can provide meaningful input into standard-setting, and identifies questions that can motivate research related to topics on the International Accounting Standards Board’s technical agenda and to the globalization of financial reporting.

. . .

Globalization of financial reporting is becoming a reality. However, many challenges remain. There are many around the world unfamiliar with independent standard-setting and an investor focus for financial reporting. They are struggling with the changes but are learning. No change is universally popular, and revolutionary “big bang” change is very difficult. Evolutionary change is somewhat easier to implement and absorb, although changing multiple times is costly. We also have not yet fully resolved the issue of individual country modifications to standards, which stand in the way of truly global financial reporting. Outside of the U.S., there is a concern that the U.S. will dominate. This concern relates not only to our thinking about issues, but also to the way the standards are written. In particular, there is a concern that the U.S. tendency to provide considerable detailed guidance will manifest itself in global standards. Inside the U.S., there is a concern that IFRS lack rigor and, thus, are not high quality. There also is a concern that the standards are not specific enough and enforcement around the world is not strict enough to ensure consistent application. Clearly, there is a tension. However, progress in the last five years toward global financial reporting has been breathtaking, and it continues apace. The SEC permitting use of IFRS in the U.S. would be a major step forward.

The implications for U.S. academics are profound. The U.S. is deeply involved in and will be affected by global financial reporting. U.S. academics need to educate first themselves and then their students to be able to participate in a global world. There also is a myriad of open questions for research that U.S. academics can address. The capital markets are demanding a single language of business. They are demanding that the single language of business be developed internationally, not solely in the U.S. This demand for a single global language of business will be met. The market forces are too great to stop. The question is how, not whether, it will happen, and how, not whether, U.S. academics will participate.

Evolutionary change gives U.S. accounting educators, CPA examiners, and textbook writers more time to evolve into international standards. The SEC is not doing any of these groups a favor by creating education chaos with a big bang. Also, this leaves in place the FASB standards, interpretations, and implementation guidelines for which the IASB has not comparable coverage to date. Examples include FIN 46 interpretations on SPE rules, securitizations, and accounting for synthetics such as synthetic leases. The FASB has yet to take action on a number if important FASB standards and interpretations.

Evolutionary change also gives the IASB more time to add educational and implementation aids since at present IFRS has relatively few illustrations and implementation guidelines. It leaves in place those illustrations and guidelines in U.S. GAAP until the FASB cherry picks them away or revises them in an evolutionary process.

In the area of fair value accounting I agree with Mary Barth on fair value accounting for financial assets. I strongly disagree on fair value accounting for most non-financial assets. My disagreements are stated at http://www.trinity.edu/rjensen/theory01.htm#FairValue

On Page 1166 she flatly asserts:

First, there is no “matching principle.” That is, matching is not an end in itself and matching is not an acceptable justification for asset or liability recognition or measurement. The conceptual framework explains that matching involves the simultaneous or combined recognition of revenues and expenses that result directly and jointly from the same transactions or other events (FASB 1985, para. 146; IASB 2001, para. 95). Matching will be an outcome of applying standards if the standards require accounting information that meets the qualitative characteristics and other criteria in the conceptual framework. Matched economic positions will naturally result in matched accounting outcomes. However, the application of a matching concept in the conceptual framework does not allow the recognition of items in the statement of financial position that do not meet the definition of assets or liabilities (IASB 2001, para. 95). Thus, there would be no justification for deferring expense recognition for an expenditure that provides no future economic benefit or for deferring income recognition for a cash inflow that will not result in a future economic sacrifice.

I strongly disagree. Neither domestic nor international standards allow early realization of revenue before it is legally earned. The standards just do not allow automobile inventories to be written up to expected sales prices until those sales are finalized. Carrying the inventories at something other than sales value is part and parcel to the "matching principle" eloquently laid out years ago by Paton and Littleton. Both international and domestic standards still require cost amortization, depreciation, and creation of warranty reserves. These are all rooted in the "matching principle" which has not yet died when defining assets and liabilities in the conceptual framework. In most instances the historical cost is still being booked and spread over the expected life of future economic benefits. Even if a company adopted a replacement cost (current cost) adjustment of historical cost of a depreciable asset, those replacement costs still have to be depreciated since old equipment cannot simply be adjusted upward to new, un-depreciated replacement cost.

Paton and Littleton never argued that the "matching principle" for expense deferral applies to assets that have "no future economic benefits." In that case there would be no benefits against which to match the deferred expense.  Hence there's no deferral in such instances. I do not buy Barth's contention that there is no longer any "matching principle." If there are potential future benefits, the matching principle still is king except in certain instances where assets are carried at exit values such is the case for precious metals actively traded in commodity markets and financial assets not classified as "held-to-maturity."

For example, consider a manufacturing plant that spends $10 million for parts for construction of custom-made production robots and another $10 million for installation costs. After about five years of operation, suppose exit values are virtually zero for both the parts (now technologically obsolete) and installation costs which never had any exit values in the first place. Exit value at zero or near-zero is misleading since it suggests that there are enormous or even infinite returns from continued successful use of old but functional robots. Replacement cost and historical cost valuations are still based on the matching principle that booked values should be matched against future revenues even if the matching amounts are somewhat arbitrary such as in the case of straight line depreciation of replacement costs. Where the matching principle fails is when expected life falls way short of actual life. Whenever possible, depreciation amounts should be revised for changed parameters.

On Page 1166, Mary Barth states:

Second, few financial statement amounts are stated at historical cost. Assets and liabilities are typically initially measured at the value established by an exchange, which is their cost. But, some type of remeasurement is pervasive. The only amounts in financial statements today that are always historical costs are those for cash and land in the transaction currency. Essentially all other amounts reflect changes in time, events, or circumstances since the transaction date. Amounts for short-term assets and liabilities, e.g., inventory, receivables, and accounts payable, are historical costs if they have not been impaired. However, once an entity recognizes an impairment of inventory or an allowance for uncollectible accounts receivable, the amounts are no longer historical costs. Also, entities depreciate or amortize long-term assets and revalue them or write them down when they are impaired, and amortize issue premium or discount on long-term debt. They also remeasure many financial instruments at fair value. Impaired, amortized, revalued, or otherwise remeasured amounts are not historical costs. Thus, framing the measurement debate in financial reporting as historical cost versus fair value misleads and obfuscates the issues.

Both international and domestic standards call for historical-cost based accounting of many assets that are not impaired and many financial assets and liabilities intended to be held to maturity. Paton and Littleton recognized historical cost write-downs under the "conservatism" principle for impairments. That did not change their usage of the term "historical cost based" financial statements or the basic underlying concept of matching. It simply recognized that historical cost must be adjusted for impairments so as to not to mislead financial statement users by reporting book values in excess of value in use. Paton and Littleton did not argue for write downs to exit values if exit values (in the case of a non-going concern) were the worst possible (liquidation) uses not intended by a going concern.

Beginning on Page 1167, Mary Barth also states:

Fifth, the income statement has not become less important than the statement of financial position. Some believe it has because the conceptual framework definitions of financial statement elements are anchored in the asset definition. Income and expenses are defined in terms of changes in assets and liabilities. However, this focus on assets and liabilities—the elements in the statement of financial position—is not because they are more important than income and expenses. Rather, it is because standard-setters have not been able to identify a conceptually consistent and operational way of defining and measuring income and expenses, and thus profit or loss, without reference to assets and liabilities. This approach also is consistent with the concept of economic income being the change in wealth during the period (Hicks 1946).

Standard setters may wish that the income statement was less important than the balance sheet, but in reality trends in earnings and cash flows are the two most watched patterns by analysts and investors who've by now come to realize that the balance sheet is a mess comprised items measured under different measuring sticks and a summation to net book value that is totally meaningless to anybody. Earnings are residually impacted by asset valuations. However, many exit value adjustments are relegated to AOCI rather than current earnings under such standards as FAS 130 and FAS 133 in order to adjust asset and liability values for fair values that might never be realized due to fair value adjustments.

In my viewpoint, exit or fair value accounting in many instances is misleading when fair values are assumed to be exit values of non-financial assets. Exit values assume the worst possible use of assets (i.e. liquidations) when in fact what is or will be required in the standards is value in the best possible use. But the best possible use includes higher order covariance components that in nearly every instance are not practical to measure. I discuss these covariance issues at http://www.trinity.edu/rjensen/theory01.htm#FairValue

In summary, I agree with Mary Barth on the issue that a single set of international accounting standards will one day be in place for virtually all nations in the free world. I also think these should be evolutionary standards where the FASB reworks domestic standards, interpretations, and implementation guidelines to eliminate differences that exist between U.S. GAAP and international GAAP.

I'm even willing to accept the elimination of many of the bright line rules in U.S. GAAP. However, I worry that more principles-based standards will lead to greater reporting inconsistencies of virtually identical transactions. One of the problems is that principles-based standards and implementation rely increasingly on imperfect conceptual frameworks. It is impossible to lay out conceptual frameworks that are not vague.

Principles-Based Accounting Relies More on Conceptual Frameworks, and Therein Lies the Problem

There are strong arguments for not converging domestic standards completely to international standards, including the arguments of Yale’s Shyam Sunder and Chicago’s Ray Ball and others such as Tom Selling, J. Edward Ketz, and David Albrecht.
Bob Jensen's threads on controversies of standard setting are at http://www.trinity.edu/rjensen/theory01.htm#Principles-Based

Mark Penno has written a very academic paper on vagueness and logical fallacies in accounting standard conceptual frameworks. This is a very important research study for all accounting educators to read, especially educators who expound principles-based standards. Many of the problems, however, also apply to rule-based standards.

I especially like the "sorites paradox" illustrated with the heap (soros) of sand illustration.

"Rules and Accounting:  Vagueness in Conceptual Frameworks," Mark C. Penno, Accounting Horizons, Vol. 22, No. 3, September 2008, pp. 339-351 ---
 

SYNOPSIS:
Rules are fundamental to financial reporting, tax regulation, and auditing processes, and therefore the limitations of rule-based structures are of primary interest to accountants. All rule systems are plagued by the problem of vagueness, which implies that some very important decisions cannot be objectively described as “right” or “wrong,” and must be based on an authority’s judgment. This problem becomes most acute when accounting faces rapid technological changes, financial engineering, creative tax planning, or changes in the way that business is done. If the environment were static, explicit rules could eventually be developed for each category and consulted when making classifications. In contrast, dynamic environments present new problems characterized by vagueness. In this paper, I will review several definitions of vagueness, and show how they are tied to a conceptual framework. In particular, I will discuss the potential roles of verifiability, relevance, and consistency under any feasible
vague conceptual accounting framework.

. . .

TYPES OF VAGUENESS
Uni-Dimensional Vagueness
Most of the literature on vagueness studies the uni-dimensional or soritical form of vagueness, with the latter label taken from the “sorites paradox.” To illustrate the paradox, suppose that I assume: If a pile of n + 1 grains of sand is a heap (soros); then a pile of n grains of sand is also a heap. But then, by permitting n to become smaller, I am—by classical logic—led to the inevitable conclusion that one grain of sand is also a heap—which is false. Technically, unidimensional vagueness requires two instances, tT and tF, where tT is definitely-a-member of Category C, and tF is definitely-not-a-member of Category C. As we move along the dimension from tT to tF, we reach an instance, say tj, which is neither definitely-a-member of Category C, nor is it definitely-not-a-member of Category C. That is, its status is indeterminate.. .

2
See, for example, Endicott (2000, 2001, 379) who argues “In fact, law is necessarily very vague.” For a treatment of gray areas, see Ullmann-Margalit (1990, 756), who refers to such gray areas in the context of “the wide spectrum of social norms, stretching from the diffuse, informal, non-institutional norms at one end to the institutional and legal ones on the other.”
3
See Cuccia et al. (1995) for an introduction to the problem(s) of vague standards in accounting.
4
See Dye (2002) for a somewhat different discussion of standards creep.
5
Contrast this to Lipman (2006) who asks “Why is language vague?”—to which his abstract replies, “I don’t know."

The twentieth century witnessed a variety of attempts to resolve this problem. (something like tj). Thus, instead of being forced to decide whether an item is either in the category or not in the category (law of excluded middle), an individual is given a third choice: the status of the item is indeterminate. The flaw with this approach, however, is that we now have to specify a new boundary between true and indeterminate items, and a second new boundary between indeterminate and false items. These boundaries again will not be sharp (requiring us to again partition the interval even further). These additional problems are collectively referred to as higher-order vagueness, with the partitioning exercise reaching the final limit in fuzzy logic, where each item is assigned a number, . . . representing the membership-value (truth-value), or in our case, degree of membership in Category C.

Other types of vagueness are discussed in the article

To conclude, I have attempted to demonstrate that any conceptual framework in accounting must acknowledge vagueness. In contrast to the popular notion of vagueness, the roles of certain vagueness-induced criteria such as consistency and relevance were made more precise, and the role of verifiability reconsidered. On a parting note, Lipman (2006) writes: “In short, it is not that people have a precise view of the world, but communicate it vaguely; instead they have a vague view of the world. I know of no model which formalizes this.” While a complete model of vague conceptual frameworks has yet to be developed, it is my hope that this paper might be viewed as a beginning.

October 19, 2008 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU]

I read Penno’s paper this morning. Fascinating read! I found the following statement intriguing: “[A]n immediate implication of vagueness is that accountants may reach a point where gathering more evidence will not change their minds, yet the accounting determinations remain controversial.” What I take from this is that no matter how much effort is expended, the “answer” relies on judgment because the data do not avail themselves to unique sets, e.g., “R&D” or “not R&D.” As the “R&D” set expands to include data that do not have common characteristics, regulators seek to improve transparency by either “lumping” (defining a unique characteristic that must exist to be in the set) or “splitting” (create subsets in which the data have unique characteristics).

When I try to make sense of papers like this, I wish I had a stronger background in philosophy, so that I could more fully appreciate the points he makes. I would love to hear what others take away from this paper.

Amy Dunbar

UConn

 

Bob Jensen's threads on controversies of standard setting are at http://www.trinity.edu/rjensen/theory01.htm#Principles-Based

Here’s a negative externality of the wipeout of FASB standards, interpretations, implementation guides, illustrations, etc.
A vast amount of openly shared accounting education tutorials, videos, spreadsheets, software, and free textbooks will disappear.
A lot of accounting cases from Harvard, Stanford, ECCH, and elsewhere will disappear.
Note that FASB referencing must change even if content changes only slightly (such as expunging of some bright lines)

From: Richard Campbell [mailto:campbell@rio.edu]
Sent: Monday, December 08, 2008 6:46 AM
To: Jensen, Robert
Subject: My nomination for "Sharing professor of the week"

Bob:
Check out Susam Crosson's videos at youtube

http://www.youtube.com/susancrosson

And check out the comments from grateful students.

Richard J. Campbell
mailto:campbell@rio.edu

December 9, 2008 reply from Bob Jensen

 

Hi Richard,

 December 9, 2008 reply from Bob Jensen

I featured Susan’s free accounting videos some time back editions of both New Bookmarks and Tidbits. Since then I’ve maintained links to her videos and other free videos, textbooks, spreadsheets, and other free course materials at http://www.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks

The changeover to IFRS is going to mess up a lot of the free stuff, especially in intermediate accounting. There will also be things that have to be changed in basic financial and managerial accounting such as extraction of LIFO as an acceptable valuation alternative for inventories. Basic accounting instructors assume that the IFRS changes are minimal for the basic courses, but if you look at the available open shared videos, tutorials, test banks, spreadsheets, and free textbooks there are countless other changes that have to be made. For example, Tom Selling correctly points out that IAS 17 is basically a clone of the amended FAS 13 lease accounting with the bright lines fuzzied up. But everywhere that the open shared materials reference FAS 13, the references and maybe quotations have to be changed to IAS 17.

In other words, even in places where the substance does not change, the references change. Those professors who think that basic accounting lecture materials and other course materials won’t change much, just have not thought this out. Every little place where a reference to a FASB standard, interpretation, EITF, etc. is mentioned (even in a footnote) has to be changed to reduce confusion for students.

Either students and faculty have to give up on using open share materials or the providers like Susan have to redo most of their videos, tutorials, test banks, spreadsheets, and free textbooks. The changeover to IFRS did not will not being doing those of us that openly share hundreds of files any favors. Will Susan remake all her free videos? Will Jensen remake all his free videos? Think of the open shared accounting materials that have to be changed at http://www.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks

We expect the authors of commercial materials to take the time and trouble to change their textbooks and textbook supplements. It’s asking a lot, however, to expect authors of free open sharing books, videos, tutorials, and test banks to redo there openly shared materials because of changes due to the replacement of US GAAP with IFRS.

At first I breathed a sigh of relief that most of my open sharing tutorials, videos, glossary, and other materials on accounting for derivative financial instruments actually point out differences between FAS 133 and IAS 39. This technically means less updating for me. But after I thought about it, these materials add a lot of noise for users who will no longer give two hoots learning how FAS 133 differs from IAS 39. They will only want to learn IAS 39 as efficiently as possible, and IAS 39 is a whole lot easier to learn than FAS 133 since IAS 39 completely ignores a lot of the hard stuff, especially stuff taken up for FAS 133 by the Derivatives Implementation Group --- http://www.fasb.org/derivatives/
Will I pull all the DIGs out of my FAS133/IAS39 free online glossary? I doubt it --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm

We assume that publishers of current textbooks will persuade the authors to rework their textbooks. But I wonder is those repositories of individual teaching cases (Harvard, Stanford, ECCH, etc,) have considered all the changes to content and references that must be changed in the teaching cases and teaching notes that reference FASB literature. In some cases, the authors of these cases are no longer living or have long since retired or have zero interest in reworking old cases. A lot of such cases will no longer be available for use in accounting courses.

Bob Jensen

Bob Jensen’s threads on the FASB vs. IFRS controversy can be found at http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

Principles-Based Accounting Relies More on Conceptual Frameworks, and Therein Lies the Problem

Mark Penno has written a very academic paper on vagueness and logical fallacies in accounting standard conceptual frameworks. This is a very important research study for all accounting educators to read, especially educators who expound principles-based standards. Many of the problems, however, also apply to rule-based standards.

I especially like the "sorites paradox" illustrated with the heap (soros) of sand illustration.

""Rules and Accounting:  Vagueness in Conceptual Frameworks," Mark C. Penno, Accounting Horizons, Vol. 22, No. 3, September 2008, pp. 339-351 ---
 

SYNOPSIS:
Rules are fundamental to financial reporting, tax regulation, and auditing processes, and therefore the limitations of rule-based structures are of primary interest to accountants. All rule systems are plagued by the problem of vagueness, which implies that some very important decisions cannot be objectively described as “right” or “wrong,” and must be based on an authority’s judgment. This problem becomes most acute when accounting faces rapid technological changes, financial engineering, creative tax planning, or changes in the way that business is done. If the environment were static, explicit rules could eventually be developed for each category and consulted when making classifications. In contrast, dynamic environments present new problems characterized by vagueness. In this paper, I will review several definitions of vagueness, and show how they are tied to a conceptual framework. In particular, I will discuss the potential roles of verifiability, relevance, and consistency under any feasible
vague conceptual accounting framework.

. . .

TYPES OF VAGUENESS
Uni-Dimensional Vagueness
Most of the literature on vagueness studies the uni-dimensional or soritical form of vagueness, with the latter label taken from the “sorites paradox.” To illustrate the paradox, suppose that I assume: If a pile of n + 1 grains of sand is a heap (soros); then a pile of n grains of sand is also a heap. But then, by permitting n to become smaller, I am—by classical logic—led to the inevitable conclusion that one grain of sand is also a heap—which is false. Technically, unidimensional vagueness requires two instances, tT and tF, where tT is definitely-a-member of Category C, and tF is definitely-not-a-member of Category C. As we move along the dimension from tT to tF, we reach an instance, say tj, which is neither definitely-a-member of Category C, nor is it definitely-not-a-member of Category C. That is, its status is indeterminate.. .

2
See, for example, Endicott (2000, 2001, 379) who argues “In fact, law is necessarily very vague.” For a treatment of gray areas, see Ullmann-Margalit (1990, 756), who refers to such gray areas in the context of “the wide spectrum of social norms, stretching from the diffuse, informal, non-institutional norms at one end to the institutional and legal ones on the other.”
3
See Cuccia et al. (1995) for an introduction to the problem(s) of vague standards in accounting.
4
See Dye (2002) for a somewhat different discussion of standards creep.
5
Contrast this to Lipman (2006) who asks “Why is language vague?”—to which his abstract replies, “I don’t know."

The twentieth century witnessed a variety of attempts to resolve this problem. (something like tj). Thus, instead of being forced to decide whether an item is either in the category or not in the category (law of excluded middle), an individual is given a third choice: the status of the item is indeterminate. The flaw with this approach, however, is that we now have to specify a new boundary between true and indeterminate items, and a second new boundary between indeterminate and false items. These boundaries again will not be sharp (requiring us to again partition the interval even further). These additional problems are collectively referred to as higher-order vagueness, with the partitioning exercise reaching the final limit in fuzzy logic, where each item is assigned a number, . . . representing the membership-value (truth-value), or in our case, degree of membership in Category C.

Other types of vagueness are discussed in the article

To conclude, I have attempted to demonstrate that any conceptual framework in accounting must acknowledge vagueness. In contrast to the popular notion of vagueness, the roles of certain vagueness-induced criteria such as consistency and relevance were made more precise, and the role of verifiability reconsidered. On a parting note, Lipman (2006) writes: “In short, it is not that people have a precise view of the world, but communicate it vaguely; instead they have a vague view of the world. I know of no model which formalizes this.” While a complete model of vague conceptual frameworks has yet to be developed, it is my hope that this paper might be viewed as a beginning.

October 19, 2008 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU]

I read Penno’s paper this morning. Fascinating read! I found the following statement intriguing: “[A]n immediate implication of vagueness is that accountants may reach a point where gathering more evidence will not change their minds, yet the accounting determinations remain controversial.” What I take from this is that no matter how much effort is expended, the “answer” relies on judgment because the data do not avail themselves to unique sets, e.g., “R&D” or “not R&D.” As the “R&D” set expands to include data that do not have common characteristics, regulators seek to improve transparency by either “lumping” (defining a unique characteristic that must exist to be in the set) or “splitting” (create subsets in which the data have unique characteristics).

When I try to make sense of papers like this, I wish I had a stronger background in philosophy, so that I could more fully appreciate the points he makes. I would love to hear what others take away from this paper.

Amy Dunbar
UConn

 

There are strong arguments for not converging domestic standards completely to international standards, including the arguments of Yale’s Shyam Sunder and Chicago’s Ray Ball and others such as Tom Selling, J. Edward Ketz, and David Albrecht.
Bob Jensen's threads on controversies of standard setting are at http://www.trinity.edu/rjensen/theory01.htm#Principles-Based

Question
Can we put the following quotations to a test in a logic course in the philosophy department?

"Some Lessons of the Financial Crisis," by Stephen Schwarzman, The Wall Street Journal, November 4, 2008 --- http://online.wsj.com/article/SB122576100620095567.html?mod=djemEditorialPage

Third, you need full transparency for financial statements. Nothing should be eliminated. Off-balance-sheet vehicles that suddenly return to the balance sheet to wreak havoc make a mockery of principles of disclosure.

Fourth, you need full disclosure of all financial instruments to the regulator. No regulator can do its job of assessing risk and systemic soundness if large parts of the financial markets are invisible to it. A regulator must be able to monitor all derivatives, including, for example, $60 trillion in credit default swaps.

 

Sixth, we need to abolish mark-to-market accounting for hard-to-value assets. There is now emerging a broad realization that mark-to-market accounting has exacerbated the current crisis. We are not talking about publicly traded equities with a readily ascertainable value. The problem involves securities held for investment purposes, and those instruments during certain times of the cycle for which there is no readily observable market. These securities and instruments would be fully disclosed to the regulator. However, a financial institution would not be forced to suddenly take huge write downs at artificial, fire-sale prices and thus contribute to financial instability.

Bob Jensen's threads on a bull crap case against fair value accounting are at http://www.trinity.edu/rjensen/2008Bailout.htm#FairValueAccounting

Bob Jensen's threads on earnings management are at http://www.trinity.edu/rjensen/theory01.htm#Manipulation

From The Wall Street Journal Accounting Weekly Review on September 12, 2008

"Closing the Information GAAP," by L. Gordon Crovitz, The Wall Street Journal, September 8, 2008; Page A17 --- http://online.wsj.com/article/SB122083366235408621.html?mod=djem_jiewr_AC

What's the definition of an accountant? Someone who solves a problem you didn't know you had in a way you don't understand.

What's an auditor? Someone who arrives after the battle and bayonets the wounded.

And drum roll, please: What are Generally Accepted Accounting Principles? The difference between accounting theory and practice.

No joke, accountants are the Rodney Dangerfields of business. But perhaps they deserve some respect after all. Accountants in the U.S. are signing up for a fundamental rethinking of how they do their jobs. As a result, it should finally be possible for global investing and trade to operate on a common understanding, or accounting, of businesses.

The Securities and Exchange Commission recently announced that the U.S. will abandon Generally Accepted Accounting Principles -- for almost 75 years, the bible for U.S. accountants -- joining more than 100 countries around the world instead in using the London-based International Financial Reporting Standards. Pointing to the "remarkably quickening pace of acceptance of a true lingua franca for accounting," SEC Chairman Chris Cox set out a timetable for all U.S. companies to drop GAAP by 2016, with the largest companies switching as early as next year.

There are specific differences between the two systems; for example, the international system only allows the first-in, first-out inventory accounting system. The most important difference is that the international standard is based on principles, whereas GAAP is based on rules. GAAP suffers from the complexity of trying to set rules for all situations, a complexity that often masks economic reality.

GAAP rules fill a nine-inch, three-volume set of pronouncements plus interpretive information. In contrast, IFRS is a slim two-inch book. GAAP was crafted in part by the pressures of the U.S. legal system. Companies have been glad for GAAP rules as defenses for claims of accounting irregularities. But these rules often only pretend to provide clarity. There are hundreds of pages of GAAP covering how to account for derivatives, but this didn't stop opaque pricing mismatches, which helped create the credit crunch. GAAP rules allowed trillions of dollars in securitized financial assets and liabilities to stay off the books of U.S. financial firms, while the international standard, by focusing on the true underlying economics, kept these on the books for firms based elsewhere.

It's surprising that there is no common language for measuring the performance of companies. Until recently, all major countries had their own accounting rules, but IFRS has become the approach of choice. Inconsistent approaches to accounting make it hard to compare an energy company based in Texas with one based in Amsterdam, a bank in New York with one in London, or a biotech firm in Boston with one in Singapore. A single set of accounting rules would mean more effective global disclosure and transparency. It would reduce costs for multinationals that must now prepare multiple books. It would also make U.S. exchanges more competitive for listings by eliminating accounting differences.

A measure of the importance of a single standard is the dislocation that getting there will cause. It will mean rewriting business school texts and retraining of corporate finance departments. The forensic accountants who sniff out problems will have to develop instincts using a new set of measures. The transition will also be tough on investors. Under the SEC proposal, larger companies in the same industry would switch to the international standard before smaller companies do. Investors for the transition period would have to compare similar companies using different accounting.

The big U.S.-based accounting firms generally support the abandonment of GAAP. Skeptics could call this switch in systems the equivalent of the accountant full-employment act for many years, but the profession itself also recognizes that GAAP often fails to reflect underlying economics.

A PriceWaterhouseCoopers briefing document for executives on the accounting change notes that changes will also be necessary in the law. "If an accounting and reporting framework that relies on professional judgment rather than detailed rules is to flourish in the U.S., the legal and regulatory environment will need to evolve in ways that remain to be seen." These include that "regulators will need to respect well-reasoned professional judgments."

A system based on principles could create new defenses for company boards and accountants who try to do the right thing, if they fully disclose why they thought that a particular accounting treatment made sense. The law will have to adjust to accept more ambiguity in accounting, as a necessary condition for reporting with maximum accuracy.

As technology has shown in other areas of life, agreed-upon standards and accepted operating systems drive usage and efficiency. Common measures add value to information. If even the belt-and-suspenders accounting profession is willing to take on the risks of switching its basic system for assessing businesses, we're truly in an era when anything that adds to understanding belongs in the asset column, while anything that undermines transparency is a liability.

Bob Jensen's threads on accounting standard setting controversies are at http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

IFRS (or maybe just the EU) Accounting Rule Flexibility in Action

"Accounting Changes Help Deutsche Bank Avoid Loss," Reuters, The New York Times, October 30, 2008 --- Click Here

New accounting rules allowed Deutsche Bank to dodge a loss in the third quarter, the company said Thursday as it also announced heavy losses in proprietary trading.

Josef Ackermann, the chairman of Deutsche, which is Germany’s flagship bank and once was seen as having escaped the worst of the market turmoil, declared a year ago that the financial crisis for his bank was over.

On Thursday, however, Mr. Ackermann departed from the optimism that had led him to declare seeing the light at the end of the tunnel several times over.

“Conditions in equity and credit markets remain extremely difficult,” he said, warning that the bank could cut its dividend to shore up capital in a “highly uncertain environment.”

Also Thursday, Germany’s finance minister, Peer Steinbrück, said that a number of German banks were expected to turn to Berlin for help. Mr. Steinbrück appeared to make a veiled reference to Deutsche Bank when he told a newspaper that those seeking help could include banks that had publicly opposed taking it in the past. Mr. Ackermann recently was quoted as saying he would be “ashamed” to take taxpayer money.

Deutsche Bank made a pretax profit of 93 million euros ($118.5 million) in the third quarter, a result possible only because of changed accounting rules. These allowed it to cut write-downs by more than 800 million euros, to 1.2 billion euros, during the period.

The new rules, sanctioned by Brussels lawmakers, soften the old system that demanded all assets reflect market prices.

Deutsche Bank, for example, has more than 22 billion euros of leveraged loans — commitments often made to private equity investors to lend money to buy companies.

Farming out these loans had become difficult as worried investors retreated to safe havens and their value had fallen. The new accounting rules allow Deutsche to hold some of these loans on their books at a fixed price.

Like all other banks, Deutsche is grappling with a freeze in interbank lending. Banks around the world have largely stopped lending to one another after the Wall Street investment bank Lehman Brothers collapsed in mid-September.

The crisis prompted the German government to start a rescue fund of 500 billion euros, under which it can give guarantees for banks seeking financing on this market or by issuing bonds, for example.

November 3, 2008 reply from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

Beware, believing what's reported in the press as truth. Reporters generally do not study accounting as part of the academic experience.

To the best of my knowledge, the recent change made by the IASB was to converge with US GAAP in permitting companies to re-classify financial assets from held for trading to available for sale. This move does not permit these assets to be held at other than fair value. It does report the change in fair value to equity, rather than in income.

This change was made specifically to create a level playing field across Europe and the US. The same change was made in Canada for the same reason.

Do I regret they made this change? Yes. I suspect they do too, but the alternative was to let the European Commission "do their own thing" in this crisis.

Regards,
Pat

November 3, 2008 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

Pat,

Actually, as I understand it the IASB change allows companies to reclassify securities out of the mark to market through income category (i.e., trading) to held to maturity in which case the securities will be carried at cost. Further, the change can be made retroactive to July 1 before most of the market disruption occurred. U.S rules allow this only in "rare" circumstances.

See http://www.iasb.org/NR/rdonlyres/BE8B72FB-B7B8-49D9-95A3-CE2BDCFB915F/0/AmdmentsIAS39andIFRS7.pdf  which includes a dissent by Jim Leisenring and John Smith from the U.S.

Denny Beresford

November 3, 2008 reply from Bob Jensen

Hi Pat and Denny,

But isn’t it interesting banks are suddenly reclassifying their portfolios seemingly to avoid reporting losses? Is this good judgment based upon principles-based standards or earnings management under flexible accounting standards?

Surely the reporters are all wrong and these reputable banks are merely using good judgments under principles-based standards. Certainly they would not use flexible accounting rules to manage earnings!

Are we making a mockery out of accounting “standards?” What you are saying Pat is that the IASB would rather change an accounting standard under political pressure from the EU than to face up to another EU carve out of IFRS. Surely this is a mockery since the change in IFRS to suit the EU (and U.S.) affects all other nations using IFRS who are not in the EU and the U.S.

What you are really telling us Pat is that IFRS adapts to threats from the EU when you stated:

Do I regret they made this change? Yes. I suspect they do too, but the alternative
was to let the European Commission "do their own thing”  . . .
Pat Walters

I call this making a mockery out of the conceptual framework that dictates that accounting standards are to be based upon what is the best accounting for investors. Instead the IASB acted in fear that the EU would “do-their-own-thing” accounting standards for banks. Of course there’s some history of this in the U.S., notably dry hole accounting for oil and gas. But the FASB has a better record of going nose-to-nose with Congress on FAS 133 and FAS 123-R.

FASB standards are sometimes flexible to a fault as well. Surely Franklin Raines would not (ha, ha) reclassify just enough macro mortgage portfolios under FAS 133 rules to meet the e.p.s target (to the penny) to get his bonus before he was fired as CEO of Fannie Mae --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation 

How can those of you teaching ethics and intermediate accounting and auditing look your students straight in the eye?

Should accountancy be reclassified in the Literature Department since financial reports are becoming more flexible fiction than fact?

Bob Jensen

November 3, 2008 reply from Tom Selling [tom.selling@GROVESITE.COM]

The following statement by Pat is not fully correct:

“…the recent change made by the IASB was to converge with US GAAP in permitting companies to re-classify financial assets from held for trading to available for sale. This move does not permit these assets to be held at other than fair value. It does report the change in fair value to equity, rather than in income.”

The revisions to IAS 39 (and FAS 133) permit loans and receivables that were being measured at fair value to be reclassified to “held to maturity”, if the entity does not intend to sell them in the “foreseeable future” (whatever the heck that means). Thus, fair value accounting would cease for these assets. Moreover, there would be a new rule for measuring impairment on these assets, which diverges from GAAP.

Best,

Tom Selling

November 3, 2008 reply from Bob Jensen

Hi Tom,

What the reclassification to “held-to-maturity” means in these times is that nobody else (now not even our government) is foolish enough to buy this hopeless dog that the bank can’t possibly unload. Paulsen’s new bail out plan entails buying into bank equity rather than buying up the banks’dog/junk mortgages. The trick now is to get these dogs on the books at historical cost as “held-to-maturity” rather than, choke, fair value.

Interestingly, this is precisely what Fannie Mae’s CEO, Franklin Raines, was doing when cherry picking which investments to designate as “held-to-maturity” in his earnings management scheme to pad his bonus --- http://www.trinity.edu/rjensen/theory01.htm#Manipulation 

Think of the irony. The good mortgages that perhaps increased in value with declining interest rates are marked upwards to fair value as “available-for-sale” or “trading” securities. The dogs that should be unloaded are instead designated as “held-to-maturity.”

A clever professor here could design a case where all the good mortgages are sold for profit, the enormous executive bonuses are paid, and the shareholders are left with the “held-to-maturity” dog kennel that is grossly overvalued on the balance sheet. What’s even worse is that this is possible under FASB and IASB accounting standards. Our standard setters are now telling us there’s nothing wrong with being left with the dog kennel. The shareholders’ class action lawyers think otherwise.

Is this what we call making investors our number one concern when setting accounting standards?

My problem here is that in theory I can and do in my FAS 133 seminars make a darn good case for not marking up HTM securities to fair value. But then I never envisioned the dog kennel problem.

I think the IASB is a bit tougher than the FASB on a decision to sell HTM investments before maturity. In IFRS it’s a bit like breaking the honor code. You may sell an insignificant sick puppy on occasion from the HTM dog kennel, but you must never sell a valuable dog before its maturity date without putting the other sick HTM dogs in the kennel up for sale as well. Selling them all might result in huge losses under the new IASB/FASB rulings allowing for the placement of very sick dogs in an HTM kennel to avoid recognizing huge losses in their value. Thus when Deutsche Bank put a lot of sick dogs in the HTM kennel to shore up 2008 reported earnings (actually to avoid a huge reported 2008 loss), Deutsche Bank better be prepared on its honor to keep virtually all of them in the kennel until they expire.

The following is a direct quotation from IAS 39.

B.19 Definition of held-to-maturity financial assets: 'tainting'

In response to unsolicited tender offers, Entity A sells a significant amount of financial assets classified as held to maturity on economically favourable terms. Entity A does not classify any financial assets acquired after the date of the sale as held to maturity. However, it does not reclassify the remaining held-to-maturity investments since it maintains that it still intends to hold them to maturity. Is Entity A in compliance with IAS 39?

No. Whenever a sale or transfer of more than an insignificant amount of financial assets classified as held to maturity (HTM) results in the conditions in IAS 39.9 and IAS 39.AG22 not being satisfied, no instruments should be classified in that category. Accordingly, any remaining HTM assets are reclassified as available-for-sale financial assets. The reclassification is recorded in the reporting period in which the sales or transfers occurred and is accounted for as a change in classification under IAS 39.51. IAS 39.9 makes it clear that at least two full financial years must pass before an entity can again classify financial assets as HTM.

Bob Jensen

Bob Jensen's threads on earnings management are at http://www.trinity.edu/rjensen/theory01.htm#Manipulation

Claims of IFRS Accounting Rule Flexibility --- http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

Press Release from IAS Plus on October 13, 2008 --- http://www.iasplus.com/pressrel/0810reclassifications.pdf

IASB amendments permit reclassification of financial instruments

The International Accounting Standards Board (IASB) today issued amendments to IAS 39 Financial Instruments: Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures that would permit the reclassification of some financial instruments. The amendments to IAS 39 introduces the possibility of reclassifications for companies applying International Financial Reporting Standards (IFRSs), which were already permitted under US generally accepted accounting principles (GAAP) in rare circumstances.

The deterioration of the world’s financial markets that has occurred during the third quarter of this year is a possible example of rare circumstances cited in these IFRS amendments and therefore justifies its immediate publication. Today’s action enables companies reporting according to IFRSs to use the reclassification amendments, if they so wish, from 1 July 2008.

These amendments are the latest in a series of steps that the IASB has undertaken to respond to the credit crisis. The IASB has worked with a number of other regional and international bodies, including the Financial Stability Forum (FSF), to address financial reporting issues associated with the credit crisis. In responding to the crisis, the IASB notes the concern expressed by EU leaders and finance ministers through the ECOFIN Council to ensure that ‘European financial institutions are not disadvantaged vis-à-vis their international competitors in terms of accounting rules and of their interpretation.’ The amendments today address the desire to reduce differences between IFRSs and US GAAP in a manner thatproduces high quality financial information for investors across the global capital markets.

Sir David Tweedie, Chairman of the IASB, said:

In addressing the rare circumstances of the current credit crisis, the IASB is committed to taking urgent action to ensure that transparency and confidence are restored to financial markets. The IASB has acted quickly to address the concerns raised by EU leaders and others regarding the issue of reclassification. Our response is consistent with the request made by European leaders and finance ministers; it is important that these amendments are permitted for use rapidly and without modification.’

For more information about the IASB’s response to the credit crisis, see the Website at http://www.iasb.org/credit+crisis.htm.

Reclassification of Financial Assets (Amendments to IAS 39 Financial Instruments:  Recognition and Measurement and IFRS 7 Financial Instruments: Disclosures) is available for eIFRS subscribers from today. Those wishing to subscribe to eIFRSs should visit the online shop or contact:

IASC Foundation Publications Department,
30 Cannon Street, London EC4M 6XH, United Kingdom.
Tel: +44 (0)20 7332 2730 Fax +44 (0)20 7332 2749
Email: publications@iasb.org Web: www.iasb.org

The following table illustrates how reclassification will be dealt with following this announcement by IFRSs when compared with US GAAP.

	US GAAP	Amended IAS 39
Reclassification of securities out of the trading category in rare circumstances	Permitted	Permitted (as amended)
Reclassification to loan category (cost basis) if intention and ability to hold for the foreseeable future (loans) or until maturity (debt securities)	Permitted	Permitted (as amended)
Reclassification if fair value option previously elected	Not Permitted	Not Permitted

Humor Between December 1 and December 31, 2008

PJ O’Rourke’s Parliament of Whores --- http://snipurl.com/parliamentwhores   

Forwarded by Professor Edwards (who ought to know)

Perks of reaching 50 or being over 60 and heading towards 70 AND PLUS!

01. Kidnappers are not very interested in you.

02. In a hostage situation you are likely to be released first.

03. No one expects you to run--anywhere.

04. People call at 9 pm and ask, did I wake you?

05. People no longer view you as a hypochondriac.

06. There is nothing left to learn the hard way.

07. Things you buy now won't wear out.

08. You can eat supper at 4 pm.

09. You can live without sex but not your glasses.

10. You get into heated arguments about pension plans.

11. You no longer think of speed limits as a challenge.

12. You quit trying to hold your stomach in no matter who walks into the room.

13. You sing along with elevator music.

14. Your eyes won't get much worse.

15 . Your investment in health insurance is finally beginning to pay off.

16. Your joints are more accurate meteorologists than the national weather service.

17. Your secrets are safe with your friends because they can't remember them either. 18. Your supply of brain cells is finally down to manageable size.

19. You can't remember who sent you this list.

And you notice these are all in Big Print for your convenience.

Forward this to everyone you can remember right now!

Never, under any circumstances, take a sleeping pill and a laxative on the same night.

Forwarded by Maureen

Pocket Taser Stun Gun, a great gift for the wife.

From a guy who purchased his lovely wife a pocket Taser for their anniversary . . .

Last weekend I saw something at Larry's Pistol & Pawn Shop that sparked my interest.

The occasion was our 15th anniversary and I was looking for a little something extra for my wife Julie.

What I came across was a 100,000-volt, pocket/purse-sized taser.

The effects of the taser were supposed to be short lived, with no long-term adverse affect on your assailant, allowing her adequate time to retreat to safety....??

WAY TOO COOL!

Long story short, I bought the device and brought it home.

I loaded two AAA batteries in the darn thing and pushed the button.

Nothing!

I was disappointed.

I learned, however, that if I pushed the button AND pressed it against a metal surface at the same time; I'd get the blue arc of electricity darting back and forth between the prongs.

AWESOME!!!

Unfortunately, I have yet to explain to Julie what that burn spot is on the face of her microwave.

Okay, so I was home alone with this new toy, thinking to myself that it couldn't be all that bad with only two triple-A batteries, right?

There I sat in my recliner, my cat Gracie looking on intently (trusting little soul) while I was reading the directions and thinking that I really needed to try this thing out on a flesh & blood moving target.

I must admit I thought about zapping Gracie (for a fraction of a second) and thought better of it. She is such a sweet cat.

But, if I was going to give this thing to my wife to protect herself against a mugger, I did want some assurance that it would work as advertised.

Am I wrong?

So, there I sat in a pair of shorts and a tank top with my reading glasses perched delicately on the bridge of my nose, directions in one hand, and taser in another.

The directions said that a one-second burst would shock and disorient your assailant; a two-second burst was supposed to cause muscle spasms and a major loss of bodily control; a three-second burst would purportedly make your assailant flop on the ground like a fish out of water.

Any burst longer than three seconds would be wasting the batteries.

All the while I'm looking at this little device measuring about 5 ' long, less than 3/4 inch in circumference; pretty cute really and (loaded with two itsy, bitsy triple-A batteries) thinking to myself, 'no possible way!'

What happened next is almost beyond description, but I'll do my best...?

I'm sitting there alone, Gracie looking on with her head cocked to one side as to say, 'don't do it dipshit,' reasoning that a one second burst from such a tiny little ole thing couldn't hurt all that bad.

I decided to give myself a one second burst just for heck of it.

I touched the prongs to my naked thigh, pushed the button, and . . . HOLY MOTHER OF GOD . . .WEAPONS OF MASS DESTRUCTION . . .

WHAT THE HELL ! ? !

I'm pretty sure Jessie Ventura ran in through the side door, picked me up in the recliner, then body slammed us both on the carpet, over and over and over again.

I vaguely recall waking up on my side in the fetal position, with tears in my eyes, body soaking wet, both nipples on fire,testicles nowhere to be found, with my left arm tucked under my body in the oddest position, and tingling in my legs?

The cat was making meowing sounds I had never heard before, clinging to a picture frame hanging above the fireplace, obviously in an attempt to avoid getting slammed by my body flopping all over the living room.

Note: If you ever feel compelled to 'mug' yourself with a taser, one note of caution: there is no such thing as a one second burst when you zap yourself! You will not let go of that thing until it is dislodged from your hand by a violent thrashing about on the floor.

A three second burst would be considered conservative?

*(^%#@, THAT HURT LIKE HELL!!!

A minute or so later (I can't be sure, as time was a relative thing at that point), I collected my wits (what little I had left), sat up and surveyed the landscape.

My bent reading glasses were on the mantel of the fireplace.

The recliner was upside down and about 8 feet or so from where it originally was.

My triceps, right thigh and both nipples were still twitching.

My face felt like it had been shot up with Novocain, and my bottom lip weighed 88 lbs. I had no control over the drooling.

Apparently I shit myself, but was too numb to know for sure and my sense of smell was gone.

I saw a faint smoke cloud above my head which I believe came from my hair.

I'm still looking for my nuts and I'm offering a significant reward for their safe return!!

P. S. My wife loved the gift, and now regularly threatens me with it!

A man arrives at the gates of Heaven --- http://www.jumbojoke.com/arriving_in_heaven.html

St. Peter asks, "Religion?"

"Methodist," the man says.

St. Peter looks down his list, and says, "Go to Room 24, but be very quiet as you pass Room 8."

Another man arrives at the gates of Heaven.

"Religion?"

"Baptist."

"Go to Room 18, but be very quiet as you pass Room 8."

A third man arrives at the gates.

"Religion?"

"Jewish."

"Go to Room 11, but be very quiet as you pass Room 8."

The man says, "I can understand there being Different rooms for different religions, but why must we all be quiet when we pass Room 8?"

"Well, the Catholics are in Room 8," St. Peter replies, "and they think they're the only ones here."

Forwarded by Auntie Bev

BATTER UP

Two 90-year-old women, Rose and Barb, had been friends all of their lives.

When it was clear that Rose was dying, Barb visited her every day.

One day Barb said, 'Rose, we both loved playing women's softball all our lives, and we played all through High School. Please do me one favor: when you get to Heaven, somehow you must let me know if there's women's soft-ball there.'

Rose looked up at Barb from her death bed and said, 'Barb, you've been my best friend for many years. If it's at all possible, I'll do this favor for you.'

Shortly after that, Rose passed on.

At midnight the following Friday, Barb was awakened from a sound sleep by a blinding flash of white light and a voice calling out to her, 'Barb, Barb.'

'Who is it?' asked Barb, sitting up suddenly. 'Who is it?' 'Barb -- it's me, Rose.'

'You're not Rose. Rose just died.' 'I'm telling you , it's me, Rose,' insisted the voice.

'Rose! Where are you?' 'In Heaven,' replied Rose. 'I have some really good news and a little bad news.'

'Tell me the good news first,' said Barb. The good news,' Rose said, 'is that there's Softball in Heaven. Better yet , all of our old buddies who died before us are here, too. Better than that, we're all young again.

Better still, it's always springtime, and it never rains or snows. And best of all, we can play softball all we want, and we never get tired.'

'That's fantastic,' said Barb. 'It's beyond my wildest dreams! So what's the bad news'

'You're pitching Tuesday.'

Forwarded by Maureen

I just want to thank all of you for your educational emails over the past year..

There's no way to save my grandchildren from being street beggars in Rio --- http://www.trinity.edu/rjensen/2008Bailout.htm#NationalDebt

Thanks to you, I no longer open a public bathroom door without using a paper towel.

I can't use the remote in a hotel room because I don't know what the last person was doing while flipping through the adult movie channels.

I can't sit down on the hotel bedspread because I can only imagine what has happened on it since it was last washed.

I can't enjoy lemon slices in my tea or on my seafood anymore because lemon peels have been found to contain all kinds of nasty germs including feces.

I have trouble shaking hands with someone who has been driving because the number one pass-time while driving alone is picking your nose (although cell phone usage may be taking the number one spot)

Eating a Little Debbie sends me on a guilt trip because I can only imagine how many gallons of trans fats I have consumed over the years.

I can't touch any woman's purse for fear she has placed it on the floor of a public bathroom. Yuck!

I must send my special thanks to whoever sent me the one about poop in the glue on envelopes because I now have to use a wet sponge with every envelope that needs sealing.

Also, now I have to scrub the top of every can I open for the same reason.

I no longer have any savings because I gave it to a sick girl (Penny Brown) who is about to die in the hospital for the 1,387,258th time.

I no longer have any money at all, but that will change once I receive the $15,000 that Bill Gates/Microsoft and AOL are sending me for participating in their special e-mail program.

I no longer worry about my soul because I have 363,214 angels looking out for me, and St. Theresa's novena has granted my every wish. ; I no longer eat KFC because their chickens are actually horrible mutant freaks with no eyes or feathers.

I no longer use cancer-causing deodorants even though I smell like a water buffalo on a hot day.

Thanks to you, I have learned that my prayers only get answered if I forward an email to seven of my friends and make a wish within five minutes.

Because of your concern I no longer drink Coca Cola because it can remove toilet stains.

I no longer can buy gasoline without taking someone along to watch the car so a serial killer won't crawl in my back seat when I'm pumping gas..

I no longer drink Pepsi or Dr Pepper since the people who make these products are atheists who refuse to put 'Under God' on their cans.

I no longer use Saran wrap in the microwave because it causes cancer.

And thanks for letting me know I can't boil a cup of water in the microwave anymore because it will blow up in my face...disfiguring me for life. ; I no longer check the coin return on pay phones because I could be pricked with a needle infected with AIDS.

I no longer go to shopping mall s because someone will drug me with a perfume sample and rob me.

I no longer receive packages from UPS or FedEx since they are actually Al Qaeda in disguise.

I no longer shop at Target since they are French and don't support our American troops or the Salvation Army.

I no longer answer the phone because someone will ask me to dial a number for which I will get a phone bill with calls to Jamaica , Uganda & Singapore and Uzbekistan .

I no longer buy expensive cookies from Neiman Marcus since I now have their recipe.

Thanks to you, I can't use anyone's toilet but mine because a big brown African spider is lurking under the seat to cause me instant death when it bites my butt.

And thanks to your great advice, I can't ever pick up $5.00 dropped in the parking lot because it probably was placed there by a sex molester waiting underneath my car to grab my leg.

I can no longer drive my car because I can't buy gas from certain gas companies!

If you don't send this e-mail to at least 144,000 people in the next 70 minutes, a large dove with diarrhea will land on your head at 5:00 PM this afternoon and the fleas from 12 camels will infest your back, causing you to grow a hairy hump. I know this will occur because it actually happened to a friend of my next door neighbor's ex-mother-in-law's second husband's cousin's beautician...

Have a wonderful day...

Oh, by the way..... A German scientist from Argentina , after a lengthy study, has discovered that people with insufficient brain activity read their e-mail with their hand on the mouse.

Don't bother taking it off now, it's too late.

Men versus Women Having Perfect Days --- http://www.amazingjokes.com/

Funny metaphors used in high school essays --- http://help.com/post/124066-funny-metaphors-used-in-high-school
A good sign they weren't plagiarized (except maybe from this site)

Kissing Quotations ... http://www.citate-celebre.com/famous-quotes/kissing-quotes/

Music Humor --- http://www.amiright.com/

Forwarded by my good neighbors

Here's a truly heartwarming story about the bond formed between a little 5-year-old girl and some construction workers that will make you believe that we all can make a difference when we give a child the gift of our time.

A young family moved into a house, next to a vacant lot. One day, a construction crew began to build a house on the empty lot. The young family's 5-year-old daughter naturally took an interest in the goings-on and spent much of each day observing the workers.

Eventually the construction crew, all of them 'gems-in-the-rough,' more or less, adopted her as a kind of project mascot. They chatted with her during coffee and lunch breaks and gave her little jobs to do here and there to make her feel important. At the end of the first week, they even presented her with a pay envelope containing ten dollars. The little girl took this home to her mother who suggested that she take her ten dollars 'pay' she'd received to the bank the next day to start a savings account.

When the girl and her mom got to the bank, the teller was equally impressed and asked the little girl how she had come by her very own pay check at such a young age. The little girl proudly replied, 'I worked last week with a real construction crew building the new house next door to us.'

'Oh my goodness gracious,' said the teller, 'and will you be working on the house again this week, too?' The little girl replied, 'I will, if those assholes at Home Depot ever deliver the FRICKEN' sheet rock.'

Kind of brings a tear to the eye - doesn't it?

Awful Puns forwarded by Auntie Bev

1. The roundest knight at king Arthur's round table was Sir Cumference.

He acquired his size from too much pi.

2. I thought I saw an eye doctor on an Alaskan island,

but it turned out to be an optical Aleutian .

3. She was only a whisky maker,

but he loved her still.

4. A rubber band pistol was confiscated from algebra class because

it was a weapon of math disruption.

5. The butcher backed into the meat grinder

and got a little behind in his work.

6. Now matter how much you push the envelope,

it'll still be stationery.

7. A dog gave birth to puppies near the road

and was cited for littering.

8. A grenade thrown into a kitchen in France would result in

Linoleum Blownapart.

9. Two silk worms had a race.

They ended up in a tie.

10. Time flies like an arrow.

Fruit flies like a banana.

11. A hole has been found in the nudist camp wall.

The police are looking into it.

12. Atheism is a non-prophet organization.

13. Two hats were hanging on a hat rack in the hallway.

One hat said to the other, 'You stay here, I'll go on a head.'

14. I wondered why the baseball kept getting bigger.

Then it hit me.

15. A sign on the lawn at a drug rehab center said: 'Keep off the Grass.'

16. A small boy swallowed some coins and was taken to a hospital.

When his grandmother telephoned to ask how he was,

a nurse said, 'No change yet.'

17. A chicken crossing the road is poultry in motion.

18. The short fortune-teller who escaped from prison was

a small medium at large.

19. The man who survived mustard gas and pepper spray is now

a seasoned veteran.

20. A backward poet writes inverse.

21. In democracy it's your vote that counts.

In feudalism it's your count that votes.

22. When cannibals ate a missionary,

they got a taste of religion.

23. Don't join dangerous cults:

Practice safe sects!

Old Ones Forwarded by Paula

Forwarded by Dick Haar

WHY GOD MADE MOMS Answers given by 2nd grade school children to the following questions:

Why did God make mothers? 1. She 's the only one who knows where the scotch tape is. 2. Mostly to clean the house. 3. To help us out of there when we were getting born.

How did God make mothers? 1. He used dirt, just like for the rest of us. 2. Magic plus super powers and a lot of stirring. 3. God made my Mom just the same like he made me. He just used bigger parts.

What ingredients are mothers made of ? 1. God makes mothers out of clouds and angel hair and everything nice in the world and one dab of mean. 2. They had to get their start from men's bones. Then they mostly use string, I think.

Why did God give you your mother and not some other mom? 1. We're related. 2. God knew she likes me a lot more than other people's moms like me.

What kind of little girl was your mom? 1. My Mom has always been my mom and none of that other stuff. 2. I don't know because I wasn't there, but my guess would be pretty bossy. 3. They say she used to be nice.

What did Mom need to know about dad before she married him? 1. His last name. 2. She had to know his background. Like is he a crook? Does he get drunk on beer? 3. Does he make at least $800 a year? Did he say NO to drugs and YES to chores?

Why did your mom marry your dad? 1. My dad makes the best spaghetti in the world. And my Mom eats a lot. 2 She got too old to do anything else with him. 3. My grandma says that Mom didn't have her thinking cap on.

Who's the boss at your house? 1. Mom doesn't want to be boss, but she has to because dad's such a goof ball. 2. Mom. You can tell by room inspection. She sees the stuff under the bed. 3. I guess Mom is, but only because she has a lot more to do than dad.

What's the difference between moms & dads? 1. Moms work at work and work at home and dads just go to work at work. 2. Moms know how to talk to teachers without scaring them. 3. Dads are taller & stronger, but moms have all the real power 'cause that's who you got to ask if you want to sleep over at your friend's. 4. Moms have magic, they make you feel better without medicine.

What does your mom do in her spare time? 1. Mothers don't do spare time. 2. To hear her tell it, she pays bills all day long.

What would it take to make your mom perfect? 1. On the inside she's already perfect. Outside, I think some kind of plastic surgery. 2. Diet. You know, her hair. I'd diet, maybe blue.

If you could change one thing about your mom, what would it be? 1. She has this weird thing about me keeping my room clean. I'd get rid of that. 2. I'd make my mom smarter. Then she would know it was my sister who did it and not me. 3. I would like for her to get rid of those invisible eyes on the back of her head.

Forwarded by Paula

Age By Wal-Mart:

You are in the middle of some kind of project around the house mowing the lawn, putting a new fence in, painting the living room, or whatever. You are hot and sweaty, covered in dirt or paint. You have your old work clothes on. You know the outfit - shorts with the hole in crotch, old T-shirt with a stain from who knows what, and an old pair of tennis shoes. Right in the middle of this great home improvement project you realize you need to run to Wal-Mart to get something to help complete the job. Depending on your age you might do the following:

In your 20's: Stop what you are doing. Shave, take a shower, blow dry your hair, brush your teeth, floss, and put on clean clothes. Check yourself in the mirror and flex. Add a dab of your favorite cologne because you never know, you just might meet some hot chick while standing in the checkout lane. You went to school with the pretty girl running the register.

In your 30's: Stop what you are doing, put on clean shorts and shirt. Change shoes. You married the hot chick so no need for much else. Wash your hands and comb your hair. Check yourself in the mirror. Still got it. Add a shot of your favorite cologne to cover the smell. The cute girl running the register is the kid sister to someone you went to school with.

In your 40's: Stop what you are doing. Put a sweatshirt that is long enough to cover the hole in the crotch of your shorts. Put on different shoes and a hat. Wash your hands. Your bottle of Brute Cologne is almost empty so you don't want to waste any of it on a trip to Wal-Mart. Check yourself in the mirror and do more sucking in than flexing. The spicy young thing running the register is your daughter's age and you feel weird thinking she is spicy.

In your 50's: Stop what you are doing. Put a hat on, wipe the dirt off your hands onto your shirt. Change shoes because you don't want to get dirt in your new sports car. Check yourself in the mirror and you swear not to wear that shirt anymore because it makes you look fat. The cutie running the register smiles when she sees you coming and you think you still have it. Then you remember the hat you have on is from Buddy's Bait & Beer Bar and it says, 'I Got Worms.'

In your 60's: Stop what you are doing. No need for a hat anymore. Hose the dog shit off your shoes. The mirror was shattered when you were in your 50's. You hope you have underwear on so nothing hangs out the hole in your pants. The girl running the register may be cute, but you don't have your glasses on so you are not sure.

In your 70's: Stop what you are doing. Wait to go to Wal-Mart until they have your prescriptions ready, too. Don't even notice the dog shit on your shoes. The young thing at the register smiles at you because you remind her of her grandfather.

In your 80's: Stop what you are doing. Start again. Then stop again. Now you remember you needed to go to Wal-Mart. Go to Wal-Mart and wander around trying to think what it is you are looking for. Fart out loud and you think someone called out your name. You went to school with the old lady who greeted you at the front door.

Humor Between December 1 and December 31, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor123108 

Humor Between November 1 and November 30, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor113008

Humor Between October 1 and October 31, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor103108

Humor Between September 1 and September 30, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor093008 

Humor Between July 1 and August 31, 2008 --- http://www.trinity.edu/rjensen/book08q3.htm#Humor083108

Humor Between June 1 and June 30, 2008 --- http://www.trinity.edu/rjensen/book08q3.htm#Humor063008

Humor Between May 1 and May 31, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor053108

Humor Between May 1 and May 31, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor053108

Humor Between April 1 and April 30, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor043008

Humor Between March 1 and March 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor033108

Humor Between February 1 and February 29, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor022908   

Humor Between January 1 and January 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor013108  

Tidbits Directory for Earlier Months and Years --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm

And that's the way it was on December 31, 2008 with a little help from my friends.

Bob Jensen's Threads --- http://www.trinity.edu/rjensen/threads.htm

International Accounting News (including the U.S.)

AccountingEducation.com and Double Entries --- http://www.accountingeducation.com/
        Upcoming international accounting conferences --- http://www.accountingeducation.com/events/index.cfm
        Thousands of journal abstracts --- http://www.accountingeducation.com/journals/index.cfm
 

Deloitte's International Accounting News --- http://www.iasplus.com/index.htm
 

Association of International Accountants --- http://www.aia.org.uk/ 

Wikipedia has a rather nice summary of accounting software at http://en.wikipedia.org/wiki/Accounting_software
Bob Jensen’s accounting software bookmarks are at http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

Bob Jensen's accounting history summary --- http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

Bob Jensen's accounting theory summary --- http://www.trinity.edu/rjensen/Theory.htm

AccountingWeb --- http://www.accountingweb.com/
AccountingWeb Student Zone --- http://www.accountingweb.com/news/student_zone.html

Introducing the New journalofaccountancy.com  (free) --- http://www.journalofaccountancy.com/Issues/2008/Nov/NovSmartStops.htm

SmartPros --- http://www.smartpros.com/

I highly recommend TheFinanceProfessor (an absolutely fabulous and totally free newsletter from a very smart finance professor, Jim Mahar from St. Bonaventure University) --- http://www.financeprofessor.com/ 

Financial Rounds (from the Unknown Professor) --- http://financialrounds.blogspot.com/

Professor Robert E. Jensen (Bob) http://www.trinity.edu/rjensen
190 Sunset Hill Road
Sugar Hill, NH 03586
Phone:  603-823-8482 
Email:  rjensen@trinity.edu  

November 30, 2008

Bob Jensen's New Bookmarks on  November 30, 2008
Bob Jensen at Trinity University 

For earlier editions of Fraud Updates go to http://www.trinity.edu/rjensen/FraudUpdates.htm
For earlier editions of Tidbits go to http://www.trinity.edu/rjensen/TidbitsDirectory.htm
For earlier editions of New Bookmarks go to http://www.trinity.edu/rjensen/bookurl.htm 

Click here to search Bob Jensen's web site if you have key words to enter --- Search Site.
For example if you want to know what Jensen documents have the term "Enron" enter the phrase Jensen AND Enron. Another search engine that covers Trinity and other universities is at http://www.searchedu.com/.

Bob Jensen's Blogs --- http://www.trinity.edu/rjensen/JensenBlogs.htm
Current and past editions of my newsletter called New Bookmarks --- http://www.trinity.edu/rjensen/bookurl.htm
Current and past editions of my newsletter called Tidbits --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm
Current and past editions of my newsletter called Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

Many useful accounting sites (scroll down) --- http://www.iasplus.com/links/links.htm

Bob Jensen's essay on the financial crisis bailout's aftermath and an alphabet soup of appendices can be found at
http://www.trinity.edu/rjensen/2008Bailout.htm

Essay

• Introductory Quotations

• The Bailout's Hidden, Albeit Noble, Agenda (for added details see Appendix Y)

• A Step Back in History Barney's Rubble

Appendix A: Impending Disaster in the U.S.

Appendix B: The Trillion Dollar Bet in 1993

Appendix C: Don't Blame Fair Value Accounting Standards This includes a bull crap case based on an article by the former head of the FDIC

Appendix D: The End of Investment Banking as We Know It

Appendix E: Your Money at Work, Fixing Others’ Mistakes (includes a great NPR public radio audio module)

Appendix F: Christopher Cox Waits Until Now to Tell Us His Horse Was Lame All Along S.E.C. Concedes Oversight Flaws Fueled Collapse And This is the Man Who Wants Accounting Standards to Have Fewer Rules

Appendix G: Why the $700 Billion Bailout Proposed by Paulson, Bush, and the Guilty-Feeling Leaders in Congress Won't Work

Appendix H: Where were the auditors? The aftermath will leave the large auditing firms in a precarious state?

Appendix I: 1999 Quote from The New York Times ''If they fail, the government will have to step up and bail them out the way it stepped up and bailed out the thrift industry.''

Appendix J:  Will the large auditing firms survive the 2008 banking meltdown?

Appendix K:  Why not bail out everybody and everything?

Appendix L:  The trouble with crony capitalism isn't capitalism. It's the cronies.

Appendix M:  Reinventing the American Dream

Appendix N: Accounting Fraud at Fannie Mae

Appendix O: If Greenspan Caused the Subprime Real Estate Bubble, Who Caused the Second Bubble That's About to Burst?

Appendix P:  Meanwhile in the U.K., the Government Protects Reckless Bankers

Appendix Q: Bob Jensen's Primer on Derivatives (with great videos from CBS)

Appendix R:  Accounting Standard Setters Bending to Industry and Government Pressure to Hide the Value of Dogs

Appendix S: Fooling Some People All the Time

Appendix T:  Regulations Recommendations

Appendix U: Subprime: Borne of Sleaze, Bribery, and Lies

Appendix V: Implications for Educators, Colleges, and Students

Appendix W: The End

Appendix: X: How Scientists Help Cause Our Financial Crisis

Appendix Y:  The Bailout's Hidden Agenda Details

Appendix Z:  What's the rush to re-inflate the stock market?

Personal Note from Bob Jensen

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Humor Between November 1 and November 30, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor113008

Humor Between October 1 and October 31, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor103108

Humor Between September 1 and September 30, 2008 --- http://www.trinity.edu/rjensen/book08q4.htm#Humor093008 

Humor Between July 1 and August 31, 2008 --- http://www.trinity.edu/rjensen/book08q3.htm#Humor083108

Humor Between June 1 and June 30, 2008 --- http://www.trinity.edu/rjensen/book08q3.htm#Humor063008

Humor Between May 1 and May 31, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor053108

Humor Between May 1 and May 31, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor053108

Humor Between April 1 and April 30, 2008 --- http://www.trinity.edu/rjensen/book08q2.htm#Humor043008

Humor Between March 1 and March 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor033108

Humor Between February 1 and February 29, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor022908   

Humor Between January 1 and January 31, 2008 --- http://www.trinity.edu/rjensen/book08q1.htm#Humor013108  

Tidbits Directory for Earlier Months and Years --- http://www.trinity.edu/rjensen/TidbitsDirectory.htm

 

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Accounting Learning and Study Games from the AICPA's StartHere --- http://www.startheregoplaces.com/games/default.aspx

• The Turnaround Game
• Catch Me If You Can
• Money Means Business
• BizzFun

Bob Jensen's threads on edutainment --- http://www.trinity.edu/rjensen/000aaa/thetools.htm#Edutainment

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Interactive Mulitmedia Excel Files on the Web

Richard Campbell's Interactive Invoice --- http://faculty.rio.edu/campbell/gp10_windows/engage.html

I thank Richard for showing us how to add online interactive hotspots to a picture. This is part of the way toward interaction. A file may become more fully interactive if it is an Excel file rather than just a picture or a non-interactive video.

Since your computer can be set to download Excel files into your Web browser for security purposes, it is possible to download Excel files with interactive hot spots. In addition, numbers can be changed such that there is calculation interaction as well. Such calculation interaction is not available in pictures.

I illustrate an interactive multimedia Excel file at http://www.cs.trinity.edu/~rjensen/ExcelMediaIllustrations/Example01.xls

The steps I follow when making interactive multimedia Excel files are as follows:

1. Prepare an Excel spreadsheet
2. Add Web links and make them active
3. Decide where to place audio clips
4. Record each audio clip as a wav file (I use the free Audacity software) --- http://audacity.sourceforge.net/
   I save these files in the same folder as the Excel spreadsheet
5. In Excel click on (Insert, Object) and choose Media Clip
   Then choose (Insert Media File, Sound) and find the appropriate wav file
6. You can also insert video clips (I record these in Camtasia)

Note that you can compress wav audio files into mp3 files and avi video files into whatever format you choose such as wmv, mov, or mpg. Adding any media to an Excel spreadsheet makes downloading slower. Media file compression, however, speeds up the process greatly if you have long media clips in your spreadsheet.

There are of course other files that you can add to Excel such as pictures.

Any downloaded MS Office file loses macro functionality in a Web browser, so you might want to avoid using macros in your Excel file.

It is also possible to add DHTML dynamic interactions to Exel files. This adds an immense amount of code to your file and the DHTML code cannot be read on all types of browsers. I have a video on how to do DHTML interaction in Excel at http://www.cs.trinity.edu/~rjensen/video/acct5342/ExcelDHTML.wmv
However, I don't view this rather complex procedure important since it became possible to read downloaded Excel files directly into a Web browser and thereby avoid many of the security risks of running Excel files in Excel itself.

Bob Jensen's threads on tricks and tools of the trade are at http://www.trinity.edu/rjensen/000aaa/thetools.htm

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Accounting for Intangibles is Arguably the Most Difficult Part of Accountancy Theory and Application
It's doubly difficult since the uncertain amounts involved may be tenfold larger than the tangibles to be accounting for under accounting standards.
Errors in identification and measurement alone may be larger than aggregated measures of tangibles.

The white paper below does not address intangible and contingent liabilities, although one company’s l intangible liability may be another company's intangible asset such that scoping out intangible liabilities may not be possible.

"Initial Accounting for Internally Generated Intangible Assets," Discussion Paper, Australian Accounting Standards Board, November 2008 --- http://www.aasb.gov.au/admin/file/content105/c9/ACCDP_IGIA_10-08.pdf

(Chapter 2) Identification
The manner by which an intangible item comes into existence is not relevant to the determination of whether the item can be identified as an asset. Therefore, intangible items of the same nature, irrespective of whether they are acquired in a business combination or internally generated (planned or unplanned), could be analysed in the same way for the purpose of determining whether they are assets. In particular, the principles and guidance for identifying the existence of and describing an intangible asset acquired in a business combination specified in IFRS 3 Business Combinations (and IAS 38 Intangible Assets) could be adopted for assessing whether internally generated intangible assets exist. Accordingly, a technique based on a hypothetical business combination is a possible technique for identifying internally generated intangible assets. (paragraph 66)

(Chapter 3) Recognition
If a cost-based model were adopted  
Internally generated intangible assets that satisfy the definition of an intangible asset in IAS 38/IFRS 3 should be subject to the Framework’s recognition criteria. Accordingly, only planned internally generated intangible assets should be contemplated for recognition, on the basis that the plan identifies the unit of account and it is only those types of internally generated intangible assets that could satisfy the reliable measurement (of cost) recognition criterion. They do not warrant more specific recognition criteria, although guidance on the meaning of a ‘discrete plan that is being or has been implemented to create an internally generated intangible asset’ would be helpful. (paragraph 87)

If a valuation-based model were adopted
Internally generated intangible assets that satisfy the definition of an intangible asset in IAS 38/IFRS 3 should be subject to the same recognition requirements for intangible assets acquired in a business combination, using a technique based on a hypothetical business combination. Accordingly, all internally generated intangible assets that would be recognised if acquired in a business combination under IFRS 3 should be recognised. While less onerous identification techniques or recognition criteria could be adopted, they have significant conceptual shortcomings. (paragraph 113)

(Chapter 4) Measurement
If a cost-based model were adopted 
It is reasonable to presume that historical cost can be reliably measured for planned internally generated intangible assets from the commencement of implementing the plan up until completion or abandonment of the plan, based on the principles in IASB standards for allocating costs to other types of assets. Therefore, the attributable costs of planned internally generated intangible assets should be required to be recognised (capitalised) as an asset. A transitional period may be warranted to allow entities time to develop adequate accounting systems. Cost is not a suitable basis for measuring unplanned internally generated intangible assets because there is no basis for reliably attributing costs. (paragraph 134)

If a valuation-based model were adopted
Internally generated intangible assets are capable of being reliably measured at fair value to the same degree that the IFRS 3 presumption (that the fair value of the same types of intangible assets acquired in a business combination is capable of reliable measurement) is valid. Subject to the outcome of the IASB/FASB Fair Value Measurement project, SFAS 157 Fair Value Measurements provides a possible basis for specifying the determination of fair value of internally generated intangible assets. Until then, IFRS 3 provides an adequate basis. (paragraph 171)

From a technical conceptual perspective, internally generated intangible assets should be required to be initially measured at fair value to enhance the decision-usefulness of financial reports. An option to adopt cost as an alternative to fair value should not be allowed. On balance, we also think that this view can be justified on practical grounds. However, we acknowledge the views of some against our conclusion. Accordingly, before our conclusion is considered for implementation, we think that further investigation of the perceived practical impediments is warranted. (paragraph 190)

(Chapter 5) Presentation/Disclosure
The current reporting requirements in IAS 1 Presentation of Financial Statements can be applied to internally generated intangible assets, and are sufficient to facilitate the: (a) separate presentation of internally generated intangible assets that are recognised; and (b) disclosure of information in relation to the accounting policies adopted and judgements made by management in relation to internally generated intangible assets equivalent to the information that is required to be disclosed about other types of assets. (paragraph 203)

 If a cost-based model were adopted
The amount of costs incurred in a reporting period and recognised in the carrying amounts of internally generated intangible assets presented in the financial statements should be disclosed together with the accounting policies adopted. In response to users’ comments, management’s rationale for capitalisation should also be disclosed. (paragraph 214)

If a valuation-based model were adopted
The methods and significant assumptions applied in determining an asset’s fair value, including the extent to which the asset’s fair value was determined directly by reference to observable prices or was estimated using other measurement techniques, should be disclosed. In addition, if changing one or more of the assumptions used to determine the fair value to reasonably possible alternative assumptions would change the fair value significantly, the entity should state this fact and disclose the effect of those changes. (paragraph 225) In response to users’ comments, the costs reliably attributable to an internally generated intangible asset should also be disclosed, either on an aggregate or a project-by-project basis. (paragraph 232) If an internally generated intangible asset does not meet the relevant recognition criteria, in the interests of providing useful information to users, entities should be required to disclose a description of the asset and the reason why the asset fails to meet the relevant recognition criteria. (paragraph 240) Consistent with the recognition and disclosure principles in the Framework and IASB standards, disclosure is not an adequate substitute for recognition and internally generated intangible items that meet the relevant asset definition and recognition criteria should be recognised in the financial statements. While a disclosure-only approach may have some merit as a pragmatic interim step towards the adoption of a recognition-based accounting approach for internally generated intangible assets, in the interests of maximising the information content of financial statements on a timely basis, a recognition-based approach is preferred. (paragraph 258)

Bob Jensen's threads on accounting for intangibles (the part under the icebergs) are at
http://www.trinity.edu/rjensen/Theory01.htm#TheoryDisputes

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A New Type of Intangible Investment (sort of not yet legal in the U.S.) --- Litigation
How should it be booked and carried in financial statements?
I say "sort of" since this intangible asset might be buried (as Purchased Goodwill") in acquisition prices when firms are purchased purchased or merged.

The notion of litigation as a separate asset class is a novel one. It's hard to imagine fund managers one day allotting a bit of their portfolio to third-party lawsuits, alongside shares, bonds, property and hedge funds. But some wealthy investors are starting to dabble in lawsuit investment, bankrolling some or all of the heavy upfront costs in return for a share of the damages in the event of a win. The London-managed hedge fund MKM Longboat last month revealed plans to invest $100million (£50.5million) to finance European lawsuits. Today a new company, Juridica, floats on AIM, having raised £80million to make litigation bets.
"The law is now an asset class," The London Times, December 21, 2007 --- http://business.timesonline.co.uk/tol/business/columnists/article3080766.ece

Jensen Comment
Under U.S. GAAP, intangible assets are generally booked only when purchased and are not conducive to fair value accounting afterwards. Probably the most serious problem in both accounting theory and practice is unbooked value (and in many cases undisclosed) of intangible assets and liabilities. Do the values of human capital and knowledge capital ring a bell? Does the cost retraining the world's workforce to use Office software other than Microsoft Office (Word, Excel, PowerPoint, etc.) ring a bell?

Contingent liabilities (particularly pending lawsuits) are problematic until the amount of the liability is both reasonably measurable and highly probable. Until now, contingent litigation assets were not investment assets. Contingent liabilities were booked as current or past expenses. Now purchased litigation assets having future value? Horrors!

In the past when a company purchased another company, some of the "goodwill" value above and beyond the traceable value to net tangible assets could easily have been the value of future litigation such as when Blackboard acquired WebCT and WebCT's patents on online education software. Patents and Copyrights may have value with respect to fending off future competition.

But patents and copyrights may also have value in future litigation regarding past infringements. Now hedge funds might invest in bringing litigation to fruition.

Intangible assets and liabilities are, and will forever remain, the largest problem in accounting theory and practice! In some cases, such as Microsoft Corporation, booked assets are so miniscule relative to unbooked intangible assets that the balance sheets are virtually a bad joke.

An enormous problem, besides the fact that current value of intangibles cannot be counted, current value can change by enormous magnitudes overnight as new discoveries are made and new legislation is passed, to say nothing of court decisions. Tangible asset values can also change, but in general they are not as volatile.

December 25, 2007 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

Bob,

SFAS 141R (available on the FASB web site) substantially changes the accounting for both contingent assets and liabilities in connection with business combinations. In fact, 141R coupled with SFAS 160 on noncontrolling interests makes major changes to both the accounting for business combinations and the accounting for consolidation procedures. While the new rules can't be applied until 2009, anyone teaching advanced accounting or where ever else these topics are covered should throw out their old lesson plans and be prepared to enter into an entirely new world of accounting - not for the better in my humble opinion.

By the way, another interesting thing to read on the FASB web site is the proposal to reduce the size of the FASB and make some other changes to improve the standard-setting process. We celebrated our family Christmas a few days ago because of travel plans and I'm working on my comment letter to the Financial Accounting Foundation today.

Merry Christmas!

Denny

December 25, 2007 reply from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU]

What I found interesting about 141R is the discussion in the appendices that showed both the FASB and IASB views and how the Boards reached convergence.

141R also added a couple paragraphs to FIN 48 that result in goodwill no longer being adjusted if the contingent tax liability is increased or decreased. Instead the DR is to tax expense, which makes a lot more sense to me. If I read the statement correctly, the purchased assets and liabilities are stated at fair value under a recognition, then measurement principle. Taxes are exempt from those two principles; instead FAS 109/FIN 48 apply. What I couldn't tell is if the purchaser still has up to one year (the maximum measurement period) to get the tax contingent liability right before the DR goes to tax expense. Can anyone help me?

Amy Dunbar
UConn

Jensen Comment
You can download FAS 141(R) from http://www.fasb.org/st/index.shtml#fas160 

Bob Jensen's threads on accounting for intangibles (the part under the icebergs) are at
http://www.trinity.edu/rjensen/Theory01.htm#TheoryDisputes

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David Albrecht asks:  Why not a day for accountants? http://profalbrecht.wordpress.com/2008/10/06/accounting-day/

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Question
Why might you want to become a CPA?

 

A great reference summarizing reasons is cited below. CPAs and non-CPAs frequently track into industry and how accounting knowledge greatly enhances career advancement in most instances:

 

STEPHEN R. MOEHRLE, GARY JOHN PREVITS, AND JENNIFER A. REYNOLDSMOEHRLE, The CPA Profession: Opportunities, Responsibilities, and Services (New York, NY: American Institute of Certified Public Accountants, 2006, pp. xxii, 254).
This monograph provides a comprehensive overview of the scope of services provided by CPA firms.

Bob Jensen's threads on accounting careers are at http://www.trinity.edu/rjensen/Bookbob1.htm#careers

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"FASB and IASB Issue Discussion Paper on Financial Statement Presentation,"  by Mark Crowley and Stephen McKinney, Deloitte & Touche LLP, Heads Up, November 10, 2008 Vol. 15, Issue 40 --- http://www.iasplus.com/usa/headsup/headsup0811presentationdp.pdf

Radical Changes in Financial Reporting --- http://www.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay
Yipes! Net earnings and eps will no longer be derived and presented. It's like getting your kids report card with summaries of his/her weekly activities and no final grade.

Five General Categories of Aggregation
"The Sums of All Parts: Redesigning Financials:  As part of radical changes to the income statement, balance sheet, and cash flow statement, FASB signs off on a series of new subtotals to be contained in each," by Marie Leone, CFO Magazine, November 14, 2007 --- http://www.cfo.com/article.cfm/10131571?f=rsspage

In another large step towards the most dramatic overhaul of financial statements in decades, the Financial Accounting Standards Board Wednesday laid out a series of subtotal figures that companies would be required to include on their balance sheets, income statements and cash flow statements.

The new look for financials will break all three statements into five general categories: business, discontinued operations, financing, income taxes, and equity (if needed). Each of those groupings will carry its own total. In addition, the business, financing, and income tax categories will be segmented into even more narrow sections, each of which will include a subtotal. For example, the business category will be broken down into operating assets, operating liabilities and a subtotal; and investing assets, investing liabilities, and a second subtotal.

(Although FASB will not officially release its proposal until the second quarter of 2008, it has made public some initial peeks at the proposed format.)

The addition of totals and subtotals is an extension of FASB's broader principle on disaggregating financial statement line items. It is the board's belief that separating line items into their components gives investors, creditors, analysts and other financial statement users a better view of a company's financial health. For example, the new format should make it easier for an investor to see how much cash a company generates by selling its products versus how much it generates by selling-off a business unit or through financial investments made by the corporate treasurer.

FASB staffers say buy- and sell-side analysts typically scrutinize financial statements by breaking them down into categories similar to the ones the board is proposing.

In keeping with its promise to strip accounting standards of complexity, the board also agreed to issue two overarching principles in its draft document on financial statement presentation. One principle instructs preparers to keep the category order consistent in each of the three financial statements. For example, if income tax is the last category shown in on the balance sheet, then it should also be the final category on the cash flow and income statement. "We're not going to tell you what order [to use], just that you should use the same order in all three statements," noted FASB Chairman Robert Herz during the meeting.

In addition, the board wants companies to "clearly distinguish" between operating assets and operating liabilities, as well as short-term assets and liabilities and their long-term counterparts. But the board is not going to prescribe how that should be done. Regarding the issue of common sums, "the only requirement will be that totals and subtotals are segmented by activities," noted board member George Batavick, "the rest will be principles."

Updating the look and functionality of financial statements is one of the joint projects that FASB is working on with the International Accounting Standards Board as the two organizations work to converge U.S. and global accounting rules. On Thursday, IASB will discuss the common totals issue and is expected to release its recommendations.

FASB expects the draft proposal to spark a healthy debate among users and preparers, and staffers are planning for a four- to six-month comment period to follow its release. One issue that will have to be thrashed out, for example, is whether discontinued operations should be relegated to its own category, or run through the income statement or financing activities.

To avoid any last-minute confusion with the Securities and Exchange Commission, Herz asked the FASB accountants working on the project to "touch base with the SEC staff just to get their input." Herz noted that last time the two groups discussed disaggregation principles, Scott Taub, not James Kroeker, was the SEC's deputy chief accountant.

Jensen Comment
Now is especially the time for accounting researchers to look into leading edge alternatives for visualizing data. My threads on that topic are at http://www.trinity.edu/rjensen/352wpVisual/000DataVisualization.htm

Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory.htm

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Credit Default Swap (CDS)
This is an insurance policy that essentially "guarantees" that if a CDO goes bad due to having turds mixed in with the chocolates, the "counterparty" who purchased the CDO will recover the value fraudulently invested in turds. On September 30, 2008 Gretchen Morgenson of The New York Times aptly explained that the huge CDO underwriter of CDOs was the insurance firm called AIG. She also explained that the first $85 billion given in bailout money by Hank Paulson to AIG was to pay the counterparties to CDS swaps. She also explained that, unlike its casualty insurance operations, AIG had no capital reserves for paying the counterparties for the the toxic mortgage-backed investments they purchased from Wall Street investment banks.

"Testimony Concerning Credit Default Swaps," by Erik Sirri Director, Division of Trading and Markets U.S. Securities and Exchange Commission, SEC, November 20, 2008 --- http://www.sec.gov/news/testimony/2008/ts112008ers.htm

I am pleased to have the opportunity today to again testify regarding the credit default swaps (CDS) market. My testimony today summarizes the key points from my testimony before this committee five weeks ago and updates it to reflect the Commission's activities since then.

CDS can serve important purposes. They can be employed to closely calibrate risk exposure to a credit or a sector. CDS can be especially useful for the business model of some financial institutions that results in the institution making heavily directional bets, and others — such as dealer banks — that take both long and short positions through their market-making and proprietary trading activities. Through CDS, market participants can shift credit risk from one party to another, and thus the CDS market may be an important element to a particular firm's willingness to participate in an issuer's securities offering.

The current CDS market operates solely on a bilateral, over-the-counter basis and has grown to many times the size of the market for the underlying credit instruments. In light of the problems involving AIG, Lehman, Fannie, Freddie, and others, attention has focused on the systemic risks posed by CDS. The ability of protection sellers (such as AIG and Lehman) to meet their CDS obligations has raised questions about the potentially destabilizing effects of the CDS market on other markets. Also, the deterioration of credit markets generally has increased the likelihood of CDS payouts, thus prompting protection buyers to seek additional margin from protection sellers. These margin calls have strained protection sellers' balance sheets and may be forcing asset sales that contribute to downward pressure on the cash securities markets.

In addition to the risks that CDS pose systemically to financial stability, CDS also present the risk of manipulation. Like all financial instruments, there is the risk that CDS are used for manipulative purposes, and there is a risk of fraud in the CDS market.

The SEC has a great interest in the CDS market because of its impact on the securities markets and the Commission's responsibility to maintain fair, orderly, and efficient securities markets. These markets are directly affected by CDS due to the interrelationship between the CDS market and the securities that compose the capital structure of the underlying issuers on which the protection is written. In addition, we have seen CDS spreads move in tandem with falling stock prices, a correlation that suggests that activities in the OTC CDS market may in fact be spilling over into the cash securities markets.

OTC market participants generally structure their acivities in CDS to comply with the CFMA's swap exclusion from the Securities Act and the Exchange Act. These CDS are "security-based swap agreements" under the CFMA, which means that the SEC currently has limited authority to enforce anti-fraud prohibitions under the federal securities laws, including prohibitions against insider trading. If CDS were standardized as a result of centralized clearing or exchange trading or other changes in the market, and no longer subject to individual negotiation, the "swap exclusion" from the securities laws under the CFMA would be unavailable.

Progress on Establishing a Central Counterparty for CDS

As announced on November 14th, a top priority for The President's Working Group on Financial Markets, in which the SEC Chairman is a member, is to oversee the implementation of central counterparty services for CDS. A central counterparty ("CCP") for CDS could be an important step in reducing the counterparty risks inherent in the CDS market, and thereby help mitigate potential systemic impacts.

By clearing and settling CDS contracts submitted by participants in the CCP, the CCP could substitute itself as the purchaser to the CDS seller and the seller to the CDS buyer. This novation process by a CCP would mean that the two counterparties to a CDS would no longer be exposed to each others' credit risk. A single, well-managed, regulated CCP could vastly simplify the containment of the failure of a major market participant. In addition, the CCP could net positions in similar instruments, thereby reducing the risk of collateral flows.

Moreover, a CCP could further reduce risk through carefully regulated uniform margining and other robust risk controls over its exposures to its participants, including specific controls on market-wide concentrations that cannot be implemented effectively when counterparty risk management is uncoordinated. A CCP also could aid in preventing the failure of a single market participant from destabilizing other market participants and, ultimately, the broader financial system.

A CCP also could help ensure that eligible trades are cleared and settled in a timely manner, thereby reducing the operational risks associated with significant volumes of unconfirmed and failed trades. It may also help to reduce the negative effects of misinformation and rumors that can occur during high volume periods, for example when one market participant is rumored to "not be taking the name" or not trading with another market participant because of concerns about its financial condition and taking on incremental credit risk exposure to the counterparty. Finally, a CCP could be a source of records regarding CDS transactions, including the identity of each party that engaged in one or more CDS transactions. Of course, to the extent that participation in a CCP is voluntary, its value as a device to prevent and detect manipulation and other fraud and abuse in the CDS market may be limited.

The Commission staff, together with Federal Reserve and CFTC staff, has been evaluating proposals to establish CCPs for CDS. SEC staff has participated in on-site assessments of these CCP proposals, including review of their risk management systems. The SEC brings to this exercise its experience over more than 30 years of regulating the clearance and settlement of securities, including derivatives on securities. The Commission will use this expertise, and its regulatory and supervisory authorities over any CCPs for CDS that may be established, to strengthen the market infrastructure and protect investors.

To facilitate the speedy establishment of one or more CCPs for CDS and to encourage market participants to voluntarily submit their CDS trades to the CCP, Commission staff are preparing conditional exemptions from the requirements of the securities laws for Commission consideration. SEC staff have been discussing the potential scope and conditions of these draft exemptions with each prospective CCP and have been coordinating with relevant U.S. and foreign regulators.

In addition, last Friday, Chairman Cox, on behalf of the SEC, signed a Memorandum of Understanding (MOU) with the Federal Reserve Board and the Commodity Futures Trading Commission. This MOU establishes a framework for consultation and information sharing on issues related to CCPs for CDS. Cooperation and coordination under the MOU will enhance each agency's ability to effectively carry out its respective regulatory responsibilities, minimize the burden on CCPs, and reduce duplicative efforts.

Other Potential Improvements to OTC Derivatives Market

As explained above, the SEC has limited authority over the current OTC CDS market. The SEC, however, is statutorily prohibited under current law from promulgating any rules regarding CDS trading in the over-the-counter market. Thus, the tools necessary to oversee this market effectively and efficiently do not exist. Chairman Cox has urged Congress to repeal this swap exclusion, which specifically prohibits the SEC from regulating the OTC swaps market.

Recordkeeping and Reporting to the SEC

The repeal of this swap exclusion would allow the SEC to promulgate recordkeeping requirements and require reporting of CDS trades to the SEC. As I discussed in my earlier testimony, a mandatory system of recordkeeping and reporting of all CDS trades to the SEC, is essential to guarding against misinformation and fraud. The information that would result from such a system would not only reduce the potential for abuse of the market, but would aid the SEC in detection of fraud in the market quickly and efficiently.

Investigations of over-the-counter CDS transactions have been far more difficult and time-consuming than those involving cash equities and options. Because these markets lack a central clearing house and are not exchange traded, audit trail data is not readily available and must be reconstructed manually. The SEC has used its anti-fraud authority over security-based swaps, including the CDS market, to expand its investigation of possible market manipulation involving certain financial institutions. The expanded investigation required hedge fund managers and other persons with positions in CDS and other derivative instruments to disclose those positions to the Commission and provide certain other information under oath. This expanded investigation is ongoing and should help to reveal the extent to which the risks I have identified played a role in recent events. Depending on its results, this investigation may lead to more specific policy recommendations.

However, because of the lack of uniform recordkeeping and reporting to the SEC, the information on security-based CDS transactions gathered from market participants has been incomplete and inconsistent. Given the interdependency of financial institutions and financial products, it is crucial for our enforcement efforts that we have a mechanism for promptly obtaining CDS trading information — who traded, how much and when — that is complete and accurate.

Recent private sector efforts may help to alleviate some of these concerns. For example, Deriv/SERV, an unregulated subsidiary of DTCC, provides automated matching and confirmation services for over-the-counter derivatives trades, including CDS. Deriv/SERV's customers include dealers and buy-side firms from more than 30 countries. According to Deriv/SERV, more than 80% of credit derivatives traded globally are now confirmed through Deriv/SERV, up from 15% in 2004. Its customer base includes 25 global dealers and more than 1,100 buy-side firms in 31 countries. While programs like Deriv/SERV may aid the Commission's efforts, from an enforcement perspective, such voluntary programs would not be expected to take the place of mandatory recordkeeping and reporting requirements to the SEC.

In the future, Deriv/SERV and similar services may be a source of reliable information about most CDS transactions. However, participation in Deriv/SERV is elective at present, and the platform does not support some of the most complex credit derivatives products. Consequently, not all persons that engage in CDS transactions are members of Deriv/SERV or similar platforms. Greater information on CDS trades, maintained in consistent form, would be useful to financial supervisors. In addition to better recordkeeping by market participants, ready information on trades and positions of dealers also would aid the SEC in its enforcement of anti-fraud and anti-manipulation rules. Finally, because Deriv/SERV is unregulated, the SEC has no authority to obtain the information stored in this facility for supervision of risk associated with the OTC CDS market and can only obtain it if given voluntarily or by subpoena.

Market Transparency

Market transparency is another improvement to the CDS market that the Commission supports. The development of a CCP could facilitate greater market transparency, including the reporting of prices for CDS, trading volumes, and aggregate open interest. The availability of pricing information can improve the fairness, efficiency, and competitiveness of markets — all of which enhance investor protection and facilitate capital formation. The degree of transparency, of course, depends on participation in the CCP, which currently is not mandatory.

Exchange Trading

A CCP also could facilitate the exchange trading of CDS because the CDS would be in standardized form. Exchange trading of credit derivatives could add both pre- and post-trade transparency to the market that would enhance efficient pricing of credit derivatives. Exchange trading also could reduce liquidity risk by providing a centralized market that allows participants to efficiently initiate and close out positions at the best available prices.

Continued in article

You can read how CDS contracts are the main reason over $100 billion is being given in the bailout to keep AIG alive --- http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

Bob Jensen's threads on accounting for credit default swaps can be found under the C-terms at http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms

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Question
Could the classic historical cost standards for financial reporting have prevented the subprime scandal?

November 25, 2008 message from Zane Swanson

Accounting could have a role in addressing crisis situations but the current historical character of the financial statements precludes explicit warnings about market failures. For the most part (balance sheet fair value accounting notwithstanding), statements present after-the-fact information. Only the auditors’ identification of a going concern problem gives an accounting advance warning. But, how many of the 2008 failed financial institutions had going concern opinions? None that I heard of this year … wait till next year. The MD&A is the communication that management is supposed to use to discuss trends. Once again, these reports come out once a year with the financial statements. Even so, how many financial institution 2007 MD&As identified the value at risk commensurate with the consequent 2008 disasters? Answer that one yourself.

With the switch from US GAAP to the European style IFRS, perhaps firms will also be coerced into preparing European style sustainability reports. Sustainability reports may not be perfect (what is?) as currently constituted, but they could be an avenue to more accurately focus attention on future events / trends about impending crises.

Zane Swanson

November 25, 2008 reply from Bob Jensen

Hi Zane,

There are almost always warnings under most any accounting system. The Paton and Littleton 1940 model required estimation of bad debts. Certainly if bad debts had been properly estimated, we would’ve had ample warning with virtually no fair value accounting other than bad debt estimation. It cannot be argued that historical cost accounting as implemented in the 1940s and 1950s would’ve failed us if bad debts were properly estimated and auditors were truly independent of their largest Wall Street clients. If bad debts had been properly estimated for banks over the past two decades there would’ve never been a crisis of this magnitude. Auditors simply caved in to bullying clients who pressured for enormous underestimation of bad debts.

Under later GAAP with FAS 105, 115, and 133 in place there were even more accounting warnings that a bubble was building and would one day burst. The problem with accounting information is that it combines with other signals in the economy that add noise and make it very difficult to predict just when the bubble will burst. If investors and lawmakers paid close attention, there were ample warnings.

Warren Buffett has been studying financial statements for the past two decades and has been loudly warning about the dangers of a gigantic derivatives bubble, and in many ways the present crisis is merely a fulfillment of his prophecy.

Frank Partnoy (in Infectious Greed) and many other analysts and academicians warned over and over again about the dangers of not regulating the derivative markets, especially the credit derivatives market --- http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds  A lot of the blame falls at the feet of Alan Greenspan who, after the big bang, finally admits he made a “terrible mistake” by not requiring greater regulation --- http://www.trinity.edu/rjensen/2008Bailout.htm 

The problem is that people in power just did not want to heed the warnings. Rep. Barney Frank kept pressuring Fannie Mae and the other mortgage lenders to make loans to poor people who really had no chance of making their mortgage payments. The investment bankers and traditional bankers were making such high commissions and bonuses that they were more than willing to keep blowing up the bubble even when it became obvious that their shareholders were going to take a beating. All along the line hogs feeding on the trough from Wall Street to Main Street knew what they were doing was wrong, but succumbed to their own greed. Accounting should not be blamed completely, although the actions of the auditors, credit rating agencies, and banks estimating bad debts were complicit in creating this mess --- http://www.trinity.edu/rjensen/2008Bailout.htm

Bob Jensen

 

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Greed has no limits!
I wish the government would simply buy a tombstone with the inscription AIG RIP.
What's interesting about this is the argument AIG dreamed up to fight this tax assessment?

From The Wall Street Journal Accounting Weekly Review on November 21, 2008

AIG's Tax Dispute with U.S. Has Twist of Irony by Jesse Drucker The Wall Street Journal Nov 14, 2008 Click here to view the full article on WSJ.com --- http://online.wsj.com/article/SB122662579362126965.html?mod=djem_jiewr_AC   TOPICS: Disclosure, Disclosure Requirements, Financial Accounting, Income Taxes SUMMARY: AIG "...is in a battle with the Internal Revenue Service over $329 million in back taxes and penalties....a portion of which relates to the 'disallowance of foreign tax credits associated with cross-border financing transactions.'....Since AIG first disclosed its dispute with the IRS over these deals last spring, the government has lent nearly $123 billion to the company in exchange for a 79.9% stake in the company." AIG's pursuit of these claims for back taxes means that the U.S. government is effectively funding these activities against its own agency. CLASSROOM APPLICATION: Questions relate to understanding the tax issues and related required financial statement disclosures under APB Opinion 28, Statement of Financial Accounting Standards No. 5, Financial Accounting Interpretation No. 48 QUESTIONS:  1. (Advanced) Access the AIG 10-Q filing at http://www.sec.gov/Archives/edgar/data/5272/000095012308014821/y72212e10vq.htm Review footnote 9 on Federal Income Taxes. As explained in the first paragraph of this note, how does the company determine its estimated income tax rate? What accounting standard requires this treatment? 2. (Introductory) When did AIG receive an IRS notice regarding the matter described in this article? 3. (Introductory) Summarize the international transactions undertaken by AIG, and other entities, which the IRS calls "abusive". 4. (Advanced) The $329 million in back taxes and penalties discussed in the article, is not identified separately in footnote 9. How did the author of this article learn of this specific amount? Where has it been recorded in the financial statements, according to the description in the article? 5. (Advanced) As noted in the article, AIG said in a securities filing that it expects the IRS to challenge transactions similar to those described in answer to question 4 above for years after 1997-1999 for which the IRS has already made notice to AIG. What accounting standard requires a disclosure of this type? Where in the footnotes to AIG's quarterly filing is this information found? 6. (Advanced) Also noted in the article is the fact that AIG has settled a leasing dispute. When, and for how much, will the impact of this settlement show in the AIG financial statements? Why was this settlement not reflected in the 10-Q filing examined above? Why do you think that AIG disclosed specific amounts related to this settlement but did not disclose amounts related to the international transactions discussed in answer to question 4 above?   Reviewed By: Judy Beckman, University of Rhode Island

"AIG's Tax Dispute With U.S. Has Twist of Irony In Battle Dating Before Big Bailout, Company Seeks IRS Refund for $329 Million in Back Payments, Penalties

American International Group Inc. is in a battle with the Internal Revenue Service over $329 million in back taxes and penalties in part stemming from the company's use of a type of transaction the IRS has called "abusive," securities filings show.

The tax dispute puts AIG -- recipient of a $150 billion federal bailout -- in the peculiar position of effectively using government funding to fight the U.S. government.

The clash dates from before the bailout: The company disclosed in a securities filing this week that it filed a "claim for refund" with the IRS. The dispute was first disclosed in May.

In the past, the insurance and financial-services giant hasn't been shy about fighting for itself. AIG has long been known for its lobbying clout. But after it got the federal rescue money, it came under fire for lobbying state mortgage regulators. AIG then pledged to stop all lobbying.

The company says the IRS is asserting $329 million in back taxes and penalties, a portion of which related to "the disallowance of foreign tax credits associated with cross-border financing transactions." The company has paid a portion of the money sought by the IRS and is seeking a refund. Any cash recouped by AIG from the government would likely add to its value if it is eventually sold.

Transactions like the ones used by AIG, long popular on Wall Street, take many forms. But in their simplest version they allow companies with overseas subsidiaries to pay foreign taxes, receive a U.S. credit for paying those taxes and then effectively split the credit with foreign lenders who in turn lower their interest costs.

The IRS concern: Such transactions mean the U.S. is effectively subsidizing the lending of foreign banks through the tax break that gets shared by the U.S. company and the foreign bank.

These maneuvers were the subject of congressional testimony by former IRS commissioner Mark Everson in 2006, who called them "abusive." He didn't specifically name AIG's role in such deals, but asserted that they "often result in the duplication of tax benefits through the use of certain structures designed to exploit inconsistencies between U.S. and foreign laws."

Proposed regulations issued by the IRS last year have effectively shut down new versions of the deals, say people who worked on such transactions.

Since AIG first disclosed its dispute with the IRS over these deals last spring, the government has lent nearly $123 billion to the company in exchange for a 79.9% stake in the company. On Sunday, the government agreed to scrap its original loans and replace them with a new, $150 billion aid package for AIG.

Nevertheless, the company is still pursuing the claim against the IRS, according to AIG spokesman Joe Norton.

"AIG's global tax organization will continue to maximize value for our shareholders, whoever they are, while fully complying with all applicable tax rules and requirements around the world," he said. "We're going to pursue the claim."

The tax dispute between the IRS and AIG covers 1997 to 1999, but AIG said in a securities filing that it expects the IRS to challenge similar transactions from later years. It didn't indicate the potential size of those additional disputes.

Separately, AIG said it had settled a tax dispute related to so-called "lease-in lease-out" tax shelters and anticipated recording an after-tax charge of between $34 million and $100 million in the fourth quarter of this year.

Were AIG losses hidden early on by creative accounting? PwC is the external auditor of AIG "A Question for A.I.G.: Where Did the Cash Go?" by Mary Williams Walsh, The New York Times, October 29, 2008 --- http://www.nytimes.com/2008/10/30/business/30aig.html?dlbk The American International Group is rapidly running through $123 billion in emergency lending provided by the Federal Reserve, raising questions about how a company claiming to be solvent in September could have developed such a big hole by October. Some analysts say at least part of the shortfall must have been there all along, hidden by irregular accounting. “You don’t just suddenly lose $120 billion overnight,” said Donn Vickrey of Gradient Analytics, an independent securities research firm in Scottsdale, Ariz. Mr. Vickrey says he believes A.I.G. must have already accumulated tens of billions of dollars worth of losses by mid-September, when it came close to collapse and received an $85 billion emergency line of credit by the Fed. That loan was later supplemented by a $38 billion lending facility. But losses on that scale do not show up in the company’s financial filings. Instead, A.I.G. replenished its capital by issuing $20 billion in stock and debt in May and reassured investors that it had an ample cushion. It also said that it was making its accounting more precise. Mr. Vickrey and other analysts are examining the company’s disclosures for clues that the cushion was threadbare and that company officials knew they had major losses months before the bailout. Tantalizing support for this argument comes from what appears to have been a behind-the-scenes clash at the company over how to value some of its derivatives contracts. An accountant brought in by the company because of an earlier scandal was pushed to the sidelines on this issue, and the company’s outside auditor, PricewaterhouseCoopers, warned of a material weakness months before the government bailout. The internal auditor resigned and is now in seclusion, according to a former colleague. His account, from a prepared text, was read by Representative Henry A. Waxman, Democrat of California and chairman of the House Committee on Oversight and Government Reform, in a hearing this month. These accounting questions are of interest not only because taxpayers are footing the bill at A.I.G. but also because the post-mortems may point to a fundamental flaw in the Fed bailout: the money is buoying an insurer — and its trading partners — whose cash needs could easily exceed the existing government backstop if the housing sector continues to deteriorate. Edward M. Liddy, the insurance executive brought in by the government to restructure A.I.G., has already said that although he does not want to seek more money from the Fed, he may have to do so. Continuing Risk Fear that the losses are bigger and that more surprises are in store is one of the factors beneath the turmoil in the credit markets, market participants say. “When investors don’t have full and honest information, they tend to sell everything, both the good and bad assets,” said Janet Tavakoli, president of Tavakoli Structured Finance, a consulting firm in Chicago. “It’s really bad for the markets. Things don’t heal until you take care of that.” A.I.G. has declined to provide a detailed account of how it has used the Fed’s money. The company said it could not provide more information ahead of its quarterly report, expected next week, the first under new management. The Fed releases a weekly figure, most recently showing that $90 billion of the $123 billion available has been drawn down. A.I.G. has outlined only broad categories: some is being used to shore up its securities-lending program, some to make good on its guaranteed investment contracts, some to pay for day-to-day operations and — of perhaps greatest interest to watchdogs — tens of billions of dollars to post collateral with other financial institutions, as required by A.I.G.’s many derivatives contracts. No information has been supplied yet about who these counterparties are, how much collateral they have received or what additional tripwires may require even more collateral if the housing market continues to slide. Ms. Tavakoli said she thought that instead of pouring in more and more money, the Fed should bring A.I.G. together with all its derivatives counterparties and put a moratorium on the collateral calls. “We did that with ACA,” she said, referring to ACA Capital Holdings, a bond insurance company that was restructured in 2007. Of the two big Fed loans, the smaller one, the $38 billion supplementary lending facility, was extended solely to prevent further losses in the securities-lending business. So far, $18 billion has been drawn down for that purpose. Continued in Article From Jim Mahar's blog on October 31, 2008 --- http://financeprofessorblog.blogspot.com/ First and foremost it gets to a serious question. Were the initial infusions (into AIG) by the government just a stop gap measure and will even more be needed. (The idea of throwing good money after bad comes to mind). Secondly in class yesterday we talked about information asymmetries and how accounting can only partially lessen the problem and that firms can have billions of dollars of losses that investors may not be aware of even after reading the financial statements. And finally a student in class is doing a paper on this and what the executives must have known (or at least should have known) before hand. Bob Jensen's threads on where the bailout money paid to AIG went are at http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout Hint:  Think credit derivatives not backed with capital reserves If AIG executives knew about these problems early on, what did the auditor not insist on disclosing? Sounds like a massive class action lawsuit here for AIG shareholders who lost their investments.

You can read more about accounting scandals in the sorry history of AIG at http://www.trinity.edu/rjensen/FraudRotten.htm#MutualFunds

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Accounting for Adjustable Mortgage Rate (ARM) Options

November 20, 2008 message from Amy Dunbar [Amy.Dunbar@BUSINESS.UCONN.EDU]

Can someone give me a reference for the “existing GAAP” rules referred to below?

From http://www.revenuerecognition.com/industry/banking/ 

Phantom Revenues

Some commercial banks have created a mortgage for homeowners and investors that has raised concerns in the banking industry and the investment community. It is the option adjustable rate mortgage or “ARM.” In an option ARM, the mortgagor has four monthly payment options; for example:

· minimum payment, which doesn’t cover interest changes (resulting in the principal growing each period and creating negative amortization);

· interest only, with no interest added to the principal balance;

· regular (interest plus principal) payments on a fully amortizable 30-year loan; and

· regular (interest plus principal) payments on a fully amortizable 15-year loan.

Because the option ARM is attractive to cash-strapped home buyers and investment-return buyers, most mortgagors chose the minimum payment option. Under that option, the interest rate (which is growing each month) adjusts the loan balance. At some point, the loan principal is reset and a new amortizable balance is set over the 30-year term, resulting in a revised mandatory repayment amount that can readily be three or four times the original monthly payment.

Of concern to bank regulators and those investing in commercial bank stocks is the treatment of such loans by the mortgagees. Under existing GAAP, the mortgagee may book revenue on the option ARM at the fully amortized amount, despite the fact that the mortgagor is only paying the minimum amount (the negative amortization case). This booking of “phantom” future revenues is the disturbing result of option ARMs.

EXAMPLE

Mr. and Mrs. Smith enter into a $500,000 mortgage on a $550,000 Florida condominium. It is an option ARM and permits the Smiths, as mortgagors, to pay a minimum monthly amount of approximately $1,600. This does not result in the payment of any principal or the full amount of monthly interest on the 30-year term loan.

The fully amortizable monthly payment for the mortgagors is closer to $4,600, or about an additional $3,000 per month. The Florida bank books the interest portion of the $3,000 that it doesn’t receive as deferred interest revenue (many would say “phantom” revenue). At some point in the negative amortization process, the loan balance resets and the mortgagors must pay the new monthly amount of $4,600. However, in the Smiths’ case, the loan is “upside-down”; that is, the value of the investment condominium (because of a rapidly changing real estate market) is less than $500,000, so foreclosure is their only option.

If the commercial bank has a significant portion of its loan portfolio in such option ARMs, with a rising money market interest rate and declining real estate values, it is a prescription for trading losses. Such affected banks will follow GAAP and book the phantom revenues, increase earnings, and then move the non-performing option ARM mortgages to the held-for-sale marketable classification and, eventually, to collection agencies.

Amy Dunbar
Department of Accounting #431
School of Business
University of Connecticut
2100 Hillside Road, Unit 1041 Storrs, CT 06269-104
land line: 860-742-0672 cell: 860-208-2737

November 20, 2008 reply from Bob Jensen

Hi Amy,

One place to look if FAS 91 --- http://www.revenuerecognition.com/industry/banking/

Sale of convertible, adjustable-rate mortgages with contingent repayment agreements are discussed in EITF 08-1. Also see EITF 98-5, Accounting for Convertible Securities with Beneficial Conversion Features or Contingently Adjustable Conversion Ratios, and EITF 00-27, Application of Issue No. 98-5 to Certain Convertible Instruments, for consideration of any beneficial conversion feature.

 Here are some SEC Rules --- http://www.sec.gov/divisions/corpfin/cfacctdisclosureissues.pdf  

One such product is an option adjustable-rate mortgage (option ARM), which is being sold to home buyers who desire smaller monthly mortgage payments. This mortgage product gives borrowers the option to make monthly payments that are less than the interest actually owed on the loan. The result is that the deferred interest is added to the principal amount of the mortgage loan creating a rising loan balance, often referred to as a negative amortization loan. If the loan balance grows to the extent that the loan-to-value ratio exceeds an established threshold, the lender may restructure the loan, requiring the borrower to immediately begin making larger payments

The types of residential mortgage loans held and the underwriting standards used to originate these loans are important to an understanding of a registrant’s financial condition and results of operations. While the information required by Industry Guide 3 includes basic categorical statistics about a registrant’s loan portfolio, more detailed information about certain loan products may be needed in order to provide a complete picture of the portfolio’s credit risk. Some disclosure examples follow for use in Description of Business or MD&A, as appropriate.

Provide disaggregated information about residential mortgage loans with features that may result in higher credit risk

• Describe the significant terms of each type of residential mortgage loan product offered, including underwriting standards used for each product, maximum loan-to-value ratios and how credit management monitors and analyzes key features, such as loan-to-value ratios and negative amortization, and changes from period to period.

• Disclose the approximate amount (or percentage) of loans originated during the period and loans as of the end of the reporting period that relate to each type of residential mortgage loan product.

 

• Disclose the approximate amount (or percentage) of off-balance sheet loans with retained credit risk which relate to each type of residential mortgage loan product.

 

• Disclose the amount of loans that experienced negative amortization during the period and the amount of increase in the loan balance during the period that resulted from negative amortization.

 

• Describe your policy for placing loans on non-accrual status when the loan’s terms allow for a minimum monthly payment less than interest accrued on the loan, and the impact of this policy on the nonperforming loan statistics disclosed.

 

• Disclose the approximate amount (or percentage) of residential mortgage loans as of the end of the reporting period with loan-to-value ratios above 100%.

• Disclose any geographic concentrations that exist as of period end in your portfolio of residential mortgage loans with high loan-to-value ratios.

Describe risk mitigation activities used to reduce exposure to credit risk related to residential mortgage loans

 

• Describe risk mitigation transactions used to reduce credit risk exposure, such as insurance arrangements, credit default agreements or credit derivatives.

• Explain any limitations of your credit risk mitigation strategies.

• Disclose the impact that credit risk mitigation transactions have had on your financial statements.

 

Disclose trends related to residential mortgage loans with features that may result in higher credit risk that are reasonably likely to have a material favorable or unfavorable impact on net interest income after the provision for loan loss

• Disclose any changes in the percentage of borrowers who have chosen a minimum payment option during the period instead of choosing a payment option that includes full payment of interest expense or payment of interest and principal.

• Describe any significant weakening in local housing markets in which you have a concentration of residential mortgage loans with high loan-to-value ratios.

• Disclose changes in credit losses and interest income recognized for higher risk loans.

As far as I can tell the IASB has not yet taken option ARMs up in the loose international standards on revenue recognition. Under IAS 18 – Revenue, sales with a buyback commitment cannot always be recognized as revenue because the significant risks and rewards of ownership of the goods are not necessarily transferred to the buyer. This, however, is principles-based without bright line rules.

Bob Jensen

Bob Jensen's threads on revenue realization are at http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

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Auditors in Ancient Egypt

Below is a portion of a message received from Blan McBride. Blan loves ancient accounting history.

Blan speculates about auditors in Egypt. It reminds me of an audit engagement I had in my early experience at E&E in Denver. For days on end I had to sit on a pile of boxed-up Gold Bond Stamp books after they had been turned into Gold Bond dealers for merchandise. My job was to verify that each box was destroyed as the stamp boxes were rather slowly fed into chemical (dissolving) tank at a factory that turned paper mush into cardboard boxes.

The redeemed stamps, being hole punched, were only of value to Gold Bond dealers since dealers were the only ones that could turn in punched stamps into the Gold Bond company for credit. But Gold Bond worried that unscrupulous dealers might work out an arrangement with the paper box company for recycling of the unintended variety.

My E&E friend Dennis and I sat very bored watching gold bond stamp books dissolved much like Blan’s Egyptian auditors must’ve been bored watching grain pour into domed warehouses. In fact Dennis and I became so bored that we started opening boxes and counting the books. We discovered than many of the boxes only had 29 books and not the required 30 books. We informed the Gold Bond company that, in turn, commenced an investigation. Sure enough several dealers were subsequently arrested.

Gold Bond had an internal control before shipping the boxes off to the paper box factory. Each box was weighed. But it turns out that the scales could not accurately detect a shortage of one redemption book which is where some unscrupulous dealers were taking advantage of a weakness in the internal control system.

I wonder how Egyptian auditors measured a cart load of grain? Certainly the piles are not perfect cones or pyramids in shape such that volume can be neatly measured by formula.

Bob Jensen

 

 November 16, 2008 message from Blan McBride [blan@comcast.net]

Good Morning, Bob,

We had a cold front pass through here last night and with the temperature down in the low 60’s, I decided to work inside this morning.  The sun’s out now and I think it’ll be warm enough to work in the shop this afternoon.  Meanwhile –

With my brain temporarily unfrozen and upon reading your daily missive, thoughts of accounting history surfaced.  (I should probably seek treatment for that condition.)  I once wrote a paper concerning the larger changes in auditing practice in the USA and how they usually follow large, well-publicized situations in which large auditing firms have had ethical problems exposed. Part of the paper related how auditors consistently attempt to separate “ethics” from the “mechanics” of their practice, also known as “It’s not my fault. I carefully followed the letter of the law”.  Price Waterhouse brought in seven other large auditing firms to testify that “We don’t observe the taking of inventory.  It’s dirty out there in the factory.”  Remember how that didn’t work?

I only dealt with the relatively short period (about four decades) between Mckesson/Robbins and National Student Marketing.  It now occurs to me that the more recent debacles concerning Enron and AA and the present unpleasantness related to valuation of mortgages (and other instruments of debt) both doubles the period and adds reinforcement to my original conclusion.  One might also conclude that the penalties laid on auditors for either ignorance, laziness, lack of ethics and combinations thereof are becoming more severe.

Now, having laid the groundwork, I attempt to make an assignment.  Obviously, (most accounting educators today) would have nothing to do with such a subject.  It deals with an increasingly lengthy period of time, whereas their interest was in increasingly shorter periods. I’m so out of touch that you and Gary Previts are the only living accounting historians I know.  I’m in awe of your output on the net and the old rule was to get something done, give it to a busy man.  Please – add your brainpower to this and run with it.

As payment, I offer the following historical question :  What proof do we have that auditors were in use in ancient Egypt?

Answer: On a wall of a burial chamber in Egypt dated around 2,000 BCE, there is a picture of a grain warehouse.  These were dome shaped with a hole for filling at the top.  When full, that hole was sealed.  When it was necessary to remove grain, a hole was made at ground level.  This was the type probably used in the Biblical story of Joseph.  The picture on the interior wall of the tomb shows a person sitting at a table at ground level and another sitting beside the hole in the top. The picture depicts each as writing as the grain is delivered.  I expect that these guys are not permitted to talk to one another.  Presumably, the records are checked by a third party to see if they match.  Hey, anyone with enough smarts to design and build a pyramid is not going to get shortchanged by a farmer if he can help it.

Remember to keep your feet dry and wear your hat outdoors. (envisioning Bob Jensen in deep snow)

Blan

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A Distance Learning Course on Introductory Accounting from the Harvard Business School --- Click Here
This course dates back to 2005 and I'm not certain how often it is updated.
It appears that students cannot get credit from Harvard for taking this course, although other colleges could give credit for taking the course.
It features narrated animations. Fees for this course can be found by phoning

A Preview is available at
http://harvardbusinessonline.hbsp.harvard.edu/b01/en/common/viewFileNavBean.jhtml?_requestid=21163
The course features narrated animations and assessment materials.

Financial Accounting: An Introductory Online Course

Publication Date: Nov 4, 2005 Availability: Available Author(s):  David F. Hawkins, Paul M. Healy, Michael Sartor     Type: Online Courses Product Number: 105708 Language: English Source: HBS Length: Information Not Available

To preview (Authorized Faculty) or purchase this online course, call (800) 545-7685 (outside the U.S. and Canada, 617-783-7600).
A Teaching Note is available for Authorized Faculty. Online course product #105708

Bob Jensen's threads on online training and education alternatives available worldwide are at http://www.trinity.edu/rjensen/crossborder.htm

 

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Nine Years is Surprisingly Steep for Accounting Fraud:  This is almost as bad as for stealing beer at a convenience store

"Tech billionaire gets 9 years in prison for fraud," MIT's Technology Review, November 14, 2008 ---
http://www.technologyreview.com/wire/21680/?nlid=1513&a=f

A one time dot-com billionaire from Las Vegas has been sentenced to nine years in prison for defrauding investors in his software company in 2001.

Prosecutors had sought a much longer sentence for Charles "Junior" Johnson, founder and CEO of the now-defunct PurchasePro.

Johnson was the ringleader of a scheme to falsely inflate PurchasePro's revenue in the first three months of 2001, as the high-tech economy was in freefall.

Seven people were convicted in the long-running investigation, which also exposed improper accounting practices at America Online, which had been PurchasePro's business partner.

Bob Jensen's rants about how white collar crime pays even if you get caught are at http://www.trinity.edu/rjensen/FraudConclusion.htm#CrimePays

Bob Jensen's fraud updates are at http://www.trinity.edu/rjensen/FraudUpdates.htm

---

Yet another reason for joining the American Accounting Association as it tries to bring state-of-the-art services to its members --- http://aaahq.org/index.cfm

 Greetings to All,

The American Accounting Association is proud to announce the AAA Digital Library, our NEW electronic journal platform website hosted by Scitation and the American Institute of Physics (AIP). You will receive an email from the Scitation Help Desk at AIP soon, with instructions on how to activate your account. You will have access to all of the AAA journals you subscribe to.

You will need to complete a brief, one-time, registration process the first time you access the new platform. If you have trouble getting access to the site, the email you receive from the Scitation Help Desk will contain information about contacting the Help Desk at Scitation.

The Digital Library has been designed to coordinate with AAACommons and we are very excited about the new features we are able to offer including article-by-article publishing; new tools and links on the abstract pages; downloadable citations; and much more.

When you receive the email from the Scitation Help Desk at AIP, please take a few minutes to register, explore the site, and gain electronic access to your AAA journals. Please send feedback and suggestions to Diane Hazard, Publications Project Director, at diane@aaahq.org.

Sincerely,

Beverly J. Harrelson
Director, Communications
American Accounting Association
Phone: 941.556.4109
Fax: 941.923.4093
AAA website: http://aaahq.org
Email: beverly@aaahq.org

 

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November 11, 2008 message from Jagdish Gangolly [gangolly@CSC.ALBANY.EDU]

You may like to read --- http://www.journalofaccountancy.com/Issues/1998/May/inaicpa.htm

Institute Receives Papers From First CPA MAY 1998

First CPA Comes Home

On February 23, 1893, New York City accountant Frank Broaker sued one of his clients. Broaker had charged the company $3 an hour to straighten out its books; the company thought the work was worth only $1 an hour. Two other accountants testified on Broaker's behalf, and, although the defendants argued this was a case of price fixing, the jury quickly found for Broaker.

Nevertheless, Broaker believed such problems would continue until the state formally recognized accountants as professionals. He proved to be a shrewd political operative and, by 1896, had circumvented opposition to a licensing bill for CPAs in the New York state senate.

The so-called Wray bill, which Broaker helped draft, made New York the first state to create CPAs. Broaker received CPA certificate no. 1 and served both on the nations first state board of examiners and as president of the American Association of Public Accountants, a predecessor to the AICPA.

On February 19, 1998, Broaker had a homecoming of sorts. His granddaughter, Marjorie Ferrigno, presented to the Institute his CPA certificate and the document appointing him to the New York state board.

November 13, 2008 reply from

Broaker was not actually the first CPA - he only received the first certificate. The first CPAs were grandfathered in and the certificates presented in alphabetical order. The manual below actually got him kicked off the board due to a perceived conflict of interest. Broaker was a person in charge of the exam and yet he published a CPA review book. Broaker unsuccessful fought his departure.

The manual --- Click Here

Jim McKinney, Ph.D., C.P.A.
Tyser Teaching Fellow Accounting and Information Assurance
Robert H. Smith School of Business
4333G Van Munching Hall
University of Maryland College Park, MD 20742-1815
 http://www.rhsmith.umd.edu 

Jensen Comment
Since the CPI was 9.9 in 1913 and 207.3 in 2008 thus far, we can only speculate what Broaker was charging in today's dollars. It appears, however, that in 1893 Broaker was probably charging over $75 per hour in 2008 dollars. This is certainly cheap by Big Four standards today, but the Big Four no longer handles many of these small clients seeking bookkeeping services. Billings by small accounting firms vary greatly, but my guess is that bookkeeping consulting could probably be obtained for less than $75 per hour today. Of course we don't know all that was entailed in the term "straighten out the books" in 1893. Were there even adding machines in 1893?

In 1960 dollars, Broaker was charging slightly over $21 per hour. Years ago, while I was an undergraduate student, I worked for part-time for Ernst & Ernst in Denver. A tax job was passed down to me for a restaurant client that only had shoe boxes full of expenditure receipts and cash register tapes for an entire year. I've no idea what my time was being billed out for on this job by E&E, but I think I was making $5 per hour in 1960. I was very fast on a ten-key adding machine, but I could never be as fast as David Fordham who now types something like 160 wpm with relatively few errors.

There was no Excel, no computers, and obviously no tax software in 1960. That goes back when men were men, and women were not CPAs --- at least not many women were CPAs in the United States. We kept one woman hidden in the back room at E&E to review our tax returns when we got them worked up. She reviewed our work because she was smarter than any of us even though she had no CPA license.

October 12, 2008 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

Bob,

I note that you were making "about $5 per hour" with E&E in Denver in 1960. I started working part-time with E&E in Los Angeles in the fall of 1960 and then full time in June 1961. My starting salary (no extra amount for overtime) was $525 a month. Based on 160 hours a month (we actually worked more, especially in the busy season) that works out to a whopping $3.28 an hour. So your pay of $5 an hour means that you were making about 50% more than me - an entirely justifiable premium for your ten-key adding machine and other skills.

Denny

October 12, 2008 reply from Bob Jensen

But you, Denny, went on to become a highly-paid executive partner in E&E.

I later worked full time for a very short while for E&E and then went on to Stanford for a PhD before entering the academy (at Michigan State) in 1966 for a whopping $11,000 per year (not including summer pay) which at the time I considered quite generous. Of course, I bought three acres with a lovely home and carriage house on the edge of the MSU campus for $30,000.

This just proves that you started at E&E for less and rose very fast. I started for E&E for more and went straight downhill in terms of pay.

Bob Jensen

October 12, 2008 reply from David Fordham, James Madison University [fordhadr@JMU.EDU]

I remember at Jones Business College in the early 1970's, the business curriculum required that all students take a 1-credit course titled, "Business Technology". It covered touch-typing, the 10-key (both of which required a speed test proficiency exam), and a machine called a "Telex". The Telex used a punched paper tape that you prepared before making a connection, to save transmission time.

I was intrigued by the Telex technology, which could multiplex several connections over a single telephone line. It used pulse circuit switching, with six-digit "phone" numbers. We actually used the Telex daily to communicate with customers, vendors, the railroads, and our other company facilities at the paper company. I vividly remember the conversion from 45 baud to 110 baud, and later the conversion from the original F1F2 punched paper tape to the TWX Bell 101 system.

In the mid-1980's I was development manager of a computer project whose scope include the replacement of the TWX system with something called "X.12 EDI", using the completely-electronic Bell 103 modems! Computer to computer communications, who'da thunk it? The Seaboard Coast Line Railroad was the only company that could provide us training on implementing the X.12 data exchange... no one else knew anything about it, including the Phone Company. (Back then, there was only 1 phone company, so everyone just referred to it as "The Phone Company", or Ma Bell. Thank Harold Green for the mess we have today...)

Today, old TWX equipment is easily adapted to higher-baud radio applications by amateur radio operators. In fact, through the use of sound card D/A A/D converters, this ancient Baudot transmission mode is still being played with by hobbyists, albeit supplemented with the more modern modes (for which it serves as their direct ancestral basis) such as PACTOR, G-TOR, CLOVER, AX.25 Packet, and my favorite, PSK31.

Most people don't know it, but these digital radio modes and their Enq-Ack CSMA-CD protocols were the inspiration behind the name of Metcalf and Bogg's "Ethernet". In the U.S., a radio transmitter is said to be "on the air". Brits are smarter and know that air does not carry radiowaves. They believe that radiowaves are carried by something invisible called "the Ether". Since these digital modes pioneered the CSMA-CD techniques, Metcalf borrowed the protocol design and CSMA-CD ideas, and named the resulting wired network (which back then used a wire bus topology similar to a single radio channel) the "ETHER-net".

BTW, thanks for the compliments Bob, but my speed used to be 180wpm *before* subtraction of mistakes, and with the subtraction came in around 160. This was years ago, however. I took a speed test in our CIT lab a couple months ago, and apparently since turning 50 a few years ago, I'm losing my touch, literally. My unadjusted speed was only 171, and adjusted for errors it dropped all the way down to 114. I wish I could blame it on their keyboard which felt different than mine, but that probably wouldn't be completely truthful. I tell you, it's terrible what aging does to you. I still go fast, but I have to rely on the spell-checker and backspace keys. Watt a grate inn vent shone they R.

David Fordham

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"Users Grade Tax Software," by Stanley Zarowin, Journal of Accountancy, October 2007 --- http://www.aicpa.org/pubs/jofa/oct2007/tax_software.htm

2008 Professional Tax Software as Listed in a November 7, 2008 Accounting Web Newsletter

Featured Tax Software ProSystem fx TaxWise ATX Lacerte UltraTax CS Great Tax Drake ProSeries GoSystem ES IntelliTax

2008 Update from WebCPA --- http://www.webcpa.com/article.cfm?articleid=29425

From the Journal of Accountancy Smart Stops on the Web in 2008

A TAX TOOLBOX
www.irs.gov/taxpros/article/0,,id=118004,00.html
This Smart Stop from the IRS provides a host of basic tools for tax professionals, handily compiled onto one page for easy access. The information ranges from recent tax law changes to standards of practice and Circular 230 information to the contact info for the Taxpayer Advocacy Panel (see “The Taxpayer Advocacy Panel: An Opportunity to Collaborate With the IRS,” JofA, Sept. 08, page 68). The page contains a host of publications on representing clients before the IRS, as well as requesting client transcripts and copies of their tax returns. Also look under “IRS Collection Tools and Your Clients Rights” for rules on representation and disclosure and Offer in Compromise guidelines.

HOMEBUYERS TAKE NOTE
www.federalhousingtaxcredit.com
Visit this new site from the National Association of Home Builders for an overview of the Housing and Economic Recovery Act of 2008, which authorizes a tax credit for qualified first-time buyers purchasing homes before July 1, 2009. The “Frequently Asked Questions” page answers both general and technical questions regarding the credit, or click on “The Law’s Other Provisions” to go beyond the act’s tax credit provisions and learn about its implications for property taxes, mortgage revenue bonds and Federal Housing Administration modernization. If you’re still looking for information, the “Home Buyer Resources” page hosts a list of links to helpful government Web sites, including state and local homebuyer assistance programs.

From Smart Stops on the Web, Journal of Accountancy, October 2007 --- http://www.aicpa.org/pubs/jofa/oct2007/smart_stops.htm

TAX

BIG RESOURCES FOR SMALL BUSINESSES www.irs.gov/businesses/small Whether you own a small business or work for one, this IRS site sorts out tax-related information so you don’t have to. There’s an A–Z index that lets you search by business type or by subject. It lists the necessary forms for each and links to information on starting up, closing down and everything in between. You also can sign up for the “e-News for Small Businesses” electronic newsletter or download complimentary tax products, including tax calendars and videos. And, of course, there’s plenty of guidance on e-filing and forms for both small businesses with employees and the self-employed. CONSTRUCTIVE CRITICISM www.improveirs.org Got a beef with the IRS? The Taxpayer Advisory Panel, a federal advisory committee established under the authority of the Treasury Department, is a group of volunteers working to improve the Service. Its Web site features a comment box and phone number where citizens can make suggestions. You can also view taxpayer suggestions that have become proposals, which range from the general (improving the quality of customer service), to the picky (adding lines to forms) to the technical (expanding the third-party authorization On The Web time frame). Want to join the panel? There’s information on becoming a member in the FAQ section. KNOW THE LAW http://tax.cchgroup.com/legislation Turn to this site for coverage of new tax legislation and analysis of its impact on taxpayers and tax professionals, plus comments on proposed tax law reform. Click on the “Full CCH Coverage Here” links for access to “Tax Briefing” PDFs, which include in-depth analyses of the legislations’ tax credits, deductions and effective dates. The site also offers “Quick Tax Facts” PDFs for several pieces of legislation, including the Small Business and Work Opportunity Act of 2007; Tax Relief and Health Care Act of 2006; and the Pension Protection Act of 2006.

 

Bob Jensen's tax helpers are at http://www.trinity.edu/rjensen/Bookbob1.htm#010304Taxation

Bob Jensen's accounting software helpers are at http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

Virtual Learning for Accounting Students

Second Life (Membership is Free) --- http://secondlife.com/
Also see --- http://en.wikipedia.org/wiki/Second_Life
A Second Life Blog --- http://blog.secondlife.com/

Videos --- Click Here

"Accounting for Second Life," by Richard A. Johnson and Joyce M. Middleton, Journal of Accountancy, June 2008 --- http://www.journalofaccountancy.com/Issues/2008/Jun/AccountingforSecondLife 

EXECUTIVE SUMMARY Second Life is a virtual world with education, public relations, and economic implications. CPA Island is the center of the public accounting profession in Second Life. At a minimum, CPA Island presents a creative communication medium to appeal to a new generation. This generation has grown up with high-speed Internet connectivity, instant messaging, and multiplayer online gaming. The spirit behind CPA Island goes beyond clearly demonstrating an awareness of the different skill set of this new generation. It embraces and celebrates these skills as important to the future of the accounting profession. The economic implications of Second Life are just now unfolding. Suspend disbelief, log on, and experience CPA Island and the other aspects of Second Life for yourself. Richard A. Johnson, CPA, Ph.D., and Joyce M. Middleton, CPA, Ph.D., are professors of accounting at Frostburg State University’s College of Business. Their e-mail addresses, respectively, are rjohnson@frostburg.edu and jmiddleton@frostburg.edu . Thanks to the pioneering efforts

Instructors can create their own Second Life virtual learning worlds.
Another great pioneer expert in Second Life is Steven Hornik at the University of Central Florida.

Bob Jensen's threads on virtual learning and Second Life are at http://www.trinity.edu/rjensen/000aaa/thetools.htm#SecondLife

The Bea Sanders/AICPA Innovation in Teaching Award  --- Click Here  http://ceae.aicpa.org/Resources/Scholarships+and+Awards/The+Bea+Sanders+AICPA+Innovation+in+Teaching+Award.htm

American Accounting Association Awards --- http://aaahq.org/awards/InventoryofAwards08.pdf

Introducing the New journalofaccountancy.com  (free) --- http://www.journalofaccountancy.com/Issues/2008/Nov/NovSmartStops.htm

Peter, Paul, and Barney: An Essay on 2008 U.S. Government Bailouts of Private Companies ---
http://www.trinity.edu/rjensen/2008Bailout.htm

 The Technology Industry in a Troubled Economy, 50 Slides from Mary Meeker, as served up by The Washington Post, November 6, 2008 --- Click Here
These would be greatly improved if they were also narrated. But the graphs and tables are useful.

From The Wall Street Journal Accounting Weekly Review on November 14, 2008

"AutoNation's Big Loss Traces Back to Detroit," by Neal E. Boudette and Sharon Terlep, The Wall Street Journal, November 7, 2008 --- http://online.wsj.com/article/SB122598503324005039.html?mod=djem_jiewr_AC

AutoNation Inc., the country's largest car-dealership chain, reported a $1.4 billion loss in the third quarter and left little doubt it sees Detroit as its problem.

It also suggested that in the future it's likely to put more resources into stores selling foreign-made cars at the expense of those carrying Big Three vehicles.

The loss, AutoNation's first quarterly setback since 1999, was the result of a noncash charge of $1.46 billion to cover a sharp decline in the value of dealerships selling vehicles made by General Motors Corp., Ford Motor Co. and Chrysler LLC. Without the charge, the auto retailer would have earned $44 million.

This is the first time AutoNation has broken out earnings generated by its Big Three, import-brand and luxury-car dealerships, and they showed what a drag GM, Ford and Chrysler were on its business.

In a telephone interview, Chairman and Chief Executive Michael J. Jackson said the earnings breakdown reveals "where the greatest weakness is and where the greatest strength is" in AutoNation's operations.

He also said the breakdown will drive future decision-making and could result in allocating more capital to the franchises of import manufacturers like Toyota Motor Corp. and Honda Motor Co. and luxury nameplates like Mercedes-Benz and BMW AG.

"There has to be a justifiable return on capital, and we are on a very different track with the domestic manufacturers than we are with the imports or premium-luxury" brands, he said.

Big Three franchises account for almost half of AutoNation's 238 stores but generated just $23 million in pretax profit, only a fifth of the total and a decline of 57% from a year earlier. Import stores, which mainly include Toyota and Honda vehicles, produced pretax profit of $53 million, down 19%. Pretax profit from luxury franchises, which include Mercedes-Benz, BMW and Lexus, was $43 million, down 24%.

AutoNation's loss was a reversal from its $72 million profit a year ago. It amounted to a per-share loss of $7.95, compared with a profit of 39 cents a share the year before. Revenue declined to $3.5 billion from $4.5 billion.

Michael Maroone, AutoNation's chief operating officer, said the company is likely to join other large dealership chains in selling some of its Detroit-brand dealerships in the next few years. "As the industry moves forward, the auto retail landscape will include fewer domestic stores," he said.

The large write-down means the company has very little value tied up in its Big Three stores. Most are located on real estate that AutoNation owns and could sell if it decided to close the stores, Mr. Jackson said.

U.S. auto sales have been falling since the spring because of high gasoline prices and the sluggish economy. But the decline worsened in September and October as credit dried up for both consumers and dealers.

In October, new-car sales fell 30% to a 25-year low, with the Big Three suffering the most. GM's sales fell 45%. Together the Detroit auto makers had 47% of the market, down from 51% a year ago.

Bob Jensen's threads on Goodwill Impairment Issues are at http://www.trinity.edu/rjensen/Theory01.htm#Impairment

We should not blame fair value accounting for the 2008 bank failures when, in point of fact, there were conflicts of interest among rating agencies that would've led to investment failures under any accounting system that did not disclose the conflicts of interest in the rating agencies themselves.

From the Financial Clippings Blog on October 22, 2008 --- http://financeclippings.blogspot.com/

I wrote earlier that credit rating agencies seem to be run like protection rackets..

from CNBC

In a hearing today before the House Oversight Committee, the credit rating agencies are being portrayed as profit-hungry institutions that would give any deal their blessing for the right price.

Case in point: this instant message exchange between two unidentified Standard & Poor's officials about a mortgage-backed security deal on 4/5/2007:

Official #1: Btw (by the way) that deal is ridiculous.

Official #2: I know right...model def (definitely) does not capture half the risk.

Official #1: We should not be rating it.

Official #2: We rate every deal. It could be structured by cows and we would rate it.

A former executive of Moody's says conflicts of interest got in the way of rating agencies properly valuing mortgage backed securities.

Former Managing Director Jerome Fons, who worked at Moody's until August of 2007, says Moody's was focused on "maxmizing revenues," leading it to make the firm more "issuer friendly."

November 6 reply fromn Paul Polinski [paulp_is@YAHOO.COM]

Hi Bob.
I'm not sure if this has been brought to the listserv yet, but the SEC's web cast for its roundtable on FAS no. 157 (accessible at http://www.connectlive.com/events/secroundtable102908/ ) makes for interesting listening, as the different stakeholder groups, including banks, investors, accountants, and one academic (Ray Ball; o.k., two, if you count Tom Linsmeier as an FASB observer) discuss the role of mark-to-market on the financial markets.

Paul

From IAS Plus on November 1, 2008 --- http://www.iasplus.com/index.htm

1 November 2008: IASB publishes fair value guidance The IASB has published educational guidance on the application of fair value measurement when markets become inactive. The guidance consists of a summary document prepared by IASB staff and the final report of the expert advisory panel established to consider the issue: The summary document sets out the context of the expert advisory panel report and highlights important issues associated with measuring the fair value of financial instruments when markets become inactive. It takes into consideration and is consistent with recent documents issued by the US FASB and the US SEC. The report of the expert advisory panel identifies practices that experts use for measuring the fair value of financial instruments when markets become inactive and practices for fair value disclosures in such situations. The report provides useful information and educational guidance about the processes used and judgements made when measuring and disclosing fair value. Here are links to: IASB Press Release (PDF 167k) Expert Advisory Panel Report (download from IASB website, PDF 665k) IASB Staff Summary Document (download from IASB website, PDF 130k) IAS Plus Credit Crunch Page – 60 links to further information

You may also want to take a look at the following working paper:
“Some Fair Values are Fairer than Others and Few if Any are True Values,” by G. Peter Wilson, Boston College ---
http://commons.aaahq.org/files/1b268f3cc0/Some_Fair_Values_are_Fairer_than_Others.pdf

Bob Jensen's threads on credit rating industry frauds are at http://www.trinity.edu/rjensen/FraudRotten.htm#CreditRatingAgencies  

Accounting for CDOs (including journal entries) under U.S. and Foreign GAAP --- http://www.trinity.edu/rjensen/TheoryOnFirmCommitments.htm

Bob Jensen's threads on fair value accounting --- http://www.trinity.edu/rjensen/theory01.htm#FairValue

Question
How do you account for and bail out a company with over $1 trillion in assets that has ownership contracting that the best experts cannot untangle?
Did you ever think Osama Bin Laden may be in for some of these bailout billions from our taxpayers?
Corporate contracting is becoming incomprehensible!

Denny Beresford forwarded this link to me.
"The Professor’s Pop Quiz: Who Controls A.I.G.?" by Steven M. Davidoff, Dealbook.com, November 18, 2018 --- http://dealbook.blogs.nytimes.com/2008/11/18/the-professors-pop-quiz-who-controls-aig/?ei=5070&emc=eta1

The terms of the government’s investment in the American International Group were released last week. After reading these terms, I have a multiple-choice question.

Who controls A.I.G.? Is it:

1) The Federal Reserve
2) The Department of the Treasury
3) The current shareholders of A.I.G. (but not the government)
4) All of the above collectively
5) No one knows

The best answer I can discern right now is number 5. The deal has become much more complicated than it was before, but the control rights over A.I.G. appear to be as follows:

1. In exchange for its $40 billion preferred share injection under the Emergency Economic Stabilization Act, the government is getting a 10 percent dividend on these shares (plus A.I.G.’s agreement to restrictions on lobbying), the same limitations on executive compensation as in other preferred equity injections, a further limitation on annual bonus pools for senior partners not to exceed 2007 and 2006 levels, and compliance with an expense policy. As for control rights — the $40 billion preferred is nonvoting except on certain major issues affecting the preferred. If A.I.G. misses dividend payments for four consecutive quarters, the Treasury has the right under the terms of this preferred stock to elect two directors and a number of directors (rounded upward) equal to 20 percent of the total number of directors after giving effect to such election.

2. In exchange for the new $60 billion Federal Credit Facility (down from $85 billion), the Federal Reserve obtains the general rights of a creditor including senior security over A.I.G.’s unregulated subsidiaries, but no real governance rights except for some negative covenants limiting A.I.G.’s operations and expenditures.

3. Finally, the government is receiving 100,000 Series C preferred shares convertible into 77.9 percent of A.I.G.’s outstanding common stock. This second preferred stock has a vote equal to 77.9 percent of A.I.G.’s share capital and is entitled to 77.9 percent of any dividends paid by A.I.G. on its common stock.

Thus, whoever controls these Series C preferred shares controls A.I.G. These Series C shares, the stock that will vote and control A.I.G., will be owned by is a trust for the benefit of the Treasury Department. The trust is called the A.I.G. Credit Facility Trust. And who are the trustees of this trust and the controllers of A.I.G.? I have no idea nor have I seen any public disclosure on the issue except for news reports in October that these trustees would be appointed by the Fed and that there would be three of them. Moreover, under Section 5.11 of the original credit agreement, a provision that appears to be unamended in the new deal, A.I.G. “shall use all reasonable efforts to cause the composition of the board of directors of [A.I.G.] to be … satisfactory to the Trust in its sole discretion.”

So, why this oddity? I must admit, I am puzzled. Perhaps it is related to accounting or some other legal requirement? But I also suspect it may be political — the government does not want to control A.I.G. directly. Rather, it is preserving some separation of ownership and control to bar future administrations from political meddling (read the Obama administration). This is probably a worthy goal — allowing A.I.G. to operate on an economic basis protected from political meddling.

However, there should be adequate oversight of the trust and some mechanisms to prevent the trustees from obtaining their own private benefits from controlling A.I.G. and its $1 trillion in assets. In addition, the trustees themselves should be chosen for their acumen and ability to right the sinking A.I.G. ship. Here, the government could begin by disclosing the terms of this trust once they are drafted.

Jensen Comment
What's even more comical is that accounting standards for various purposes, such as when implementing securitization accounting under FAS 140, are heavily dependent upon the "degree of control" irrespective of actual number of equity shares owned. How do such standards get implemented when top experts have no idea who controls what and for how long? Real life just is not as simple as what we teach in Accounting 101.

What do you want to bet that lucrative consulting contracts are being given to Andy Fastow to draft these ownership and control contracts? Here's an example of one that Andy cut his teeth on --- http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

Bob Jensen's essay on the bailout mess is at http://www.trinity.edu/rjensen/2008Bailout.htm

Selling New Equity to Pay Dividends:  Reminds Me About the South Sea Bubble of 1720 ---
http://en.wikipedia.org/wiki/South_Sea_bubble

"Fooling Some People All the Time"

"Melting into Air:  Before the financial system went bust, it went postmodern," by John Lanchester, The New Yorker, November 10, 2008 --- http://www.newyorker.com/arts/critics/atlarge/2008/11/10/081110crat_atlarge_lanchester

This is also why the financial masters of the universe tend not to write books. If you have been proved—proved—right, why bother? If you need to tell it, you can’t truly know it. The story of David Einhorn and Allied Capital is an example of a moneyman who believed, with absolute certainty, that he was in the right, who said so, and who then watched the world fail to react to his irrefutable demonstration of his own rightness. This drove him so crazy that he did what was, for a hedge-fund manager, a bizarre thing: he wrote a book about it.

The story began on May 15, 2002, when Einhorn, who runs a hedge fund called Greenlight Capital, made a speech for a children’s-cancer charity in Hackensack, New Jersey. The charity holds an annual fund-raiser at which investment luminaries give advice on specific shares. Einhorn was one of eleven speakers that day, but his speech had a twist: he recommended shorting—betting against—a firm called Allied Capital. Allied is a “business development company,” which invests in companies in their early stages. Einhorn found things not to like in Allied’s accounting practices—in particular, its way of assessing the value of its investments. The mark-to-market accounting that Einhorn favored is based on the price an asset would fetch if it were sold today, but many of Allied’s investments were in small startups that had, in effect, no market to which they could be marked. In Einhorn’s view, Allied’s way of pricing its holdings amounted to “the you-have-got-to-be-kidding-me method of accounting.” At the same time, Allied was issuing new equity, and, according to Einhorn, the revenue from this could be used to fund the dividend payments that were keeping Allied’s investors happy. To Einhorn, this looked like a potential Ponzi scheme.

The next day, Allied’s stock dipped more than twenty per cent, and a storm of controversy and counter-accusations began to rage. “Those engaging in the current misinformation campaign against Allied Capital are cynically trying to take advantage of the current post-Enron environment by tarring a great and honest company like Allied Capital with the broad brush of a Big Lie,” Allied’s C.E.O. said. Einhorn would be the first to admit that he wanted Allied’s stock to drop, which might make his motives seem impure to the general reader, but not to him. The function of hedge funds is, by his account, to expose faulty companies and make money in the process. Joseph Schumpeter described capitalism as “creative destruction”: hedge funds are destructive agents, predators targeting the weak and infirm. As Einhorn might see it, people like him are especially necessary because so many others have been asleep at the wheel. His book about his five-year battle with Allied, “Fooling Some of the People All of the Time” (Wiley; $29.95), depicts analysts, financial journalists, and the S.E.C. as being culpably complacent. The S.E.C. spent three years investigating Allied. It found that Allied violated accounting guidelines, but noted that the company had since made improvements. There were no penalties. Einhorn calls the S.E.C. judgment “the lightest of taps on the wrist with the softest of feathers.” He deeply minds this, not least because the complacency of the watchdogs prevents him from being proved right on a reasonable schedule: if they had seen things his way, Allied’s stock price would have promptly collapsed and his short selling would be hugely profitable. As it was, Greenlight shorted Allied at $26.25, only to spend the next years watching the stock drift sideways and upward; eventually, in January of 2007, it hit thirty-three dollars.

All this has a great deal of resonance now, because, on May 21st of this year, at the same charity event, Einhorn announced that Greenlight had shorted another stock, on the ground of the company’s exposure to financial derivatives based on dangerous subprime loans. The company was Lehman Brothers. There was little delay in Einhorn’s being proved right about that one: the toppling company shook the entire financial system. A global cascade of bank implosions ensued—Wachovia, Washington Mutual, and the Icelandic banking system being merely some of the highlights to date—and a global bailout of the entire system had to be put in train. The short sellers were proved right, and also came to be seen as culprits; so was mark-to-market accounting, since it caused sudden, cataclysmic drops in the book value of companies whose holdings had become illiquid. It is therefore the perfect moment for a short-selling advocate of marking to market to publish his account. One can only speculate whether Einhorn would have written his book if he had known what was going to happen next. (One of the things that have happened is that, on September 30th, Ciena Capital, an Allied portfolio company to whose fraudulent lending Einhorn dedicates many pages, went into bankruptcy; this coincided with a collapse in the value of Allied stock—finally!—to a price of around six dollars a share.) Given the esteem with which Einhorn’s profession is regarded these days, it’s a little as if the assassin of Archduke Franz Ferdinand had taken the outbreak of the First World War as the timely moment to publish a book advocating bomb-throwing—and the book had turned out to be unexpectedly persuasive.

In the case of Business Loan Express, Allied evidently was forced to pump another $12 million of equity into it to keep it going, and the subsidiary stopped paying dividends to the parent. But Allied still reported $19.7 milllion in interest income and fees from its subsidiary. And it chooses not to tell us how much money any of its subsidiaries really earned. In normal accounting, that would never be allowed. It should not be allowed here.
Floyd Norris, "Allied Capital Barely Knows Its Subsidiary," The New York Times, March 1, 2007 --- http://norris.blogs.nytimes.com/tag/allied-capital/

Heavy Insider Trading --- http://investing.businessweek.com/research/stocks/ownership/ownership.asp?symbol=ALD

Allied's independent auditor is KPMG
KPMG has a lot of problems with litigation --- http://www.trinity.edu/rjensen/fraud001.htm

Bob Jensen's threads on the collapse of the Banking System are at http://www.trinity.edu/rjensen/2008Bailout.htm

Bob Jensen's threads on fraud are at http://www.trinity.edu/rjensen/Fraud.htm
Also see Fraud Rotten at http://www.trinity.edu/rjensen/FraudRotten.htm

Bob Jensen's threads on accounting theory are at http://www.trinity.edu/rjensen/theory01.htm
Also see the theory of fair value accounting at http://www.trinity.edu/rjensen/theory01.htm#FairValue

Accounting Quizzes You Can Use --- http://www.accountingweb.com/quiz/

Our ACEM friend Barbara Scofield added some quiz items on October 13 and again on October 6 and many earlier weeks.
Thanks for sharing Barbara

Funny metaphors used in high school essays --- http://help.com/post/124066-funny-metaphors-used-in-high-school
 A good sign they weren't plagiarized (except maybe from this site)

The Apollo Alliance, a coalition of environmentalists and labor unions, wants the federal government to spend $500 billion over 10 years to "build America's 21st century clean energy economy" and thereby "create more than five million high quality green-collar jobs." Barack Obama says he can accomplish the same goal for only $150 billion, which gives you a sense of how reliable these projections are.

More fundamentally, both the Apollo Alliance and Obama, who has liberally borrowed from its ideas, mistakenly treat the manpower required to reduce greenhouse gas emissions as a measure of success, when it should be viewed as a cost to be minimized. Obama's "green jobs" rhetoric is part of his strategy to conceal the enormous expense associated with his plan to "transform our entire economy" and "build a new economy that is powered by clean and secure energy."

Obama wants to "implement an economy-wide cap-and-trade program to reduce greenhouse gas emissions 80 percent by 2050." That is even more ambitious than the goal of a cap-and-trade bill that the Department of Energy estimates would cost between $444 billion and $1.3 trillion in reduced economic growth over two decades.

Depending on how bad the effects of global warming are expected to be and how effective Obama's plan is at ameliorating them, such a sacrifice could be justified. But Obama has not made that case. Instead he has said, in essence: Sacrifice? What sacrifice?

The basic problem addressed by a cap-and-trade system, which uses tradable permits to charge companies for the greenhouse gases they generate, is that people contribute to climate change without bearing the cost of their behavior. Like a carbon tax, which achieves the same result more explicitly, a cap-and-trade system works only if it makes energy use (and the emissions associated with it) more expensive.

What are we to make, then, of Obama's promise to cushion the blow of rising gasoline prices and home heating bills by providing "emergency energy rebates"? That is exactly the opposite of what the government should do if it wants to encourage energy conservation and make alternative energy sources more competitive. "Under my plan of a cap-and-trade system," Obama admitted during an unusually candid interview with the San Francisco Chronicle in January, "electricity rates would necessarily skyrocket."

If Obama's cap-and-trade plan works as advertised, it will create incentives for businesses to achieve greenhouse gas reductions as efficiently as possible. He nevertheless cannot resist centrally planning the response—for example, by arbitrarily requiring that 25 percent of the nation's electricity come from renewable resources by 2025, instead of letting the market decide what mix of conservation and alternative energy makes the most sense.

A recent RAND Corporation study concludes that, without "dramatic progress in renewable energy technology," reaching this "25X'25" goal will mean "significantly increasing consumer costs." And the study did not consider "the transition and adjustment costs associated with initiating such a significant shift from fossil fuels to renewable energy technologies."

Those costs involve not just the loss of jobs in carbon-intense parts of the economy but the loss of jobs that would be created if the resources used to mitigate global warming were available for other purposes. Obama and other "clean energy" boosters do not take those losses into account, acting as if every "green job" is a net gain to the economy.

The Apollo Alliance goes so far as to brag that "renewable energy creates more jobs than coal," as if this were a selling point, as opposed to a sign of lower efficiency. It enthusiastically likens the creation of a "clean energy economy" to "the World War II industrial mobilization."

The analogy is more telling than the alliance realizes: Like a war, the effort to dramatically reduce greenhouse gas emissions may be justified to prevent a more costly outcome. But the economic activity it generates has to be weighed against the destruction it causes, something the president-elect so far has shown no inclination to do.

Debt Versus Equity: Dense Fog on the Mezzanine Level
Deloitte has submitted a Letter of Comment (PDF 277k) on the IASB's Discussion Paper: Financial Instruments with Characteristics of Equity. We strongly support development of a standard addressing how to distinguish between liabilities and equity. We do not support any of the three approaches outlined in the Discussion Paper, but we believe that the basic ownership approach is a suitable starting point. Below is an excerpt from our letter. Past comment letters are Here.
IASPlus, September 5, 2008 --- http://www.iasplus.com/index.htm

What is debt? What is equity? What is a Trup?
Banks are going to create huge problems for accountants with newer hybrid instruments

From Jim Mahar's Blog on February 6, 2005 --- http://financeprofessorblog.blogspot.com/

The Financial Times has a very cool article on financial engineering and the development of securities that combine debt and equity-like features.

FT.com / Home UK - Banks hope to cash in on rush into hybrid securities: "Securities that straddle the debt and equity worlds are not new. They combine features of debt such as regular interest-like payments and equity-like characteristics such as long or perpetual maturities and the ability to defer payments."

"About a decade ago, regulated financial institutions started issuing so-called trust preferred securities, or Trups, which are functionally similar to preferred stock but can be structured to achieve extra benefits such as tax deductibility for the issuing company. Other hybrid structures have also been tried.

But bankers were still searching for what several called the “holy grail” – an instrument that looked like debt to its issuer, the tax man and investors, but like equity to credit rating agencies and regulators.

That goal came closer a year ago when Moody’s, the credit rating agency, changed its previously conservative policies, opening the door for it to treat structures with some debt-like features more like equity."

The link to the Financial Times article ---
http://news.ft.com/cms/s/e22d70f2-9674-11da-a5ba-0000779e2340.html

The CAlCPA Tax Listserv

September 4, 2008 message from Scott Bonacker [lister@bonackers.com]
Scott has been a long-time contributor to the AECM listserv (he's a techie as well as a practicing CPA)

I found another listserve that is exceptional -

CalCPA maintains http://groups.yahoo.com/taxtalk/  and they let almost anyone join it.
Jim Counts, CPA is moderator.

There are several highly capable people that make frequent answers to tax questions posted there, and the answers are often in depth.

Scott

Bob Jensen's threads on blogs and listservs are at http://www.trinity.edu/rjensen/ListServRoles.htm

"Pressure gauge," The Economist, August 21, 2008 --- http://www.economist.com/finance/displaystory.cfm?story_id=11985964

IN THE weeks before Bear Stearns, a Wall Street bank, collapsed in March, nervous investors scanned not just its share price for a measure of its health, but the price of its credit-default swaps (CDSs), too. These once-obscure instruments, now widely enough followed that they have even earned a mention on an American TV crime series, clearly indicated that the firm’s days were numbered. The five-year CDS spread had more than doubled to 740 basis points (bps), meaning it cost $740,000 to insure $10m of its debt. The higher the spread, the greater the expectation of default.

Once again, CDS spreads on Wall Street banks are pushing higher, having fallen in March after the Federal Reserve extended emergency lending facilities to them. Reportedly one firm, Morgan Stanley, is monitoring its own CDS spreads to assess the market’s perception of its corporate health; if they rise too high, it intends to cut back its lending. Whether the CDS market is accurately assessing the creditworthiness of Lehman Brothers, trading on August 20th at 376 bps, double the level in early May, will be the next test of its worth.

There are some who doubt whether the CDS market is a reliable barometer of financial health. Though its gross value has ballooned in size from $4 trillion in 2003 to over $62 trillion, many of the contracts written on individual companies are thinly traded, lack transparency, and are prone to wild swings.

Recent spikes in CDS spreads on the three largest Icelandic banks are a case in point. In July spreads on Kaupthing and Glitnir rose to levels 35% higher than those observed for Bear Stearns in the days before it was bought out, according to Fitch Solutions, part of the Fitch rating and risk group. But the panic subsided after they released second-quarter earnings. Insiders say CDSs are increasingly used for speculation as well as hedging, which creates distracting “noise” particularly when the markets are as fearful as they have been recently.

On the other hand, although CDS spreads may overshoot, they do not generally stay wrong for long. Moody’s, another rating agency, says that market-implied ratings, such as those provided by CDS spreads, tally loosely with credit ratings 80% of the time. What is more, CDS spreads frequently anticipate ratings changes. Fitch Solutions reckons that the CDS market has anticipated over half of all observed ratings activities on CDS-traded entities as much as three months in advance. Though the magnitude of the moves may at times be unrealistic, the direction is usually at least as good a distress signal as the stock market.

Bob Jensen's threads on Credit Derivative and Credit Risk Swap --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm#C-Terms
Scroll down to "Credit Derivative and Credit Risk Swap."

Bob Jensen's threads on the litigation woes of the large auditing firms are at http://www.trinity.edu/rjensen/Fraud001.htm

Disclosures about Credit Derivatives and Certain Guarantees: An Amendment of FASB Statement No. 133 and FASB Interpretation No. 45; and Clarification of the Effective Date of FASB Statement No. 161
FASB, September 12, 2008 --- http://www.fasb.org/pdf/fsp_fas133-1&fin45-4.pdf

Debt Versus Equity: Dense Fog on the Mezzanine Level
Deloitte has submitted a Letter of Comment (PDF 277k) on the IASB's Discussion Paper: Financial Instruments with Characteristics of Equity. We strongly support development of a standard addressing how to distinguish between liabilities and equity. We do not support any of the three approaches outlined in the Discussion Paper, but we believe that the basic ownership approach is a suitable starting point. Below is an excerpt from our letter. Past comment letters are Here.
IASPlus, September 5, 2008 --- http://www.iasplus.com/index.htm

What is debt? What is equity? What is a Trup?
Banks are going to create huge problems for accountants with newer hybrid instruments

From Jim Mahar's Blog on February 6, 2005 --- http://financeprofessorblog.blogspot.com/

The Financial Times has a very cool article on financial engineering and the development of securities that combine debt and equity-like features.

FT.com / Home UK - Banks hope to cash in on rush into hybrid securities: "Securities that straddle the debt and equity worlds are not new. They combine features of debt such as regular interest-like payments and equity-like characteristics such as long or perpetual maturities and the ability to defer payments."

"About a decade ago, regulated financial institutions started issuing so-called trust preferred securities, or Trups, which are functionally similar to preferred stock but can be structured to achieve extra benefits such as tax deductibility for the issuing company. Other hybrid structures have also been tried.

But bankers were still searching for what several called the “holy grail” – an instrument that looked like debt to its issuer, the tax man and investors, but like equity to credit rating agencies and regulators.

That goal came closer a year ago when Moody’s, the credit rating agency, changed its previously conservative policies, opening the door for it to treat structures with some debt-like features more like equity."

The link to the Financial Times article ---
http://news.ft.com/cms/s/e22d70f2-9674-11da-a5ba-0000779e2340.html

A CPA Auditor in Deloitte Commits Felony Fraud Over Years of Managing Audits
Question
How should his fraud be disclosed on a victim's financial statements?

October 31, 2008 message from Dennis Beresford [dberesfo@terry.uga.edu]

Deloitte Says Partner Traded Illegally

WILMINGTON, DEL. (CN) -
Deloitte & Touche says a 30-year partner traded on inside information he got from audits, and lied about it for years. It sued Thomas P. Flanagan in Chancery Court. Flanagan "for 30 years was a partner" in Deloitte & Touche or a predecessor "until his abrupt resignation less than two months ago," Deloitte claims. It says he betrayed his trust and violated company policy by trading in securities of audit clients, including some of his own accounts, since 2005. "Compounding his wrongdoing, Flanagan repeatedly lied to Deloitte about his clandestine trading activities in annual written certifications, going to far as to conceal the existence of a number of his brokerage accounts to avoid detection of his improper conduct," Deloitte says. It says that both Deloitte and its clients have had to pay legal costs to investigate Deloitte's ability to continue as independent auditor, due to Flanagan's shenanigans. It seeks monetary damages. The complaint does not state, or estimate, how much Flanagan made from his alleged inside trades. Deloitte says that it still does not know the extent of them. Deloitte & Touche is represented by Paul Lockwood with Skadden Arps.

http://www.courthousenews.com/2008/10/30/Deloitte_Says_Partner_Traded_Illegally.htm

 

October 31, 2008 message from Dennis Beresford [dberesfo@terry.uga.edu]

Bob,

Here's a little more information. This is from the most recent 10-Q for USG. I understand that similar approaches were used in the other cases where this occurred.

Note that the person in question was the "advisory partner" rather than engagement partner or concurring partner. Most of the large firms use senior partners in a similar "relationship management" way. So the person wouldn't necessarily have been involved in detailed auditing or review, but he might have been involved if there were significant judgmental issues that the engagement team needed to resolve. In this case it looks like D&T decided that wasn't the case.

Denny

ITEM 5. OTHER INFORMATION
Since 2002, Deloitte & Touche LLP has served as the independent registered public accountants with respect to our financial statements. In September 2008, Deloitte advised us that they believed a member of Deloitte’s client service team that serves us had entered into two option trades involving our securities in July 2007. This individual had served as the advisory partner on Deloitte’s client service team for us from 2004 until September 2008. The advisory partner is no longer an active partner at Deloitte. Under the Deloitte client service model as we understand it, the role of an advisory partner is primarily to serve in a client-relationship maintenance and assessment role. Securities and Exchange Commission rules require that we file annual financial statements that are audited by registered independent public accountants. SEC rules also provide that when a partner serving in a capacity such as that of this advisory partner has an investment in securities of an audit client, the audit firm should not be considered independent with respect to that client. Based on our review of the former advisory partner’s role and activities, we do not believe that he had any substantive role or influenced any substantive portion of any audit or review of our financial statements. The former advisory partner attended many, but not all, of our audit committee meetings. At these meetings, he reviewed with the committee reports of the annual inspection of Deloitte conducted by the Public Company Accounting Oversight Board as well as Deloitte’s annual client service assessments. He did not review any substantive audit matters with the committee at any of these meetings or at any other time. The former advisory partner also met once or twice a year with our audit committee chair and once per year with the other members of our audit committee as well as our chief executive officer and chief financial officer. The stated purpose of these meetings was to foster and strengthen Deloitte’s ongoing relationship with us. The former advisory partner attended our annual meetings of shareholders as one of the Deloitte representatives attending those meetings. Neither the former advisory partner nor any other Deloitte representatives spoke at any of these meetings and no questions were asked of Deloitte. At the direction of our audit committee, we conducted an extensive investigation into the facts and circumstances of the extent of any involvement of the former advisory partner with our audit. We retained outside counsel and a consulting firm specializing in accounting issues to assist in this investigation. Outside counsel led the process and conducted personal interviews with the current and former lead client service partners, the concurring review partner, the current and former senior managers on our account and the tax matters partner, as well as the members of our audit committee and key members of our internal finance and accounting departments, including our chief financial

 

Deloitte has sued its former partner --- http://www.accountingweb.com/cgi-bin/item.cgi?id=106418

Bob Jensen's threads on Deloitte are at http://www.trinity.edu/rjensen/Fraud001.htm

Bob Jensen's Fraud Updates --- http://www.trinity.edu/rjensen/FraudUpdates.htm

Question
Where were the auditors when reviewing bad debt allowances?

Hint
The were hiding behind the same reasons to be used again and again when fair value accounting is required by the IASB and the FASB.

From The Wall Street Journal Accounting Weekly Review on September 12, 2008 ---
http://online.wsj.com/article/SB122083722708908863.html?mod=djem_jiewr_AC

"No End Yet to the Capital Punishment," by Peter Eavis and David Reilly, The Wall Street Journal, September 8, 2008; Page C10             http://online.wsj.com/article/SB122083722708908863.html?mod=djem_jiewr_AC 

Investors may be tempted to see the government's takeover of Fannie Mae and Freddie Mac as the kind of cathartic action that marks a decisive turning point for the U.S. banking system and the wider stock market.

But the chief problem at Fannie and Freddie -- an inadequate capital cushion against losses -- also bedevils large banks in the U.S and Europe more than 12 months into the credit crunch.

While the capital shortage may not be as dire as at Fannie and Freddie, private banks can't count on a government rescue. Some will fail. Others will have to issue massive amounts of capital to shore up their shaky balance sheets.

Make no mistake, the government's move to shore up Fannie and Freddie will likely give markets a short-term boost, especially if investors believe this can help underpin house prices in the U.S. But this move by the Treasury comes just as a new, more general threat looms: On top of U.S. economic problems, underlined by Friday's jump in the unemployment rate, the rest of the world is slowing.

The broader strains now facing the markets are not as easily relieved by central banks or governments as the company specific crises at Fannie and Freddie or Bear Stearns earlier this year.

Of course, central banks could cut interest rates in the face of this threat. Even the Federal Reserve has some room to cut the Fed Funds rate from 2%. That may be one reason bank stocks rallied Friday in the U.S. despite the dismal unemployment figure.

Rate cuts would theoretically allow banks to harvest easy profits by borrowing more cheaply and lending to high-quality borrowers at attractive rates. The trouble is, banks are being extra cautious, justifiably, about lending as the economy slows.

The shakeout of the past year has done almost nothing to improve the average U.S. household balance sheet. So while a government commitment to buy mortgage-backed securities, also announced Sunday, may cause mortgage rates to fall, banks may not want to lend at lower rates because they don't feel they're being compensated for the risks in this uncertain economy.

And while banks are reluctant to lend, many are having problems borrowing to fund themselves. That is because the market's assessment of their creditworthiness is darkening.

A closely followed yardstick that measures the gap between interbank lending rates and the expected federal-funds rate has widened beyond July's distressed levels. When this gap widens, banks are perceived to be riskier.

Also, the cost of insuring against default by large banks is rising.

The takeover of Fannie and Freddie could even worsen that sentiment, as investors grow even more cynical of regulatory measures of capital.

For months, Fannie, Freddie, their regulator and other government officials have assured investors that measures of regulatory capital showed the mortgage firms weren't financially hobbled.

The government's takeover shows this wasn't the case. Given that, investors are going to want concrete actions from banks, not continued pronouncements that losses on mortgage-related securities are only temporary and will one day bounce back.

That will translate into highly dilutive issues of common stock, which will be necessary if banks are to raise capital to the levels required to reassure anxious funding sources.

And that is why bank investors who place too much hope in the bailout of Fannie and Freddie could get burned.

Bob Jensen's threads on independence and professionalism in auditing are at
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Complexities in the Definition of a Derivative Financial Instrument

December 3, 2008 message from David Albrecht [albrecht@PROFALBRECHT.COM]

Derivatives are contracts to be settled in the future. They have to be based on an asset, an index or a debt security.

Derivative contracts can be entered into for hedging purposes or speculative purposes

In the game of monopoly, there are several instances when there is a need for hedging (also known as insurance).

Frequently, players need to go to jail. The penalties for going to jail are (1) payment of $50 for getting out of jail, and (2) payment of any rent on the first turn when emerging from jail. A trip around the board (40 squares) takes about 5 turns. I have no idea, over the long run, what is your chance of going to jail at least once during a trip around the board. My uninformed guess is that 20% of the time you travel around the board you will end up in jail.

Early in the game, before there is much development of houses and hotels, your cost for going to jail is most likely only going to be $50. You may pay that immediately in cash, or you can attempt to roll doubles (a very bad strategy). All books on strategy for the game of Monopoly recommend paying the $50 and getting out of jail as quickly as possible if there are still unpurchased properties available.

I think the expected value or cost of going to jail in such circumstance is $10. Sometimes you are lucky and never go to jail, sometimes you are unlucky and go to jail a lot.

Later on in a game when an opponent has built hotels on St. James, Tennessee and New York (with rents of 900, 900 and 1,000), the cost of going to jail significantly increases when you consider that eventually you must exit jail and pay rent on any square upon which you land. For example, your odds of avoiding landing any orange property are about 65%. It's the 35% that is the killer.

I think that as a sideline, a player could offer "going to jail"

insurance every time someone reaches Go and starts a new trip around the board.

As I read the literature on derivatives and accounting for derivatives, it seems to me that both sides of the contract qualify as derivatives and therefore need to be accounted for if each token is an SEC reporting token. The token purchasing the insurance is hedging, and the token offering the insurance is speculating. Do I have this right? If an accounting period ends while an insured token still has a reasonable probability of getting sent to jail, then the derivative contract must be valued at some estimate of fair value. Again, do I have this right?

It also seems to me that depending on whether you are ahead or behind in a game, you might very well wish to offer and sell to other players an opportunity to make a pre-payment in exchange for a certain percentage of rent every time someone lands on your house or hotel, or you might wish to buy into such into either such arrangement. Aren't both sides of this contract for speculative purposes? On the other hand, you might want to offer rent discounts that expire after going around the board once. Again, wouldn't this be hedging for the party that purchases a rent discount and for speculation for the party that sells it?

I think also, that options can be built into a game of monopoly. For example, upon acquiring the final piece of property that creates a color group monopoly and before making any sort of building plans, you could offer opponents an option to pay future rents at a fixed level. Of course, if you don't build enough houses or a hotel, then the option would not be exercises by the purchasing opponent, but it would be exercises if you had built enough houses or hotels.

Of course, all sorts of speculative contracts could be entered into. For example, you might bet with opponent B that opponent C will go bankrupt on the current trip around the board. Isn't this also a derivative contract? It is entered into for speculative purposes, I presume. Another example would be to speculate (bet) on whether or not earnings reach a certain dollar amount for the coming accounting period.

Are there any

 

December 3m 2008 reply from Bob Jensen

Hi David,

I’ve never heard of a derivative contract on the net earnings of a company as a whole. The definition of “net earnings” is generally too complicated and subject to too many contingencies to get counterparties to agree on such complex contracts. I don’t think a net earnings hedge of an entire company would even be eligible for hedge accounting under either the FAS 133 or the IAS 39 standard.

It is possible to lock in a profit on a contracted commodity notional by hedging both the future purchase price and the future selling price in separate derivative contracts, but this is not the same as net earnings of an entire firm. More commonly the firm already has a position (even ownership of the notional itself) and is locking in a profit on a specific amount of notional.

Derivative contracts are written on more precise notionals and underlyings such as the price of a commodity or the default of a debt payment.

You should probably make your definition of derivatives more precise by defining a notional, underlying (index), and net settlement (required in FAS 133 for hedge accounting but not in IAS 39).

The Monopoly Game could add buying properties with credit (even with accelerated subprime mortgages) and credit derivative swaps (CDSs). It might also be a way of adding Black Swan Theory. But the game would probably become too complicated even for geeks.

What distinguishes credit derivatives from commodity derivatives is the possibility that the entire notional may be lost in a credit derivative and the virtual impossibility that the notional may be lost in a commodity derivative --- unless the spot price of a commodity like corn, wheat, copper, and oil drops to zero which is not likely even under the Black Swan Theory.

When Investor I enters into 40 corn futures contracts with Farmer F, most contracts are traded with a "net settlement clause" such the notional value of 100,000 bushels of corn "net settles" is never at risk. At settlement time, Farmer F and Investor I net settle on only the difference between the current spot price and the contracted future (strike) price. The corn itself never changes hands in a physical sense in futures markets. If Investor I really wants corn, he can then buy it at the spot price in the corn market even though his net price depends how he net settled his futures contracts in the futures market.

Put more simply, there are no black swans in most commodity derivative trades, but there may be black swans in credit derivative trades --- http://en.wikipedia.org/wiki/Black_swan_theory
There are also quite a few YouTube videos on the Black Swan Theory.

To distinguish traditional financial securities from derivative financial securities for my students, I always compared bond sales (financial securities sales where the notional changes hands on the date of the sale) with interest rate swaps (derivative financial securities where the notional changes hands).

When Investor I buys a bond for a $1 million notional from Debtor D, the risk of repayment is transferred from I to D the instant the $1 million is transferred to D.

When A and B enter into an interest rate swap on a $1 million notional, the notional never changes hands such that the notional itself is never at risk. Net settlement (usually quarterly throughout the life of the swap) is based on the difference between the spot rate of interest and the contracted forward rate. This makes such swaps ideal hedges to convert variable rate bonds to fixed rate risk and vice versa.

 

 

Credit derivative swaps are not interest rate swaps, and the notional of a credit derivative swap may be at risk if value of the notional itself drops to zero --- that black swan.

If you are going to teach derivatives, the following distinctions between the FAS 133 and IAS 39 standards should be emphasized, although don't make too much of the fact that the IAS 39 definition does not require net settlement for hedge accounting. Most derivatives encountered when applying IAS 39 will net settle.

 

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The terminology related to IAS 39 is very complicated. Bob Jensen maintains an extensive online glossary of FAS 133 and IAS 39 terminology.[1] Entries related to IAS 39 are boxed in green, and entries related to DIG implementation guidelines are blocked in red.

Paragraph 9 of IAS 39 reads, in part, as follows:

The following terms are used in this Standard with the meanings specified: Definition of a derivative A derivative is a financial instrument or other contract within the scope of this Standard (see Paragraphs 2–7) with all three of the following characteristics: (a)           its value changes in response to the change in a specified interest rate, financial instrument price, commodity price, foreign exchange rate, index of prices or rates, credit rating or credit index, or other variable, provided in the case of a non-financial variable that the variable is not specific to a party to the contract (sometimes called the 'underlying'); (b)           it requires no initial net investment or an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors; and (c)           it is settled at a future date.

Later on this definition is elaborated in the following IAS 39 paragraphs:   AG9        Typical examples of derivatives are futures and forward, swap and option contracts. A derivative usually has a notional amount, which is an amount of currency, a number of shares, a number of units of weight or volume or other units specified in the contract. However, a derivative instrument does not require the holder or writer to invest or receive the notional amount at the inception of the contract. Alternatively, a derivative could require a fixed payment or payment of an amount that can change (but not proportionally with a change in the underlying) as a result of some future event that is unrelated to a notional amount. For example, a contract may require a fixed payment of CU1,000 if six-month LIBOR increases by 100 basis points. Such a contract is a derivative even though a notional amount is not specified.   AG10      The definition of a derivative in this Standard includes contracts that are settled gross by delivery of the underlying item (eg a forward contract to purchase a fixed rate debt instrument). An entity may have a contract to buy or sell a non-financial item that can be settled net in cash or another financial instrument or by exchanging financial instruments (eg a contract to buy or sell a commodity at a fixed price at a future date). Such a contract is within the scope of this Standard unless it was entered into and continues to be held for the purpose of delivery of a non-financial item in accordance with the entity's expected purchase, sale or usage requirements (see Paragraphs 5–7).   AG11      One of the defining characteristics of a derivative is that it has an initial net investment that is smaller than would be required for other types of contracts that would be expected to have a similar response to changes in market factors. An option contract meets that definition because the premium is less than the investment that would be required to obtain the underlying financial instrument to which the option is linked. A currency swap that requires an initial exchange of different currencies of equal fair values meets the definition because it has a zero initial net investment. AG12      A regular way purchase or sale gives rise to a fixed price commitment between trade date and settlement date that meets the definition of a derivative. However, because of the short duration of the commitment it is not recognised as a derivative financial instrument. Rather, this Standard provides for special accounting for such regular way contracts (see Paragraphs 38 and AG53–AG56).   AG12A   The definition of a derivative refers to non-financial variables that are not specific to a party to the contract. These include an index of earthquake losses in a particular region and an index of temperatures in a particular city. Non-financial variables specific to a party to the contract include the occurrence or non-occurrence of a fire that damages or destroys an asset of a party to the contract. A change in the fair value of a non-financial asset is specific to the owner if the fair value reflects not only changes in market prices for such assets (a financial variable) but also the condition of the specific non-financial asset held (a non-financial variable). For example, if a guarantee of the residual value of a specific car exposes the guarantor to the risk of changes in the car's physical condition, the change in that residual value is specific to the owner of the car.[2]

The above definition differs somewhat from the definition of a derivative financial instrument scoped into FAS 133. The key difference is in the concept of “net settlement.”

Definitions of derivatives

• IAS 39: Does not define “net settlement” as being required to be scoped into IAS 39 as a derivative such as when interest rate swap payments and receipts are not net settled into a single payment.
• FAS 133: Net settlement is an explicit requirement to be scoped into FAS 133 as a derivative financial instrument.

Implications: This is not a major difference since IAS 39 scoped out most of what is not net settled such as Normal Purchases and Normal Sales (NPNS) and other instances where physical delivery transpires in commodities rather than cash settlements. Also IAS 39 applies net settlement as a criterion in scoping a loan commitment into IAS 39.[3]

And in B2 of IAS 39 we find the following examples of derivatives and examples of derivatives that are not scoped into IAS 39:

 

Type of contract	Main pricing-settlement variable (underlying variable)
Interest rate swap	Interest rates
Currency swap (foreign exchange swap)	Currency rates
Commodity swap	Commodity prices
Equity swap	Equity prices (equity of another entity)
Credit swap	Credit rating, credit index or credit price
Total return swap	Total fair value of the reference asset and interest rates
Purchased or written treasury bond option (call or put)	Interest rates
Purchased or written currency option (call or put)	Currency rates
Purchased or written commodity option (call or put)	Commodity prices
Purchased or written stock option (call or put)	Equity prices (equity of another entity)
Interest rate futures linked to government debt (treasury futures)	Interest rates
Currency futures	Currency rates
Commodity futures	Commodity prices
Interest rate forward linked to government debt (treasury forward)	Interest rates
Currency forward	Currency rates
Commodity forward	Commodity prices
Equity forward	Equity prices (equity of another entity)

 

The above list is not exhaustive. Any contract that has an underlying may be a derivative. Weather derivatives cannot get hedge accounting under FAS 133. They were excluded in the original version of IAS 39, but an amendment in 2003 made it possible to get hedge accounting treatment if hedged item does not fall under other IFRS 4. The above list provides examples of contracts that normally qualify as derivatives under IAS 39. Moreover, even if an instrument meets the definition of a derivative contract, special provisions of IAS 39 may apply, for example, if it is a weather derivative (see IAS 39.AG1), a contract to buy or sell a non-financial item such as commodity (see IAS 39.5 and IAS 39.AG10) or a contract settled in an entity's own shares (see IAS 32.21–IAS 32.24). Therefore, an entity must evaluate the contract to determine whether the other characteristics of a derivative are present and whether special provisions apply.^[4]

Share-based employee compensation such as employee stock options (ESOs) is not scoped into either IAS 39 or FAS 133. Such compensation contracts are scoped in IFRS 2 and IAS 123(R).

A loan obligation is a contract to make or receive a loan in the future. If it is a firm commitment in the sense of a specified rate of interest, its accounting depends a great deal whether or not the loan commitment will net settle due to changes in market rates of interest. FAS 133 is very clear that loan commitments that do not net settle are not required to be booked as derivative financial instruments, although certain problems of conflict between FAS 133 versus FAS 65 had to be resolved in Paragraphs A26-A33 if FAS 149.

Loan commitments that net settle were more of a problem in IAS 39 since net settlement is not required in the IAS 39 definition of a derivative. However, IAS 39 added a net settlement condition for loan commitments as follows:

BC15       Loan commitments are firm commitments to provide credit under pre-specified terms and conditions. In the IAS 39 implementation guidance process, the question was raised whether a bank's loan commitments are derivatives accounted for at fair value under IAS 39. This question arises because a commitment to make a loan at a specified rate of interest during a fixed period of time meets the definition of a derivative. In effect, it is a written option for the potential borrower to obtain a loan at a specified rate.   BC16       To simplify the accounting for holders and issuers of loan commitments, the Board decided to exclude particular loan commitments from the scope of IAS 39. The effect of the exclusion is that an entity will not recognise and measure changes in fair value of these loan commitments that result from changes in market interest rates or credit spreads. This is consistent with the measurement of the loan that results if the holder of the loan commitment exercises its right to obtain financing, because changes in market interest rates do not affect the measurement of an asset measured at amortised cost (assuming it is not designated in a category other than loans and receivables).   BC17       However, the Board decided that an entity should be permitted to measure a loan commitment at fair value with changes in fair value recognised in profit or loss on the basis of designation at inception of the loan commitment as a financial liability through profit or loss. This may be appropriate, for example, if the entity manages risk exposures related to loan commitments on a fair value basis.   BC18       The Board further decided that a loan commitment should be excluded from the scope of IAS 39 only if it cannot be settled net.  If the value of a loan commitment can be settled net in cash or another financial instrument, including when the entity has a past practice of selling the resulting loan assets shortly after origination, it is difficult to justify its exclusion from the requirement in IAS 39 to measure at fair value similar instruments that meet the definition of a derivative.   BC19       Some comments received on the Exposure Draft disagreed with the Board's proposal that an entity that has a past practice of selling the assets resulting from its loan commitments shortly after origination should apply IAS 39 to all of its loan commitments. The Board considered this concern and agreed that the words in the Exposure Draft did not reflect the Board's intention. Thus, the Board clarified that if an entity has a past practice of selling the assets resulting from its loan commitments shortly after origination, it applies IAS 39 only to its loan commitments in the same class.   BC20       Finally, the Board decided that commitments to provide a loan at a below-market interest rate should be initially measured at fair value, and subsequently measured at the higher of (a) the amount that would be recognised under IAS 37 and (b) the amount initially recognised less, where appropriate, cumulative amortisation recognised in accordance with IAS 18 Revenue. It noted that without such a requirement, liabilities that result from such commitments might not be recognised in the balance sheet, because in many cases no cash consideration is received.   BC20A   As discussed in paragraphs BC21–BC23E, the Board amended IAS 39 in 2005 to address financial guarantee contracts. In making those amendments, the Board moved the material on loan commitments from the scope section of the Standard to the section on subsequent measurement (Paragraph 47(d)). The purpose of this change was to rationalise the presentation of this material without making substantive changes.[5]

Paragraph BC18 above especially brings IAS 39 closer to FAS 133 with respect to the net settlement criterion for loan commitments to be derivatives. Paragraph 4 of IAS 39 notes that installment payments are not the same as net settlements.

If a loan commitment with a locked in rate of interest net settles and is booked as a derivative financial instrument, a hedge of this loan commitment cannot get hedge accounting. However, if the loan commitment does not net settle and is not booked, then the question of hedge accounting depends upon how the loan eventually will be carried when it is transacted and booked. If it will be carried at fair value, then hedge accounting is not allowed for any derivative that hedges this unbooked loan commitment. If the loan will be carried at amortized cost, however, fair value hedge accounting is available for the hedging derivative just as it is for a purchase commitment of inventory and fixed assets. Cash flow hedging makes no sense since there is no cash flow risk on a loan commitment that has a contracted interest rate.

In matters of valuing loan commitments at fair value, if they meet the net settlement condition of a derivative and are booked at fair value, a question arises as to fair value measurement when future servicing rights are embedded in the value of the loan as is the case for most mortgage loans. A key paragraph of the SEC’s SAB 105 reads as follows:

Facts: Bank A enters into a loan commitment with a customer to originate a mortgage loan at a specified rate. As part of this written loan commitment, Bank A expects to receive future net cash flows related to servicing rights from servicing fees (included in the loan's interest rate or otherwise), late charges, and other ancillary sources, or from selling the servicing rights to a third party. If Bank A intends to sell the mortgage loan after it is funded, pursuant to paragraph 6 of FASB Statement No. 133, Accounting for Derivative Instruments and Hedging Activities, as amended by FASB Statement No. 149, Amendment of Statement 133 on Derivative Instruments and Hedging Activities ("Statement 133"), the written loan commitment is accounted for as a derivative instrument and recorded at fair value through earnings (referred to hereafter as a "derivative loan commitment"). If Bank A does not intend to sell the mortgage loan after it is funded, the written loan commitment is not accounted for as a derivative under Statement 133. However, paragraph 7(c) of FASB Statement No. 159, The Fair Value Option for Financial Assets and Financial Liabilities ("Statement 159"), permits Bank A to record the written loan commitment at fair value through earnings (referred to hereafter as a "written loan commitment"). Pursuant to Statement 159, the fair value measurement for a written loan commitment would include the expected net future cash flows related to the associated servicing of the loan.[6]

 

In summary, the loan commitment must in some instances be booked at fair value and in other instances it may be booked at fair value under the Fair Value Option (FVO) in FAS 159. However, FAS 159 makes fair value booking optional when it is not required under SAB 105, FAS 133, and FAS 149. If the loan commitment is not booked, the accounting for it would be much like the accounting for unbooked purchase/sale contracts illustrated by Bob Jensen.[7]

Additional Considerations

 

PwC in Comperio makes the following observation:

SEC Staff Accounting Bulletin 105, Application of Accounting Principles to Loan Commitments (SAB 105), specifies that in estimating the fair value of loan commitments that are subject to FAS 133, an entity should exclude from its calculation the expected future cash flows related to the associated servicing of the loan. It is unclear whether the guidance in SAB 105 would also apply to loan commitments that are not subject to FAS 133 but are eligible for the FVO under FAS 159. The SEC Staff has requested that an industry group led by the Mortgage Bankers Association assist in resolving this issue[8]

 

Also consider DIG Issue No. C-13 as amended by FAS 149. Pursuant to FAS 156, a mortgage banking enterprise may elect to subsequently measure (BOOKED) servicing assets and servicing liabilities at fair value with changes in fair value reported in the period in which they occur. By electing the Fair Value Measurement Method, the mortgage banking enterprise may simplify its objective for hedge accounting because the Fair Value Measurement Method requires income statement recognition of the changes in fair value of those servicing assets and servicing liabilities, which will potentially offset the changes in fair value of the derivative instruments in the same accounting period without designating formal FAS 133 hedging relationships. The FASB’s Accounting Standards Codification online database provides useful information regarding recognition of derivatives. Derecognition of derivatives is also discussed.[9]

 

(i)                  Rationale and Synthesis

There are occasional differences between IAS 39 and FAS 133 in terms of what types of contracts must be booked as derivative financial instruments. Some examples of differences and similarities are listed below:

1.      FAS 133 requires that a derivative contract have at least one specified notional. IAS 39 makes some exceptions such as the exception illustrated in AG1 above. However, in nearly all cases derivatives have at least one specified notional upon which settlements are based. Paragraph B8 of IAS 39 also allows the notional to be variable in the case of foreign exchange (FX) hedging and illustrates this with a derivative settlement based on sales volume.

2.      FAS 133 requires that contract payments be net settled with only the difference between what is owed being transmitted in cash. For example, in an interest rate swap, FAS 133 requires that the swap receivable be netted against the swap payable on each settlement date with only the net difference actually being transmitted. Paragraph B3 of IAS 39 allows that gross payments be swapped. There are, however, no cross payments of the notionals themselves used in calculating the interest payments. The net versus gross settlement differences in the two standards is generally not very important. If a derivative is likely to entail physical delivery in place of cash settlement, it is not scoped into either FAS 133 or IAS 39.

3.      Both standards specify no initial investment or a very small investment (usually called a premium) that is nowhere close to the value of the notional of the contract. This is a main difference between a financial instrument (such as a bond or a purchase/sale contract) and a derivative financial instrument. The usual example of a small investment is the premium that is paid by the purchaser of an option to the writer (seller) of the option, although there can also be small premiums on other contracts such as interest rate swaps. Most forward, futures, and swap contracts have no initial investment and the risks involved are usually much less than the full value of the entire notional. IAS 39 allows interest rate swap payments to be prepaid without affecting the “no initial investment” constraint.[10] Like FAS 133, IAS 39 does not allow for prepayments at the full notional value of a forward contract.[11]

4.      IAS 39 Paragraph B18 (g) allows some leeway as to whether companies want to account for credit default swaps as insurance contracts or derivative financial instruments. FAS 133 in general is more specific as to what is to be accounted for as insurance by standards other than FAS 133 relative to discretion permitted under IAS 39 for insurance-like derivatives. Although various international standards cover some aspects of insurance, IFRS 4 is the main standard for insurance accounting guidelines.

 

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