New Bookmarks
Year 2009 Quarter 2:  April 1 to June 30 Additions to Bob Jensen's Bookmarks
Bob Jensen at Trinity University

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

Choose a Date Below for Additions to the Bookmarks File

June 30

May 31

April 30

March 31

February 28

January 31  

June 30, 2009

Bob Jensen's New Bookmarks on  June 30, 2009
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 Box in Upper Right Corner.
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.

Cool Search Engines That Are Not Google --- http://www.wired.com/epicenter/2009/06/coolsearchengines

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

Federal Revenue and Spending Book of Charts (Great Charts on Bad Budgeting) ---
http://www.heritage.org/research/features/BudgetChartBook/index.html

The Master List of Free Online College Courses --- http://universitiesandcolleges.org/

Free Online Textbooks, Videos, and Tutorials --- http://www.trinity.edu/rjensen/ElectronicLiterature.htm#Textbooks
Free Tutorials in Various Disciplines --- http://www.trinity.edu/rjensen/Bookbob2.htm#Tutorials
Edutainment and Learning Games --- http://www.trinity.edu/rjensen/000aaa/thetools.htm#Edutainment
Open Sharing Courses --- http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI
The Master List of Free Online College Courses --- http://universitiesandcolleges.org/

Bob Jensen's threads for online worldwide education and training alternatives ---
http://www.trinity.edu/rjensen/Crossborder.htm

"U. of Manitoba Researchers Publish Open-Source Handbook on Educational Technology," by Steve Kolowich, Chronicle of Higher Education, March 19, 2009 --- http://chronicle.com/wiredcampus/index.php?id=3671&utm_source=wc&utm_medium=en

Social Networking for Education:  The Beautiful and the Ugly
(including Google's Wave and Orcut for Social Networking and some education uses of Twitter)
Updates will be at http://www.trinity.edu/rjensen/ListservRoles.htm

Humor Between June 1 and June 30. 2009
http://www.trinity.edu/rjensen/book09q2.htm#Humor063009  

Humor Between May 1 and May 31, 2009 ---
http://www.trinity.edu/rjensen/book09q2.htm#Humor053109    

Humor Between April 1 and April 30, 2009 ---
http://www.trinity.edu/rjensen/book09q2.htm#Humor043009   

Humor Between March 1 and March 31, 2009 --- http://www.trinity.edu/rjensen/book09q1.htm#Humor033109  

Humor Between February 1 and February 28, 2009 --- http://www.trinity.edu/rjensen/book09q1.htm#Humor022809   

Humor Between January 1 and January 31, 2009 --- http://www.trinity.edu/rjensen/book09q1.htm#Humor01310

If a man's poor and not a bad fellow, he's considered worthless; if he is rich and a very bad fellow, he's considered a good client.
Titus Maccius Plautus, 255 BC to 185 BC

100 Greatest Discoveries in Physics --- http://www.documentary-log.com/d281-100-greatest-discoveries-physics/
Most were important enough to be authenticated before being considered worthy discoveries

Question
Is empirical accounting research just fun and games generating outcomes not worth authenticating?

June 17, 2009 message from Richard.Sansing [Richard.C.Sansing@TUCK.DARTMOUTH.EDU]

On Jun 17, 2009, at 9:55 AM, Ron Huefner wrote:

> > > I'm disturbed by the tone of this discussion, implying that most of > accounting research/publication is just a big game.

I think it is fair to say that some members of this group view accounting research as a game, and a rigged one at that. Other members of this group do not share that view. Keeping these different perspectives in mind is helpful when trying to make sense of the discussion.

Richard

June 17, 2009 reply from Bob Jensen

Hi Richard,

I think you're correct Richard, but until academic accountics researchers and their leading journals begin to take replication more seriously, it's very hard to believe in non-replicated harvests of accountics research. Those that are truly serious about accounting research must become more serious about authenticating accounting research.

Perhaps it would seem less of a game if independent researchers took the trouble to replicate findings. On occasion there are some replications (such as the verification of Eric Lie's stock options backdating research), but publication of replications is indeed rare.

It's time for editors of TAR, JAR, JAE, and other leading journals to change their publication policies on replication studies --- http://www.trinity.edu/rjensen/theory01.htm#Replication 

Bob Jensen

June 17, 2009 reply from Paul Williams [Paul_Williams@NCSU.EDU]

On 17 Jun 2009 at 9:55, Ron Huefner wrote:

> I'm disturbed by the tone of this discussion, implying that most of > accounting research/publication is just a big game. It seems to demean our
> efforts in a Pogo-like way (we are being our own worst enemy if we don't
> respect our own work). Does some game-playing occur? Undoubtedly. Is it
> the norm? I don't think so (though it's always possible that I'm naive and
> out-of-touch)

A Pogo-like way is healthy because Pogo was thoughtful enough to face some realities. I have done considerable work on the structure of the US academy (as has Bob) and the way Bob characterizes it is closer to the truth -- when work deserves to be disparaged, intellectual honesty compels us to disparage it. At an AAA meeting a number of years ago I listened to an editor of one of our most prominent US accounting journals offer the following alternative hypothesis to the one that the academy was structured to advance accounting knowledge: "We have constructed a game to identify who the cleverest people are so we know who to give the money to."

The research on the structure of our academy, if viewed with an open, Pogo-like mind suggests that this alternative hypothesis is more credible than one of being honestly engaged in understanding (if that were the case our research would not be almost entirely structured as tests of conventional economic theories that are constructed not be testable).

I have served numerous times on our university's promotion and tenure committee. I chaired it this past year. I have reviewed the dossiers of people from many disciplines. In the process I have learned quite a bit about the cultures of other disciplines. The discussion about multiple authors, which is the rule in the hard sciences (sometimes there are literally dozens of them), is an interesting contrast. Those disciplines have developed protocols on the order of author listing (it isn't alphabetical) that reflects the relative contributions of the authors to the project.

I've seen people denied tenure because they were not the "lead" author on enough papers. It is a system that is self-reinforcing. Is it abused? Sure, what one isn't, but it seems to work reasonably well. Accounting has no such protocol. At my shop we have reached the point where the same credit is given to a person on a three-author paper as is given to a person with a single authored paper. Without the protocol that exists in the natural sciences on credit for multiple authors, there is little other way to describe our process as other than a game.

Another protocol in the laboratory or bench sciences is the maintenance of a lab journal. You can always spot a lab scientist at our faculty senate meetings because they are the people taking notes in a bound journal (a diary). Because replication is crucial to science, there is a moral imperative that an experimental scientist keep a precise record of each step in the experimental process. He or she must provide the exact recipe so that any scientist is able to produce the result. (One of the most interesting studies of the sociology of science involved the lab journals of Millikin reporting his various iterations of the oil-drop experiment; guess which ones he published -- you guessed it -- the ones most consistent with his prior beliefs.

Without those lab journals, this knowledge would be lost forever). Most of the work published in our leading accounting journals is laboratory work (accountics, as Bob describes it). Data are gathered (usually selected from a publicly available data source) and all manner of choices are made by the experimenter in conducting the experiment before the final published result is obtained. For example, do we know what truncation decisions were made or how many different models were run before the published one arose? But we have no requirement that the experimenter keep a detailed log of all of these choices. We have to rely on the recipe given in the article itself, which is seldom sufficient to replicate what was actually done.

When Bill Cooper suggested that the AAA require authors publishing in TAR to provide their data (not their logs, because they don't have them) to the public, our noted accounting scientists screamed bloody murder. We still have only a voluntary disclosure policy. If we were truly serious about learning something from our work, we would mandate that sufficient information be provided to allow anyone to replicate the experiments before we publishe the results. That we don't do that may say something about us.

For the interested: Adil E. Shamoo and David B. Resnik, Responsible Conduct of Research, 2003, Oxford University Press. I took a course in this taught by one of NC State's philosophers. There is a huge literature on appropriate research conduct in the sciences (social and natural). In accounting there is practically none. For a discipline whose alleged expertise is "controls" we have virtually none over the research process. Guess we are all saints.

Paul Williams paul_williams@ncsu.edu
(919)515-4436

June 17, 2009 reply from Roger Collins [rcollins@TRU.CA]

Paul,

Thanks for an excellent post. For those interested, the Shamoo and Resnik text you mention is now into its second edition

Adil E. Shamoo and David B. Resnik, Responsible Conduct of Research # Paperback: 440 pages # Publisher: Oxford University Press; Second Edition edition (Feb 24 2009) # Language: English # ISBN-10: 019536824X # ISBN-13: 978-0195368246

Roger

Roger Collins
TRU School of Business & Economics

June 20, 2009 reply from David Albrecht [albrecht@PROFALBRECHT.COM]

To be clear about what I think (as if anybody cares), I think that a substantial amount of game playing takes place, but accounting research itself does not need to be characterized as a game. I believe that (1) there are many incentives to manipulate the system for personal gain, (2) many accounting professors participate in the system and play games because they are forced to participate and game playing seems to be efficient and effective, and (3) there are enough ethically challenged amongst the accounting professoriate to justify a general world view of skepticism.

Dave Albrecht

June 20, 2009 reply from Bob Jensen

Hi David,

I wish I could repeat some private messages I'm receiving from accounting professors about (ratting?) how some of their colleagues are gaming the research/publishing system.

Most mention a 99-1 model or its near-equivalent. Others mention the 98-1-1 model. The worst is a message revealing a 94-1-1-1-1-1-1-model.

Of course I believe many, probably most, joint authoring efforts are legitimate for reasons astutely mentioned by Ron Huefner. But there also is a lot a gaming going on.

Paul Williams notes that at every juncture empirical accounting researchers make subjective decisions that make it almost impossible to truly replicate outcomes. In a private message he notes that a top researcher (who chaired a lot of doctoral dissertations) made an on-campus presentation in which he admitted to 16 times in his research study being presented where he made decisions that would've made it virtually impossible to independently replicate his work. The source of the data was a commercial database that can be purchased by anybody, but it alone would not have been sufficient for research outcomes authentication.

It would seem that if the top research journals announced a change in policy and invited submissions of research replications there might be few submissions that actually authenticate earlier published outcomes. Until accounting researchers commence keeping "lab journal" (and making them available to teams of authentication researchers) I doubt that there will be serious replication of empirical academic accounting research. Until then we must, in the words of Paul Williams, regard our empirical accounting researchers as "saints."

What's more disheartening are reports of failed efforts to replicate the empirical results of some of the AAA's Seminal and/or Notable contributions award winners. The makes me wonder if another type of gaming (selectively massaging of data) is going on at the highest level of prestige in academic accounting research.

Bob Jensen

June 20, 2009 reply from Jagdish Gangolly [gangolly@GMAIL.COM]

Bob,

1. Free ridership should bother the culprit more than the rest. The culprit will establish a reputation and soon the number of people willing to collaborate with the person will dwindle.

Unless of course, the person also establishes reputation as a saint. I have heard of many free-riding saints in accounting.

2. I think requiring publicly disclosed lab journal is a very good idea. I also favour replications, provided the design of each original as well as replicated study is authenticated by a statistician and a domain expert (economics, finance, psychology,...). Some adult supervision may not be a bad idea if we are unwilling to seek collaborations with other disciplines.

3. I personally believe a good solution for accounting is a Darwinian one: Shut down all establishment journals and let the "market" decide. The fittest results will survive in the long run. Establishment journals are riddled with moral hazard in the absence of observability and replications. This solution will also prevent the development of ayatollahs pretending to be editors and referees. (Of course there are many good editors and referees, but they are, in my opinion exceptions). Sunshine is a good disinfectant.

I say the above in spite of the fact that my own personal experience has not been that bad (most papers I chose to send to accounting journals were accepted, but many of the inane comments even on papers accepted and the fact that some were accepted in spite of their mediocrity drive me to this conclusion).

Regards,

Jagdish S. Gangolly
Department of Informatics College of Computing & Information
State University of New York at Albany Harriman Campus,
Building 7A, Suite 220
Albany, NY 12222
Phone: 518-9568251

 

Bob Jensen's threads on the history what's wrong with academic accounting research are at 
http://www.trinity.edu/rjensen/395wpTAR/03MainDocumentMar2007.htm 

FASB Codification Database Supersedes All FASB Standards

Countdown to Codification Alert:  FASB Alert #4, 5-22-09

What happens to U.S. GAAP literature when the Codification goes live on July 1, 2009?
All existing standards that were used to create the Codification will become superseded upon the adoption of the Codification.  The FASB will no longer update and maintain the superseded standards. Also, upon adoption of the Codification, the U.S. GAAP hierarchy will flatten from five levels to two­authoritative and non-authoritative.  The following table illustrates the result:

 
DON’T BE CAUGHT OFF GUARD!  GET READY FOR THE CODIFICATION!
 
The FASB is expected to institute a major change in the way accounting standards are organized. The FASB Accounting Standards Codification^TM is expected to become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (GAAP).   After final approval by the FASB only one level of authoritative GAAP will exist, other than guidance issued by the Securities and Exchange Commission (SEC). All other literature will be non-authoritative.
 
While the FASB Codification is designed to make it much easier to research accounting issues, the transition to use of the Codification will require some advance training.  These weekly “Countdown to Codification” alerts are designed to provide tips to make that transition easier.
 
The FASB offers a free online tutorial at http://asc.fasb.org.  A recorded instructional webcast­The Move to Codification of US GAAP, first presented live on March 13, 2008­also is available at http://www.fasb.org/fasb_webcast_series/index.shtml. In addition, Codification training opportunities are offered through professional accounting organizations such as the American Institute of Certified Public Accountants (AICPA).

As of June 20, 2009 there is still some question whether faculty, students, and colleges will get the a free deal on the $150 basic version or the $850 professional version that includes cross referencing.

The following message was forwarded by David Albrecht on June 16, 2009

From: "Tracey E. Sutherland" <traceysutherland@aaahq.org>
Organization: American Accounting Association
Date: Tue, 16 Jun 2009 17:25:23 -0400

FAF and AAA to Provide FASB Codification to Faculty and Students

On July 1, 2009, the Financial Accounting Standards Board (FASB) is instituting a major change in the way accounting standards are organized. On that date, the FASB Accounting Standards Codification™ (FASB Codification) will become the single official source of authoritative, nongovernmental U.S. generally accepted accounting principles (U.S. GAAP).  After that date, only one level of authoritative U.S. GAAP will exist, other than guidance issued by the Securities and Exchange Commission (SEC).  All other literature will be non-authoritative.

As part of its educational mission, the Financial Accounting Foundation (FAF), the oversight and administrative body of the FASB, in a joint initiative with the American Accounting Association (AAA), will provide faculty and students in accounting programs at post-secondary academic institutions with the Professional View of the online FASB Codification.

Accounting Program Access—No Cost to Individual Faculty or Students
The Professional View of the FASB Codification will be accessible at no cost to individual faculty and students, through the AAA’s Academic Access program, available to Registered Accounting Programs.  The Professional View will provide advanced search functions with special utilities to assist in the navigation of content, representing the fully functional view of the FASB Codification that will be used by auditors, financial analysts, investors, and preparers of financial statements.  All of the features that have been available with the verification version currently at http://asc.fasb.org are included with the Professional View.
AAA Academic Access

The AAA will provide direct services to accounting departments through its Academic Access program; issuing authentication credentials for faculty and students through Registered Accounting Programs, at a low annual institutional fee of $150.  Information about this program will be forthcoming directly from AAA and on the AAA website at http://aaahq.org/FASB/Access.cfm.

Transitional Access—From July 1 through August 31, 2009
The AAA will provide credentials to individual faculty and students, at no charge, during the transition period before the beginning of the fall semester when faculty and students will receive credentials for access through their Registered Accounting Programs.

The FAF, FASB, and AAA are enthusiastic about this new initiative and understand the value of this program to accounting education and scholarship, in addition to its benefit to faculty and students to have access to the advanced view of U.S. GAAP that will be used by accounting professionals.


******************
This advertisement was sent to you from the American Accounting Association. This message includes valuable information about upcoming events hosted by the American Accounting Association. If you no longer want to receive email announcements from us, please send an email to office@aaahq.org with "EMAIL OPT-OUT" in the subject line.
American Accounting Association | 5717 Bessie Drive | Sarasota, FL 34233-2399 | Phone: (941) 921-7747 | Fax: (941) 923-4093 | Office@aaahq.org

The FASB home page is at http://www.fasb.org/home

June 24, 2009 Update
There was some doubt initially about whether the free or discounted faculty and student access version of the FASB Codification database would be the "Professional" version (that includes searching and cross-referencing at an $850 single user license per year).

The AAA registration site for the discounted ($150 annual discount price) version makes it clear that accounting education departments or schools will get the full "Professional" version at a discount, thereby saving each academic program $700 per year savings per license. What is not yet perfectly clear is whether this is a single-user access license. My reading is that multiple users within a department or school can use the Codification database at the same time. I could be wrong.

The AAA program enrollment site for this discounted version is http://aaahq.org/FASB/Access.cfm 
The form is at https://aaahq.org/AAAforms/FASB/enroll.cfm

Since all future financial statements will no longer reference hard copy sources like FAS 166 or EITF 98-1 or FIN 48, it is vital for students and teachers and researchers to have access to the Codification database for financial statement analysis.

Reasons why registration for the Codification database is important are given at http://www.cfo.com/article.cfm/13854787/c_2984368/?f=archives
Also see http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

June 25, 2009 Update
Bad News
The AAA program enrollment site for this discounted version is http://aaahq.org/FASB/Access.cfm 
 The form is at https://aaahq.org/AAAforms/FASB/enroll.cfm
And if a college library pays $850 for a license, the Codification database can only be used by one user at a time.

Good News
An Accounting Education Department’s $150 license can be used by multiple faculty members and students simultaneously, which is indeed good news.

It’s not yet clear how an accounting department will facilitate multiple-user access, but I guess we will learn that very soon. For example how can students and faculty off campus access the $150 professional version of the Codification database.

Reasons why a Department’s enrollment for the Codification database is important are given at http://www.cfo.com/article.cfm/13854787/c_2984368/?f=archives

Codification:  Dumb! Dumb! Dumb!

Codification of the FASB standards, interpretations, and other hard copy FASB documentation into a searchable "Codification" database, like the road to hell, is paved with good intentions. Bits and pieces of hard copy dealing with a given topic are scattered in many different hard copy FASB references and bringing this all together in newly coded Codification numbered sections and subsections is a fabulous "paving" idea.

FASB News Release --- Click Here

Just to see how important this is for accounting and finance students as well as faculty, go to
http://www.cfo.com/article.cfm/13854787/c_2984368/?f=archives

Also see http://www.journalofaccountancy.com/Web/July1Codification

And see http://www.journalofaccountancy.com/Web/Codification

At least Codification of FASB hard copy was a great "paving" idea until it became evident that FASB standards most likely will be entirely replaced by IASB international standards (IFRS). It's still uncertain when and if IFRS will replace the FASB standards, but recent events in Washington DC suggest that the transition will most likely happen at the end of 2014. This means that millions of dollars and millions of professional work time hours by accountants, auditors, educators, and financial analysts will be spent using the FASB's new Codification database that commenced on July 1, 2009 and will most likely self destruct on December 31, 2014. As I indicated, when and if IFRS will take over is still uncertain and controversial, but I'm betting the shiny new FASB Codification database will self destruct in 2014 --- http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

As a result of scheduled obsolescence, what commenced as a Codification smart idea became dumb and dumber in 2009.

Furthermore, the Codification database has some huge limitations because it contains only a subset of the FASB hard copy material that it ostensibly is replacing.

• FASB hard copy contains many wonderful illustrations that are, in my viewpoint, ideal for learning about standards and their interpretations. In fact many of the illustrations make FASB standards much easier to learn than IFRS international standards that are illustration-lite. Sadly many of the best FASB hard copy illustrations were left out of the Codification database such that these illustrations cannot be located by search and cross referencing. For example, when teaching the highly complicated FAS 133, the most important teaching aids for my students were the illustrations in Appendix A and Appendix B of FAS 133. Most of those wonderful illustrations are not in the Codification database which, in turn, makes it much less useful to accounting and finance educators. Dumb! Dumb! Dumb!
   
• FASB hard copy contains much implementation guidance for complicated questions raised by auditors and their clients, guidance that is not contained or even cross-referenced  in the Codification database. The huge example here is the massive amount of implementation guidance for FAS 133 rendered by the FASB's Derivative Implementation Guidance Group (DIGG) --- http://www.fasb.org/derivatives/
  The many DIGG documents are difficult to search and cross reference. Including them in the Codification database would be terrific --- no such luck. Dumb! Dumb! Dumb!
   
• Financial accounting textbooks, lecture materials, handouts, problem assignments, and cases do not at the moment reference the Codification database sections and subsections. Since corporate annual reports, at least for the next five years, will now have Codification database referencing rather than hard copy referencing, textbook publishers and educators will have to revise all these materials. Textbook publishers are probably ecstatic since all used books will be obsolete. Educators are not so ecstatic about revising so much of their own teaching material Furthermore, the financial accounting textbooks used in the 2009-2010 academic year will be obsolete. Dumb! Dumb! Dumb!
   
• As Pat Walters pointed out, the Codification database does not include the Conceptual Framework hard copy. This means that the Conceptual Framework cannot be searched and cross referenced in the Codification database. Dumb! Dumb! Dumb!
   
• The auditing standards make thousands upon thousands of references to FASB hard copy references. These will have to be changed to Codification database references until the Codification database self destructs. Dumb! Dumb! Dumb!
   
• Accounting firms their clients will have to change vast amounts of materials to incorporate new Codification database referencing. For example, PwC will have to spend millions of dollars overhauling its massive Comperio database and for what? All this time and effort will have been wasted when the Codification database self destructs in about five years. Dumb! Dumb! Dumb!
   
• Accounting firms and their clients will have to spend a lot of time and money training employees on how to use the Codification database that will self destruct in about five years --- Dumb! Dumb! Dumb!
   
• Accounting software and millions of relational databases of accounting data will have to be revised for Codification database referencing. And the revised software will be useful for less than four years of use.  Dumb! Dumb! Dumb!
   
• NASBA will have to revise future CPA examinations for referencing to Codification database referencing. But when should these revisions take place since virtually none of the financial accounting textbooks will have such referencing for at least a year and maybe more? As far as the CPA examination, the classes graduating in 2010 and 2011 will not have had textbooks that incorporated the Codification references. It seems a little unfair to hit candidates with a different referencing system than was in their textbooks. Dumb! Dumb! Dumb!
   
• This year early adopters of XBRL who tagged their financial statements with FASB hard copy references will be putting out obsolete XBRL tagging. All the U.S. standard XBRL tagging software and financial analysis software will have to be rewritten --- http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives
  And it will be written for less than four years of use.  Dumb! Dumb! Dumb!
   

• I’ve been using the Codification database rather intensively on a FAS 133 project since it became available. I can’t tell you how disappointed I am in content of the database, the lousy illustrations, and the poor search engine. The IASB search engine is vastly superior. Dumb! Dumb! Dumb!
   

• The FASB will allow free access to the Codification database. But the search and cross referencing software is only available for a single-user license costing $850 per year. What makes electronic databases useful are the utilities for search and cross referencing. Hence the FASB will be raking in millions of dollars for a database that self destructs in about five years. Smart? Smart? Smart?
  The only good news is that college accounting departments can obtain multiple-user licenses for faculty and students at a discounted $150 price. As an accounting educator should I say thanks, but I have a hard time saying thanks for something that is dumb, dumb, and dumb.
  
  I'm told that the Codification database was mostly paid for with government SOX grants. If it was bought and paid for by the government, why does the FASB need to rake in millions more for the Codification database search and cross referencing utilities? This is especially bothersome since the FASB itself will probably give way to the IASB in just a few years. When that happens the money and intellectual capital we put into the FASB Codification database all goes down the drain. Dumb! Dumb! Dumb!

So what would've been smart for the FASB at this juncture?
Since the FASB is taking it as a given that it will virtually be out of business in 2015 (actually it will become a downsized subsidiary of the IASB). The FASB should forget implementation (selling) the FASB Codification database and commence full bore into expanding it into an IASB Codification database. Then it will be ready to roll in 2015 when the IASB standards replace the FASB standards. FASB standards could be left codified as well such that users can easily compare what used to be required by the FASB with what is now (after 2015) required by the IASB.

More importantly, the FASB should work 24/7 adding implementation guidelines and illustrations into an IASB Codification database to make up for the sad state of international standards in terms of implementation guidelines for complex U.S. financial contracting. Tons of illustrations should also be added to the illustration-lite international standards at the moment.

But implementing the FASB Codification database for five years or less is dumb, dumb, and dumb!

"I'm glad I'm not young anymore."

June 28, 2009 reply from Louis Matherne [matherne@OPTONLINE.NET]

Bob,

I don't agree with the following...

"... This year early adopters of XBRL who tagged their financial statements with FASB hard copy references will be putting out obsolete XBRL tagging. All the U.S. standard XBRL tagging software and financial analysis software will have to be rewritten..."

While there will undoubtedly be some impact to the current USGAAP taxonomies, I expect it to be minimal. The references that are currently in the taxonomy are largely in sync with their codification replacements as the FAF and XBRL US have been working on this expected transition for some time.

From a mechanical point of view it will be a fairly simple exercise to "slip stream" in the codification references.

Louis

June 28, 2009 reply from Zane Swanson [ZSwanson@UCO.EDU]

Askaref (which I developed with 2 others) is designed for handheld internet devices to do that cross-referencing between line item accounts, XBRL tags, and GAAP references (FASBs, etc). Having gone through the database machinations to make this function work, I would say that effort is nontrivial, but not rocket science. Until I see what a official release of the XBRL tagging for the Codification, I would suggest that blanket statements are premature about the ease to “slip stream” references or the rendering of databases as useless. In any event, it will make users and support individuals mad if this feature is delayed … like the Boeing 787 dreamliner (the launch date keeps getting delayed and there is a corresponding loss of value). With respect to XBRL tagging errors being generated by the inclusion of Codification, it is difficult to get into the mind of the user/preparer who is selecting the “best match” of a XBRL tag with an accounting line item. I do agree that referencing the appropriate GAAP is critical in order to select the “best match” of an XBRL tag. If this referencing activity is made more difficult or has incomplete links, then it is logical that more errors will occur.

With regard to textbooks, one fix that I have seen is a cross reference table which lists textbook pages and their FASB references with the Codification references. Hardly elegant, but it works.

Zane Swanson

June 28, 2009 reply from Bob Jensen

Hi Louis

I was influenced by the following quotation that does not make it sound so slip stream and mechanical as firms struggle to update the XBRL tags:

Any company with a scheduled filing date before July 22 for a quarter ending June 15 or later can opt to file its report using the out-of-date 2008 taxonomy. The SEC, though, is encouraging filers to use the current set of data tags. To accommodate that request, a company with a line item affected by new FASB literature will have to create its own extensions to the core taxonomy. Not only would that require extra effort by companies, Hannon lamented that "a bunch of rogue XBRL elements" not formed the same way from company to company would inevitably hinder analyses of the effect of FASB's new pronouncements on financial statements.
David McCann, "Speed Bumps for Early XBRL Filers, Users," CFO.com, June 26, 2009 ---
http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives

I hope you are correct because it will be a race to update all the tagging software and implement these tags in corporate annual reports before the FASB Codification archive database self destructs.

Another problem is that companies that are affected by FAS 133 often refer to DIGG documents that will not be updated for Codification references. This could lead to rather confusing outcomes where a footnote quotation from a DIGG refers to Paragraph 243 of FAS 133 and the XBRL tag refers to Section 8-15-38 of the Codification database that is not part of the DIGG document.. It will be especially troublesome with FAS 133 since there is so much FAS 133 hard copy that was left out of the Codification database such that searches and references of the database cannot even find many hard copy references originally issued by the FASB.

I don't think it's as easy as you make it sound and for what purpose with an archival database that will most likely self destruct in such a relatively short period of time?

Thanks,
Bob Jensen

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

Bob Jensen's free tutorials on FAS 133, IAS 39, and DIGG pronouncements are at
http://www.trinity.edu/rjensen/caseans/000index.htm 

From IAS Plus on June 3, 2009 --- http://www.iasplus.com/index.htm
July 3 and July 6 Webcasts on IAS 39 Replacement

On Friday 3 July 2009 and again on Monday 6 July 2009, the IASB will host two live webcasts to keep interested parties up to date on progress of the IASB's comprehensive project to replace IAS 39. The webcasts will focus on the Board's recently published Request for Information on the feasibility of an expected loss model. The webcasts will include presentations by two IASB project staff people followed by a Q&A session where registered participants can send in questions for the IASB staff to answer. Each webcast, including the question and answer session, is expected to last around one hour. Details of the webcasts:

• Webcast Topic: Project to comprehensively review IAS 39 – Expected loss impairment model
• Date and Time - First Webcast: Friday 3 July 2009 10:00am (London time)
• Date and Time - Second Webcast: Monday 6 July 2009 3:00pm (London time)
• Presenters: Sue Lloyd, Senior Technical Consultant and Martin Friedhoff, Project Manager
• More Information and Registration
• Project Page on IASB Website
• Project Page on IAS Plus

 

Questions
Didn't anybody think that the FASB's new Codification transition would render XBRL markups obsolete even before they got off the ground? What about financial accounting textbooks for next year and the CPA examination?

Answer
I'm certain somebody thought about it, but nobody wanted to shut off this train smoke on the Codification transition commencing July 1, 2009

There is also the issue that virtually all financial accounting textbooks purchased by students for the 2009-2010 academic year will be obsolete (I suspect). Such is life in the fast lane. When will the CPA examination gulp down the Codification references?

And the Codification transition in 2009 is such a spike in cost and confusion given that it will probably itself be obsolete around 2014 or thereabouts when it is replaced by IFRS. Such is life in the fast lane where CEP providers and software writers and publishers are singing (the stink being train smoke as standard setters railroad in the changes on express trains):

Ca-chink, ca-chink,
We're getting rich on all this stink!"

"Speed Bumps for Early XBRL Filers, Users," by David McCann, CFO.com, June 26, 2009 ---
http://www.cfo.com/article.cfm/13932485/c_2984368/?f=archives

A solution is said to be coming soon to a thorny technical issue that had threatened to temporarily render electronic financial reports tagged in eXtensible Business Reporting Language less useful than had been hoped.

The source of the problem is the Financial Accounting Standards Board's new codification of accounting standards, which is set to take effect July 1. One key advantage of XBRL-prepared electronic reports is that each data-tagged line item displays references to the accounting and regulatory rules applicable to that item. That gives users of the financial statements valuable context for the reported number.

But the current XBRL taxonomy — that is, the set of tags corresponding to the line items — aligns with the pre-codification organization of the FASB literature. That means that as of July 1, users of data-tagged reports will see references to standards that don't match up with the new codification. A new taxonomy incorporating references to the newly codified accounting rules is not expected to be released until early 2010.

Neither FASB nor the non-profit entity that is working to establish XBRL as a financial reporting format in the United States had announced whether or when a temporary fix for the problem would be made available. But yesterday, Mark Bolgiano, chief executive of XBRL US, told CFO.com that one would be ready in July. The two organizations are working together, he said, to create an extension to the existing 2009 taxonomy that will display the references correctly.

FASB, though, hedged a bit on the July timeframe. A spokesperson told CFO.com that the accounting standards board is "shooting" to have the fix ready by the end of the month, but there is no specific scheduled date.

Even a short delay could affect investors, banks, and other users of financial statements filed by any of the 500 largest public companies with fiscal periods ending June 30 — that is to say, most of them. And to the extent there is any confusion about the accounting underlying the information in the reports, it could, of course, could cause some communications problems for finance executives. The Securities and Exchange Commission earlier this year required those 500 companies to file financials using XBRL for periods ending June 15 of this year and later. (About 1,800 more companies have to do so starting with quarters concluding on or after June 15, 2010, with the rest following a year after that.)

In fact, a late-July or later release of the fix would likely mean that most of the first wave of XBRL filings — after those by a small group of voluntary early adopters that included Microsoft and Pepsico — would contain the incorrect references, according to Neal Hannon, senior consultant for XBRL strategies at The Gilbane Group, an information technology consulting firm.

Everybody involved in the production of financial reports, Hannon said, including software companies and financial printers, will need some time to understand the solution and make sure it's compatible with their products, before companies can begin to prepare financials containng references to the codification accounting standards.

Still, Hannon called the forthcoming solution "great news," saying he had been concerned for months that the necessary programming might not prove doable, at least in a reasonable time frame. He characterized XBRL-tagged financial reports without references to the current underlying accounting literature as unacceptable. "What would be the point?" he said.

Even if the fix were delayed, financial-report users would still be able to locate the accounting standards relating to specific line items, according to Tom Hoey, FASB's codification project director. The board's codification website contains a tool that cross-references the old organization of generally accepted accounting principles with the new one. "It's not as though people have to be completely lost," Hoey said, but added, "they might find it more cumbersome for a short period."

Indeed, Hannon noted that a user would have to run two programs simultaneously, switching back and forth between an XBRL software reader and the cross-reference tool, which he said would be somewhat unwieldy when performing robust analyses of financial statements.

Meanwhile, there is another speed bump for the early days of XBRL filings: The SEC's Edgar filing database will not be ready to accept data-tagged reports using the 2009 taxonomy, containing several FASB rules and interpretations published this year, until July 22.

Any company with a scheduled filing date before July 22 for a quarter ending June 15 or later can opt to file its report using the out-of-date 2008 taxonomy. The SEC, though, is encouraging filers to use the current set of data tags. To accommodate that request, a company with a line item affected by new FASB literature will have to create its own extensions to the core taxonomy. Not only would that require extra effort by companies, Hannon lamented that "a bunch of rogue XBRL elements" not formed the same way from company to company would inevitably hinder analyses of the effect of FASB's new pronouncements on financial statements.

Continued in article

Bob Jensen's XBRL threads (and free tutorial videos) are at
http://www.trinity.edu/rjensen/XBRLandOLAP.htm

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

"The Best Online Tools (software, services) for Personal Finance," by Shelly Banjo, The Wall Street Journal, June 8, 2009 --- http://www.trinity.edu/rjensen/PersonalFinanceTools.htm

1. Budgeting Your Money

2. Creating a Financial Plan

3. Tracking Investments and Getting Advice

4. Checking for Fraud

5. Keeping Track of Credit

6. Managing Loans

Details at http://www.trinity.edu/rjensen/PersonalFinanceTools.htm

PBS Television will now answer your personal finance questions ---
http://www.pbs.org/newshour/insider/business/jan-june09/pocketchange_05-05.html

"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 Curriculum Targets Younger Audience, Journal of Accountancy, December 2008 --- http://www.journalofaccountancy.com/Issues/2008/Dec/NewFTPTargetsYoungerAudience.htm

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

Bob Jensen's threads on Accounting Software ---
http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

The Worldcom fraud accompanied by one of the largest bankruptcies is characterized by what, in my viewpoint, was the worst audit in the history of the world that contributed, along with Enron, to the implosion of the historic Arthur Andersen accounting firm.

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, WorldCom treated "foresight of top management" as an intangible asset akin to patents or trademarks.  
See  http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

Punch Line
This "foresight of top management" led to a 25-year prison sentence for Worldcom's CEO, five years for the CFO (which in his case was much to lenient) and one year plus a day for the controller (who ended up having to be in prison for only ten months.) Yes all that reported goodwill in the balance sheet of Worldcom was an unusual twist.

June 15, 2009 message from Dennis Beresford [dberesfo@TERRY.UGA.EDU]

I apologize if this is something that has already been mentioned but I just became aware of a very interesting video of former WorldCom Controller David Meyers at Baylor University last March - http://www.baylortv.com/streaming/001496/300kbps_str.asx 

The first 20 minutes is his presentation, which is pretty good - but the last 45 minutes or so of Q&A is the best part. It is something that would be very worthwhile to show to almost any auditing or similar class as a warning to those about to enter the accounting profession.

Denny Beresford

Jensen Comment on Some Things You Can Learn from the Video
David Meyers became a convicted felon largely because he did not say no when his supervisor (Scott Sullivan, CFO)  asked him to commit illegal and fraudulent accounting entries that he, Meyers, knew were wrong. Interestingly, Andersen actually lost the audit midstream to KPMG, but KPMG hired the same same audit team that had been working on the audit while employed by Andersen. David Myers still feels great guilt over how much he hurt investors. The implication is that these auditors were careless in a very sloppy audit but were duped by Worldcom executives rather than be an actual part of the fraud. In my opinion, however, that the carelessness was beyond the pale --- this was really, really, really bad auditing and accounting.

At the time he did wrong, he rationalized that he was doing good by shielding Worldcom from bankruptcy and protecting employees, shareholders, and creditors. However, what he and other criminals at Worldcom did was eventually make matters worse. He did not anticipate this, however, when he was covering up the accounting fraud. He could've spent 65 years in prison, but eventually only served ten months in prison because he cooperated in convicting his bosses. In fact, all he did after the fact is tell the truth to prosecutors. His CEO, Bernard Ebbers, got 25 years and is still in prison.

The audit team while with Andersen and KPMG relied too much on analytical review and too little on substantive testing and did not detect basic accounting errors from Auditing 101 (largely regarding capitalization of over $1 billion expenses that under any reasonable test should have been expensed).

Meyers feels that if Sarbanes-Oxley had been in place it may have deterred the fraud. It also would've greatly increased the audit revenues so that Andersen/KPMG could've done a better job.

To Meyers' credit, he did not exercise his $17 million in stock options because he felt that he should not personally benefit from the fraud that he was a part of while it was taking place. However, he did participate in the fraud to keep his job (and salary). He also felt compelled to follow orders the CFO that he knew was wrong.

The hero is detecting the fraud was Worldcom's internal auditor Cynthia Cooper who subsequently wrote the book:
Extraordinary Circumstances: The Journey of a Corporate Whistleblower (Hoboken, New Jersey: John Wiley & Sons, Inc.. ISBN 978-0-470-12429) http://www.amazon.com/gp/reader/0470124296/ref=sib_dp_pt#

Meyers does note that the whistleblower, Cooper, is now a hero to the world, but when she blew the whistle she was despised by virtually everybody at Worldcom. This is a price often paid by whistleblowers --- http://www.trinity.edu/rjensen/FraudConclusion.htm#WhistleBlowing

Bob Jensen's threads on the Worldcom fraud are at http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

KPMG Should Be Tougher on Testing, PCAOB Finds The Big Four audit firm was cited for not ramping up its tests of some clients' assumptions and internal controls
KPMG did not show enough skepticism toward clients last year, according to the Public Company Accounting Oversight Board, which cited the Big Four accounting firm for deficiencies related to audits it performed on nine companies. The deficiencies were detailed in an inspection report released this week by the PCAOB that covered KPMG's 2008 audit season. The shortcomings focused mostly on a lack of proper evidence provided by KPMG to support its audit opinions on pension plans and securities valuations. But in some instances, the firm was cited for weak testing of internal controls over financial reporting and the application of generally accepted accounting principles.
Marie Leone, CFO.com, June 19, 2009 ---
http://www.cfo.com/article.cfm/13888653/c_2984368/?f=archives

In one instance, the audit lacked evidence about whether the pension plans contained subprime assets. In another case, the PCAOB noted, the audit firm didn't collect enough supporting material to gain an understanding of how the trustee gauged the fair values of the assets when no quoted market prices were available.

The PCAOB, which inspects the largest public accounting firms on an annual basis, also found that three other KPMG audits were shy an appropriate amount of internal controls testing related to loan-loss allowances, securities valuations, and financing receivables.

In one audit, KPMG accepted its client's data on non-performing loans without determining whether the information was "supportable and appropriate." In another case, KPMG "failed to perform sufficient audit procedures" with regard to the valuation of hard-to-price financial instruments.

In still another case, the PCAOB found that KPMG "failed to identify" that a client's revised accounting of an outsourcing deal was not in compliance with GAAP because some of the deferred costs failed to meet the definition of an asset - and the costs did not represent a probably future economic benefit for the client.

KPMG’s “Unusual Twist”
While KPMG's strategy isn't uncommon among corporations with lots of units in different states, the accounting firm offered an unusual twist: Under KPMG's direction, WorldCom treated "foresight of top management" as an intangible asset akin to patents or trademarks.  
See  http://www.trinity.edu/rjensen/FraudEnron.htm#WorldcomFraud

Punch Line
This "foresight of top management" led to a 25-year prison sentence for Worldcom's CEO, five years for the CFO (which in his case was much to lenient) and one year plus a day for the controller (who ended up having to be in prison for only ten months.) Yes all that reported goodwill in the balance sheet of Worldcom was an unusual twist.

Integrity is a cornerstone of our culture and we continue to make great progress in our effort to build a model ethics and compliance program. This means fostering awareness, trust, and personal responsibility at every level of the firm. This year, we issued our first ever ethics and compliance progress report and guidebook. This report, Ethics and Compliance Report 2007: It Starts with You, highlights initiatives that we have in place to support our values-based compliance culture, and features real-life stories of some of KPMG's partners and employees who faced ethical challenges and how they handled them. We responded to heightened interest in ethics education and input from your fellow academics and created our KPMG Ethical Compass—A Toolkit for Integrity in Business, a three-module package of classroom materialsto help you present ethics-related topics to your students.
An Open Letter From Tim Flynn, Chairman and CEO, KPMG LLP
This was part of an email message that I assume was sent to the academy of accountants.

Once again the link to the Ethics and Compliance Report 2007 is at http://www.kpmgcampus.com/whoweare/ethics.pdf

Bob Jensen's threads on the "Two Faces of KPMG" ---
http://www.trinity.edu/rjensen/fraud001.htm

"PCAOB Rips E&Y on Revenue Recognition:  Two of Ernst & Young's clients had to restate financial results after the accounting-firm overseer found departures from GAAP," by Sarah Johnson, CFO.com, May 27, 2009 --- http://www.cfo.com/article.cfm/13725058/c_13725042 

Ernst & Young failed to note when two clients strayed from revenue-recognition rules, according to the latest inspection report on the Big Four firm by the Public Company Accounting Oversight Board. Consequently, the regulator's sixth annual inspection of E&Y resulted in those clients having to restate their previously issued financial statements to make up for the departure from U.S. generally accepted accounting principles.

These companies — whose identity the PCAOB keeps confidential — had "failed" to fully follow FAS 48, Revenue Recognition When Right of Return Exists. The rule calls on companies to, at the time of sale, make reasonable estimates of how many products that customers will return as a factor in deciding when revenue can be recorded.

Further criticizing the audit firm for its work on a third client, the PCAOB claims E&Y didn't test the issuer's VSOE, or vendor-specific objective evidence, which is used to figure out whether the amount of revenue recognized for individual parts of a technology contract was reasonable.

The PCAOB noted the revenue recognition audit deficiencies mentioned here, as well as several others at eight of E&Y's clients after reviewing the firm's work between April and December of last year. The deficiencies were linked to the firm's national office in New York and 22 of its 85 U.S. offices. These errors were significant enough for the oversight board to conclude the firm "had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements or internal control over financial reporting."

The PCAOB also criticized E&Y for not fully exploring a client's revenue contracts to see how their terms could affect the issuer's revenue recognition, for not doing enough work to assess the valuation of another issuer's securities, and for relying on information an issuer had deemed unreliable for estimating an income-tax valuation allowance.

To be sure, eight clients may not be many in terms of the number of audits looked at by the oversight board, or when taking into account that E&Y audits more than 2,300 publicly traded companies. The PCAOB, however, doesn't specify how many audits it reviewed and discourages readers of its inspection reports from drawing conclusion on a firm's performance based solely on the number of the reported deficiencies mentioned. "Board inspection reports are not intended to serve as balanced report cards or overall rating tools," the PCAOB notes.

For its part, E&Y, in all but two of the deficiencies cited, revisited its work and made changes. "Although we do not always agree with the characterization in the report ... in some instances we did agree to perform certain additional procedures or improve aspects of our audit documentation," E&Y wrote in a letter dated May 4, that was included in the PCAOB report.

Read the PCAOB report at http://www.pcaobus.org/Inspections/Public_Reports/2009/Ernst_Young.pdf

Bob Jensen's threads on Ernst & Young ---
http://www.trinity.edu/rjensen/fraud001.htm

Video: Financial Reporting in Today’s Economy - Buyouts, Takeovers, Downsizing ---
http://www.simoleonsense.com/video-financial-reporting-in-todays-economy-buyouts-takeovers-downsizing/

The John Stewart & Jim Cramer battle made numerous rounds and yet the question still remains- should the financial media be held accountable for failing to warn citizens of the economic/financial downturn?

Introduction (Via Fora.TV)

Should financial media be held accountable for their failure to have warned the public of the current economic downturn? What steps are being taken to avoid this happening in the future?

A panel of leading financial reporters assess the global crisis and discuss the ‘perfect storm’ of events that led to it. Aspiring journalists will hear how to avoid the perils and pitfalls of the profession, and media observers can decide for themselves if the media is to blame.

About the Speaker (Via Fora.TV)

Liz Claman - Liz Claman joined FOX Business Network (FBN) as an anchor in October 2007. Her debut included an exclusive interview with Berkshire Hathaway CEO and legendary investor Warren Buffett.

Alan Murray - Alan Murray is a Deputy Managing Editor of The Wall Street Journal and Executive Editor for the Journal Online. He also has editorial responsibility for Wall Street Journal television, books, conferences, and the MarketWatch web site. Mr. Murray spent a decade as the Journal’s Washington bureau chief.

Jeff Bercovici - Jeff Bercovici joined Conde Nast Portfolio from Radar magazine, where he was part of the relaunch team for both the online and print editions.

Bob Jensen's threads on accounting theory and financial reporting are at
http://www.trinity.edu/rjensen/theory01.htm

Fiery Debate Over Fair Value Accounting
"The Fair-Value Deadbeat Debate Returns: On hiatus while other fair-value questions were debated, the hotly-contested issue of why companies can book a gain when their credit rating sinks has returned to center stage," by  Marie Leone, CFO.com, June 29, 2009 --- http://www.cfo.com/article.cfm/13932186/c_2984368/?f=archives

A new discussion paper released last week by the staff of the International Accounting Standards Board has revived an old, but still fiery fair-value controversy.

At issue: the role of credit risk in measuring the fair value of a liability. According to the paper's opening statement: the topic has "arguably ... generated more comment and controversy than any other aspect of fair value measurement."

At the heated core of the dispute is the question of why accounting rules allow companies to book a gain when their credit rating actually sinks. The accounting convention, which opponents contend is counterintuitive if not ridiculous, has prompted "a visceral response to an intellectual issue," says Wayne Upton, the IASB project principal who authored the discussion paper.

For all the hubbub around it, the rule is rather simple: When a company chooses to use the fair value method of accounting, it must mark its liabilities as well as its assets to market. As a company's credit rating goes down, so does the price of its debt, which therefore must be re-measured by marking the liability to market. The difference between the debt's carrying value and its so-called fair value is then recorded as a debit to liabilities, and a credit to income.

Consider an oversimplified example to clarify the accounting treatment. A company records a $100 liability for a bond it has issued. Overnight, the company's credit rating drops from A to BB. That drop causes the price of the bond trading in the market to decrease from $100 to $90. The $10 difference, under current accounting rules, is recorded as a $10 debit to liabilities on the balance sheet and a $10 credit to income on the income statement.

As the company's credit rating and the price of the bond rise — to, say, $100 again — the accounting is reversed. Income takes a $10 hit, while the liability account is credited.

That accounting oddity has been a lingering problem since 2000, when the Financial Accounting Standards Board introduced Concept Statement 7, which includes a general theory on credit standing and measuring liabilities. The notion was hotly debated again in 2005, when IASB revised IAS 39, its measurement rule for financial instruments and in 2006 when FASB issued FAS 157, its fair-value measurement standard.

Addison Everett, the practice leader for global capital markets at PricewaterhouseCoopers, notes that the debate cooled down over the last 18 months as the liquidity crisis bubbled up. The crisis spotlighted more politically charged fair-value topics such as asset valuation in illiquid markets, classification of financial assets, asset impairment, and financial disclosures, he says.

But the credit risk quandary is back, demanding the attention of investors, regulators, and lawmakers who were carefully watching ailing financial institutions as they posted their first-quarter earnings results. As financial results were disclosed this year, it became clear that IAS 39 and FAS 157 were being used to boost income as banks and insurance companies became less creditworthy. For example, in the first quarter, Citigroup benefited from its credit rating downgrade by posting a $30 million gain on its own bond debt.

A Credit Suisse report looking back to last year, flagged a similar trend. The bank examined the first-quarter 2008 10-Qs of the 380 members of the S&P 500 with either November or December year-end closes, the first big companies to adopt FAS 157. For the 25 companies with the biggest liabilities on their balance sheets measured at fair value, widening credit spreads-an indication of a lack of creditworthiness-spawned first-quarter earnings gains ranging from $11 million to $3.6 billion.

Those keen on keeping the rules intact and allowing companies to book a gain when credit ratings worsen give several reasons for their stance. Most are laid out neatly in the IASB discussion paper. Consistency is one argument. "Accountants accept that the initial measurement of a liability incurred in an exchange for cash includes the effect of the borrower's credit risk," according to the paper. There's "no reason why subsequent current measurements should exclude changes."

There's a practical problem with that argument, however. Not all liabilities are financial in nature. Non-financial liabilities, such as those tied to plant closings (asset removal), product warranties, pensions, insurance claims, and obl igations linked to sales contracts, are not as easily marked to market as a clear-cut borrowing. Often non-financial liabilities represent a transaction with an individual counterparty that has already placed a price on the chance of not being repaid. For many of those liabilities, "accounting standards differ in their treatment of credit risk," notes the paper.

One cure is to use a risk-free discount rate for all liabilities in order to apply a consistent measurement approach. But applying a blanket discount rate to the initial measure of debt leaves accountants with the problem of what to do with the debit. That is, for financial liabilities, should the debit be treated as a borrowing penalty and therefore as a charge against earnings? Or should the debit be subtracted from shareholder's equity and amortized into earnings over the life of the debt? For non-financial debt, should the debit be the recognized warranty or plant-closing expense?

Continued in article

June 26, 2009 reply from walkerrb@ACTRIX.CO.NZ

This issue arose at the time of FASB's (brilliant) special report on using cash flow information in 1996. Between the time of the issue of the special report and the conceptual statement emanating from it, the position had changed. In the report, from memory, the position was the actuarially pure one in which both sides of the balance sheet were discounted at the same, risk free rate.

When the CS was issued in draft it had changed to the, arguably, actuarially invalid position that the balance sheet was discounted at different rates - assets would be at the risk free rate and liabilities at a rate reflecting the credit risk of the accounting entity.

At the time I found this to be bizarre. I have slowly changed my mind over the last decade. The apparent maintenance of actuarial purity across the balance sheet is actually an illusion. To apply the risk free rate to assets necessitates a significant degree of mathematical calculation prior to its application (see IAS 36 para 30). No such computation is necessary for liabilities.

Ultimately, it is best to look at the practical effects of which two are illustrative.

Firstly, the value of a liability should be the same as the value of the asset in the counter-party's records, being the creditor. The creditor would apply a process which would compute the credit risk premium from a probability analysis, being the spread, and then apply the risk free rate. All that is happening in debtor's accounting records is the mirror of this process. Intuitively this must be correct.

Second, I do recall many years ago being sent a case by a man named William (?) Hackney, a lawyer from Pittsburgh I think who wrote academic articles about the determination of corporate solvency and GAAP. (I have lost touch with him, does anybody know him?). The case involved TWA and its solvency. One side argued that the correct value of its liabilities for solvency purposes was its market value. Its debt traded at 50 cents in the dollar so its liabilities were 50% of its face value.

Dr Liability Cr Equity

with 50% of the value.

The other contestant in the matter claimed the liability should be face value.

I have lost my copy of the case but I think the discounter won. This makes a kind of perverse sense. One of the essential characteristics of a liability is that it results in an outflow of funds. A company with an asset costing $100 fully funded by a liability where that asset fetches only $25 will only cause an outflow of funds to $25. That must be the value of the liability therefore.

Where this becomes perverse is that a company is never insolvent because as it falls into the abyss its liabilities erode in the same proportion to the erosion of its assets. In insolvency law this becomes extremely problematic as insolvency is the determinant of civil or criminal sanction or penalty.

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

The FASB Probably Won't Care for this Teaching Case
But it provides good input for student debates on fair value accounting
In fairness, the FASB contends that the what bankers claim is a major change in FAS 157 really is a cosmetic change that wasn't truly needed but is no big deal if it makes bankers happy. If the banks really wanted to bypass Level 1 and 2 fair value estimation, they could've moved to Level 3 all along without the rule change. Whatever the reasons or excuses, banks with toxic loan portfolios can now report higher earnings that have little to do with higher cash flows (unless the cash is rolled in from TARP bailout loans and gifts is reduced because gullible investors are relying on phony bank earnings reports). Sadly, the European Union is now bringing similar pressures to bear on IFRS fair value accounting.

Personally, I thought the blaming fair value accounting standards by Bill Isaac and his billionaire friends (Warren Buffet and Steve Forbes) for the bank failures was a pile of crap --- http://www.trinity.edu/rjensen/2008Bailout.htm#FairValue
The banks failed because of dysfunctional mortgage lending policies that encouraged fraud, dysfunctional performance compensation schemes that encouraged bankers to cheat shareholders, and too much reliance on David Li's flawed Gaussian copula function --- http://www.trinity.edu/rjensen/2008Bailout.htm

The frauds were exacerbated by unprofessional CPA auditing firms and credit rating agencies that were anything but independent of the clients that paid their fees --- http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

Sadly, the bankers want to blame fair value accounting standards for the the collapse of their system. This is like blaming Hans Brinker for having such a small finger in in a Holland dike.

From The Wall Street Journal Weekly Accounting Review on June 4, 2009

Congress Helped Banks Defang Key Rule
by Susan Pulliam and Tom McGinty
The Wall Street Journal
Jun 03, 2009
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB124396078596677535.html?mod=djem_jiewr_AC

TOPICS: Accounting For Investments, Advanced Financial Accounting, Banking, Fair Value Accounting, Fair-Value Accounting Rules, Financial Accounting Standards Board, Financial Reporting

SUMMARY: This article reports on a WSJ investigation into lobbying of, and contributions to, members of the House Financial Services subcommittee. "Earlier this year...thirty-one financial firms and trade groups formed a coalition and spent $27.6 million in the first quarter lobbying Washington about [changing the FASB's fair value] rule and other issues, according to a Wall Street Journal analysis of public filings. They also directed campaign contributions totaling $286,000 to legislators on a key committee, many of whom pushed for the rule change, the filings indicate." The FASB ultimately responded to pressure by issuing a staff position on April 9, 2009 allowing financial institutions to use greater judgment in determining market values when markets show evidence of illiquidity and signs of being disorderly than was originally included in Statement 157. "The American Bankers Association (ABA)...acknowledges that it exerted pressure to change the rules. The ABA was the biggest donor to the campaign funds of committee members in the weeks before the hearing. It gave a total of $74,500 to 33 members of the committee in the first quarter, according to the Journal analysis of public filings. An ABA spokesman says that is its normal level of support for lawmakers, and that the initiative was part of a broader effort to change accounting rules....We worked that hearing," says ABA President Edward Yingling. "We told people that the hearing should be used to talk about the big problems with 'mark to market,' and you had 20 straight members of Congress, one after another, turn to FASB and say, 'Fix it.'"

CLASSROOM APPLICATION: This article shows the political nature of the accounting standards setting process. It also shows how the press can obtain information and conduct analyses to keep interested individuals aware of the process. In this case, the interested individuals include investor groups who feel that the accounting changes watered down the fair value reporting standards.

QUESTIONS: 
1. (Introductory) In general, what are the requirements established in FASB Statement No. 157, Fair Value Measurements? Hint: you may access this FASB document on their web site at http://www.fasb.org/st/

2. (Introductory) What changes were implemented with FASB Staff Position (FSP) 157-4? Again, you may access the document at http://www.fasb.org/st/

3. (Introductory) In general, what is the usual process for establishing authoritative accounting literature?

4. (Advanced) How did the U.S. political process influence this change in accounting requirements under fair value reporting? What are the concerns with the usual process for establishing accounting standards?

5. (Advanced) As reported in this article, who is displeased with this change in financial reporting requirements? Are their concerns limited to whether the appropriate accounting requirements have been set?

6. (Advanced) What do you think about having our elected officials in Congress, influence the process of establishing accounting standards?

Reviewed By: Judy Beckman, University of Rhode Island

"Congress Helped Banks Defang Key Rule," Susan Pulliam and Tom McGinty, The Wall Street Journal, June 3, 2009 --- http://online.wsj.com/article/SB124396078596677535.html?mod=djem_jiewr_AC

Not long after the bottom fell out of the market for mortgage securities last fall, a group of financial firms took aim at an accounting rule that forced them to report billions of dollars of losses on those assets.

Marshalling a multimillion-dollar lobbying campaign, these firms persuaded key members of Congress to pressure the accounting industry to change the rule in April. The payoff is likely to be fatter bottom lines in the second quarter.

The accounting issue lies at the heart of the financial crisis: Are the hardest-to-value securities worth no more than what the market is willing to pay, or did the market grow too dysfunctional to properly set values?

The rule change angered some investor advocates. "This is political interference on a major issue, and it raises questions about whether accounting standards going forward will have the quality and integrity that the market needs," says Patrick Finnegan, director of financial-reporting policy for CFA Institute Centre for Financial Market Integrity, an investor trade group.

Backers of the change say it was necessary because existing accounting rules never contemplated the kind of market turmoil that unfolded last year.

The rules had required banks, securities firms and insurers to use market prices to help assign values to mortgage securities and other assets that don't trade on exchanges -- to "mark to market." But when markets went haywire last fall, financial firms complained that the rules forced them to slash the value of many assets based on fire-sale prices. That contributed to big losses that depleted their capital and left several of the nation's largest firms on the brink of failure.

Earlier this year, financial-services organizations put their lobbyists on the case. Thirty-one financial firms and trade groups formed a coalition and spent $27.6 million in the first quarter lobbying Washington about the rule and other issues, according to a Wall Street Journal analysis of public filings. They also directed campaign contributions totaling $286,000 to legislators on a key committee, many of whom pushed for the rule change, the filings indicate.

Rep. Paul Kanjorski, a Pennsylvania Democrat who heads the House Financial Services subcommittee that pressed for the accounting change, received $18,500 from coalition members in the first quarter, the second-highest total among committee members, according to Federal Election Commission records. Over the past two years, Mr. Kanjorski received $704,000 in contributions from banking and insurance firms, the third-highest total among members of Congress, according to the FEC and the Center for Responsive Politics.

A spokeswoman says Rep. Kanjorski believes the accounting industry's rule-making body, the Financial Accounting Standards Board, or FASB, made the right move since neither mark-to-market critics nor advocates are "entirely pleased with the outcome." She says campaign contributions didn't factor into the congressman's thinking.

Congressional Attention During a March 12 hearing before the House subcommittee, FASB came under intense pressure from committee members. "If the regulators and standard setters do not act now to improve the standards, then the Congress will have no other option than to act itself," Rep. Kanjorski said in his opening remarks.

"We want you to act," Rep. Kanjorski told Robert Herz, FASB's chief. Mr. Herz waffled about how quickly the standards board could act. Rep. Kanjorski leaned over the dais. "You do understand the message that we're sending?" he said.

"Yes," Mr. Herz replied. "I absolutely do, sir."

FASB made speedy revisions to its rules. In an interview, Mr. Herz said FASB merely accelerated the matter on its agenda, and tried to be responsive to input from investors and financial-services firms.

The change helped turn around investor sentiment on banks. Financial firms had the option of reflecting the accounting change in their first-quarter results; they will be required to do so in the second quarter. Wells Fargo & Co. said the change increased its capital by $4.4 billion in the first quarter. Citigroup Inc. said the change added $413 million to first-quarter earnings. The Federal Home Loan Bank of Boston said the shift boosted its first-quarter earnings by $349 million.

Robert Willens, a tax and accounting analyst, estimates that the changes will increase bank earnings in the second quarter by an average of 7%.

Building Pressure The American Bankers Association, a trade group, acknowledges that it exerted pressure to change the rules. The ABA was the biggest donor to the campaign funds of committee members in the weeks before the hearing. It gave a total of $74,500 to 33 members of the committee in the first quarter, according to the Journal analysis of public filings. An ABA spokesman says that is its normal level of support for lawmakers, and that the initiative was part of a broader effort to change accounting rules.

"We worked that hearing," says ABA President Edward Yingling. "We told people that the hearing should be used to talk about the big problems with 'mark to market,' and you had 20 straight members of Congress, one after another, turn to FASB and say, 'Fix it.'"

The banking industry's victory stands in contrast to at least one defeat it has been dealt in recent weeks, on new credit-card legislation.

Changing Environment Mark-to-market accounting has been around for decades. Many banks were content with the rules when the markets were going up. But the rules became a big problem in late 2007. As markets turned down, FASB clarified the rules and established how certain financial instruments, including mortgage securities, should be valued.

Continued in article

"More Sausage Hiding: Banks," Market Ticker, June 4, 2009 ---
http://market-ticker.denninger.net/archives/1089-More-Sausage-Hiding-Banks.html  

Now we see real reporting instead of the puff piece on Bloomberg yesterday:

In a move that confirmed the suspicions of many analysts, the agency called off plans to start a $1 billion (read that $1 trillion) pilot program this month that was intended to help banks clean up their balance sheets and eventually sell off hundreds of billions of dollars worth of troubled mortgages and other loans.

Many banks have refused to sell their loans, in part because doing so would force them to mark down the value of those loans and book big losses. Even though the government was prepared to prop up prices by offering cheap financing to investors, the prices that banks were demanding have remained far higher than the prices that investors were willing to pay.

Translation:

The banks are still carrying these "assets" at well-above their actual market value. This means their balance sheets are showing them to be healthier than they really are.

The Government, which claimed it was going to "drain the swamp" and get the market moving again, tried everything short of the barrel of an M-16 in the mouth of people like Blankfein and Pandit, but couldn't get them to sell.

But rather than force the recognition of market prices on the balance sheets, which would force these banks to either sell or be FDIC'd (incidentally, the only correct pair of options the banks should have) the government instead is allowing the banks to continue to lie about the market value of these "assets" and carry them above what the market will pay - that is, they are allowing the continuing intentional distortion of so-called "book value", reserve ratios and soundness.

Of course this isn't how the government banking cartel (the same so-called "regulators" that allowed and even encouraged book-cooking when it came to reserves and deposits) sees it:

F.D.I.C. officials portrayed the change as a sign that banks were returning to health on their own.

Baloney. If the banks were returning to health on their own they wouldn't care if the market price was recognized on their balance sheets.

The FDIC is lying.

But some analysts said the banks’ reluctance to clean up their balance sheets meant they were merely postponing their day of reckoning. Indeed, some analysts said government policies had made it easier for banks to gloss over their bad loans.

"Gloss over" is another fancy word for fraudulent accounting practices, all made "legitimate" by our government.

No one knows exactly how many losses are buried in the troubled mortgages on banks’ books, but some analysts estimate that the unrecognized losses total more than $1 trillion. Under accounting rules, banks do not have to write down the value of most mortgages unless they sell them or they fall delinquent.

And, as Wells Fargo did last year, they can change the rules on when something is "delinquent"! That is, it can be 30 days behind today, 60 tomorrow, and three years next week. That's all ok, according to our so-called "regulators."

The Federal Reserve also is pumping hundreds of billions of dollars into mortgage-backed securities, and into other kinds of consumer and business lending. Starting next month, the Fed plans to offer cheap financing for investors who want to buy “legacy” securities backed by mortgages on commercial real estate.

Of course this simply means that the Federal Reserve (that is, you) will eat the loss.

Heh, its only your (tax) money, right?

No banker left behind, no fraud to be punished (ever) indeed.

PS: The deception cannot continue beyond where the cash flow ceases. In the end you can't pay your electric bill with phony capitalized interest that you will NEVER collect! That day, unfortunately, will likely coincide with the collapse of the FDIC, at which point every nickel you have in any bank anywhere will be GONE, courtesy of our government continuing to enable, allow and even participate in raw fraud. Its been going on now for more than two years folks, and the cops have all been bribed!

Sydney Finkelstein, the Steven Roth professor of management at the Tuck School of Business at Dartmouth College, also pointed out that Bank of America booked a $2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired last quarter to prices that were higher than Merrill kept them. “Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty,” he said
"Bank Profits Appear Out of Thin Air ," by Andrew Ross Sorkin, The New York Times, April 20, 2009 --- http://www.nytimes.com/2009/04/21/business/21sorkin.html?_r=1&dbk

This is starting to feel like amateur hour for aspiring magicians.

Another day, another attempt by a Wall Street bank to pull a bunny out of the hat, showing off an earnings report that it hopes will elicit oohs and aahs from the market. Goldman Sachs, JPMorgan Chase, Citigroup and, on Monday, Bank of America all tried to wow their audiences with what appeared to be — presto! — better-than-expected numbers.

But in each case, investors spotted the attempts at sleight of hand, and didn’t buy it for a second.

With Goldman Sachs, the disappearing month of December didn’t quite disappear (it changed its reporting calendar, effectively erasing the impact of a $1.5 billion loss that month); JPMorgan Chase reported a dazzling profit partly because the price of its bonds dropped (theoretically, they could retire them and buy them back at a cheaper price; that’s sort of like saying you’re richer because the value of your home has dropped); Citigroup pulled the same trick.

Bank of America sold its shares in China Construction Bank to book a big one-time profit, but Ken Lewis heralded the results as “a testament to the value and breadth of the franchise.”

Sydney Finkelstein, the Steven Roth professor of management at the Tuck School of Business at Dartmouth College, also pointed out that Bank of America booked a $2.2 billion gain by increasing the value of Merrill Lynch’s assets it acquired last quarter to prices that were higher than Merrill kept them.

Although perfectly legal, this move is also perfectly delusional, because some day soon these assets will be written down to their fair value, and it won’t be pretty,” he said.

Continued in article

June 5, 2009 reply from John Anderson [jcanderson27@COMCAST.NET]

Professor Jensen,

I agree and have been amazed about the “supposed” problems with FAS 157 which were trumpeted by those who had either not read it … or were convinced that those they were filling full of propaganda would never read it. (Somebody ask Steve Forbes or Larry Kudlow!)

However, I have heard that the issue was not the Banks or the FASB’s original text, but the PCAOB’s hammering of any Audit Firm which allowed Level 3 to be used. This would be concerning if the PCAOB was not following the rules put forth by the FASB. Sort of a world of SRO dysfunction, if true! Have you heard anything about this? (It may be only criticism of inappropriate use of Level 3)

Whether the PCAOB and the FASB are at odds, or if the Banks still have not marked to market, either aberrant reality is a problem.

To your knowledge, do any of the big banks use second tier audit firms (or lower) who perhaps do not interact as frequently with the PCAOB? (I know it sound crazy but since Madoff you must always ask.)

Finally, how does the PCAOB stay away from testifying in front of Kanjorski’s Congressional Committee?

Best Regards!

John

John Anderson, CPA, CISA, CISM, CGEIT, CITP
Financial & IT Business
Consultant 14 Tanglewood Road
Boxford, MA 01921

 

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

Bob Jensen's recent slide show on on fair value accounting --- http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/
Click on the 10FairValueFSU.ppt file

Video:  Three Things Every CPA Should Know --- http://www.journalofaccountancy.com/Multimedia/ODellonInternationalStandards.htm

Fighting the Battle Against Off-Balance-Sheet Financing"  Winning a Battle Does Not Mean Winning a War
But it's better than losing the battle

"FASB Issues New Standards for Securitizations and Special Purpose Entities," SmartPros, June 15, 2009 --- http://accounting.smartpros.com/x66815.xml 

The FASB has published Financial Accounting Statements No. 166, Accounting for Transfers of Financial Assets, and No. 167, Amendments to FASB Interpretation No. 46(R), which change the way entities account for securitizations and special-purpose entities.

The new standards will impact financial institution balance sheets beginning in 2010. The impact of both new standards has been taken into account by regulators in the recent “stress tests.”

These projects were initiated at the request of investors, the SEC, and The President’s Working Group on Financial Markets. Copies of the new standards are available at the FASB’s website, along with a concise briefing document.

Statement 166 is a revision to Statement No. 140, Accounting for Transfers and Servicing of Financial Assets and Extinguishments of Liabilities, and will require more information about transfers of financial assets, including securitization transactions, and where companies have continuing exposure to the risks related to transferred financial assets. It eliminates the concept of a “qualifying special-purpose entity,” changes the requirements for derecognizing financial assets, and requires additional disclosures.

Statement 167 is a revision to FASB Interpretation No. 46(R), Consolidation of Variable Interest Entities, and changes how a company determines when an entity that is insufficiently capitalized or is not controlled through voting (or similar rights) should be consolidated. The determination of whether a company is required to consolidate an entity is based on, among other things, an entity’s purpose and design and a company’s ability to direct the activities of the entity that most significantly impact the entity’s economic performance.

Robert Herz, chairman of the FASB, said:

“These changes were proposed and considered to improve existing standards and to address concerns about companies who were stretching the use of off-balance sheet entities to the detriment of investors. The new standards eliminate existing exceptions, strengthen the standards relating to securitizations and special-purpose entities, and enhance disclosure requirements.  They’ll provide better transparency for investors about a company’s activities and risks in these areas.”

Both new standards will require a number of new disclosures. Statement 167 will require a company to provide additional disclosures about its involvement with variable interest entities and any significant changes in risk exposure due to that involvement.   A company will be required to disclose how its involvement with a variable interest entity affects the company’s financial statements.   Statement 166 enhances information reported to users of financial statements by providing greater transparency about transfers of financial assets and a company’s continuing involvement in transferred financial assets. 

Both Statements 166 and 167 will be effective at the start of a company’s first fiscal year beginning after November 15, 2009, or January 1, 2010 for companies reporting earnings on a calendar-year basis.

Hiding Debt in VIEs (read that QSPEs) No Longer So Simple
"FASB Tightens Off-Balance-Sheet Loan Rule," SmartPros, May 18, 2009 ---
http://accounting.smartpros.com/x66572.xml

The board that sets U.S. accounting standards on Monday moved to end companies' use of a device that allowed them to park hundreds of billions of dollars in loans off their balance sheets without capital cushions and has been blamed for helping stoke banks' losses in the housing boom.

The change will tighten the use of so-called "qualifying special purpose entities" by requiring companies to report to regulators the loans contained in them and to increase their capital reserves in proportion as a cushion against potential losses.

It was the lack of disclosure and absence of capital supporting ballooning subprime mortgage loans in these special entities that aggravated the massive losses sustained by banks, regulators say.

The change by the Financial Accounting Standards Board could result in about $900 billion in assets being brought onto the balance sheets of the nation's 19 largest banks, according to federal regulators. The information was provided by Citigroup Inc., JPMorgan Chase & Co. and 17 other institutions during the government's recent "stress tests," an analysis designed to determine which banks would need more capital if the economy worsened.

In its quarterly regulatory filing earlier this month, Citigroup said the rule change could have "a significant impact" on its financial statements. Citigroup estimated it would result in the recognition of $165.8 billion in additional assets, including $90.5 billion in credit card loans.

JPMorgan estimated in its quarterly filing that the impact of consolidation of the bank's qualifying special purpose entities and variable interest entities could be up to $145 billion.

In general, companies transfer assets from balance sheets to special purpose entities to insulate themselves from risk or to finance a large project. Under the change by the FASB, many qualifying special purpose entities will have to be moved back to a company's main balance sheet.

Outside investors often take interests in those entities, for example, making an investment in a bank's holdings of mortgage loans in exchange for payments from borrowers. Under the new standard, companies must bring back any entity in which they hold an interest that gives them "control over the most significant activities," according to FASB. Companies must perform analyses to determine that.

In cases where companies have "continuing involvements" with off-balance-sheet entities, they will have to provide new disclosures.

"That's a step in the right direction," said Edward Ketz, an associate professor of accounting at Pennsylvania State University. He cited estimates that U.S. banks will need to report up to $1 trillion in loans due to the rule change.

The FASB said the rule change was intended "to improve consistency and transparency in financial reporting." The FASB voted 5-0 to adopt it at a public meeting of its board at its headquarters in Norwalk, Conn. A revised proposal had been opened to a public comment period that ended in November.

The rule change, which applies both to public and privately held companies, takes effect for companies' annual reporting periods starting after Nov. 15.

"It's great to see that they didn't defer it," said Jack Ciesielski, a Baltimore-based accounting expert who writes a financial newsletter. Investors finally "will get an idea of how leveraged these things really are," he said.

The change by FASB cuts in the opposite direction of its move last month - surrounded by controversy and with some dissension by board members - giving companies more leeway in valuing assets and reporting losses. That revision in the so-called "mark-to-market" accounting rules was expected to help boost battered banks' balance sheets, while the new rule change likely will result in financial institutions recognizing on their books billions in high-risk loans that may default.

FASB acted on the mark-to-market rules amid intense pressure from Congress, which threatened legislation. The board received hundreds of comment letters opposing the move from mutual funds, accounting firms and others contending that it would damage honest financial reckoning by masking the deficiencies and risks lurking within the system.

"A Fortress Balance Sheet:  Two seasoned treasurers say what's on their minds — and making balance sheets shock-proof is just one notion," by Edward Teach, CFO.com, June 18, 2009 ---
http://www.cfo.com/article.cfm/13886371/c_2984368/?f=archives

The shift in priorities from earnings per share to cash was confirmed by a recent survey conducted by the National Association of Corporate Treasurers, said Edward Liebert, chairman of the association and treasurer of Rohm & Haas, which was acquired by Dow Chemical in April. "You can miss your earnings targets and survive, but you can only run out of cash once," commented Liebert. Treasurers voiced four other top concerns in the NACT survey: employee benefit funding, primarily pensions; capital spending; cost control, such as keeping insurance premiums and bank fees down; and maintaining or gaining access to capital markets.

Tus said he first heard the phrase "fortress balance sheet" from Jamie Dimon, CEO of JPMorgan Chase & Co. "What it really means is having a balance sheet that can withstand shocks," Tus explained, particularly those that may "come out of the woodwork," such as contingent liabilities and covenant breaches. A fortress balance sheet also gives companies deal-making flexibility, he added. "Historically, companies that do the best deals do them at the trough of the market, not at the peak."

Continued in article

Holy Cow Video:  From Grass to Glass (not humor) ---
http://www.youtube.com/watch?v=JJRy82i8e5Q&feature=email

This may be a bit of a stretch, but I think that instructors teaching managerial/cost accounting may set students thinking about the economies of scale in milk production.

When I grew up on a farm in Iowa, virtually every small town had its own "creamery" where milk and cream separations from each farm were picked up locally and bottled in each of the small towns. Virtually all the small town creameries have been defunct for years.

Here is an attention-grabbing video that could be a great beginning for study of the production cost function components of dairy farming.

Milk:  From Grass to Glass (not humor) ---
http://www.youtube.com/watch?v=JJRy82i8e5Q&feature=email

One operation near Chicago provides enough milk for eight million people --- much more than is needed in the entire city of Chicago.

The methane gas from the manure provides all electric power needed in each barn.

On the down side, think of the down side of large-scale diaries and factories in terms of monopoly pricing and the risk of supply disruption such as when a disease like hoof-and-mouth or mad-cow wipes out the milk supply for the entire city of Chicago. What is the cost and technology of preventing this type of disaster from happening? Why are we more vulnerable to terrorists in our food production and distribution system?

What were the advantages of small town creameries? Why did they all fail?

Brigham Young University (BYU) launched its Open CourseWare (OCW) pilot with
six Creative Commons licensed courses

Before reading this module you may want to read about the Creative Commons ---
http://en.wikipedia.org/wiki/Creative_Commons
Creative Commons Home Page --- http://creativecommons.org/

From Canada's Creative Commons --- http://creativecommons.org/weblog/entry/15108

Jane Park, June 10th, 2009

It appears that David Wiley’s move to Brigham Young University has already resulted in progress towards opening the university’s content. Long-time pioneer and academic of open education, Wiley reports that BYU’s Independent Study has launched its Open CourseWare (OCW) pilot with six Creative Commons licensed courses under CC BY NC-SA.

“The pilot includes three university-level courses and three high school-level courses (BYU IS offers 250 university-level courses online for credit and another 250 high school-level courses online for credit). The courses in BYU IS OCW are content-complete - that is, they are the full courses as delivered online without the need of additional textbooks or other materials (only graded assessments have been removed).”

The most interesting thing about this pilot is that it “is part of a dissertation study to measure the impact of OCW courses on paying enrollments.” So far, “the results are very positive - 85 of the 3500 people who visited the OCW site last month registered for for-credit courses… if this pattern remains stable, then BYU IS OCW will be financially self-sustainable with the ability to add and update a number of new courses to the collection each year, indefinitely, should they so choose.” Echoing Wiley, that is an exciting prospect. We look forward to seeing these results develop, in addition to other inquiries into the sustainability of general OER initiatives in the future…

BYU Independent Study --- http://ce.byu.edu/is/site/courses/ocw/
Also see http://ce.byu.edu/is/site/aboutus/index.cfm

 

University Courses

• Public Speaking (TMA 150)
• Personal Finance (BUSM 418)
• Cooking in the Home (SFL 110)

  High School Courses

• United States Government and Citizenship (GOVT 45)
• World Geography: The Forces That Shape Our World (GEOG 41)
• Earth Science, Part 1 (EARTH 41)

You may view, use, and reuse all materials in the Open CourseWare courses. Please note that Open CourseWare courses do not provide the opportunity to submit assessments for credit, interact with faculty, or receive credit or a certificate upon completion. BYU Independent Study provides these courses as a community service under a Creative Commons license. The course materials are freely available for you to use, download, modify and share as long as you do not sell the products you derive from them. If you alter, transform, or build upon the courses, you may distribute your work only using licensing terms the same as or similar to the Creative Commons Atribution-Noncommercial-Share Alike 3.0.

University Courses  (includes art, accounting, chemistry, etc.)
High School Courses
Middle School Courses
Personal Enrichment Courses
Free Courses (includes such things as dating and romance)

Bob Jensen's threads on open sharing (learning materials, videos, lectures, and entire courses) are at http://www.trinity.edu/rjensen/000aaa/updateee.htm#OKI

Bob Jensen's threads on distance education training and education alternatives are at
http://www.trinity.edu/rjensen/Crossborder.htm

This article provides (allegedly) conclusive evidence that the U.S. stock market is highly inefficient

From the Financial Rounds Blog on June 16, 2009 --- http://financialrounds.blogspot.com/

A Good Paper on "Return Factors"

Robert Haugen is one of (if not THE) best-known figure in the behavioral finance (i.e. "markets are not efficient") camp. He wrote one of the earliest books on the topic in 1995 (The New Finance) and runs a quantitative finance shop based on much of his research. In a recent paper with Nardin Baker of UC-Irvine, he examines the explanatory and predictive ability of a wide array of observable factors. Here's the abstract

This article provides conclusive evidence that the U.S. stock market is highly inefficient. Our results, spanning a 45 year period, indicate dramatic, consistent, and negative payoffs to measures of risk, positive payoffs to measures of current profitability, positive payoffs to measures of cheapness, positive payoffs to momentum in stock return, and negative payoffs to recent stock performance. Our comprehensive expected return factor model successfully predicts future return, out of sample, in each of the forty-five years covered by our study save one. Stunningly, the ten percent of stocks with highest expected return, in aggregate, are low risk and highly profitable, with positive trends in profitability. They are cheap relative to current earnings, cash flow, sales, and dividends. They have relatively large market capitalization and positive price momentum over the previous year. The ten percent with lowest expected return (decile 1) have exactly the opposite profile, and we find a smooth transition in the profiles as we go from 1 through 10. We split the whole 45-year time period into five sub-periods, and find that the relative profiles hold over all periods. Undeniably, the highest expected return stocks are, collectively, highly attractive; the lowest expected return stocks are very scary - results fatal to the efficient market hypothesis. While this evidence is consistent with risk loving in the cross-section, we also present strong evidence consistent with risk aversion in the market aggregate's longitudinal behavior. These behaviors cannot simultaneously exist in an efficient market.

Here are some of the factors that they find statistically significant:
 

• Price Multiples such as price to cash flow, sales, book value, and earnings (negative relationship with subsequent returns
   
• Profitabiliy measures such as ROE, ROA, and Profit Margins (positive relationship)
• Volatility in returns, whether "raw" or "residual" (negative relationship)
• Momentum (positive relationship)
• Recent returns (positive rel;ationship with last year's return, negative with last month's return, and last month's "residual" return)

Read the whole thing here

It's worth reading. Haugen is clearly not an ubiased observer (he does run a shop based on the idea that markets are inefficient), and there's definitely some serious data mining going on here. Having said that, it's definitely worth reading. It gives a very good summary of many of the factors that prior research has found to be significantly related to subsequent returns. I'll be making the next group of student in Unknown University's student-managed fund read it.

Bob Jensen's threads on the Efficient Market Hypothesis are at http://www.trinity.edu/rjensen/theory01.htm#EMH

Minority Interests:  Lambs being led to slaughter?

From The Wall Street Journal Accounting Weekly Review on June 11, 2009

Investors Missing the Jewel in Crown
by Martin Peers
The Wall Street Journal
Jun 06, 2009
Click here to view the full article on WSJ.com
http://online.wsj.com/article/SB124425049774290141.html?mod=djem_jiewr_AC

TOPICS: Advanced Financial Accounting, Consolidations, Debt, Financial Accounting, Financial Analysis

SUMMARY: The article assesses the situation of two companies associated with financial difficulties: Crown Media, 67% owned by Hallmark Cards, and Clear Channel Outdoor, 89% owned by Clear Channel Media. In the latter case, the entity in financial difficulty is the owner company. Questions ask students to look at a quarterly filing by Crown Media, to consider the situation facing noncontrolling interest shareholders, and to understand the use of earnings multiplier analysis for pricing a security.

CLASSROOM APPLICATION: The article is good for introducing the interrelationships between affiliated entities when covering consolidations. It also covers alternative calculations of, and analytical use of, a P/E ratio.

QUESTIONS: 
1. (Introductory) Access the Crown Media 10-Q filing for the quarter ended March 31, 2009 at http://www.sec.gov/Archives/edgar/data/1103837/000110383709000008/mainform5709.htm Alternatively, click on the live link to Crown Media in the WSJ article, click on SEC Filings in the left hand column, then choose the 10-Q filing made on May 7, 2009. Describe the company's financial position and results of operations.

2. (Advanced) Crown Media's majority shareholder is Hallmark Cards "which also happens to be its primary lender to the tune of a billion dollars...." Where is this debt shown in the balance sheet? How is it described in the footnotes? When is it coming due?

3. (Advanced) What has Hallmark Cards proposed to do about the debt owed by Crown Media? What impact will this transaction have on the minority Crown Shareholders?

4. (Advanced) Do you think the noncontrolling interest shareholders in Crown Media can do anything to stop Hallmark Cards from unilaterally implementing whatever changes it desires? Support your answer.

5. (Introductory) Refer to the description of Clear Channel Outdoor. How is the company's share price assessed? In your answer, define the term "price-earnings ratio" or P/E ratio and explain the two ways in which this is measured.

6. (Advanced) What does the author mean when he writes that "anyone buying Outdoor stock should remember that" the existence of a majority shareholder with significant debt holdings also could pose problems for an investment?

Reviewed By: Judy Beckman, University of Rhode Island

"Investors Missing the Jewel in Crown," by Martin Peers, The Wall Street Journal, June 5, 2009 ---
http://online.wsj.com/article/SB124425049774290141.html?mod=djem_jiewr_AC

Investing in a company controlled by its primary lender can be hazardous. Just ask shareholders in Crown Media.

Owner of the Hallmark TV channel, Crown is 67%-owned by Hallmark Cards, which also happens to be its primary lender to the tune of a billion dollars. With the debt due next year, Hallmark on May 28 proposed swapping about half of its debt for equity, which would massively dilute the public shareholders. Crown's stock, long supported by hope that the channel would get scooped up by a big media company, is down 36% since then.

Helping feed outrage among some shareholders was the fact that the swap proposal comes as the Hallmark Channel was making inroads with advertisers. Profits were on the horizon.

Clear Channel Outdoor holds parallels. The billboard company owes $2.5 billion to Clear Channel Media, its 89% shareholder, a fraught situation for Outdoor's public holders.

In this case, of course, the parent is in financial distress. Hence the significance of Outdoor's contemplation of refinancing options, which could lead to the loan being repaid. The hope among some investors is that events conspire to prevent that, forcing the parent into bankruptcy and putting Outdoor up for auction.

That could bail out shareholders. At $6.36 a share at Friday's close, Outdoor's enterprise value is roughly 9.8 times projected 2009 earnings before interest, taxes, depreciation and amortization, below Lamar Advertising's 10.9 times multiple. Using 2010 projections and an equivalent multiple implies a share price above $10.

But as Crown showed, the interests of a majority shareholder who doubles as a lender don't necessarily coincide with minority holders. Anyone buying Outdoor stock should remember that.

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

Bob Jensen's threads on corporate governance are at
http://www.trinity.edu/rjensen/fraud001.htm#Governance

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

Don't toss hedge accounting just because it's complicated

I have trouble with Tom’s argument to toss out hedge accounting in FAS 133 and IAS 39 --- Click Here
 http://accountingonion.typepad.com/theaccountingonion/2009/06/regulate-derivatives-start-with-better-accounting.html

It’s foolish not to book and maintain derivatives at fair value since in the 1980s and early 1990s derivatives were becoming the primary means of off-balance-sheet financing with enormous risks unreported financial risks, especially interest rate swaps and forward contracts and written options. Purchased options were less of a problem since risk was capped.

Tom’s argument for maintaining derivatives at fair value even if they are hedges is not a problem if the hedged items are booked and maintained at fair value such as when a company enters into a forward contracts to hedge its inventories of precious metals.

But Tom and I part company when the hedged item is not even booked, which is the case for the majority of hedging contracts. Accounting tradition for the most part does not hedge forecasted transactions such as plans to purchase a million gallons of jet fuel in 18 months or plans to sell $10 million notionals in bonds three months from now. Hedged items cannot be carried on the balance sheet at fair value if they are not even booked. And there is good reason why we do not want purchase contracts and forecasted transactions booked. Reason number 1 is that we do not want to book executory contracts and forecasted transactions that are easily broken for zero or at most a nominal penalties relative to the notionals involved. For example, when Dow Jones contracted to buy newsprint (paper) from St Regis Paper Company for the next 20 years, some trees to be used for the paper were not yet planted. If Dow Jones should break the contract, the penalty damages might be less than one percent of the value of a completed transaction.

Now suppose Southwest Airlines has a forecasted transaction (not even a contract) to purchase a million gallons of jet fuel in 18 months. Since it has cash flow risk, it enters into a derivative contract (usually purchased option in the case of Southwest) to hedge the unknown fuel price of this forecasted transaction. FAS 133 and IAS 39 require the booking of the derivative as a cash flow hedge and maintaining it at fair value. The hedged item is not booked. Hence, the impact on earnings for changes in the value would be asymmetrical unless the changes in value of the derivative were “deferred” in OCI as permitted as “hedge accounting” under FAS 133 and IAS 39.

If there were no “hedge accounting,” Southwest Airlines would be greatly punished for hedging cash flow by having to report possibly huge variations in earnings at least quarterly when in fact there is no cash flow risk because of the hedge. Reported interim earnings would be much more stable if Southwest did not hedge cash flow risk. But not hedging cash flow risk due to financial reporting penalties is highly problematic. Economic and accounting hit head on for no good reason, and this collision was avoided by FAS 133 and IAS 39.

Since the majority of hedging transactions are designed to hedge cash flow or fair value risk, it makes no sense to me to punish companies for hedging and encouraging them to instead speculate in forecasted transactions and firm commitments (unbooked purchase contracts at fixed prices).

The FASB originally, when the FAS 133 project was commenced, wanted to book all derivative contracts and maintain them at fair value with no alternatives for hedge accounting. FAS 133 would’ve been about 20 pages long and simple to implement. But companies that hedge voiced huge and very well-reasoned objections. The forced FAS 133 and its amending standards to be over 2,000 pages and hellishly complicated.

But this is one instance where hellish complications are essential in my viewpoint. We should not make the mistake of tossing out hedge accounting because the standards are complicated. There are some ways to simplify the standards, but hedge accounting standards cannot be as simple as most other standards. The reason is that there are thousands of different types of hedging contracts, and a simple baby formula for nutrition just will not suffice in the case of all these types of hedging contracts.

Bob Jensen's free tutorials and videos for FAS 133 and IAS 39 are at
http://www.trinity.edu/rjensen/caseans/000index.htm

June 29, 2009 reply from Tom Selling [tom.selling@GROVESITE.COM]

First, I picked my OilCo example because it was also accounted for as a ‘hedge’ of an anticipated transaction—just like your Southwest example. I hope you agree that OilCo was speculating. As to Southwest, you say that Southwest was hedging, but I say they were speculating. If fuel prices had gone south instead of north, Southwest would have been at a severe cost disadvantage against the airlines that did not buy their fuel forward (and they would have become a case study of failure instead of success). In essence, the forward contracts leveraged their profits and cash flows. That’s not hedging, it’s speculating.

FAS 133 has been an abject failure, as have all other ‘special hedge accounting’ solutions that came before it. There will always be some sort of mismatch between accounting and underlying economics, but ‘special hedge accounting’ is not the way to mitigate that. You say that some companies would have been unfairly penalized by entering into hedges without hedge accounting. I say, with current events providing evidence, that much more value was destroyed because special hedge accounting provided cover for inappropriate speculation. To managers, it has been all about keeping risks off the balance sheet and earnings stable; reducing (transferring) economic risks that shareholders may be exposed to is an afterthought. And, besides, most of the time shareholders can reduce their risks by diversification. As we have seen the hard way, transaction risk reduction (what FAS 133 requires) can be more than offset by increases in enterprise risk. On a global scale, FAS 133 (and IAS 39) has done much more to enable managers to use derivatives as instruments of mass economic destruction than help them manage economic risks. And of course, instead of 2000 pages of guidance (and the huge costs that go along with it), we’d have 20 pages.

Although I did not mention it in my blog post, I could be reluctantly persuaded to allow hedge accounting for foreign currency forwards, but that’s as far as I would go.

Best,
Tom

June 30, 2009 reply from Bob Jensen

Hi Tom,

Southwest Airlines was hedging and not speculating when they purchased options to hedge jet fuel prices. If prices went down, all they lost was the relatively small price of the options (actually there were a few times when the options prices became too high and Southwest instead elected to speculate). If prices went up, Southwest could buy fuel at the strike price rather than the higher fuel prices. If Southwest had instead hedged with futures, forward, or swap derivative contracts, it is a bit more like speculation in that if prices decline Southwest takes an opportunity loss on the price declines, but opportunity losses do not entail writing checks from the bank account quite the same as real losses from unhedged price increases.

In any case, Southwest's only possible loss was the premium paid for the purchase options and did not quite have the same unbounded opportunity losses as with futures, forwards, and swaps. In reality, companies that manage risks with futures, forwards, and swaps generally do not have unbounded risk due to other hedging positions.

What you are really arguing is that accounting for most derivatives should not distinguish “asymmetric-booking” hedging derivative contracts from speculation derivative contracts. I argue that failure to distinguish between hedging and speculation is very, very, very, very misleading to investors. I do not think FAS 133 is an "abject failure." Quite to the contrary (except in the case of credit derivatives)!

I have to say I disagree entirely about “derivatives” being the cause of misleading financial reporting. The current economic crisis was heavily caused by AIG’s credit derivatives that were essentially undercapitalized insurance contracts. Credit derivatives should’ve been regulated like insurance contracts and not FAS 133 derivatives. Credit derivatives should never have been scoped into FAS 133.

The issue in your post concerns derivatives apart from credit derivatives, derivatives that are so very popular in managing financial risk, especially commodity price risk and interest rate fluctuation risk. Before FAS 119 and FAS 133 it was the wild west of off-balance sheet financing with undisclosed swaps and forward contracts, although we did have better accounting for futures contracts because they clear for cash each day. Scandals were soaring, in large measure, due to failure of the FASB to monitor the explosion in derivatives frauds. Arthur Levitt once told the Chairman of the FASB that the FASB’s three biggest problems, before FAS 133, were 1-derivatives, 2-derivatives, and 3-derivatives --- http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

When you respond to my post please take up the issue of purchase contracts and non-contracted forecasted transactions since these account for the overwhelming majority of “asymmetric-booking” derivatives contracts hedges being reported today. Then show me how booking changes in value of a hedging contract as current earnings makes sense when the changes in value of the hedged item are not, and should not, be booked.

Then show me how this asymmetric-booking reporting of changes in value of a hedging contract not offset in current earnings by changes in the value of the item it hedges provides meaningful information to investors, especially since the majority of such hedging contracts are carried to maturity and all the interim changes in their value are never realized in cash.

Show me why this asymmetric-booking of changes in value of hedging contracts versus non-reporting of offsetting changes in the value of the unbooked hedged item benefits investors. Show me how the failure to distinguish earnings changes from derivative contract speculations from earnings changes from derivative hedging benefits investors.

What you are really arguing is that accounting for such derivatives should not distinguish hedging derivative contracts from speculation derivative contracts. I argue that failure to distinguish between hedging and speculation is very, very, very, very misleading to investors.

Derivative contracts are now the most popular vehicles for managing risk. They are extremely important for managing risk. I think FAS 133 and IAS 39 can be improved, but failure to distinguish hedging derivative contracts from speculations in terms of the booking of value changes of these derivatives will be an enormous loss to users of financial statements.

The biggest complaint I get from academe is that professors mostly just don’t understand FAS 133 and IAS 39. I think this says more about professors than it does about the accounting. In fairness, to understand these two standards accounting professors have to learn a lot more about finance than they ever wanted to know. For example, they have to learn about contango swaps and other forms of relatively complex hedging contracts used in financial risk management.

Finance professors, in turn, have to learn a whole lot more about accounting than they ever wanted to know. For example, they have to learn the rationale behind not booking purchase contracts and the issue of damage settlements that may run close to 100% of notionals for executed contracts and less than 1% of notionals for executory purchase contracts. And hedged forecasted transactions that are not even written into contracts are other unbooked balls of wax that can be hedged.

There may be a better way to distinguish earnings changes arising from speculation derivative contracts versus hedging derivative contracts, but the FAS 133 approach at the moment is the best I can think of until you have that “aha” moment that will render FAS 133 hedge accounting meaningless.

I anxiously await your “aha” moment Tom as long as you distinguish booked from unbooked hedged items.

Bob Jensen

"The New Role of Risk Management: Rebuilding the Model," Interview with Wharton professors Dick Herring and Francis Diebold, and also with John Drzik, who is president and chief executive officer of Oliver Wyman Group, Knowledge@wharton, June 25, 2009 --- http://knowledge.wharton.upenn.edu/article.cfm?articleid=2268

Bob Jensen's free tutorials and videos for FAS 133 and IAS 39 are at
http://www.trinity.edu/rjensen/caseans/000index.htm

An Academic Study of the History of the AECM

"Knowledge Sharing among Accounting Academics in an Electronic Network of Practice," by  Eileen Z. Taylor and Uday S. Murthy, Accounting Horizons 23 (2), 151 (2009);
Electronic edition subscribers can download an copy from
http://aaapubs.aip.org/dbt/dbt.jsp?KEY=ACHXXX&Volume=LASTVOL&Issue=LASTISS
Others might be able to access the article from at their college libraries.

SYNOPSIS:
Using a multi-method approach, we explore accounting academics' knowledge-sharing practices in an Electronic Network of Practice (ENOP)—the Accounting Education using Computers and Multimedia (AECM) email list. Established in 1996, the AECM email list serves the global accounting academic community. A review of postings to AECM for the period January–June 2006 indicates that members use this network to post questions, replies, and opinions covering a variety of topics, but focusing on financial accounting practice and education. Sixty-nine AECM members constituting 9.2 percent of the AECM membership base responded to a survey that measured their self-perceptions about altruism, reciprocation, reputation, commitment, and participation in AECM. The results suggest that altruism is a significant predictor of posting frequency, but neither reputation nor commitment significantly relate to posting frequency. These findings imply that designers and administrators of the recently launched AAA Commons platform should seek ways of capitalizing on the altruistic tendencies of accounting academics. The study's limitations include low statistical power and potential inconsistencies in coding the large number of postings. ©2009 American Accounting Association

Jensen Comment
The article above affords an opportunity to comment on the AAA Commons about Barry Rice and the AECM. I have initiated the posting below at http://commons.aaahq.org/posts/b7f123c2be 

If you are an AAA member it is an opportunity to add comments to the above posting. You might mention your own reaction to the Taylor and Murthy research paper on the AECM. Do you agree or disagree with the major findings of Taylor and Murthy?

It is also an opportunity to thank Barry Rice for what he enabled you to learn from the AECM over the years since 1996. It is also fabulous that the AECM archived all this messaging.

The AAA Commons access page is at https://commons.aaahq.org/signin 
It can only be accessed by American Accounting Association members and invited guests (some students).

Bob Jensen's threads on the roles of listservs are at http://www.trinity.edu/rjensen/ListservRoles.htm

Eileen Taylor also has an XBRL article
"Accuracy Essential to Success of XBRL Financial Filing Program," by Eileen Z. Taylor and Matt Shipman, NC State News, June 8, 2009 --- http://news.ncsu.edu/news/2009/06/wmstaylorxbrl.php

The largest 500 companies regulated by the U.S. Securities and Exchange Commission (SEC) are poised to submit quarterly financial reports that, for the first time, will be tagged using XBRL code – which will allow computers to "read" their content and make it easier for people to find and analyze financial data contained in the reports. However, a new study by researchers at North Carolina State University finds that XBRL filings submitted voluntarily as part of an SEC pilot for the program contained significant flaws. If the accuracy of the upcoming filings is not significantly improved, the researchers say, these errors will undermine confidence in the XBRL program from the very beginning.

The goal of XBRL is to make quarterly and annual reports computer-readable, allowing investors, companies, finance professionals and academics to sort and access data more efficiently. "Rather than going through a report page by page to find the information they're looking for, users can plug their requests into the computer and have it pull up all relevant data," explains Dr. Eileen Taylor, an assistant professor of accounting at NC State and co-author of the recent study on the accuracy of the voluntary XBRL filings.

Another benefit of XBRL is that it requires companies to use standardized tags for financial statement items, making it easier for users to compare data from different companies. This is significant because companies often use different terms to refer to the same thing. "For example," Taylor says, "one company may refer to its 'operating revenue,' while another company may use the term 'sales of goods net,' and both mean the same thing. By using standardized tags, users can compare apples to apples, which really levels the playing field for individual investors," who may not have the time or expertise to find and accurately compare data from these reports on their own.

But, while the XBRL concept is promising, the study from NC State found that reports from companies that participated in the voluntary pilot program contained multiple errors. "They were poorly tagged," Taylor says, "and there were fundamental errors of accounting. One report, for example, contained too many zeros – turning millions into billions." In their abstract, the researchers note that "These errors are serious because since XBRL data is computer-readable, users will not visually recognize the errors, especially when using XBRL analysis software." In other words, users won't be able to spot that something is wrong.

Now the SEC is requiring that companies file their reports in XBRL, as well as through traditional methods. The mandate is being phased in, with the 500 largest companies required to submit XBRL filings for the quarter ending June 15. The researchers are concerned that, if the upcoming XBRL filings do not represent a significant improvement from the voluntary reports, stakeholders in the financial community will not have any faith in the XBRL program – and it will be rendered relatively ineffective.

The study, "A Comparison of XBRL Filings to Corporate 10-Ks – Evidence from the Voluntary Filing Program," examined XBRL filings by 22 companies that participated in the SEC's voluntary pilot program in 2006. The study was co-authored by Taylor, Drs. Al Y. S. Chen and Jon Bartley, who are both professors of accounting at NC State. The study will be presented at the American Accounting Association Annual Meeting being held in New York City, Aug. 2-5.

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

The 2008-2009 Economic Downfall
Great Graphic:  Infographic: Anatomy of the Crash
http://www.simoleonsense.com/infographic-anatomy-of-the-crash/
Bob Jensen's threads on the downfall --- http://www.trinity.edu/rjensen/2008Bailout.htm 

50 Great Examples of Data Visualization ---
http://www.webdesignerdepot.com/2009/06/50-great-examples-of-data-visualization/
Bob Jensen's threads on visualization of multivariate data ---
http://www.trinity.edu/rjensen/352wpvisual/000datavisualization.htm

Once Again:  The Controversy of Neutrality in the Setting of Accounting Standards

In Concepts Statement No. 2, the FASB asserts it should not issue a standard for the purpose of achieving some particular economic behavior. Among other things, this statement implies that the board should not set accounting standards in an attempt to bolster the economy or some industry sector. Ideally, scorekeeping should not affect how the game is played. But this is an impossible ideal since changes in rules for keeping score almost always change player behavior. Hence, accounting standards cannot be ideally neutral. The FASB, however, actively attempts not to not take political sides on changing behavior that favors certain political segments of society. In other words, the FASB still operates on the basis that fairness and transparency in the spirit of neutrality override politics. However, there is a huge gray zone that, in large measure, involves how companies, analysts, investors, creditors, and even the media react to new accounting rules. Sometimes they react in ways that are not anticipated by the FASB

"Public Workers' Free Health Care Hangs Over Taxpayers," SmartPros, June 24, 2009 --- http://accounting.smartpros.com/x66887.xml

Over the next 30 years, Nassau County expects to spend $3.6 billion paying health care bills for its retired workers. Already this year, it spent more for retirees' health care than it did for their pensions, according to financial statements it plans to publish Wednesday.

Suffolk County faces an even higher liability, according to its latest accounting -- $4.1 billion over 30 years, according to county comptroller Joseph Sawicki.

Free health care for life is a prized benefit of public employment, but its rapidly rising cost to taxpayers is looming into view like the iceberg that sank the Titanic, thanks to the phasing in of a national accounting rule known as GASB-45.

That rule, issued in 2004, also applies to towns, villages, school districts and public authorities. It requires the 30-year cost of retiree health benefits to be listed on their annual financial reports. This year, for the first time, governments with as little as $10 million in revenue will begin reporting those costs in their financial statements, filed at the end of this month. But they are not required to set aside money to cover those costs.

"While we're facing difficult times, now is not the time to ignore this issue and push it aside," said state Comptroller Tom DiNapoli Tuesday, calling the expense "staggering."

New York State has the highest costs in the nation for retired employees' medical care -- an estimated $55 billion over the next 30 years. It, too, paid more last year for retirees' health benefits than their pension costs. Those health costs are only going to go up, warns DiNapoli, who has proposed creating a trust fund governments can use to save for their retirees' health costs. That will reduce the long-term expense, he argues.

But at the moment, county officials seem more interested in finding ways to reduce the obligations than set aside extra money to meet them.

"Knowledge of this figure does not change the pressure on our hard-pressed county taxpayers since we only pay one year's health care bill at a time," said Nassau Comptroller Howard Weitzman, who last year worked with the county legislature on a new benefits package for nonunion employees that increased the number of years required for them to vest lifetime benefits. But his office acknowledged that nonunion employees make up only a small share of the county workforce.

In Suffolk, County Executive Steve Levy is also looking to trim benefits, and blamed the current predicament on a series of nine government downsizings approved by the legislature in eight years that were followed by new hires into many of the same positions.

"Those early retirement incentives of the 1990s are coming home to roost," he said.

Levy has required nonunion employees to contribute at least 10 percent of their health benefits, and said the issue will figure prominently in future contract talks.

"New rules have to be written for new employees coming into the game," he said.

"How well does the FASB consider the consequences of its work?" by Dennis Beresford, All Business, March 1, 1989 ---
http://www.allbusiness.com/accounting/methods-standards/105127-1.html

Neutrality is the quality that distinguishes technical decision-making from political decision-making. Neutrality is defined in FASB Concepts Statement 2 as the absence of bias that is intended to attain a predetermined result. Professor Paul B. W. Miller, who has held fellowships at both the FASB and the SEC, has written a paper titled: "Neutrality--The Forgotten Concept in Accounting Standards Setting." It is an excellent paper, but I take exception to his title. The FASB has not forgotten neutrality, even though some of its constituents may appear to have. Neutrality is written into our mission statement as a primary consideration. And the neutrality concept dominates every Board meeting discussion, every informal conversation, and every memorandum that is written at the FASB. As I have indicated, not even those who have a mandate to consider public policy matters have a firm grasp on the macroeconomic or the social consequences of their actions. The FASB has no mandate to consider public policy matters. It has said repeatedly that it is not qualified to adjudicate such matters and therefore does not seek such a mandate. Decisions on such matters properly reside in the United States Congress and with public agencies.

The only mandate the FASB has, or wants, is to formulate unbiased standards that advance the art of financial reporting for the benefit of investors, creditors, and all other users of financial information. This means standards that result in information on which economic decisions can be based with a reasonable degree of confidence.

A fear of information

Unfortunately, there is sometimes a fear that reliable, relevant financial information may bring about damaging consequences. But damaging to whom? Our democracy is based on free dissemination of reliable information. Yes, at times that kind of information has had temporarily damaging consequences for certain parties. But on balance, considering all interests, and the future as well as the present, society has concluded in favor of freedom of information. Why should we fear it in financial reporting?

Continued in article

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

In particular note the section on Post-Employment Benefits Accounting --- http://www.trinity.edu/rjensen/theory01.htm#CookieJar

June 29, 2009 reply from Orenstein, Edith [eorenstein@financialexecutives.org]

Prof. Jensen,

Your post on 'neutrality' is very thought provoking and I am especially appreciative of the link to Denny Beresford's article published in 1989 in Financial Executive Magazine, which I had not recalled reading for some time if ever; it is a great article. 

I was fortunate to have Dr. David Solomons as my accounting theory professor at Penn in 1982, and I have always been fascinated by the accounting standard-setting process and Con. 2's qualitative characteristics of financial reporting, in particular neutrality and representational faithfulness, as well as the subject of accounting standard-setting vis-a-vis public policy.

One of my favorite quotes from the term paper I wrote in Dr. Solomons' class on the subject of 'Standard-Setting and Social Choice" was by Dale Gerboth, in which Gerboth said:

“The public accounting profession has acquired a unique quasi-legislative power that, in important respects, is self-conferred. Furthermore, its accounting ‘legislation’ affects the economic well-being of thousands of business enterprises and millions of individuals, few of whom had anything to do with giving the profession its power or have a significant say in its use. By any standard, that is a remarkable accomplishment.” [Gerboth, Dale L., "Research, Intuition, and Politics in Accounting Inquiry" The Accounting Review, Vol. 48, No. 3 (July 1973), pp. 475-482, published by the American Accounting Association (cite is on pg 481).]

Returning to Denny's 1989 article, I find it significant that he wrote:

"The only mandate the FASB has, or wants, is to formulate unbiased standards that advance the art of financial reporting for the benefit of investors, creditors, and all other users of financial information. This means standards that result in information on which economic decisions can be based with a reasonable degree of confidence. ... Unfortunately, there is sometimes a fear that reliable, relevant financial information may bring about damaging consequences."

I believe the above statement makes sense, and extending it further, the point I'd make (let me note now these are my personal views) is that: it's one thing if people want to 'throw caution to the wind' so to speak by saying 'ignore public policy (or economic) consequences' - but it's another thing to say that when the proposed accounting treatment would not necessarily 'result in information on which economic decisions can be based with a reasonable degree of confidence" or when 'reliability' has been overly sacrificed for perceived 'relevance.'

Another consideration should be -  'relevance' for whom and by whom, e.g. relevance for some who base their own business or consulting service on, e.g. fire-sale or liquidation prices, vs. e.g. going concern models of valuation? 

Said another way, I think it's one thing to risk economic upheaval for high quality standards, vs. risk economic upheaval for accounting standards of questionable relevance, reliability or representational faithfulness.

Maybe the concept of 'first, do no harm' is another way of saying this, i.e., do not inflict unnecessary harm, particularly without exploring the reasonableness of alternatives, and exploring motivations of all parties involved, and the ability for investors to truly 'understand' what's behind numbers reported in accordance with the accounting standards, and the reliability of those numbers.

Thank you.
Regards,
Edith Orenstein, Director, Accounting Policy Analysis, FEI
eorenstein@financialexecutives.org web: www.financialexecutives.org blog: www.financialexecutives.org/blog

June 30, 2009 reply from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

Bob & Edith:

Rebecca McEnally & I wrote an article on Neutrality in Financial Statements for the FASB Report in 2003 from the perspective of the investor/creditor in which we support the concept of attempting to achieve neutrality rather than conservatism (or prudence) in financial reporting and why. (Available from me if anyone wants.)

One of the issues I've encountered over the years is an elevation of "reliability" in financial reporting to a stature I don't believe is warranted.

What do we really mean by reliable information? Someone can demonstrate how it is calculated? Most would get the same answer if asked to measure? Is something reliable when it's easy to audit?

Every balance sheet item including cash & cash equivalent has an element of estimation in the measurement, especially in mult-national companies that have selected functional currencies and translated them into the presentation currency of the group.

Even with a goal of "neutrality" as one of its qualitative characteristic, financial reporting will always be subjective. Lack of "reliable measurement" can be used to do that. Measurements even at cost require decisions about what's "directly attributable" and what isn't.

Neutrality may not be achievable but let's at least try.

Regards
Pat Walters

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

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Question
What are some "aha" moments in the history of accounting that are attributed to one person's original/seminal idea?

"A Wandering Mind Heads:  Straight Toward Insight Researchers Map the Anatomy." The Wall Street Journal, June 19, 2009 --- http://online.wsj.com/article/SB124535297048828601.html 

It happened to Archimedes in the bath. To Descartes it took place in bed while watching flies on his ceiling. And to Newton it occurred in an orchard, when he saw an apple fall. Each had a moment of insight. To Archimedes came a way to calculate density and volume; to Descartes, the idea of coordinate geometry; and to Newton, the law of universal gravity.

Five light-bulb moments of understanding that revolutionized science.

In our fables of science and discovery, the crucial role of insight is a cherished theme. To these epiphanies, we owe the concept of alternating electrical current, the discovery of penicillin, and on a less lofty note, the invention of Post-its, ice-cream cones, and Velcro. The burst of mental clarity can be so powerful that, as legend would have it, Archimedes jumped out of his tub and ran naked through the streets, shouting to his startled neighbors: "Eureka! I've got it."

In today's innovation economy, engineers, economists and policy makers are eager to foster creative thinking among knowledge workers. Until recently, these sorts of revelations were too elusive for serious scientific study. Scholars suspect the story of Archimedes isn't even entirely true. Lately, though, researchers have been able to document the brain's behavior during Eureka moments by recording brain-wave patterns and imaging the neural circuits that become active as volunteers struggle to solve anagrams, riddles and other brain teasers.

Following the brain as it rises to a mental challenge, scientists are seeking their own insights into these light-bulb flashes of understanding, but they are as hard to define clinically as they are to study in a lab.

To be sure, we've all had our "Aha" moments. They materialize without warning, often through an unconscious shift in mental perspective that can abruptly alter how we perceive a problem. "An 'aha' moment is any sudden comprehension that allows you to see something in a different light," says psychologist John Kounios at Drexel University in Philadelphia. "It could be the solution to a problem; it could be getting a joke; or suddenly recognizing a face. It could be realizing that a friend of yours is not really a friend."

These sudden insights, they found, are the culmination of an intense and complex series of brain states that require more neural resources than methodical reasoning. People who solve problems through insight generate different patterns of brain waves than those who solve problems analytically. "Your brain is really working quite hard before this moment of insight," says psychologist Mark Wheeler at the University of Pittsburgh. "There is a lot going on behind the scenes."

In fact, our brain may be most actively engaged when our mind is wandering and we've actually lost track of our thoughts, a new brain-scanning study suggests. "Solving a problem with insight is fundamentally different from solving a problem analytically," Dr. Kounios says. "There really are different brain mechanisms involved."

By most measures, we spend about a third of our time daydreaming, yet our brain is unusually active during these seemingly idle moments. Left to its own devices, our brain activates several areas associated with complex problem solving, which researchers had previously assumed were dormant during daydreams. Moreover, it appears to be the only time these areas work in unison.

"People assumed that when your mind wandered it was empty," says cognitive neuroscientist Kalina Christoff at the University of British Columbia in Vancouver, who reported the findings last month in the Proceedings of the National Academy of Sciences. As measured by brain activity, however, "mind wandering is a much more active state than we ever imagined, much more active than during reasoning with a complex problem."

She suspects that the flypaper of an unfocused mind may trap new ideas and unexpected associations more effectively than methodical reasoning. That may create the mental framework for new ideas. "You can see regions of these networks becoming active just prior to people arriving at an insight," she says.

In a series of experiments over the past five years, Dr. Kounios and his collaborator Mark Jung-Beeman at Northwestern University used brain scanners and EEG sensors to study insights taking form below the surface of self-awareness. They recorded the neural activity of volunteers wrestling with word puzzles and scanned their brains as they sought solutions.

Some volunteers found answers by methodically working through the possibilities. Some were stumped. For others, even though the solution seemed to come out of nowhere, they had no doubt it was correct.

In those cases, the EEG recordings revealed a distinctive flash of gamma waves emanating from the brain's right hemisphere, which is involved in handling associations and assembling elements of a problem. The brain broadcast that signal one-third of a second before a volunteer experienced their conscious moment of insight -- an eternity at the speed of thought.

The scientists may have recorded the first snapshots of a Eureka moment. "It almost certainly reflects the popping into awareness of a solution," says Dr. Kounios.

In addition, they found that tell-tale burst of gamma waves was almost always preceded by a change in alpha brain-wave intensity in the visual cortex, which controls what we see. They took it as evidence that the brain was dampening the neurons there similar to the way we consciously close our eyes to concentrate.

"You want to quiet the noise in your head to solidify that fragile germ of an idea," says Dr. Jung-Beeman at Northwestern.

At the University of London's Goldsmith College, psychologist Joydeep Bhattacharya also has been probing for insight moments by peppering people with verbal puzzles.

Continued in article

Jensen Comment
I'm having a hard time finding a worthy "aha" moment in accountancy. It certainly would not be Pacioli's double entry contribution since double entry accounting is thought to have been used for over 1,000 years before Pacioli. There have been aha moments in the invention of derivative contracts, but none of them to my knowledge are attributable to accountants. There have been some seminal accounting ideas such as ABC costing, but I think a team of people at Deere is credited for ABC Costing.

What are some "aha" moments in the history of accounting that are attributed to one person's original/seminal idea? 
A short summary of the history of accounting is available at
http://www.trinity.edu/rjensen/theory01.htm#AccountingHistory

-----Original Message----- 
From: Dale Flesher University of Mississippi [mailto:actonya@HOTMAIL.COM]  
Sent: Friday, January 25, 2002 1:35 PM 
To: AECM@LISTSERV.LOYOLA.EDU 
Subject: Re: The Only Invention of Academic Accountants

Contrary to a recent statement in this forum, Dollar-Value Lifo (DVL) was not developed by a professor. The father of DVL was Herbert T. McAnly, who retired in 1964 as a partner at Ernst & Ernst after 44 years with the firm. Throughout his career, McAnly was known as "Mr. LIFO."

Although he did not develop LIFO, which had been around for decades in the form of the base-stock method, he did develop DVL after the Internal Revenue began accepting LIFO from all types of companies. The Treasury would probably never have agreed to allow all companies to use LIFO (in 1939) had they been able to prognosticate McAnly's idea. He first described the concept in an address delivered at the Accounting Clinic and the Central States Accounting Conference in Chicago in May 1941. His concept was finally accepted by the IRS following the Hutzler Brothers Co. case in 1947 (8 TC 14 (1947)). He later worked with the Treasury Department trying to get more practical regulations relating to LIFO.

Dale L. Flesher 
Professor of Accountancy University of Mississippi

June 29, 2009 reply from Dale Flesher [acdlf@olemiss.edu]

Bob:

With respect to your recent posting on the AAA Commons, I would like to make a nomination for an "Aha" moment in accounting. I suggest that Donaldson Brown's invention of the expanded return-on-investment formula (DuPont formula) in 1914 was such a moment. In fact, as I recall, Brown called it his "Eureka" moment in his biography.

In 1914, Brown was asked for a report on the performance of several operating departments. It was at this point that he developed the procedure now known as the DuPont formula. Brown recounted the event in his memoirs as follows:

“An event occurred in l914 which proved to be the turning point of my business career. The circumstances which led up to it were accidental, and I have often wondered what might have been my fate and fortune in industrial management if I had not, that summer, hit upon the mathematical equation (R=TxP) which serves as the heading of this chapter.

Mr. Barksdale was in bad health and was forced to take extended time off, which he spent with his family in Westport, New York. During a period of such absence from the office, the President of the company, Coleman duPont called for a study and report on the performance and accomplishments of the several operating departments. I undertook the job. …

The basis of my report gauging the performance of the various operating departments was a simple mathematical formula: R = T x P. The factor R represented the rate of return on capital invested, which is a final and fundamental measure of industrial efficiency in terms of management’s primary responsibility. The T stood for the rate of turnover of invested capital, and P for the percentage of profit on sales. On the investment side T was broken down into components, embracing plant and other fixed investment items, as well as amounts tied up in working capital in various categories such as raw materials, work in process, finished product, accounts receivable and required operating cash balances.

Dale Flesher
University of Mississippi

A short summary of the history of accounting is available at
http://www.trinity.edu/rjensen/theory01.htm#AccountingHistory

When teaching about the time value of money accounting and finance professors often make reference to losses expected when a "little old lady tucks cash under her mattress." Now we have to add an added risk to the risk of losing the time value of money.

An Israeli woman mistakenly threw out a mattress with $1 million inside, setting off a frantic search through tons of garbage at a number of landfill sites. The woman told Army Radio that she bought her elderly mother a new mattress as a surprise on Monday and threw out the old one, only to discover that her mother had hidden her life savings inside.
"Woman mistakenly junks $1m mattress," Jerusalem Post, June 10, 2009 ---
http://www.jpost.com/servlet/Satellite?cid=1244371059980&pagename=JPost%2FJPArticle%2FShowFull

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

Does Corporate Transparency Contribute to Efficient Resource Allocation? --- Click Here
http://blogs.law.harvard.edu/corpgov/2009/06/03/corporate-transparency-and-resource-allocation/ The Harvard Law School Forum on Corporate Governance and Financial Regulation » Corporate Transparency and Resource Allocation

This post comes from Jere R. Francis, Inder K. Khurana, Raynolde Pereira and Shawn Huang of the University of Missouri-Columbia.)

In our paper Does Corporate Transparency Contribute to Efficient Resource Allocation? which was recently accepted for publication in the Journal of Accounting Research, we examine whether the country-level information environment positively affects the timely reallocation of resources in response to growth shocks (or changes in growth opportunities) by improving the transfer of resources from industries which experience negative growth shocks to those that experience positive growth shocks.

We hypothesize that if a pair of countries has a high level of corporate transparency in each country, then investors are better able to recognize and direct resources towards industries which experience positive growth shocks and away from industries which experience negative growth shocks, irrespective of financial development. Our sample consists of calculated correlations in industry growth rates for 666 country pairs based on 37 unique countries and 37 manufacturing industries for the period 1980-1990 using industry-level data from a United Nations Industrial Development Organization (2000) database. We merge these correlations with country-level measures of corporate transparency that capture the quality of the financial reporting regime, the intensity of private information collection, the quality of information dissemination structures, the level of earnings opacity and stock price synchronicity.

We find transparency is positively associated with the correlation in industry-specific growth rates across country pairs. This positive association is consistent with the notion that corporate transparency helps to channel resources to those particular industries with good growth opportunities and hence contributes to more effective inter-sector allocation of resources. These results generally hold across alternative measures of transparency. In addition, we find that the impact of corporate transparency on the co-movement in growth rates is greater for country pairs with similar levels of economic development. Third, we find that the residual transparency metrics positively explain co-movements in industry-specific growth rates among country pairs, which indicates that transparency over and above that predicted by the underlying institutions facilitates resource allocation. Finally, we measure a country’s level of ex ante growth opportunities using the price-earnings ratio of global industry portfolios weighted by a country’s industrial mix and find that it is only countries with high transparency where there is an association between ex ante global growth opportunities of firms (within a country) and the country’s realized ex post growth in real GDP per capita. This result is consistent with the argument that firms in more transparent settings are better able to exploit global growth shocks and thus achieve higher realized growth rates.

The full paper is available for download here.

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

Talk About a Competitive Advantage for Chrysler:  Immune from Safety Lawsuits
Paul Sheridan is former head of Chrysler's Minivan Safety Leadership Team and winner of the 2005 Civil Justice Foundation National Champion award for his work in transportation safety. He has reviewed the Obama administration's Chrysler bailout plan and notes that it strips away the rights of some people to receive compensation for safety defects in Chrysler products. The president had declared that Chrysler vehicle owners could rely on the government to back repairs covered under warranty. If your transmission fails, he will stand with you. However, if your spouse burned to death due to a fuel system defect, and you are actively seeking redress through product litigation, Obama does not stand with you....There is no precedent for this blatant abuse of the unsuspecting taxpayer who had no say and no representation. Essentially, Obama is demanding that Chrysler safety-defect victims pay to have their own lawsuits dismissed. Is this vicious fleecing allowed by the Constitution?
Hank, "Obama Bailout Plan Kills Safety Lawsuits," Federal Review, May 31, 2009 ---
http://www.federalreview.com/2009/05/obama-bailout-plan-kills-safety.htm
Jensen Comment
Of course if your Ford has a safety defect you can sue Ford into the ground. I wonder how these guarantees and lawsuit protections factor into accounting differences between Chrysler and Ford?

The Tale of Joseph E. Connor

While leading Price Waterhouse, he called for regulation of the then-Big Eight public accounting firms, stated that auditors duck responsibility for fraud, and expressed disapproval of the work of the FASB.

Before reading this you might want to read the biography of a former Price Waterhouse CEO and United Nations Under-Secretary-General for Management named Joseph E. Connor ---
http://www.un.org/News/ossg/sg/stories/connor_bio.html

Accounting Executive Led an Overhaul at the U.N.
by Stephen Miller
The Wall Street Journal
May 23, 2009
Click here to view the full article on WSJ.com

TOPICS: Accounting, Audit Firms, Auditing, Ethics, Public Accounting, Public Accounting Firms

SUMMARY: This obituary describes a man who led Price Waterhouse prior to its merger with Coopers & Lybrand, then went on to lead administration at the U.N., significantly improving its operational efficiencies. While leading Price Waterhouse, he called for regulation of the then-Big Eight public accounting firms, stated that auditors duck responsibility for fraud, and expressed disapproval of the work of the FASB.

CLASSROOM APPLICATION: The article can be used to introduce the big public accounting firms, their role in society and financial markets, and the leadership abilities that the accounting and auditing professions can develop. The need for accountants' and auditors' ethical strengths also can be made evident using this piece.

QUESTIONS: 
1. (Introductory) What firm did Mr. Connor, the subject of this obituary, lead? With what other public accounting firm did Mr. Connor's firm merge?

2. (Introductory) What are the names of the other large public accounting firms presently operating in the U.S.?

3. (Advanced) Consider Mr. Connor's position in 1978 that public accounting was "becoming a semi-public institution." How are public accounting firms operated? How are their operations regulated? Consider in particular, the public firms that audit the companies that are publicly-traded on U.S. exchanges.

4. (Advanced) Mr. Connor also argued that "auditors duck responsibility for fraud." What steps must an auditor take when fraud is detected? Have those requirements changed over time?

5. (Advanced) When he moved to the U.N., Mr. Connor described the operation as "precariously balanced" with "no capital and no reserves." What do these statements mean?

6. (Advanced) How difficult do you think it was for Mr. Connor to express the opinions he stated during his career? How have his arguments borne out over time?

Reviewed By: Judy Beckman, University of Rhode Island

"Accounting Executive Led an Overhaul at the U.N.," by Stephen Miller, The Wall Street Journal, May 23, 2009 --- http://online.wsj.com/article/SB124303178202948519.html?mod=djem_jiewr_AC

Joseph E. Connor, who died May 6 at age 77, was a reform-minded chairman of Price Waterhouse & Co. who went on to lead a restructuring at the United Nations as Undersecretary General for Administration and Management.

At the U.N., where he served from 1994 to 2002, Mr. Connor oversaw a reduction in staffing in what was generally seen by U.S. officials as a bloated institution. Relations got so bad that the U.S. for years underpaid its dues in protest until reforms instituted by Mr. Connor led the U.S. to pay arrears in 1999. Mr. Connor's was a loud and insistent voice that Washington pay up.

"His private-sector experience was invaluable," said former U.N. secretary general Kofi Annan, who credits Mr. Connor with introducing modern management practices.

At Price Waterhouse, where Mr. Connor was chairman for a decade starting in 1978, he became a lightning rod by advocating increased public oversight of the "Big Eight" accounting firms that dominated audits of public companies. "We must recognize that we have become a semi-public institution," he told Fortune in 1978.

He testified on accounting rules before Congress and was critical of the Financial Accounting Standards Board, a professional rule-maker. He also urged that accountants should publicly reveal fraud when they detected it in their clients' books.

"Auditors have been ducking responsibility for fraud for too long," he told the Independent newspaper in 1988. He added that when he had said such things publicly in the past, "I had to buy myself a lot of lunches for some time afterwards."

As a freshly minted Columbia University M.B.A. in 1956, Mr. Connor went to work at Price Waterhouse in New York. He became a partner in 1967 and was put in charge of the firm's Western U.S. operations in 1975. There his responsibilities included overseeing the Price Waterhouse partner who counted the votes for the Academy Awards, though he never knew the winners in advance himself, family members say. His own practice included auditing Exxon and the World Bank.

As Price Waterhouse chairman, Mr. Connor reduced bureaucracy, even while the firm was doubling from 400 to 800 partners. In 1988, he was elected chairman of the Price Waterhouse World Firm, which coordinates the activities of the company's local partnerships around the globe.

"Our slogan since we began has been, 'Be strong in the capital exporting countries,'" he told the Journal of Commerce in 1987, adding that he was planning to promote business in Germany and Japan.

Experienced as he was with auditing top firms, Mr. Connor found the U.N. a rude awakening. "I've never seen anything so precariously balanced at this scale," he told the New York Times in 1995. "There's no capital and no reserves." He was forced to divert money meant for peacekeeping to staff salaries, and publicly compared such financial legerdemain to a Ponzi scheme.

In addition to hectoring American officials into paying the U.S.'s bills, Mr. Connor also proposed selling bonds based on U.S. and other nations' U.N. obligations. The idea came to naught as the U.N. charter doesn't envision dealing with financial markets.

Bob Jensen's threads on auditor professionalism and independence are at http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Bob Jensen's threads on fraud are at
http://www.trinity.edu/rjensen/fraud.htm

"Foreign listings, US equity markets, and the impact of the Sarbanes-Oxley Act," by Jefferson Duarte, Katie Kong, Stephan Siegel, and Lance Young," SSRN (free download), January 23, 2009 ---
http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1018581

This paper examines the effects of the Sarbanes-Oxley Act (SOX) by studying both foreign firms’ decisions to list in the US or the UK and local market stock price reactions to US listing announcements before and after SOX. This research design allows us to overcome difficulties with other studies in the literature that have lead to mixed results. We have three main findings: First, we estimate that if SOX had been a complete surprise to the market, US equity values would increase between 10% and 16%. Second, small firms do not react differently to SOX than large firms. Third, minority investors place greater value on the increased manager accountability imposed by SOX than on the costs associated with the increased accountability. In summary, we find evidence that SOX imposed costs upon managers and insiders but was beneficial for minority investors.

Those of you who watched the FASB relax FAS 157 fair value rules under heavy political pressure my be even more fascinated by the IASB reaction to even heavier European Union fair value rule relaxation pressure being placed on the IASB

"Valuing Funds' Private Assets," by Mark Collard, SmartPros, June 1, 2009 ---  http://accounting.smartpros.com/x66650.xml

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

FASB Statement No. 165, Subsequent Events --- http://www.fasb.org/news/nr052809.shtml

The Financial Accounting Standards Board (FASB) today issued FASB Statement No. 165, Subsequent Events. This Statement is effective for interim and annual periods ending after June 15, 2009.

This Statement is intended to establish general standards of accounting for and disclosure of events that occur after the balance sheet date but before financial statements are issued or are available to be issued. It requires the disclosure of the date through which an entity has evaluated subsequent events and the basis for that date—that is, whether that date represents the date the financial statements were issued or were available to be issued. This disclosure should alert all users of financial statements that an entity has not evaluated subsequent events after that date in the set of financial statements being presented.

In particular, this Statement sets forth:

The period after the balance sheet date during which management of a reporting entity should evaluate events or transactions that may occur for potential recognition or disclosure in the financial statements;

The circumstances under which an entity should recognize events or transactions occurring after the balance sheet date in its financial statements;

The disclosures that an entity should make about events or transactions that occurred after the balance sheet date.

Statement 165 can be found online at www.fasb.org  

 

When Private Equity Owners Screw Their Bankers
The sad part is that Wachovia did not require independent audits
Now there are no deep pocket auditors to sue

Wachovia, for instance, provided tens of millions of dollars in loans and lines of credit backed by assets to Archway despite the fact the company had not had a formal independent audit of its financial statements in three years. A spokeswoman for Wells Fargo, which acquired Wachovia last year, declined comment.
"Oh, No! What Happened to Archway?" by Julie Creswell, The New York Times, May 30, 2009 --- http://www.nytimes.com/2009/05/31/business/31archway.html?_r=1

SITTING in his office late one evening in April last year, Keith Roberts, the director of finance for the Archway & Mother’s Cookie Company, stared in shocked silence at the numbers on his desk.

He knew things had been bad — daily reports he had been monitoring for six months showed that cookie sales at the company had been dismal. But the financial data he was looking at showed much more robust sales.

“Where on earth had all of these sales come from?” Mr. Roberts recalls thinking to himself.

Tired, but intrigued, he began digging through orders and shipping and inventory records until, well after midnight, he reached the conclusion that Archway, based in Battle Creek, Mich., was booking nonexistent sales.

He reasoned that sham transactions allowed Archway, which was owned by a private-equity firm, Catterton Partners, to maintain access to badly needed money from its lender, Wachovia. Mr. Roberts’s investigation eventually caused Wachovia to pull its financing lines, helping to push Archway into bankruptcy last fall. Two other food companies picked off much of its assets earlier this year for $42 million and are churning out the brands’ cookies again.

As accounting scandals go, Archway is no Enron. Not in the size of the possible accounting fraud itself — sales were probably overstated by a few million dollars — or in its sophistication or ingenuity. Yet what court documents filed in Delaware describe as a fairly simplistic fraud went on for months, seemingly missed by the company’s lenders as well as its savvy, private-equity stewards.

And Archway’s collapse is a reminder of the apparent lengths to which some of the nation’s biggest banks went to do deals with private-equity firms during the recent buyout boom.

Wachovia, for instance, provided tens of millions of dollars in loans and lines of credit backed by assets to Archway despite the fact the company had not had a formal independent audit of its financial statements in three years. A spokeswoman for Wells Fargo, which acquired Wachovia last year, declined comment.

Archway’s failure also raises questions about how some private-equity shops operate. When they acquire broken companies, the firms pledge to use their financial, strategic and operational expertise to fix them. The firms receive management fees from their portfolio companies while also charging investors — large institutions and pension funds — fees for managing their money.

Although Catterton placed three of its partners on Archway’s board, naming one as vice chairman, it hired a management company, Insight Holdings, to handle day-to-day operations at Archway. Several former executives and employees who worked at Archway’s headquarters say Insight conducted most of its oversight of the company via telephone and videoconferences.

The Catterton partners, these former employees say, were never seen at Archway. Catterton and Insight nonetheless collected about $6 million in management fees and compensation during their nearly four-year tenure running Archway, court documents assert.

In an e-mailed statement, a spokeswoman for Catterton said the firm did make on-site visits to Archway and stopped receiving fees in October 2007. In total, she said, Catterton received only $2.75 million in fees, half of which was distributed to its investors.

A multitude of lawsuits have been filed in connection with Archway’s collapse, including suits brought by former employees as well as independent distributors. In one suit filed earlier this year in Delaware bankruptcy court, a committee of unsecured creditors contends that the alleged accounting fraud continued for as long as it did because of the “control, participation and acquiescence” of Catterton.

Continued in article

Bob Jensen's threads on the credit crisis are at http://www.trinity.edu/rjensen/2008Bailout.htm

Wasted Taxpayer Money:  Purchase Accounting Rule Will Enable Banks to Report Billions in TARP Profits
"Banks Stand to Reap Billions From Purchased Bad Loans," by Julie Crawshaw, NewsMax, May 27, 2009 ---
http://moneynews.newsmax.com/financenews/purchase_accounting_rule/2009/05/27/218542.html

An accounting rule that governs how banks book acquired loans is making it possible for banks that purchased bad loans to reap billions.

Applying this regulation — known as the purchase accounting rule — to mortgages and commercial loans that lost value during the credit crisis gives acquiring banks an incentive to mark down loans they acquire as aggressively as possible, says RBC Capital Markets analyst Gerard Cassidy.

"One of the beauties of purchase accounting is after you mark down your assets, you accrete them back in," Cassidy told Bloomberg. "Those transactions should be favorable over the long run."

Here’s how it works: When JPMorgan bought WaMu out of receivership last September, it used the purchase accounting rule to record impaired loans at fair value, marking down $118.2 billion of assets by 25 percent.

Now, JPMorgan says that first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank with an accretable-yield balance that could result in additional income of $29.1 billion.

So JPMorgan, Wells Fargo, Bank of America, and PNC Financial Services all stand to make big bucks on bad loans they bought from Washington Mutual, Wachovia, Countrywide and National City.

Their combined deals provide a $56 billion in accretable yields, which is the difference between the value of the loans on the banks’ balance sheets and the cash flow they’re expected to produce.

However, it’s tough to tell how much the yield will increase the acquiring banks’ total revenues because banks don’t disclose all their expenses and book the additional revenues over the lives of the loans.

May 28, 2009 reply from Tom Selling [tom.selling@GROVESITE.COM]

Thanks for providing fodder for what I hope will be a "fun" blog post. Under APB 16, you had to evaluate the adequacy of the allowance for bad debts in an acquisition. With the objective of curbing this particular abuse, the SEC issued a Staff Accounting Bulletin (SAB Codification Topic 2.B.5) that constrained the acquiror from changing the allowance for bad debts, unless the plans for collection was fundamentally different.

The new problem arises, because when the loans were held by the acquiree, they were measured at contractual amount less the allowance for bad debts. Upon acquisition, they now have to be measured at fair value. If the acquirer wants to maximize future profits, it will maximize the difference between the old and new carrying value, subject to the following considerations: (1) auditor and/or SEC push back; (2) future goodwill impairment charges, and (3) capital adequacy regulations.

As to Denny's comment about ultimate collectibility, current managers may not care if the loans go further south some years from now. This generation will be compensated based on accounting profits over the next 2-3 years -- and will be long gone before the proverbial stuff hits the fan.

The more things change, the more they remain the same. I think that the biggest lesson here, Bob, and something I expect you will react to, is that multi-attribute accounting standards don't work.

Best,
Tom

May 29, 2009 reply from Bob Jensen

Hi Tom,

When I first learned about how business firms were exploiting derivative financial instruments contracts in large measure to avoid accounting rules, and before FAS 119/133 issuance, I attended a workshop in Orlando back in the 1980s conducted by Deloitte's derivatives accounting expert John Smith (who later did a lot of IAS 39 work for the IASB).

John told us about a Deloitte client in L.A. that was behaving so strangely that the auditor in charge brought it to John's attention (John was the top research partner in Deloitte at the time). Bank X was repeatedly taking reversing positions on an interest rate swap in a manner such that each time a reversing position was taken there was an ultimate cash flow loss. It seemed that Bank X was making a terrible mistake. John Smith posed this problem as a case to us derivatives accounting neophyte professors in the audience in Orlando.

I recall that the first professor to shout out the answer from the audience was Hugo Nurnberg. Hugo was the first among us neophytes to recognize that, prior to FAS 133 rules, Bank X was making harmful economic decisions just to "frontload income" as Hugo put it. By frontloading income, the CEO got bigger bonuses in what was a bit like Ponzi damage to shareholders. Each year frontloaded income in similar contracting grows by enough to cover tailing cash flow losses. Bonuses and share prices accordingly grow and grow until, dah, frontloaded income is no longer sufficient to cover the tailing cash flow losses. I wonder if a California relative of Bernie Madoff was running Bank X. By the time the Ponzi exploded the Bank X CEO was probably living in luxury in Hawaii.

This was one of the first times I became aware of how executives are willing to maximize personal gains at the ultimate expense of the shareholders for whom they are acting as agents. Since the roaring derivatives fraud days of the 1990s such behavior became the rule rather than the exception, which is why we're in such a dire economic crisis today. Alan Greenspan and Chris Cox belatedly admitted that they "made mistakes" by assuming bankers would put shareholder interests above their own personal greed --- http://www.trinity.edu/rjensen/2008Bailout.htm#SEC

I wonder if this current TARP poison plan is a bit of a Ponzi scheme to inflate banking share prices in what will once again be a royal screwing of investors?

My timeline on the massive derivative financial instruments frauds is at http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

Bob Jensen

June 1, 2009 rely from The Accounting Onion [tom.selling@grovesite.com]

From a MoneyNews.com story published this Wednesday headlined "Banks Stand to Reap Billions from Purchased Bad Loans," came an account of a jaw-dropping transaction. It was spawned by FAS 141(R), the latest and greatest standard on accounting for business combinations:

"When JPMorgan bought WaMu out of receivership last September, it used the purchase accounting rule [FAS 141(R)] to record impaired loans at fair value, marking down 118.2 billion of assets by 25 percent.

Now, JPMorgan says its first-quarter gains from the WaMu loans resulted in $1.26 billion in interest income and left the bank within an accretable-yield balance that could result in additional income of $29.1 billion."

Business combination accounting has forever been fertile ground for earnings and balance sheet management for one simple reason: the opportunity to tweak the amounts reported for the assets acquired and liabilities assumed, with the ultimate objective of brightening post-acquisition earnings reports. But, as tiresome as that old game might be, the kind of maneuver that JPMorgan's management has engineered is a novel twist on an old loophole that had once been closed pretty tightly by the SEC.

 

The Closed Loophole that Would Be Re-Opened by the FASB

Once the "pooling of interests" method of business combination accounting of APB 16 was abolished with the advent of FAS 141 (not to be confused with FAS 141(R)), the most basic surviving principle of business combination accounting became thus: the acquisition of a business should always be reflected on the financial statements of the acquiror by assigning a new carrying amount to each of the acquired company's assets and liabilities. This new carrying amount would be updated, based on current assumptions and estimates regarding the future role of the acquired assets and liabilities in the combined entity. The implementation of this principle had long been known as the "purchase accounting" method for business combinations.

With certain important exceptions, SFAS 141 mandated that new carrying amounts for assets acquired in a business combinations would be based on their fair values. The exception that is germane to the JPMorgan story pertains to loans (i.e., trade receivables, interest-bearing loans and marketable debt securities classified as held-to-maturity). The measurement bases for these items were carried forward from APB 16's version of the purchase accounting method: a gross amount reduced by an appropriate allowance for uncollectible accounts. This exception to loan measurement was important, because it also meant that a 1986 SEC staff position would still be applicable to purchase accounting.

At that time, the SEC saw fit to put a stop to unwarranted increases in the allowance for loan losses as part of the business combination transaction. Increases to loan loss allowances would mathematically transfer future loan losses to goodwill, where they would be deferred indefinitely, with the effect of reporting inflated earnings in future periods as the loans were eventually settled for more than their understated carrying amounts. Staff Accounting Bulletin 61 (Topic 2-A(5)) states that the SEC would not permit any adjustments of the acquiree's estimate of loan loss reserves, unless the acquiror's plans for ultimate recovery of the loans were demonstrably different from the plans that had served as the basis for the acquiree's estimates of the loss reserves.

FASB Amnesia?

FAS 141(R) did away with the "purchase method" and established the "acquisition method" of accounting for business combinations. It apparently did so out of a belief that measurements of assets and liabilities that are based on the most current information available are usually, if not always, preferable to valuations based on less-current information. The JPMorgan case glaringly points to a significant flaw in that belief: inconsistent application of fair value could be more harmful than consistent application of a less desirable attribute. As to the case at hand:

§ WaMu, as is quite common, accounted for its loans based on a held-to-maturity model. That is, except for recognizing declines in creditworthiness, the loan carrying amount is based on the original contractual terms; interest is accrued by multiplying the net carrying amount by the yield to maturity as of the date the loan was originated/acquired.

§ Even though the market value of these loans had declined significantly as they turned toxic, WaMu apparently was not required to record losses to bring the loans down to their fair values.

§ JPMorgan, when acquiring WaMu, was required by FAS 141(R) to mark the loans to market. Subsequent accounting by JPMorgan will continue the WaMu the held-to-maturity model.

It would be a pretty safe bet that JPMorgan was very 'conservative' in their estimates of fair value for the loans; that's because the lower the fair value, the higher the yield to maturity, and the higher the amount of reported future earnings. Of course, there are some limits to JPMorgan's estimate of fair value: auditor pushback, SEC review, increased risk of goodwill impairment charges, and capital adequacy regulations. But, at least in this case, it is possible to become rich without being greedy.

Where is the SEC!?

Maybe there has been more coverage of this issue, but I haven't seen it; kudos to its author, Julie Crawshaw of Newsmax. If we are concerned that bank executives are being overcompensated, especially on the taxpayers' dime, here is a prime example of where insufficient oversight has spawned a new source of moral hazard.

For starters, the SEC should put a stop to this obvious and blatant abuse, immediately. They should issue another SAB, carving out the offending provision of FAS 141(R) and restoring the long-established and functioning status quo. Every company that benefitted from the ill-conceived accounting rule should be forced to retroactively restate their earnings – especially any financial institution on the government dole.

Perhaps the lack of permanent leadership in the Commission's Office of the Chief Accountant is contributing to a lack of attention to this obvious problem, but it is in no way an excuse. Also, this is a problem created by the FASB. Let's be charitable and call it an unintended consequence, but whatever the cause, the FASB should move to fix it forthwith. I'm suggesting that the SEC should act first, solely because they have the demonstrated capability of being able to move the fastest. That's because a SAB doesn't have to be exposed for comment before it can be issued.

But, lacking any actions by either the FASB or SEC to put the cat back in the bag, auditors (perhaps via the PCAOB), and boards should be put on notice of a new potential scheme to inflate executive compensation in the absence of actual value creation for stakeholders. If a single dime of executive compensation comes out of accreted excess earnings from these business combination games, I hope that private securities lawyers will round up the proxies and the lawsuits, settling for nothing less than "a pound of flesh."

A larger lesson is important to briefly discuss in order to understand how this kind of loophole can occur: in accounting for financial assets, the only workable system is comprehensive mark-to-market, all of the time. The current situation is a consequence (intended or otherwise) of the piecemeal approach pursued by the FASB (and IASB) towards fair value accounting.

Why the expensive TARP Bailout Plan won't work ---
http://www.trinity.edu/rjensen/2008Bailout.htm#BailoutStupidity

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

"PCAOB Rips E&Y on Revenue Recognition:  Two of Ernst & Young's clients had to restate financial results after the accounting-firm overseer found departures from GAAP," by Sarah Johnson, CFO.com, May 27, 2009 --- http://www.cfo.com/article.cfm/13725058/c_13725042 

Ernst & Young failed to note when two clients strayed from revenue-recognition rules, according to the latest inspection report on the Big Four firm by the Public Company Accounting Oversight Board. Consequently, the regulator's sixth annual inspection of E&Y resulted in those clients having to restate their previously issued financial statements to make up for the departure from U.S. generally accepted accounting principles.

These companies — whose identity the PCAOB keeps confidential — had "failed" to fully follow FAS 48, Revenue Recognition When Right of Return Exists. The rule calls on companies to, at the time of sale, make reasonable estimates of how many products that customers will return as a factor in deciding when revenue can be recorded.

Further criticizing the audit firm for its work on a third client, the PCAOB claims E&Y didn't test the issuer's VSOE, or vendor-specific objective evidence, which is used to figure out whether the amount of revenue recognized for individual parts of a technology contract was reasonable.

The PCAOB noted the revenue recognition audit deficiencies mentioned here, as well as several others at eight of E&Y's clients after reviewing the firm's work between April and December of last year. The deficiencies were linked to the firm's national office in New York and 22 of its 85 U.S. offices. These errors were significant enough for the oversight board to conclude the firm "had not obtained sufficient competent evidential matter to support its opinion on the issuer's financial statements or internal control over financial reporting."

The PCAOB also criticized E&Y for not fully exploring a client's revenue contracts to see how their terms could affect the issuer's revenue recognition, for not doing enough work to assess the valuation of another issuer's securities, and for relying on information an issuer had deemed unreliable for estimating an income-tax valuation allowance.

To be sure, eight clients may not be many in terms of the number of audits looked at by the oversight board, or when taking into account that E&Y audits more than 2,300 publicly traded companies. The PCAOB, however, doesn't specify how many audits it reviewed and discourages readers of its inspection reports from drawing conclusion on a firm's performance based solely on the number of the reported deficiencies mentioned. "Board inspection reports are not intended to serve as balanced report cards or overall rating tools," the PCAOB notes.

For its part, E&Y, in all but two of the deficiencies cited, revisited its work and made changes. "Although we do not always agree with the characterization in the report ... in some instances we did agree to perform certain additional procedures or improve aspects of our audit documentation," E&Y wrote in a letter dated May 4, that was included in the PCAOB report.

Read the PCAOB report at http://www.pcaobus.org/Inspections/Public_Reports/2009/Ernst_Young.pdf
Part 1 of the report is partially quoted below:

Firm (Ernst & Young)  failed to identify a material weakness in the issuer's internal controls over the accounting for sales returns.

Issuer B
In this audit, the Firm failed to identify a departure from GAAP that it should have identified and addressed before issuing its audit report. The issuer failed to appropriately account for estimated future product returns at the time of sale in accordance with SFAS No. 48.

Issuer C
 In this audit, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had identified certain terms and conditions contained in the issuer's revenue contracts and evaluated their effect on the issuer's ability to report revenue on a gross basis. Further, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had identified and evaluated certain other terms and conditions included in these contracts, such as multiple products and deliverables, acceptance clauses, guarantees of cost savings, and volume rebates, that may have affected the issuer's revenue recognition.

Issuer D
During the fourth quarter, the issuer recorded three individually significant adjustments to correct misstatements in its income tax balances. Two of these misstatements related to prior years. The third related to the issuer's first quarter adoption of Financial Accounting Standards Board Interpretation No. 48, Accounting for Uncertainty in Income Taxes ("FIN 48"). The issuer corrected all three misstatements, which netted to an insignificant amount, by adjusting the current year's income tax expense. The Firm concluded that two of the adjustments should have been recorded as corrections of prior years' errors and the third adjustment should have been recorded as a charge to retained earnings as of the beginning of the year under audit. The Firm also concluded that the net effect of the misstatements was not material to either the current year's or the prior year's financial statements.

In evaluating the net effect of the misstatements, the Firm failed to sufficiently quantify and evaluate one of the misstatements, which related to the income tax valuation allowance. The Firm's analysis both excluded a significant tax asset and relied on information that the issuer had deemed to be unreliable for the purpose of estimating the income tax valuation allowance because the use of the information by the issuer in the past had produced results that were not accurate. Further, the Firm did not evaluate the effect of this misstatement on prior years because it assumed that all amounts related solely to the preceding year, despite evidence to the contrary. Finally, concerning one of the other misstatements, the Firm failed to evaluate the materiality of the FIN 48 adjustment, which represented almost 75 percent of the initial FIN 48 liability recorded in the first quarter, against the cumulative effect of the accounting change.

Issuer E
In this audit, the Firm failed in the following respects to obtain sufficient competent evidential matter to support its audit opinion –

• • The Firm failed to perform sufficient procedures to assess the valuation of certain securities. Specifically, there was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had sufficiently evaluated whether certain of the assumptions underlying the issuer's valuation of the securities were reasonable, and not inconsistent with information that would be used by other market participants to value these types of securities. While the Firm obtained certain historical information, the Firm did not analyze how this historical information provided evidence on the reasonableness of the issuer's assumptions.
   
• The Firm failed to perform sufficient procedures to assess the valuation of certain of the issuer's loans in the following respects – o To determine the values of certain loans, the issuer used prices from certain recent transactions. There was no evidence in the audit documentation, and no persuasive other evidence, that the Firm had evaluated whether the loans being valued were of comparable quality to the loans included in the transactions.
   
  • For other loans, the Firm developed an independent estimate of the value. The Firm's independent estimate was not appropriately supported, as it was based on the incorrect premise that the transactions to which the Firm looked for certain of the inputs were comparable to transactions that would involve the loans being valued

Issuer F
With respect to a significant portion of the issuer's revenue, the Firm failed to test the issuer's vendor-specific objective evidence of the value of deliverables offered in multiple-element arrangements in order to determine whether the amount of revenue that was recognized for individual elements was reasonable. Further, regarding revenue cut-off, the Firm noted that, in the year under audit and the preceding year, revenue significantly increased during the final month of each quarter and at year end. Nonetheless, other than obtaining a list of all contracts, including any changes made to existing contracts, the Firm's substantive procedures to test sales cut-off were limited to analytical procedures that failed to provide the necessary level of assurance because the Firm did not establish expectations for the procedures. Issuer G In this audit, in evaluating the issuer's reserve analysis for two impaired loans, the Firm failed to perform procedures, beyond management inquiries, to evaluate the appropriateness of the methods and the reasonableness of the assumptions that the issuer and certain specialists engaged by the issuer used in estimating the fair value of certain assets that collateralized the loans. Issuer H The issuer amortized certain of its intangible assets on a straight-line basis over the estimated useful lives of the assets. The Firm failed to evaluate whether the issuer's use of the straight-line basis was appropriate given evidence that the economic benefit of the intangible assets was expected not to be consumed at the same rate throughout the assets' lives.

In addition to evaluating the quality of the audit work performed on specific audits, the inspection included review of certain of the Firm's practices, policies, and processes related to audit quality. This review addressed practices, policies, and procedures concerning audit performance and the following five areas (1) management structure and processes, including the tone at the top; (2) practices for partner management, including allocation of partner resources and partner evaluation, compensation, admission, and disciplinary actions; (3) policies and procedures for considering and addressing the risks involved in accepting and retaining clients, including the application of the Firm's risk-rating system; (4) processes related to the Firm's use of audit work that the Firm's foreign affiliates perform on the foreign operations of the Firm's U.S. issuer audit clients; and (5) the Firm's processes for monitoring audit performance, including processes for identifying and assessing indicators of deficiencies in audit performance and processes for responding to weaknesses in quality control. Any defects in, or criticisms of, the Firm's quality control system are discussed in the nonpublic portion of this report and will remain nonpublic unless the Firm fails to address them to the Board's satisfaction within 12 months of the date of this report.

End of Part 1

Bob Jensen's threads on Ernst & Young are at
http://www.trinity.edu/rjensen/fraud001.htm#Ernst

Bob Jensen's threads on independence and professionalism in auditing are at
http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

Bob Jensen's threads on revenue accounting are at
http://www.trinity.edu/rjensen/ecommerce/eitf01.htm

"Former E&Y Partners Cannot Defer Capgemini Income:  Courts agree with the IRS and strike down assumption made by consultants who received stock in exchange for partnership interests," by Robert Willens, CFO.com, April 20, 2009 ---
http://www.cfo.com/article.cfm/13522514/c_2984354/?f=archives

The Supreme Court Puts Sarbanes-Oxley and the PCAOB on the Chopping Block Here's a pleasant surprise: The Supreme Court agreed yesterday to hear arguments in a case challenging the constitutionality of the Sarbanes-Oxley Act of 2002. This could get interesting. "Sarbox and the Constitution," The Wall Street Journal, May 19, 2009 --- http://online.wsj.com/article/SB124268754900032175.html Jensen Comment This is a pleasant surprise for CEOs who do not want to take responsibility for internal controls in their companies and for companies that want weaker and cheaper financial audits. It is not a pleasant surprise for auditing firms. It could return auditing to the 1990s when audits became unprofitable commodities. This could be a disaster to auditing firm revenues. Hopefully the Supreme Court will instead lock in SOX for the smelly feet of unscrupulous corporations. It also could badly hurt the recovery of the stock market since investors will have less confidence in the integrity of financial statements. The poor services of auditing firms became a focal point in the U.S. Congress when equity markets appeared of the verge of collapse due to fear and distrust of the financial reporting of corporations dependent upon equity markets for capital. The Roaring 1990s burned and crashed. In a desperation move Congress passed the Sarbanes-Oxley Act (SOX) of 2002 --- http://en.wikipedia.org/wiki/Sarbanes-Oxley_Act SOX was a shot in the arm for the auditing industry. SOX forced the auditing industry to upgrade services with SOX legal backing that doubled or even tripled or quadrupled fees for such services. Clients continue to grumble about the soaring costs of audits, but in my opinion SOX was a small price to pay for saving our equity capital markets.

"Over 3 million of Deloitte's Free IFRS e-Learning modules downloaded," IAS Plus, June 1, 2009 ---
http://www.iasplus.com/index.htm

As of 31 May 2009, 3,164,828 Deloitte IFRS e-learning modules have been downloaded by visitors to IAS Plus. During 2008 alone, 1,070,387 modules were downloladed. Deloitte's IFRS e-learning was launched at the end of January 2004. Many of the downloaded modules have multiple users because organisations are permitted to install them on their own servers for the internal use of their employees or students. These figures do not include modules completed by Deloitte staff, who access the e-Learning on internal networks. You can always access IFRS e-Learning without charge by clicking on the light bulb icon on the IAS Plus home page. Thirty-seven modules are now available and regularly updated. We are making the Deloitte IFRS e-Learning available in the public interest without charge.

Download site --- http://www.deloitteifrslearning.com/

Bob Jensen's threads on the controversial and as yet uncertain transition to international standards in place of present U.S. GAAP --- http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

Foreign Companies Listed on U.S. Stock Exchanges

May 29, 2009 message from Pinsker, Robert [RPinsker@ODU.EDU]

Somewhere in this discussion someone mentioned that there were roughly 100 foreign companies who trade in the U.S. that have chosen to adopt IFRS this year. Is there a source for that information? Also, about how many foreign companies trade here (to get an idea if 100 is "a lot" or not)? I am interested in the reasons why (or not) IFRS is chosen.

Thanks for the help.

Best,

Robert Pinsker Ph.D., CPA
Associate Professor of Accounting
Old Dominion University

May 29, 2009 reply from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

Robert:

I believe I'm the one that mentioned this because I'm working on a project where I need this information. Unfortunately, at the present time, there is no one source (to my knowledge).

One simply starts non-US companies listed on either NYSE or NASDAQ. The NYSE makes do this somewhat easier than NASDAQ.

First, you narrow the companies to those that use Form 20-F (rather than 10-K which means the company definitely uses US GAAP and meets all other reporting and disclosure requirments for a US issuer). Then, you look at the financial statements one at a time to identify if they report under IFRS or some other GAAP (potentially US GAAP) and whether or not the audit report agrees with the company's statement of compliance with IFRS.

There are far more foreign private issuers that trade in the US. I haven't attempted to count or codify them. Some companies have several different types of securities listed which makes a simple count difficult. If you are really interested, you can go to the NYSE website, listing directory for the NYSE, and then to non-US listed companies.

Regards
Pat

"Effect of Principles-Based Versus Rules-Based Standards and Auditor Type on Financial Managers' Reporting Judgments," Karim Jamal (University of Alberta) and Hun-Tong Tan Nanyang (Technological University), SSRN, July 21, 2008 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1165442

Abstract:
Managers sometimes implement accounting standards (such as the lease standard) opportunistically to move debt off balance-sheet. Regulators are under pressure to adopt principles-based accounting standards to reduce such opportunism. However, there are lingering concerns about whether principles-based standards can be properly implemented and enforced. We report results of an experiment where highly experienced financial managers, with incentives to structure a transaction off balance sheet, take a reporting position on how a lease is to be disclosed. We manipulate the type of GAAP (principles-based, rules-based) and the type of auditor (client-oriented, principles-oriented, or rules-oriented). Our results show that when the auditor is client-oriented, the nature of GAAP does not matter, and that a move towards more principles-based standards is likely to result in improved financial reporting quality only when there is a corresponding shift in auditors' mindsets towards beings more principles-oriented.

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

Are accounting internal controls at universities lax?

"This person was a dean," says Ms. Willihnganz, the provost. "And deans here have a very wide breadth of control. They have a lot of authority. I think, in fact, no one else here at this university could have gotten some of those things through. Because he was a dean, he was trusted."

"Education Dean's Fraud Case Teaches U. of Louisville a Hard Lesson:  The former official now awaits trial. Some colleagues say the university should have caught him earlier," by David Glenn, Chronicle of Higher Education, June 12,. 2009 --- http://chronicle.com/weekly/v55/i39/39a00102.htm?utm_source=at&utm_medium=en

At the end of 2005, Robert D. Felner was riding high. A well-paid dean at the University of Louisville, he had just secured a $694,000 earmarked grant from the U.S. Department of Education to create an elaborate research center to help Kentucky's public schools.

The grant proposal, which Mr. Felner had labored over for months, made some impressive promises. Five Louisville faculty members would devote time to the center, and four other people would be hired. The advisory board would be led by Virginia G. Fox, Kentucky's secretary of education.

On paper this all seemed plausible: From 1996 until 2003, Mr. Felner directed the University of Rhode Island's education school, where he helped create a well-regarded statewide research center.

To put it gently, Mr. Felner did not duplicate that feat at Louisville.

By the spring of 2008, all but $96,000 of the grant had been spent, but none of the tasks listed in Mr. Felner's proposal had been accomplished. Hundreds of thousands of surveys of students, teachers, and parents? School officials in Kentucky say they know of no such studies. Conferences and special issues of education journals? None. An advisory committee led by the state's top education officials? They say they never heard of Mr. Felner's center.

At this point, Mr. Felner was heading for the exit, continuing his climb up the academic ladder. Late in May 2008, he told his colleagues that he had been hired as chancellor of the University of Wisconsin-Parkside, effective August 1.

During his final weeks at Louisville, Mr. Felner pressed his luck one last time. Even though only $96,000 remained in the account, he implored Louisville officials to approve a $200,000 subcontract with a nonprofit organization in Illinois that had already received $450,000 from the grant. Perhaps, he suggested, the university could draw on a special fund that had been established by the daughter of a former trustee.

The Illinois group, Mr. Felner said, had been surveying students and teachers in Kentucky. That survey would "let us give the feds something that should make them very happy about the efficiency and joint commitment of the university to doing a good job with an earmark, as I know we will want more from this agency," he wrote in an e-mail message on June 18.

Two days later, Mr. Felner's offices were raided by federal agents who took away his files and laptops. He was questioned for hours by a U.S. Postal Service inspector and a member of the University of Louisville's police department. That weekend he called Wisconsin officials: Sadly, he wouldn't be coming to Parkside after all.

In October a federal grand jury indicted Mr. Felner on nine counts of mail fraud, money laundering, and tax evasion. According to the indictment, the Illinois nonprofit group, known as the National Center on Public Education and Prevention, was simply a shell that funneled money into the personal bank accounts of Mr. Felner and Thomas Schroeder, a former student of his and the group's "executive director." Prosecutors say the two men siphoned away not only the $694,000 earmarked grant, but also $1.7-million in payments from three urban school districts, money that ought to have gone to the legitimate public-education center that Mr. Felner had created in Rhode Island.

Mr. Felner and Mr. Schroeder now await trial on charges that could send them to prison for decades. No trial date has been set.

None of the accusations have been proved in court, and Mr. Felner's lawyers have signaled in pretrial briefs that they will defend him aggressively. (They declined to comment for this article.)

But two facts seem hard to avoid: All but $96,000 of the earmarked grant has been spent. And there is no evidence that the activities listed in Mr. Felner's grant proposal have been carried out.

A Question of Oversight

When Louisville accepted the earmarked grant, its officials signed the boilerplate language attached to most federal contracts. The university, they promised, had "the institutional, managerial, and financial capability ... to ensure proper planning, management, and completion of the project."

But did it in fact have that capability? For several months in 2007, Mr. Felner charged almost $37,000 of his salary against the grant, but there is no evidence that he ever worked on the project. (In an October 2008 memorandum, Robert N. Ronau, the college of education's associate dean for research, declared that he knew of no reports, articles, or other products that resulted from the grant.). Federal regulations require that universities use "suitable means of verification that the work was performed" when they prepare time-and-effort reports; Louisville officials declined to comment on how Mr. Felner's time-and-effort reports were processed.) And when he sent his first big payment to the Illinois group, Mr. Felner constructed the deal as a personal-services contract instead of a formal subcontract, which would have been subject to more oversight by the university. But no one corrected that error for more than a year.

In the months since Mr. Felner's indictment, Louisville has seen a parade of blue-ribbon committees, auditors, and management consultants. University leaders insist that they have streamlined their research-compliance systems to prevent any more trouble. They also emphasize that it was a university employee who tipped off law enforcement to Mr. Felner's actions. (Who did this and when remains a mystery — but e-mail records obtained by The Chronicle make clear that by May 2008, Louisville's research administrators were becoming more openly skeptical of Mr. Felner's claims.)

"What these reports have affirmed is that we basically have pretty good practices in place," says Shirley C. Willihnganz, Louisville's provost. "I think what we had in this case was a person who abused the system. And so it's not so much that our policies were bad or that our procedures were bad. We had a person who did not follow them and did not respect them."

But some of Mr. Felner's former colleagues insist that he should have been stopped long before the spring of 2008. They say the university coddled Mr. Felner and turned a blind eye to his grant management, in part because the doctoral program in education rose impressively in the annual U.S. News & World Report rankings after his arrival. If the university had paid more attention to the many faculty and student grievances against Mr. Felner — and especially to a 2006 faculty vote of no confidence in his leadership — the grant money might never have gone missing, they say.

"The University of Louisville, like everybody, is aspiring to bring in more grant dollars," says Bryant A. Stamford, a professor of exercise science at Hanover College who left Louisville's faculty in 2005 after a dispute with Mr. Felner. "When you put yourself in that position, it's pretty amazing what you're willing to do. You sacrifice the infrastructure of the university in order to put out a report that says, Look, grants are up by 60 percent this year."

The Louisville affair comes at a time when officials of Emory University, Harvard University, and other institutions have faced Senate investigations revealing that scholars had failed to disclose hundreds of thousands of dollars they had received from pharmaceutical companies. Throughout the country, research administrators are asking themselves if tougher rules could detect miscreants, or whether determined liars will always find a way around the rules.

Throwing a Bone

In 2005, two years after he arrived at Louisville, Mr. Felner won his $694,000 earmarked federal grant, which was billed as "Support and Continuous Improvement of No Child Left Behind in Kentucky."

The earmark was sponsored by U.S. Representative Anne M. Northup, a Republican who then represented Kentucky's third district. It is easy to see what might have attracted Ms. Northup to Mr. Felner's proposal: He claimed to have lined up cooperation from a host of Kentucky school districts and public officials, and he could point to the track record of his Rhode Island center.

In fact, the proposal promised not only to replicate the success of Mr. Felner's Rhode Island center. It promised to bring the Rhode Island center to Louisville. The National Center on Public Education and Social Policy was "formerly located at the University of Rhode Island" and would "now be subsumed under the aegis of" Mr. Felner's Louisville office, the proposal said.

So maybe it should have raised eyebrows among Louisville's research administrators when in March 2006, only a few months after he had won the earmark, Mr. Felner sent $60,000 of the grant money to Rhode Island.

The "work plan" attached to that subcontract was a blizzard of verbiage that said nothing very specific about what the Rhode Island center was supposed to do with the $60,000. "The National Center on Public Education and Social Policy at the University of Rhode Island agrees to provide data analysis and support relating to critical questions and educational research issues focused on No Child Left Behind Initiatives for project work conducted by the University of Louisville," the plan read. "By subcontracting with the University of Rhode Island, the NCLB Center can begin work immediately with data collected by the Center. URI's established level of expertise and technological capabilities are sophisticated enough to assimilate endeavors of this magnitude seamlessly while the Center is in the process of building their systems and personnel."

The $60,000 actually had nothing to do with Mr. Felner's earmark, according to federal prosecutors and officials at Rhode Island. Instead, they say, Mr. Felner was throwing a bone to his former colleagues, whom he and Mr. Schroeder had cheated out of more than $1.7-million in income.

Here we need to make a quick detour into the heart of the prosecutors' allegations. Between 2000 and 2003, the Rhode Island center conducted tens of thousands of surveys in public schools in Atlanta, Buffalo, and Santa Monica. But Mr. Felner and Mr. Schroeder allegedly tricked the three districts into sending their payments to their fraudulent Illinois organization, whose name was very similar to the Rhode Island center's. (In Rhode Island: the National Center on Public Education and Social Policy. In Illinois: the National Center on Public Education and Prevention.) The Illinois money then flowed into the two men's bank accounts, prosecutors say. Mr. Felner owns four houses whose combined value is more than $2-million.

Stephen Brand, a professor of education at Rhode Island who worked on the three survey projects, says that Mr. Felner strung the center along with vague promises and explanations about why the school districts' money had not materialized. But Mr. Brand says he does not know many details. "I haven't seen copies of those three contracts," he says. "I don't think anyone here has ever seen them." (Anne Seitsinger, the Rhode Island center's director, declined repeated requests for an interview.)

In any case, the Rhode Island center managed to survive for several years without the $1.7-million because it had accumulated a substantial surplus from its multiyear, multimillion-dollar survey contract with the state of Rhode Island. But by 2005 it was facing a deficit. That year, according to The Providence Journal, the center's business manager wrote to Mr. Felner in Louisville: "Are you giving out loans? We sure need one right now."

The $60,000 subcontract was apparently just such a "loan." The money was used only to cover the Rhode Island center's operating deficit. Despite its purported power to "assimilate endeavors of this magnitude seamlessly," the Rhode Island center never actually did any work on the earmarked Louisville grant.

Robert A. Weygand, Rhode Island's vice president for administration, concedes that it was wrong for the center to accept the $60,000, and he says the university has tightened the oversight of all its research centers. But he emphasizes that federal prosecutors have not charged anyone at Rhode Island with any crime. "What they've told us is that we're a victim of a million-dollar theft," Mr. Weygand says. "We have a right to compensation from any funds that may be recovered from Mr. Felner. We've been working with the Secret Service."

Budget Details

The $60,000 Rhode Island subcontract was only a prelude. At the end of 2006, Mr. Felner told his colleagues that Louisville needed to sign a $250,000 personal-services contract with the Illinois center. His grant proposal had said nothing about the Illinois center, but Mr. Felner now declared that that center, as the "developer/owner of the High Performance Learning Communities Assessments," was the only entity that could effectively survey students and teachers in Kentucky. At the end of 2007, he sent another $200,000 to Illinois. According to prosecutors, the entire $450,000 eventually ended up in Mr. Felner's and Mr. Schroeder's wallets.

Where the work plan on the Rhode Island subcontract had been flowery and vague, the work plans on the Illinois subcontracts were curt and vague. The first one said only that the Illinois center would "provide for the use" of the survey assessments "and the use of data derived therefrom." The second one said that the Illinois center would provide survey data from 135,000 students, 50,000 parents, and 10,500 teachers — but it did not name any Kentucky school districts where the surveys would be conducted.

E-mail records offer a detailed tracing of how that second Illinois subcontract was constructed. The process suggests how Mr. Felner tended to parry research administrators' efforts — such as they were — to wring accurate information from him.

On November 9, 2007, Jennifer E. Taylor, director of grant support and sponsored programs at the college of education, wrote to Mr. Felner to report that she had spoken with B. Ann LaPerle, an assistant in the university's office of grants management. "I just spoke with Ann about the subcontract with Tom [Schroeder]'s group," Ms. Taylor wrote. "We are going to need a detailed budget, so if you have time today, we can get this out and processed."

Mr. Felner replied with a small tantrum. "I have no idea what that means but will try as we have never done such a thing," he wrote. "We tend to pay them by the number of students and surveys but since we do not have enough to actually pay for it all so they are giving us some for free this could be tricky. And given the delays already if it takes another week or so we simply will not be able to do it this year nor finish the work. Unbelievable!"

Later that day, Ms. Taylor wrote to Ms. LaPerle, instructing that the subcontract's detailed budget should read simply "$1 per survey for 200,000 surveys."

But hours later, Mr. Felner weighed in with a more detailed budget — the one that ultimately appeared on the subcontract. Mr. Felner's version stipulated 135,000 student surveys at a price of $1.25 each, 10,500 teacher surveys at $1.45 each, and so on through several more categories.

Apparently no one questioned the discrepancy between the two versions. And neither Ms. LaPerle nor Ms. Taylor asked for any proof that the Illinois center had done any work on its first subcontract, which had been signed almost a year earlier.

It is that last element that seems most startling. It must have been an open secret in Ms. Taylor's office that the Illinois group had received $250,000 at the beginning of 2007 but that no surveys had been conducted. Ms. Taylor has left the university. Her supervisor, Mr. Ronau, declined requests for an interview.

So why did Louisville officials not catch this apparent fraud for a full two years? The Rhode Island subcontract said the center was supposed to submit a final report by the end of September 2006, but no report was ever submitted. The Illinois contracts likewise specified report dates, and one of them said that its work would require approval by a human-subjects-protection board. None of that ever happened — but there is no evidence that anyone objected before the spring of 2008.

"This person was a dean," says Ms. Willihnganz, the provost. "And deans here have a very wide breadth of control. They have a lot of authority. I think, in fact, no one else here at this university could have gotten some of those things through. Because he was a dean, he was trusted."

Misplaced Trust

But that is exactly what many of Mr. Felner's former colleagues dispute. Louisville's leaders, they say, had plenty of reason to distrust Mr. Felner long before he began to send six-figure checks to Illinois.

Continued in article

Kansas State U. Audit Finds Possible Financial Shenanigans
An audit released Friday by the Kansas State Board of Regents has found thousands of dollars worth of payments to companies owned by current and former university officials, The Kansas City Star is reporting. The officials include Bill Snyder, the football coach; Tim Weiser, a former athletic director; and Robert S. Krause, a former vice president for institutional advancement and former athletic director. The 34-page audit, which describes other poor accounting and possible IRS problems for the university, is part of an exit review by the Board of Regents of Kansas State’s former president, Jon Wefald, who left this year.
Heidi Landecker, Chronicle of Higher Education, June 20, 2009 ---
http://chronicle.com/news/article/6673/kansas-state-u-audit-finds-questionable-payments-to-officials

Bob Jensen's threads on Financial and Academic Lack of Accountability and Conflicts of Interest ---
http://www.trinity.edu/rjensen/HigherEdControversies.htm#Accountability

BDO Seidman:  Good News and the Bad News

Y PATRICK DANNER
pdanner@MiamiHerald.com
640 words
17 June 2009
The Miami Herald
A1
3
English
(c) Copyright 2009, The Miami Herald. All Rights Reserved.

BDO International is not liable for $351 million in punitive damages that a Miami jury awarded a Portuguese bank in 2007, a Miami-Dade Circuit judge has ruled.

Banco Espirito Santo was awarded $170 million for its losses and $351 million in punitive damages for the negligence of accounting firm BDO Seidman. The reason: BDO failed to uncover fraud at a now-defunct financial services firm in which the bank held a stake. Still left to be decided is whether BDO International is on the hook for the $170 million award, too.

TRIAL UNDER WAY

In a trial now under way in Miami-Dade Circuit, Banco Espirito Santo had wanted a new jury to hold BDO International responsible for the 2007 award, as well. The bank alleged BDO International was grossly negligent in failing to ensure Chicago-based BDO Seidman performed proper audits of factoring firm E.S. Bankest.

Belgium-based BDO International was part of the earlier trial, but was dismissed from the case after a judge found the bank presented no evidence establishing its claim against BDO International. An appeals court disagreed and ordered that a jury must decide whether BDO International was responsible for ensuring the quality of BDO Seidman's audits.

 

Article continues

QUESTION FOR JURY

Still left for the jury to decide is whether BDO International should be responsible for the $170 million in losses sustained by the bank because of the fraud. The bank alleges BDO International is liable for the verdict because BDO Seidman is an agent of BDO International. BDO Seidman has appealed the verdict.

On Tuesday, BDO International completed the presentation of its case. Closing arguments in the trial, which started two weeks ago, may happen on Wednesday.

Document MHLD000020090617e56h0000o

From The Wall Street Journal Accounting Weekly Review on June 18, 2009

In BDO Case, 7 Charged with Fraud
by Chad Bray
The Wall Street Journal
Jun 10, 2009
Click here to view the full article on WSJ.com ---
http://online.wsj.com/article/SB124458292771699471.html?mod=djem_jiewr_AC

TOPICS: Ethics, Public Accounting, Public Accounting Firms, Tax Evasion, Tax Shelters, Taxation

SUMMARY: "Seven people including the former chief executive and chairman of accounting firm BDO Seidman LLP have been charged criminally in an allegedly fraudulent tax-shelter scheme that generated billions of dollars in false tax losses for clients." The remaining six include three former Jenkens & Gilchrist PC lawyers--one of which is Paul Daugerdas, former head of the law firm's Chicago office who joined the firm bringing in the revenue from these tax-structured transactions--and two former investment-bank employees. The investment bank wasn't named in the indictment but "a person familiar with the matter" said it was Deutsche Bank AG.

CLASSROOM APPLICATION: Ethics, including the need to stand up against others' unethical actions, can be discussed with this article.

QUESTIONS: 
1. (Introductory) What is tax evasion? Differentiate it from tax avoidance.

2. (Advanced) What types of firms have been charged in this "27-count federal indictment, which includes charges of conspiracy and tax evasion"? How must these types of firms work together to structure tax-beneficial transactions?

3. (Introductory) Refer to the related articles. Summarize the description of the types of transactions questioned by the IRS and leading to the indictment.

4. (Advanced) Are there ways in which structured transactions can be legitimate tax shelters? What are some general requirements that must be met for a transaction to be considered legitimate?

5. (Introductory) Refer again to the related articles. What were the Jenkens & Gilchrist partners' concerns about the risk of the transactions and services structured and sold by the Chicago office partner Mr. Daugerdas? What factors did they allow to override their concerns?

6. (Introductory) Place yourself in the position of partner in the law firm of Jenkens & Gilchrist. Consider the issues discussed at the board meetings in offering a position to Mr. Daugerdas and in dealing with the beginning lawsuits from clients facing IRS scrutiny. How would you react in each of these meetings?

7. (Advanced) What is the affiliation of the accounting firm BDO Seidman in these transactions? How could the accounting firm and its partner be held responsible for a transaction designed by another firm--a law firm, not an accounting firm, at that?

Reviewed By: Judy Beckman, University of Rhode Island

RELATED ARTICLES: 
How A Bid to Boost Profits Led to a Law Firm's Demise
by Nathan Koppel
May 17, 2007
Online Exclusive

Gone But Not Forgotten: Jenkens Gilchrist Trio Indicted for Tax Fraud
by Ashby Jones
Jun 09, 2009
Online Exclusive

"Former BDO Seidman vice chair pleads guilty to tax fraud," AccountingWeb, March 20, 2009 ---
http://www.accountingweb.com/cgi-bin/item.cgi?id=107235 

Adrian Dicker, a United Kingdom chartered accountant and former vice chairman and board member at a major international accounting firm, has pleaded guilty to conspiring with certain tax shelter promoters to defraud the United States in connection with tax shelter transactions involving clients of the accounting firm and the law firm Jenkens & Gilchrist (J&G), the Justice Department and Internal Revenue Service (IRS) announced. In the hearing before U.S. Magistrate Judge Theodore H. Katz in the Southern District of New York, Dicker, who is a resident of Princeton Junction, NJ, also pleaded guilty to tax evasion in connection with a multi-million dollar tax shelter that Dicker helped sell to a client of the accounting firm.

According to the information and the guilty plea, between 1995 and 2000, Dicker was a partner in the New York office of the accounting firm which he identified during his guilty plea as BDO Seidman. From early 1999 through October 2000, Dicker was on the firm's Board of Directors, and through October 2003 he served as a retired partner director. From 1998 until 2000, Dicker was one of the leaders of the firm's "Tax Solutions Group" (TSG), a group led by the firm's chief executive officer, Dicker, and another New York-based tax partner. The activities of the TSG were devoted to designing, marketing, and implementing high-fee tax strategies for wealthy clients, including tax shelter transactions.

According to the information and the guilty plea, Dicker and the other two TSG managers used a bonus structure that handsomely rewarded the accounting firm personnel involved in the design, marketing, and implementation of the TSG's transactions, including: the individual who referred the client to TSG personnel; the TSG member who pitched and closed the sale; other TSG members; and TSG management. From July 1999, Dicker, the CEO, and the other TSG manager earned and shared equally 30 percent of the net profits of the TSG. Dicker earned approximately $6.7 million in net TSG profits, as well as salary and bonuses between 1998 and 2000. In addition, the CEO of the firm doled out additional bonuses from the profits earned as a result of the sale of the tax shelter products. Moreover, the firm made the sale of the tax shelter products a focal point of its aggressive "value added" product promotion activities, using a "Tax $ells" logo and other marketing hype to induce employees to generate additional tax shelter sales.

According to the information and the guilty plea, while serving as a manager of the TSG, Dicker, along with other TSG partners, engaged in the design, marketing, and implementation of two different tax shelter transactions with the Chicago office of the law firm of Jenkens & Gilchrist, as well as an international bank with its U.S. headquarters in New York. As a member of TSG and the accounting firm's tax opinion committee - which reviewed the tax opinions issued in connection with tax shelter transactions sold by the accounting firm and J&G - Dicker knew that the tax shelter transactions he helped vet and sell would be respected and allowed by the IRS only if the client had a substantial non-tax business purpose for entering the transaction, and the client had a reasonable possibility of making a profit through the transaction. Dicker and his co-conspirators knew and understood that the clients entering into the tax shelter transactions being marketed and sold with J&G had neither a substantial non-tax business purpose nor a reasonable possibility of earning a profit, given the large amount of fees being charged by the accounting firm and J&G to enter the transaction. Those fees were set by the co-conspirators as a percentage of the tax loss being sought by the tax shelter clients. Dicker also knew that the clients who purchased the tax shelter had no non-tax business reasons for entering into the transactions and their pre-planned steps.

According to the information and the guilty plea, in order to make it appear that the tax shelter clients of Dicker, other TSG members, and J&G had the requisite business purpose and possibility of profit, Dicker and his co-conspirators reviewed and approved the use of a legal opinion letter issued by J&G that contained false and fraudulent representations purportedly made by the clients about their motivations for entering into the transactions. In addition, Dicker and his co-conspirators created and used, or approved of the creation and use of, other documents in the transactions that were false, fraudulent, and misleading in order to paint a picture for the IRS that was patently untrue - that is, that the clients had a legitimate non-tax business purpose for entering the transaction and executing the preplanned steps of the transaction. Dicker also admitted during his plea that TSG members created and placed into client files certain paperwork that falsely conveyed fabricated business purposes and rationales for clients entering into the shelters. The false paperwork was created to mislead and defraud the IRS.

Continued in article

Bob Jensen's threads on accounting firms are at
http://www.trinity.edu/rjensen/Fraud001.htm

Journal of Accountancy Question and Answer About Tech Q&A

Q: I find your Tech Q&A column very useful. Is there some way I can track down items you published earlier? It sure would be handy.

A: Several readers have asked about this, and yes, the magazine has a very comprehensive and easy-to-use Web site for locating articles. Go to www.journalofaccountancy.com/BrowseTopics , and then cursor down to the “Technology” area and then to “Tech Tips.” The Web site also has a very powerful search engine for tracking down articles by subject, author, headline and more.

"Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers."

"Jury in Michigan Sides with SEC in Kmart Case," SmartPros, June 1, 2009 ---
http://accounting.smartpros.com/x66692.xml

The former head of Kmart Corp., who told jurors he was hired to save the venerable retailer, was found liable Monday for misleading investors about company finances before a bankruptcy filing in 2002.

The verdict in the civil fraud trial followed 10 days of testimony in federal court in Ann Arbor. The case was a fresh look at Charles Conaway's brief tenure and the desperate scramble to keep Kmart afloat before one of the largest bankruptcies in retail history.

The Securities and Exchange Commission accused him of failing to disclose that the retailer was delaying payments to suppliers to save cash. The trial centered on a conference call with analysts and Kmart's quarterly report to regulators, both in November 2001.

"It was a clean sweep," SEC trial lawyer Alan Lieberman said of the verdict.

"It is never enough for the numbers to be right. For the average investor, the numbers being right do not tell the whole story," he said. "They need to know the material information that management knows. The foundation of the markets is full and honest disclosure."

The SEC blamed Conaway for not sharing details in the report's management-analysis section. He testified that he didn't write it, didn't read it and relied on his chief financial officer and others.

During a call with Wall Street analysts, Conaway said sales were poor - and the stock took a 15 percent hit - but he didn't talk about the vendor strategy or an ill-timed purchase of $800 million in merchandise.

He testified that Kmart had $1 billion in cash and credit when the call was made and the quarterly report was filed. Conaway said it "never" crossed his mind that he was withholding critical news.

The jury, however, found that he acted "with intent to defraud or with reckless disregard for the truth."

Despite Conaway's testimony, the jury found that delaying payments to vendors was a "material liquidity deficiency" affecting Kmart's finances and should have been publicly reported.

Conaway's lawyer, Scott Lassar, said they were disappointed with the verdict and would pursue an appeal.

U.S. Magistrate Judge Steven Pepe will handle the penalty phase. Conaway, 48, could be fined and banned from serving as an executive or director at a public company.

He had a successful career in the drugstore industry when he agreed in 2000 to try to turn around Kmart, which was no match for discount rivals Wal-Mart Stores Inc. and Target Corp. Conaway was gone less than two years later.

Kmart emerged from Chapter 11 bankruptcy as a smaller company and now is part of Sears Holdings Corp., based in Hoffman Estates, Ill.

The lawsuit against Conaway and his former CFO, John McDonald Jr., was filed in 2005, three years after the bankruptcy.

Ronald Kiima, formerly an assistant chief accountant at the SEC, said when a company fails "there's a lot of `What did you know and when did you know it?'"

"If you don't give the sausage-making of what happened during a quarter, that could be an issue," Kiima said in an interview. "For a CEO to say he didn't lay eyes on the report is pretty damning."

Continued in article

Jensen Comment
Discount retailer Kmart came under investigation for irregular accounting practices in 2002. In January an anonymous letter initiated an internal probe of the company's accounting practices. The Detroit News obtained a copy of the letter that contains allegations pointing to senior Kmart officials as purposely violating accounting principles with the knowledge of the company's auditors, PricewaterhouseCoopers. http://www.accountingweb.com/item/82286 

Bankrupt retailer Kmart explained the impact of accounting irregularities and said employees involved in questionable accounting practices are no longer with the company. http://www.accountingweb.com/item/90935 

Kmart's CFO Steps up to Accounting Questions

AccountingWEB US - Sep-19-2002 -  Bankrupt retailer Kmart explained the impact of accounting irregularities in a Form 10-Q filed with the U.S. Securities and Exchange Commission (SEC) this week. Chief Financial Officer Al Koch said several employees involved in questionable accounting practices are no longer with the company. Speaking to the concerns about vendor allowances recently raised in anonymous letters from in-house accountants, Mr. Koch said, "It was not hugely widespread, but neither was it one or two people." The Kmart whistleblowers who wrote the letters said they were being asked to record transactions in obvious violation of generally accepted accounting principles. They also said "resident auditors from PricewaterhouseCoopers are hesitant to pursue these issues or even question obvious changes in revenue and expense patterns." In response to the letters, the company admitted it had erroneously accounted for certain vendor transactions as up-front consideration, instead of deferring appropriate amounts and recognizing them over the life of the contract. It also said it decided to change its accounting method. Starting with fourth quarter 2001, Kmart's policy is to recognize a cost recovery from vendors only when a formal agreement has been obtained and the underlying activity has been performed. According to this week's Form 10-Q, early recognition of vendor allowances resulted in understatement of the company's fiscal year 2000 net loss by approximately $26 million and overstatement of its fiscal year 2001 net loss by approximately $78 million, both net of taxes. The 10-Q also said the company has been looking at historical patterns of markdowns and markdown reserves and their relation to earnings. Kmart is under investigation by the SEC and the Justice Department. The Federal Bureau of Investigation, which is handling the investigation for the U.S. Attorney, said its investigation could result in criminal charges. In the months before Kmart's bankruptcy filing, top executives took home approximately $29 million in retention loans and severance packages. A spokesperson for PwC said the firm is cooperating with the investigations.

Bob Jensen's threads on the KMart auditing firm, PwC, are at http://www.trinity.edu/rjensen/fraud001.htm#PwC

"Chasing Tax Revenue Across State Lines:  Cash-starved states like Massachusetts are going after businesses that profit from their residents but are headquartered outside their borders," by Jessica Silver-Greenberg, Business Week, May 21, 2009 --- http://www.businessweek.com/magazine/content/09_22/b4133028564343.htm?link_position=link9

Companies have long flocked to low-tax locales like Delaware and South Dakota. But those tax advantages may soon be in jeopardy. States, which collectively could face a $50 billion budget shortfall over the next two years, are scrambling for cash and may start hitting up companies for more money—even companies outside their borders. "The states are turning over every rock for money," says Richard D. Pomp, a professor at the University of Connecticut School of Law. "If they haven't been looking at the issue, they will."

Massachusetts officials just got the green light from the state's highest court to collect taxes from a multitude of companies headquartered elsewhere. Last year the state moved to collect more than $2 million in taxes from credit-card giant Capital One Financial (COF). The state claimed that Cap One made a sizable chunk of money from cardholders who reside there, and so the company had to fork over taxes on the income.

Cap One balked, taking the matter to the state's Appellate Tax Board. The company's argument: It didn't have a branch or an office in the state, the traditional standard for collecting corporate income tax. Cap One lost the case and a subsequent appeal to the Massachusetts Supreme Judicial Court in March. "The uncertainty and burden of trying to comply with state-by-state standards creates a significant hardship for businesses trying to navigate the economic consequences of their decisions," says Ryan Schneider, president of card services for Cap One.

Cap One is petitioning the U.S. Supreme Court to hear the case. If the nation's top court takes up the matter—and rules in the company's favor—it could halt the momentum nationwide to tax out-of-state companies. But the U.S. Supreme Court may not be sympathetic to Cap One. The justices refused to review a similar case in 2007 involving MBNA (BAC), now owned by Bank of America (BAC). Indiana courts decided the credit-card issuer owed taxes on fees and interest paid by local cardholders. Like Cap One, MBNA didn't have an office in the state. The differences between the two cases aren't meaningful, explains Washington (D.C.) attorney Donald M. Griswold, who represented MBNA in the matter. That's why, he says, "there's a snowball's chance in hell" the Supreme Court will hear Cap One's case.

The credit-card industry isn't the only one facing a bigger tax bill if more states follow Massachusetts' lead. Tax experts and lawyers figure states also may go after insurers, online retailers, software makers, and other companies that mainly operate in a single state but have customers across the U.S. Earlier this year the New York Supreme Court backed a state law that requires Amazon.com (AMZN) and other online retailers to charge sales tax on residents' purchases. "The big question here is whether you have to pay taxes where you don't have a physical presence," says Walter Hellerstein, a professor at the University of Georgia School of Law. "That's a huge dollar issue for companies.

How huge? Massachusetts tax officials estimate they will be able to collect an extra $20 million from companies following the Cap One ruling and another against Toys 'R' Us. That's a significant sum in the state, which collected $1 billion last year in corporate income taxes, according to a recent study by Ernst & Young. "This is an issue states should be paying attention to," says Kevin Brown, general counsel at the Massachusetts Revenue Dept. "There's a lot of money at stake."

To add insult to injury, the Governor of Massachusetts (Deval Patrick) is also trying to collect Mass. sales taxes of purchases made by Mass. residents when they travel outside the State of Massachusetts. For example suppose a resident of Boston travels to bordering New Hampshire where there is no sales tax and buys a set of tires, Gov. Patrick wants the N.H. retailer to collect and transmit the Mass. sales tax. It would help retailers outside of Mass. if Mass. residents would wear a scarlet letter M around their necks when traveling out of state. That would help retailers distinguish Mass. shoppers from other shoppers. Otherwise there is no legal way to identify a Massachusetts resident traveling out of state.

From The Wall Street Journal Accounting Weekly Review on June 25, 2009

Amazon Threatens Cuts Over State Taxes
by Geoffrey A. Fowler
Jun 19, 2009
Click here to view the full article on WSJ.com

TOPICS: sales tax

SUMMARY: Given the impact of the economic downturn on state coffers, legislatures are considering levying state sales tax collection requirements for on-line sales. The main article was written following the North Carolina legislature's proposal to take this step; a subsequent article reports that Amazon made similar warnings to California, Hawaii and other states and they considered the same step.

CLASSROOM APPLICATION: Coverage of state sales taxes at an introductory accounting level is the focus of the questions.

QUESTIONS: 
1. (Introductory) How do companies which charge sales taxes remit them to government authorities? Describe your answer in terms of general journal summary entries for each step in the process.

2. (Advanced) What is the difference between sellers' collection of sales taxes on sales made in "brick and mortar" stores and those made online?

3. (Advanced) How are sales taxes on online sales supposed to be collected by state governments?

4. (Introductory) Why are states proposing now to change their laws on collection of online sales taxes? Do you think this is the first time that such proposals have been made?

5. (Advanced) How does Amazon's reaction in North Carolina compare to its actions in relation to the State of New York's recently enacted internet sales tax law?

Reviewed By: Judy Beckman, University of Rhode Island

RELATED ARTICLES: 
Amazon Warns California Lawmakers on Sales Tax Bill
by Geoffrey A. Fowler
Jun 23, 2009
Online Exclusive

"Amazon Threatens Cuts Over State Taxes," by Geoffrey A. Fowler, The Wall Street Journal, June 19, 2009 ---
http://online.wsj.com/article/SB124536499760129079.html?mod=djem_jiewr_AC

Cash-strapped states trying to force retailers to collect taxes on online sales are spurring efforts by Internet retailer Amazon.com Inc. to avoid being swept under the proposed laws.

North Carolina is close to passing a law that would force online retailers to collect the state's 4.5% sales tax from marketing affiliates, people who get a sales commission from online customer referrals. Amazon, of Seattle, Wash., told its North Carolina marketing affiliates on Wednesday that it would stop doing business with them by July 1 if the law takes effect. Cutting the affiliates would enable Amazon to avoid collecting tax on sales in the state.

"We believe the way North Carolina is going about collecting the sales tax is unconstitutional," said Amazon spokeswoman Patty Smith. "It isn't appropriate for us to have to comply with an unconstitutional burden."

Hawaii is weighing a similar law. California's Legislature earlier this year tabled a bill targeting marketing affiliates, while Connecticut has discussed but not acted on a bill. The states see sales taxes on online purchases as offsetting declining collections elsewhere. A study released in April by the University of Tennessee estimated that uncollected Internet sales taxes will cost state and local governments more than $11 billion a year by 2012.

New York passed an Internet sales tax law last year, which Amazon challenged in court but lost. While the retailer appeals that ruling, it is collecting taxes from New York customers. States including Maryland, Minnesota, and Tennessee have considered then scrapped similar proposals.

Online shoppers are already supposed to pay tax for items they have bought online by self-reporting taxes, but most don't bother. Forcing e-commerce companies to collect the tax upfront could take away some of the price advantage that online shopping has over traditional retailing.

Amazon does collect sales tax in states such as Washington where it has offices and warehouses. In North Carolina, the issue boils down to whether states count marketing affiliates as commissioned sales people with a physical presence in the state, or -- as Amazon maintains -- merely advertising outlets.

The e-commerce tax, which would be collected on goods such as books and digital downloads such as music, could bring North Carolina more than $13 million in revenue next year. North Carolina state Senator David Hoyle, a Democrat, said he supports the legislation because the state faces a $4.7 billion budget gap.

Permitting e-commerce companies to avoid charging and collecting taxes is "anti-competitive" for the local merchants who do add sale tax to their sales, said Sen. Hoyle, co-chairman of the state senate's finance committee.

Amazon and other e-commerce companies have supported an effort by about 20 states to streamline state tax laws. Congress is considering a law, called the "Main Street Fairness Act," based on that effort.

In North Carolina, small businesses who make money from Amazon's affiliate program say they're caught in the middle. Amazon declined to say how many affiliates it has in the state.

George Trantas, of Durham, N.C., earns about $1,000 a month by referring readers of his sneaker blog to Amazon for purchases. He opposes the bill.

"If Amazon has no people in the state, they shouldn't have to collect taxes," Mr. Trantas said. "The state of North Carolina is short-sighted."