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 CodificationTM 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

All users will have free access to the Codification database, but not the free access to the $850 “Professional” searching and cross-referencing services.

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.

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:

 


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


Not for Accounting Amateurs
Tom's Mea Culpa and Some Good (Critical) Reasoning That Follows

"SAB 112: Let the New Earnings Game Begin," by Tom Selling, The Accounting Onion, June 21, 2009 ---
http://accountingonion.typepad.com/theaccountingonion/2009/06/sab-112-let-the-new-earnings-game-begin.html

In a recent post on business combinations accounting that is related to SAB 112, I criticized the FASB for creating yet another loophole in business combinations accounting that make M&A transactions more attractive than they really should be. To recap, I described how JP Morgan wrote down toxic loans acquired from WaMu so that, going forward, JP Morgan had a built-in stream of future earnings at very high interest rates.

First, a Mea Culpa

I was feeling pretty satisfied with myself until reader Michael interrupted my reverie with several interesting and valid comments. With great reluctance, I began to re-think parts of my screed.

First of all, he found a couple of inaccuracies in my telling, which should be corrected:

"Tom, I think I'm with you on your conclusion (i.e. mark all financial assets to fair value (replacement cost?)) but the area of GAAP causing the inconsistent measurement is not FAS 141(R). FAS 141(R) was first effective for transactions that closed on or after 1/1/09 for calendar year companies. JPMorgan was subject to FAS 141 (no R) for this transaction and disclosed as such. However, you may be aware that even under FAS 141, certain loans were required to be accounted for at fair value, notwithstanding the SAB [Topic 2A-(5)]...those loans that were purchased at a significant discount are subject to the guidance in SOP 03-3, which requires a fair value measurement [at the acquisition date] for such loans. Given the purely awful composition of WaMu's portfolio, it is not surprising that half their loans fell into that guidance. I think most of the focus should be on the criminal allowance put up by WaMu pre-transaction...$2 billion on $240 billion in loans at 3/31/08, $8 billion on $240 at 6/30/08. Yikes." [italics and bolding supplied]


 

That's a really interesting last sentence, especially coming from an auditor, and I'm betting that even the PCAOB will not want to go near that one. As important as that may be, it's a digression from the mea culpa I now proffer to all who read that post: I overlooked the fact that SOP 03-3 would be applicable, because I mistakenly thought the acquisition of WaMu was accounted for under FAS 141(R).

Michael's comment and my mea culpa notwithstanding, the fact remains that henceforth, FAS 141(R) has taken over for SOP 03-3 in the earnings management toolbox when it comes to making sure that a business combination transaction will be accretive to future earnings. (Note: that doesn't mean that SOP 03-3 has become obsolete. Loan acquisitions that are not part of a business combination are also within its scope.)

Michael also responded to my suggestion that the offending provision of FAS 141(R) should be suspended until loans are fair valued.  He pointed out that should that day ever come, the invitation for earnings management of which I spoke doesn't completely go away:

" … [L]et's assume that all financial instruments were remeasured each period at fair value. While there will be timing differences with loans that are measured at fair value at acquisition, net income over the life of the same loans will be the same...if JPMorgan had to continue to remark the loans, they'd still recognize that accretion into earnings if the loans ultimately perform. I understand your generally well founded skepticism, but I think this is one of the less offensive areas of FAS 141R.

Michael is right (again). I could live with an outcome whereby unbiased fair value measurements will provide a stream of accounting earnings to an acquiree. But, I am indeed more than a little skeptical that two versions of fair value will emerge from FAS 141(R)—if they haven't already from other games that executives will play with earnings. The WaMu's will still have strong incentives to overstate market value, and even Michael implies that auditors are not likely to stand in their way. The JP Morgans of the world have incentives to understate the same fair values.

Enter SAB 112

That's where SAB 112 comes into the discussion. Among other ministerial changes, it deleted Topic 2A-(5) of the SAB codification, which I described in the earlier post and became unnecessary after FAS 141(R) instituted the fair value requirement for acquired loans. The crux of this post is this: if the SEC thought that manipulation of loan loss reserves during a business combination merited an anti-abuse rule, then more than ministerial adaptations were called for.  How can the SEC be so naïve as to think that fair value will fix the problem of loan value manipulation? Instead of merely deleting Topic 2A-(5), they should have re-written it to put the brakes on what will surely become a new recipe for chicken salad. It would have been really simple for the SEC to make the following rule:

Irrespective of pre- and post-acquisition bases of measurement, the new carrying amount of every asset recognized may be no less at the date of acquisition than the carrying amount recognized by the acquiree; similarly, the fair value of liabilities assumed may be no greater than amounts recognized by acquirees.

I know that my suggestion may sound unprinicpled and draconian to some (and I would be prepared to allow for some exceptions), but the reality is that no set of business combination accounting rules will be perfectly 'efficient.' For any accounting rule, it is inevitable that some value-creating transactions will be discouraged, and some value-destroying transactions will occur because the accounting result is too sweet to resist. The key for regulators is to strike an appropriate balance based on broadly acceptable objectives for financial reporting.

In regard to business combinations, there have been no such objectives ever before.  It is clear that the rules have been completely out of whack since the inception of GAAP in the 1930s. As for the last few decades, the evidence is crystal clear that our economy has been administered a nearly lethal dose of value-destroying business combinations to juice executive compensation while killing share prices and wreaking havoc among rank and file employees. That's why I believe it is time to trying something more radical: an acquiror should not be able to create a stream of reported earnings by writedowns to assets or increases to liabilities. Therefore, post acquisition writedowns of assets and write-ups of liabilities would be charged against the post-combination earnings of the acquiror.

Let's see if the 'new SEC' is up to the task. We'll know they're doing it right if the EU and IASB have conniptions over it.

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


Video (humor?):  Jon Stewart versus Jim Cramer (CNBC) on The Daily Show ---
http://www.youtube.com/watch?v=Vi6bxKAAHzQ

See the full episode --- http://www.youtube.com/watch?v=dwUXx4DR0wo

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.

Question
Would you like to see (AIG) Special Purpose Vehicles pull away from the loading ($25 billion) dock?

"AIG Sells Shares to Fed: Papa's Little Dividend? The New York Fed has agreed to get involved in the life insurance business by investing $25 billion in two special-purpose vehicles," by David M. Katz, CFO.com, June 25, 2009 --- http://www.cfo.com/article.cfm/13932672/c_2984368/?f=archives

In a move aimed at cutting American International Group's $40 billion debt to the Federal Reserve Bank of New York by $25 billion and setting up two AIG life insurance giants as initial public offerings, the N.Y. Fed has agreed to a debt-for-equity swap done via special-purpose vehicles.

Under the agreement announced today, AIG will place the equity of American International Assurance Company and American Life Insurance Company in separate SPVs in exchange for preferred and common shares of the vehicles. The New York Fed will get all the preferred shares in the two SPVs, amounting to $16 billion in the AIA unit and $9 billion in the ALICO vehicle.

The New York Fed will be paid a 5 percent dividend on its shares, which it will get at a fairly hefty discount, until September 2013. For shares that aren't redeemed by that date, the SPVs would start paying a 9 percent dividend.

The face value of the preferred shares represents a percentage of the estimated fair-market value of AIA and ALICO. With the IPOs looming, the parties aren't saying what that value is. But the New York Fed, which will hold all the preferred shares, will get a majority stake in the economic value of the companies.

For its part, AIG will hold all the common equity in the two SPVs and "will benefit from the fair market value of AIA and ALICO in excess of the value of the preferred interests as the SPVs monetize their stakes in these companies in the future," AIG said in a release issued today.

The dates of the closing of the deal and the IPOs aren't tied to each other. The AIG-New York Fed transaction is expected to close late in the third quarter of this year. AIA, which has already launched its IPO process, is expected to start the offering in 2010. While ALICO hasn't started the process of its offering just yet, it has announced its attention to do so.

As for the SPVs, they will structured as limited-liability companies in Delaware. Until they're spun off, AIA and ALICO will remain wholly owned subsidiaries of AIG, consolidated in the company's reported financial statements.

"Placing AIA and ALICO into SPVs represents a major step toward repaying taxpayers and preserving the value of AIA and ALICO, two terrific life insurance businesses with great futures," said Edward Liddy, AIG's chairman and chief executive officer said in the release. "Operating AIA's and ALICO's successful business models in the SPV format will enhance the value of these franchises as we move forward with our global restructuring."

Asked why the company chose to structure the arrangement by means of the much stigmatized method of setting up SPVs, AIG spokesperson Christina Pretto told CFO that since the vehicles were on-balance-sheet entities they wouldn't be the target of disapproval.

AIA has one of the biggest books of life insurance in Asia, and ALICO has a large presence in Japan. While both are profitable, AIG has found it impossible to achieve its goal of selling the companies-at least partly because they are so large.

Continued in article

Accounting for CDOs (Securitizations) ---
http://www.trinity.edu/rjensen/theory01.htm#CDO

Bob Jensen's threads on Off-Balance-Sheet Financing (OBSF) are at
http://www.trinity.edu/rjensen/theory01.htm#OBSF2


"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   High School Courses

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:
 

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

From The Wall Street Journal Accounting Weekly Review on May 26, 2009

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 –

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."




  • Humor Between June 1 and June 30, 2009

    I'll keep my money
    You keep the Change

    Bumper Sticker


    The 10 Dumbest Tech Products So Far ---
    http://www.pcworld.com/article/165546/the_10_dumbest_tech_products_so_far.html


    Forwarded by Col. Booth

    Negative, ma'am. Just serious by nature.'

    The young lady looked at his awards and decorations and said, 'It looks like you have seen a lot of action.'

    'Yes, ma'am, a lot of action.'

    The young lady, tiring of trying to start up a conversation, said, 'You know, you should lighten up a little. Relax and enjoy yourself.'

    The Sergeant Major just stared at her in his serious manner.

    Finally the young lady said, 'You know, I hope you don't take this the wrong way, but when was the last time you had sex?'

    '1955, ma'am.'

    'Well, there you are. No wonder you're so serious. You really need to chill out! I mean, no sex since 1955! She took his hand and led him to a private room where she proceeded to 'relax' him several times. Afterwards, panting for breath, she leaned against his bare chest and said, 'Wow, you sure didn't forget much since 1955.'

    The Sergeant Major said in his serious voice, after glancing at his watch, 'I hope not; it's only 2130 now.'


    Neither a borrower nor a lender be
    Darwin Award Winner --- http://www.darwinawards.com/darwin/darwin2008-25.html

    23-year-old Strahinja Raseta was wanted by Croatian police for murder, as well as for a spectacular robbery of a central post office. He fled to Serbia to evade the law.

    But even bad guys have friends. Raseta had a friend, and his friend had lent him E15,000. Some loans can never be repaid. This was such a loan. Finding himself unable to earn or steal the funds needed to reimburse his friend, Raseta attempted to end the matter in another way--by murdering the lender!

    He crawled under his creditor's Jeep and planted an explosive. However, the muffler was still hot, and the heat set off the explosive while Raseta was beneath the vehicle. He died in hospital the next day in the Serbian capital city of Belgrade, illustrating the truth of the Shakespearean adage, "Neither a borrower nor a lender be."


    Drunks are supposed to be indestructible
    Darwin Award Winners --- http://www.darwinawards.com/darwin/darwin2008-23.html

    Sleeping residents of Chilliwack (Canada) were awakened early one morning by the sound of a small aircraft flying lower than usual. The engine noise was like a mosquito, zooming too close too quick, then veering away. What the bleep was going on? In the wee hours of the night, during a bout of heavy drinking, two future Darwin Award nominees concluded that, with neither had a pilot's license nor flight training, they nevertheless knew enough to pilot an aircraft. knew all they needed to know to at a local dive, They drew the obvious conclusion, and decided to take a plane from the small local airport for a drunken joyride over the city. They invited two females along for the ride; fortunately, the level-headed ladies declined.

    From idea to execution, the plan evolved quickly. One of the gentlemen worked at the airport and had access to the tarmac. The two men then managed to unlock a plane and get it off the ground and into the sky. They went on to buzz around in the dark, skimming above the roofs of the houses. This went on for an extended period of time.

    Eventually they decided to land. They attempted to land on the grassy median between east and west-bound lanes of the Trans Canada Highway. They almost made it under the electrical wires that cross the median. Almost. Where these wires were concerned, fate intervened. Instead of making a soft landing on the grassy verge, the tail clipped the wires, sending the aircraft diving nose-first into the ground and killing both occupants.

    Only then were the sleepy Chilliwack residents able to return to their REM sleep.


    Forwarded by Maxine

    Yesterday I confused by Poli-Grip with my Preparation H.
    Now I talk like an a-hole but my gums don't itch.


    Forwarded by Gene and Joan

    Did you hear about the 83 year old woman who talked herself out of a speeding ticket by telling the young officer that she had to get there before she forgot where she was going?

    Makes perfectly good sense to me.....


    Forwarded by Gene and Joan

     In the British game of cricket, the first testicular guard was used in 1874.

    The first helmet was used in 1974.

    It took 100 years for men to realize that their brain could also be important.


    Forwarded by Maureen

    A Woman's Perfect Breakfast

    She's sitting at the table with her gourmet coffee.
    Her son is on the cover of the Wheaties box.
    Her daughter is on the cover of Business Week.
    Her boyfriend is on the cover of Playgirl.
    And her husband is on the back of the milk carton


    Forwarded by Barb Hessel

    An Old Farmer's Advice

    Your fences need to be horse-high, pig-tight, and bull-strong.

    Keep skunks and bankers at a distance.

    Life is simpler when you plow around the stump.

    A bumblebee is considerably faster than a John Deere tractor.

    Words that soak into your ears are whispered . . . not yelled.

    Meanness don't jes' happen overnight.

    Forgive your enemies. It messes up their heads.

    Do not corner something that you know is meaner than you.

    It don't take a very big person to carry a grudge.

    You cannot unsay a cruel word.

    Every path has a few puddles.

    When you wallow with pigs, expect to get dirty.

    The best sermons are lived, not preached.

    Most of the stuff people worry about ain't never gonna happen anyway.

    Don't judge folks by their relatives.

    Remember that silence is sometimes the best answer.

    Live a good, honorable life. Then, when you get older and think back, you'll enjoy it a second time.

    Don't interfere with somethin' that ain't botherin' you none.

    Timing has a lot to do with the success of the rain dance.

    If you find yourself in a hole, the first thing to do is stop digging.

    The biggest troublemaker you'll probably ever have to deal with, watches you from the mirror every morning.

    Always drink upstream from the herd.

    Good judgment comes from experience . . . and a lot of that comes from bad judgment.

    Lettin' the cat outta th' bag is a whole lot easier than puttin' him back in.

    If you get to thinkin' you're a person of some influence, jes' try orderin' somebody else's dog around.

    Live simply, love generously, care deeply, and speak kindly. Leave the rest to God.

    Don't pick a fight with an old man. If he's too old to fight, he'll jes' kill ya.

    Sometimes you get; and, sometimes you get got.


    Forwarded by Maureen

    BBQ RULES 
    We are about to enter the BBQ season. Therefore it is important to refresh your memory on the etiquette of this sublime outdoor
     cooking activity . When a man volunteers to do the BBQ the following chain of events are put into motion: 

    Routine... 

    (1) The woman buys the food. 

    (2) The woman makes the salad, prepares the vegetables, and makes dessert. 

    (3) The woman prepares the meat for cooking, places it on a tray along with the necessary cooking utensils and sauces, and takes it to the man who is lounging beside the grill - beer in hand. 

    (4) The woman remains outside the compulsory three meter exclusion zone where the exuberance of testosterone and other manly bonding activities can take place without the interference of the woman. 

    Here comes the important part: 

    (5) THE MAN PLACES THE MEAT ON THE GRILL. 

    More routine... 

    (6) The woman goes inside to organise the plates and cutlery. 

    (7) The woman comes out to tell the man that the meat is looking great. He thanks her and asks if she will bring another beer while he flips the meat 

    Important again: 

    (8) THE MAN TAKES THE MEAT OFF THE GRILL AND HANDS IT TO THE WOMAN. 

    More routine... 

    (9) The woman prepares the plates, salad, bread, utensils, napkins, sauces, and brings them to the table. 

    (10) After eating, the woman clears the table and does the dishes. 

    And most important of all: 

    (11) Everyone PRAISES the MAN and THANKS HIM for his cooking efforts. 

    (12) The man asks the woman how she enjoyed ' her night off ', and, upon seeing her annoyed reaction, concludes that there's just no pleasing some women.


    Forwarded by Niki

    THE BASIC RULES FOR CLOTHESLINES: (if you don't know what clotheslines are, better skip this)

    1. You had to wash the clothes line before hanging any clothes - walk the entire lengths of each line with a damp cloth around the lines. 2. You had to hang the clothes in a certain order, and always hang "whites" with "whites," and hang them first. 3. You never hung a shirt by the shoulders - always by the tail!. What would the neighbors think? 4. Wash day on a Monday! ... Never hang clothes on the weekend, or Sunday, for Heaven's sake! 5. Hang the sheets and towels on the outside lines so you could hide your "unmentionables" in the middle (perverts & busybodies, y'know!). 6. It didn't matter if it was sub zero weather ... Clothes would "freeze-dry." 7. Always gather the clothes pins when taking down dry clothes! Pins left on the lines were "tacky!" 8. If you were efficient, you would line the clothes up so that each item did not need two clothes pins, but shared one of the clothes pins with the next washed item. 9. Clothes off of the line before dinner time, neatly folded in the clothes basket, and ready to be ironed. 10. IRONED?! Well, that's a whole other subject!

    A Poem

    A clothesline was a news forecast To neighbors passing by, There were no secrets you could keep When clothes were hung to dry.

    It also was a friendly link For neighbors always knew If company had stopped on by To spend a night or two.

    For then you'd see the "fancy sheets" And towels upon the line; You'd see the "company table cloths" With intricate designs.

    The line announced a baby's birth From folks who lived inside - As brand new infant clothes were hung, So carefully with pride!

    The ages of the children could So readily be known By watching how the sizes changed, You'd know how much they'd grown!

    It also told when illness struck, As extra sheets were hung; Then nightclothes, and a bathrobe, too, Haphazardly were strung.

    It also said, "Gone on vacation now" When lines hung limp and bare. It told, "We're back!" when full lines sagged With not an inch to spare!

    New folks in town were scorned upon If wash was dingy and gray, As neighbors carefully raised their brows, And looked the other way . .

    But clotheslines now are of the past, For dryers make work much less. Now what goes on inside a home Is anybody's guess!

    I really miss that way of life. It was a friendly sign When neighbors knew each other best By what hung on the line.


    Forwarded by Paula

    These were posted on an Australian Tourism Website and the answers are the actual responses by the website officials, who obviously have a great sense of humour.
    __________________________________________________
    Q: Does it ever get windy in Australia ? I have never seen it rain on TV, how do the plants grow?  (UK ).
    A: We import all plants fully grown and then just sit around watching them die.
    __________________________________________________
    Q: Will I be able to see kangaroos in the street?  ( USA )
    A: Depends how much you've been drinking.
    __________________________________________________
    Q: I want to walk from Perth to Sydney - can I follow the railroad tracks?  (Sweden)
    A: Sure, it's only three thousand miles, take lots of water.
     __________________________________________________
    Q: Are there any ATMs (cash machines) in Australia ? Can you send me a list of them in Brisbane, Cairns, Townsville and HerveyBay?  ( UK )
    A: What did your last slave die of?
     __________________________________________________
    Q: Can you give me some information about hippo racing in Australia ? ( USA)
    A: A-fri-ca is the big triangle shaped continent south of Europe.  Aus-tra-lia is that big island in the middle of the Pacific which does not.... oh forget it. Sure, the hippo racing is every Tuesday night in Kings Cross. Come naked.
    __________________________________________________
    Q: Which direction is North in Australia?  ( USA )
    A: Face south and then turn 180 degrees.  Contact us when you get here and we'll send the rest of the directions.
    _________________________________________________
    Q: Can I bring cutlery into Australia ? ( UK )
    A: Why? Just use your fingers like we do.
     __________________________________________________
    Q: Can you send me the Vienna Boys' Choir schedule? ( USA )
    A: Aus-tri-a is that quaint little country bordering Ger-man-y, which is…oh forget it. Sure, the Vienna Boys Choir plays every Tuesday night in Kings Cross, straight after the hippo races. Come naked.
    __________________________________________________
    Q: Can I wear high heels in Australia?  ( UK )
    A: You are a British politician, right?
     ____________________________ ______________________
    Q: Are there supermarkets in Sydney and is milk available all year round? (Germany)
    A: No, we are a peaceful civilization of vegan hunter/gatherers.  Milk is illegal.
    __________________________________________________
    Q: Please send a list of all doctors in Australia who can Dispense rattlesnake serum. (USA)
     A: Rattlesnakes live in A-meri-ca which is where YOU come from.  All Australian snakes are perfectly harmless, can be safely handled and make good pets.
    __________________________________________________
    Q: I have a question about a famous animal in Australia, but I forget its name. It's a kind of bear and lives in trees.  (USA )
    A: It's called a Drop Bear.  They are so called because they drop out of Gum trees and eat the brains of anyone walking underneath them.  You can scare them off by spraying yourself with human urine before you go out walking.
    __________________________________________________
    Q: I have developed a new product that is the fountain of youth.  Can you tell me where I can sell it in Australia?  (USA )
    A: Anywhere significant numbers of Americans gather.
    __________________________________________________
    Q: Can you tell me the regions in Tasmania where the female population is smaller than the male population? (Italy )
    A: Yes, gay night clubs.
    __________________________________________________
    Q: Do you celebrate Christmas in Australia?  (France )
    A: Only at Christmas.
     __________________________________________________
    Q: I was in Australia in 1969 on R+R, and I want to contact the Girl I dated while I was staying in Kings Cross. Can you help? (USA )
    A: Yes, and you will still have to pay her by the hour.
     __________________________________________________
    Q: Will I be able to speak English most places I go?  ( USA )
    A: Yes, but you'll have to learn it first.


    Daily Humor (mostly humor but not always)
    Snopes also has an interesting page called Odd News that I intend to examine daily since the items on this page are transient
    --- http://www.snopes.com/daily/


    Forwarded by Paula

    His request approved, the CBC (Canada) news photographer quickly used a cell phone to call the local airport to charter a flight. He was told a twin engine plane would be waiting for him at the airport.

    Arriving at the airfield, he spotted a plane warming up outside a hanger. He jumped in with his bag, slammed the door shut, and shouted, "Let's go."

    The pilot taxied out, swung the plane into the wind and took off. Once in the air, the photographer instructed the pilot: "Fly over the valley and make low passes so I can take pictures of the fires on the hillsides."

    "Why?" asked the pilot.

    "Because I'm a photographer for CBC News," he

    Responded. "And I need to get some close up shots."

    The pilot was strangely silent for a moment. Finally he stammered: "So, what you're telling me is .... you're NOT my flight instructor."


    Forwarded by Paula

    A very gentle Seguin, Texas lady was driving across a high bridge in Texas one day. As she neared the top of the bridge, she noticed a young man getting ready to jump. She stopped her car, rolled down the window and said, "Please don't jump, think of your dear mother and father."

    He replied, "Mom and Dad are both dead; I'm going to jump."

    She said, "Well, think of your wife and children."

    He replied, "I'm not married and I don't have any kids."

    She said, "Well, Remember the Alamo."

    He replied, ''What's the Alamo?''

    She replied, ''Well bless your heart......... just go ahead and jump, you damn Yankee.''


    Forwarded by Maureen

    Robert Whiting, an elderly gentleman of 83, arrived in Paris by plane. At French Customs, he took a few minutes to locate his passport in his carry on.

    'You have been to France before, monsieur?' the customs officer asked sarcastically.

    Mr. Whiting admitted that he had been to France previously. 'Then you should know enough to have your passport ready.'

    The American said, 'The last time I was here, I didn't have to show it.

    'Impossible. Americans always have to show your passports on arrival in France !'

    The American senior gave the Frenchman a long hard look. Then he quietly explained, 'Well, when I came ashore at Omaha Beach on D-Day in 1944 to help liberate this country, I couldn't find a single Frenchmen to show a passport to.'

    You could have heard a pin drop.


    The 10 Dumbest Tech Products So Far ---
    http://www.pcworld.com/article/165546/the_10_dumbest_tech_products_so_far.html


    Forwarded by Dick and Cec

    Guess I am older than dirt, I remembered all of them.
    'Someone asked the other day, 'What was your favorite fast-food when you were growing up?'

    'We didn't have fast food when I was growing up,' I informed him.

    'All the food was slow.' 

    'C'mon, seriously. Where did you eat?'

    'It was a place called 'at home,'' I explained.

    'Mom cooked every day and when Dad got home from work, we sat down together at the dining room table, and if I didn't like what she put on my plate I was allowed to sit there until I did like it.'


    By this time, the kid was laughing so hard I was afraid he was going to suffer serious internal damage, so I didn't tell him the part about how I had to have permission to leave the table.

    But here are some other things I would have told him about my childhood if I figured his system could have handled it:

    Some parents NEVER owned their own house, wore Levis , set foot on a golf course, traveled out of the country or had a credit card.

    In their later years they had something called a revolving charge card. The card was good only at Sears Roebuck. Or maybe it wasSears & Roebuck

    Either way, there is no Roebuck anymore. Maybe he died.


    My parents never drove me to soccer practice. This was mostly because we never had heard of soccer. I had a bicycle that weighed probably 50 pounds, and only had one speed, (slow).

    We didn't have a television in our house until I was 5.

    It was, of course, black and white, and the station went off the air at midnight, after playing the national anthem and a poem about God; it came back on the air at about 6 a.m. and there was usually a locally produced news and farm show on, featuring local people.


    I was 13 before I tasted my first pizza, it was called 'pizza pie.'

    When I bit into it, I burned the roof of my mouth and the cheese slid off, swung down, plastered itself against my chin and burned that, too. It's still the best pizza I ever had.


    We didn't have a car until I was 4. It was an old black Dodge.


    I never had a telephone in my room.

    The only phone in the house was in the living room and it was on a party line. Before you could dial, you had to listen and make sure some people you didn't know weren't already using the line.

    Pizzas were not delivered to our home. But milk was.

    All newspapers were delivered by boys and all boys delivered newspapers --my brother delivered a newspaper, six days a week. It cost 7 cents a paper, of which he got to keep 2 cents. He had to get up at 6AM every morning.

    On Saturday, he had to collect the 42 cents from his customers. His favorite customers were the ones who gave him 50 cents and told him to keep the change. His least favorite customers were the ones who seemed to never be home on collection day.

    Movie stars kissed with their mouths shut. At least, they did in the movies. There were no movie ratings because all movies were responsibly produced for everyone to enjoy viewing, without profanity or violence or most anything offensive.


    If you grew up in a generation before there was fast food, you may want to share some of these memories with your children or grandchildren. Just don't blame me if they bust a gut laughing.

    Growing up isn't what it used to be, is it?

    MEMORIES from a friend :

    My Dad is cleaning out my grandmother's house (she died in December) and he brought me an old Royal Crown Cola bottle. In the bottle top was a stopper with a bunch of holes in it. I knew immediately what it was, but my daughter had no idea. She thought they had tried to make it a salt shaker or something. I knew it as the bottle that sat on the end of the ironing board to 'sprinkle' clothes with because we didn't have steam irons. Man, I am old.

    How many do you remember?



    Head lights dimmer switches on the floor. 
    Ignition switches on the dashboard.
    Heaters mounted on the inside of the fire wall. 
    Real ice boxes.
    Pant leg clips for bicycles without chain guards. 
    Soldering irons you heat on a gas burner.
    Using hand signals for cars without turn signals. 

    Older Than Dirt Quiz :

    Count all the ones that you remember not the ones you were told about

    Ratings at the bottom.

    1 Blackjack chewing gum
    2. Wax Coke-shaped bottles with colored sugar water 
    3. Candy cigarettes
    4. Soda pop machines that dispensed glass bottles 
    5. Coffee shops or diners with tableside juke boxes 
    Home milk delivery in glass bottles with cardboard stoppers 
    7. Party lines on the telephone
    8. Newsreels before the movie! 
    9. P.F. Flyers
    10. Butch wax 
    11. TV test patterns that came on at night after the last show and were there until TV shows started again in the morning. (there were only 3 channels [if you were fortunate]) 
    12. Peashooters 
    13. Howdy Doody 
    14. 45 RPM records 
    15. S& H greenstamps 
    16 Hi-fi's
    17. Metal ice trays with lever 
    18. Mimeograph paper
    19 Blue flashbulb
    20. Packards
    21. Roller skate keys I still have mine. G
    22. Cork popguns 
    23. Drive-ins
    24. Studebakers
    25. Wash tub wringers 

    If you remembered 0-5 = You're still young 
    If you remembered 6-10 = You are getting older 
    If you remembered 11-15 = Don't tell your age,
    If you remembered 16-25 = You're older than dirt!


    I might be older than dirt but those memories are some of the best parts of my life.

    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

     






    And that's the way it was on June 30, 2009 with a little help from my friends.

     

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

     

    International Accounting News (including the U.S.)

    AccountingEducation.com and Double Entries --- http://www.accountingeducation.com/
            Upcoming international accounting conferences --- http://www.accountingeducation.com/events/index.cfm
            Thousands of journal abstracts --- http://www.accountingeducation.com/journals/index.cfm
     

    Deloitte's International Accounting News --- http://www.iasplus.com/index.htm
     

    Association of International Accountants --- http://www.aia.org.uk/ 

    Wikipedia has a rather nice summary of accounting software at http://en.wikipedia.org/wiki/Accounting_software
    Bob Jensen’s accounting software bookmarks are at http://www.trinity.edu/rjensen/Bookbob1.htm#AccountingSoftware

    Bob Jensen's accounting history summary --- http://www.trinity.edu/rjensen/Theory01.htm#AccountingHistory

    Bob Jensen's accounting theory summary --- http://www.trinity.edu/rjensen/Theory.htm

     

    AccountingWeb --- http://www.accountingweb.com/
    AccountingWeb Student Zone --- http://www.accountingweb.com/news/student_zone.html

     

    Introducing the New journalofaccountancy.com  (free) --- http://www.journalofaccountancy.com/Issues/2008/Nov/NovSmartStops.htm

     

    SmartPros --- http://www.smartpros.com/

     

    I highly recommend TheFinanceProfessor (an absolutely fabulous and totally free newsletter from a very smart finance professor, Jim Mahar from St. Bonaventure University) --- http://www.financeprofessor.com/ 

     

    Financial Rounds (from the Unknown Professor) --- http://financialrounds.blogspot.com/

     

     

    Professor Robert E. Jensen (Bob) http://www.trinity.edu/rjensen
    190 Sunset Hill Road
    Sugar Hill, NH 03586
    Phone:  603-823-8482 
    Email:  rjensen@trinity.edu  

     

     

     

     

    May 31, 2009

    Bob Jensen's New Bookmarks on  May 31, 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.

    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




    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

     




    Although I don't use Twitter, members of the American Accounting Association may now view the AAA's tweets at http://twitter.com/aaahq


    Congratulations Ira

    May 4 message from Roger Debreceny [roger@DEBRECENY.COM]

    AAA V-P and head of Illinois Urbana-Champaign, Ira Solomon, has received the AICPA’s Distinguished Achievement in Accounting Education award  (http://preview.tinyurl.com/d3f7sd). Many on this list will know of Ira’s innovative and important work with Project Discovery at UIUC (also thoroughly adopted at Nanyang Technological University in Singapore), his monographs with Tim Bell and Mark Peecher and the KPMG Audit Cases.

    Roger Debreceny

    Shidler College Distinguished Professor of Accounting
    Shidler College of Business
    University of Hawai'i at Mānoa
    Phone: +1 808 956 8545 Cell: +1 808 393 1352
    roger@debreceny.com  rogersd@hawaii.edu
    www.debreceny.com
    www.twitter.com/debreceny


    Funny stories about the busy tax season for accountants ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=107452


    Small Business Accounting Software (Simple Solutions promotional video) ---
    http://www.youtube.com/watch?v=30CcqXrM8ug

    For small and medium sized businesses I recommend looking into Webledger alternatives ---
    http://www.trinity.edu/rjensen/webledger.htm

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


    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:
     Emacs!
    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 CodificationTM 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).

     

    The FASB Codification database --- http://asc.fasb.org/asccontent&trid=2273304&nav_type=left_nav

    May 11, 2009 message from Tom Selling [tom.selling@GROVESITE.COM]

    Does anybody know how the codification will affect services like PwC Comperio, or any other of the third party accounting research products that are out there?

    Thanks,
    Tom Sellin
    g

    May 12, 2009 reply from Bob Jensen

    Hi Tom,

    I can’t imagine that the FASB Codification is any threat to the much more comprehensive database services such as PwC’s Comperio. Nor is it any threat to Web crawlers like Google. Firstly, Comperio covers auditing standards as well as accounting standards. Comperio also covers other topics such as some AIS topics. Secondly, Comperio covers international standards and many foreign domestic standards. Thirdly, Comperio covers millions of communications not available in the Codification database. Google has warehoused billions upon billions of more communications on accounting, auditing, and related topics.

    The FASB Codification compliments Comperio and will make Comperio itself more efficient. What the Codification attempts to do is to consolidate disparate documentation (standards, interpretations, memoranda, FSPs, EITFs, etc.) together on each major topic. Comperio will eventually build on the Codification consolidations. More importantly, it seems that the Codification adds important illustrations of implementation. Sadly, it also omits many important illustrations such as some of the longer and extremely important illustrations from the appendices of FAS 133. The EITFs have many illustrations and debates not yet available in the Codification database. Hence, I do not think it’s time to chuck the hard copy even if you have both the Codification and the Comperio databases at your disposal.

    There are still many other gaps in the Codification database such as the huge collection of DIGs for FAS 133. This is just another illustration that the Codification database is a work in progress with very limited resources comparison to Comperio and most certainly Google.

    Personally, I’ve been disappointed in the Codification database to date. And I’ve found the search engine of Comperio and the IASB search engine (which I really like) for its international standards database to be much more comprehensive and efficient than the Codification search engine. The Codification Glossaries need a lot of work. Personally I prefer my own glossary of FAS 133 and IAS 30 --- http://www.trinity.edu/rjensen/acct5341/speakers/133glosf.htm 

    One way, albeit an expensive way, to make the Codification database more effective and comprehensive would be to make it more Web friendly. For example FASB standards are covered in many “blogs” such as AccountingWeb, SmartPros, IAS Plus, Jensen’s Threads, the AECM, etc. Adding links to important modules in those blogs for references would greatly expand upon major topics that are sometimes barely outlined in the Codification database.

    Another way is to either serve up video in the Codification database or link to video on important topics. These include suggested search terms that make it easier to find videos on YouTube, college course tutorials, professional organization videos (such as those from the AICPA), etc.

    The FASB did a lot with the limited resources at hand when it built the Codification database to date. But it has a long, long, long way to go as far as I’m concerned. Students and practitioners who confine their research to the Codification database will be missing an enormous amount of the bigger picture. Don’t cancel your library subscription to Comperio for a long, long time into the future.

    Bob Jensen

    Changes in the Wind for the FASB's Accounting Standards Codification Database Project ---

    "FASB Advances GAAP Codification Plan," Journal of Accountancy, March 31, 2009 --- http://www.journalofaccountancy.com/Web/20091591.htm

    FASB took another step forward in its plan to codify U.S. GAAP with the release Friday of an exposure draft on changes to the GAAP hierarchy.

     

    FASB is taking comments on the proposal until May 8. In the draft, the standard setter reiterates the planned July 1 effective date for the FASB Accounting Standards Codification to become the single source of authoritative U.S. accounting and reporting standards, except for SEC rules and interpretive releases.

     

    The 20-page proposal would modify FASB Statement no. 162, The Hierarchy of Generally Accepted Accounting Principles. The proposal would establish only two levels of GAAP—authoritative and nonauthoritative.

     

    As of July 1, the FASB Accounting Standards Codification (ASC) would supersede all then-existing, non-SEC accounting and reporting standards for nongovernmental entities.  The FASB ASC disassembled and reassembled thousands of nongovernmental accounting pronouncements (including those of FASB, the Emerging Issues Task Force, and the AICPA) to organize them under roughly 90 topics and include all accounting standards issued by a standard setter within levels A–D of the current U.S. GAAP hierarchy. The ASC also includes relevant portions of authoritative content issued by the SEC, as well as selected SEC staff interpretations and administrative guidance issued by the SEC.

     

    FASB points out in the exposure draft that it decided to include in the codification the AICPA Technical Inquiry Service (TIS) Section 5100, Revenue Recognition, paragraphs 38–76, which may result in an accounting change for private entities that had not previously applied the guidance. FASB provided specific transition provisions for private entities affected by the change.    

    Visit the AICPA Web site’s GAAP Codification page to review resources related to the codification project.

    Accounting Standards Codification Site --- http://asc.fasb.org/asccontent&trid=2273304&nav_type=left_nav


     


    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.

    Bob Jensen's threads on FAS 141 and QSPEs, SPEs, SPVs, and VIEs are at http://www.trinity.edu/rjensen//theory/00overview/speOverview.htm

    Bob Jensen's threads on Off-Balance-Sheet Financing (OBSF) are at
    http://www.trinity.edu/rjensen/theory01.htm#OBSF2


    "New Sales Tax Deduction Not Limited to One Vehicle," SmartPros, May 18, 2009 ---
    http://accounting.smartpros.com/x66569.xml

    Thomson Reuters tax expert obtains guidance from the IRS on the issue of separate vehicle purchases and the new sales tax deduction.

    In an effort to stimulate automobile sales, the American Recovery and Reinvestment Act of 2009 included a new income tax deduction for state or local sales or excise taxes paid on qualifying motor vehicle purchases made after February 16, 2009 and before January 1, 2010. The deduction is limited to the taxes on the first $49,500 of the cost of the vehicle. A previous release from the Tax & Accounting business of Thomson Reuters (dated March 2nd) stated that the legislation was unclear as to whether this limitation applied to an individual’s total vehicle purchases or each separate vehicle purchase, and that presumably the IRS would address this in guidance.

    The IRS has not yet issued formal guidance on this. However, William E. Massey, a Senior Tax Analyst from the Tax & Accounting business of Thomson Reuters, contacted the IRS about this issue and a spokesperson from its National Media Relations office responded as follows: “If you buy a car costing more than $49,500, you get a deduction based only on the first $49,500 of the purchase price. The limitation is imposed on a per vehicle basis. Accordingly, a taxpayer may deduct the taxes paid on the purchase of more than one vehicle, even if the total of the purchase price exceeds $49,500. There is no limitation on the number of vehicles an individual can purchase.”

    “This is good news for a taxpayer who needs to purchase two or more cars this year. Under the position stated by the IRS spokesperson, he or she can deduct the sales taxes on the first $49,500 of the purchase price of each one,” notes Massey. For example, an individual could buy a car for use in his or her business and another for personal use and deduct the taxes up to the limit on each vehicle.

    “Keep in mind, the deduction isn’t limited to cars,” reminds Massey. “Qualifying vehicles also include light trucks and motorcycles, as well motor homes.” In all cases, the original use of the vehicle must commence with the taxpayer. Massey observes that “this means that the motor vehicle must be brand new to qualify. But this does not mean that only 2009 or 2010 model year vehicles may qualify. A 2008 or earlier model may qualify as long as it is brand new when purchased by the taxpayer this year after February 16.”

    While there is no limit on the number of vehicles that can qualify for the new deduction, there is an income limit. Under this limit, the amount of sales or excise taxes that may be treated as qualified motor vehicle taxes is phased out ratably for a taxpayer with modified AGI (MAGI) between $125,000 and $135,000 ($250,000 and $260,000 on a joint return). MAGI is adjusted gross income computed in a special way.

    Jensen Comment
    Darn! I'm screwed out of this tax break since New Hampshire has no sales tax. But I'm still waiting to get $4,500 on my 1989 Cadillac that I inherited from my father in 2001. My dilemma is that nothing has ever gone wrong with this car and it appears to be better than any car manufactured these days.

    Bob Jensen's threads on the Recovery and Reinvestment Act are at http://www.trinity.edu/rjensen/2008Bailout.htm


    Management Accounting Simulations

    May 1, 2009 message from Roger Collins [rcollins@TRU.CA]

    I've been assigned to teach a course in "Strategic Management Accounting" as part of our summer session offerings for final year BBA undergraduate accounting majors. The previous presenter of the course built it around a set of cases plus a simulation - VK Gadget. See..
    http://www.microbuspub.com/maspg3.htm 

    While I'm in general agreement with the approach I'm wondering whether anyone on the list has experience of the VK Gadget simulation, or of any other simulations that they would think appropriate. There is an optional text with the simulation - "Management Accounting - A Venture Into Decision Making" - but our students have a more in-depth knowledge of management accounting by the time they reach their final year than this book provides.

    The only potential alternative that I've discovered to the VK Gadget simulation so far is "The Business Strategy Game" from Globus.See..
    http://www.glo-bus.com 

    I get the impression that this simulation is easier to run and to administer than VK Gadget (important to me, as I have to get up to speed quickly) but it doesn't seem to go into management accounting issues in such depth.

    Any comments would be much appreciated.

    Regards,

    Roger Collins
    TRU School of Business

    May 1, 2009 reply from David Albrecht [albrecht@PROFALBRECHT.COM]

    I used the Management Accounting Simulation from the same company. I found it required a significant investment on the part of students before they ever could get started. The time and effort needed was so significant, that only two groups of two students even went ahead with the investment. Most students just entered numbers. I was using the simulation for cost accounting students, which I find to be more dedicated to work than the typical managerial accounting students.

    What was scariest was the amount of work that would be required of the professor before even starting. I had difficulty in figuring out what to do from the instructions. I think I could have figured it out eventually if I had gone ahead and made the time investment and completed the assignments, just like I later asked the students to do. My estimate was about 25 hours to get up to speed, and I wasn't willing to make that investment. No wonder most students didn't do it either.

    I found the instructions to administer the game to be confusing, and I couldn't even input data without being talked through it by the simulation author.

    My campus bookstore charged students 38.40 for the instruction book. I eventually dropped the simulation, and refunded students their 38.40 from my own pocket (ouch).

    I don't know if the simulation game you are talking about is the same, or a related product by the same company, but I'd be very skeptical.

    A far better managerial accounting simulation is to use a business computer game called Gazillionaire (from Lavamind). In this computer game, each player owns a company with two products/services--either transporting passengers or transporting materials/products on the single company vessel. Each player must make decisions about financing, setting prices, allocating space on vessel between passengers/cargo, purchase of insurance, payment of taxes, where to travel, etc.

    I have students play the game until they figure out the various components. Then I have the students play the game on paper until they have a plan that will work: enable them to ultimately accumulate retained earnings of 1,000,000. Once I approve their plans, they go ahead and play the game and then do a variance analysis, and figure out what they can do for the next time they play they play the simulation game.

    If anyone goes this route, I can share my very rudimentary instructions. Also, I warn: students must truly immerse themselves in the business--figuring out what info they need that can help them cut costs and increase revenues. It cuts down on the amount of classroom content that can be covered. But it is well worth it.

    Sometimes I hear from students that they learned more from my monopoly simulation game and gazillionaire simulation game than the rest of their collegiate experience.

    David Albrecht

    May 2, 2009 reply from dekalmte [dekalmte@XTRA.CO.NZ]

    Roger

    We use a simulation called Mikes Bikes Advanced through http://www.smartsims.com/ 

    Most of the administration can be undertaken by the helpful staff at Smartsims. The multiplayer version is housed on their servers and can be accessed by anyone (who has paid the requisite fee) with an internet connection.

    I have run in it our Strategic Management Accounting course for five years. Students find it easy to access and use. I form them into teams and they compete against each other to manufacture and sell bicycles (no knowledge of bicycle manufacture required).

    Assessment is around a business plan and establishing KPI (along the lines of a 'balanced score card'). Each team is 'in business' for a number of years and they are to report on successes and failures. It doesn't necessarily focus on the technical skills of 'management accounting' - we cover and assess through other mechanisms - but does really open their minds to the strategic, and integrated, nature of decision making. It requires that they develop the soft skills that accounting bodies expect to be squeezed into the curriculum. Students do enjoy the competitive nature of the challenge.

    Good Luck,

    Frank Weterman
    frank.weterman@manukau.ac.nz 
    Faculty of Business Manukau Institute of Technology
    Auckland New Zealand

     

    May 2, 2009 reply from Bob Jensen

    Hi Roger,

    The Mike's Bikes author is Pete Mazany. Pete's one of Frank's colleagues on the faculty at the University of Auckland. In the past, In the past I've used Pete in my technology workshops. If management accounting is to be emphasized to students who are relatively advanced in management accounting, the Mike's Bikes case may be too superficial in terms of accounting content, although this is an excellent policy decision making simulation. The case is networked and online. Pete spent a lot of money and time in programming this simulation. Pete earned his doctorate at Yale under one of the top game theory scholars of the world.

    There is an excellent case study directory at Michigan State University --- http://aib.msu.edu/resources/casedepositories.asp
    Most cases are not simulations. However, enter "simulation" in the search box on the left margin of the AIB home page and see what you find.

    It is not common to find simulation cases with good accompanying textbooks. One problem is that if the simulation cases are updated quite often, the accompanying textbook may be a little out or date. If neither the simulation case nor the textbook is updated quite often, then I become dubious about using such material over time. Updating financial accounting simulations is probably a bigger problem relative to managerial accounting because of the way financial accounting standards are amended monthly.

    Bob Rubin at Depaul has a video of possible interest, but it's more of a teaser. You would have to contact Bob or Gayle for more information (and may not have enough accounting content) --- http://www.youtube.com/watch?v=lz1VNyJpmQw 
    Also see Gayle Landuyt's video --- http://www.youtube.com/watch?v=8Oo2jaCN-v8 

    Bob Jensen's threads on Tools and Tricks of the Trade --- http://www.trinity.edu/rjensen/000aaa/thetools.htm


    Das VoondeBar:  New German Accounting Law
    Includes capitalization of internally-generated intangibles and consolidation of SPEs

    From IAS Plus on April 30, 2009 --- http://www.iasplus.com/index.htm

     
    The German Parliament has passed the Act to Modernise Accounting Law (in German: Bilanzrechtsmodernisierungsgesetz). A goal of the legislation is to reduce the financial reporting burden on German companies. The accounting requirements under the Act are described as an alternative to International Financial Reporting Standards for small and medium-sized companies that do not participate in capital markets. In announcing the new law, the German Federal Ministry of Justice (which administers the Commercial Code (ComC) in Germany) said:
    The modernised ComC accounting law is also an answer to the International Financial Reporting Standards (IFRS), published by the International Accounting Standards Board (IASB). The IFRS are geared to suit capital market oriented enterprises; in other words, they also serve information needs of financial analysts, professional investors and other participants in the capital markets.

    By far the majority of those German enterprises that are required by law to keep accounts and records do not take part in the capital market at all. For this reason, there is no justification for committing all the enterprises that are required to keep accounts and records to the cost-intensive and highly complex IFRS. Also the draft recently discussed by the IASB of a standard IFRS for Small and Medium-Sized Entities is not a good alternative for drawing up an informative annual financial statement. Practitioners in Germany have strongly criticised the IASB draft because its application – compared with ComC accounting law – would still be much too complicated and costly.

    The law exempts 'sole merchants' (prorietorships) with less than €500,000 turnover and Euro 50,000 profit from any obligation to keep accounts and records. Small companies (less than 50 employees, assets of €4.8 million, and annual turnover of €4.8 million) need not have an audit and may publish only a balance sheet. Medium-sized companies (less than 250 employees, assets of €19.2 million, and annual turnover of €38.5 million) have reduced disclosure requirements and may combine balance sheet items. Among the new accounting provisions of the ComC:
    • Companies will be permitted to capitalise internally generated intangible assets, while getting an immediate tax deduction for the costs.
    • Financial institutions will measure financial instruments designated as 'held for trading' at fair value, with value changes recognised in a 'special reserve'. The Ministry of Justice press release states: 'This special reserve has to be built up from part of the enterprise's trading profits when times are good and can then be used to offset trading losses when times get worse. Hence this special provision has an anticyclical effect. Here the necessary steps have been taken in order to respond to the financial markets crisis.'
    • Special purpose entities that are controlled must be consolidated.
    The new law takes effect 1 January 2010, with early application for 2009 permitted. Click for

    Jensen Comment
    This illustrates how European nations may pass accounting laws in spite of being subject to IFRS in the EU.

    As the FASB goes, so goes ?????
    The EU's finance ministers and the European Commission are ratcheting up pressure on the setters of accounting standards in Europe to soften their rules on valuing assets. Finance ministers threatened to summon a representative of the International Accounting Standards Board (IASB) to their next meeting in June to explain its stance. Christine Lagarde, France's finance minister, said this week that the IASB's response so far had not been sufficient.
    "European Ministers Put Pressure on Accounting Standards Board," CFO.com, May 7, 2009 ---
    http://www.cfo.com/article.cfm/13613096/c_2984368/?f=archives

     

    Controversies in the setting of accounting standards ---
    http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting

    Bob Jensen's threads on accounting for intangibles ---
    http://www.trinity.edu/rjensen/theory01.htm#TheoryDisputes


    A class-action lawsuit, settled earlier this week, says the audit firm should have considered the homebuilder's "make the numbers" culture to be a red flag as the housing market tanked.

    "Deloitte to Pay $1M in Beazer Suit," by Sarah Johnson, CFO.com, May 7, 2009 --- http://www.cfo.com/article.cfm/13612963/c_2984368/?f=archives

    Deloitte & Touche has agreed to pay investors of Beazer Homes USA nearly $1 million to settle claims the firm should have noticed the homebuilder was issuing inaccurate financial statements as the housing market began to decline earlier this decade.

    The audit firm, Beazer, and former Beazer executives have settled the class-action lawsuit for a total of $30.5 million, pending approval by the U.S. District Court for the Northern District of Georgia. Deloitte is scheduled to pay $950,000.

    The investors had accused Beazer of managing earnings, recognizing revenue earlier than allowed under generally accepted accounting principles, improperly accounting for sales/leaseback transactions, creating "cookie jar" reserves, and not recording land and goodwill impairment charges at the proper time.

    For example, according to the allegations, Beazer conducted house closings on homes that weren't move-in ready to push up the date the company could record the revenue from the sales and backdated documents of home sales so that they could be recorded in earlier financial reporting periods. Under FAS 66, Accounting for Sales of Real Estate, the seller recognizes its profit only after a sale is completed.

    In a complaint filed nearly two years ago, the plaintiffs said that because of Beazer's culture to "make the numbers" during a time when housing sales had significantly slowed, the company's employees were dealing with unrealistic budgets and pressure to hit financial goals or risk losing their jobs — and that Deloitte should have noticed these issues existed and planned its audit accordingly.

    The investors accused Deloitte of turning "a blind eye" to the myriad of "red flags" that should have alerted the firm to potential GAAP violations. These warning signs included the "excessive pressure" employees were under to meet their higher-ups' sales goals, tight competition in Beazer's market, and weak internal controls. Accusing the auditor of "severe recklessness," the shareholders alleged, for example, that Deloitte should have noticed that Beazer was likely overdue in recording impairments on their land assets, as the real estate market began to decline, among other the other alleged accounting violations.

    "Deloitte either knowingly ignored or recklessly disregarded Beazer's wide-ranging material control deficiencies and material weaknesses during the class period," according to the shareholders' complaint. "For example, Deloitte was specifically aware that financial periods were regularly held open or re-opened because it had access to Beazer's detailed financial and accounting information via, among other means, access to Beazer's JD Edwards software."

    In an educational brochure on public-company accounting released yesterday, the Center for Audit Quality, the trade group for audit firms, said auditors consider potential areas of misconduct for a particular company when deciding what areas of a business to review. However, the CAQ cautioned, "because auditors do not examine every transaction and event, there is no guarantee that all ma­terial misstatements, whether caused by error or fraud, will be detected."

    In the Beazer settlement, none of the defendants has admitted wrongdoing. "Deloitte denies all liability and settled to avoid the expense and uncertainty of continued litigation," a spokeswoman told CFO.com.

    For its part, Beazer says its insurance provider will pay for the settlement, meaning "there will be no financial contribution by the company." By settling, the firm added, "the uncertainties, distractions, burden and further expense associated with this litigation" have been eliminated.

    The suit's plaintiffs include institutional investor Glickenhaus & Co., Northern California Carpenters Pension Fund, and other pension funds. Shareholders holding Beazer stock between January 2005 and May 2008 would benefit from the settlement.

    Last year, Beazer restated several years' worth of financial statements to fix many of the same issues mentioned in the class-action suit. An internal investigation into its mortgage-origination business also resulted in the firing of its chief accounting officer who was accused of violating the company's ethics policy by trying to destroy company documents.

    Beazer settled a related case with the U.S. Securities and Exchange Commission without paying any penalty. It is still under investigation by the U.S. Attorney's Office in North Carolina, according to its most recent 10-K.

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


    Question
    Will the business school faculty shortage be a thing of the past?

    "Business PhD Applications on the Rise:  A weak job market has many contemplating PhDs and faculty jobs. Will the business school faculty shortage be a thing of the past?" by Alison Damast, Business Week, May 11, 2009 ---
    http://www.businessweek.com/bschools/content/may2009/bs20090511_815452.htm?link_position=link1

    With expenses such as business lunches being curtailed and a dwindling list of new clients, Wayne Nelms knew it was only a matter of time before he would be laid off by accounting firm Grant Thornton.

    "The writing was on the wall. I just didn't know when," says Nelms, 36, who worked as senior internal auditor at the company's Baltimore office for two-and-a-half-years. "Then I got the e-mail."

    By January he was out of a job and found himself at a crossroads. Reluctant to jump back into the job market immediately, he started exploring his options and stumbled upon the PhD Project, a nonprofit that encourages minority business professionals to earn PhDs and go on to become professors. He'd heard of the program back when he was an MBA student at Howard University but had put it on the back burner after graduation.

    "When D-day happened, I decided, well I can do one of two things with my future: Either get a doctorate or look for a good old dependable job," said Nelms, who got in contact with the PhD Project. A few weeks later he applied and was accepted to the accounting PhD program at Morgan State University in Baltimore, Md., where he'll be starting full-time this fall. Says Nelms: "With a doctorate, I thought my destiny would be a little more in my control."

    Nelms is part of a growing wave of professionals who are leaving the battered business world behind for a career in the hallowed halls of academia. Applications are up substantially this year at many top business PhD programs, with some business schools reporting jumps in applications as high as 40%. PhD program directors attribute the jump to professionals fleeing a weak job market, coupled with a surge of interest from undergraduates bypassing that job market entirely to head straight for school.

    An Encouraging Sign Meanwhile, organizations like the PhD Project say more people than ever before are expressing interest in their programs and annual conference, which attracted the largest number of participants in the organization's 15-year history this fall. It's an encouraging sign for the world of management education, where a looming faculty shortage has had B-school deans worried for years.

    The surge of interest in becoming a business professor comes just as a backlash is being felt among those in the business community who hold MBAs, says Yuval Bar-Or, an adjunct at Johns Hopkins University's Carey Business School and author of Is a PhD for Me? A Cautionary Guide for Aspiring Doctoral Students, slated for release on May 19. Many fleeing the business world for academia may view it as a more venerable profession, he says.

    "MBAs are now persona non grata in many places, and there is a fair amount of animosity being directed at them for living in the fast lane, spending everyone's money, and not being responsible enough," Bar-Or says. "So business leaders, in society's eyes, have been knocked off a pedestal, and that may be causing a lot of people with an interest in business to want to go down a path that is more respected in society."

    Those who have been thinking about getting a PhD are not wasting any time exploring their options. Potential PhD students were out in full force this fall at the PhD Project's annual conference in Chicago last November, where attendees mingled with professors and deans from nearly 100 business schools around the country. The conference usually attracts around 330 people, but this year 832 people applied, about 534 of whom were invited to attend.

    "This was a substantial increase. It was so big that we were starting to worry from a budgetary standpoint about how we were going to pay for everything and if the room and hotel was going to be big enough," said Bernie Milano, president of the PhD Project. He expects that interest will continue to grow. He's already received 65 applications for next year's conference, triple the amount he usually receives by this time of year, he says.

    Continued in article

    Jensen Comment
    There are a number of things working against an explosion of doctoral students in accountancy.
    Firstly, the traditionally large accounting doctoral programs (Illinois, Texas, Michigan, Indiana, Florida, Wisconsin, Ohio State, etc.) have greatly shrunk in size since their days of glory before the "accountics" revolution commenced in the 1960s. Shrinking departmental budgets will further dry up funding going into doctoral programs and accounting research in general. Generosity of hard-pressed accounting firms and alumni may also shrink private donations that are often used heavily to fund endowed chair faculty and other needs of doctoral programs.

    Secondly, many jobless accountants with high GMAT scores often have children and financial responsibilities and will be turned off by the five-year average time it takes to get an accounting PhD, especially for jobless applicants who have weak and or maybe  forgotten  accountics prerequisites (calculus, advanced calculus, linear algebra, mathematical statistics, econometrics, data mining, etc.) for which few have interest in studying for five more years of their lives. Accounting doctoral programs now have little to do with accounting and everything to do with making graduates scientists in econometrics, mathematics, and psychometrics --- http://www.trinity.edu/rjensen/theory01.htm#DoctoralPrograms

    Thirdly, virtually all colleges and universities are now being forced to downsize in some way due to shrinking budget allocations. Recovery of these budgets will be slow long after the current recession turns around because of the many demands placed upon states for other priorities such as Medicare and expanded welfare that was only temporarily shrunk by the Clinton Administration.. While expanding entitlements for poor people, President Obama promises to eventually reduce the Federal deficit which means more and more of the funding burdens will fall upon state taxation. Californians are now showing the world that taxpayers are not in the mood for higher state taxes. I do not anticipate that the shrinking doctoral programs in accountancy will get heavy revival funding for years to come.

    Fourthly, due to shrinking budgets and explosive growth in undergraduate accountancy programs, virtually all colleges and universities, with blessings from the AACSB, are creating full-time faculty positions for former practitioners who do not have accounting doctoral degrees (although many have law degrees or doctorates in other disciplines). These faculty reduce the demand for more expensive graduates from accountancy doctoral programs. And this is an outlet for early retirees who are great instructors with specialized skills (e.g., ERP, auditing, and tax) that are more in line with undergraduate teaching curricula in accountancy undergraduate and masters programs.

    The new AICPA-sponsored fellowship program for doctoral students who elect auditing and tax will help but the number of students funded in these professional specialties is too small to have much of an impact on filling empty tenure track positions. The KMPG Foundation fellowships for minority students has helped to get more African Americans into accounting doctoral programs, but I do not anticipate great increases in this funding source. The numerical impact of both these dedicated programs will be very small among the thousands of accountancy education programs in the United States.

    There will be substantial increases in the doctoral programs in management, marketing, MIS, and economics. Finance is a question mark since the number of undergraduate students majoring in finance will greatly decline due to black hole in job opportunities for graduates in finance. With declines in undergraduate finance majors there will be less demand for newly-minted professors of finance. Economics will probably fare better because the fact that economics doctoral students on average only take three years beyond a bachelors degree to complete the doctoral program. Three-year doctorates are  drawing cards to many returning jobless graduate students who do not want to spend more than three years earning a doctorate. And there will probably be increased opportunities for economists in Obama's exploding Federal government. Purportedly increasing numbers of doctoral students in economics are looking forward to civil service careers --- http://www.trinity.edu/rjensen/Bookbob1.htm#careers

    May 20, 20096 reply from Zane Swanson [ZSwanson@UCO.EDU]

    One other mitigating factor which could increase space at PhD schools may happen “if” PhD students opt for leaving campus “all but dissertation” due to the monetary attraction from schools who need to fill faculty shortage positions.

    Zane Swanson

    May 21, 2009 reply from Bob Jensen

    Hi Zane,

    I think there are more reasons these days not to leave ABD until the dissertation draft is completed and given preliminary approval by the dissertation advisor. Firstly, most PhD programs provide financial incentives to say on campus (e.g., assistantships for the first three or four years and fellowships at the dissertation stage).

    Secondly, most hiring schools place increased stress on dissertation completion. Tenure clocks start running upon arrival at a new job whether or not the dissertation is completed. Since publishing is more difficult for ABD faculty concentrating on both teaching and thesis completion, this is a huge incentive to delay startup of a new job.

    Thirdly, student evaluation of instructors has become an enormous factor in performance evaluation. A newly hired ABD tenure track professor cannot shirk on teaching preparation and time spent with students. This factor has changed greatly over the past few decades. In 1970 an ABD professor could afford to spend less time on teaching until the dissertation was accepted. Not anymore!

    Of course there are many other factors that complicate matters. An ABD candidate may follow a spouse to a new job. An ABD candidate may go beyond five years when there is little financial support in the sixth year of a doctoral program. Sometimes there is a new expected baby adding to financial burdens.

    Sadly, most excuses for working full time ABD become reasons for never finishing the dissertation. This happens time and time again. The spouse of a new professor at Trinity University in 2000 was herself ABD in microbiology at the University of Illinois. She was ever so close to finishing but decided to move with her husband to San Antonio and have two new babies after moving. Her husband doubts that she will ever finish her PhD degree since it’s especially difficult in science to take up where she left off years ago. How many times have we heard similar stories about ABD full-time teachers and ABD spouses who become full time parents?

    Bob Jensen

     

    You can read more about the accountics revolution that shrank the accountancy doctoral programs at http://www.trinity.edu/rjensen/395wpTAR/Web/TAR395wp.htm

    You can read more about trends in accountancy doctoral programs at
    http://www.trinity.edu/rjensen/theory01.htm#DoctoralPrograms


    "Test Preparation May Help High Scorers Most, Report Says," by Eric Hoover, Chronicle of Higher Education, May 20, 2009 --- Click Here

    Students with above-average scores on standardized admissions tests are likely to get the greatest benefit from commercial test preparation, according to a new report from the National Association for College Admission Counseling.

    Yet those benefits may not outweigh the costs for many families, says the report's author, Derek C. Briggs, associate professor of education at the University of Colorado at Boulder. "If there are effects to be gained through preparation," Mr. Briggs said, "can you get the same effect without spending the money? That's a pertinent question in this economy."

    Existing research suggests that coaching tends to raise students' SAT scores by up to 30 points. Yet students cannot necessarily attribute gains they might see to coaching alone, Mr. Briggs says.

    After all, students who take the test more than once tend to see their scores increase anyway. So, Mr. Briggs suggests, some students may raise their scores just as much by doing what he once did: taking a series of practice tests in a relatively inexpensive book.

    But even if test takers raise their scores by 30 points, would that make a difference in admissions? It may depend on the scores they start with and the selectiveness of the colleges to which they apply.

    In his report, "Preparation for College Admission Exams," Mr. Briggs examined to what extent such increases influence admissions decisions. One third of colleges he surveyed agreed that in some cases an increase of 20 points on the SAT's math section, or an increase of 10 points on the critical-reading section, would "significantly improve" an applicant's chances.

    The proportion of colleges that agreed with that statement rose as the base SAT scores (the scores earned before the gains) increased. That was especially true of more-selective colleges, where applicants' scores fall in a relatively narrow range.

    "If you come from a wealthy family and have high scores to begin with and can spend $1,000, then test prep might be worth it for those 30 points," Mr. Briggs said. "What's unfortunate is if middle-class or poorer families think test prep is going to raise their scores by 300 points. If you're a kid with scores between 400 to 500, I'm not sure it's going to make any difference."

    Seppy Basili, a vice president at Kaplan Test Prep and Admissions, was concerned about what that conclusion might say to test takers, particularly black and Hispanic students who, on average, do not score as high as their white peers on the SAT. "I wouldn't want the message to minority students to be that you can't benefit by preparing," said Mr. Basili, who had not seen the report but was familiar with its findings.

    Mr. Basili agreed that practice alone can help students improve their scores, but he described effective test preparation as something that also helps students analyze the mistakes they make on exams and develop strategies for correcting them.

    Yet Mr. Basili agreed with at least one of Mr. Briggs's observations: the quality of test coaching, like anything else, varies. "I would be the first to tell you that not all test prep is great," Mr. Basili said.

    Also see http://www.insidehighered.com/news/2009/05/20/testprep

    Bob Jensen's threads on affirmative action controversies in admissions can be found at
    http://www.trinity.edu/rjensen/HigherEdControversies.htm#AcademicStandards


    A research firm predicts 3,589 companies will report that their auditors doubt they will continue as going concerns

    "Auditors: Nearly 25% of Companies May Not Be Going Concerns," by Sarah Johnson, CFO.com, April 22, 2009 ---
    http://www.cfo.com/article.cfm/13525910/c_2984368/?f=archives

    The auditors of nearly one-quarter of companies feel that the companies may not live out the year.

    Auditors have become increasingly doubtful about their clients' ability to continue as going concerns, according to the most recent report on the subject by Audit Analytics, which has tracked the number of such going-concern opinions this decade in a recently released report. With calendar year-end 2008 filings still coming in to the Securities and Exchange Commission, the research firm estimates there will be 3,589 going-concern opinions eventually filed for 2008 annual reports, an increase of 9% compared to last year's total of 3,293 going-concern opinions.

    Audit Analytics made this prediction based on a compilation of regulatory filings made as of late March for 2008 10-Ks. Its data suggests auditors' going-concern doubts were more commonplace compared to the previous year. If the firm's estimate is correct, the number of auditors' documented worries about their clients' viability will reach the highest level this decade.

    In 2001, 19.2% of companies noted their auditors' going-concern uncertainty. But only 15% had those qualifications in 2003, according to the Audit Analytics report. For 2007 10-Ks, that number rose to 20.9%, reflecting the highest number of going-concern doubts since 2000. Now the total could reach 23.4% percent, the firm's researchers say.

    The audit profession has been predicting a surge in the number of going-concern doubts since last fall, when auditors were on the verge of beginning their annual reviews for calendar year-end companies amid the rough economy. Last month, on the heels of General Motors revealing its auditors' going-concern doubts, Grant Thornton CEO Ed Nussbaum told CFO.com there will be "an unprecedented number of going-concern footnote disclosures and clarification from the auditors" forthcoming.

    Auditors must consider several factors during their annual client reviews that may signal that a company won't be in existence 12 months from now. Among them: negative recurring operating losses, working capital deficiencies, loan defaults, unlikely prospects for more financing, and work stoppages. Auditors also consider such external issues as legal proceedings and the loss of a key customer or supplier.

    Auditors' going-concern evaluations don't stop there. If they have doubts about a company's future, they tend to confer with their client's management and review the company's plans for overcoming the problems noted and decide whether those plans can likely keep the company in business. If they still aren't satisfied, then the auditors will explain why they have "substantial doubt" about the company's ability to stay a going concern in an opinion filed with the company's 10-K.

    In late March, when Audit Analytics compiled the data, only 10,895 auditor opinions had been filed for year-end 2008 with the SEC. That means that Audit Analytics' forecast could be off, since the data doesn't account for about 5,000 10-Ks that were still due. Still left to be collected was data from smaller companies, late filers, and foreign filers. But it's likely that companies that have missed the SEC's filing deadlines are dealing with financial issues, possibly involving discussions over a going-concern qualification with their auditors, suggests Don Whalen, research director at Audit Analytics.

    To be sure, what the findings mean has yet to be determined . Still unclear is whether audit firms are being more conservative in their forecasts because regulators have indicated they will keep a close watch on going-concern opinions.

    Continued in article

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


    Questions About Addictions to Consultancy
    Will "independent" auditing firms ever overcome addictions to consultancy that compromises "independence"?

    "This banking inquiry is purely cosmetic:  The pseudo-investigations into the banking crisis are being run by firms with a history of unsavoury financial arrangements," by Prim Sikka, The Guardian, May 5, 2009 ---
    http://www.guardian.co.uk/commentisfree/2009/may/05/banking-inquiry-fsa

    Nearly two years after the start of the economic crisis and £1.4bn of bailouts, the Treasury select committee has provided a scathing critique of the failures of the banking industry and its regulators (pdf). To obfuscate the issues, the Financial Services Authority (FSA) has already decided on pseudo-investigations, which is unacceptable. For any investigation to command public confidence it needs to be independent, credible, thorough and on the public record. The FSA initiative fails on all counts.

    In the absence of any commitment to publish a report and all the material at its disposal, the investigation will be little more than cosmetic. The FSA's regulatory shortcomings are central to the banking crisis. It presided over the development of a shadow banking system and showed no inclination to regulate it. It allowed banks to publish opaque accounts, indulge in tax avoidance schemes and develop dangerous financial products. It allowed banks to run up excessive leverage (pdf) and paid little attention to the adequacy of their capital base. It allowed bank executives to collect huge bonuses for mediocre performance. Its ideology of light regulation curried favour with banking elites and paid little attention to the need to protect citizens and society.

    The FSA is seeking help from the "big four" accounting firms – Deloitte, PricewaterhouseCoopers, KPMG and Ernst & Young – for its investigation. This is a tacit admission that it does not have in-house capacity to understand the accounting practices of banks. It could not have diligently monitored the accounting practices of banks either before or since the crisis. By relying on consultants, the FSA is unlikely to build any institutional expertise and thus will not be in a position to efficiently monitor banks now or in the future.

    Major accounting firms must be eyeing multimillion pound contracts but have been involved in too many unsavoury episodes to command public trust. Last year, a court in Ireland designated a VAT avoidance scheme designed by accountancy firm Deloitte & Touche as "an abusive practice''. Last month, two former US executives of KPMG were given a prison sentence for their role in facilitating tax evasion. Previously, the firm had admitted "criminal wrongdoing" and paid a fine of $456m (£304m). A former employee of Ernst & Young has pleaded guilty (pdf) to facilitating tax fraud and there are tax fraud trials ongoing of four current and former partners of its US arm. Three former executives of ChuoAoyama PricewaterhouseCoopers, the Japanese arm of PricewaterhouseCoopers, received suspended prison sentences for helping a major client to falsify accounts. These may be exceptional incidents, but what credibility will these firms lend to the FSA's investigations?

    Almost all major banks are audited by one of the "big four" accounting firms. They collected millions of pounds in audit and consultancy fees, but none reported any financial problems before the banking crash. There were plenty of warnings. For example, in September 2007, Northern Rock, was relying on government help (pdf) for its survival. In April 2007, New Century Financial, the second largest subprime mortgage provider in the US, filed for bankruptcy protection.

    Continued in article

    Bob Jensen's threads on independence issues in auditing ---
    http://www.trinity.edu/rjensen/fraud001.htm#Professionalism

    Questions about whether the Big Four auditors will survive the banking scandals ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#AuditFirms

    The saga of lawsuits among the large auditing firms ---
    http://www.trinity.edu/rjensen/fraud001.htm


    Teaching Case:  A Real World Example of Zero-Based Budgeting

    Unease Brewing at Anheuser as New Owners Slash Costs
    by David Kesmodel and Suzanne Vranica
    The Wall Street Journal

    Apr 29, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB124096182942565947.html?mod=djem_jiewr_AC

    TOPICS: Budgeting, Cost Accounting, Cost Management, Managerial Accounting

    SUMMARY: At Anheuser-Busch in St. Louis, Missouri, "...executives and others now work a few feet apart" at clustered desks after new owners InBev eliminated executive perks, demolished plush offices, and began requiring sharing secretarial services. "...InBev has turned a family-led company that spared little expense into one that is focused entirely on cost-cutting and profit margins, while rethinking the way it sells beer."

    CLASSROOM APPLICATION: The article includes a discussion of zero-based budgeting that can be used in managerial accounting course covering the topic.

    QUESTIONS: 
    1. (Introductory) Who is InBev? How was the company formed? What iconic American beer brands are now owned by this company?

    2. (Introductory) What cultural differences are evident between owners of InBev and Anheuser-Busch? What factors do you think lead to these cultural differences?

    3. (Introductory) How has InBev "focused on cost-cutting and profit margins"? Cite all points in the article related to these strategies. In your answer, define the term "profit margin" as it relates to the strategies being undertaken.

    4. (Advanced) What is zero-based budgeting? How does that process help to focus on cost-cutting efforts?

    5. (Advanced) What strategies indicate that InBev is "rethinking the way it sells beer"? What evidence in the article indicates success in these efforts? What arguments might refute the fact that strategy change accounts for this improvement?

    Reviewed By: Judy Beckman, University of Rhode Island

    "Unease Brewing at Anheuser As New Owners Slash Costs," by David Kesmodel and Suzanne Vranica, The Wall Street Journal, April 29, 2009 --- http://online.wsj.com/article/SB124096182942565947.html?mod=djem_jiewr_AC

    Construction crews arrived at One Busch Place a few months ago and demolished the ornate executive suites at Anheuser-Busch Cos. In their place the workers built a sea of desks, where executives and others now work a few feet apart.

    It is just one piece of a sweeping makeover of the iconic American brewer by InBev, the Belgian company that bought Anheuser-Busch last fall. In about six months, InBev has turned a family-led company that spared little expense into one that is focused intently on cost-cutting and profit margins, while rethinking the way it sells beer.

    The new owner has cut jobs, revamped the compensation system and dropped perks that had made Anheuser-Busch workers the envy of others in St. Louis. Managers accustomed to flying first class or on company planes now fly coach. Freebies like tickets to St. Louis Cardinals games are suddenly scarce.

    Suppliers haven't been spared the knife. The combined company, Anheuser-Busch InBev NV, has told barley merchants, ad agencies and other vendors that it wants to take up to 120 days to pay bills. The brewer of Budweiser, a company with a rich history of memorable ads, has tossed out some sports deals that were central to marketing at the old Anheuser-Busch.

    The changes have been tough for workers to swallow. Some are grappling with heavier workloads, anxious about job security and frustrated with the emphasis on penny-pinching, say people close to the brewer. Former executives say workers feel less appreciated in a no-frills culture with fewer perks.

    InBev's response: It's more effective to make "sweeping, dramatic changes" than incremental ones, said a spokeswoman for the Belgian company, which has a history of many past mergers and acquisitions. Asked if morale in the U.S. is suffering, Dave Peacock, a 40-year-old Anheuser-Busch veteran who heads the U.S. division, said, "I think there's probably some truth....Some people react very well, some people struggle with it." Returning to the issue later in an interview, he said the newly merged company "is like a start-up....That excites some people and turns off others."

    It isn't yet clear how well the megadeal will pan out. The combination created the world's largest brewer by sales. But the tumult could offer an opening for MillerCoors LLC, which is exhorting its people to exploit the transition by trying to grab more shelf space at large retailers.

    Anheuser-Busch has nearly half of the U.S. beer market. It got a stronger challenger last summer, however, when SABMiller PLC and Molson Coors Brewing Co. linked their U.S. divisions in the joint venture called MillerCoors, with 29% of the U.S. market. "The next chapter in American beer is being written," MillerCoors President Tom Long said at a conference last month.

    Market-Share Gain But it was Anheuser-Busch InBev that logged a market-share gain the first quarter of this year, an increase of about three-quarters of a percentage point at sales at retail stores excluding Wal-Mart Stores Inc. The figures, from Information Resources Inc., show Anheuser-Busch InBev lifting its U.S. beer sales 5.7% in dollar terms from a year earlier. Bars and restaurants aren't included.

    The U.S. market is holding up well despite the recession, Anheuser-Busch InBev Chief Executive Carlos Brito said Tuesday. "In tough times, it's a great market to be exposed to," Mr. Brito, 48, said at a news conference after the company's annual meeting in Brussels. He declined to be interviewed for this article.

    InBev emerged as a beer heavyweight five years ago through the linkup of Brazil's AmBev, known for Brahma beer, and the Belgian producer of Stella Artois, Interbrew SA. Though it was based in Leuven, Belgium, the Brazilians' culture came to dominate. That approach stresses a sharp eye on costs and incentive-based pay structures.

    InBev eschews fancy offices and company cars, and groups of its executives share a single secretary. It uses zero-based budgeting -- meaning all expenses must be justified each year, not just increases. The company says it saved €250,000 ($325,000) by telling employees in the U.K. to use double-sided black-and-white printing, spending the money to hire more salespeople.

    "We always say, the leaner the business, the more money we'll have at the end of the year to share," Mr. Brito, the CEO, said in a speech last year to students at his alma mater, Stanford University business school.

    Anheuser-Busch took a different path, spending amply on everything from top beer ingredients to the best hotel accommodations. Executives didn't just have secretaries -- many also had executive assistants, who traveled with their bosses, took notes and learned the business in a kind of apprenticeship.

    Most employees, even those at the company's Sea World and Busch Gardens theme parks, got free beer. Once the owner of the St. Louis Cardinals, the company continued to shell out heavily for tickets to Cardinals games, used in marketing. Employees who wanted the company to donate beer or merchandise for community events faced little red tape. The St. Louis company often made "best places to work" lists.

    Heavy ad spending on sports events, often as the exclusive beer advertiser, helped Anheuser-Busch become the U.S.'s dominant brewer. But its growth and stock performance turned sluggish in recent years as U.S. sales of imports and small-batch "craft" beers rose faster than the St. Louis giant's brands.

    After InBev swooped in last fall with a $52 billion takeover, it sacked about 1,400 employees in the U.S., equal to 6% of the U.S. work force before the merger, and 415 contractor positions. These followed 1,000 employee buyouts accepted at Anheuser-Busch just before the merger.

    InBev has overhauled the U.S. division's compensation system for salaried employees, as part of what an internal memo called "an increased focus on meritocracy." In the future, the company will pay salaried workers 80% to 100% of the market rate for comparable jobs, "and any increases above that require special justification and approvals," said the memo. That changed a system in which "high performers...might have seen fewer rewards as dollars were spread more evenly."

    Continued in article

    Bob Jensen's threads on outrageous executive compensation are at http://www.trinity.edu/rjensen/FraudConclusion.htm#OutrageousCompensation


    Before reading this you may want to read about receivables factoring at
    http://en.wikipedia.org/wiki/Factoring_(finance) 

    Real World Examples of Factoring of Receivables

    From The Wall Street Journal Accounting Weekly Review on May 14, 2009

    Getting Your Due
    by Simona Covel
    The Wall Street Journal

    May 11, 2009
    (Print Edition Only:  Not available online)

    TOPICS: Advances, Factoring, Financial Accounting

    SUMMARY: "Borrowing against receivables isn't new. For hundreds of years, cash-strapped companies have hired...factors to advance them funds based on money owed by customers....A few companies are [offering]...products and services designed to make the process of borrowing against customer invoices cheaper and more transparent." One example of a company using these services is Data Drive Thru, Inc., a young start up that has made it to selling to big box stores such as Staples,. CFO Brad Oldham says, "Retailers may not be real fast paying, but they do pay." Data Drive Thru posts its invoices on Receivables Exchange LLC, which can be thought of as "eBay for receivables...Lenders then peruse the site, searching for receivables against which they are willing to lend. Lenders bid on those invoices, with the majority electing a fixed buyout price similar to eBay's 'buy it now' feature." Factoring can be expensive though less so on this facility than traditional past practices. Further, other companies have joined the market to provide verification services for the receivables being factored.

    CLASSROOM APPLICATION: Covering the unusual topic of factoring can be brought to "cyber" life with this article.

    QUESTIONS: 
    1. (Introductory) What is factoring of receivables? What journal entries are recorded when factoring receivables?

    2. (Advanced) How expensive is it to factor receivables? In your answer, quote one rate given in the article and express the rate as an annual interest rate.

    3. (Introductory) Why do companies undertake factoring as a means of obtaining cash if it is so expensive?

    4. (Advanced) What is "transparency" in the process of factoring receivables? Specifically, cite examples in the article of activities that help provide this quality in these financing transactions.

    5. (Advanced) Refer to the chart showing the average number of days it takes private companies to collect money owed by customers. How is this statistic calculated? Be specific, including the source of the financial data for the calculation.

    Reviewed By: Judy Beckman, University of Rhode Island

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


    A Cost Accounting/Decision Case

    From The Wall Street Journal Accounting Weekly Review on May 7, 2009

    New Deal Gives Glenn Beck Share in Book Profits
    The Wall Street Journal
    by Jeffrey A. Trachtenberg
    May 04, 2009
    Click here to view the full article on WSJ.com

    TOPICS: Adjusting Entries, Advances, Financial Accounting, Fixed Costs, Managerial Accounting, Variable Costs

    SUMMARY: Glenn Beck, in a wide-ranging contract with Simon & Schuster, will accept smaller book advances in exchange for a share in the profits. The arrangement lets Simon & Schuster experiment with formats, genres and categories because there is less cost up front in an uncertain market, giving the author the comfort of knowing he'll be compensated if sales go up, while also protecting the company.

    CLASSROOM APPLICATION: This article is a good illustration of a business incorporating fixed and variable cost information in strategic management decisions. You can discuss the traditional model of a higher advance vs. this new approach of reducing fixed costs to address the challenges in the current recession and state of the book industry.

    QUESTIONS: 
    1. (Advanced) What are fixed costs? What are variable costs? Why do managers need to be aware of the differences? How do these costs impact planning and budgeting?

    2. (Introductory) How are fixed costs impacted by this new arrangement? How are variable costs changed in this new arrangement?

    3. (Introductory) In what situations are low fixed costs and high variable costs favorable for a company? When are high fixed costs and low variable costs more favorable?

    4. (Advanced) What are the benefits for the publisher with this new deal? What are the benefits to the author? Which arrangement - high or low fixed costs - seems to be better for the publisher? What arrangement is better for an author? As a publisher, what factors would you take into consideration in deciding whether to offer this kind of deal? As an author, what factors would you consider?

    5. (Advanced) Why is this particular compensation arrangement so important in the current economy? Do you think that this type of deal will be similarly attractive when the economy rebounds? Why or why not?

    6. (Introductory) From a financial accounting standpoint, how would the publishing company book an advance? What would be the journal entries at the time of contract and at the time of payment? Would there be any adjusting entries involved? Why or why not? If so, what would they be?

    7. (Advanced) What other industries or businesses could benefit from a change in cost structure? Give several specific examples and explain why they should change.

    Reviewed By: Linda Christiansen, Indiana University Southeast

    "New Deal Gives Beck Share in Book Profits," by Jeffrey A. Trachtenberg, The Wall Street Journal, May 4,, 2009 ---
    http://online.wsj.com/article/SB124140022601982149.html?mod=djem_jiewr_AC

    Author and talk-show host Glenn Beck has signed a wide-ranging contract with CBS Corp.'s Simon & Schuster publishing arm that gives him profit participation in each new book, a perk the publisher has traditionally reserved solely for its most important writers, such as Stephen King.

    The deal reduces the publisher's risk by paring Mr. Beck's advances at a time when the book business is rocky.

    The move also locks in an author whose media presence has helped make him a best-selling writer. According to Simon & Schuster, Mr. Beck's first book, the 2003 nonfiction work "The Real America," sold 50,000 hardcovers; 2007's nonfiction "An Inconvenient Book" sold 500,000 hardcovers; and his novel "The Christmas Sweater," published in 2008, sold 775,000 hardcovers.

    Authors typically receive a royalty of 15% of the publisher's suggested retail price on hardcover titles and a 7% to 10% royalty on paperbacks, money paid out after publishers have recouped their advance. Mr. Beck will accept smaller advances in exchange for a share in the profits. The deal will also provide him with more creative control over how his books are designed and marketed.

    "I'd rather take a lower advance and have a partnership," Mr. Beck, 45 years old, said. "I'll bet on myself and a smart person on the other side of the table every time." Mr. Beck said he took satisfaction in having a deal similar to that of Mr. King, noting that Mr. King described him in a magazine column as "Satan's mentally challenged younger brother."

    This year, Mr. Beck will offer three new titles: "America's March to Socialism," which will be issued in May as an original audiobook read by the author; "Glenn Beck's Common Sense," which will be published as an ebook original in June and later as a fancy paperback; and "Arguing with Idiots," a nonfiction title that arrives in September from Simon & Schuster's Threshold Editions. A children's picture book of "The Christmas Sweater" is also expected to hit bookshelves this fall.

    The arrangement lets Simon & Schuster experiment with formats, genres and categories because there is less cost up front, said Carolyn Reidy, CEO of Simon & Schuster. "In an uncertain market, it gives the author the comfort of knowing he'll be compensated if sales go up, while also giving us protection," she said.

    Mr. Beck's radio show, "The Glenn Beck Program," is syndicated nationwide. His eponymous talk show on the Fox News Channel, which premiered in January, draws an average of 2.2 million viewers, according to Nielsen Co. Fox is owned by News Corp., which also owns The Wall Street Journal publisher Dow Jones & Co. "There was a time when I had to explain who he was," said Louise Burke, publisher of Simon & Schuster's Pocket Books imprint, which issued his first book. "That's no longer the case."

     


    How to account for inventory loans with clawback provisions?

    From The Wall Street Journal Accounting Weekly Review on April 30, 2009

    Car Dealers' Next Headache: Inventory Loans
    by John D. Stoll
    The Wall Street Journal

    Apr 27, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB124078863198457471.html?mod=djem_jiewr_AC

    TOPICS: Bankruptcy, Financial Accounting, Inventory Systems, Managerial Accounting

    SUMMARY: Chrysler and GM auto dealers are facing worries over slow sales and possible debt calls on their inventory loans due to falling values of these U.S. auto makers' brands. This discussion of the domino-effect of U.S. automakers' bankruptcies focuses on the impact on car dealers' financing of vehicle inventories.

    CLASSROOM APPLICATION: The article can be used in financial or managerial accounting courses covering inventories and current liabilities, from the introductory level up.

    QUESTIONS: 
    1. (Introductory) What are 'wholesale loans' or 'floorplan financing' arrangements for car dealerships? From where do car dealerships obtain these loans?

    2. (Advanced) Are these inventory-financing loans short-term debt or long-term? Support your answer.

    3. (Introductory) Why does the looming bankruptcy of the U.S. car makers Chrysler LLC and General Motors Corp. lead to potential calls for immediate repayment, in full or in part, of loans owed by car dealership companies?

    4. (Advanced) Why might such debt repayment be required in the case of bankruptcy proceedings? In your answer, provide an overview of the overall bankruptcy process that might lead to this result.

    Reviewed By: Judy Beckman, University of Rhode Island

    "Car Dealers' Next Headache: Inventory Loans," by John D. Stoll, The Wall Street Journal, April 27, 2009 ---
    http://online.wsj.com/article/SB124078863198457471.html?mod=djem_jiewr_AC

    For Chrysler LLC and General Motors Corp. dealerships, slow sales are just part of their worries. Now they're bracing for possible auto-maker bankruptcy filings that could trigger repayment of their inventory loans.

    The two auto makers have about 10,000 dealers in the U.S., with the bulk of them carrying considerable debt, mainly from the money they borrow to buy cars that sit on their lots. If Chrysler or GM were to file for bankruptcy protection, the banks extending that credit could immediately begin calling dealer loans, demanding a good portion of the money back and refusing to extend any more inventory financing.

    U.S. taxpayers, meanwhile, could be called to the rescue.

    At issue are loans for inventory, known as "wholesale" loans or "floorplan" financing, that are primarily given by GMAC LLC and Chrysler Financial to dealers so they can buy vehicles to stock their showrooms. These loans are typically backed by the vehicles that are being financed by the dealer and paid back when the vehicles are sold.

    Chrysler Financial and GMAC, run independently and answering to different shareholders, have "clawback" provisions that allow the finance companies to demand at least partial payment of the loans in the event of a bankruptcy because the value of the vehicles being used as collateral would plummet. Other lenders are believed to have similar provisions.

    Last week, the National Automobile Dealers Association met with the Treasury's task force on the auto industry to talk about the issue, particularly as it pertains to Chrysler, but walked away without a solution, NADA Chairman John McEleney said.

    "It's a huge problem that we don't have the answer to," Mr. McEleney said in a telephone interview late last week. "I feel a little better because the task force seems to understand."

    Mr. McEleney said NADA is looking for some guarantees from the Obama administration that would help prevent dealer failures that could result from the clawback provisions.

    An Obama administration official briefed on the meeting said "it was a good discussion and a thoughtful exchange, but certainly there was no commitment.

    On Monday, GM President and CEO Fritz Henderson is scheduled to present an update on the company's revised viability plan. Mr. Henderson is expected to announce further reductions of plants and brands, including the iconic Pontiac brand, and GM could launch a debt-for-equity exchange with unsecured bondholders who are owed about $28 billion. The exchange must commence Monday in order to avoid default on a $1 billion loan that is due for payment June 1.

    GM also needs to make progress on cutting hourly labor costs, and reducing the amount of cash it owes United Auto Worker retirees for future health-care obligations.

    The administration is faced with a balancing act in how it should help the thousands of dealers selling GM and Chrysler vehicles, just as it does with auto-parts makers..

    On the one hand, bankruptcy would be a way to help the two U.S. companies outmaneuver uncompetitive supply contracts with parts makers and onerous state franchise laws that protect underperforming dealers from being closed down.

    Just as Treasury officials have demanded major concessions from the UAW and bondholders, they are also calling for a sharp decrease in the amount of dealers and suppliers connected to GM and Chrysler.

    But completely ignoring their plight could lead to a unintended collapse of the whole network of companies dependent on the two companies, and that could lead to tens of thousands of job losses in coming months at the auto-parts companies, and dealers. Auto suppliers received a $5 billion aid package from Treasury in March. Treasury officials also designed a government warranty program for GM and Chrysler dealers so that buyers would feel safer buying cars from two companies on the edge of collapse.

    Traditionally, three-quarters of the dealers at both Chrysler and GM finance their inventories through GMAC or Chrysler Financial because those companies typically make wholesale loans the top priority when it comes to auto-industry lending, and because credit is typically extended at a discount rate.

    A person familiar with Chrysler Financial's position on the clawback provision said the company will work with each dealer on a case-by-case basis.

    GMAC alone currently extends over $20 billion in wholesale financing to U.S. dealers for inventory purposes.

    GM, in documents filed in February with the Treasury , said direct financing to dealers for inventory could end up costing taxpayers between $2 billion and $14 billion over the course of the company's stay in bankruptcy, should a Chapter 11 filing come to pass. Chrysler's projection on the matter is unclear.

    As of the end of the first quarter, GM and Chrysler dealers had 1.1 million vehicles of unsold inventory on their lots. The two companies sold 660,000 vehicles during the entire first quarter, and there is little indication that an uptick in sales will help clear the inventory.

    The administration's auto task force has been considering indirect ways of helping dealers, such as measures that would allow GM and Chrysler to once again offer leases on new vehicles, something they stopped doing last summer, people familiar with the matter said. They are also looking at how the auto makers can trim dealer networks.

    Principles-Based Accounting Standard Question
    FASB accounting standards are more rule-based than their international IASB counterparts that are more principles-based. The above case is an excellent test of whether principles-based standards will lead to more consistency in how to account for such inventory loans when the rules-based standards are somewhat difficult to apply. In other words, would international standards lead to more consistency regarding how automobile manufacturers and dealers account for inventory loans with "clawback" provisions?

    Arguments for and against principles-based standards are given at
    http://www.trinity.edu/rjensen/theory01.htm#Principles-Based


    Students may be interested in reading about a reverse stock split
    GM Plans 1-for-100 Reverse Stock Split  --- http://accounting.smartpros.com/x66464.xml


    Credit Derivative Swap Fraud
    "SEC Charges Pair with Insider Trading in Swaps," SmartPros, May 5, 2009 ---
    http://accounting.smartpros.com/x66466.xml

    The Securities and Exchange Commission on Tuesday charged a securities salesman and a portfolio manager with insider trading in the first such case involving credit default swaps.

    The SEC alleges that Jon-Paul Rorech, a salesman at Deutsche Bank Securities Inc., tipped off Renato Negrin, a former portfolio manager at hedge fund investment adviser Millennium Partners LP, about a possible change in terms of a bond being issued by VNU NV, a Dutch publishing company that owns Nielsen Media and other media businesses, in 2006. Deutsche Bank was acting as the lead underwriter of the VNU bond issuance.

    With knowledge of the potential change in bond terms, Negrin purchased credit default swaps on VNU for a Millennium hedge fund, according to the SEC complaint. After news of the bond terms was released, Negrin sold the swaps at a profit of $1.2 million, according to the SEC.

    Credit default swaps are an insurance-like contract that protects a buyer from potential losses that might be incurred on an underlying financial investment, such as a corporate bond or mortgage-backed security. Many of those types of underlying investments have lost much of their value or increasingly defaulted amid the credit crisis.

    If the underlying financial investment is not repaid, the buyer of the swap is covered in full for the losses through the swap.

    Credit default swaps have been widely seen as one of the major factors in the credit crisis. The trading of swaps helped push Lehman Brothers Holdings Inc. into bankruptcy protection and American International Group Inc. the to brink of failure before being bailed out by the government.

    Richard Strassberg, a lawyer representing Rorech, said in a statement that his client acted "consistently with the accepted practice in the industry." Strassberg said Rorech did not violate any securities laws tied to the sale of the VNU bonds.

    A lawyer for Negrin was not immediately available to comment on the case.

    The SEC is asking for the judge to force the two to repay the money gained from the transaction, plus penalties and back interest on the allegedly ill-gotten gains.

    The SEC's hedge fund working group handled the investigation. The group has brought more than 100 cases alleging fraud and manipulation by hedge funds over the past five years, including more than 20 in 2009.

    From Jim Mahar's Blog on May 15, 2009 --- http://financeprofessorblog.blogspot.com/

    From NPR: Financial Time's Gillian Tett on JP Morgan and Derivatives
    I listened to this on the radio tonight. It was so good, that the very first chance I had to blog it, I did. Good stuff!

    Fresh Air from WHYY : NPR:
    "Journalist Gillian Tett warned about the problems in the financial industry long before many of her colleagues. In her new book, Fool's Gold, Tett examines the role J.P. Morgan played in creating and marketing risky and complex financial products"

    The author is from FT fame and FT has two extracts from the book.

    "The first sign that there might be a structural problem with the innovative bundles of credit derivatives that bankers at JP Morgan had dreamed up emerged in the second half of 1998. In the preceding months, Blythe Masters and Bill Demchak – key members of JP Morgan’s credit derivatives team – had been pestering financial regulators. They believed that by using the new credit derivative products they had helped create, JP Morgan could better manage the risks in its portfolio of loans to companies, and thereby reduce the amount of capital it needed to put aside to cover possible defaults. The question was by how much. (Though these bundles of credit derivatives later went under other names, such as collateralised debt obligations [CDOs], at that time these pioneering structures were known as “Bistro” deals, short for Broad Index Secured Trust Offering). Masters and Demchak had done the first couple of Bistro deals on behalf of their own bank without knowing the answer to their question for sure. But when they were doing these deals for other banks, the question of reserve capital became more important – the others were mainly interested in cutting their reserve requirements."

    Bob Jensen's threads on the role credit derivatives played in the financial crisis beginning in 2008 ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout

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

    Bob Jensen's threads on derivative financial instruments fraud ---
    http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds


    Computing a College's Cost of Each Degree Awarded: 
    This illustrates problems managerial accountants face when estimating various types of costs in industry

    "What Does a Degree Cost?" by Doug Lederman, Inside Higher Ed, May 19, 2009 --- http://www.insidehighered.com/news/2009/05/19/degree

    College tuition prices keep rising. State budgets are stagnant or shrinking. And policy makers, from President Obama on down, are increasingly calling for increases in the number of Americans who get some higher education or training.

    Those factors have led more state legislators, trustees and others to argue that, to accomplish the latter goal given the former circumstances, colleges are going to have to lower what they spend to produce the average credential they award. But any discussion of lowering the "cost per degree" must start with a more fundamental question: What does a degree cost to produce now?

    That question may be basic, but it is not simple, as a new report from the Delta Project on Postsecondary Education Costs, Productivity, and Accountability makes clear. The paper, prepared by Nate Johnson, associate director of institutional planning and research at the University of Florida, lays out a range of possible approaches to calculating the cost of a college degree and then calculates them using a rich set of data from the State University System of Florida, where Johnson formerly worked.

    The paper shows that it is distinctly possible to come up with such a figure, but the wide variation in the numbers -- based on institution type, program, degree level, and other factors -- suggests that the answer will depend in large part on how the question is framed. And that decision is a surprisingly value-laden one, says Johnson. "You frame the question one way if you are only interested in students who graduate, and another way if you want to know the cost for people who go to college and don't complete," he says. "The point is, this is not just a data question. It's a question of what it is that we want from our colleges and universities."

    The broad work of the Delta Project and its founder, Jane Wellman, is to analyze the "spending side" of the higher education cost and price picture; the group has released a series of reports that try to document the interplay of colleges' revenues and expenditures, and how those trends affect what they charge to students. The new study, which grew out of Johnson's work in Florida, he says, aims to develop a "common language," if not a common format, for focusing the discussion about how one might measure the cost of a degree in a particular institution, system or state. Toward that end, Johnson proposes several possible ways of calculating the average cost of a degree.

    The analyses are based on data showing that the Florida university system incurred an average of $288 in direct and indirect instructional expenditures per credit hour, with wide variation by level ($188 for lower division undergraduate, $537 for master's, etc.), institution ($240 for an upper level undergraduate credit at the massive University of Central Florida, $677 for the same credit at the 700-student New College), and field of study ($159 in family/consumer sciences, $509 for natural resources/conservation). The analysis counts only those expenditures derived from state appropriations and student tuition, excluding endowment and other funds.

    The first estimate, which Johnson calls the "catalog cost," calculates what a college would spend to educate a student who fulfills the "catalog requirements" of the average degree to the letter -- no more, no less. (The equation: cost per credit hour x instructional expenditures/credit hours.) The average cost is $26,485, with institutions within the Florida system ranging from $22,440 to nearly double that. Johnson also found significant variation by field because of vastly different requirements and program length, with mechanical engineering averaging $37,870 vs. $27,159 for elementary education.

    The catalog method is easily understood, but it "does not reflect actual student behavior," Johnson notes. More accurate in gauging how students actually maneuver through institutions, he writes, is the "transcript method" of cost analysis, in which the total number of credit hours students take are multiplied by the cost per credit hour, and then divided by the number of degrees awarded. The average freshman who entered a Florida system university and graduated in 2003-4 "attempted" 131 credits, including failed or withdrawn courses and subtracting for any AP or dual enrollment courses that reduced their course requirements.

    The average "transcript cost," then, was $31,763; converting to 2006 dollars, to make parallel to the figures from the "catalog cost" analysis, Johnson writes, the average figure is $33,672. (The 2003-4 figure for mechanical engineering was $47,257.)

    Both the catalog and transcript cost methods factor into the calculation only those costs incurred by students who actually graduate. The third major analysis, "full cost attribution," examines the entire amount that an institution or system spent on instructional purposes to achieve an "aggregate level of degree completion." The equation looks like this: all credits taken at an institution over three years x the three-year average cost per credit hour/three years of degrees.

    Not surprisingly, because all courses taken by all students would be allocated to the smaller proportion who actually earned degrees, this produces the highest cost per degree number; $37,757 in 2002-3 dollars, equivalent to $40,645 in 2005-6, Johnson writes. This analysis grows less predictable and valid the more narrowly it is drawn, he adds, because programs with high attrition, or into which many students transfer late in the game, can have their figures drastically altered. The overall high and low for the Florida university system, for example, were $170,831 for "multidisciplinary studies" and $21,473 for parks and recreation, and the variation by degree level was enormous: $33,425 for a law degree, $259,781 for an M.D., and $121,725 for a doctorate.

    So which is the most accurate assessment of what a university spends to educate a graduate? The catalog cost of $26,485, the transcript cost of $33,672, or the "full cost" $40,645? The last is "probably closer to an answer" to the question that policy makers are increasingly asking now, about "what would we have to spend to get more graduates," though that assumes that colleges maintained their current enrollment and expenditure levels, he notes.

    But the other key point, Johnson says, is that the choice of how you measure cost depends, to an extent, on how you perceive the role of colleges. Using the "full cost" measure, he asserts, more or less says that most of what a university does is designed to educate students, and that "all of those costs could be attributed to the cost of producing college graduates," as overhead, he says.

    "If you highly value research or public service," though, "you could almost say that the graduates are free -- a byproduct" of what you spend on those other purposes.

    Jensen Comment
    See Bob Jensen's threads on "Systemic" problems of accountancy --- http://www.trinity.edu/rjensen/FraudConclusion.htm#BadNews
    Especially note the problems of joint costing that plague college cost accounting.

    Bob Jensen's threads on higher education controversies ---
    http://www.trinity.edu/rjensen/HigherEdControversies.htm

     


    The big news is the possible side tracking of the Herz-Cox Express Train for replacing U.S. accounting standards (FASB rules) with international standards (IFRS) in 2014. The rush to re-educate and retrain accountants in the United States is now give a more reasonable time frame. The rush filing gaps in international GAAP has been give a more reasonable time frame. There is now more time for the International Accounting Standards Board to obtain better funding and to improve its infrastructure, especially its research budget and staff.

    April 23, 2009 message from Neal Hannon [neal@GILBANE.COM]

    In preparation for a May 14th talk at Florida State, i have assembled a wiki, http://ficpa-ifrs.wikispaces.com/ where i have posted several recent articles about the SEC IFRS roadmap.  Please feel free to visit, join the wiki and contribute to the materials assembled.  Thanks,

     Neal Hannon


    The other big news items were the the infamous fair value accounting FASB Staff Positions (FSPs) announced on April 2, 2009. This relaxation/reinterpretation of fair value definitions and impairment testing arose largely out of political pressures and accusations that fair value accounting rules played a large role in the banking crisis of 2008 and recovery in 2009.

    On April 9, 2009, the Financial Accounting Standards Board ("FASB") issued the three FSPs: --- http://www.fasb.org/news/nr040909.shtml

    FSP FAS 157-4, Determining Fair Value When the Volume and Level of Activity for the Asset or Liability Have Significantly Decreased and Identifying Transactions That Are Not Orderly ("FSP FAS 157-4") ---
    http://www.fasb.org/pdf/fsp_fas157-4.pdf

    FSP FAS 115-2 and FAS 124-2, Recognition and Presentation of Other-Than-Temporary Impairments ("FSP FAS 115-2") ---
    http://www.fasb.org/pdf/fsp_fas115-2andfas124-2.pdf

    FSP FAS 107-1 and APB 28-1, Interim Disclosures about Fair Value of Financial Instruments ("FSP FAS 107-1") ---
    http://www.fasb.org/pdf/fsp_fas107-1andapb28-1.pdf
    /

    In response the PCAOB issued "Staff Audit Practice Alert No. 4," April 21, 2009 ---
    http://www.pcaobus.org/Standards/Staff_Questions_and_Answers/2009/04-21_APA_4.pdf

    Question
    What are the implications of the April 2, 2009 Fair Value Accounting FSPs for international accounting standards?

    April 22. 2009 message from Deloitte to the IASB --- http://www.iasplus.com/index.htm

    ·  Deloitte's IFRS Global Office has submitted to the IASB a Letter of Comment on IASB's Request for Views on Proposed FASB Amendments on Fair Value Measurement and Impairment Requirements. On 19 March 2009, the IASB requested views on what were, then, two proposed FASB Staff Positions. The FASB has since adopted the two proposals as final FSPs, along with a third related FSP dealing with disclosures, as follows:

    • FSP FAS 157-4, which provides guidance on determining fair value when market activity has decreased
    • FSP FAS 115-2 and FAS 124-2, which addresses other-than-temporary impairments for debt securities
    • FSP FAS 107-1 and APB 28-1, which discusses fair value disclosures for financial instruments in interim periods

    The Deloitte letter to the IASB provides our detailed views on each of the final FASB Staff Positions and contrasts them with IFRSs. Here are two excerpts from our letter:

    • Regarding FAS 157-4, the Deloitte letter to the IASB states:
      We believe that the FASB Staff Position FAS 157-4 is broadly consistent with the principles of fair value in IFRSs and the Expert Advisory Panel document and therefore an amendment to IFRSs is not necessary. However, in light of the IASB's imminent release of an exposure draft on Fair Value Measurements, the IASB should consider whether the words used in the FASB Staff Position FAS 157-4 are consistent with the exposure draft and whether the wording of the exposure draft should be aligned with the FASB Staff Position FAS 157-4. In addition, the IASB should seek the views of the Expert Advisory Panel to establish whether differences in the words of the FASB Staff Position FAS 157-4 and the Expert Advisory Panel report are expected to have any practical effect.
       
    • Regarding FAS 115-2 and 124-2, the Deloitte letter to the IASB states:
      As noted in the request for views, the differences between U.S. GAAP and IFRSs with respect to scope, impairment triggers, impairment measurements, and recoveries are numerous and complex. A short term project to fully converge with FASB's amendment would entail substantial changes to IFRSs that would require significant efforts and would create unnecessary complexities (e.g., recognizing impairments of held-to-maturity securities that are not due to credit in other comprehensive income). Instead, we would encourage both Boards to expedite their work on a joint standard that would improve reporting for all financial instruments including impairment issues (e.g., loss recognition triggers, measurement of losses, recognition of recoveries, etc.).

    Another difference, maybe temporary, between FASB and IASB rulings
    From IAS Plus on April 25, 2009 --- http://www.iasplus.com/index.htm

     In deciding not to adopt FSP FAS 115-2 and FAS 124-2, the IASB said that, instead, it will take up the broad issue of impairment as part of its Comprehensive Review of IAS 39. The IASB believes that an immediate response to the recent FSP on impairment is unnecessary. The IASB also announced a timetable for the IAS 39 review, which calls for issuance of an exposure draft of a proposed replacement for IAS 39 by October 2009.

    Question
    What impact does the infamous FSB easing of fair value accounting rules have on bank earnings?

    Answer
    We anticipated that banks would show higher valued assets and capital reserves (due to less write down of sick investments) and higher earnings due to not having to write down toxic investments so deeply ---
     http://www.fasb.org/news/nr040909.shtml
    Almost everybody, including the banks themselves, claims that the rosy first-quarter earnings of the the large U.S. banks cannot be sustained. Bank of America discovered that rosy earnings alone will not lure (read that sucker) investors into buying into poisoned banks. Of course not all the jump in earnings is due to the change in FASB rules for fair value accounting. Much of the earnings jump is due to a spike in re-financing of real estate mortgages after the Fed eased mortgage rates to historic lows. Banks cannot count on this re-financing surge in revenues to continue.

    "Accounting Change Boosts Wells Fargo," SmartPros, April 23, 2009 ---  http://accounting.smartpros.com/x66270.xml

    Wells Fargo yesterday showed the potentially dramatic impact of the recent loosening of accounting rules as it reported a first-quarter profit of $3.05 billion.

    The San Francisco company said the accounting change, which has generated controversy, allowed it to increase capital reserves by more than $4 billion. The increase could make a critical difference in the federal government's evaluation of the company's ability to withstand a deepening recession, accounting experts said.

    "This makes them look a lot healthier in the eyes of the government and presumably other observers as well," said Robert Willens, who advises financial companies on tax and accounting issues. "And you would think therefore that they will have passed the stress test with flying colors."

    Wells Fargo reported that first-quarter earnings fell 7 percent to 56 cents a share, from 60 cents a share or $2 billion during the first quarter of last year. The company had issued an unusual statement two weeks ago disclosing its bottom line but offering little explanation of how the result was achieved.

    Yesterday, the company said its retail banking operations had outperformed those of its major rivals, Bank of America and J.P. Morgan Chase, in significant part because of Wells Fargo's position as the nation's largest mortgage lender. The company's income from mortgage lending surged fourfold to $2.5 billion as it benefited from a refinancing boom driven by federal efforts to hold down interest rates.

    Wells Fargo took an investment of $25 billion from the Treasury Department. It also is the major beneficiary of a change in federal tax law last fall that shelters billions of dollars of its own profits from taxes based on losses incurred by Wachovia, the troubled bank it bought in December. The deal made Wells Fargo the largest banking firm in the Washington region by number of branches.

    The Financial Accounting Standards Board, under intense pressure from banks and Congress, agreed in early April to let banks report higher values for some assets. Most large banks have made a point of saying that their results were achieved without this kind of accounting adjustment. Wells Fargo's action, however, underscored the room for maneuver available to other banks in future quarters.

    Wells Fargo had set aside almost $10 billion from its capital, the pool of money banks are required to maintain as a reserve, to reflect a decline in the value of its investments. The decline was based on the prices that buyers were paying for similar assets. After the FASB change, which allows banks to substitute their own judgment in some cases, Wells Fargo decided market prices were too low by more than $4 billion, and it returned that amount to its capital pool.

    Bob Jensen’s PowerPoint slides (to date) on fair value accounting ---
    http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/10FairValueFSU.ppt

    Bob Jensen’s threads on accounting valuation are at
    http://www.trinity.edu/rjensen/Theory01.htm#FairValue


    "Time to count the cost of failure:  Accounting firms are trying to shield themselves from the consequences of the financial crisis despite being partly to blame." by Prem Sikka, The Guardian, May 21, 2009 ---
    http://www.guardian.co.uk/commentisfree/2009/may/21/accounting-financial-crisis

    Will large auditing firms survive their professional failures and suspected non-independence prior to the bank failures and other corporate bankruptcies? The spate of shareholder and creditor lawsuits have already commenced and some of the claims are enormous ---
    http://www.trinity.edu/rjensen/2008Bailout.htm#Auditors


    From The Wall Street Journal Accounting Weekly Review on May 7, 2009

    New FASB Rule Aims to Clarify 'Net Income'
    by Michael Rapoport
    The Wall Street Journal

    May 01, 2009
    Click here to view the full article on WSJ.com

    TOPICS: FAS 160, FASB, Financial Accounting, Income Statement, International Accounting Standards, Net Income

    SUMMARY: A new FASB standard requires companies to disclose income related to minority stakes in other firms. U.S. accounting-standard setters threw some observers of corporate profits a curveball this earnings season by fiddling with what companies mean by "net income." It requires companies to disclose income related to so-called noncontrolling interests -- investments in other firms in which a company owns only a minority stake. That would make such income easier to see and bring U.S. rules more into line with international accounting standards.

    CLASSROOM APPLICATION: This article helps to notify students of the coming changes to the income statement. It also can serve as a basis for discussion regarding the role of the FASB and how changes to many aspects of accounting are possible. Finally, the mention of international accounting standards can generate some discussion about the differences between the U.S. system and systems in other countries, as well as the changes on the horizon.

    QUESTIONS: 
    1. (
    Introductory) What is the FASB? What is its authority and it corresponding responsibilities? Who is on the FASB?

    2. (
    Advanced) What is the change that the FASB is making to financial statements? Why is the FASB making these changes? How will the changes impact U.S. corporations from a practical standpoint?

    3. (
    Introductory) What are the benefits of the changes? What are some of the problems that could come from these changes? Do you think that these changes will achieve the goals of the FASB in this instance? Why or why not?

    4. (
    Introductory) How will The Wall Street Journal report net income in the future? Why would The Journal take that approach?

    5. (
    Advanced) The article states that the change would bring U.S. rules more in line with international accounting standards. Why is that important? Why is accounting in the U.S. different from that in other countries? Should the rules be the same throughout the world? Why or why not? What changes are on the horizon?

    Reviewed By: Linda Christiansen, Indiana University Southeast

    "New FASB Rule Aims to Clarify 'Net Income'," by Michael Rapoport, The Wall Street Journal, May 1, 2009 ---
    http://online.wsj.com/article/SB124113216598274933.html

    U.S. accounting-standard setters threw some observers of corporate profits a curveball this earnings season by fiddling with what companies mean by "net income."

    The decision to replace the time-honored bottom line -- the most basic measurement of corporate performance -- with formulations like "net income attributable to the company" has changed the familiar look of earnings statements at a time when corporate profits are being closely scrutinized for signs of the economy's health.

    The move by the Financial Accounting Standards Board is aimed at giving investors more detail about companies' investments. But E.J. Atorino, a media and publishing analyst for Benchmark Research, said the improvement is marginal at best.

    "I think these accountants have gone crazy," he said. "They're just making life more complicated."

    A FASB spokesman declined to comment. The changes are a result of Financial Accounting Standard 160, which took effect with the first quarter for most companies. It requires companies to disclose income related to so-called noncontrolling interests -- investments in other firms in which a company owns only a minority stake. That would make such income easier to see and bring U.S. rules more into line with international accounting standards.

    So far so good. But the change also requires companies to report net income before and after income from noncontrolling interests. As a result, "net income" is no longer the bottom line.

    What used to be simply called "net income" at a company holding minority stakes is now called "net income attributable to" the parent company -- even though it is the same figure, calculated the same way. The presentation and terminology change, but not the numbers themselves.

    For instance, McGraw-Hill Cos. on Tuesday reported first-quarter "net income" of $66.0 million. It then deducted $3 million from noncontrolling interests and reported "net income attributable to The McGraw-Hill Companies, Inc." of $63 million -- compared with $81.1 million a year earlier. That $81.1 million was originally reported last year as simply "net income."

    Colgate-Palmolive Co., seeking to avoid possible confusion when it reported earnings Thursday, took a different tack. It started with "net income including noncontrolling interests," allowing it to keep "net income" as its bottom line. Colgate spokeswoman Hope Spiller said the company chose the wording for the purpose of "simplicity and consistency."

    When writing about corporate earnings, The Wall Street Journal will focus on "net income attributable" to the company or the equivalent. Earnings per share -- the figure closely watched by analysts -- are also based on the "attributable" number.

    The change has no effect on the bottom-line number, as companies have always excluded income from minority stakes. There may be a greater effect on the balance sheet, however, where noncontrolling interests will now figure into calculations of shareholder equity.

     Corrections and Amplifications:

    A company's "noncontrolling interests" are minority stakes in its subsidiaries that are owned by outside parties. This article incorrectly defined noncontrolling interests as investments in other firms in which a company owns only a minority stake.

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


    Question
    Why did Morgan Stanley lower first quarter earnings because the credit spreads on some of its long-term debt had narrowed?

    Paragraph 15 of FAS 157

    Application to liabilities
    15. A fair value measurement assumes that the liability is transferred to a market participant at the measurement date (the liability to the counterparty continues; it is not settled) and that the nonperformance risk relating to that liability is the same before and after its transfer. Nonperformance risk refers to the risk that the obligation will not be fulfilled and affects the value at which the liability is transferred.
    Therefore, the fair value of the liability shall reflect the nonperformance risk relating to that liability. Nonperformance risk includes but may not be limited to the reporting entity’s own credit risk. The reporting entity shall consider the effect of its credit risk (credit standing) on the fair value of the liability in all periods in which the liability is measured at fair value. That effect may differ depending on the liability, for example, whether the liability is an obligation to deliver cash (a financial liability) or an obligation to deliver goods or services (a nonfinancial liability), and the terms of credit enhancements related to the liability, if any.

    Credit Spread of a Bond --- http://en.wikipedia.org/wiki/Credit_spread_(bond)

    In finance, a credit spread is the yield spread, or difference in yield between different securities, due to different credit quality. The credit spread reflects the additional net yield an investor can earn from a security with more credit risk relative to one with less credit risk. The credit spread of a particular security is often quoted in relation to the yield on a credit risk-free benchmark security or reference rate.

    There are several measures of credit spread, including Z-spread and option-adjusted spread.

    Jensen Note
    Under the April 9, 2009 FSPs issued by the FASB, unrealized mark-to-market gains and losses attributable to changes in credit risk are posted to current earnings whereas non-credit fair value adjustments are posted to AOCI. ---
    (slide show) --- http://www.cs.trinity.edu/~rjensen/Calgary/CD/JensenPowerPoint/10FairValueFSU.ppt
     

    Reduced credit spread on a bond investment ceteris paribus increases market value of a bond and, thereby, results higher unrealized earnings due to mark-to-market upward adjustment of an asset. Reduced credit spread on a liability has the opposite impact on earnings for the unrealized loss due to a mark-to-market adjustment that increases the fair value of the liability. This is a bit confusing, since by reducing credit risk on their debt, debtors take an earnings hit when adjusting the debt to fair value.

    "Mark-to-market Madness," by David M. Katz, CFO.com, April 24, 2009 --- http://www.cfo.com/blogs/?f=header

    As if they needed any, the critics of fair value got a fresh new example of the craziness of an oft-decried provision in FAS 157, paragraph 15 of Fair Value Measurements. The provision rewards companies whose credit spreads on their debt liabilities have widened and punishes those who have become more creditworthy.

    On Wednesday, Morgan Stanley reported that it had to cut its first-quarter net revenues $1.5 billion because the credit spreads on some of its long-term debt had narrowed. What happened was that as the investment bank grew more reliable to its creditors over the first part of the year, its debt became more valuable. And under the dictates of mark-to-mark accounting, the firm had to take a writeoff because of this very positive occurrence.

    Sound nuts? It has sounded so to many observers. In the 15th paragraph of 157 FASB says, nevertheless, that "the fair value of [a company's] liability shall reflect the nonperformance risk relating to that liability." Thus, as the nonperformance risk--as reflected by slimmer credit spreads—narrowed, Morgan Stanley had to reflect the decreased value of its debt as a decrease in sales on its income statement.

    Like the alleged evils of mark-to-market accounting in illiquid markets—although to a lesser extent—the irrational practice of forcing improved creditworthiness to be reflected in revenue decreases has become fodder for fair value’s enemies. When FASB made its recent amendments to 157, it neglected to attack the provision. If only to preserve fair-value accounting from more political attacks, it should do so now.

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


    We need honest accounting more than ever, not fantasy teases for investors

    This is a pretty good article on how players (banks), umpires (regulators), and fans (like billionnaires Stever Forbes and Warren Buffet) have inappropriately blamed the scorekeepers (accounts) for the demise of the big banks. In fact the December 30, 2008 research report calls this attribution of blame just plain wrong (and self-serving).

    The wonderful December 30, 2008 research report of the SEC shows that fair value accounting is neither the cause nor the cure for the banking crisis. The liquidity problem of the holders of the toxic investments is caused by trillions of dollars invested in underperforming (often zero performing) of bad investments mortgages or mortgaged-backed bonds that have to be written down unless auditors agree to simply lie about values. That is not likely to happen, but client pressures on auditors to value on the high side for many properties will be heavy handed.
    The wonderful full SEC report that bankers and regulators do not want to read can be freely downloaded at http://www.sec.gov/news/studies/2008/marktomarket123008.pdf

    "We Need Honest Accounting:  Relax regulatory capital rules if need be, but don't let banks hide the truth," by James A. Chanos, The Wall Street Journal, March 24, 2009 --- http://online.wsj.com/article/SB123785319919419659.html?mod=djemEditorialPage

    Mark-to-market (MTM) accounting is under fierce attack by bank CEOs and others who are pressing Congress to suspend, if not repeal, the rules they blame for the current financial crisis. Yet their pleas to bubble-wrap financial statements run counter to increased calls for greater financial-market transparency and ongoing efforts to restore investor trust.

    We have a sorry history of the banking industry driving statutory and regulatory changes. Now banks want accounting fixes to mask their recklessness. Meanwhile, there has been no acknowledgment of culpability in what top management in these financial institutions did -- despite warnings -- to help bring about the crisis. Theirs is a record of lax risk management, flawed models, reckless lending, and excessively leveraged investment strategies. In the worst instances, they acted with moral indifference, knowing that what they were doing was flawed, but still willing to pocket the fees and accompanying bonuses.

    MTM accounting isn't perfect, but it does provide a compass for investors to figure out what an asset would be worth in today's market if it were sold in an orderly fashion to a willing buyer. Before MTM took effect, the Financial Accounting Standards Board (FASB) produced much evidence to show that valuing financial instruments and other difficult-to-price assets by "historical" costs, or "mark to management," was folly.

    The rules now under attack are neither as significant nor as inflexible as critics charge. MTM is generally limited to investments held for trading purposes, and to certain derivatives. For many financial institutions, these investments represent a minority of their total investment portfolio. A recent study by Bloomberg columnist David Reilly of the 12 largest banks in the KBW Bank Index shows that only 29% of the $8.46 trillion in assets are at MTM prices. In General Electric's case, the portion is just 2%.

    Why is that so? Most bank assets are in loans, which are held at their original cost using amortization rules, minus a reserve that banks must set aside as a safety cushion for potential future losses.

    MTM rules also give banks a choice. MTM accounting is not required for securities held to maturity, but you need to demonstrate a "positive intent and ability" that you will do so. Further, an SEC 2008 report found that "over 90% of investments marked-to-market are valued based on observable inputs."

    Financial institutions had no problem in using MTM to benefit from the drop in prices of their own notes and bonds, since the rule also applies to liabilities. And when the value of the securitized loans they held was soaring, they eagerly embraced MTM. Once committed to that accounting discipline, though, they were obligated to continue doing so for the duration of their holding of securities they've marked to market. And one wonders if they are as equally willing to forego MTM for valuing the same illiquid securities in client accounts for margin loans as they are for their proprietary trading accounts?

    But these facts haven't stopped the charge forward on Capitol Hill. At a recent hearing, bankers said that MTM forced them to price securities well below their real valuation, making it difficult to purge toxic assets from their books at anything but fire-sale prices. They also justified their attack with claims that loans, mortgages and other securities are now safe or close to safe, ignoring mounting evidence that losses are growing across a greater swath of credit. This makes the timing of the anti-MTM lobbying appear even more suspect. And not all financial firms are calling for loosening MTM standards; Goldman Sachs and others who are standing firm on this issue should be applauded.

    According to J.P. Morgan, approximately $450 billion of collateralized debt obligations (CDOs) of asset-backed securities were issued from late 2005 to mid-2007. Of that amount, roughly $305 billion is now in a formal state of default and $102 billion of this amount has already been liquidated. The latest monthly mortgage reports from investment banks are equally sobering. It is no surprise, then, that the largest underwriters of mortgages and CDOs have been decimated.

    Commercial banking regulations generally do not require banks to sell assets to meet capital requirements just because market values decline. But if "impairment" charges under MTM do push banks below regulatory capital requirements and limit their ability to lend when they can't raise more capital, then the solution is to grant temporary regulatory capital "relief," which is itself an arbitrary number.

    There is a connection between efforts over the past 12 years to reduce regulatory oversight, weaken capital requirements, and silence the financial detectives who uncovered such scandals as Lehman and Enron. The assault against MTM is just the latest chapter.

    Instead of acknowledging mistakes, we are told this is a "once in 100 years" anomaly with the market not functioning correctly. It isn't lost on investors that the MTM criticisms come, too, as private equity firms must now report the value of their investments. The truth is the market is functioning correctly. It's just that MTM critics don't like the prices that investors are willing to pay.

    The FASB and Securities and Exchange Commission (SEC) must stand firm in their respective efforts to ensure that investors get a true sense of the losses facing banks and investment firms. To be sure, we should work to make MTM accounting more precise, following, for example, the counsel of the President's Working Group on Financial Markets and the SEC's December 2008 recommendations for achieving greater clarity in valuation approaches.

    Unfortunately, the FASB proposal on March 16 represents capitulation. It calls for "significant judgment" by banks in determining if a market or an asset is "inactive" and if a transaction is "distressed." This would give banks more discretion to throw out "quotes" and use valuation alternatives, including cash-flow estimates, to determine value in illiquid markets. In other words, it allows banks to substitute their own wishful-thinking judgments of value for market prices.

    The FASB is also changing the criteria used to determine impairment, giving companies more flexibility to not recognize impairments if they don't have "the intent to sell." Banks will only need to state that they are more likely than not to be able to hold onto an underwater asset until its price "recovers." CFOs will also have a choice to divide impairments into "credit losses" and "other losses," which means fewer of these charges will be counted against income. If approved, companies could start this quarter to report net income that ignores sharp declines in securities they own. The FASB is taking comments until April 1, but its vote is a fait accompli.

    Obfuscating sound accounting rules by gutting MTM rules will only further reduce investors' trust in the financial statements of all companies, causing private capital -- desperately needed in securities markets -- to become even scarcer. Worse, obfuscation will further erode confidence in the American economy, with dire consequences for the very financial institutions who are calling for MTM changes. If need be, temporarily relax the arbitrary levels of regulatory capital, rather than compromise the integrity of all financial statements.

    Audio on Fair Value Accounting (Canada)

    May 1, 2009 message from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

    If any of you are interested in listening to the media conference given by Paul Cherry, Chair of Canadian Accounting Standard Board, you can access an audio file through the link below. The story was picked up by the National Post, the Globe and Mail, Reuters, Bloomberg, Canadian Press and a number of small online news outlets and blogs.

    http://www.vvcnetwork.ca/acsb/20090430/audio.html 

    Regards
    Pat

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


    Looking for blue sky above polluted bank accounting hot air
    Bank Profits Appear Out of Thin Air in 2009

    Question
    What direction did the price of shares of Bank of America move when BofA announced higher than expected earnings for the first quarter of 2009?

    Answer
    Down, because investors suspect that such earnings were not sustainable while BofA holds billions of dollars of Countrywide and Merrill Lynch toxic paper that will drive down future earnings due to non-performance of home owners and business owners who will not fully perform on loans.

    The magic accounting tricks in 2009 are hurting rather than helping to restore faith in accounting and auditing after the 2008 banking crash.

    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.

    Investors reacted by throwing tomatoes. Bank of America’s stock plunged 24 percent, as did other bank stocks. They’ve had enough.

    Why can’t anybody read the room here? After all the financial wizardry that got the country — actually, the world — into trouble, why don’t these bankers give their audience what it seems to crave? Perhaps a bit of simple math that could fit on the back of an envelope, with no asterisks and no fine print, might win cheers instead of jeers from the market.

    What’s particularly puzzling is why the banks don’t just try to make some money the old-fashioned way. After all, earning it, if you could call it that, has never been easier with a business model sponsored by the federal government. That’s the one in which Uncle Sam and we taxpayers are offering the banks dirt-cheap money, which they can turn around and lend at much higher rates.

    “If the federal government let me borrow money at zero percent interest, and then lend it out at 4 to 12 percent interest, even I could make a profit,” said Professor Finkelstein of the Tuck School. “And if a college professor can make money in banking in 2009, what should we expect from the highly paid C.E.O.’s that populate corner offices?”

    But maybe now the banks are simply following the lead of Washington, which keeps trotting out the latest idea for shoring up the financial system.

    The latest big idea is the so-called stress test that is being applied to the banks, with results expected at the end of this month.

    This is playing to a tough crowd that long ago decided to stop suspending disbelief. If the stress test is done honestly, it is impossible to believe that some banks won’t fail. If no bank fails, then what’s the value of the stress test? To tell us everything is fine, when people know it’s not?

    “I can’t think of a single, positive thing to say about the stress test concept — the process by which it will be carried out, or outcome it will produce, no matter what the outcome is,” Thomas K. Brown, an analyst at Bankstocks.com, wrote. “Nothing good can come of this and, under certain, non-far-fetched scenarios, it might end up making the banking system’s problems worse.”

    The results of the stress test could lead to calls for capital for some of the banks. Citi is mentioned most often as a candidate for more help, but there could be others.

    The expectation, before Monday at least, was that the government would pump new money into the banks that needed it most.

    But that was before the government reached into its bag of tricks again. Now Treasury, instead of putting up new money, is considering swapping its preferred shares in these banks for common shares.

    The benefit to the bank is that it will have more capital to meet its ratio requirements, and therefore won’t have to pay a 5 percent dividend to the government. In the case of Citi, that would save the bank hundreds of millions of dollars a year.

    And — ta da! — it will miraculously stretch taxpayer dollars without spending a penny more.


    FASB Eases Fair-Value Rules Amid Lawmaker Pressure

    April 2, 2009 message from Ganesh M. Pandit [profgmp@HOTMAIL.COM]

    The FASB has voted to relax the fair value accounting rules.

    http://www.bloomberg.com/apps/news?pid=20601087&sid=agfrKseJ94jc&refer=home

    Ganesh M Pandit
    Adelphi University

     

    April 2, 2009 reply from Bob Jensen

    Hi Ganesh,

    The FASB, now offers an audio file has an audio explanation of why they’re making special fair value accounting allowances for banks. It is linked at the FASB home page.--- http://www.fasb.org/

    Be patient. This audio file loads very slowly. 
    It may have long pauses while it loads new segments, but these pauses will vary with your bandwidth.

    It is not streaming audio and can be easily saved as a file.

     It probably should be shared with all accounting students!

    April 2, 2009—
    Audio of Today's Press Conference with Robert Herz, Teresa Polley, and Russell Golden on Fair Value and OTTI Actions
    (Posted: 04/02/09)

     "FASB Eases Fair-Value Rules Amid Lawmaker Pressure (Update3)," by Ian Katz, Bloomberg News, April 2, 2009 ---
    http://www.bloomberg.com/apps/news?pid=20601087&sid=agfrKseJ94jc&refer=home 

    The Financial Accounting Standards Board, pressured by U.S. lawmakers and financial companies, voted to relax fair-value rules that Citigroup Inc. and Wells Fargo & Co. say don’t work when markets are inactive.

    The changes to so-called mark-to-market accounting allow companies to use “significant” judgment when gauging the price of some investments on their books, including mortgage-backed securities. Analysts say the measure may reduce banks’ writedowns and boost their first-quarter net income by 20 percent or more. FASB voted 3-2 to approve the rules at a meeting today in Norwalk, Connecticut.

    “Congress clearly indicated that some easing was probably appropriate in this instance,” House Democratic Leader Steny Hoyer of Maryland said today in a Bloomberg Television interview.

    House Financial Services Committee members pressed FASB Chairman Robert Herz at a March 12 hearing to revise fair-value, which requires banks to mark assets each quarter to reflect market prices, saying the rule unfairly punished financial companies. FASB’s proposals, made four days later, spurred criticism from investor advocates and accounting-industry groups, which say fair-value forces companies to disclose their true financial health.

    Financial shares rose after the FASB move. Citigroup rose 4 percent to $2.79 at 11:46 a.m. in New York Stock Exchange composite trading. Bank of America Corp. added 5.5 percent to $7.44. JPMorgan Chase & Co. rose 1 percent to $28.36.

    Seeking Suspension

    Blackstone Group LP Chairman Stephen Schwarzman, the American Bankers Association and 65 lawmakers in the House of Representatives last September urged that fair-value accounting, mandated by FASB, be suspended. William Isaac, chairman of the Federal Deposit Insurance Corp. from 1981 to 1985, has called fair value “extremely and needlessly destructive” and “a major cause” of the credit crisis. Robert Rubin, the former Citigroup senior counselor and Treasury secretary, said Jan. 27 the rule has done “a great deal of damage.”

    “Good decision,” Citigroup Chairman Richard Parsons said of FASB’s move. The market for mortgages and other assets was not working, so something had to change, Parsons said in a New York interview today.

    Banks rely on competitors’ asset sales to help determine the fair-market value of similar securities they hold on their own books. FASB’s staff conceded their March 17 proposal led to a “presumption” that all security sales are “distressed” unless evidence proves otherwise. Such an interpretation may have allowed financial companies to ignore transactions in valuing their assets.

    ‘Orderly’ Transactions

    FASB staff said banks should only disregard transactions that aren’t “orderly,” including situations in which the “seller is near bankruptcy” or needed to sell the asset to comply with regulatory requirements. Responding to criticism from investor and accounting groups, the staff said in a report today it was not FASB’s intent “to change the objective of a fair-value measurement.”

    Fair-value “provides the kind of transparency essential to restoring public confidence in U.S. markets,” former Securities and Exchange Commission Chairman Arthur Levitt said in an interview yesterday.

    Levitt is co-chairman, along with former SEC head William Donaldson, of the Investors’ Working Group, a non-partisan panel formed to recommend improvements to regulation of U.S. financial markets. Other members of the group, which met in New York yesterday, include Brooksley Born, former chairman of the Commodity Futures Trading Commission, and Bill Miller, chief investment officer of Legg Mason Capital Management Inc.

    ‘Deeply Concerned’

    “The group is deeply concerned about the apparent FASB succumbing to political pressures, which prevent U.S. investors from understanding the true obligations of U.S. financial institutions,” Levitt said. Levitt is a senior adviser at buyout firm Carlyle Group and a board member at Bloomberg LP, the parent of Bloomberg News.

    Fair-value requires companies to set values on most securities each quarter based on market prices. Wells Fargo and other banks argue the rule doesn’t make sense when trading has dried up because it forces companies to write down assets to fire-sale prices.

    By letting banks use internal models instead of market prices and allowing them to take into account the cash flow of securities, FASB’s changes could raise bank industry earnings by 20 percent, according to Robert Willens, a former managing director at Lehman Brothers Holdings Inc. who runs his own tax and accounting advisory firm in New York.

    Companies weighed down by mortgage-backed securities, such as New York-based Citigroup, could cut their losses by 50 percent to 70 percent, said Richard Dietrich, an accounting professor at Ohio State University in Columbus.

    FASB rejected requests from banks to let them apply the fair-value change to their year-end financial statements for 2008. While the new standard takes effect for earnings reports filed at the end of June, FASB said companies could apply it to their first-quarter financial statements.

     

    "FASB's FSP Decisions: Bigger than Basketball?" Seeking Alpha, April 2, 2009 ---
    http://seekingalpha.com/article/129189-fasb-s-fsp-decisions-bigger-than-basketball

    Finally, the FASB held its long-anticipated meeting on the two FSPs that would have gutted fair value reporting as it exists. There's been more hoopla (and hope-la) about these two amendments than in all of March Madness.

    Briefly, here's what transpired, as best as I could tell from the webcast of the meeting:

    1. FSP 157-e, the proposal which would have provided a direct route to Level 3 modeling of fair values whenever there was a problem with quoted prices, will be quite different from the original plan. There will be indicators of inactive markets in the final FSP, but they'll only be indicators for a preparer to consider - and more importantly, their presence WILL NOT create a presumption of a distressed price for securities in question. That part of the proposal would have greased the skids for Level 3 modeling. Not now.

    There will be added required disclosures, which were not in the exposure draft. One that I caught: quarterly "aging" disclosures of the securities that are in a continuous loss position for more than 12 months and less than 12 months. As discussed in last week's report on the proposals, these now-annual disclosures are useful for assessing riskiness of assets that could become a firm's next other-than-temporary impairment charge.

    Bottom line: investors didn't lose here.

    2. FSP FAS 115-a, 124-a, and EITF 99-20-b, the proposal that softens the blow of recognizing other-than-temporary impairments, was essentially unchanged from the original proposal. It remains a chancre on the body of accounting literature. The credit portion of an other-than-impairment loss will be recognized in earnings, with all other attributed loss being recorded in "other comprehensive income," to be amortized into earnings over the life of the associated security. That's assuming the other-than-temporary impairment is recognized at all, because the determination will still be largely driven by the intent of the reporting entity and whether it's more likely than not that it will have to sell the security before recovery. This is a huge mulligan for banks with junky securities.

    If OTT charges are taken, the full amount of the impairment will be disclosed on the income statement with the amount being shunted into other comprehensive income shown as a reduction of the loss, leaving only the credit portion to be recognized in current period earnings.

    Bottom line: Investors lost on this vote, and they will have to pay more attention to OCI in the future, as it becomes a more frequently-used receptacle for unwanted debits. When investors note these "detoured charges" in earnings, they should skip the detour and factor the full charge into their evaluation of earnings. A small victory for investors: the original proposal would have included other-than-temporary impairments on equity securities. The final decision will affect only debt securities.

    There was a third, much less-heralded FSP voted upon at the meeting:

    3. FSP FAS 107-a and APB 28-a, which will make the now-annual fair value disclosures for all financial instruments required on a quarterly basis. This will be required beginning in the second quarter, with early implementation allowed in the first quarter.

    All three FSPs will become effective in the second quarter, with early implementation allowed in the first quarter. Note: any firm electing early adoption of the impairment FSP cannot wait until later to adopt the FSP 157-e fair value amendment. If they change the way they recognize impairments, they also have to change how they consider the calculation of fair values.

    Some board members expressed hope that this was the last of the "emergency amendments" to take place at the end of a reporting period. It seems too much to hope for; there could more ahead, depending on how meddlesome the G-20 would like to be. Remember when IFRS in the United States was a hot topic? To a very large degree, that sprouted from a trans-Atlantic summit meeting between the EU and the White House. The same thing could happen again if the G-20 gang decides they know accounting better than the standard-setters.

     

    Jensen Comment
    It’s another one of those 3-2 FASB votes that gets Tom Selling hot under the collar. Guess which Board members voted yes?

    I’m less critical of the so-called “easing of fair value rules” because I always thought it was possible to estimate cash flows and build a model under Level 3 of FAS 157. To me this is all smoke and mirrors that lend added justification for banks to underestimate their bad debt reserves. When the lawsuits roll in there will be more authoritative support for inflating income of banks --- that’s what its all about isn’t it?

    Banks need to attract more investors to their manure piles. It’s a whole new springtime for maggots to pursue outrageous leveraging.

    The best illustration of the smoke and mirrors part comes from the incomprehensible FASB audio mp3 file on April 2. Try to get your best students to make any sense out of that magic lantern show!

    The AICPA's Fair Value Accounting Resources --- http://www.journalofaccountancy.com/Web/FairValueResources.htm

    Questions
    Did the FASB's amended fair value guidelines give the players (banks), umpires (regulators), and fans (notably shareholders like Steve Forbes and Warren Buffett seeking a new stock market bubble) the overvalued wine they were seeking? Will the new guidelines mostly increase client pressures on auditors to sign off on fantasy financial statements?


    Although the new FASB Guidelines for estimating fair value under FAS 157 and FAS 115 in "broken markets" expands client/auditor discretion for some types of assets having long-term value such as real estate, it's asking a lot to have auditors agree once again to rosy valuation of sorry-looking toxic investments such as the value of a mortgage that's about to wither on the vine. You can't squeeze sweet grape juice from shriveled homeowners, let alone fine wine. It may, however, be that higher value on foreclosed properties in bank inventories will lead to some partying over banks' financial statements.

    The wonderful December 30, 2008 research report of the SEC shows that fair value accounting is neither the cause nor the cure for the banking crisis. The liquidity problem of the holders of the toxic investments is caused by trillions of dollars invested in underperforming (often zero performing) of bad investments mortgages or mortgaged-backed bonds that have to be written down unless auditors agree to simply lie about values. That is not likely to happen, but client pressures on auditors to value on the high side for many properties will be heavy handed.
    The wonderful full SEC report that bankers and regulators do not want to read can be freely downloaded at http://www.sec.gov/news/studies/2008/marktomarket123008.pdf

     

    "Expedited fair value guidance may ease pressure on banks," AccountingWeb, March 17, 2009 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=107232

    Following a hearing at a House Financial Services subcommittee last week, the Financial Accounting Standards Board (FASB) agreed to expedite release of their proposed guidance for the application of FAS 157 "Fair Value Measurement." The proposed guidance was published for public comment on March 17th and will be voted on by the Board on April 2. If approved, the FASB recommends that the guidance be effective for interim and annual periods ending after March 15, 2009. According to CFO.com, FASB chairman, Robert H. Herz, chairman of the Financial Accounting Standards Board (FASB), told legislators, "We can have the guidance in three weeks, but whether that will fix everything is another [issue]."

    SB's proposal give more detailed guidance for valuing assets that would be classified as Level 3 under FAS 157, where values are assigned in the absence of an active market or where a sale has occurred in distressed circumstances when prices are temporarily weighed down. The new guidance allows companies to use their own models and estimates and exercise "significant judgment" to determine whether a market exists or whether the input is from a distressed sale. Under FAS 157, financial instruments' fair values cannot be based on distressed sales.

    FASB had planned to issue the proposed guidance by the end of the second quarter. A study on mark-to-market accounting standards conducted by the Securities and Exchange Commission (SEC), which was mandated by the Emergency Economic Stabilization Act of 2008, concluded that more application guidance to determine fair values was needed in current market conditions. On February 18, Herz announced that FASB agreed with the SEC study and would develop additional guidance.

    Thomas Linsmeier, FASB board member, said that they hoped that the new guidance could lead to more accurate and possibly higher values, CFO.com reports. "What we are voting on will hopefully elevate fair values to a more reasonable price so investors are more comfortable investing in the banking system," he said.

    Edward Yingling, president of the American Bankers Association, said in a statement he welcomed the proposal but expressed caution about the ways it might be used by auditors, MarketWatch says. "While we welcome today's news, it will be important to look at the details of the written proposal to see how fully it improves the guidance. It will also be imperative to examine the practical effect the proposal will have based on the various ways it is interpreted."

    The FASB proposal recommends that companies take two steps to determine whether there an active market exists and whether a recent sale is distressed before applying their own models and judgment:

    Step 1: Determine whether there are factors present that indicate that the market for the asset is not active at the measurement date. Factors include:

    ·         Few recent transactions (based on volume and level of activity in the market). Thus, there is not sufficient frequency and volume to provide pricing information on an ongoing basis.
     

    ·         Price quotations are not based on current information.
     

    ·         Price quotations vary substantially either over time or among market makers (for example, some brokered markets).
     

    ·         Indices that previously were highly correlated with the fair values of the asset are demonstrably uncorrelated with recent fair values.
     

    ·         Abnormal (or significant increases in) liquidity risk premiums or implied yields for quoted prices when compared to reasonable estimates of credit and other nonperformance risk for the asset class.
     

    ·         Significant widening of the bid-ask spread.
     

    ·         Little information is released publicly (for example, a principal-to-principal market).

    If after evaluating all the factors the sum of the evidence indicates that the market is not active, the reporting entity shall apply step 2.

    Step 2: Evaluate the quoted price (that is, a recent transaction or broker price quotation) to determine whether the quoted price is not associated with a distressed transaction. The reporting entity shall presume that the quoted price is associated with a distressed transaction unless the reporting entity has evidence that indicates that both of the following factors are present for a given quoted price:

    ·         There was a period prior to the measurement date to allow for marketing activities that are usual and customary for transactions involving such assets or liabilities (for example, there was not a regulatory requirement to sell).
     

    ·         There were multiple bidders for the asset.

    The proposed guidance also provides examples of measurement approaches in the event that the observable input is from a distressed sale.

    At Monday's meeting, Herz deflated any beliefs that FASB's new guidance will be a panacea for the many ills of the U.S. economy. "There's not much accounting can do other than help people get the facts and use their best judgment," he said.

    The International Accounting Standards Board, which sets accounting rules followed by more than 100 countries, plans to publish a draft rule to replace and simplify fair-value accounting rules. Critics say the rules have exacerbated the credit crunch by forcing write-downs. "We plan to replace it, the whole thing. We want to stop patching up the standard and we want to write a new one. We are aware that the current model is too complex. We need to simplify.... We will move to exposure draft hopefully within the next six months," said Philippe Danjou, a member of the IASB board.

    FASB's FSP Decisions: Bigger than Basketball?" Seeking Alpha, April 2, 2009 ---
    http://seekingalpha.com/article/129189-fasb-s-fsp-decisions-bigger-than-basketball

    Finally, the FASB held its long-anticipated meeting on the two FSPs that would have gutted fair value reporting as it exists. There's been more hoopla (and hope-la) about these two amendments than in all of March Madness.

    Briefly, here's what transpired, as best as I could tell from the webcast of the meeting:

    1. FSP 157-e, the proposal which would have provided a direct route to Level 3 modeling of fair values whenever there was a problem with quoted prices, will be quite different from the original plan. There will be indicators of inactive markets in the final FSP, but they'll only be indicators for a preparer to consider - and more importantly, their presence WILL NOT create a presumption of a distressed price for securities in question. That part of the proposal would have greased the skids for Level 3 modeling. Not now.

    There will be added required disclosures, which were not in the exposure draft. One that I caught: quarterly "aging" disclosures of the securities that are in a continuous loss position for more than 12 months and less than 12 months. As discussed in last week's report on the proposals, these now-annual disclosures are useful for assessing riskiness of assets that could become a firm's next other-than-temporary impairment charge.

    Bottom line: investors didn't lose here.

    2. FSP FAS 115-a, 124-a, and EITF 99-20-b, the proposal that softens the blow of recognizing other-than-temporary impairments, was essentially unchanged from the original proposal. It remains a chancre on the body of accounting literature. The credit portion of an other-than-impairment loss will be recognized in earnings, with all other attributed loss being recorded in "other comprehensive income," to be amortized into earnings over the life of the associated security. That's assuming the other-than-temporary impairment is recognized at all, because the determination will still be largely driven by the intent of the reporting entity and whether it's more likely than not that it will have to sell the security before recovery. This is a huge mulligan for banks with junky securities.

    If OTT charges are taken, the full amount of the impairment will be disclosed on the income statement with the amount being shunted into other comprehensive income shown as a reduction of the loss, leaving only the credit portion to be recognized in current period earnings.

    Bottom line: Investors lost on this vote, and they will have to pay more attention to OCI in the future, as it becomes a more frequently-used receptacle for unwanted debits. When investors note these "detoured charges" in earnings, they should skip the detour and factor the full charge into their evaluation of earnings. A small victory for investors: the original proposal would have included other-than-temporary impairments on equity securities. The final decision will affect only debt securities.

    There was a third, much less-heralded FSP voted upon at the meeting:

    3. FSP FAS 107-a and APB 28-a, which will make the now-annual fair value disclosures for all financial instruments required on a quarterly basis. This will be required beginning in the second quarter, with early implementation allowed in the first quarter.

    All three FSPs will become effective in the second quarter, with early implementation allowed in the first quarter. Note: any firm electing early adoption of the impairment FSP cannot wait until later to adopt the FSP 157-e fair value amendment. If they change the way they recognize impairments, they also have to change how they consider the calculation of fair values.

    Some board members expressed hope that this was the last of the "emergency amendments" to take place at the end of a reporting period. It seems too much to hope for; there could more ahead, depending on how meddlesome the G-20 would like to be. Remember when IFRS in the United States was a hot topic? To a very large degree, that sprouted from a trans-Atlantic summit meeting between the EU and the White House. The same thing could happen again if the G-20 gang decides they know accounting better than the standard-setters.

    "FASB Approves New Mark-to-Market Guidance," by Matthew G. Lamoreaux, Journal of Accountancy, April 2, 2009 ---
    http://www.journalofaccountancy.com/Web/20091601.htm 

    Exactly three weeks after FASB Chairman Robert Herz’s March 12 testimony before a rancorous House Financial Services subcommittee, the independent standard-setting board voted Thursday to release three new pieces of guidance to address concerns over the application of fair value accounting standards in current market conditions.

    All three new pronouncements will be published in the form of FASB Staff Positions (FSPs). FASB Technical Director Russell Golden said in a press conference following the meeting that the final FSPs would not be available until next week.

    FASB Staff Position no. FAS 157-e, Determining Whether a Market Is Not Active and a Transaction Is Not Distressed, establishes a process to determine whether a market is not active and a transaction is not distressed. The FSP says companies should look at several factors and use judgment to ascertain if a formerly active market has become inactive. Once a market is determined to be inactive, more work will be required. The company must see if observed prices or broker quotes obtained represent “distressed transactions.” Other techniques such as a discounted cash flow analysis might also be appropriate in that circumstance, as long as it meets the objective of estimating the orderly selling price of the asset in the current market.

    The AICPA’s Accounting Standards Executive Committee (AcSEC) submitted a comment letter to FASB recommending against adoption of FSP FAS 157-e based on concerns that it could be interpreted in a way that would contradict the exit price model of FASB Statement no. 157, Fair Value Measurements.

    But following the meeting, AcSEC Chairman Jay Hanson said he was pleased that FASB clarified during its deliberations on Thursday that the FSP is not intended to change the measurement objective of Statement no. 157.

    The second FASB document—FSP FAS 115-a, FAS 124-a, and EITF 99-20-b, Recognition and Presentation of Other-Than-Temporary Impairments—deals with other-than-temporary impairment (OTTI). This FSP was passed by a 3-2 vote. Under the new rules, once an OTTI is determined for a debt security, the portion of an asset write down attributed to credit losses may flow through earnings and the remaining portion may flow through other comprehensive income, depending on the situation and facts involved. There will be several new required disclosures about how the charges are split.

    Initial reaction from financial institutions regarding the new OTTI rules was positive. “I am pleased to see the changes being made and believe they will provide more accurate financial information,” said Security Financial Bank CFO Mark C. Oldenberg, CPA. “I expect there will be substantial discussion on how to determine ‘credit losses’ versus ‘market losses’ and whether to allow recovery of OTTI losses.”

    But at least some investors did not appear to be quite so enthusiastic. “The new guidance seems to be a result of government pressure,” said Jason S. Inman, CPA, of McDonnell Investment Management LLC. “The fair value concept before the change allowed for greater transparency in the market and for an investor to make a decision as to whether or not the company had the ability to hold those assets until recovery.”

    “Investors lost on this vote,” wrote former FASB Emerging Issues Task Force member Jack Ciesielski, CPA, on the AAO Weblog regarding the new OTTI rules. “And they will have to pay more attention to other comprehensive income in the future, as it becomes a more frequently-used receptacle for unwanted debits. When investors note these ‘detoured charges’ in earnings, they should skip the detour and factor the full charge into their evaluation of earnings.”

    The third piece of guidance—FSP FAS 107-B and APB 28-A, Interim Disclosures About Fair Value of Financial Instruments—will increase the frequency from annually to quarterly of disclosures providing qualitative and quantitative information about fair value estimates for all those financial instruments not measured on the balance sheet at fair value.

    All three FSPs will be effective for periods ending after June 15, 2009. Early adoption is permitted for periods ending after March 15, 2009. However, if a company wants to adopt the FSP FAS 115-a, FAS 124-a, and EITF 99-20-b in the first quarter, it must also adopt the FSP FAS 157-e at the same time.

    April 3 message from Bob Jensen

    Hi David,

    I think I can correctly surmise what IASB Board members who eventually dissent on easing fair value accounting rules, and I think I it will be for the same reasons why two of five FASB Board members voted against the FASB fair value changes announced at http://www.fasb.org/action/sbd040209.shtml

    Yes Robert Herz
    Yes Leslie Seidman
    Yes Lawrence Smith
    No Thomas Linsmeier
    No Marc Siegel

    Reasons for the No votes have not been announced, but they probably will be published soon by the FASB.

    The same 3-2 voting outcome happened on FSP EITF 99-20-1

    "FSP EITF 99-20-1: Dissenting Board Members Hit the Nail on the Head," by Tom Selling, The Accounting Onion, January 14, 2009 --- http://accountingonion.typepad.com/theaccountingonion/2009/01/fsp-eitf-99-20.html

    Is there a pattern here in FASB voting on Fair Value Accounting? Maybe not if we accept the rationale give to us by Denny Beresford. My own opinion is that this is not really a fundamental change in FAS 157 since Level 3 always allowed valuation based on models. What has changed is that clients and auditors will no longer be so hesitant to move down to Level 3 after this official re-affirmation of Level 3 taken by the FASB on April 2 ---
    http://seekingalpha.com/article/129189-fasb-s-fsp-decisions-bigger-than-basketball

    There are three United States IASB Board Members Mary Barth, John Smith, and Jim Leisenring. My guess is that two of the  three (maybe all three) will strongly dissent if the IASB follows the April 2 lead on easing fair value accounting rules set by the FASB on April 2.

    Mary Barth and John Smith strongly dissented when the IASB voted to allow entities a free choice between the partial and full fair value alternatives to goodwill and NCI measurement. Jim Leisingring went along with the majority of the IASB on that issue, but I think he has stronger feelings about easing fair value accounting rules. I don’t anticipate strong objections from the majority of the IASB voting members.

    If I’m correct the dissent is a straw man if you buy into the Level 3 of the original FAS 157. However, it is a real tiger now that banks will once again be underestimating bad debt reserves and overstating income with less worry about investor class action lawsuits. This so-called change in accounting rules certainly is consistent with “principled-based” accounting standards and will lead to inconsistencies on how virtually identical financial instruments are accounted for in practice.

    Bob Jensen


    April 2, 2009—
     Audio of Today's Press Conference with Robert Herz, Teresa Polley, and Russell Golden on Fair Value and OTTI Actions
    (Posted: 04/02/09)

    April 3, 2009 reply from Dennis Beresford [dberesfo@TERRY.UGA.EDU

    One of the IASB board members is on my campus today and he fully expects the IASB to follow the FASB's lead, which he strongly disagrees with. For the record, I think the FASB's action was much needed clarification of the intent of SFAS 157 and I applaud its efforts. This was not at all a situation of "bowing to pressure" but rather one of realizing that earlier guidance hadn't been applied in the intended manner. The FASB clearly accelerated its work in response to Congressional concerns but moving too slowly has been a fault of the FASB from the beginning, including the 10 1/2 years I was there.

    Bob Jensen

    "Herz Should Resign," by: J. Edward Ketz, SmartPros, April 2009 --- http://accounting.smartpros.com/x66142.xml

    April 2, 2009 is a day of accounting infamy. It is a day in which the Financial Accounting Standards Board (FASB) bowed to the pressures of the banking community and Congress to allow distortions, massagings, and manipulations of the U.S. financial reports. Because of these cowardly acts, I think it time for Robert Herz to resign from the FASB.

    Robert Herz is the chairman of the FASB, appointed on July 1, 2002 and reappointed on July 1, 2007. Before this he was a senior partner with PricewaterhouseCoopers. I have read many of his papers and I have heard some of his speeches. I have found Mr. Herz quite intelligent, filled with much knowledge about accounting and finance, well-mannered, articulate, and an avid defender of the accounting profession.

    Unfortunately, I also find Herz lacking in courage and moral fortitude. Whenever some bully comes on the scene and challenges him and the FASB to a fight, he runs away. When accounting truth is at stake, he compromises and enables corporate managers to use methods and vehicles by which they can cook the books. Shame!

    The first thing the FASB did at its April 2 meeting concerns whether a market is not active and a transaction is not distressed. In this FSP FAS 157-e, the board allows business enterprises to weigh the evidence whether the a transaction involved an orderly market; in reality it will permit managers to ignore distressed conditions, some of which they themselves created, and to pretend some “value” based on normalcy. Clearly, this will buoy asset prices on the balance sheet and reduce losses or create gains on the income statement. Too bad this is fiction.

    In the second matter the FASB addressed other-than-temporary impairments. In this FSP the FASB permits managers to overlook other-than-temporary impairments if management believes that it does not have the intent to sell the security and it is more likely than not it will not have to sell the security before recovery of its cost basis. Of course, that will be just about everybody so this is a vacuous recognition condition.

    The FSP goes on to state that gains or losses due to credit risk will go into the income statement, while noncredit gains and losses will bypass the income statement and go directly into comprehensive income. This distinction appears academic as in practice it is hard to distinguish credit losses from noncredit losses. Clearly, this decision will give managers ample room to manipulate the income statement.

    The FASB got pushed into this decision and Robert Herz caved in. This isn’t the first time either. Herz became chairman after Enron’s special purpose entities exploded on Wall Street and has yet to do anything about them. These special purpose entities have also played a part in the current banking crisis. Herz also presided over the new rules on business combinations. While I applaud the elimination of the pooling option, which enabled many corporate frauds, I remain skeptical of the treatment of goodwill, which is another loophole. And Robert Herz keeps preaching against complexity and for simplicity and principles-based accounting, which are keywords to allow corporate executives the power to do as they wish with the recognition and measurement of revenues and other elements. (Bob, if these FSPs are based on any legitimate principles, pray tell us which ones.)

    Writing about these items when originally proposed, Jonathan Weil referred to the FASB as the Fraudulent Accounting Standards Board. I am sympathetic with his f-word, but I think it may be too harsh. After all, the board is “merely” allowing managers to commit fraud without facing any disincentives. But I think there are other f-words that we could employ, such as fearful, feckless, and futile.

    Mr. Herz, please resign. You are making the board ineffective as a standard bearer for accounting truth. While I think you have a sense of right and wrong, you are not willing to hold bankers accountable for their mistakes and you are not willing to stand up against politicians who favor lies.

    This essay reflects the opinion of the author and not necessarily the opinion of The Pennsylvania State University.

    Jensen Comment
    Jonathon Weil was a prominent WSJ reporter during the Enron scandal
    "GLASS LEWIS NAMED JONATHAN WEIL MANAGING DIRECTOR AND EDITOR OF FINANCIAL RESEARCH in 2006 ---
    http://www.glasslewis.com/downloads/354-38.pdf

    The idea that massive changes have been made is a huge overstatement. FASB is basically reiterating what it has said all along. A number of comments from both bank insiders and analysts indicate that no material changes have been made,  . . . Estimates vary but it seems MTM changes won’t have as big an impact as some would like to believe. Remember, as Jim Chanos pointed out, the vast majority of bank assets such as ordinary loans, are NOT marked to market and that the delinquencies on almost all classes of loans continue to rise. Thus relaxing mark to market will not help stop the rising delinquencies across a wide swathe of bank assets. The idea that giving bank executives more leeway in how they price their assets when a large part of the current problems is a lack of transparency is laughable.
    "Latest on Mark to Market Scapegoat," The Fundamental Analyst, on April 2, 2009 --- http://www.thefundamentalanalyst.com/?p=1145

    Jensen Comment
    Although I tend to agree that the FASB's April 2, 2009 change was not that much of a change at all since Level 3 value estimates could come from subjective estimates of future streams of cash flows. However, the problem will be that the banks themselves use this re-enforce banks to depart from market on bad debt reserves. Banks will accordingly understate bad debt reserves and overstate earnings.

    Bob Jensen’s threads on fair value accounting --- Bob Jensen’s threads on accounting valuation are at
    http://www.trinity.edu/rjensen/Theory01.htm#FairValue


     

    From The Wall Street Journal Accounting Weekly Review on April 1, 2009
    This case was published one day prior to the FASB decision to ease the rules on fair value accounting for banks.

    Accounting Rules Should Avoid Impairment
    by Michael Rapoport
    The Wall Street Journal

    Apr 01, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB123853741935475351.html?mod=djem_jiewr_AC
     

    TOPICS: Available-for-Sale, FASB, Financial Accounting, Financial Accounting Standards Board, Mark-to-Market, Mark-to-Market Accounting

    SUMMARY: Accounting rule makers will vote Thursday on proposals to soften "mark-to-market" accounting, the controversial rules requiring companies to peg their investments' value to the market's ups and downs. Many banks blame the rules for worsening their current problems, by locking in losses that they say are merely temporary.

    CLASSROOM APPLICATION: Financial institutions continue to criticize the mark-to-market accounting rules. This article reports on the proposal to soften those rules, keeping our classes current on the issue. Additionally, this article offers an opportunity to discuss an opinion piece, which takes the slant that the criticism of these rules is "largely bogus." You could use this article as an opportunity to discuss opinion pieces versus articles that report only news with no commentary, as well as ask the students their opinions on whether they agree with the writer.

    QUESTIONS: 
    1. (
    Introductory) What changes have been proposed regarding mark-to-market accounting? What body votes on these proposals?

    2. (
    Advanced) Why is mark-to-market accounting such a big issue in the business world? What claims do financial institutions make regarding mark-to-market? What do mark-to-market supporters say?

    3. (
    Advanced) What are "available-for-sale" investments? What is the current accounting treatment for these assets? Please explain the changes under the proposal. How would the change affect financial reporting and investors?

    4. (
    Introductory) What is the FASB? What concerns does the writer have regarding FASB independence? Do you think those concerns are legitimate?

    5. (
    Introductory) What is the position of the writer in this article? How does this article differ from news stories? Why do newspapers publish these types of articles? Do you agree with the writer? Why or why not?
     

    Reviewed By: Linda Christiansen, Indiana University Southeast
     

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    Bob Jensen’s threads on accounting valuation are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

     

    Three leading accountics (not a spelled wrong) professors (from MIT, Chicago, and Wharton) question the costs versus benefits of the SEC's proposed changeover from U.S. GAAP to international (IFRS) GAAP
    "Mind the GAAP: Analyzing the Proposed Switch to International Accounting Standards," Knowledge@Wharton , April 1, 2009 --- http://knowledge.wharton.upenn.edu/article.cfm?articleid=2192

    But there are some tough questions about the move that have yet to be answered, according to Wharton accounting professor Luzi Hail, who, with professors Christian Leuz from the University of Chicago and Peter Wysocki of MIT's Sloan School of Management, recently conducted research on the potential impacts of the change. They present their findings in a paper titled, "Global Accounting Convergence and the Potential Adoption of IFRS by the United States: An Analysis of Economic and Policy Factors." In March, the FASB and its parent, the Financial Accounting Foundation (FAF), sent a 132-page letter to the Securities and Exchange Commission reflecting many of the concerns raised in the research, which received funding from the FASB but, according to Hail, was conducted and reported independently.  

     

    Jensen Comment
    Since the large international accounting firms are four-square behind this transition, I still conclude that U.S. GAAP is in its dying days --- http://www.trinity.edu/rjensen/theory01.htm#MethodsForSetting
    Academic arguments at this point are ... well . . . er . . .well . . . academic.


    Question
    When is $7 billion not a material bad debt exposure?

    Answer
    When the "bad debt" is from an "empty creditor"
    Now do you understand?

    "'Empty Creditors' and the Crisis How Goldman's $7 billion was 'not material," by Henry T.C. Hu, The Wall Street Journal, April 10, 2009 ---
    http://online.wsj.com/article/SB123933166470307811.html

    The defining moments of our financial crisis are now familiar. Last September, Lehman collapsed and AIG was teetering. Because an AIG collapse was viewed as posing unacceptable systemic risks, the Federal Reserve provided the company with an emergency $85 billion loan on Sept. 16.

    But a curious incident that fateful day raises significant public policy issues. Goldman Sachs reported that its exposure to AIG was "not material." Yet on March 15 of this year, AIG disclosed that it paid $7 billion of its government loan last fall to satisfy obligations to Goldman. A "not material" statement and a $7 billion payout appear to be at odds.

    Why didn't Goldman bark that September day? One explanation is that Goldman was, to use a term that I coined a few years ago, largely an "empty creditor" of AIG. More generally, the empty-creditor phenomenon helps explain otherwise-puzzling creditor behavior toward troubled debtors. Addressing the phenomenon can help us cope with its impact on individual debtors and the overall financial system.

    What is an empty creditor? Consider that debt ownership conveys a package of economic rights (to receive principal and interest), contractual control rights (to enforce the terms of the agreement), and other legal rights (to participate in bankruptcy proceedings). Traditionally, law and business practice assume these components are bundled together. Another foundational assumption: Creditors generally want to keep solvent firms out of bankruptcy and to maximize their value.

    These assumptions can no longer be relied on. Credit default swaps and other products now permit a creditor to avoid any actual exposure to financial risk from a shaky debt -- while still maintaining his formal contractual control rights to enforce the terms of the debt agreement, and his legal rights under bankruptcy and other laws.

    Thus the "empty creditor": someone (or institution) who may have the contractual control but, by simultaneously holding credit default swaps, little or no economic exposure if the debt goes bad. Indeed, if a creditor holds enough credit default swaps, he may simultaneously have control rights and incentives to cause the debtor firm's value to fall. And if bankruptcy occurs, the empty creditor may undermine proper reorganization, especially if his interests (or non-interests) are not fully disclosed to the bankruptcy court.

    Goldman Sachs was apparently an empty creditor of AIG. On March 20, David Viniar, Goldman's chief financial officer, indicated that the company had bought credit default swaps from "large financial institutions" that would pay off if AIG defaulted on its debt. A Bloomberg News story on that day quotes Mr. Viniar as saying that "[n]et-net I would think we had a gain over time" with respect to the credit default swap contracts.

    Goldman asserted its contractual rights to require AIG to provide collateral on transactions between the two, notwithstanding the impact of such collateral calls on AIG. This behavior was understandable: Goldman had responsibilities to its own shareholders and, in Mr. Viniar's words, was "fully protected and didn't have to take a loss."

    Nothing in the law prevents any creditor from decoupling his actual economic exposure from his debt. And I do not suggest any inappropriate behavior on the part of Goldman or any other party from such "debt decoupling." But none of the existing regulatory efforts involving credit derivatives are directed at the empty-creditor issue. Empty creditors have weaker incentives to cooperate with troubled corporations to avoid collapse and, if collapse occurs, can cause substantive and disclosure complexities in bankruptcy.

    An initial, incremental, and low-cost step lies in the area of a real-time informational clearinghouse for credit default swaps and other over-the-counter (OTC) derivatives transactions and other crucial derivatives-related information. Creditors are not generally required to disclose the "emptiness" of their status, or how they achieved it. More generally, OTC derivatives contracts are individually negotiated and not required to be disclosed to any regulator, much less to the public generally. No one regulator, nor the capital markets generally, know on a real-time basis the entity-specific exposures, the ultimate resting places of the credit, market, and other risks associated with OTC derivatives.

    With such a clearinghouse, the interconnectedness of market participants' exposures would have been clearer, governmental decisions about bailing out Lehman and AIG would have been better informed, and the market's disciplining forces could have played larger roles. Most important, a clearinghouse could have helped financial institutions to avoid misunderstanding their own products, and modeling and risk assessment systems -- misunderstandings that contributed to the global economic crisis.

    Henry Hu is a professor at the University of Texas Law School.

    Bob Jensen's threads on the credit derivatives mess of AIG are at http://www.trinity.edu/rjensen/2008Bailout.htm#Bailout


    Before reading this May 4, 2009 article you may want to read some introductory modules about Overstock.com at
    http://en.wikipedia.org/wiki/Overstock.com

    "Overstock.com and PricewaterhouseCoopers: Errors in Submissions to SEC Division of Corporation Finance," White Collar Fraud, May 19, 2008 --- http://whitecollarfraud.blogspot.com/2008/05/overstockcom-and-pricewaterhousecoopers.html

    "To Grant Thornton, New Auditors for Overstock.com," White Collar Fraud, March 30, 2009 --- http://whitecollarfraud.blogspot.com/2009/03/to-grant-thornton-new-auditors-for.html

    "Overstock.com's First Quarter Financial Performance Aided by GAAP Violations,"  White Collar Fraud, May 4, 2009 ---
    http://whitecollarfraud.blogspot.com/2009/05/overstockcoms-first-quarter-financial.html

    Overstock.com (NASDAQ: OSTK) and its management team led by its CEO and masquerading stock market reformer Patrick Byrne (pictured on right) continued its pattern of false and misleading disclosures and departures from Generally Accepted Accounting Principles (GAAP) in its latest Q1 2009 financial report.

    In Q1 2009, Overstock.com reported a net loss of $2.1 million compared to $4.7 million in Q1 2008 and claimed an earnings improvement of $2.6 million. However, the company's reported $2.6 reduction in net losses was aided by a violation of GAAP (described in more detail below) that reduced losses by $1.9 million and buybacks of Senior Notes issued in 2004 under false pretenses that reduced losses by another $1.9 million.

    After the issuance of the Senior Notes in November 2004, Overstock.com has twice restated financial reports for Q1 2003 to Q3 2004 (the accounting periods immediately preceding the issuance of such notes) because of reported accounting errors and material weaknesses in internal controls.

    While new CFO Steve Chestnut hyped that "It's been a great Q1," the reality is that Overstock.com’s reported losses actually widened by $1.2 million after considering violations of GAAP ($1.9 million) and buying back notes issued under false pretenses ($1.9 million).

    How Overstock.com improperly reported of an accounting error and created a “cookie jar reserve” to manage future earnings by improperly deferring recognition of an income

    Before we begin, let’s review certain events starting in January 2008.

    In January 2008, the Securities and Exchange Commission discovered that Overstock.com's revenue accounting failed to comply with GAAP and SEC disclosure rules, from the company's inception. This blog detailed how the company provided the SEC with a flawed and misleading materiality analysis to convince them that its revenue accounting error was not material. The company wanted to avoid a restatement of prior affected financial reports arising from intentional revenue accounting errors uncovered by the SEC.

    Instead, the company used a one-time cumulative adjustment in its Q4 2007 financial report, apparently to hide the material impact of such errors on previous affected individual financial reports. In Q4 2007, Overstock.com reduced revenues by $13.7 million and increased net losses by $2.1 million resulting from the one-time cumulative adjustment to correct its revenue accounting errors.

    Q3 2008

    On October 24, 2008, Overstock.com's Q3 2008 press release disclosed new customer refund and credit errors and the company warned investors that all previous financial reports issued from 2003 to Q2 2008 “should no longer be relied upon.” This time, Overstock.com restated all financial reports dating back to 2003. In addition, Overstock.com reversed its one-time cumulative adjustment in Q4 2007 used to correct its revenue accounting errors and also restated all financial statements to correct those errors, as I previously recommended.

    The company reported that the combined amount of revenue accounting errors and customer refund and credit accounting errors resulted in a cumulative reduction in previously reported revenues of $12.9 million and an increase in accumulated losses of $10.3 million.

    Q4 2008

    On January 30, 2009, Overstock.com reported a $1 million profit and $.04 earnings per share for Q4 2008, after 15 consecutive quarterly losses and it beat mean analysts’ consensus expectations of negative $0.04 earnings per share. CEO Patrick Byrne gloated, "After a tough three years, returning to GAAP profitability is a relief." However, Overstock.com's press release failed to disclose that its $1 million reported profit resulted from a one-time gain of $1.8 million relating to payments received from fulfillment partners for amounts previously underbilled them.

    During the earnings call that followed the press release, CFO Steve Chesnut finally revealed to investors that:

    Gross profit dollars were $43.6 million, a 6% decrease. This included a one-time gain of $1.8 million relating to payments from partners who were under-billed earlier in the year.

    Before Q3 2008, Overstock.com failed to bill its fulfillment partners for offsetting cost reimbursements and fees resulting from its customer refund and credit errors. After discovering foul up, Overstock.com improperly corrected the billing errors by recognizing income in future periods when such amounts were recovered or on a cash basis (non-GAAP).

    In a blog post, I explained why Statement of Financial Accounting Standards No. 154 required Overstock.com to restate affected prior period financial reports to reflect when the underbilled cost reimbursements and fees were actually earned by the company (accrual basis or GAAP). In other words, Overstock.com should have corrected prior financial reports to accurately reflect when the income was earned from fulfillment partners who were previously underbilled for cost reimbursements and fees.

    If Overstock.com properly followed accounting rules, it would have reported an $800,000 loss instead of a $1 million profit, it would have reported sixteen consecutive losses instead of 15 consecutive losses, and it would have failed to meet mean analysts’ consensus expectation for earnings per share (anyone of three materiality yardsticks under SEC Staff Accounting Bulletin No. 99 that would have triggered a restatement of prior year’s effected financial reports).

    Patrick Byrne responds on a stock market chat board

    In my next blog post, I described how CEO Patrick M. Byrne tried to explain away Overstock.com’s treatment of the “one-time gain” in an unsigned post, using an alias, on an internet stock market chat board. Byrne’s chat board post was later removed and re-posted with his name attached to it, after I complained to the SEC. Here is what Patrick Byrne told readers on the chat board:

    Antar's ramblings are gibberish. Show them to any accountant and they will confirm. He has no clue what he is talking about.

    For example: when one discovers that one underpaid some suppliers $1 million and overpaid others $1 million. For those whom one underpaid, one immediately recognizes a $1 million liability, and cleans it up by paying. For those one overpaid, one does not immediately book an asset of a $1 million receivable: instead, one books that as the monies flow in. Simple conservatism demands this (If we went to book the asset the moment we found it, how much should we book? The whole $1 million? An estimate of the portion of it we think we'll be able to collect?) The result is asymmetric treatment. Yet Antar is screaming his head off about this, while never once addressing this simple principle. Of course, if we had booked the found asset the moment we found it, he would have screamed his head off about that. Behind everything this guy writes, there is a gross obfuscation like this. His purpose is just to get as much noise out there as he can.

    Note: Bold print and italics added by me.

    In other words, Overstock.com improperly used cash basis accounting (non-GAAP) rather than accrual basis accounting (GAAP) to correct its accounting error. I criticized Byrne’s response noting that:

    … Overstock.com recognized the "one-time of $1.8 million" using cash-basis accounting when it "received payments from partners who were under-billed earlier in the year" instead of accrual basis accounting, which requires income to be recognized when earned. A public company is not permitted to correct any accounting error using cash-basis accounting.

    Overstock.com tries to justify improper cash basis accounting in Q4 2008 to correct an accounting error

    Overstock.com needed to justify Patrick Byrne’s stock chat board ramblings. About two weeks later, Overstock.com filed its fiscal year 2008 10-K report with the SEC and the company concocted a new excuse to justify using cash basis accounting to correct its accounting error and avoid restating prior affected financial reports:

    In addition, during Q4 2008, we reduced Cost of Goods Sold by $1.8 million for billing recoveries from partners who were underbilled earlier in the year for certain fees and charges that they were contractually obligated to pay. When the underbilling was originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the partner and the partner had the wherewithal to pay).

    Note: Bold print and italics added by me.

    Overstock.com improperly claimed that a "gain contingency" existed by using the rationale that the collection of all "underbilled...fees and charges...was not assured....”

    Why Overstock.com's accounting for underbilled "fees and charges" violated GAAP

    Overstock.com already earned those "fees and charges" and its fulfillment partners were "contractually obligated to pay" such underbilled amounts. There was no question that Overstock.com was owed money from its fulfillment partners and that such income was earned in prior periods.

    If there was any question as to the recovery of any amounts owed the company, management should have made a reasonable estimate of uncollectible amounts (loss contingency) and booked an appropriate reserve against amounts due from fulfillment partners to reduce accrued income (See SFAS No. 5 paragraph 1, 2, 8, 22, and 23). It didn’t. Instead, Overstock.com claimed that the all amounts due the company from underbilling its fulfillment partners was "not assured" and improperly called such potential recoveries a "gain contingency" (SFAS No. 5 paragraph 1, 2, and 17).

    The only way that Overstock.com could recognize income from underbilling its fulfillment partners in future accounting periods is if there was a “significant uncertainty as to collection” of all underbilled amounts (See SFAS No. 5 paragraph 23)

    As it turns out, a large portion of the underbilled amounts to fulfillment partners was easily recoverable within a brief period of time. In fact, within 68 days of announcing underbilling errors, the company already collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year.” Therefore, Overstock.com cannot claim that there was a "significant uncertainty as to collection" or that recovery was "not assured."

    No gain contingency existed. Overstock.com already earned "fees and charges" from underbilled fulfillment partners in prior periods. Rather, a loss contingency existed for a reasonably estimated amount of uncollectible "fees and charges." Overstock.com should have restated prior affected financial reports to properly reflect income earned from fulfillment partners instead of reflecting such income when amounts were collected in future quarters. Management should have made a reasonable estimate for unrecoverable amounts and booked an appropriate reserve against "fees and charges" owed to it (See SFAS No. 5 Paragraph 22 and 23).

    Therefore, Overstock.com overstated its customer refund and credit accounting error by failing to accrue fees and charges due from its fulfillment partners as income in the appropriate accounting periods, less a reasonable reserve for unrecoverable amounts. By deferring recognition of income until underbilled amounts were collected, the company effectively created a "cookie jar" reserve to increase future earnings.

    In addition, Overstock.com failed to disclose any potential “gain contingency” in its Q3 2008 10-Q report, when it disclosed that it underbilled its fulfillment partners (See SFAS No. 5 Paragraph 17b). Apparently, Overstock.com used a backdated rationale for using cash basis accounting to correct its accounting error in response to my blog posts (here and here) detailing its violation of GAAP.

    PricewaterhouseCoopers warns against using "conservatism to manage future earnings"

    As I detailed above, Patrick Byrne claimed on an internet chat board that “conservatism demands" waiting until "monies flow in" from under-billed fulfillment partners to recognize income, after such an error is discovered by the company. However, a document from PricewaterhouseCoopers (Overstock.com’s auditors thru 2008) web site cautions against using “conservatism” to manage future earnings by deferring gains to future accounting periods:

    SFAS No. 5 Technical Notes cautions about using “conservatism” to manage future earnings by deferring gains to future accounting periods:

    "Conservatism...should no[t] connote deliberate, consistent understatement of net assets and profits." Emphasis added] CON 5 describes realization in terms of recognition criteria for revenues and gains, as:"Revenue and gains generally are not recognized until realized or realizable... when products (goods or services), merchandise or other assets are exchanged for cash or claims to cash...[and] when related assets received or held are readily convertible to known amounts of cash or claims to cash....Revenues are not recognized until earned ...when the entity has substantially accomplished what it must do to be entitled to the benefits represented by the revenues." Almost invariably, gain contingencies do not meet these revenue recognition criteria.

    Note: Bold print and italics added by me.

    Overstock.com "substantially accomplished what it must do to be entitled to the benefits represented by the revenues" since the fulfillment partners were "contractually obligated" to pay underbilled amounts. Those underbilled "fees and charges" were "realizable" as evidenced by the fact that the company already collected a total of “$1.8 million relating to payments from partners who were underbilled earlier in the year" within a mere 68 days of announcing its billing errors.

    If we follow guidance by Overstock.com's fiscal year 2008 auditors, the amounts due from underbilling fulfillment partners cannot be considered a gain contingency, as claimed by the company. PricewaterhouseCoopers was subsequently terminated as Overstock.com's auditors and replaced by Grant Thornton.

    Q1 2009

    In Q1 2009, even more amounts from underbilling fulfillment partners were recovered. In addition, the company disclosed a new accounting error by failing to book a “refund due of overbillings by a freight carrier for charges from Q4 2008.” See quote from 10-Q report below:

    In the first quarter of 2009, we reduced total cost of goods sold by $1.9 million for billing recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay, and a refund due of overbillings by a freight carrier for charges from the fourth quarter of 2008. When the underbilling and overbillings were originally discovered, we determined that the recovery of such amounts was not assured, and that consequently the potential recoveries constituted a gain contingency. Accordingly, we determined that the appropriate accounting treatment for the potential recoveries was to record their benefit only when such amounts became realizable (i.e., an agreement had been reached with the other party and the other party had the wherewithal to pay).

    Note: Bold print and italics added by me.

    Overstock.com continued to improperly recognize deferred income from previously underbilling fulfillment partners. The new auditors, Grant Thornton, would be wise to review Overstock.com's accounting treatment of billing errors and recommend that its clients restate affected financial reports to comply with GAAP. Otherwise, they should not give the company a clean audit opinion for 2009.

    Using accounting errors to previous quarters to boost profits in future quarters

    Lee Webb from Stockwatch sums up Overstock.com's accounting latest trickery:

    … Overstock.com managed to turn a controversial fourth-quarter profit last year after discovering that it had underbilled its fulfillment partners to the tune of $1.8-million earlier in the year. Rather than backing that amount out into the appropriate periods, Overstock.com reported it as one-time gain and reduced the cost of goods sold for the quarter by $1.8-million. That bit of accounting turned what would have been an $800,000 fourth-quarter loss into a $1-million profit.

    As it turns out, Overstock.com managed to find some more money that it used to reduce the cost of goods sold for the first quarter of 2009, too.

    "In Q1 2009, we reduced total cost of goods sold by $1.9-million for recoveries from partners who were underbilled in 2008 for certain fees and charges that they were contractually obligated to pay and a refund due of overbillings by a freight carrier for charges from Q4 2008," the company disclosed.

    "We just keep squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out," Mr. Byrne remarked during the conference call after chief financial officer Steve Chesnut said that the underbilling and overbilling had been found "as part of good corporate diligence and governance."

    In addition, Overstock.com managed to record a $1.9-million gain, reported as part of "other income," by extinguishing $4.9-million worth of its senior convertible notes, which it bought back at rather hefty discount. If not for the fortuitous 2008 underbilling recoveries, fourth-quarter overbillings refund and the paper gain from extinguishing some of its debt, Overstock.com would have tallied a first-quarter loss of $5.9-million or approximately 26 cents per share.

    So, while Overstock.com did not manage to conjure up a first-quarter profit by using the same accounting abracadabra employed in the fourth quarter, it did succeed in trimming its net loss to $2.1-million.

    Bad corporate diligence and governance

    During the Q1 2009 earnings conference call, CFO Steve Chesnut boasted about finding accounting errors:

    So just as part of good corporate diligence and governance we've found these items.

    Note: Bold print and italics added by me.

    Actually, it was bad corporate diligence and governance by CEO Patrick Byrne that caused the accounting errors to happen by focusing on a vicious retaliatory smear campaign against critics, while he runs his company into the ground with $267 million in accumulated losses to date and never reporting a profitable year.

    Memo to Grant Thornton (Overstock.com's new auditors)

    Overstock.com is a company that has not produced a single financial report prior to Q3 2008 in compliance with Generally Accepted Accounting Principles and Securities and Exchange Commission disclosure rules from its inception, without having to later correct them, unless such reports were too old to correct. Two more financial reports (Q4 2008 and Q1 2009) don't comply with GAAP and need to be restated, too.

    To be continued in part 2.

    In the mean time, please read:

    William K. Wolfrum: "Sam E. Antar: From Crazy Eddie to Patrick Byrne's Worst Nightmare."

    Gary Weiss: "The Whisper Campaign Against an Overstock.com Whistleblower"

    Written by:

    Sam E. Antar (former Crazy Eddie CFO and a convicted felon)

    Blog Update:

    Investigative journalist and author Gary Weiss commented on Overstock.com's history of GAAP violations in his blog:

    There are few certainties in this world: gravity, the speed of light, and, more obviously every quarter, the utter unreliability of Overstock.com financial statements.

    Acclaimed forensic accountant and author Tracy Coenen notes in her blog:

    Don’t laugh too hard at Patrick Byrne’s explanation of the repeated accounting errors and improper treatment of those errors, as reported by Lee Webb of Stockwatch:

    “We just keep squeezing the tube of toothpaste thinner and thinner and finding new stuff to come out,” Mr. Byrne remarked during the conference call after chief financial officer Steve Chesnut said that the underbilling and overbilling had been found “as part of good corporate diligence and governance.”

    Good corporate diligence and governance? Is this guy for real? How about having an accounting system that prevents errors from occurring every quarter?

    Of course, Overstock.com management has to explain away why Sam Antar is finding all these manipulations and irregularities in their financial reporting. They can stalk and harass him all they want, call him a criminal all they want, but there is no explaining it away. The numbers don’t lie. Overstock.com just always counted on no one being as thorough as Sam.

    Bob Jensen's threads on PwC auditors can be found at http://www.trinity.edu/rjensen/fraud001.htm


    Professor Ketz Asserts Other Comprehensive Income (OCI from FAS 130)
    may be More Important to Study Than Reported Income

    "Citigroup Remains in Critical Condition," by: J. Edward Ketz , SmartPros, May 2009 ---
    http://accounting.smartpros.com/x66534.xml
    Note that all Citigroup dollar amounts are in millions of dollars such that  $(27,684) is really a $27,684,000,000 billion loss.

    The stress tests conducted by the Fed are a farce inasmuch as the stress isn't too strenuous. That the Fed ascertained additional capital requirements for several banks merely points out the obvious - the banking sector remains in serious trouble.

    That the financial industry was and remains in trouble is not revelatory to those who pay attention to fair value measurements. Take Citigroup for instance. This firm, once a giant among banks, now gasps for its existence.

    Citi’s reported net income was $(27,684) for 2008 (all accounting numbers in millions of dollars). While this is a smelly number, the odor grows worse when one adjusts it for various items that bypass the income statement.

    Ever since the FASB invented the comprehensive income statement in a political move to get business enterprises to do some accounting for items they didn’t want to disclose, I have advocated that investors use comprehensive income instead of net income. Comprehensive income includes relevant items that have had a real economic impact on the business entity; therefore, investors will find these items informative.

    For fiscal 2008, Citi shows unrealized losses on its available-for-sale securities of $(10,118). It also shows a loss on the foreign currency translation adjustment of $(6,972), a loss on its cash flow hedges of $(2,026), and a loss for additional pension liability adjustment of $(1,419). This makes Citi’s comprehensive income $(48,219).

    But the bad news doesn’t end there. The pension footnote (footnote 9) shows the expected rate of return is 7.75%. While this is what is required per FAS 87, it is nonsense. Did anybody know the 2008 rate of return in (say) 2005? The FASB should get rid of such fantasyland assumptions and require business enterprises to employ the actual rate of return. If Citi had done so on its pension assets, it would have had an actual return of (5.42)%, so we shall adjust downward the 2008 income by another $1,370.

    The most interesting item is Citi’s move with respect to its investments. It reports debt securities in its 2007 held-to-maturity portfolio of only $1. By year end 2008, however, this amount mushroomed to $64,459. Clearly, Citi is shielding these debt instruments from fair value accounting and the reporting of additional losses. Footnote 16 indicates that these losses for 2008 amounted to $(4,082).

    Another item concerns the firm’s deferred income tax assets. For 2008, Citi discloses $52,079 in deferred income tax assets and a valuation allowance of zero. Given that Citi paid no federal income taxes in 2007 or 2008 and likely will pay no federal income taxes in the near future, if ever, how can the company justify a valuation allowance of zero? Whatever amount it should be would further reduce the profits of the firm. Since we don’t know how to estimate this valuation allowance correctly, we shall continue to hold its balance at zero, even though this is clearly wrong.

    Putting these considerations together, Citigroup has an adjusted income in 2008 of $(53,671). This is still an estimate but clearly it is more nearly accurate than the reported number. And it reveals that Citi lost twice as much as it reported.

    Recently, we have been hearing how Citi has turned things around and that the first quarter in 2009 returns Citi to the black column with a profit of $1,593. Don’t believe a word of it!

    Items in comprehensive income shows a modest gain in the available-for-sale portfolio of $20, gains on cash flow hedges of $1,483, and a gain because of the pension liability adjustment of $66. Unfortunately, these gains are wiped out by a loss in the foreign currency translation adjustment of $(2,974). Comprehensive remains ugly at $(225).

    We don’t have any disclosure in the quarterly report about actual versus expected returns on pension assets, so we cannot adjust them to show the truth.

    But, the strategy to move debt securities from available-to-sale to held-to-maturity paid off significantly. First quarter results show a staggering loss on these securities of $(7,772).

    So far, the adjusted earnings for Citigroup for the first quarter of 2009 is $(7,584). Don’t tell me that Citi has improved its operations.

    Further, these numbers have been improved by an eccentricity in FAS 157. For some silly reason, the board allows entities to show a gain on their liabilities if the firm’s own credit risk has increased. This takes a perfectly good notion of fair value of liabilities to an absurd result. Failing companies might be able to make liabilities disappear by claiming a sufficiently high increase in their own credit ratings! Utter rubbish—and the FASB should amend its statement.

    Citi disclosed in a conference call that the first quarter results include a gain of $2,700 because of this increase in its own nonperformance risk. This gain is total nonsense, so I would adjust quarterly income further, giving Citi adjusted earnings of $(10,284).

    Citigroup suffered a cardiac arrest in 2008, and it remains in critical condition. Any other conclusion is propaganda or self deception. And forget the stress tests; they are so flawed that Lehman Brothers might pass them. The Fed says that Citi needs another $5,500 in capital to weather any additional economic crises it might face. It isn’t true. Citi needs a lot more capital than that just to weather current conditions. If a real crisis occurs, Citi will become a flat-liner; it might die anyway.

    If you want to protect your portfolio, don’t listen to the optimistic forecasts coming from Washington and don’t stop at the reported income number. Look at the fair value disclosures within SEC filings, adjust reported earnings for these fair value gains and losses, and then you will obtain the truth.

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


    "JPMorgan (read that Chase Bank) faces SEC lawsuit," by Aline van Duyn and Francesco Guerrera, Financial Times, May 8, 2009 ---

    JPMorgan Chase may be sued by US regulators for violating securities laws and market rules related to the sale of bonds and interest-rate swaps to Jefferson County, Alabama.

    The potential Securities and Exchange Commission action is the latest twist in a complex debt financing saga which has already led to charges against Jefferson County officials and which has left the municipality struggling to avoid default on over $3bn of debt, much of it taken on to improve its sewage system.

    JPMorgan said in a regulatory filing, made late on Thursday just as the results of bank stress tests were being released, that it had been told about the SEC action on April 21. It said it “has been engaged in discussions with the SEC staff in an attempt to resolve the matter prior to litigation”. The bank had no further comment on Friday.

    Jefferson County is one of the most indebted municipalities in the US due to its expensive overhaul of its sewage system. JPMorgan is one of the lenders which has repeatedly extended the deadline on payments due by Jefferson County on its debt and derivatives.

    A law is currently being considered that would create a new tax which would provide revenues to pay the sewer debt. If Jefferson County defaults, it would be the biggest by a US municipality, dwarfing the problems faced by California’s Orange County in the 1990s.

    The mayor of Birmingham, Alabama, and two of his friends were last year charged by US regulators in connection with an undisclosed payment scheme related to municipal bond and swap deals.

    The SEC alleged that Larry Langford, the mayor, received more than $156,000 in cash and benefits from a broker hired to arrange bond offerings and swap agreements on behalf of Jefferson County, where Birmingham is located.

    Although the details of the SEC investigation are not known, it is likely to be related to the payment scheme through which banks like JPMorgan paid fees to local brokers at the request of Jefferson County.

    The credit crisis has brought to light numerous problems in the municipal bond markets. Many borrowers relied on bond insurance to sell their deals, and the collapse in the credit ratings of bond insurers has made it difficult for many to raise funds or to do so at low interest rates.

    Bob Jensen's banking fraud threads are at
    http://www.trinity.edu/rjensen/FraudRotten.htm#InvestmentBanking


    Reports are surfacing that CPA auditors were warned about toxic assets and pending bank failures.
    Yet virtually all of the failed banks in 2008 and early 2009 received clean audit opinions not warning of "going concern" weaknesses

    Aside from the massive lawsuits that have been or will soon be filed against banks, mortgage finance companies, and their auditors, it the big question will be investigations of the PCAOB into those failed audits. The Federal Government PCAOB's reputation is somewhat at stake here --- http://www.pcaobus.org/

    "CPAs MIA," by Ralph Nader , Independent Political Report, April 12, 2009 --- http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/

    Where were the giant accounting firms, the CPAs, and the rest of the accounting profession while the Wall Street towers of fraud, deception and cover-ups were fracturing our economy, looting and draining trillions of dollars of other peoples’ money?

    This is the licensed profession that is paid to exercise independent judgment with independent standards to give investors, pension funds, mutual funds, and the rest of the financial world accurate descriptions of corporate financial realities.

    It is now obvious that the accountants collapsed their own skill, integrity and self-respect faster and earlier than the collapse of Wall Street and the corporate barons. The accountants—both external and internal—could have blown the whistle on what Teddy Roosevelt called the “malefactors of great wealth.”

    The Big Four auditors knew what was going on with these complex, abstractly structured finance instruments, these collateralized debt obligations (CDOs) and other financial products too abstruse to label. They were on high alert after early warning scandals involving Long Term Capital Management, Enron, and others a decade or so ago. These corporate casino capitalists used the latest tricks to cook the books with many of the on-balance sheet or off-balance sheet structured investment vehicles that metastasized big time in the first decade of this new century. These big firms can’t excuse themselves for relying on conflicted rating companies, like Moody’s or Standard & Poor, that gave triple-A ratings to CDO tranches in return for big fees. Imagine the conflict. After all, “prestigious” outside auditors were supposed to be on the inside incisively examining the books and their footnotes, on which the rating firms excessively relied.

    Let’s be specific with names. Carl Olson, chairman of the Fund for Stockowners Rights wrote in the letters column of The New York Times Magazine (January 28, 2009) that “PricewaterhouseCoopers O.K.’d AIG and FreddieMac. Deloitte & Touche certified Merrill Lynch and Bear Stearns. Ernst & Young vouched for Lehman Brothers and IndyMac Bank. KPMG assured over Countrywide and Wachovia. These ‘Big Four’ C.P.A. firms apparently felt they could act with impunity.” “Undoubtedly they knew that the state boards of accountancy,” continued Mr. Olson, “which granted them their licenses to audit, would not consider these transgressions seriously. And they were right…Not one of them has taken up any serious investigation of the misbehaving auditors of the recent debacle companies.”

    “Misbehaving” is too kind a word. The “Big Four” destroyed their very reason for being by their involvement in these and other boondoggles that have made headlines and dragooned our federal government into bailing them out with disbursements, loans and guarantees totaling trillions of dollars. “Criminally negligent” is a better phrase for what these big accounting firms got rich doing—which is to look the other way.

    Holding accounting firms like these accountable is very difficult. It got more difficult in 1995 when Congress passed a bill shielding them from investor lawsuits charging that they “aided and abetted” fraudulent or deceptive schemes by their corporate clients. Clinton vetoed the legislation, but Senator Chris Dodd (D-CT) led the fight to over-ride the veto.

    Moreover, the under-funded and understaffed state boards of accountancy are dominated by accountants and are beyond inaction. What can you expect?

    As for the Securities and Exchange Commission (SEC), “asleep at the switch for years” would be a charitable description of that now embarrassed agency whose mission is to supposedly protect savers and shareholders. This agency even missed the massive Madoff Ponzi scheme.

    The question of accounting probity will not go away. In the past couple of weeks, the non-profit Financial Accounting Standards Board (FASB)—assigned to be the professional conscience of accountancy—buckled under overt pressure from Congress and the banks. It loosened the mark-to-market requirement to value assets at fair market value or what buyers are willing to pay.

    This decision by the FASB is enforceable by the SEC and immediately “cheered Wall Street” and pushed big bank stocks upward. Robert Willens, an accounting analyst, estimated this change could boost earnings at some banks by up to twenty percent. Voilà, just like that. Magic!

    Overpricing depressed assets may make bank bosses happy, but not investors or a former SEC Chairman, Arthur Levitt, who was “very disappointed” and called the FASB decision “a step toward the kind of opaqueness that created the economic problems that we’re enduring today.”

    To show the deterioration in standards, banks tried to get the FASB and the SEC in the 1980s to water down fair-value accounting during the savings and loan failures. Then-SEC Chairman Richard Breeden refused outright. Not today.

    Former SEC chief accountant, Lynn Turner, presently a reformer of his own profession, supports mark-to-market or fair value accounting as part of bringing all assets and liabilities, including credit derivatives, back on the balance sheets of the financial firms. He wants regulation of the credit rating agencies, mortgage originators and the perverse incentives that lead to making bad loans. He even wants the SEC to review these new financial products before they come to market, eliminating “hidden financing.”

    Now comes the life insurance industry, buying up some small banks to qualify for their own large federal bailouts for making bad, risky speculations.

    The brilliant Joseph M. Belth, writing in his astute newsletter, the Insurance Forum (May 2009), noted that life insurers are lobbying state insurance departments to weaken statutory accounting rules so as to “increase assets and/or decrease liabilities.” Some states have already caved. Again, voilà, suddenly there is an increase in capital. Magic. Here we go again.

    Who among the brainy, head up accountants, in practice or in academia, will join with Lynn Turner and rescue this demeaned, chronically rubber-stamping “profession,” especially the “Big Four,” from its pathetic pretension for which tens of millions of people are paying dearly?

    Reports are surfacing that CPA auditors were warned about toxic assets and pending bank failures.
    Yet virtually all of the failed banks in 2008 and early 2009 received clean audit opinions not warning of "going concern" weaknesses

    Aside from the massive lawsuits that have been or will soon be filed against banks, mortgage finance companies, and their auditors, it the big question will be investigations of the PCAOB into those failed audits. The Federal Government PCAOB's reputation is somewhat at stake here --- http://www.pcaobus.org/

    "CPAs MIA," by Ralph Nader , Independent Political Report, April 12, 2009 --- http://www.independentpoliticalreport.com/2009/04/ralph-nader-cpas-mia/

    Where were the giant accounting firms, the CPAs, and the rest of the accounting profession while the Wall Street towers of fraud, deception and cover-ups were fracturing our economy, looting and draining trillions of dollars of other peoples’ money?

    This is the licensed profession that is paid to exercise independent judgment with independent standards to give investors, pension funds, mutual funds, and the rest of the financial world accurate descriptions of corporate financial realities.

    It is now obvious that the accountants collapsed their own skill, integrity and self-respect faster and earlier than the collapse of Wall Street and the corporate barons. The accountants—both external and internal—could have blown the whistle on what Teddy Roosevelt called the “malefactors of great wealth.”

    The Big Four auditors knew what was going on with these complex, abstractly structured finance instruments, these collateralized debt obligations (CDOs) and other financial products too abstruse to label. They were on high alert after early warning scandals involving Long Term Capital Management, Enron, and others a decade or so ago. These corporate casino capitalists used the latest tricks to cook the books with many of the on-balance sheet or off-balance sheet structured investment vehicles that metastasized big time in the first decade of this new century. These big firms can’t excuse themselves for relying on conflicted rating companies, like Moody’s or Standard & Poor, that gave triple-A ratings to CDO tranches in return for big fees. Imagine the conflict. After all, “prestigious” outside auditors were supposed to be on the inside incisively examining the books and their footnotes, on which the rating firms excessively relied.

    Let’s be specific with names. Carl Olson, chairman of the Fund for Stockowners Rights wrote in the letters column of The New York Times Magazine (January 28, 2009) that “PricewaterhouseCoopers O.K.’d AIG and FreddieMac. Deloitte & Touche certified Merrill Lynch and Bear Stearns. Ernst & Young vouched for Lehman Brothers and IndyMac Bank. KPMG assured over Countrywide and Wachovia. These ‘Big Four’ C.P.A. firms apparently felt they could act with impunity.” “Undoubtedly they knew that the state boards of accountancy,” continued Mr. Olson, “which granted them their licenses to audit, would not consider these transgressions seriously. And they were right…Not one of them has taken up any serious investigation of the misbehaving auditors of the recent debacle companies.”

    “Misbehaving” is too kind a word. The “Big Four” destroyed their very reason for being by their involvement in these and other boondoggles that have made headlines and dragooned our federal government into bailing them out with disbursements, loans and guarantees totaling trillions of dollars. “Criminally negligent” is a better phrase for what these big accounting firms got rich doing—which is to look the other way.

    Holding accounting firms like these accountable is very difficult. It got more difficult in 1995 when Congress passed a bill shielding them from investor lawsuits charging that they “aided and abetted” fraudulent or deceptive schemes by their corporate clients. Clinton vetoed the legislation, but Senator Chris Dodd (D-CT) led the fight to over-ride the veto.

    Moreover, the under-funded and understaffed state boards of accountancy are dominated by accountants and are beyond inaction. What can you expect?

    As for the Securities and Exchange Commission (SEC), “asleep at the switch for years” would be a charitable description of that now embarrassed agency whose mission is to supposedly protect savers and shareholders. This agency even missed the massive Madoff Ponzi scheme.

    The question of accounting probity will not go away. In the past couple of weeks, the non-profit Financial Accounting Standards Board (FASB)—assigned to be the professional conscience of accountancy—buckled under overt pressure from Congress and the banks. It loosened the mark-to-market requirement to value assets at fair market value or what buyers are willing to pay.

    This decision by the FASB is enforceable by the SEC and immediately “cheered Wall Street” and pushed big bank stocks upward. Robert Willens, an accounting analyst, estimated this change could boost earnings at some banks by up to twenty percent. Voilà, just like that. Magic!

    Overpricing depressed assets may make bank bosses happy, but not investors or a former SEC Chairman, Arthur Levitt, who was “very disappointed” and called the FASB decision “a step toward the kind of opaqueness that created the economic problems that we’re enduring today.”

    To show the deterioration in standards, banks tried to get the FASB and the SEC in the 1980s to water down fair-value accounting during the savings and loan failures. Then-SEC Chairman Richard Breeden refused outright. Not today.

    Former SEC chief accountant, Lynn Turner, presently a reformer of his own profession, supports mark-to-market or fair value accounting as part of bringing all assets and liabilities, including credit derivatives, back on the balance sheets of the financial firms. He wants regulation of the credit rating agencies, mortgage originators and the perverse incentives that lead to making bad loans. He even wants the SEC to review these new financial products before they come to market, eliminating “hidden financing.”

    Now comes the life insurance industry, buying up some small banks to qualify for their own large federal bailouts for making bad, risky speculations.

    The brilliant Joseph M. Belth, writing in his astute newsletter, the Insurance Forum (May 2009), noted that life insurers are lobbying state insurance departments to weaken statutory accounting rules so as to “increase assets and/or decrease liabilities.” Some states have already caved. Again, voilà, suddenly there is an increase in capital. Magic. Here we go again.

    Who among the brainy, head up accountants, in practice or in academia, will join with Lynn Turner and rescue this demeaned, chronically rubber-stamping “profession,” especially the “Big Four,” from its pathetic pretension for which tens of millions of people are paying dearly?

    The Fate of the Large Auditing Firms After the 2008 Banking Meltdown

    Questions
    Where were the auditors when auditing those risky investments and bad debt reserves of the ailing banks?
    Answer:  Not sure.


    Where will the auditors be in after the shareholders in the failing banks lose all or almost all in the meltdowns?
    Answer: In court, because the shareholders are the fall guys not being bailed out in when banks declare bankruptcy or are bought out cheap just before declaring bankruptcy. Shareholder will understandably turn to the deep pocket auditors.

    "Financial Crisis Provides Fertile Ground for Boom in Lawsuits," by Jonathan D. Glater, The New York Times, Octobver 17, 2008 --- http://www.nytimes.com/2008/10/18/business/18suits.html?_r=1&partner=permalink&exprod=permalink&oref=slogin

    It seems like just a few months ago — because it was — that trial lawyers, those advocates who take on companies on behalf of investors, customers or even other businesses, had a wretched reputation. Three of the best known of those lawyers, William S. Lerach, Melvyn I. Weiss and Richard F. Scruggs, had all pleaded guilty to crimes. Defense lawyers were gleeful.

    But the pendulum has shifted again, much as in the years after the collapse of Enron and WorldCom.

    Accusations of executive excess, accounting fraud and lack of disclosure are far more credible now, since bad bets on real estate and securities linked to home loans have caused some of the biggest and most prestigious financial firms in the country — Lehman Brothers, the American International Group, Fannie Mae, Freddie Mac — to collapse, sell parts of themselves at fire-sale prices or suffer outright government takeovers. A legal argument rarely used in investor lawsuits is tempting: res ipsa loquitur, or the thing speaks for itself.

    “There’s clearly going to be an erosion in the presumption that these senior-ranking executives should be given the benefit of the doubt,” said John P. Coffey, a partner at Bernstein Litowitz Berger & Grossmann, adding that as a result of regulators’ investigations and angry former employees, there is also more information available to plaintiffs about questionable conduct. “There’s clearly going to be an effect there; judges are human.”

    So are investors, who are angry. Individual shareholders as well as big companies want someone else to pay for their losses on investments in everything from basic stocks to exotic swaps. And lawyers are emboldened in their claims by the huge losses and obvious errors in judgment at companies that, until recently, confidently asserted their immunity to market turbulence.

    Investors’ lawyers can point at statements and actions by regulators to bolster their claims. In a suit filed in mid-September by Fannie Mae shareholders, the plaintiffs blamed a government plan to buy shares of the company and then take it over for helping to depress the company’s stock price. The lawsuit names Merrill Lynch, Citigroup, Morgan Stanley and others as defendants, accusing them of making false statements about Fannie Mae’s financial condition.

    “The more you think about it, there’re so many different ways that so many different people could be responsible for this,” said H. Adam Prussin, a partner at Pomerantz Haudek Block Grossman & Gross, referring to losses suffered in this financial crisis. His firm is representing Fannie Mae investors. “There are the lenders who screwed up in the first place, there are the people who bought these things from the lenders and then didn’t account correctly for them.”

    A recent report by the law firm Fulbright & Jaworski found that more than one-third of lawyers working internally for companies expected to see more litigation in 2009. Lawyers at the biggest companies were more likely to expect a boom in lawsuits, according to the study.

    One factor contributing to litigation is the rapid availability of information about corporate mistakes and losses, which in the past might have taken longer to circulate among investors, said Michael Young, a partner at Willkie Farr & Gallagher in New York.

    “What’s really going on here is a type of accounting that is capturing changes in value and making them public much faster than anything we’ve seen before,” Mr. Young said.

    Armed with such data, shareholders have charged the courthouse steps, claiming that companies failed to disclose their vulnerability to declines in the real estate market, often through holdings of securities backed by home loans. Even companies that have suffered huge losses may still be worth pursuing because of their liability insurance.

    “You can’t get blood from a stone,” said Joseph A. Grundfest, a former commissioner of the Securities and Exchange Commission who now teaches at Stanford Law School. “But you sure can get money from the insurance company that covered the stone.”

    There are other deep pockets, even in the current economic climate. When confronted by bankruptcy filings or government takeovers, the lawsuits name every possible defendant involved in a stock offering — the underwriters, the rating agencies and individual executives — but not the issuing company itself. That way, they avoid the problem of fighting with other creditors in bankruptcy or the question of whether they can sue the government.

    In the case brought by Fannie shareholders, for example, Fannie itself is not a defendant. A suit filed last month by investors who bought Freddie Mac shares names only Goldman Sachs, JPMorgan Chase and Citigroup. The suit claims that the investment firms, which underwrote a Freddie Mac stock offering, did not disclose the company’s “massive exposure to mortgage-related losses.” (JPMorgan Chase did not underwrite the offering itself but it acquired Bear Sterns, which did).

    Events have moved quickly enough that some lawyers have found that their lawsuits may have been filed too early, before the biggest losses and consequently before the biggest damage claims were possible.

    Continued in article

     

    "The harder they fall: Will the Big Four survive the credit crunch?" by Rob Lewis, AccountingWeb, October 2008 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=106124

    Ever since Arthur Andersen left the market after its scandalous role in the fall of Enron, people have been asking how long it will be before another big firm follows suit. The (UK) Financial Reporting Council (FRC) has been trying ever since to make sure that the Big Four will be protected if found guilty of similar negligence. The introduction of limited liability should help, but given the accelerating meltdown of the global financial system, will it be enough?

    As always, and as was the case with Arthur Andersen, it will be events in America that determine the fate of the Big Four. This summer the U.S. Treasury's Advisory Committee of the Auditing Profession met in Washington and heard that between them the six largest firms had 27 outstanding litigation proceedings against them with damage exposure above $1 billion, seven of which exceed $10 billion. It is impossible to buy insurance that will cover such catastrophic liability and any one of them, if successful, could prove a fatal blow.

    That U.S. Treasury committee met again last week to discuss the viability of limited liability for auditors in the U.S., but the 21-strong panel decided against it. With that, the hope of some silver bullet solution to the Big Four's problems expired. Committee member Lynn Turner, formerly a chief accountant to the Securities and Exchange Commission (SEC), was plainly baffled such an idea had even been seriously suggested.

    "Do you believe that an auditor found to have been aware of financial reporting problems but never reporting them to the public should be the subject of liability caps or some type of litigation reform protecting them?" he asked. Turner summed the situation up nicely when he described the big accounting firms as a "federally mandated and authorized cartel" which was "too big to [be allowed to] fail".

    When Arthur Andersen went down six years ago, Turner had never been quite able to believe that the firm's bad behavior had really been all that anomalous. "It's beyond Andersen," he told CBS Frontline that same year, "it's something that's embedded in the system at this time. This notion that everything is fine in the system just because you can't see it is totally off-base."

    The credibility of the markets

    Looking at recent economic events, Turner's suspicions that the credibility of the markets were at stake has plainly proved prescient. So too may his belief that unethical accounting was not so much a case of a few bad apples, but a bad barrel.

    Consider some of the recent and outstanding claims against the biggest six firms. In Miami last August a jury ordered BDO Seidman to pay $521 million in damages for its negligence in a Portuguese bank audit; almost as much as the firm's estimated revenue for that year. In the U.S., banks and the shareholders of banks are perfectly prepared to go after auditors, and when they win they tend to win big. Note than when Her Majesty's Treasury hired the BDO's valuation partner Andrew Caldwell for the controversial Northern Rock valuation, they hired the man and not the firm. The firms are already worried enough about litigation.

    KPMG provides a clear example of how the credit crunch might cull the Big Four. The firm was already looking vulnerable before it hit: there was the 2005 'deferred prosecution' agreement with the New York Attorney's Office, the damning German probe into the Siemens bribery scandal, a lawsuit from superconductor company Vitesse for 'audit failures' and a minor fine from the UK's Joint Disciplinary Scheme (JDS) for allowing fraud to occur at Independent Insurance (it may only have been half a million, but it was the JDS' biggest fine to date). But when the subprime problems of U.S. lender New Century enter the picture, the damages involved escalate drastically.

    A U.S. Justice Department report has already concluded that KPMG either helped perpetrate the fraud at the mortgager or deliberately ignored it. Class-action lawsuits are already pending. Only weeks before the report was published the U.S. Supreme Court's Stone Ridge ruling immunized third party advisers like accountants and bankers from the disgruntled shareholders of other entities, but that may be not much of a shield. Of course, New Century might not be KPMG's biggest problem. That's probably the Federal National Mortgage Association, or Fannie Mae.

    Fannie Mae initiated litigation way back in 2006, and is trying to reclaim more than $2 billion from its old auditors. That's on top of the $400 million KPMG agreed to pay the SEC to settle the regulator's fraud allegations. Its defense so far has been one of complete innocence, asserting that Fannie Mae successfully hid all evidence of anything untoward. Now that the FBI is investigating the mortgage lender, such a position will have to be abandoned if incriminating evidence turns up. Ostensibly, the Federal investigation relates to Fannie Mae's relationship with ratings agencies, but you never know what will fall out of the closet.

    So KPMG is in a spot of bother, but it's not alone. Ernst and Young will almost inevitably see itself in court over the demise of its audit client Lehman Brothers. Similarly, PricewaterhouseCoopers is surely going to feel some heat for its auditing of what was once the world's largest insurance company, AIG, assuming the Northern Rock Shareholders Group doesn't take a pop at it first.

    Continued in article

     

    Bob Jensen's threads on the litigation woes of the large auditing firms are at http://www.trinity.edu/rjensen/Fraud001.htm

    The most serious problem in the U.S. audit model is that clients are becoming bigger and bigger due to non-enforcement of anti-trust laws. For example, the merger of Mobile and Exxon created an even larger single client. The merger of Bear Stearns and JP Morgan created a much larger client. The number of potential clients is shrinking while the size of the clients is exploding. According to the CEO of Bank of America, in a CBS Sixty Minutes interview on October 19, 2008, half of all banking customers in the United States now have accounts with Bank of America. That was before Bank of America bought out Merrill Lynch.

    As these giants merge to become bigger giants, it gets to a point where their auditors cannot afford to lose a giant client producing upwards of $100 million in audit revenue each year. Real independence of audits breaks down because a giant client can become a bully with its audit firm fearful of losing giant clients.

    Enron was an extreme but not necessarily an outlier. It will most likely be alleged in court over the next few years that giant Wall Street banks bullied their auditors into going along with understating financial risk before the 2008 banking meltdown. We certainly witnessed the understating of financial risk in 2007 and 2008.

    I think we need an Accounting Court to deal with clients who become bullies --- http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism

    The Accounting Hall of Fame Citation for Leonard Spacek --- http://fisher.osu.edu/acctmis/hof/spacek.html

    It must be kept in mind that the statements certified are not ours but are our clients--and our clients do not care to mix explanations of accounting theory with explanations of their business nor can we pass onto our readers the responsibility for appraisal of differences in accounting theory. Those fields are for you and me to grapple with, not the public. In general, clients are not primarily interested in arguments of accounting theory at the time of preparing their reports. The companies whose accounts are certified are chiefly interested in what is said to their shareholders, and in the hard practical facts of how accounting rules affect them, their competitors and other companies. Usually they are very critical of what we call accounting principles when these called principles are unrealistic, inconsistent, or do not protect or distinguish scrupulous management from the scrupulous.
    "The Need for An Accounting Court," by Leonard Spacek, The Accounting Review, 1958, Pages 368-379  --- http://www.trinity.edu/rjensen/FraudSpacek01.htm

    Jensen Comment
    Fifty years later I'm a strong advocate of an accounting court, but I envision a somewhat different court than envisioned by the great Leonard Spacek in 1958. Since 1958, the failure of anti-trust enforcement has allowed business firms to merge into enormous multi-billion or even trillion dollar clients who've become powerful bullies that put extreme pressures on auditors to bend accounting and auditing principles. For example see the way executives of Fannie Mae pressured KPMG to bend the rules (an act that eventually got KPMG fired from the audit).

    In my opinion the time has come where auditors and clients can take their major disputes to an Accounting Court that will use expert independent judges to resolve these disputes much like the Derivatives Implementation Group (DIG)  resolved technical issues for the implementation of FAS 133. The main difference, however, is that an Accounting Court should hear and resolve disputes in private confidence that allows auditors and clients to keep these disputes away from the media. The main advantage of such an Accounting Court is that it might restrain clients from bullying auditors such as became the case when Fannie Mae bullied KPMG.

    Who would sit on accounting courts is open to debate, but the "judges" could be formed by the State Boards of Accountancy much like a grand jury is formed by a court of law. Accounting court cases, however, should be confidential since they deal with sensitive client information.

    I really don't anticipate a flood o cases in an accounting court. But I do view the threat of taking client-auditor disputes to such courts (in confidence) as a means of curbing the bullying of auditors by their enormous clients.

    The problem is that poor anti-trust enforcement coupled with mergers of huge companies have combined to create mega-clients that auditing firms cannot afford to lose after gearing up to handle such large clients. I think we saw this in the "clean opinions" given to all the enormous failing banks (like WaMu) and enormous Wall Street investment banks (like Lehman). The big auditing firms just could not afford to question bad debt estimates, mortgage application lies, and CDO manipulations of such clients.

    I find it hard to believe that auditors failed to detect an undercurrent of massive subprime "Sleaze, Bribery, and Lies" that transpired in the Main Street banks and mortgage lending companies --- http://www.trinity.edu/rjensen/2008Bailout.htm#Sleaze
    The sleaze was so prevalent the auditors must've worn their chest-high waders on these audits

    Bob Jensen's threads on the fate of the large auditing firms following the subprime scandals ---
     


    Debit and Credit Waltz" by Josef Strauss

    May 23, 2009 message from Barry Rice [brice@LOYOLA.EDU]

    I was listening to a Baltimore classical radio station yesterday and heard the announcer say that the next tune he was playing was the "Debit and Credit Waltz" by Josef Strauss. Needless to say, that caught my attention. Today, when I researched it, this is what I found at
    http://www.naxos.com/mainsite/blurbs_reviews.asp?item_code=8.223664&catNum=223664&filetype=About this Recording&language=English

    "[5] Soll und Haben, Walzer (Debit and Credit. Waltz), Op. 68

    The business sector of Vienna suffered long and hard during the economic crisis which beset Austria starting in approximately 1846. It was not until 1855 that merchants, from wholesalers to sales personnel, had recovered sufficiently to recognise the growing importance of the merchant class with their own ball to be held at Sperl’s during the Carnival season. On that occasion, Johann Strauss played his high-spirited Handels-Elite-Quadrille, Op. 166, for the first time at Sperl’s. On 21st February 1859, another ball of this kind was held, this time in the elegant Sofiensaal. The Strauss orchestra was again hired to provide the music, but Johann Strauss did not appear before his musicians on this evening, leaving the ball to his brother Josef, who contributed the traditional dedication piece, the waltz Soll und Haben.

    On the following day, the Theaterzeitung had this to say, among other things: "The attendance was quite numerous. Overcrowding, however, was not a problem and did not interfere with the guests’ dancing enjoyment, especially by youthful revellers. The festival took place amidst unspoilt and unbridled merriment. The dresses of the ladies were splendid. Of the waltzes presented by Strauss for this occasion, the one entitled Soll und Haben was the best". The publisher Carl Haslinger took his time to release the work, issuing it on 21st August 1859 under the double title Soll und Haben - Handels-Elite-Ball-Tänze. Although it was not possible to confirm whether or not the instrumental parts were ever printed, they were easy to reproduce, because the printing dies were available as a source."

    The entire STRAUSS, Josef: Edition - Vol. 25 recording can be purchased and downloaded from http://www.naxos.com/catalogue/item.asp?item_code=8.223664 . The single, 9-minute Debit and Credit Waltz track can also be purchased and downloaded. Of course, the traditional CD format is available through Amazon.

    May 25, 2009 reply from Bob Jensen

    Hi Barry, It’s amazing how virtually all accountants think of the ledger when they see the phrase “Debit and Credit.” This most likely was the 19th Century context when for the "Debit and Credit Waltz" by Josef Strauss.

    The following is a controversial quotation in economic history http://www.trinity.edu/rjensen/theory01.htm#AccountingHistory 

    "The power of double-entry bookkeeping has been praised by many notable authors throughout history. In Wilhelm Meister, Goethe states, "What advantage does he derive from the system of bookkeeping by double-entry! It is among the finest inventions of the human mind"... Werner Sombart, a German economic historian, says, "... double-entry bookkeeping is borne of the same spirit as the system of Galileo and Newton" and "Capitalism without double-entry bookkeeping is simply inconceivable. They hold together as form and matter. And one may indeed doubt whether capitalism has procured in double-entry bookkeeping a tool which activates its forces, or whether double-entry bookkeeping has first given rise to capitalism out of its own (rational and systematic) spirit".
    You can read about Werner Sombart at http://en.wikipedia.org/wiki/Werner_Sombart#Works_by_Sombart 

    Thank you Barry. I never heard of this Straus composition until now, although in the 21st Century there are a number of YouTube “debit and credit” rap songs in the context of “Debit Card” versus “Credit Card” --- banking cards that did not exist in the 19th Century.

    We all love accounting --- http://www.youtube.com/watch?v=Fr_DMRZ730k 

    Bob Jensen

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


    Before reading this it is advisable to read about the Efficient Market Hypothesis --- http://en.wikipedia.org/wiki/Efficient_Market_Hypothesis
    For decades Fama and French have been the leading scholars on this hypothesis

    Are mutual fund managers with "superior skills" earning their keep?

    For 1984-2006...mutual funds on average and the average dollar invested in funds underperform three-factor and four-factor benchmarks by about the amount of costs (fees and expenses). Thus, if there are fund managers with skill that enhances expected returns relative to passive benchmarks, they are offset by managers whose stock picks lower expected returns. We attempt to identify the presence of skill via bootstrap simulations. The tests for net returns say that even in the extreme right tails of the cross-sections of three-factor and four-factor t(α) estimates, there is no evidence of fund managers with skill sufficient to cover costs.
    Eugene F. Fama and Kenneth R. French, "Luck versus Skill in the Cross Section of Mutual Fund Alpha Estimates," SSRN, March 9, 2009 --- http://papers.ssrn.com/sol3/papers.cfm?abstract_id=1356021

    Abstract:
    The aggregate portfolio of U.S. equity mutual funds is close to the market portfolio, but the high costs of active management show up intact as lower returns to investors. Bootstrap simulations produce no evidence that any managers have enough skill to cover the costs they impose on investors. If we add back costs, there is some evidence of inferior and superior performance (non-zero true alpha) in the extreme tails of the cross section of mutual fund alpha estimates. The evidence for performance is, however, weak, especially for successful funds, and we cannot reject the hypothesis that no fund managers have skill that enhances expected returns.

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


    From The Wall Street Journal Accounting Weekly Review on April 23, 2009

    Report Faults World Bank's Anti-Fraud Methods
    by Bob Davis
    Apr 17, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

    TOPICS: Auditing, Auditing Services, Internal Auditing, Internal Controls

    SUMMARY: The World Bank's Independent Evaluation Group produced a report in fall 2008, which cited the bank's fraud-detection procedures in its main program providing aid to poor countries as a material weakness. This $40 billion program is called the International Development Association (IDA). "[World] Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries....Generally, the IDA received good marks and the results 'should overall be considered a quite respectable outcome,' the report said."

    CLASSROOM APPLICATION: The application of internal control procedures, and their independent testing, outside of corporations can be an eye-opener for students.

    QUESTIONS: 
    1. (Introductory) What is the World Bank?

    2. (Introductory) Who issued a report on the internal controls in place in World Bank programs? Why was this review of internal controls undertaken?

    3. (Advanced) Describe a corporate function similar to the group that undertook the review described in answer to question 2 above.

    4. (Advanced) Which World Bank program has been found to have material weaknesses in control systems? What system has been found as a material weakness?

    5. (Advanced) Define the terms "material weakness" and "significant deficiency" in relation to audits of corporate internal control systems.

    6. (Advanced) Do you think that the meaning of these terms in the report on World Bank programs is the same as the definitions you have provided? Why or why not?

    Reviewed By: Judy Beckman, University of Rhode Island

     

    "Report Faults World Bank's Anti-Fraud Methods," by Bob Davis, The Wall Street Journal, April 17, 2009 ---
    http://online.wsj.com/article/SB123992586755527389.html?mod=djem_jiewr_AC

    The World Bank's fraud-detection procedures in its main aid program to poor countries were labeled a "material weakness" in an internal report, adding to the bank's woes in handling corruption issues.

    The bank's Independent Evaluation Group gave it the lowest possible rating for fraud-detection procedures in the $40 billion aid program, called the International Development Association. That could hurt contributions to the effort, which gives grants and interest-free loans to the world's 78 poorest countries.

    The 690-page report, the first for the program, was completed last fall. Since then it has been the subject of lengthy discussions between World Bank management and the independent evaluation unit over whether the single designation of "material weakness," the lowest of four ratings, was justified. None of the program's other marks were as low; six other areas were labeled "significant deficiencies."

    "The bank's traditional control systems weren't designed to address fraud and corruption," one of the report's authors, Ian Hume, said in an interview. "They were designed for efficiency and equity -- the cheapest possible price." That increases the risk that corruption could occur in the use of IDA grants, he said.

    The World Bank has been pilloried by critics for years for not taking corruption seriously enough, and some staffers worried that the report's publication was being delayed for political reasons. The U.S., in particular, pushed for its publication, said bank staffers.

    "We have had a tough but cordial interaction with [World Bank] management along the way," said Cheryl Gray, director of the evaluation group.

    The report was published on the unit's Web site late Wednesday, but not publicized. Its presence was noted by a small icon on the bottom right of the page. Ms. Gray says that the group didn't intend to bury the report and said the unit didn't put out a press release because the report was "technical and jargony." After an inquiry from The Wall Street Journal, it was given greater prominence on the Web site. Ms. Gray said she had planned to make the change anyway.

    The report concluded that the World Bank "has until recently had few if any specific tools" to directly address fraud and corruption "at all stages in the lending cycle." An advisory panel that backed the "material weakness" designation wrote that fraud and corruption issues "involve a considerable reputation risk, involving at least a potential loss of confidence by various stakeholders."

    The Obama administration recently asked Congress to approve a three-year, $3.7 billion contribution to the bank's IDA program. A Democratic congressional staffer said it was too early to tell whether the report would make passage more difficult. Overall, the World Bank won commitments in December 2007 for $41.6 billion in funding for IDA over three years.

    Bank staffers said that the IDA program faces particularly difficult challenges because corruption is often a problem in especially poor countries. "We operate in some of the most difficult and challenging environments in the world," Fayez Choudhury, the World Bank's controller, said in an interview. "We are always looking to up our game."

    The bank's management pressed to get the fraud-and-corruption designation improved by a notch to "significant deficiency." It argued that the evaluation group didn't take into account steps it had taken over the past year to improve its controls.

    "The bank is firmly committed to mainstreaming governance and anticorruption efforts into its development work," said a management statement. It listed a number of improvements including the creation of an independent advisory board. The bank said it is trying to better integrate fraud prevention and corruption prevention generally into its operations.

    The report doesn't examine cases of actual corruption, though it notes there have been several instances that have received publicity, including health-clinic contracts in India. Rather, it looks at the systems and procedures in place to identify and prevent corruption.

    The report uses standards similar to those applied to corporate controls. Generally, the IDA received good marks and the results "should overall be considered a quite respectable outcome," the report said.

    For decades, the World Bank largely ignored corruption, figuring that some graft was the price of doing business in poor countries. Starting in 1996, however, former World Bank President James Wolfensohn focused more attention on the issue, as did his successor, Paul Wolfowitz, who held up loans to some poor countries because of concerns about corruption. That led to charges that the bank was enforcing corruption rules selectively.

    After Mr. Wolfowitz came under fire earlier for showing favoritism to his girlfriend, a bank employee, some developing nations dismissed the bank's efforts as hypocritical. Mr. Wolfowitz resigned in 2007 and the World Bank's current president, Robert Zoellick , has been trying to depoliticize the corruption issue, especially by beefing up the Department of Institutional Integrity, the main antifraud unit at the bank.

    Reviews of other institutions have also turned up designations of "material weakness." A U.S. Treasury "accountability report" for the year ended Sept. 30, 2008, for instance, found four such designations, including three involving the Internal Revenue Service's modernization, computer security and accounting, and one involving government-wide financial statements.

    Bob Jensen's threads on World Bank Fraud are at http://www.trinity.edu/rjensen/FraudRotten.htm#WorldBank


    "Critics Pan New Financial Statements:  A long-planned overhaul of financial statements gets a rough reception from preparers at its initial unveiling, particularly from banks. Meanwhile, a survey says a large majority of CFOs don't even know about the proposal," by Tim Reason, CFO.com, April 24, 2009 --- http://www.cfo.com/article.cfm/13561804

    It's been called the most dramatic overhaul of financial statements since the cash flow statement was introduced more than two decades ago. But when the comment period closed last week on the ideas for radically changing financial statements, the proposed design from the world's accounting standard setters had been called a few other things too: "poorly defined," "confusing," cluttered, "information overload," "inconsistent with management's internal reporting," and, frequently, "costly."

    In October 2008, the Financial Accounting Standards Board and the International Accounting Standards Board jointly issued a discussion paper laying out their preliminary ideas for changes to financial statements that would fundamentally alter the way information is presented on the financial statements. Comments were due last week.

    The two boards said their goal was to tie the different financial statements more closely together, provide deeper dives into financial numbers that are often aggregated at a very high level, and also provide a heavy emphasis on cash and liquidity. A key feature of the proposal is that managers would separate a company's actual business activities from its financing or funding activities. As a result, each of the three statements — balance sheet, income statement, and cash-flow statement — will be divided into two major sections: business and financing.

    The financing section will include those activities that fund a company's business. For nonfinancial institutions, that would primarily include cash, bank loans, bonds, and other items that arise from general capital-raising efforts.

    The business section — which would be further subdivided into operating and investing categories — would focus on what a company does to produce goods and provide services. The operating category will include primary or "core" revenue and expense-generating activities, and the investing category will include activities that generate a return but are not "core."

    Many preparers, particularly banks, commented that FASB and IASB needed to do more to clearly define 'operating' and 'investing' activities. "They're using the same terminology that we use in FAS 95 for cash flows," Grant Thornton partner John Hepp told CFO.com, "But they have completely different meanings from what they meant [in FAS 95]." Indeed, Hepp's sentiments are echoed in Grant Thornton's official comment letter, which notes not only that the distinction between the operating and investing sections is "very confusing," but also that "the [discussion paper] itself uses three different descriptions."

    "I don't think FASB or IASB is real clear on what these terms mean, so I don't know how management would apply them," Hepp added.

    Some of the debate, of course, may come down to FASB's and IASB's desire to have management itself define what activities it considers to be part of their company's business model for adding to shareholder value, versus simple investment returns.

    "Users of financial statements analyze how a company creates value separately from how it funds that value creation," said FASB senior project manager Kim Petrone in a webcast at the beginning of this year. "So we want to separate the creating activities from the financing activities." Petrone explained that companies will begin by classifying assets and liabilities based on how they are used by management. "That management approach is going to be very important because it allows [the accounting] to apply to many different entities. It's been asked if this will apply to banks, and it will apply to banks."

    But banks themselves were less than thrilled with that portion of the proposal. While conceding that it might be useful for investors of non-bank institutions to see financing activities separated from business activities, the American Bankers Association said "this kind of breakout will have little or no value to users of financial statements of banking institutions. . . . In essence, both investing activities and financing activities normally are operating activities at a bank."

    "The nature of the banking industry would lead, in our opinion, to the vast majority of activities being presented within the business activities (operating category)," concurred the British Bankers Association, adding that, for financial institutions, "we do not believe that the separation of business activities from financing activities will provide users with information that is more decision-useful than the current presentation method."

    While banks might find it impossible to distinguish between financing and operating activities, it is interesting to think that some of the distinctions proposed might have helped banks highlight the difference between actual losses and the writedowns that many were forced to take as a result of changes in fair value. Indeed, that's what at least one analyst, not speaking specifically about the banking industry, suggested just over a year ago. "As we see more fair value coming through the financial statements, those statements need to do a better job of showing where the changes are coming from; this would help a lot," Janet Pegg, a senior managing director and an accounting analyst at Bear Stearns, told CFO magazine in Feb 2008.

    Continued in article

    David Albrecht pointed out the following related links:

    How Extreme Is the Makeover?   http://www.cfo.com/article.cfm/13174906

    Huge Changes in Store for Financial Statements   http://www.cfo.com/article.cfm/13048671

    Accounting Boards Hang on to the Bottom Line   http://www.cfo.com/article.cfm/12447487

    International Accounting Standards Board Chairman Sir David Tweedie   http://www.cfo.com/article.cfm/11957302

    A New Vision for Accounting   http://www.cfo.com/article.cfm/10597001

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


    Note the Link to Company Audits

    "The corporate kleptomaniacs Companies are boosting their profits through cartels and price-fixing strategies. It is time to jail their executives for picking our pockets," by Prem Sikka, The Guardian, April 19, 2008 --- http://commentisfree.guardian.co.uk/prem_sikka_/2008/04/the_corporate_kleptomaniacs.html

    Companies increasingly take people for a ride. They issue glossy brochures and mount PR campaigns to tell us that they believe in "corporate social responsibility". In reality, too many are trying to find new ways of picking our pockets.

    Customers are routinely fleeced through price-fixing cartels. Major construction companies are just the latest example. Allegations of price fixing relate to companies selling dairy products, chocolates, gas and electricity, water, travel, video games, glass, rubber products, company audits and almost everything else. Such is the lust for higher profits that there have even been suspected cartels for coffins, literally a last chance for corporate barons to get their hands on our money.

    Companies and their advisers sell us the fiction of free markets. Yet their impulse is to build cartels, fix prices, make excessive profits and generally fleece customers. Many continue to announce record profits. The official UK statistics showed that towards the end of 2007 the rate of return for manufacturing firms rose to 9.7% from 8.8%. Service companies' profitability eased to 21.2% from a record high of 21.4%. The rate of return for North Sea oil companies rose to 32.5% from 30.1%. Supermarkets and energy companies have declared record profits. One can only wonder how much of this is derived from cartels and price fixing. The artificially higher prices also contribute to a higher rate of inflation which hits the poorest sections of the community particularly hard.

    Cartels cannot be operated without the active involvement of company executives and their advisers. A key economic incentive for cartels is profit-related executive remuneration. Higher profits give them higher remuneration. Capitalism does not provide any moral guidance as to how much profit or remuneration is enough. Markets, stockbrokers and analysts also generate pressures on companies to constantly produce higher profits. Companies respond by lowering wages to labour, reneging on pension obligations, dodging taxes and cooking the books. Markets take a short-term view and ask no questions about the social consequences of executive greed.

    The usual UK response to price fixing is to fine companies, and many simply treat this as another cost, which is likely to be passed on to the customer. This will never deter them. Governments talk about being tough on crime and causes of crime, but they don't seem to include corporate barons who are effectively picking peoples' pockets.

    Governments need to get tough. In addition to fines on companies, the relevant executives need to be fined. In the first instance, they should also be required to personally compensate the fleeced customers. Executives participating in cartels should automatically receive a lifetime ban on becoming company directors. There should be prison sentences for company directors designing and operating cartels. That already is possible in the US. Australia's new Labour government has recently said that it will impose jail terms on executives involved in cartels or price fixing. The same should happen in the UK too. All correspondence and contracts relating to the cartels should be publicly available so that we can all see how corporations develop strategies to pick our pockets and choose whether to boycott their products and services.

    Is there a political party willing to take up the challenge?

    Bob Jensen's threads on The Saga of Audit Firm Professionalism and Independence are at http://www.trinity.edu/rjensen/Fraud001.htm#Professionalism 

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

     


    G20 Declaration and IASB Response

    From Deloitte's IAS Plus Blog on April 8, 2009 --- http://www.iasplus.com/index.htm

  • 8 April 2009: G20 Declaration and IASB response
     
      The Declaration on Strengthening the Financial System (PDF 137k) issued by the leaders of the Group of 20 (G20) following their meeting in London on 2 April 2009 calls on the accounting standard setters to improve standards for determining the fair values of financial instruments in illiquid markets and to take other actions regarding complexity of financial reporting, provisioning, and off balance sheet financing, among other matters:
    Accounting standards
    We have agreed that the accounting standard setters should improve standards for the valuation of financial instruments based on their liquidity and investors' holding horizons, while reaffirming the framework of fair value accounting.

    We also welcome the FSF recommendations on procyclicality that address accounting issues. We have agreed that accounting standard setters should take action by the end of 2009 to:

    • reduce the complexity of accounting standards for financial instruments;
    • strengthen accounting recognition of loan-loss provisions by incorporating a broader range of credit information;
    • improve accounting standards for provisioning, off-balance sheet exposures and valuation uncertainty;
    • achieve clarity and consistency in the application of valuation standards internationally, working with supervisors;
    • make significant progress towards a single set of high quality global accounting standards; and
    • within the framework of the independent accounting standard setting process, improve involvement of stakeholders, including prudential regulators and emerging markets, through the IASB's constitutional review.
    The IASB has responded to the G20 leaders' recommendations and, at the same time, to Recent Decisions taken by the US Financial Accounting Standards Board (FASB). Here are excerpts:
    • The IASB's response to the G20: 'The IASB is committed to taking action on each of the items recommended by the G20 by the end of 2009, the target date suggested by the G20, in order to ensure globally consistent and appropriate responses to the crisis.'

       

    • The IASB's response to the FASB actions: 'Initial reports regarding new or additional divergences between IFRSs and US GAAP being created by these FSPs appear to be overstated. A preliminary review of the FASB's decisions by IASB staff indicates that FASB�s objectives and approach on the application of fair value when a market is not active appear to be broadly similar to those in IFRSs.'
    Click for IASB Press Release (PDF 106k).
  • The Institute of Chartered Accountants of Scotland (ICAS) says that key business information and risks to companies are obscured by the volume and level of detail of disclosures in corporate annual reports. This means that investors and other users of financial information have found it harder than it should be to determine important details about listed companies during the financial crisis. Please click through for further details.
    "ICAS SAYS ANNUAL REPORTS HAVE FAILED TO TELL A CLEAR STORY DURING THE FINANCIAL CRISIS," AccountingEducation.com, April 6, 2009 --- http://accountingeducation.com/index.cfm?page=newsdetails&id=149309
    Jensen Comment
    Scotland is part of the United Kingdom which in turn is part of the European Union. Hence Scotland is under IFRS accounting standards with possible exceptions adopted by the EU.

    Bob Jensen's threads on controversies in the setting of accounting standards are at http://www.iasplus.com/index.htm


    The Filled and Unfilled KPMG Professorships in Accounting

    The KPMG Foundation --- http://www.kpmgfoundation.org/index.asp

    The KPMG Foundation 2008 Annual Report summarizes how much, and it has been a lot, the KPMG Foundation has done for higher education in accounting. The two most notable programs among various programs, at least in my thinking, have been the minority student doctoral fellowships program and the KPMG professorships. The KPMG Professorship program motivates alumni who work or previously worked for KPMG to donate annually back to their alma maters to help provide those universities with top accounting professors. The KPMG Professors in 38 universities are listed on Page 3 of the 2008 KPMG Foundation 2008 Annual Report. This pleases me since I was, for a time, the KPMG Professor at Florida State University.

    What saddens me, however, is to note that the same Page 3 of the Report also lists the 11 universities that have unfilled KPMG Professorships. It seems a shame to not spend these funds for top accounting faculty since, in most cases, these universities have accounting faculty shortages. The 11 universities are as follows:

    The KPMG Foundation is also providing donations, along with the other CPA firms, to the AICPA's new Accounting Doctoral Scholars fellowship program for doctoral students specializing in tax and auditing, two specialties where there are notable shortages in among the annual supply of doctoral graduates for teaching and research.

    In so many ways, CPA firms have given generously of money, time, training, and materials to higher education accountancy programs. This has helped tie the accounting schools/departments much closer to the profession than many other disciplines have with their professions.

    What I admire most is that the CPA firms have done this when the professors themselves have been negligent in responding to pleas for more involvement by accounting educators in standard setting and for research innovations of interest to CPA practitioners (name one in financial accounting?) --- http://www.trinity.edu/rjensen/theory01.htm#AcademicsVersusProfession

    Of course the CPA firms benefit greatly from availability of highly talented accounting graduates who have made it through rigorous filters of 30 or more credits in accounting in our colleges. The students, in turn, benefit greatly from internships provided by the firms and from financial support given to their alma maters. It would be even better if the firms' partners benefitted from academic accounting research to the extent that they could remember two or three top academic accounting journal studies off the tops of their heads.

    Also see http://www.trinity.edu/rjensen/theory01.htm#DoctoralPrograms


    The National Library of the Accounting Profession

    Hi Linda,

    The National Library of the Accounting Profession at Ole Miss has a home page at http://www.olemiss.edu/depts/accountancy/libraries.html  

    This includes a link to the Digital Collection in this library.
    My reason for mentioning this is explained below.

    In 1986 when Steve Zeff was President of the AAA, I was his Program Director for the annual meetings in the heart of Times Square (Marriott Marquis). Although NYC is always a relatively high priced hotel city and a rather poor choice for accompanying families with small children, NYC did have some huge advantages for me as program director and for registrants who attended some unique sessions in NYC.

    The biggest advantage (aside from the private showing of CATS that I've already mentioned) was that we could get some top investment bankers from Wall Street to appear on the program. Those particular sessions were so well attended that people were packed into the meeting rooms like sardines. Those speakers would've never taken the time to take a day off to fly to be in a concurrent session of the AAA annual meetings. But they agreed to take the time off to take a cab to Times Square to be on our program.

    I suspect that there will be similar advantages for the 2009 meetings in NYC if the AAA can arrange for parole of some of the top Wall Street speakers. It would really be nice to compare how the messages changed between 1986 and 2009.

    I've already mentioned that, before I retired in 2006, I captured nearly two decades of video of sessions at accounting educator meetings, especially the American Accounting Association annual meetings. I suspect that some of those 1986 NYC sessions are among the 200+ videotapes that I donated to the National Library of the Accounting Profession at the University of Mississippi.

    It may be necessary to travel to the University of Mississippi to view these tapes, but Dale Flesher can probably arrange it so researchers can view these and other archived presentations on my tapes. Dale has my only copies.

    The National Library of the Accounting Profession at Ole Miss has a home page at http://www.olemiss.edu/depts/accountancy/libraries.html
    This includes a link to the Digital Collection in this library, but these are only a small percentage of the recordings available in the library.

    I mention my video tapes because in later years I taped two successive annual meeting presentations by Denny Beresford when, as Chairman of the FASB, his struggles to get FAS 119 and 133 launched were just getting started under a storm of controversy. People don't realize that the SEC virtually mandated that the FASB generate FAS 133. SEC Director told Denny that the “top three priorities at the FASB should be Derivatives, Derivatives, and Derivatives.”

    I have made audio recordings of Denny's two successive sessions available online. Denny is not only an articulate speaker he has a great sense of humor. One of my all time favorite lines is when he referred to a "derivative as something a person my age takes when prunes just quite do the job."

    To download the audio files of Dennis Beresford scroll down at http://www.cs.trinity.edu/~rjensen/000overview/mp3/133summ.htm

    Bob Jensen


    "Make Sense of Financial Reporting with XBRL," Pennsylvania CPA Journal via SmartPros, April 4, 2009, ---
    http://accounting.smartpros.com/x66163.xml

    Jensen Comment

    Probably the most important XBRL and IDEA links at the moment are as follows:

    IDEA (destined to replace EDGAR) --- http://www.sec.gov/spotlight/idea.shtml

    XBRL Home --- http://www.xbrl.org/Home/
    www.xbrl.org is XBRL International. www.xbrl.us is the U.S. jurisdiction.

    Financial Reporting Using XBRL (maintained by Charles Hoffman) --- http://xbrl.squarespace.com/journal/?currentPage=2

    XBRL Canada Blog (maintained by Jerry Trites) --- http://www.zorba.ca/xbrlblog.html

    XBRL Networking --- http://xbrlnetwork.ning.com/

    Hitachi interactive data blog on XBRL --- http://hitachidatainteractive.com/ 

    TryXBRL --- http://www.tryxbrl.org/

    Bryant University Resource Center --- http://www.xbrl.org/Home/

     

    Rivet XBRL Markup Software (Proprietary) --- http://www.rivetsoftware.com/

     

    UB Matrix Enterprise Applications Suite (Proprietary) --- http://www.ubmatrix.com/products/enterprise_application_suite.htm

    April 14, 2009 reply from Eric E. Cohen/RBJ [cybercpa@SPRYNET.COM]

    A few more links:

    FREE XBRL software for use by academics/consortium: http://www.fujitsu.com/global/services/software/interstage/xbrltools/ 
    FREE (and royalty free) XBRL Validation engine and (not free) XML/XBRL tooling: http://www.altova.com 

    Important webcasts and learning resources for one of the NON-financial reporting sides of XBRL - the XBRL Global Ledger Framework (XBRL GL) - http://gl.iphix.net

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


    Issues in Teaching Computerized Accounting

    April 30, 2009 message from Mark Meuwissen [MarkM@ALEXTECH.EDU]

    My students are learning the mechanical process, but aren't able to apply their knowledge

    So we don't clutter everyone's email accounts, or publicly praise or bash any particular author, please feel free to respond directly to my email at markm@alextech.edu <mailto:markm@alextech.edu>  . If you have a comment relevent to the entire group, then go ahead and reply to all.

    Background:

    I am teaching a two credit course where one credit each is dedicated to QuickBooks and Peachtree. I use the same publisher for both, but am not happy with the Peachtree textbook. The textbook is very mechanical walking through each of the various tasks you need to learn with lots of pictures. However, the textbook has too many errors and is so step by step that the students don't have to think about what they are doing. This approach is okay for the first half semester using QuickBooks, but by the second half of the semester, they are ready for a little more application. We have considered dropping Peachtree and spending the second half of the semester on application case studies for QuickBooks, but at this time, I'm looking for a better Peachtree solution.

    To explain the issue a different way, I think my students are mechanically good at QuickBooks. We finish the entire textbook and do a fair amount of the end of chapter assignments. However, several of my better students attempted to compete in a BPA computerized accounting contest and failed to even get the company set up. I also had a test group play Monopoly, and asked them to record all their transactions in QuickBooks. It was a pretty sad day for me when I saw income statements with the purchase of a house recorded as an expense, accumulated depreciation as a debit with the offsetting credit to land, opening balance equity accounts rather than capital accounts, undeposited funds on the balance sheet, and a few other odd things.

    Everyone taking this course will have completed Principles of Accounting.

    What I need:

    I am looking for testimonials or advise on how some of you have bridged the gap between textbook and application. I am curious what textbooks you like and why. Any suggestions? Do you feel there is a need to teach both Peachtree and QuickBooks?

    Thank you for any thoughts you might have.

    Mark Meuwissen
    Accounting Instructor,
    Alexandria Technical College

    May 3, 2009 reply from Bob Jensen

    Hi Mark,

    The problem may be that your students are learning the computerized accounting but not accounting. Hence garbage in, garbage out.

    Some colleges avoid this by not teaching computerized accounting in order to free up more time to learn accounting.

    Other colleges provide accounting in credit courses and computerized accounting in non-credit courses.

    Other colleges require computerized accounting and accounting in three or four basic courses rather than the typical two-course sequence of Principles of Accounting. However, those schools often do not require as many upper division accounting courses.

    You might especially look for David Fordham's commentary about this by scrolling down at http://www.trinity.edu/rjensen/Bookbob1.htm#software 

    Bob Jensen


    Questions
    What is American Airline's estimate of the labor cost per seat per mile?
    What are the accounting issues in calculating and using this number?
    Calculate the distance between airports --- http://www.convertunits.com/distance/

    Union Troubles at American Airlines --- Among other things, pilots want a 50% pay increase
    Unions do not seem to be swayed by the strong likelihood that AMR will declare bankruptcy
    Is American Airlines too big to fail?
    Is labor counting, with a friend in the Whitehouse, on a government bailout of American Airlines?

    From The Wall Street Journal Accounting Weekly Review on April 16, 2009

    Labor Demands Cloud AMR Outlook
    The Wall Street Journal
    by Mike Esterl
    Apr 13, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB123966126899114845.html?mod=djem_jiewr_AC
     

    TOPICS: Cost Accounting, Cost Management, Derivatives, Financial Analysis, Financial Statement Analysis, Managerial Accounting

    SUMMARY: The two articles cover current issues facing the airline industry. Despite AMR Corp. facing liquidity concerns and a first-quarter loss to be announced on Wednesday, 4/15, that is expected to amount to about $400 million, American airlines pilots are demanding a 50% increase in pay. The pilots gave pay concessions in 2003 to help the company survive at that time, but now "the 2003 concessions 'are viewed by our pilots as a loan, and it's time to restore [them],' says Sam Mayer, a pilot union spokesman and 767 captain for American." Southwest Airlines is mentioned in the first article; the related article focuses on its difficulties after having entering into fuel cost hedging transactions.

    CLASSROOM APPLICATION: The article may be used in management accounting classes to discuss labor cost measurements, labor negotiations, and other cost measurements unique to the airline industry. To assess costs facing the airline industry, typical financial statement ratios are measured in relation to passenger miles: American's labor cost is identified as the highest of 13 biggest airlines complied by the Federal Bureau of Transportation Statistics at $.0369 per available seat mile. The related article also covers fuel costs and hedging activities from a managerial accounting and financial accounting perspective.

    QUESTIONS: 
    1. (Introductory) What is the current state of the airline industry, inasmuch as you can glean from this article or your general knowledge.

    2. (Introductory) Why are American Airlines pilots negotiating for significant pay increases in their next labor contract? How are their negotiations with corporate management undertaken--that is, who negotiates for the pilots?

    3. (Introductory) Airline employees are expressing discontent about management pay in the last few years. How is this issue related to turmoil in other U.S. corporations about that issue?

    4. (Advanced) How are airline costs measured? Define the formula you think may be used for these measurements. How does this help compare costs amongst different carriers?

    5. (Advanced) Who compiles statistics about airline operating costs? How are this entity's needs satisfied by general purpose financial reporting and financial reporting requirements established by the Financial Accounting Standards Board? In your answer, define the term "general purpose financial statements".

    6. (Advanced) Refer to the related article regarding Southwest Airline's "fuel-hedging program". How do airlines hedge fuel costs? Be specific in describing the types of contracts the airline will enter into and the accounting requirements for those contracts.

    7. (Advanced) What does this mean to say that the "value" of the Southwest fuel hedging program is declining?

    8. (Advanced) What actions are Southwest taking regarding future fuel needs? What do you think that behavior says about the company's expectations for future oil prices?
     

    Reviewed By: Judy Beckman, University of Rhode Island
     

    RELATED ARTICLES: 
    Southwest Airlines Swings to $91 Million Loss, Plans Buyouts
    by Mike Esterl
    Apr 16, 2009
    Online Exclusive
     

    "Labor Demands Cloud AMR Outlook." by Mike Esterl, The Wall Street Journal, April 18, 2009 ---
    http://online.wsj.com/article/SB123966126899114845.html?mod=djem_jiewr_AC

    American Airlines is mired in increasingly contentious labor negotiations with its pilots, flight attendants and maintenance crews -- six years after union concessions allowed the carrier to avoid bankruptcy protection.

    The AMR Corp. unit faces growing liquidity concerns as it prepares to announce Wednesday a first-quarter loss that analysts have forecast at about $400 million. American last month said it expected to end the quarter with a cash and short-term investment balance of approximately $3.1 billion, down from $3.6 billion at the end of December.

    Wednesday's report will be the first in a series of what are likely to be dismal earnings announcements from U.S. airlines. Even as the recession is gutting corporate travel budgets, workers at many carriers, emboldened by what they see as a more labor-friendly environment in Washington, are trying to win back wage cuts that helped the industry survive the last downturn.

    The situation is especially tense at American. Workers at the second-largest U.S. airline by traffic agreed in 2003 to $1.8 billion in payroll cuts, pushing compensation to levels of a decade earlier. But many of the airline's rivals -- including Delta Air Lines Inc., US Airways Group Inc. and UAL Corp. unit United Airlines -- secured bigger cuts in recent years through bankruptcy courts.

    American's labor cost, at 3.69 cents per available seat mile as of last September, was the highest in a list of 13 biggest airlines compiled by the federal Bureau of Transportation Statistics. Southwest Airlines Co. was No. 2 at 3.44 cents. Also, employee benefits, which were cut sharply at other airlines, have remained largely intact at American.

    Nevertheless, American's pilots are demanding a 50% pay increase. The Allied Pilots Association has rented billboards near the Dallas-Fort Worth and Chicago O'Hare airports, slamming $300 million in bonuses to the company's top 1,000 executives over the past three years and highlighting an ongoing government probe into possible safety violations at the airline.

    The 2003 concessions "are viewed by our pilots as a loan, and it's time to restore us," says Sam Mayer, a pilot-union spokesman and 767 captain for American.

    American's pilots are among the most experienced in the industry and among the highest paid. They earned an average of about $225,000 in salary and benefits in 2007, depending on seniority and other factors -- well above a 15-airline average of $188,268, according to the Massachusetts Institute of Technology.

    American's management says its executive compensation is in line with other airlines and that the airline's safety is top-notch.

    The Federal Aviation Administration is continuing its investigation of wiring problems on American aircraft. The airline and pilots union since last May have been in talks supervised by the National Mediation Board. American has since entered federal mediation with representatives of its flight attendants and maintenance crews.

    Delta, the biggest U.S. airline, and Southwest Airlines, the largest low-cost carrier, recently struck agreements for increases well below what is sought at American. But talks are growing more combative at US Airways, where pilots are pressing for federal mediation. Negotiations with United's main unions are getting underway this month.

    Negotiations at American could drag on for months. Under federal labor law, airline employees are prohibited from striking until mediators declare an impasse. If they strike, the White House can order employees back to work, as it did 24 minutes after a pilot strike was called at American in 1997.

    Laura Glading, head of the Association of Professional Flight Attendants, says American attendants also want to be made whole after their salaries were cut by more than 25% six years ago. The Transport Workers Union of America, which represents American's maintenance crews, has called for annual pay increases of 6%, 4% and 3%, respectively, over the next three years. Transport workers plan to shred and burn mock executive pay checks at American's headquarters in Fort Worth on Tuesday.

    American has yet to make wage counterproposals to the pilots' union or flight attendants, preferring to first work on productivity issues. The airline's most recent offer to transport workers included a 5% bonus payment in return for scaled-back medical benefits. American also said last week that it will freeze wages for nonunion employees, which represent about a quarter of the airline's U.S. work force.

    Analysts say big pay increases at American could push the airline to the brink of insolvency.

    American executives are making the same argument as they urge unions to scale back demands. "If we don't exist, they don't exist," says Jeffrey Brundage, American's senior vice president for human resources.

    Fitch Ratings slashed the airline's credit rating last month to triple-C, pushing the rating deeper into speculative, or junk, territory.

    The deadlock with pilots already has stalled American's plan to fly planes to Beijing from Dallas, which is subject to the pilots' approval because it involves long-distance flights. Unions also could step up opposition to possible job cuts from a proposed trans-Atlantic alliance between American and British Airways PLC that is receiving antitrust scrutiny. Unions hope their leverage will improve since President Barack Obama nominated Linda Puchala, a former flight-attendant-union official, last month to run the National Mediation Board. Ms. Puchala awaits Senate confirmation and didn't respond to requests for an interview.

    The current chairman, Read Van de Water, was a former lobbyist for Northwest Airlines Corp. The board has been neutral in all its work, she says, and has been equally strict with companies and unions. Ms. Van de Water says negotiations between American and its pilots have been "very, very tough" and that both sides remain far apart.

    Jensen Comment
    There are huge problems in computing the labor cost per seat per mile for American Airlines. First of all there's the problem of defining "labor" cost. Secondly, there are joint costs of providing services such as cargo and mail hauling versus passenger hauling. Any joint cost allocation formula is arbitrary. Thirdly, many airline labor costs such as maintenance labor costs and pilot costs and passenger agent costs are fixed or semi-fixed such that adding or eliminating flights does not correlate very well with changes in labor costs.

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


    Capital Structure --- http://en.wikipedia.org/wiki/Capital_Structure
    Modigliani-Miller theorem --- http://en.wikipedia.org/wiki/Modigliani-Miller_theorem

    The Modigliani-Miller theorem (of Franco Modigliani, Merton Miller) forms the basis for modern thinking on capital structure. The basic theorem states that, in the absence of taxes, bankruptcy costs, and asymmetric information, and in an efficient market, the value of a firm is unaffected by how that firm is financed.[1] It does not matter if the firm's capital is raised by issuing stock or selling debt. It does not matter what the firm's dividend policy is. Therefore, the Modigliani-Miller theorem is also often called the capital structure irrelevance principle.

    Modigliani was awarded the 1985 Nobel Prize in Economics for this and other contributions.

    Miller was awarded the 1990 Nobel Prize in Economics, along with Harry Markowitz and William Sharpe, for their "work in the theory of financial economics," with Miller specifically cited for "fundamental contributions to the theory of corporate finance."

     

    The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company's securities or the risk of investing in them. My belief -- first stated 40 years ago in a graduate thesis and later confirmed by experience -- is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors -- the company and its management, industry dynamics, the state of capital markets, the economy, government regulation and social trends. When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.
    Michael Milken, "Why Capital Structure Matters Companies that repurchased stock two years ago are in a world of hurt," The Wall Street Journal, April 21, 2009 --- http://online.wsj.com/article/SB124027187331937083.html

    Thirty-five years ago business publications were writing that major money-center banks would fail, and quoted investors who said, "I'll never own a stock again!" Meanwhile, some state and local governments as well as utilities seemed on the brink of collapse. Corporate debt often sold for pennies on the dollar while profitable, growing companies were starved for capital.

    If that all sounds familiar today, it's worth remembering that 1974 was also a turning point. With financial institutions weakened by the recession, public and private markets began displacing banks as the source of most corporate financing. Bonds rallied strongly in 1975-76, providing underpinning for the stock market, which rose 75%. Some high-yield funds achieved unleveraged, two-year rates of return approaching 100%.

    The accessibility of capital markets has grown continuously since 1974. Businesses are not as dependent on banks, which now own less than a third of the loans they originate. In the first quarter of 2009, many corporations took advantage of low absolute levels of interest rates to raise $840 billion in the global bond market. That's 100% more than in the first quarter of 2008, and is a typical increase at this stage of a market cycle. Just as in the 1974 recession, investment-grade companies have started to reliquify. Once that happens, the market begins to open for lower-rated bonds. Thus BB- and B-rated corporations are now raising capital through new issues of equity, debt and convertibles.

    This cyclical process today appears to be where it was in early 1975, when balance sheets began to improve and corporations with strong capital structures started acquiring others. In a single recent week, Roche raised more than $40 billion in the public markets to help finance its merger with Genentech. Other companies such as Altria, HCA, Staples and Dole Foods, have used bond proceeds to pay off short-term bank debt, strengthening their balance sheets and helping restore bank liquidity. These new corporate bond issues have provided investors with positive returns this year even as other asset groups declined.

    The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company's securities or the risk of investing in them.

    My belief -- first stated 40 years ago in a graduate thesis and later confirmed by experience -- is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors -- the company and its management, industry dynamics, the state of capital markets, the economy, government regulation and social trends. When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.

    Over the past four decades, many companies have struggled with the wrong capital structures. During cycles of credit expansion, companies have often failed to build enough liquidity to survive the inevitable contractions. Especially vulnerable are enterprises with unpredictable revenue streams that end up with too much debt during business slowdowns. It happened 40 years ago, it happened 20 years ago, and it's happening again.

    Overleveraging in many industries -- especially airlines, aerospace and technology -- started in the late 1960s. As the perceived risk of investing in such businesses grew in the 1970s, the price at which their debt securities traded fell sharply. But by using the capital markets to deleverage -- by paying off these securities at lower, discounted prices through tax-free exchanges of equity for debt, debt for debt, assets for debt and cash for debt -- most companies avoided default and saved jobs. (Congress later imposed a tax on the difference between the tax basis of the debt and the discounted price at which it was retired.)

    Issuing new equity can of course depress a stock's value in two ways: It increases the supply, thus lowering the price; and it "signals" that management thinks the stock price is high relative to its true value. Conversely, a company that repurchases some of its own stock signals an undervalued stock. Buying stock back, the theory goes, will reduce the supply and increase the price. Dozens of finance students have earned Ph.D.s by describing such signaling dynamics. But history has shown that both theories about lowering and raising stock prices are wrong with regard to deleveraging by companies that are seen as credit risks.

    Two recent examples are Alcoa and Johnson Controls each of which saw its stock price increase sharply after a new equity issue last month. This has happened repeatedly over the past 40 years. When a company uses the proceeds from issuance of stock or an equity-linked security to deleverage by paying off debt, the perception of credit risk declines, and the stock price generally rises.

    The decision to increase or decrease leverage depends on market conditions and investors' receptivity to debt. The period from the late-1970s to the mid-1980s generally favored debt financing. Then, in the late '80s, equity market values rose above the replacement costs of such balance-sheet assets as plants and equipment for the first time in 15 years. It was a signal to deleverage.

    In this decade, many companies, financial institutions and governments again started to overleverage, a concern we noted in several Milken Institute forums. Along with others, including the U.S. Chamber of Commerce, we also pointed out that when companies reduce fixed obligations through asset exchanges, any tax on the discount ultimately costs jobs. Congress responded in the recent stimulus bill by deferring the tax for five years and spreading the liability over an additional five years. As a result, companies have already moved to repurchase or exchange more than $100 billion in debt to strengthen their balance sheets. That has helped save jobs.

    The new law is also helpful for companies that made the mistake of buying back their stock with new debt or cash in the years before the market's recent fall. These purchases peaked at more than $700 billion in 2007 near the market top -- and in many cases, the value of the repurchased stock has dropped by more than half and has led to ratings downgrades. Particularly hard hit were some of the world's largest companies (i.e., General Electric, AIG, Merrill Lynch); financial institutions (Hartford Financial, Lincoln National, Washington Mutual); retailers (Macy's, Home Depot); media companies (CBS, Gannett); and industrial manufacturers (Eastman Kodak, Motorola, Xerox).

    Without stock buybacks, many such companies would have little debt and would have greater flexibility during this period of increased credit constraints. In other words, their current financial problems are self-imposed. Instead of entering the recession with adequate liquidity and less debt with long maturities, they had the wrong capital structure for the time.

    The current recession started in real estate, just as in 1974. Back then, many real-estate investment trusts lost as much as 90% of their value in less than a year because they were too highly leveraged and too dependent on commercial paper at a time when interest rates were doubling. This time around it was a combination of excessive leverage in real-estate-related financial instruments, a serious lowering of underwriting standards, and ratings that bore little relationship to reality. The experience of both periods highlights two fallacies that seem to recur in 20-year cycles: that any loan to real estate is a good loan, and that property values always rise. Fact: Over the past 120 years, home prices have declined about 40% of the time.

    History isn't a sine wave of endlessly repeated patterns. It's more like a helix that brings similar events around in a different orbit. But what we see today does echo the 1970s, as companies use the capital markets to push out debt maturities and pay off loans. That gives them breathing room and provides hope that history will repeat itself in a strong economic recovery.

    It doesn't matter whether a company is big or small. Capital structure matters. It always has and always will.

    Michael Milken is chairman of the Milken Institute.

    April 22, 2009 reply from David Albrecht [albrecht@PROFALBRECHT.COM]

  • The late Nobel laureate Merton Miller and I, although good friends, long debated whether this kind of capital-structure management is an essential job of corporate leaders. Miller believed that capital structure was not important in valuing a company's securities or the risk of investing in them. My belief -- first stated 40 years ago in a graduate thesis and later confirmed by experience -- is that capital structure significantly affects both value and risk. The optimal capital structure evolves constantly, and successful corporate leaders must constantly consider six factors -- the company and its management, industry dynamics, the state of capital markets, the economy, government regulation and social trends. When these six factors indicate rising business risk, even a dollar of debt may be too much for some companies.

    Bob, is the above passage your statement? If so, AECMers will no doubt be alarmed to hear that once again I agree with you. Oh, I don't agree to the extent that I've been teaching it 40 years (after all, you are older than I), but I have been teaching it for ten years or so.

    When I teach the right side of the balance sheet, as well as the non-operating part of the income statement), I run students through a review of capital structure. The right hand side of the balance sheet starts with current liabilities (20-30% of assets on average), then the remaining 70-80% is split between long-term liabilities and common equity. It is easy to see the industry risk effect on the relative composition of this large remainder. Companies that are inherently risky due to being built on easy to disappear intellectual property have very little in the way long-term liabilities. Examples are Internet/software companies like Google or Microsoft, and pharmaceuticals like Merck. Companies that are mostly riskless due to permanence of their assets can bear much in the way of long-term liabilities. I used to cite commercial banks as an example, because the legal system and federal guarantees protects some of the liabilities.

    I for one champion the move to value liabilities at fair value, as it can be a useful benchmark for analysts to judge the relative proportion of debt to equity in the capital structure.

    However, there is a lot of criticism of fair value applied to the right side of the balance sheet. I've received a handful of comments that oppose right-hand side fair valuation in severe downturns just like we have experienced. Because bank assets take a hit, the survivability of the bank is at question. This means that if a higher or riskier interest rate were applied to value right-hand side liabilities, there would be a gain that could swamp the losses from the asset side. There are some that don't like a company reporting a neutral income statement when the company is going down the tubes. Consequently, they call for scaling back the fair value rule to the asset side only.

    David Albrecht

    April 22, 2009 reply from Bob Jensen

    Hi David,

    That passage was written by Mike Milken, which is why I had it in italics and a different color.

    I don’t think Milken was thinking about accounting rules when he wrote this article. He probably was thinking more in terms of held-to-maturity debt under FAS 115 rules where HTM debt is not marked-to-market with changing capital structure levels that are actually hypothetical.

    The problem with fair value adjustments of long term debt is that these adjustments are poorly correlated with cash flows and can change capital structure in misleading ways for firms not intending to buy back debt. There are many reasons firms will not buy back debt even when there are gains to be realized from declines in interest rates. One of the big barriers is the transaction cost of buying back debt which makes it take a pretty large drop in interest rates to make buy-backs worthwhile.

    Another factor is that debt holders often will not sell unless forced to do so in call back clauses of debt contracts, but the call back penalties may be very high and add to the transactions costs. For this reason debt is commonly classified as HTM and not adjusted to fair value.

    Another reason firms do not commonly buy back debt is that FAS 125 ended the practice of in-substance defeasance for getting around call back fees and transactions costs for live debt that was being removed, before FAS 125, with defeasance accounting.

    In-substance defeasance used to be a ploy to take debt off the balance sheet. It was invented by Exxon in 1982 as a means of capturing the millions in a gain on debt (bonds) that had gone up significantly in value due to rising interest rates. The debt itself was permanently "parked" with an independent trustee as if it had been cancelled by risk free government bonds also placed with the trustee in a manner that the risk free assets would be sufficient to pay off the parked debt at maturity. The defeased (parked) $515 million in debt was taken off of Exxon's balance sheet and the $132 million gain of the debt was booked into current earnings --- http://www.bsu.edu/majb/resource/pdf/vol04num2.pdf 

    Defeasance was thus looked upon as an alternative to outright extinguishment of debt until the FASB passed FAS 125 that ended the ability of companies to use in-substance defeasance to remove debt from the balance sheet. Prior to FAS 125, defeasance became enormously popular as an OBSF ploy.

    The bottom line is that I think long-term debt should not be adjusted for fair value although fair value trends should be disclosed in footnotes.

    As with CAPM, the MM assumptions are unrealistic. However, much empirical evidence (of the accountics variety) points to evidence that the MM theory is relatively robust. However, this empirical support also makes limiting assumptions in testing models that test the MM theory. The MM theorem has been used over and over again in practice to justify adding leverage.

    Certainly the MM Theorem has not gone unchallenged. Probably the best known critic is Myron Gordon Gordon, Myron J. (1989). "Corporate Finance Under the MM Theorems". Financial Management 18 (2): 19–28

    I think most finance courses have tended to treat it the MM theorem as a given. The theorem has been expanded to include taxation.

    Yale’s finance/economics professor Robert Shiller has a video lecture on MM theory at http://www.youtube.com/watch?v=Wj1GnT8xlj4 

    Bob Jensen

     


    Datawatch's Monarch data mining software --- http://www.datawatch.com/_products/monarch_pro.php
    "Kean and Emory Introduce Students to Data Mining," by Dian Schaffhauser, Campus Technology, April 6, 2009 ---
    http://campustechnology.com/articles/2009/04/06/kean-and-emory-introduce-students-to-data-mining.aspx
    Link forwarded by Ed Scribner

    Two universities--Kean University in Union, NJ and Emory University in Atlanta, GA--have gone public with their use of Datawatch's Monarch data mining software to teach students how to perform business intelligence work.

    Kean professor Beth Brilliant introduced Monarch to graduate students of her accounting information systems (AIS) and auditing information system classes.

    "I have been using Monarch for years as a [certified public accountant] and swear by it," said Brilliant. "For example, I use Monarch to quickly find any bank discrepancies. As I work for a law firm with client trust accounts, this is extremely important, as all accounts must balance to the penny. I am able to reconcile all the accounts in minutes thanks to Monarch, picking up differences in checks from pennies to hundreds of thousands of dollars."

    Brilliant added, "My department has also become more efficient with the use of Monarch, saving hours by importing data into the accounting system electronically vs. manually. Reports that I receive from vendors are saved as PDF files, which are mined using Monarch. The data is then extracted and imported into our accounting system. This not only saves time but it removes the risk of manual data input errors."

    "I rely on Monarch to ensure data quality and to ensure I know exactly where company data is coming from, with no need to rely on the company's accounting and IT departments," she explained. "Monarch is an excellent resource for auditors and accountants, and well worth including Monarch within my AIS coursework."

    Robert Gross teaches a graduate course on managing healthcare databases at the Rollins School of Public Health at Emory. The course is part of the curriculum for the university's master of public health degree.

    "Most of my students are physicians and other working healthcare providers, middle managers and public health agency leaders," said Gross. "The students are non-technical, yet must understand how to independently gather, sift, sort, and work effectively with public and private healthcare information sources. We address issues including effective data access strategies, how to ensure data quality, comply fully with HIPAA, and actively work with healthcare data using Excel, Access, and several statistical analysis products."

    Continued in article

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


    "Are clean opinions materially misstated?" by Gary Zeune, AccountingWeb, January 30, 2009 ---
    http://www.accountingweb.com/cgi-bin/item.cgi?id=106906

    Have you ever asked yourself, "Why do we even do audits?" Most CPAs will say, "Because they are required?" But why are audits required? Audited financial statements are valuable because they reduce the client's cost of capital. How? Because audited statements reduce the user's assessed risk. Assume a bank has a loan request from two companies, identical in every respect, except that one has audited statements and the other doesn't. All things being equal, the bank will charge a lower rate of interest, and maybe impose fewer or less onerous covenants, to the company with audited statements.

    So where does audited financial statement value come from? There are two sources. The first source is that the numbers are fairly presented, not materially misstated. To most users fairly presented means the numbers are 'right' or 'accurate.' The second source of value is that users believe the numbers are right. Even if the financial statements have a 'clean' opinion, if the user, bank loan officer, donor, vendor, customer, taxpayer, doesn't believe it, the statements have no value.

    So how do you create 'believability' value? We all know that the second general standard in SAS No. 1 requires auditors to be independent. To be qualified to issue an opinion you must be independent. If you're not independent you have disqualified yourself from issuing and opinion, even if the numbers are 'right.' Here are four requirements in SAS No. 1 that you must comply with to qualify to issue an opinion:

     

    1. For dependability of his findings, auditors must be without bias — not a prosecutor but should have judicial impartiality and an obligation for fairness on those who rely on it.
       
    2. To be independent, an auditor must be intellectually honest.
       
    3. Auditors should avoid situations that may lead outsiders to doubt their independence.
       
    4. Our code of conduct has precepts to guard against presumption of loss of independence.

    Unfortunately, there are a whole host of structural defects and behaviors that make if nearly impossible to comply with the independence requirement.

    Auditors must be without bias

    The first problem is that our profession's model is fundamentally flawed. Who pays for the work? The client. What's the flaw? No one can be truly independent of someone who pays for the work.

    Think about this: Would it be a good idea for restaurant inspectors, building inspectors, power plant inspectors, OHSA inspectors, FDIC inspectors, or meat packing plant inspectors to be paid by the companies they inspect? Why not? Because doing this would impair their judgment and independence.

    Why don't we have the restaurants pay for the inspections, but have a code of professional conduct requiring the inspectors to be independent? Because we all know such a system would not work. So how are auditors independent when they are paid by the client? That's the system we're stuck with. So until the profession develops another payment mechanism, our independence will always be suspect. No amount of rules or punishment is as powerful a motivator as getting paid. If people followed the rules, no one would cook the books, and Arthur Andersen would still be around.

    An auditor must be intellectually honest

    Are you an ethical CPA? "Of course," you say to yourself. But have you ever had a client who treats the company (could be a private or public company, government, or non-profit entity) as his or her own personal piggy bank? Yep. If you knowingly let your client take a clearly personal expense through the entity, it's a violation of SAS No. 1. Why? Because you've knowingly allowed your client to violate his or her own internal controls. Please explain how it's intellectually honest to knowingly let a client violate internal controls to take an illegal tax deduction.

    Furthermore, paragraph 10 of SAS 107, "Audit Risk and Materiality in Conducting an Audit" in part states: "When the auditor encounters evidence of potential fraud, regardless of its materiality, the auditor should consider the implications for the integrity of management or employees and the possible effect on other aspects of the audit."

    Just because the deduction is immaterial for financial reporting does not mean it's legally OK. In other words, legality and materiality are two different things. How can auditors render a clean opinion knowing the financial statements are misstated by an illegal amount? It's willful because you see the deduction and do nothing about it, for example, by putting the illegal deductions on your" passed adjustments" list. Doesn't "willful blindness" of illegal activities by its nature render the auditor not independent? In other words, if an auditor is truly independent, he or she would stand up to the client and force proper accounting. Issue a 1099, repay the money and set up a receivable. Do anything for proper accounting.

    Avoid situations that may lead outsiders to doubt their independence

    SAS 107 defines materiality as "the magnitude of an omission or misstatement of accounting information that, in the light of surrounding circumstances, makes it probable that the judgment of a reasonable person relying on the information would have been changed or influenced by the omission or misstatement." Note that there is no percentage or amount in the definition.

    Thus, if users would make a different decision, then the amount/transaction/event are material. Note the definition says "reasonable person." It does not say "reasonable accountant or reasonable auditor." Who are these "reasonable persons?" Think bank loan officer, nonprofit donor, taxpayer, regulator, or newspaper reporter. If you were required to disclose every personal expense taken as a corporate deduction in the opinion, would you allow them? If not, on what basis is it to look the other way now?

    Furthermore, paragraph 14 of SAS 107 and Policy 2 of Statement on Quality Control Standards No. 7, Establishing and Maintaining a System of Quality Control for a Firm's Accounting and Auditing Practice, both require the firm to have the expertise necessary to properly perform the engagement. If you don't have the expertise, you're not independent. For example, Bernard Madoff has admitted to a $50 billion Ponzi scheme. The auditor was a three-person firm? Thus, the situation rendered the firm unqualified to issue an opinion.

    Guard against presumption of loss of independence

    I can't tell you how many times I've had people in class say, "If we didn't let clients run small personal expenses through the company, we wouldn't have any clients." My reply is, "In other words, if you don't let your clients cheat on their income tax returns, you wouldn't have an accounting firm?"

    Think about this, if you aren't willing to walk away, lose the client, and refuse to let a client cheat on the tax return, even if completely insignificant, how can you sign the opinion saying you're independent? Using this standard, are you or your partners or is your firm independent? It's a scary thought for the reliability of financial statements.

    So what might be a solution?

    The only real solution is to structure a system where the client does not pay for the audit. But the system will change only after there is another round of audit failures. And we find, again, that the current system does not work, and Congress mandates change in how audits are paid for (those options require another article).

    Because of recent scandals about the reliability of drug testing, medical journal publishers have instituted strict disclosure of financial interests or other conflicts between scientists testing the drugs and the pharmaceutical manufacturers.

    Do you think full and fair disclosure of drug testing conflicts is a good idea so that users, doctors, hospitals, the public, have independent test results? If so, why don't the AICPA and SEC require firms disclose in the opinion that the client paid for the audit? If we are so confident of our independence, why do we hide our relationship?

    Will you do the right thing?

    I know much of this conflicts with what has for some firms become acceptable practice. It's no different than breaking the law when you speed when driving. You rationalize your behavior. "I'm just keeping up with traffic. There aren't many cops around. I'm a really good driver. If I drive the speed limit I'll get run over." All those may be true. But it doesn't make speeding legal. And just because many clients do it doesn't make it legal.

    It's that simple. You won't like this: If you have clients that will leave if you don't allow past behaviors, which puts the firm at risk? Whose fault is that?

    What's the solution? Simply comply with our profession's requirement to be independent. If you don't, you've disqualified yourself from rendering an opinion, even if the numbers are right.

    About the author
    Gary D. Zeune, CPA, is a nationally recognized speaker and writer on fraud and auditing, and founder of The Pros & The Cons, the nation's only speakers' bureau for white-collar criminals. He teaches fraud classes for the FBI and numerous professional associations, and is the author of The CEO's Complete Guide to Committing Fraud and Outside the Box Performance. Contact Gary at gzfraud@bigfoot.com or 614-761-8911

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


    "The trouble with tax tricks:  Companies' tax avoidance schemes inflate profits and distort the market – those responsible must be made to come clean," by Prem Sikka, The Guardian, April 4, 2009 --- http://www.guardian.co.uk/commentisfree/2009/apr/03/tax-avoidance-economics

    Any action from G20 leaders who have focused on tax havens and are promising reforms would be welcomed, as many countries are losing tax revenues that could be used to improve social infrastructure. However, none have made any commitment to force companies to explain how their profits are inflated by tax avoidance schemes. This has serious consequences for managing the domestic economy and equity between corporate stakeholders.

    Tax avoidance has created a mirage of large corporate profits, which has turned many a CEO into a media star and even secured knighthoods and peerages for some. Yet the profits have been manufactured by a sleight of hand. Let us get back to the basics. To generate wealth, at the very least, three kinds of capital need to be invested. Shareholders invest finance capital and expect to receive a return. Markets exert pressure for this to be maximised. Employees invest human capital and expect to receive a return in the shape of wages and salaries. Society invests social capital (health, education, family, security, legal system) and expects a return in the shape of taxes. Over the years, corporate tax rates have been reduced, but the return on social capital is under constant attack by tax avoidance schemes. The aim is to transfer the return accruing to society to shareholders. Companies have reported higher profits, not because they undertook higher economic activity or produced more desirable goods and services, but simply by expropriating the returns due to society. This can only be maintained as long as governments and civil society remain docile.

    Companies engaging in tax avoidance schemes publish higher profits but do not explain the impact of tax avoidance schemes on these profits. Consequently, markets cannot make assessment of the quality of their earnings, ie how much of the profit is due to production of goods and services and thus sustainable, and how much is due to expropriation of wealth from society. In the absence of such information, markets cannot make a rational assessment of future cashflows accruing to shareholders. Inevitably, market assessment of risk is mispriced and resources are misallocated. By concealing tax avoidance schemes, companies have deliberately provided misleading information to markets. The subsequent imposition of penalties for tax avoidance, if any, will reduce future company profits. But the cost will be borne by the then shareholders rather than by the earlier shareholders who benefited from the tax scams. Thus the secrecy surrounding tax avoidance schemes causes involuntary wealth transfers and must also undermine confidence in corporations because they are not willing to come clean.

    Governments collect data on corporate profits to gauge the health of the economy and develop economic policies. However, this barometer is misleading too because it does not distinguish between normal commercial sustainable profits and profits inflated by tax avoidance.

    Company executives are major beneficiaries of tax avoidance because their remuneration is frequently linked to reported profits. They can increase these through production of goods and services, but many have deliberately chosen to raid the taxes accruing to society. Company executives could provide honest information and explain how much of their remuneration is derived from the use of tax avoidance schemes, but none have done so. As a result, no shareholder or regulator can make an objective assessment of company performance, executive performance or remuneration. By the time the taxman catches up with the company and imposes fines and penalties, many an executive has moved on to newer pastures and is not required to return remuneration to meet any portion of those penalties. Seemingly, there are no penalties for artificially inflating executive remuneration.

    Under the UK Companies Act 2006, company directors have a duty to avoid conflicts of interests. They are required to promote the success of the company for the benefit of its members, which is taken to mean "long-term increase in value" and must also publish "true and fair" accounts. It is difficult to see how such obligations can be discharged by systematic misleading of markets, shareholders, governments and taxpayers. Hopefully, stakeholders will bring test cases.

     


    "In Defense of Derivatives and How to Regulate Them:  The much-maligned financial instruments have legitimate uses," by Rene M. Stulz, The Wall Street Journal, April 6, 2009 --- http://online.wsj.com/article/SB123906100164095047.html#mod=djemEditorialPage
    A lengthy quotation is provided below after some introductory remarks.

    Jensen Comment
    For years I've maintained a Timeline on derivative financial instruments fraud and the evolution of FAS 133, FIN 141(R), and IAS 39 provisions to steadily improve the accounting for such instruments. At the same time, however, the Federal Reserve under Alan Greenspan and the SEC under various inept directors allowed investment banks to conduct frauds year after year in unregulated markets, albeit that many of the transactions were not fraudulent. However, many were highly fraudulent even in the most prestigious investment banks and brokerage firms like Merrill Lynch that, among other frauds, bilked Orange County of over a billion dollars.

    My Timeline beginning in Roman times is at http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds

    Steve Kroft on Sixty Minutes, July 23, 1995
    Introductory Segment --- http://www.cbsnews.com/video/watch/?id=4501762n%3fsource=search_video
    Another (more revealing) Segment on the infamous 1994 $1 billion losses in derivatives for Orange County instigated by complex derivatives sold by Merrill Lynch to Orange County's naive Treasurer --- http://www.trinity.edu/rjensen/acct5341/Calgary/CDfiles/video/FAS133/SIXTY01.wmv

    My hero has been Frank Partnoy who was for a short time one of the bad guys selling dubious derivatives. Frank had a conscience and since the early 1990s wrote whistle blowing books that, while entertaining, did not persuade policy makers like Alan Greenspan and Arthur Levitt to regulate the wild west derivatives market.

  • 1994
    Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 229, ISBN 0-8050-7510-0)

    Third, financial derivatives were now everywhere --- and largely unregulated. Increasingly, parties were using financial engineering to take advantage of the differences in legal rules among jurisdictions, or to take new risks in new markets. In 1994, The Economist magazine noted, "Some financial innovation is driven by wealthy firms and individuals seeking ways of escaping from the regulatory machinery that governs established financial markets." With such innovation, the regulators' grip on financial markets loosened during the mid-to-late 1990s . . . After Long-Term Capital (Management) collapsed, even Alan Greenspan admitted that financial markets had been close to the brink.

  •  

  • Infectious Greed:  How Deceit and Risk Corrupted the Financial Markets  (Henry Holt and Company, 2003, Page 17, ISBN 0-8050-7510-0)

    As 1987 began, Andy Krieger (at Salomon Brothers and doing currency trading through Bankers Trust) found what he believed was an incredible opportunity to make money trading currency options The U.S. Federal Reserve and various central banks in Europe had implemented policies to maintain their currencies within a stable zone. The dollar had been falling for several years, but during 1987 it stabilized, and by the fall of 1987 the volatility numbers traders were using to evaluate currency options were very low. As a result, currency options were incredibly cheap . . . If these (currency trading banks) had been buying and selling stocks instead of currencies, such efforts to move short-term prices would have constituted "market manipulation." But currency markets were unregulated free-for-all, where manipulative trading tactics were quite common and perfectly legal. By manipulating prices, a trader might be able to generate profits even if the markets were quite efficient. This was something academics studying financial markets hadn't yet considered. And it was something the traders loved to do.

    Manipulative practices were especially common in the over-the-counter markets --- the wild Wild West of trading. Instead of buying and selling options on a centralized exchange, which acted as a counterparty to all trades, traders could enter into private contracts with buyers and selliers, typically other banks . . . The exchanges monitored manipulative practices but nobody watched the over-the-counter traders.

    In one infamous episode, Krieger sold, or shorted, roughly the entire money supply of New Zealand. He also held call options --- of similar amounts --- which benevit if the kiwi went up, and therefore woudl offset any losses from his short position . . . Krieger's stragegy drew from one of the central insights of modern finance, generally known as parity (or put-call parity), and it is worth taking a few minutes to contemplate --- http://en.wikipedia.org/wiki/Put-call_parity

    . . .

    Currency-options traders were shocked, and trading currency options nearly halted for a few hours before Krieger resigned. Again, rumors swirled about Krieger's resignation, including word that Banker Trust had incurred huge losses in currency options, perhas as mch as $100 million. A spokesman denied the rumors, the the denial only fed speculation about what had happened at Bankers Trust.

  •  

    "In Defense of Derivatives and How to Regulate Them:  The much-maligned financial instruments have legitimate uses," by Rene M. Stulz, The Wall Street Journal, April 6, 2009 --- http://online.wsj.com/article/SB123906100164095047.html#mod=djemEditorialPage

    There are two sides to derivatives -- one positive and beneficial, one exploitive and negative. Of the latter, the most visible example today comes to us courtesy of the American International Group (AIG) and reveals what happens when a lightly regulated but highly interconnected financial institution ends up positioned in a way that it cannot survive a housing crash and then such a crash occurs.

    The other side of derivatives, however, involves the less-publicized but widespread use of these financial instruments in ways that benefit companies. Derivatives have been immensely valuable tools and will be instrumental in providing the liquidity needed to jump-start the economy. Derivatives are used by a vast number of U.S. companies, both small and large, to manage various risks that arise in connection with their businesses.

    From the perspective of Main Street companies, derivatives are not just about high finance, quants and politics, but about investing in America's core industries, jobs and economic recovery. Companies find that over-the-counter derivatives are essential to their day-to-day operations. Derivatives help insulate them from risk, which allows them to borrow capital at better prices than they would otherwise. And derivatives are more useful than ever in these days of unusual volatility in financial markets.

    For example, not being able to hedge currency risk through the use of a derivative can leave a company exposed to fluctuations in currency markets. Without derivatives companies could see movements in exchange rates turn a profitable export contract into a money-losing agreement.

    In its current annual report, Caterpillar Inc. makes the case for why it relies on derivatives: "Our risk management policy . . . allows for the use of derivative financial instruments to prudently manage foreign currency exchange rate, interest rate, commodity price and Caterpillar stock price exposures."

    For those unfamiliar with market jargon, credit default swaps, which are most often in the news, are simply financial contracts between two parties. If, for example, you own bonds in a company and are worried that the company will default, you can manage your risk and protect your holdings with a credit default swap. Under it, you would make regular payments to maintain the contract. If the company does not default, you're out-of-pocket the payments. But if the company does default, the swap serves as a form of insurance by giving you the right to exchange the questionable bonds for the principal amount, or to be reimbursed in other ways. There's nothing exotic or complex about these contracts. They can be highly valuable for Main Street firms, because they enable them to protect themselves against the failure of large customers.

    However, Main Street firms cannot afford derivatives unless there is a competitive market for them with participants willing to take the opposite position. Restricting access to derivative markets, which is being proposed by some in Congress as well as by some regulators, would make the costs of derivatives prohibitively expensive and eliminate liquidity.

    That derivatives benefit our financial system and our national economy is well established. Twenty-nine of the 30 companies that make up the Dow Jones Industrial Average use derivatives. According to data from Greenwich Associates, two-thirds of large companies (those that have sales of more than $2 billion) use over-the-counter derivatives and more than half of all mid-size companies (those that have sales between $500 million and $2 billion) are very active in derivatives markets. Derivatives are necessary and helpful tools for companies seeking to manage financial risk.

    The most important benefit of derivatives is that they allow businesses to hedge risks that otherwise could not be hedged. This does a number of positive things. It transfers risk, allowing firms to guard against being forced into financial distress. It also frees lenders to offer credit on better terms, giving companies access to funds that they can use to keep their doors open, lights on and, even, invest in new technologies, build new plants, or hire new employees.

    It's important for regulators not to overreact by pushing for counterproductive new rules. The regulators, after all, were no better at foreseeing the current crisis than the private sector, proving that regulation has obvious limits and cannot replace efforts by financial institutions to devise risk-management approaches that enable them to cope with crises in the financial markets of the 21st century.

    At the same time, some sensible regulations are in order. With the interconnectedness of markets today and the systemic problems facing the world's economies, there is a lot that can be done to limit systemic risks. One beneficial step would be for Congress to adopt some version of a systemic-risk regulator that would place every participant in the financial markets that poses a systemic risk, including derivatives traders, under federal regulatory oversight.

    Unbelievably, the arm of AIG that dealt with derivative products was not subject to serious scrutiny by a federal agency with relevant experience. A systemic-risk regulator, or markets-stability regulator, should oversee every kind of financial institution that is found to be systemically important, including banks, broker-dealers, insurance companies, hedge funds, private equity funds and others. That regulator should have the authority to ensure that such financial institutions have sufficient capital to reduce the risks they pose to the financial system, to examine parent companies and subsidiaries, and to bring enforcement actions.

    Additionally, a clearinghouse for standardized credit default swaps was launched in March, and other competitor clearinghouses are under construction. Clearinghouses clear and settle trades and limit the risk to the larger financial system if any one dealer, like AIG, fails to meet its obligations. A clearinghouse also allows regulators to monitor the exposure firms have to these products, while simultaneously ensuring that each firm posts the necessary collateral to cover its obligations under its trades.

    However, clearinghouses should be reserved for established and standardized derivatives, leaving participants in capital markets free to engage in bilateral contracts for derivatives that fulfill specific needs as well as for new products. Further, use of a clearinghouse should not be compulsory, but capital-requirement regulations should recognize that derivatives positions that are not put through a clearinghouse may pose greater systemic risks than those that are.

    The subprime mess triggered one of the most destructive financial crises in decades. It's not surprising, then, that the hunt is on for culprits. But derivatives are not the culprit. They had little to do with the rise and collapse of housing prices. Wider availability of housing derivatives would have actually reduced the impact of the collapse of housing prices if homeowners had been able to hedge against possible decreases in home values.

    Our businesses need derivatives. Most of us choose to drive cars even though they sometimes crash. But we also insist that cars are made as safe as it makes economic sense for them to be, and that speed limits and other rules of the road are enforced. The same logic should apply to derivatives.

    Dr. Stulz is a professor of finance at the Fisher College of The Ohio State University.

    From The Wall Street Journal Accounting Weekly Review on April 23, 2009

    Don't Kill the Good Part of the Derivatives Market
    by Gary DeWaal and Michael Hope
    The Wall Street Journal

    Apr 17, 2009
    Click here to view the full article on WSJ.com ---
    http://online.wsj.com/article/SB123993535782328107.html?mod=djem_jiewr_AC

    TOPICS: Advanced Financial Accounting, Derivatives

    SUMMARY: "René Stulz makes an excellent case why the responsible use of derivatives can help bona fide users, and ultimately help Main Street," writes this New York resident to the WSJ Opinion page editors. However, Mr. Hope of Pacific Palisades, CA, recalls in his letter a time when, as a "young, inexperienced chief financial officer of a Fortune 500 company," he decided against "investing" in interest rate swaps "pitched" by "a prominent investment banking firm." Professor Stulz's related letter was published on the opinion page on April 7.

    CLASSROOM APPLICATION: Accounting students studying derivatives should realize the economic and finance issues behind these contracts in addition to understanding the accounting requirements and being able to execute entries for them. The letter describing how a CFO raised questions about transactions new to him at the time provides a helpful perspective as well.

    QUESTIONS: 
    1. (Introductory) Refer to the related article by Professor René Stulz of the Finance Department at the Ohio State University's Fisher College of Business. In it, he cites the financial statement disclosure by Caterpillar, Inc., regarding the risks it hedges by using derivatives. List these risks and state the derivatives used to hedge against those risks.

    2. (Advanced) Why must there be a market behind derivatives in order for them to be executed? In your answer, comment on the difference between standardized derivatives traded via a clearinghouse and individualized derivative contracts.

    3. (Advanced) What derivatives did Mr. Hope consider using as a "young, inexperienced CFO at a Fortune 500 company"? What risks were those derivatives designed to hedge? In your answer, explain how that hedging contract could benefit his company. Also, explain what economic factors likely led to the fact that a strategy of not using derivatives "worked out fine" for his company. (Hint: consider what happened to interest rates during the 1980s.)

    4. (Introductory) What questions did Mr. Hope raise regarding the market for the interest rate swap he was considering for his company? How are those questions similar to considerations now for developing regulations over derivatives markets?

    Reviewed By: Judy Beckman, University of Rhode Island

    RELATED ARTICLES: 
    In Defense of Derivatives and How to Regulate Them
    by René M. Stulz
    Apr 06, 2009
    Online Exclusive

     

     

  • While Frank Portnoy was fighting for more financial markets regulation, guess who was fighting against it tooth and nail?
    Few remember that Bill Clinton's administration, along with Greenspan and Levitt, fought successfully against regulation of financial markets.
    It's now Deja vu Larry Summers who is the liberal Keynesian scholar behind President Obama's economic recovery and budget spending.
    People remember Larry Summers as Harvard President who was forced out of office by feminists.
    But few remember that he was also Treasury Secretary during the presidency of Bill Clinton.
    Even fewer remember him as a virulent opponent of financial markets regulation.

     

    In 1997, Brooksley Born warned in congressional testimony that unregulated trading in derivatives could "threaten our regulated markets or, indeed, our economy without any federal agency knowing about it." Born called for greater transparency--disclosure of trades and reserves as a buffer against losses. Instead of heeding this oracle's warnings, Greenspan, Rubin & Summers rushed to silence her. As the Times story reveals, Born's wise warnings "incited fierce opposition" from Greenspan and Rubin who "concluded that merely discussing new rules threatened the derivatives market." Greenspan deployed condescension and told Born she didn't know what she doing and she'd cause a financial crisis . . . In early 1998, according to the Times story, one of the guys, Larry Summers, called Born to "chastise her for taking steps he said would lead to a financial crisis. But Born kept at it, unwilling to let arrogant men undermine her good judgment. But it got tougher out there. In June 1998, Greenspan, Rubin and the then head of the SEC, Arthur Levitt, Jr., called on Congress "to prevent Ms. Born from acting until more senior regulators developed their own recommendations." (Levitt now says he regrets that decision.) Months later, the huge hedge fund Long Term Capital Management nearly collapsed--confirming some of Born's warnings. (Bets on derivatives were a key reason.) "Despite that event," the Times reports, " Congress (apparently as a result of Greenspan & Summer's urging, influence-peddling and pressure) "froze" Born's Commissions' regulatory authority. The next year, Born left as head of the Commission.Born did not talk to the Times for their article. What emerges is a story of reckless, willful and arrogant action and behaviour designed to undermine a wise woman's good judgment. The three marketeers' disdain for modest regulation of new and risky financial instruments reveals a faith-based fundamentalist approach to the management of markets and risk. If there is any accountability left in our system, Greenspan, Rubin and Summers should not be telling anyone how to run anything. Instead, Barack Obama might do well to bring back Brooksley Born and promote to his team economists who haven't contributed to the ugly mess we're in.
    Katrina vanden Heuvel, "The Woman Greenspan, Rubin & Summers Silenced," The Nation, October 9, 2008 ---
    http://www.thenation.com/blogs/edcut/370925/the_woman_greenspan_rubin_summers_silenced

    Link forwarded by Jagdish Gangolly

    The Woman Who Tried Early On to Save Our Money and Prevent This Economic Crisis and Countless Financial Frauds
    Brooksley Born --- http://en.wikipedia.org/wiki/Brooksley_Born
    In 1964, Brooksley was the first female student in history to become President of Stanford's Law Review.

    The Obama administration has pledged an overhaul of the financial system, including the way derivatives are regulated. Worrisome to some observers is the fact that his economic team includes some former Treasury officials who were lined up in opposition to Born a decade ago.
    "Prophet and Loss," by Rick Schmitt, Stanford Magazine, March/April 2009, pp. 40-47.

    Brooksley Born (the first woman at Stanford to be president of the Law Review) was named to head the Commodity Futures Trading Commission in 1996. She “advocated reigning in the huge and growing market for financial derivatives…Back in the 1990’s, however, Born’s proposal stirred an almost visceral response from other regulators in the Clinton administration (notably explosive and rude 1998 reactions from Treasury Secretary Robert Rubin and Deputy Secretary Larry Summers and SEC Chairman Arthur Levitt to her suggestion that derivatives swap markets be regulated)  as well as members of Congress and lobbyists…Ultimately Greenspan and the other regulators foiled Born’s efforts and Congress took the extraordinary step of enacting legislation that prohibited her agency from taking any action…Speaking out for the first time, Born says she takes no pleasure from the turn of events. She says she was just doing her job based on the evidence in front of her. Looking back, she laments what she says was the outsized influence of Wall Stret lobbyists on the process, and the refusal of her fellow regulators, especially Greenspan, to discuss even modest reforms. ‘Recognizing the dangers…was not rocket science, but it was contrary to the conventional wisdom and certainly contrary to the economic interests of Wall Street at the moment,‘ she says.”
    As quoted on March 20, 2009 at http://openpalm.wordpress.com/2009/03/20/the-woman-who-tried-to-save-our-money/

    Not only have individual financial institutions become less vulnerable to shocks from underlying risk factors, but also the financial system as a whole has become more resilient.
    Alan Greenspan in 2004 as quoted by Peter S. Goodman, Taking a Good Look at the Greenspan Legacy," The New York Times, October 8, 2008 --- http://www.nytimes.com/2008/10/09/business/economy/09greenspan.html?em 

    “I made a mistake in presuming that the self-interest of organisations, specifically banks and others, was such that they were best capable of protecting their own shareholders,” he said. In the second of two days of tense hearings on Capitol Hill, Henry Waxman, chairman of the House of Representatives, clashed with current and former regulators and with Republicans on his own committee over blame for the financial crisis.
    "‘I made a mistake,’ admits Greenspan," by Alan Beattie and James Politi, Financial Times, October 23, 2008 --- http://www.ft.com/cms/s/0/aee9e3a2-a11f-11dd-82fd-000077b07658.html?nclick_check=1 

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger.
    "The Reeducation of Larry Summers:  He's become a champion of massive government intervention in the economy, and he's even learning how to play nice. ," by Michael Hirsh and Evan Thomas, Newsweek Magazine, March 2, 2009 --- http://www.newsweek.com/id/185934

    Larry Summers had the rumpled, slightly sleepy look of a professor who has been up all night solving equations. President Obama's top economic adviser, the man mainly in charge of the immense government bailout, splayed himself on a sofa in the Roosevelt Room in the White House, beneath a portrait of Franklin Roosevelt, and did his best to be patient with two NEWSWEEK reporters. They were asking him to explain how he had changed—reeducated himself—since the freewheeling days of the late 1990s, when Summers had been part of a government that basically got out of the way of the financial markets as they headed for the edge of the cliff.

    Summers responded by quoting John Maynard Keynes, whose economic theory calling for massive government spending became identified with Roosevelt's New Deal and is at the heart of the Obama administration's stimulus plan. "Keynes famously said of someone who accused him of inconsistency: 'When circumstances change, I change my opinion'," said Summers, raising his heavy-lidded eyes at the reporters as he quoted Keynes's kicker: " 'What do you do?' " The implication, not so subtle, is that smart people are not dogmatic—stuck in one narrow ideological groove —but rather open-minded, flexible and intellectually alert—able to change with the times.

    . . .

    Some of the stories go well beyond complaints about his manners. Brooksley Born, chairwoman of the Commodity Futures Trading Commission, received a call in March 1998 in her office in downtown Washington. On the other end was Deputy Treasury Secretary Summers. According to witnesses at the CFTC, Summers proceeded to dress her down, loudly and rudely. "She was ashen," recalls Born's deputy Michael Greenberger, who walked in as the call was ending. "She said, 'That was Larry Summers. He was shouting at me'." A few weeks before, Born had put out a proposal suggesting that U.S. authorities begin exploring how to regulate the vast global market in derivatives. Summers's phone call was the first sign that her humble plan had riled America's reigning economic elite.

    Rubin, Fed chairman Alan Greenspan and Summers were concerned that even a hint of regulation would send all the derivatives trading overseas, costing America business. Summers bluntly insisted that Born drop her proposal, says Greenberger. According to another former CFTC official who would recount the episode only on condition of anonymity, Born was "astonished" Summers would take the position "that you shouldn't even ask questions about a market that was many, many trillions of dollars in notional value—and that none of us knew anything about."

    Arthur Levitt, who was head of the SEC at the time of Born's proposal, today admits flatly that she had things right about derivatives while he, Rubin, Greenspan and Summers didn't. ("All tragedies in life are preceded by warnings," Levitt says. "We had a warning. It was from Brooksley Born. We didn't listen.") Summers told NEWSWEEK: "I believed at the time, and believe much more strongly today, that new regulations with respect to systemic risk were appropriate and necessary, but expressed the strong view of Secretary Rubin, chairman Greenspan and SEC chief Levitt that the way the CFTC was proposing to go about it was likely to be ineffective and itself imposed major risks into the market." (At the time, the Rubin Treasury Department argued against the Born proposal by maintaining that the CFTC didn't have legal jurisdiction.) Still, Summers allowed that "there's no question that with hindsight, stronger regulation would have been appropriate" before the financial crash. He added: "Large swaths of economics are going to have to be rethought on the basis of what's happened." In the past year Summers has refashioned himself as a champion of intensive financial regulation. In his last column for the Financial Times before joining the Obama administration, Summers said the pendulum "should now swing towards an enhanced role for government in saving the market system from its excesses and inadequacies."

  • Continued in article

  •  


    Unlike many other nations that either did not have national accounting standards or had weak and incomplete sets of standards, the FASB over the years produced the best set of accounting standards in the world (although there is no such thing a perfect set since companies are always writing contracts to circumvent most any standard). The FASB standards were heavily rule-based due to the continual battles fought by the FASB in the trenches of U.S. firms seeking to manage earnings and keep debt of the balance sheet with ever-increasing contract complexities such as interest rate swaps invented in the 1980s, SPE ploys, securitization "sales," synthetic leasing, etc.
                         

    • The experiences of those frazzled executives in charge of reducing risks in the credit derivatives market are starting to resemble Alice’s adventures in Wonderland. Alice shrank after drinking a potion, but was then too small to reach the key to open the door. The cake she ate did make her grow, but far too much. It was not until she found a mushroom that allowed her to both grow and shrink that she was able to adjust to the right size, and enter the beautiful garden. It took an awfully long time, with quite a number of unpleasant experiences, to get there.
      Aline van Duyn, "The adventure never ends in the derivatives Wonderland," Financial Times, September 11, 2008 --- Click Here

       
    • While Lehman Brothers was fighting for its life in the markets today, it was also battling in a Senate panel's hearing on whether the company and others created a set of financial products whose primary purpose is to dodge taxes owned on U.S. stock dividends. The "most compelling" reason for entering into dividend-related stock swaps are the tax savings, Highbridge Capital Management Treasury and Finance Director Richard Potapchuk told the Senate's Permanent Subcommittee on Investigations. Lehman Brothers (nyse: LEH - news - people ), Morgan Stanley (nyse: MS - news - people ) and Deutsche Bank (nyse: DB - news - people ) are among the companies behind the products.
      Anitia Raghaven, The Tax Dodge Derivative, Forbes, September 11, 2008 --- Click Here
       
    There will be a time “beyond crisis,” asserts Robert C. Merton, who delves into the dense science of derivatives — a field he has fundamentally shaped — to explain how the vast global economic collapse has come about, and how financial innovations at the heart of the collapse could also be tools for reconstruction. Merton uses deceptively simple graphs to show how risk propagated rapidly across financial networks, bringing down financial institutions. While he admits the crisis “is very big and complicated,” Merton boils a piece of it down to the use of put options, a derivative contract that’s been around since the 17th century. This asset-value insurance contract, a guarantee of debt, is the basis for the credit default swaps widely adopted by financial giants in the last few years — now widely regarded as a primary cause of the meltdown. It turns out, says Merton, that the put “makes risky debt very complicated, and treacherous…” In these puts, if the value of assets goes down, the guarantee value goes up, so the value of the written insurance is worth more. The value of this guarantee is very sensitive to the movement of the underlying asset. When dealing with puts on the local level, this movement can be tracked and managed more easily. But when financial institutions manipulate bundles of assets (for instance, mortgage-backed securities), the increase in risk proves non-linear. Add some volatility, like the jolts posed by widespread drops in housing prices, and the difference between the decline in asset value and the value of the guarantee becomes enormous — leading to mountains of debt and felling behemoths like AIG (insurer to lenders).
    "Video:  Robert C. Merton: Observations on the Science of Finance in the Practice of Finance," Simoleon Sense, April 6, 2009 --- Click Here
    Snipped Link --- http://snipurl.com/mertenputs  [www_simoleonsense_com] 
    Jensen Comment
    Nobel Economist Robert Merton knows very well about the dense science and practice of derivatives. He was a principle loser in Long Term Capital's 1993 "Trillion Dollar Bet" that nearly brought down Wall Street --- http://www.trinity.edu/rjensen/FraudRotten.htm#LTCM

    Pricing of gold forward rate --- http://cij.inspiriting.com/?p=491
    Accounting instructors having to teach IAS 39 or FAS 133 often seek illustrations about the required valuation/auditing of derivatives at fair value. Since gold fever has increased in this economic crisis, valuation of forward contracts in gold may be doubly of interest to students

    Bob Jensen's timeline on the disasters of not regulating markets for derivative financial instruments --- http://www.trinity.edu/rjensen/FraudRotten.htm#DerivativesFrauds



    From The Accounting Onion

    "Lease Accounting: Replacement Cost is the Only Hope for a Principles-Based Solution," Accounting Onion, April 8, 2009 --- Click Here

    "Replacement Cost Rebound," Accounting Onion, April 2, 2009 --- Click Here


    Cost Allocation Methods (Historical Cost, PLA Historical Cost, and Entry Value Replacement Cost) versus
    Value Accounting Methods (Exit Value, Economic Value)

    Hi Tom, 

    Your latest Onion piece is a good starting point for a “blank paper” beginning for the debate on fair value accounting --- http://accountingonion.typepad.com/theaccountingonion/2009/04/a-new-title.html  

    But it overlooks some of the major problems, particularly problems in current (replacement) cost accounting that are summarized at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

    Replacement costs also have huge problems as summarized below.

    Market Value Accounting: Entry Value (Current Cost, Replacement Cost) Accounting

    Beginning in 1979, FAS 33 required large corporations to provide a supplementary schedule of condensed balance sheets and income statements comparing annual outcomes under three valuation bases --- Unadjusted Historical Cost, Price Level Adjusted (PLA) Historical Cost, and Current Cost Entry Value (adjusted for depreciation and amortization). Companies complained heavily that users did not obtain value that justified the cost of implementing FAS 33. Analysts complained that the FASB allowed such crude estimates that the FAS 33 schedules were virtually useless, especially the Current Cost estimates. The FASB rescinded FAS 33 when it issued FAS 89 in 1986.

    Current cost accounting by whatever name (e.g., current or replacement cost) entails the historical cost of balance sheet items with current (replacement) costs. Depreciation rates can be re-set based upon current costs rather than historical costs. 
    Replacement cost accounting is a cost allocation system and not a fair value system of accounting.

    Beginning in 1979, FAS 33 required large corporations to provide a supplementary schedule of condensed balance sheets and income statements comparing annual outcomes under three valuation bases --- Unadjusted Historical Cost, PLA-Adjusted historical cost, and Current Cost Entry Value (adjusted for depreciation and amortization). Companies are no longer required to generate FAS 33-type comparisons. The primary basis of accounting in the U.S. is unadjusted historical cost with numerous exceptions in particular instances. For example, price-level adjustments may be required for operations in hyperinflation nations. Exit value accounting is required for firms deemed highly likely to become non-going concerns. Exit value accounting is required for personal financial statements (whether an individual or a personal partnership such as two married people). Economic (discounted cash flow) valuations are required for certain types of assets and liabilities such as pension liabilities. Hence in the United States and virtually every other nation, accounting standards do not require or even allow one single basis of accounting. Beginning in January 2005, all nations in the European Union adopted the IASB's international standards that have moved closer and closer each year to the FASB/SEC standards of the United States.

     

    Advantages of Entry Value (Current Cost, Replacement Cost) Accounting

    Although I am not in general a current cost (replacement cost, entry-value) advocate, I think you and Tom are missing the main theory behind the passage of the now defunct FAS 33 that leaned toward replacement cost valuation as opposed to exit valuation.

    The best illustration in favor of replacement cost accounting is the infamous Blue Book used by automobile and truck dealers that lists composite wholesale trading for each make and model of vehicle in recent years. The Blue Book illustration is relevant with respect to business equipment currently in use in a company since virtually all that equipment is now in the “used” category, although most of it will not have a complete Blue Book per se.

    The theory of Blue Book pricing in accounting is that each used vehicle is unique to a point that exit valuation in particular instances is very difficult since no two used vehicles have the same exit value in a particular instances. But the Blue Book is a market-composite hundreds of dealer transactions of each make and model in recent months and years on the wholesale market.

    Hence I don’t have any idea about what my 1999 Jeep Cherokee in particular is worth, and any exit value estimate of my vehicle is pretty much a wild guess relative to what it most likely would cost me to replace it with another 1999 Jeep Cherokee from a random sample selection among 2,000 Jeep dealers across the United States. I merely have to look up the Blue Book price and then estimate what the dealer charges as a mark up if I want to replace my 1999 Jeep Cherokee.

    Since Blue Book pricing is based upon actual trades that take place, it’s far more reliable than exit value sticker prices of vehicles in the sales lots.

     Conclusion
    It is sometimes the replacement market of actual transactions that makes a Blue Book composite replacement cost more reliable than an exit value estimate of what I will pay for a particular car from a particular dealer at retail. Of course this argument is not as crucial to financial assets and liabilities that are not as unique as a particular used vehicle. Replacement cost valuation for accounting becomes more defensible for non-financial assets.

     

    Disadvantages of Entry Value (Current Cost, Replacement Cost) Accounting

    Hi Again Tom,

    I would not trash a lawn mower under warranty even if I bought the new one. My motto for warranty providers is to make them pay and pay for the lemons they sell to me.

    In my case it was a pain for Sears and (less for me) to have to keep returning to my home to fix my snow thrower. But in the process, my stubborn nature paid off for millions of consumers who had trouble with their chute-cable freeze ups on snow throwers.I think that Craftsman is mostly a boiler plate for put on snow throwers manufactured for a variety of retail distributors. In any case, engineers finally solved the chute cable problem by simply shortening the cables from about four feet to two feet. Now my snow thrower works terrific. If you had persisted with your lawn mower problem, maybe engineers would have discovered a miracle solution.

    The key is to have an onsite warranty. If you have to haul the item to a service center, the hassle is too much of a pain in the tail.

    What I wonder about your IFRS comment below is what constitutes “adequate” accumulated depreciation? Obviously, “adequate” cannot mean the full cost of replacement. It could mean the cost of replacement depreciated over the current fraction of estimated useful life, but this would be tantamount to replacement cost accounting. I don’t think IFRS has abandoned historical cost accounting in favor of replacement cost accounting.

    Therefore, I’ve very confused as to how “adequate” is defined in your message below.

    As to my recommendation for financial statements, I think the only practical solution is M2M for financial items and historical cost for non-financial items still in use (with LCM only for permanently-impaired inventory). Something like FAS 33 requiring supplemental disclosures of entry and exit values with price level adjustments would be great, but the requirements for measurement would have to be far more accurate than crude sector price index adjustments.

    I think that unrealized gains and losses due to M2M should not impact current earnings. These should be deferred in AOCI or something equivalent.

    Bob Jensen

    Hi again Tom,

     I agree with what you state about covariances of replacement cost estimates, but it is important to note that replacement cost accounting is really a cost allocation process rather than a valuation process for non-financial items subject to depreciation and amortization. Depreciation and amortization allocation formulas use such arbitrary estimates of economic lives, salvage values, and cost allocation patterns that it’s not clear why additive aggregation is any more meaningful under replacement cost aggregations than it is under historical cost aggregations. Neither one aggregates to anything we can meaningfully call value in use.

     Companies are no longer required to generate FAS 33-type comparisons.  The primary basis of accounting in the U.S. is unadjusted historical cost with numerous exceptions in particular instances.  For example, price-level adjustments may be required for operations in hyperinflation nations.  Exit value accounting is required for firms deemed highly likely to become non-going concerns.  Exit value accounting is required for personal financial statements (whether an individual or a personal partnership such as two married people).  Economic (discounted cash flow) valuations are required for certain types of assets and liabilities such as pension liabilities.  Exit value accounting is required for impaired items such as damaged inventories and inoperable machinery.

    Hence in the United States and virtually every other nation, accounting standards do not require or even allow one single basis of accounting.  Beginning in January 2005, all nations in the European Union adopted the IASB's international standards that have moved closer and closer each year to the FASB/SEC standards of the United States.

    The FASB and the IASB state that "value in use" is the ideal valuation measure if it can be measured reliably at realistic estimation costs. Exit value and economic (discounted cash flow) generally do not meet these two criteria for value in use of non-financial items. There is nearly always no practical means of estimating higher order covariances. and additivity aggregations are meaningless without such covariances.  In the case of economic valuation, estimation of future cash flows and discount rates enters the realm of fantasy for long-lived items. Alsoreliable exit value estimation of some items like all the hotel properties of Days Inns can be very expensive, which is a major reason Days Inns only did it once for financial reporting purposes in 1987. Accordingly, "value in use" is an ideal which cannot be practically achieved under either exit or economic valuation methods.

    The FASB and the IASB state that "value in use" is the ideal valuation measure, but this ideal can never be achieved with cost allocation methods. Both historical cost and replacement (current, entry) value "valuation" methods are not really valuation methods at all. These are cost allocation methods that for items subject to depreciation or amortization in value are reliant upon usually arbitrary estimates of non-financial item useful lives, value decline assumptions such as straight line or double declining balance declines, and salvage value estimates. Under historical cost, the book value thus becomes an arbitrary residual of the rationing of original cost by arbitrary cost allocation formulas. Under replacement (current, entry) cost allocation the estimated current replacement costs are subjected to n arbitrary residual of the rationing of replacement cost by arbitrary cost allocation formulas.

    Although both historical and replacement cost allocations over time avoid covariance problems in additive aggregations of book values, the meanings of such aggregations are of very dubious utility to investors and other decision makers. For example suppose the $10 million 2008 book value of a fleet of passenger vans is added to the $200 million 2008 book value of Days Inn hotel properties, what does the $210 million aggregation mean to anybody?

    Both the passenger vans and hotel buildings have been subjected to arbitrary estimates of economic lives, salvage values, and depreciation patters such as double declining balance depreciation for vans and straight-line depreciation for hotel buildings. This is the case whether historical cost or current replacement costs have been allocated by depreciation formulas.

    Hence it is not clear that for going concern companies that have heavy investments in non-financial assets that any known addition of individual items makes any sense under economic, exit, entry, or historical cost book value estimation process. Aggregations might make some sense for financial items with negligible covariances, but for non-financial items. Attempts to estimate total value itself basted upon stock market marginal trades are misleading since marginal trades of a small proportion of shares ignores huge blockage factors valuations, especially blockage factors that carry managerial control along with the blockage purchase. Countless mergers and acquisitions repeatedly illustrate that estimations of total values of companies are generally subject to huge margins of error, especially when intangibles play an enormous part of the value of an enterprise.

    Both the FASB and the IASB require in many instances that exit value accounting be used for financial items. In part that is because for financial items it is often more reasonable to assume zero covariances among items. The recent banking failures caused by covariance among toxic mortgage investments lends some doubt to this assumption, but the issue of David Li’s faltering and infamous Gaussian copula function is being ignored by both the IASB and the FASB in recommending exit value accounting for many (most) financial items --- http://en.wikipedia.org/wiki/Gaussian_copula#Gaussian_copula
    For how the defect in this formula contributed to the 2008 fall of many banks see
    ---
    http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

    I might add that Bob Herz and the FASB as a whole recognize that additive aggregation in financial statement items is probably more misleading than helpful. This is why a very radical proposal is underway in the FASB to do away with aggregations, including the presentation of net income and earnings-per-share bottom liners --- http://www.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay

    The above link also discusses the vehement disagreement between Bob Herz and the financial community on the proposal to do away with the bottom line.

    This bottom line aggregation problem is also bound up in the “quality of earnings” controversy --- http://www.trinity.edu/rjensen/Theory01.htm#CoreEarnings
    However, the concept of reporting core earnings is not nearly as controversial as the proposal not to report any bottom lines

    Bob Jensen's threads on fair value accounting are at various other links:

    Fair Value Accounting Controversies --- http://www.trinity.edu/rjensen/Theory01.htm#FairValue

    Return on Investment Theory --- http://www.trinity.edu/rjensen/roi.htm

    Interest Rate Swap Valuation, Forward Rate Derivation, and Yield Curves for FAS 133 and IAS 39 on Accounting for Derivative Financial Instruments ---
    http://www.trinity.edu/rjensen/acct5341/speakers/133swapvalue.htm

     

    Market Value Accounting: Exit Value (Liquidation, Fair Value) Accounting

    Whereas entry value is what it will cost to replace an item, exit value is the value of disposing of the item. It can even be negative in some instances where costs of clean up and disposal make to exit price negative. Exit value accounting is required under GAAP for personal financial statements (individuals and married couples) and companies that are deemed likely to become non-going concerns. See "Personal Financial Statements," by Anthony Mancuso, The CPA Journal, September 1992 --- http://www.nysscpa.org/cpajournal/old/13606731.htm 

    Some theorists advocate exit value accounting for going concerns as well as non-going concerns. Both nationally (particularly under FAS 115 and FAS 133) and internationally (under IAS 32 and 39 for), exit value accounting is presently required in some instances for financial instrument assets and liabilities. Both the FASB and the IASB have exposure drafts advocating fair value accounting for all financial instruments.

    FASB's Exposure Draft for Fair Value Adjustments to all Financial Instruments
    On December 14, 1999 the FASB issued Exposure Draft 204-B entitled Reporting Financial Instruments and Certain Related Assets and Liabilities at Fair Value.

     

    If an item is viewed as a financial instrument rather than inventory, the accounting becomes more complicated under FAS 115. Traders in financial instruments adjust such instruments to fair value with all changes in value passing through current earnings. Business firms who are not deemed to be traders must designate the instrument as either available-for-sale (AFS) or hold-to-maturity (HTM). A HTM instrument is maintained at original cost. An AFS financial instrument must be marked-to-market, but the changes in value pass through OCI rather than current earnings until the instrument is actually sold or otherwise expires.  Under international standards, the IASB requires fair value adjustments for most financial instruments. This has led to strong reaction from businesses around the world, especially banks. There are now two major working group debates. In 1999 the Joint Working Group of the Banking Associations sharply rebuffed the IAS 39 fair value accounting in two white papers that can be downloaded from http://www.iasc.org.uk/frame/cen3_112.htm.

     

    ·         Financial Instruments: Issues Relating to Banks (strongly argues for required fair value adjustments of financial instruments). The issue date is August 31, 1999.

     

    ·         Accounting for financial Instruments for Banks (concludes that a modified form of historical cost is optimal for bank accounting). The issue date is October 4, 1999.

     

    Advantages of Exit Value (Liquidation, Fair Value) Accounting

    Exit value reporting is not deemed desirable or practical for going concern businesses for a number of reasons that I will not go into in great depth here.

     

    Disadvantages of Exit Value (Liquidation, Fair Value) Accounting

    ·     Operating assets are bought to use rather than sell. For example, as long as no consideration is being given to selling or abandoning a manufacturing plant, recording the fluctuating values of the land and buildings creates a misleading fluctuation in earnings and balance sheet volatility. Who cares if the value of the land went up by $1 million in 1994 and down by $2 million in 1998 if the plant that sits on the land has been in operation for 60 years and no consideration is being given to leaving this plant?

     

    ·     Some assets like software, knowledge databases, and Web servers for e-Commerce cost millions of dollars to develop for the benefit of future revenue growth and future expense savings. These assets may have immense value if the entire firm is sold, but they may have no market as unbundled assets. In fact it may be impossible to unbundle such assets from the firm as a whole. Examples include the Enterprise Planning Model SAP system in firms such as Union Carbide. These systems costing millions of dollars have no exit value in the context of exit value accounting even though they are designed to benefit the companies for many years into the future

    .

    ·     Exit value accounting records anticipated profits well in advance of transactions. For example, a large home building company with 200 completed houses in inventory would record the profits of these homes long before the company even had any buyers for those homes. Even though exit value accounting is billed as a conservative approach, there are instances where it is far from conservative

    .

    ·     Value of a subsystem of items differs from the sum of the value of its parts. Investors may be lulled into thinking that the sum of all subsystem net assets valued at liquidation prices is the value of the system of these net assets. Values may differ depending upon how the subsystems are diced and sliced in a sale.

     

    ·     Appraisals of exit values are both to expensive to obtain for each accounting report date and are highly subjective and subject to enormous variations of opinion. The U.S. Savings and Loan scandals of the 1980s demonstrated how reliance upon appraisals is an invitation for massive frauds. Experiments by some, mostly real estate companies, to use exit value-based accounting died on the vine, including well-known attempts decades ago by TRC, Rouse, and Days Inn.

     

    ·     Exit values are affected by how something is sold. If quick cash is needed, the best price may only be half of what the price can be by waiting for the right time and the right buyer.

     

    ·     Financial contracts that for one reason or another are deemed as to be "held-to-maturity" items may cause misleading increases and decreases in reported values that will never be realized.  A good example is the market value of a fixed-rate bond that may go up and down with interest rates but will always pay its face value at maturity no matter what happens to interest rates.

     

    ·         Exit value markets are often thin and inefficient markets.

     

    Hi Pat,

     My main computer that contains the IASB literature is in the shop at the moment. But I will do the best I can with other references.

     The FASB’s concept of “value in use” is entirely different from “use value” conceptualized by Karl Marx --- http://en.wikipedia.org/wiki/Use_value

     Value in use originates in the concept that a firm computing net present value of an asset will use its own optimal use future stream of cash flows where that stream may not be attainable by any other company --- http://en.wikipedia.org/wiki/Value-in-use
    The Glossary of the FASB’s Accounting Standards Database Codification database defines “value in use” as
    The amount determined by discounting the future cash flows (including the ultimate proceeds of disposal) expected to be derived from the use of an asset at an appropriate rate that allows for the risk of the activities concerned”

     All too often Value in Use (VIU) is equated to discounted future cash flows of an item in optimal use. Discounted cash flow estimation may be a fantasyland ideal that is not altogether necessary. For example, if IBM has a factory robot assembling computer components, it is virtually impossible to trace future computer sale cash flows to the portion of cash flows attributed to one assembly robot. Exit value is probably a useless surrogate for an installed factory robot since exit value is absurdly low relative to VIU of the robot. Other surrogate valuations may be much closer to VIU, including the replacement cost appropriately adjusted for differences in economic life of the present robot versus a now robot. The thing about VIU is that, when exit value is highly misleading, then other valuation estimates are possible, including replacement cost based upon current entry values for an IBM purchase of a new robot plus engineering estimates of current installation cost of a replacement robot.

     Exit value is generally considered an exchange price that’s agreed upon by a buyer and a seller. Both buyer and seller may have different values in use such as when Days Inn sells 200 hotels to Holiday Inn. Covariance with brand name and other intangibles means that the value in use of each hotel differs for Days Inn versus Holiday Inn.

     Both the FASB and the IASB generally consider exit value to be the worst possible seller’s use (e.g., forced liquidation) of the item in liquidation rather than use in a going concern. It is very misleading when a going concern owner has zero intention to sell the item. The ideal is value in use rather than exit value for a going concern having an item that is operational. The presumption is that the exit value may be the worst possible use value for the seller but is almost certainly not the best possible use value for the buyer. Otherwise the buyer would not agree on that exchange price.

     Value in Use (VIU) should not be confused with what the FASB calls Value in Exchange (VIE) ---
    http://findarticles.com/p/articles/mi_hb6421/is_2004_July/ai_n29102623/
    A good illustration of VIU versus VIE in the context of FAS 157 is provided at http://www.tncpa.org/Journal/articles/FASB_157.pdf

    In the August 2008 annual American Accounting Association meetings Tom Linsmeier and another speaker from BYU put great emphasis on how exit value is the worst possible value for present owners that are going concerns. They both claimed preference for Value in Use.

     Neither the FASB nor the IASB is entirely consistent on value in use being the ideal. Paragraphs A5-A12 in FAS 157 illustrate how value in use (VIU) may be used in fair value measurement. However, keep in mind that current fair value accounting requirements apply mostly to financial items except in a few isolated instances of non-financial items such as precious metal inventories. VIU measurement controversies are usually much greater for non-financial items such as fixed operating assets and real estate investments. The controversy has and always will be the trade-off between objectivity of valuation versus the possibility that the more objective valuations may be less useful or even very misleading. For example, a forced liquidation exchange value of an item may be very misleading if the owner has zero intention of selling. On the other hand, a VIU that depends heavily on subjective estimates subject to wide measurement error may also highly misleading and make fraud easier.

    A6. Highest and best use is a valuation concept that refers broadly to the use of an asset that would maximize the value of the asset or the group of assets in which the asset would be used by market participants. For some assets, in particular, nonfinancial assets, application of the highest-and-best-use concept could have a significant effect on the fair value measurement.

    Examples 1–3 illustrate the application of the highest-and-best-use concept in situations in which nonfinancial assets are newly acquired.
    Paragraph A6 of FAS 157 --- http://www.fasb.org/pdf/aop_FAS157.pdf

    Traditionally, value in-use fairly reflects the economics of a specific transaction. But the FASB has indicated in recently issued guidelines, that it prefers looking to the market, rather than company-specific valuations. Regardless of which approach is chosen, future income statements will be affected. The value in-use approach will generally result in higher depreciation expense and lower reported earnings. The value in-exchange approach will usually result in more of the initial purchase price being allocated to goodwill, which must be tested for impairment every year.
    “SFAS 141 Impacts Choice of Method Used to Value PP & E” --- http://www.valuationresearch.com/content/Knowledge_center/back_issues/35_2002_2.htm

    C38. In the context of the related guidance included in the Exposure Draft, some respondents referred to possible conflicts between the in-use valuation premise and the exchange notion encompassed within the definition of fair value. In this Statement, the Board clarified that the exchange notion applies regardless of the valuation premise used to measure the fair value of an asset. Whether using an in-use or an in-exchange valuation premise, the measurement is a market-based measurement determined based on the use of an asset by market participants, not a value determined based solely on the use of an asset by the reporting entity (a value-in-use or entity-specific

    measurement).

    Paragraph C38 of FAS 157 --- http://www.fasb.org/pdf/aop_FAS157.pdf

    Jensen Comment
    Hence the FASB offers ambiguous guidance on exchange value versus value in use. The FASB likes exchange value (VIE) in terms of objectivity relative to the dastardly subjectivity of value in use (VIU). At the same time the FASB hates exchange valuation that puts asset values at the worst possible use of the asset, e.g. forced liquidation valuation of an asset that a going concern has every intention of using at much higher value. Also there’s absolutely no forced liquidation value for portions of fixed assets such as enormous installation costs of ERP and other database systems, blast or electric furnaces producing steel, factory robots, and assets requiring millions of dollars in winning governmental permits, many of which are not transferrable in liquidation sales.
    . Of course at present, neither the FASB nor the IASB require fair value accounting for most types of non-financial assets, including steel furnaces, ERP, factory robots, etc. If the FASB extends fair value accounting to all non-financial items, the FASB will most certainly have to back off priority for objective exchange values for items having zero exchange value such as non-transferable components of fixed assets such as installation costs.

    The AICPA provides lots of resources for fair value measurement but the AICPA is of little use in providing resources for estimating value in use.
    T
    he AICPA's Fair Value Accounting Resources --- http://www.journalofaccountancy.com/Web/FairValueResources.htm

    The IASB is as inconsistent as the FASB on issues of VIU versus VIE. The ideal is VIU that can be objectively determined such as an asset or liability with contractual future cash flows and minimal loss risk. As VIU becomes more subjective in terms managerial choices as to the future cash flow stream of 200 hotels in the hands of Days Inns versus Holiday Inns, then VIE is probably going to be preferred by the FASB and the IASB. But this can be misleading, because valuing hotels at a forced liquidation exit value may be more misleading than historical cost book value when there’s no intention whatsoever for the owner to sell the hotel. This would be especially misleading if Holiday Inns had to use forced liquidation exit values in this period of distressed real estate values where owners have no intention of selling out at distressed real estate values. Of course at present, neither the FASB nor the IASB require fair value accounting for most types of non-financial assets, including real estate. If fair value accounting is extended to all non-financial assets, I think that preferences for VIE will have to give way to VIU. VIE likely to be highly misleading (overly conservative) when trying to evaluate investment potential of a successful going concern.

    Value in use issues also rear up in standards involving value impairment tests such as

    Value in use [IAS 36, par. 18; IAS 38, par. 83]

    Economic Value (Discounted Cash Flow, Present Value) Accounting

    There are over 100 instances where present GAAP requires that historical cost accounting be abandoned in favor of discounted cash flow accounting (e.g., when valuing pension liabilities and computing fair values of derivative financial instruments). These apply in situations where future cash inflows and outflows can be reliably estimated and are attributable to the particular asset or liability being valued on a discounted cash flow basis.

    Advantages of Economic Value (Discounted Cash Flow, Present Value) Accounting

    Disadvantages of Economic Value (Discounted Cash Flow, Present Value) Accounting

    Bob Jensen’s threads on accounting valuation are at http://www.trinity.edu/rjensen/Theory01.htm#FairValue

    The Accounting Onion --- http://accountingonion.typepad.com/theaccountingonion/2009/04/a-new-title.html   

     

     

     

     

    April 3, 2009 message from Tom Selling [tom.selling@GROVESITE.COM]

    Bob,

    There are two sources of covariance that need to be dealt with: (1) covariances among assets recognized, and (2) covariances between recognized and non-recognized assets. I think replacement cost rules can easily cope with (1) without sacrificing additivity – i.e., that total assets on the balance sheet will represent the total minimum current cost of replacing the recognized assets of the business entity, assuming (for the moment) that there are no unrecognized assets. There may be issues of allocating the replacement cost among asset categories, but I don’t see that as a big problem, because everything adds up to the desired number.

    Since the nature of the assets we don’t recognize are very different in nature from the ones we recognize, I don’t see anything irrational (you may be able to enlighten me here) about having an expectation that the covariances of the second type, above, are 0. An expectation is different from a “declaration” or an “assumption.”

    I feel like a greased pig trying to escape your clutches! But unlike the pig, I’m learning a lot.

    Best,

    Tom

    April 4, 2009 reply from Bob Jensen

    Hi Tom,

    I agree with what you state about covariances of replacement cost estimates, but it is important to note that replacement cost accounting is really a cost allocation process rather than a valuation process for non-financial items subject to depreciation and amortization. Depreciation and amortization allocation formulas use such arbitrary estimates of economic lives, salvage values, and cost allocation patterns that it’s not clear why additive aggregation is any more meaningful under replacement cost aggregations than it is under historical cost aggregations. Neither one aggregates to anything we can meaningfully call value in use.

    Companies are no longer required to generate FAS 33-type comparisons.  The primary basis of accounting in the U.S. is unadjusted historical cost with numerous exceptions in particular instances.  For example, price-level adjustments may be required for operations in hyperinflation nations.  Exit value accounting is required for firms deemed highly likely to become non-going concerns.  Exit value accounting is required for personal financial statements (whether an individual or a personal partnership such as two married people).  Economic (discounted cash flow) valuations are required for certain types of assets and liabilities such as pension liabilities.  Exit value accounting is required for impaired items such as damaged inventories and inoperable machinery.

    Hence in the United States and virtually every other nation, accounting standards do not require or even allow one single basis of accounting.  Beginning in January 2005, all nations in the European Union adopted the IASB's international standards that have moved closer and closer each year to the FASB/SEC standards of the United States.

    The FASB and the IASB state that "value in use" is the ideal valuation measure if it can be measured reliably at realistic estimation costs. Exit value and economic (discounted cash flow) generally do not meet these two criteria for value in use of non-financial items. There is nearly always no practical means of estimating higher order covariances. and additivity aggregations are meaningless without such covariances.  In the case of economic valuation, estimation of future cash flows and discount rates enters the realm of fantasy for long-lived items. Alsoreliable exit value estimation of some items like all the hotel properties of Days Inns can be very expensive, which is a major reason Days Inns only did it once for financial reporting purposes in 1987. Accordingly, "value in use" is an ideal which cannot be practically achieved under either exit or economic valuation methods.

    The FASB and the IASB state that "value in use" is the ideal valuation measure, but this ideal can never be achieved with cost allocation methods. Both historical cost and replacement (current, entry) value "valuation" methods are not really valuation methods at all. These are cost allocation methods that for items subject to depreciation or amortization in value are reliant upon usually arbitrary estimates of non-financial item useful lives, value decline assumptions such as straight line or double declining balance declines, and salvage value estimates. Under historical cost, the book value thus becomes an arbitrary residual of the rationing of original cost by arbitrary cost allocation formulas. Under replacement (current, entry) cost allocation the estimated current replacement costs are subjected to n arbitrary residual of the rationing of replacement cost by arbitrary cost allocation formulas.

    Although both historical and replacement cost allocations over time avoid covariance problems in additive aggregations of book values, the meanings of such aggregations are of very dubious utility to investors and other decision makers. For example suppose the $10 million 2008 book value of a fleet of passenger vans is added to the $200 million 2008 book value of Days Inn hotel properties, what does the $210 million aggregation mean to anybody?

    Both the passenger vans and hotel buildings have been subjected to arbitrary estimates of economic lives, salvage values, and depreciation patters such as double declining balance depreciation for vans and straight-line depreciation for hotel buildings. This is the case whether historical cost or current replacement costs have been allocated by depreciation formulas.

    Hence it is not clear that for going concern companies that have heavy investments in non-financial assets that any known addition of individual items makes any sense under economic, exit, entry, or historical cost book value estimation process. Aggregations might make some sense for financial items with negligible covariances, but for non-financial items. Attempts to estimate total value itself basted upon stock market marginal trades are misleading since marginal trades of a small proportion of shares ignores huge blockage factors valuations, especially blockage factors that carry managerial control along with the blockage purchase. Countless mergers and acquisitions repeatedly illustrate that estimations of total values of companies are generally subject to huge margins of error, especially when intangibles play an enormous part of the value of an enterprise.

    Both the FASB and the IASB require in many instances that exit value accounting be used for financial items. In part that is because for financial items it is often more reasonable to assume zero covariances among items. The recent banking failures caused by covariance among toxic mortgage investments lends some doubt to this assumption, but the issue of David Li’s faltering and infamous Gaussian copula function is being ignored by both the IASB and the FASB in recommending exit value accounting for many (most) financial items --- http://en.wikipedia.org/wiki/Gaussian_copula#Gaussian_copula
    For how the defect in this formula contributed to the 2008 fall of many banks see
    ---
    http://financeprofessorblog.blogspot.com/2009/03/recipe-for-disaster-formula-that-killed.html 

    I might add that Bob Herz and the FASB as a whole recognize that additive aggregation in financial statement items is probably more misleading than helpful. This is why a very radical proposal is underway in the FASB to do away with aggregations, including the presentation of net income and earnings-per-share bottom liners --- http://www.trinity.edu/rjensen/Theory01.htm#ChangesOnTheWay 

    The above link also discusses the vehement disagreement between Bob Herz and the financial community on the proposal to do away with the bottom line.

    This bottom line aggregation problem is also bound up in the “quality of earnings” controversy ---
    http://www.trinity.edu/rjensen/Theory01.htm#CoreEarnings 
    However, the concept of reporting core earnings is not nearly as controversial as the proposal not to report any bottom lines.

    April 4, 2009 reply from Patricia Walters [patricia@DISCLOSUREANALYTICS.COM]

    Bob:

    You said: "The FASB and the IASB state that "value in use" is the ideal valuation measure if it can be measured reliably at realistic estimation costs."

    Given that, for many years now, they have both been working toward reliable external measurements rather than internal measurements, could you point me to where in the literature "value in use" is considered the "ideal"?

    Pat

    April 4, 2009 reply from Bob Jensen

    Hi Pat,

    The FASB’s concept of “value in use” is entirely different from “use value” conceptualized by Karl Marx --- http://en.wikipedia.org/wiki/Use_value

    Value in use originates in the concept that a firm computing net present value of an asset will use its own optimal use future stream of cash flows where that stream may not be attainable by any other company --- http://en.wikipedia.org/wiki/Value-in-use
    The Glossary of the FASB’s Accounting Standards Database Codification database defines “value in use” as
    The amount determined by discounting the future cash flows (including the ultimate proceeds of disposal) expected to be derived from the use of an asset at an appropriate rate that allows for the risk of the activities concerned”

    All too often Value in Use (VIU) is equated to discounted future cash flows of an item in optimal use. Discounted cash flow estimation may be a fantasyland ideal that is not altogether necessary. For example, if IBM has a factory robot assembling computer components, it is virtually impossible to trace future computer sale cash flows to the portion of cash flows attributed to one assembly robot. Exit value is probably a useless surrogate for an installed factory robot since exit value is absurdly low relative to VIU of the robot. Other surrogate valuations may be much closer to VIU, including the replacement cost appropriately adjusted for differences in economic life of the present robot versus a now robot. The thing about VIU is that, when exit value is highly misleading, then other valuation estimates are possible, including replacement cost based upon current entry values for an IBM purchase of a new robot plus engineering estimates of current installation cost of a replacement robot.

    Another approach to measure value in use is to have engineers estimate the cost savings of an assembly robot vis-a-vis the production costs without the robot. Of course this requires some subjectivity. Some of this data may have been generated at the time the decision was made to invest in the robot.

    Exit value is generally considered an exchange price that’s agreed upon by a buyer and a seller. Both buyer and seller may have different values in use such as when Days Inn sells 200 hotels to Holiday Inn. Covariance with brand name and other intangibles means that the value in use of each hotel differs for Days Inn versus Holiday Inn.

    Both the FASB and the IASB generally consider exit value to be the worst possible seller’s use (e.g., forced liquidation) of the item in liquidation rather than use in a going concern. It is very misleading when a going concern owner has zero intention to sell the item. The ideal is value in use rather than exit value for a going concern having an item that is operational. The presumption is that the exit value may be the worst possible use value for the seller but is almost certainly not the best possible use value for the buyer. Otherwise the buyer would not agree on that exchange price.

    Value in Use (VIU) should not be confused with what the FASB calls Value in Exchange (VIE) ---
    http://findarticles.com/p/articles/mi_hb6421/is_2004_July/ai_n29102623/
    A good illustration of VIU versus VIE in the context of FAS 157 is provided at http://www.tncpa.org/Journal/articles/FASB_157.pdf

    In the August 2008 annual American Accounting Association meetings Tom Linsmeier and another speaker from BYU put great emphasis on how exit value is the worst possible value for present owners that are going concerns. They both claimed preference for Value in Use.

    Neither the FASB nor the IASB is entirely consistent on value in use being the ideal. Paragraphs A5-A12 in FAS 157 illustrate how value in use (VIU) may be used in fair value measurement. However, keep in mind that current fair value accounting requirements apply mostly to financial items except in a few isolated instances of non-financial items such as precious metal inventories. VIU measurement controversies are usually much greater for non-financial items such as fixed operating assets and real estate investments. The controversy has and always will be the trade-off between objectivity of valuation versus the possibility that the more objective valuations may be less useful or even very misleading. For example, a forced liquidation exchange value of an item may be very misleading if the owner has zero intention of selling. On the other hand, a VIU that depends heavily on subjective estimates subject to wide measurement error may also highly misleading and make fraud easier.

    A6. Highest and best use is a valuation concept that refers broadly to the use of an asset that would maximize the value of the asset or the group of assets in which the asset would be used by market participants. For some assets, in particular, nonfinancial assets, application of the highest-and-best-use concept could have a significant effect on the fair value measurement.

    Examples 1–3 illustrate the application of the highest-and-best-use concept in situations in which nonfinancial assets are newly acquired.
    Paragraph A6 of FAS 157 --- http://www.fasb.org/pdf/aop_FAS157.pdf

    Traditionally, value in-use fairly reflects the economics of a specific transaction. But the FASB has indicated in recently issued guidelines, that it prefers looking to the market, rather than company-specific valuations. Regardless of which approach is chosen, future income statements will be affected. The value in-use approach will generally result in higher depreciation expense and lower reported earnings. The value in-exchange approach will usually result in more of the initial purchase price being allocated to goodwill, which must be tested for impairment every year.
    “SFAS 141 Impacts Choice of Method Used to Value PP & E” --- http://www.valuationresearch.com/content/Knowledge_center/back_issues/35_2002_2.htm

    C38. In the context of the related guidance included in the Exposure Draft, some respondents referred to possible conflicts between the in-use valuation premise and the exchange notion encompassed within the definition of fair value. In this Statement, the Board clarified that the exchange notion applies regardless of the valuation premise used to measure the fair value of an asset. Whether using an in-use or an in-exchange valuation premise, the measurement is a market-based measurement determined based on the use of an asset by market participants, not a value determined based solely on the use of an asset by the reporting entity (a value-in-use or entity-specificmeasurement).
    Paragraph C38 of FAS 157 --- http://www.fasb.org/pdf/aop_FAS157.pdf

    Jensen Comment
    Hence the FASB offers ambiguous guidance on exchange value versus value in use. The FASB likes exchange value (VIE) in terms of objectivity relative to the dastardly subjectivity of value in use (VIU). At the same time the FASB hates exchange valuation that puts asset values at the worst possible use of the asset, e.g. forced liquidation valuation of an asset that a going concern has every intention of using at much higher value. Also there’s absolutely no forced liquidation value for portions of fixed assets such as enormous installation costs of ERP and other database systems, blast or electric furnaces producing steel, factory robots, and assets requiring millions of dollars in winning governmental permits, many of which are not transferrable in liquidation sales.
    . Of course at present, neither the FASB nor the IASB require fair value accounting for most types of non-financial assets, including steel furnaces, ERP, factory robots, etc. If the FASB extends fair value accounting to all non-financial items, the FASB will most certainly have to back off priority for objective exchange values for items having zero exchange value such as non-transferable components of fixed assets such as installation costs.

    The AICPA provides lots of resources for fair value measurement but the AICPA is of little use in providing resources for estimating value in use.
    T
    he AICPA's Fair Value Accounting Resources --- http://www.journalofaccountancy.com/Web/FairValueResources.htm

    The IASB is as inconsistent as the FASB on issues of VIU versus VIE. The ideal is VIU that can be objectively determined such as an asset or liability with contractual future cash flows and minimal loss risk. As VIU becomes more subjective in terms managerial choices as to the future cash flow stream of 200 hotels in the hands of Days Inns versus Holiday Inns, then VIE is probably going to be preferred by the FASB and the IASB. But this can be misleading, because valuing hotels at a forced liquidation exit value may be more misleading than historical cost book value when there’s no intention whatsoever for the owner to sell the hotel. This would be especially misleading if Holiday Inns had to use forced liquidation exit values in this period of distressed real estate values where owners have no intention of selling out at distressed real estate values. Of course at present, neither the FASB nor the IASB require fair value accounting for most types of non-financial assets, including real estate. If fair value accounting is extended to all non-financial assets, I think that preferences for VIE will have to give way to VIU. VIE likely to be highly misleading (overly conservative) when trying to evaluate investment potential of a successful going concern.

    Value in use issues also rear up in standards involving value impairment tests such as
    Value in use [IAS 36, par. 18; IAS 38, par. 83]

     

    Bob Jensen's other threads on fair value accounting are at various other links:

    Return on Investment Theory --- http://www.trinity.edu/rjensen/roi.htm

    Interest Rate Swap Valuation, Forward Rate Derivation, and Yield Curves for FAS 133 and IAS 39 on Accounting for Derivative Financial Instruments ---
    http://www.trinity.edu/rjensen/acct5341/speakers/133swapvalue.htm

     


    No. FAS 141(R)-1 --- http://www.fasb.org/pdf/fsp_fas141r-1.pdf
    Title: Accounting for Assets Acquired and Liabilities Assumed in a Business Combination That Arise from Contingencies
    Date Issued: April 1, 2009
    Jensen Comment
    This is an illustration of a principles based "standard" that will be very difficult to implement and virtually impossible to consistently apply among different firms.


    From The Wall Street Journal Weekly Accounting Review on April 16, 2009

    More States Look to Raise Taxes
    The Wall Street Journal
    by Leslie Eaton
    Apr 09, 2009
    Click here to view the full article on WSJ.com
    http://online.wsj.com/article/SB123923448796803135.html?mod=djem_jiewr_AC
     

    TOPICS: Governmental Accounting, Income Tax, Revenue Forecast, sales tax, State Income Tax, State Taxation, Tax Laws, Taxation

    SUMMARY: Since most states must by law balance their budgets every year, dwindling sales and income tax revenues during this economic downturn have led to discussions about increasing income and sales tax rates. "At least 10 states are considering some kind of major increase in sales or income taxes: Arizona, Connecticut, Delaware, Illinois, Massachusetts, Minnesota, New Jersey, Oregon, Washington and Wisconsin. California and New York already have agreed on multibillion-dollar tax increases that went into effect earlier this year. Fiscal experts say more states are likely to try to raise tax revenue in coming months, especially once they tally the latest shortfalls from April 15 income-tax filings, often the biggest single source of funds for the 43 states that levy them....[However,] many states remain determined to balance their budgets by relying solely on spending cuts. That is the case in Indiana, where raising revenue 'is really not on the table,' said Pat Bauer, the speaker of the state House." The article finishes with a discussion of year over year comparisons and state revenue forecasts used to assess what actions states must take in these difficult times.

    CLASSROOM APPLICATION: The article can be used both to discuss state tax levies in a tax class and to discuss governmental budgeting in a governmental accounting class.

    QUESTIONS: 
    1. (Introductory) As described in this article, what are the major sources of revenue to state governments?

    2. (Advanced) Why are states raising income and sales tax rates when current economic times make it difficult for many households even under current tax levies?

    3. (Advanced) When can states best project their tax revenues for the fiscal year? Why must they make these projections?

    4. (Introductory) For how long a period does Indiana usually prepare its budget? What has changed in this year?

    5. (Advanced) What Financial analysis techniques do states undertake to forecast their revenues in order to decide on their course of action? Cite all that you can find in the article.

    6. (Advanced) How do governmental entities include bad debts assessment as part of the analysis described in answer to question 5?
     

    Reviewed By: Judy Beckman, University of Rhode Island


    May 3, 2009 message from Neal Hannon [nhannon@GMAIL.COM]

    Mike Willis (XBRL International, PwC) has asked for comments and votes for http://www.thenationaldialogue.org/ideas/collaboration 
    Please help and pass the word. Thanks!

    Looking for alternative uses of XBRL? Check out with State Controller Kim Wallin is doing in Nevada. XBRL Ends Spreadsheet Hell Tools Sponsored By

    May 1, 2009, By Wayne Hanson

    "The goals were timely and accurate data, stronger internal controls, reduced costs, a standardized system of seamless data exchange, business processes and data elements. XBRL met all of those goals." -- Nevada Controller Kim Wallin (pictured)

    States and localities have in recent years been engaged in developing financial Web sites, transparency portals, campaign finance disclosure and online checkbooks to open the process of government spending to a very interested and sometimes skeptical public. Recently, with the flood of federal stimulus money, that development has accelerated.

    While a commitment to openness and transparency is commendable, tracking grants and other financial information -- across multiple agencies and departments running different software on incompatible systems -- is a tough job for jurisdictions, and the resulting information may be too late for real-time decision making, and too complex for anyone but a professional auditor to understand. Increasingly, XBRL is being heralded as a solution.

    What is XBRL?

    XBRL stands for eXtensible Business Reporting Language -- an XML-based open standard for financial reporting. "Instead of treating financial information as a block of text -- as in a standard Internet page or a printed document -- XBRL provides an identifying tag for each individual item of data," says an explanation on the XBRL International Web site. "This is computer readable. For example, company net profit has its own unique tag. In addition, the tags provide other information about the item, such as whether it is a monetary item, percentage or fraction, etc.

    "XBRL can show how items are related to one another," continues the site. "It can thus represent how they are calculated. It can also identify whether they fall into particular groupings for organizational or presentational purposes. Most importantly, XBRL is easily extensible, so ... organizations can adapt it to meet a variety of special requirements."

    "The introduction of XBRL tags enables automated processing of business information by computer software, cutting out laborious and costly processes of manual re-entry and comparison. Computers can treat XBRL data ‘intelligently' ... they can recognize the information in an XBRL document, select it, analyze it, store it, exchange it with other computers and present it automatically in a variety of ways for users. XBRL greatly increases the speed of handling of financial data, reduces the chance of error and permits automatic checking of information."

    More in the full article http://www.govtech.com/gt/653427

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


    Charles Ponzi (1882-1949) --- http://en.wikipedia.org/wiki/Charles_Ponzi
    Ponzi Frauds --- http://en.wikipedia.org/wiki/Ponzi_game

    Bernard Madoff --- http://en.wikipedia.org/wiki/Madoff

    "How Bernie Madoff did it:  Madoff is behind bars and isn't talking. But a Fortune investigation uncovers secrets of his massive swindle," by James Bandler, Nicholas Varchaver and Doris Burke, CNN Money, April 24, 2009 ---
    http://money.cnn.com/2009/04/24/news/newsmakers/madoff.brief.fortune/index.htm?cnn=yes

    Since Bernard Madoff was arrested in December and confessed to masterminding a multi-billion Ponzi scheme, countless people have wondered: Who else was involved? Who knew about the fraud? After all, Madoff not only engineered an epic swindle, he insisted to the FBI that he did it all by himself. To date, Madoff has not implicated anybody but himself.

    But the contours of the case are changing.

    Fortune has learned that Frank DiPascali, the chief lieutenant in Madoff's secretive investment business, is trying to negotiate a plea deal with federal prosecutors. In exchange for a reduced sentence, he would divulge his encyclopedic knowledge of Madoff's scheme. And unlike his boss, DiPascali is willing to name names.

    According to a person familiar with the matter, DiPascali has no evidence that other Madoff family members were participants in the fraud. However, he is prepared to testify that he manipulated phony returns on behalf of some key Madoff investors, including Frank Avellino, who used to run a so-called feeder fund, Jeffry Picower, whose foundation had to close as a result of Madoff-related losses, and others.

    If, for example, one of these special customers had large gains on other investments, he would tell DiPascali, who would fabricate a loss to reduce the tax bill. If true, that would mean these investors knew their returns were fishy.

    Explains the source familiar with the matter: "This is a group of inside investors -- all individuals with very, very high net worths who, hypothetically speaking, received a 20% markup or 25% markup or a 15% loss if they needed it." The investors would tell DiPascali, for example, that their other investments had soared and they needed to find some losses to cut their tax bills. DiPascali would adjust their Madoff results accordingly.

    (Gary Woodfield, a lawyer for Avellino, and William Zabel, the attorney for Picower, both declined to comment. Marc Mukasey, DiPascali's laywer, says, "We expect and encourage a thorough investigation.")

    Inside the Madoff swindle: Read the full story --- http://money.cnn.com/2009/04/24/news/newsmakers/madoff.fortune/index.htm

    These special deals for select Madoff investors have become a key focus for federal prosecutors, according to this source and a second one familiar with the investigation. The second source describes the arrangements as "kickbacks" and "