The Next Accounting Controversy

Standard-setters have moved on from fixing fair-value rules and have set their sights on off-balance-sheet accounting and loan-loss provisioning.

Revisions to how companies account for off-balance-sheet items and loan-loss provisions will knock fair-value accounting off the front page with respect to financial reporting, according to James Kroeker, acting chief accountant at Securities and Exchange Commission.

Further, new guidance on these topics set to be released by the Financial Accounting Standards Board and the International Accounting Standards Board will “change the financial-reporting landscape,” he told the audience during an industry conference today.

Regarding off-balance vehicles, Kroeker expects this type of structured finance  to continue to evolve but believes the elimination of qualified special purchase entities — or QSPEs — and forthcoming guidance will go a long way to change the sometimes questionable nature of off-balance-sheet activity by requiring companies to focus on the true economic substance of transactions. FASB recently ousted the concept of a QSPE from U.S. accounting literature and its reworking of FAS 140 and FIN 46(R) for new guidance to be released later this year.

Kroeker, who was speaking at a financial-reporting conference sponsored by Baruch College, noted that the key issue regarding off-balance sheet accounting stems from corporate balance sheets that have been weighed down by underperforming assets, such as subprime mortgages.

He also pointed out that guidance being prepared by FASB and IASB related to FAS 140 and FIN 46(R) focuses on control issues. Specifically, the aim of the guidance will, among other things, be to eliminate the appearance that there is joint control of off-balance-sheet assets when in reality, the original owner retains the risk.

Without the QSPEs, the off-balance-sheet vehicles that gave banks and other companies a way to keep securitized assets off their balance sheets, banks and others will have to absorb the hidden losses. Changes to FIN 46(R) will provide new, more stringent criteria for when banks are allowed to transfer ownership of securitized assets and liabilities.  

Also at the conference, FASB chairman Robert Herz said that “faithful application of the standards” — and not just the new guidance — will repair some of the market volatility caused by off-balance-sheet shenanigans. He cited the “mythical” QSPE and how banks stretched and abused the associated rules.

With respect to accounting for loan losses, new FASB guidance will likely call for companies to disclose the economics of the transaction and record the early capture of losses.

Herz also said he remains “passionate” about his “labor of love” — the move toward international financial reporting standards. However, he does not favor “the early option” the SEC has floated for U.S. companies to adopt the global rules over U.S. generally accepted accounting principles. Instead, he said, more work needs to be done by FASB, the SEC, and the Public Company Accounting Oversight Board, which sets auditing rules, before American companies can adopt IFRS.

Some of the issues they’ll need to resolve include how private companies will implement IFRS, tax reporting, and a cost-benefit study for making such a move. The SEC is considering comments made on its proposed timeline for moving all U.S. publicly traded companies to IFRS by 2016, and FASB and IASB have been working to meld their rules by 2011.

Moreover, Herz alluded to the international standard-setter’s funding and oversight structure, which has been tested by politics in recent months. “If the U.S. is going to ride the IFRS horse, we have to make sure the IASB horse is stable,” Herz said. 

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