Commission Wants More Exhaustive MD&A

Proposal would require new section in annual reports, lot more explaining. Elsewhere: FASB weighs in on debt accounting. Plus: What kind of bonus did Conseco's CFO get last year?

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Financial regulators and standard-setters were busy on Tuesday. Both the Securities and Exchange Commission and the Financial Accounting Standards Board (FASB) offered changes to existing accounting practices.

The SEC voted unanimously to require corporate filers to explain how they apply critical accounting policies in the Management’s Discussion and Analysis (MD&A) section of their financial statements.

The new rule would require companies to include an Application of Critical Accounting Policies section in annual reports, registration statements, and proxy and information statements. In that section, a filer would have to disclose any information about the “critical” accounting estimates that are made by the company in applying its accounting policies. Corporate filers would also have to offer details about the initial adoption of a new accounting policy.

Under the SEC’s proposal, an accounting estimate would be deemed critical if it requires a company to make assumptions about matters that are highly uncertain at the time of the estimation. The estimate would also be deemed critical if the filer could have reasonably made different estimates—or if periodic changes to the estimate the company did make would have a material impact on the filer’s financial condition or operating results.

The bugaboo here? Corporate filers are still pretty much left to their own devices to determine what constitutes a “material impact.” In fact, as CFO.com reported in January, regulators at the SEC are still struggling to come up with a more-precise definition of material impact.

The SEC’s proposal is clearly a response to the recent high-profile bankruptcies of Enron, Global Crossing, and Kmart, as well as the recent raft of corporate revenue restatements. The commission’s proposal would require the following information in the MD&A section:

  • A discussion that identifies and describes an estimate, the methodology used, certain assumptions, and reasonably likely changes.
  • An explanation of the significance of an accounting estimate to a company’s financial condition, changes in financial condition, and results of operations, and, where material, an identification of line items in a company’s financial statements affected by an accounting estimate.
  • A quantitative discussion of changes in line items in financial statements and overall financial performance if a company were to assume that the accounting estimate was changed. This can be done either by using reasonably possible near-term changes in certain assumptions underlying an accounting estimate or by using a reasonably possible range of the accounting estimate.
  • A quantitative and qualitative discussion of any material changes made to an accounting estimate in the past three years, the reasons for the changes, and the effect on line items in financial statements and overall financial performance.
  • A statement of whether a company’s senior management has discussed the development and selection of an accounting estimate—and the MD&A disclosure regarding that estimate—with the audit committee of the company’s board of directors.
  • An identification of the segments of a company’s business the accounting estimate affects.
  • A discussion of an estimate on a segment basis, mirroring the one required on a companywide basis, to the extent that a failure to present that information would result in an omission that renders the disclosure materially misleading.

Companies would also be required to disclose:

  • The events or transactions that gave rise to the initial adoption.
  • The accounting principle that has been adopted and the method of applying that principle.
  • The impact on a company’s financial condition, changes in financial condition, and results of operations (discussed on a qualitative basis).
  • An explanation as to why an estimate was chosen, particularly if a company could have used an estimate based on acceptable principles. A company must also list alternative methods for calculating the figure, and must disclose why it made the choice it did (including, where material, qualitative disclosure of the impact the alternatives would have had on its financial presentation).
  • If no accounting literature exists that governs the accounting for the events or transactions giving rise to the initial adoption, an explanation of the decision regarding which accounting principle to use and which method of applying that principle to use.

The commission is seeking comments on the proposals for the next 60 days.

FASB Issues Statement No. 145

While the SEC was disclosing its thoughts on disclosure, FASB got down to brass tacks. On Tuesday, it issued Statement No. 145, which updates, clarifies, and simplifies existing accounting pronouncements.

The statement, known in some circles as Rescission of FASB Statements No. 4, 44, and 64, Amendment of FASB Statement No. 13, and Technical Corrections, revisits the accounting for gains and losses from the extinguishment of debt.

“This was particularly important to those operating in the secondary lending market,” said Cathy Coburn, project research associate at FASB, “because the use of debt extinguishment is a part of their day-to-day risk management activities, and Statement 4, issued in 1975, no longer addressed the needs of a changed marketplace.”

The particulars: Statement 145 rescinds Statement 4, which required all gains and losses from extinguishment of debt to be aggregated and, if material, classified as an extraordinary item, net of related income tax effect. As a result, the criteria in Opinion 30 will now be used to classify those gains and losses. Statement 64 amended Statement 4, and is no longer necessary because Statement 4 has been rescinded, noted FASB.

Statement 44 was issued to establish accounting requirements for the effects of transition to the provisions of the Motor Carrier Act of 1980. “Because the transition has been completed, Statement 44 is no longer necessary,” announced FASB.

Statement 145 amends Statement 13 to require that certain lease modifications that have economic effects similar to sale-leaseback transactions be accounted for in the same manner as sale-leaseback transactions. “This amendment is consistent with the FASB’s goal of requiring similar accounting treatment for transactions that have similar economic effects,” added FASB. The standards board also noted that the statement makes technical corrections to existing pronouncements.

There will be a quiz on this tomorrow.

More Andersen Defections

Deloitte & Touche and Ernst & Young were the big winners yesterday in the continuing client exodus from Arthur Andersen.

Deloitte scooped up three big accounts: Ohio energy company Cinergy; Kaiser Aluminum Corp. and its wholly-owned subsidiary, Kaiser Aluminum & Chemical Corp.; and chemical producer Stepan Co.

Stepan management said Andersen had been the company’s auditor since 1958.

E&Y signed on Merrimac Industries Inc. and Acuity Brands Inc., which was spun off from National Service Industries Inc. last November. National Service has used Andersen as its independent auditor since 1964.

Drop in Tech Spend Hurts KPMG

KPMG Consulting reported that earnings fell 20 percent, to $23.7 million (or 15 cents per share), in the company’s fiscal 2002 third quarter. The numbers matched Wall Street analyst estimates, however. Revenues fell 22 percent, to $582.3 million, from the comparable period a year ago. The company noted that revenue generated by its public-services business unit remained strong. But gains there were offset by declining revenue in the consultancy’s financial-services and high-technology businesses.

(To see how the Big Five firms stack up in revenues and lines of practice, click here.)

Short Takes

>>Advanta CFO Philip Browne was awarded a $1.77 million bonus in 2001. All told, Browne earned $2.6 million last year.

>> Conseco CFO Charles Chokel received a $541,154 salary and a $1 million bonus in 2001. That’s quite a jump from the $600,000 he made the previous year.

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