The Accounting Onion

Making Revenue Recognition Simple and Informative

One thing that everyone should be able to agree on is that the accounting rules for measuring and reporting revenue ("revenue recognition") are a huge mess. There are too many of them, and far too many inconsistencies amongst them.

One of my favorite examples for illustrating how dysfunctional the rules can be is this illustrative example taken from a 1999 SEC Staff Accounting Bulletin (No. 101):

"A registrant sells a lifetime membership in a health club. After paying a nonrefundable "initiation fee," the customer is permitted to use the health club indefinitely, so long as the customer also pays an additional usage fee each month. The monthly usage fees collected from all customers are adequate to cover the operating costs of the health club. … Question: when should the revenue relating to nonrefundable, up-front fees in [this type of an arrangement] be recognized?"

If all you knew about accounting was that "assets" are what you have and "liabilities" are what you owe, then you should respond that the revenue should be recognized "when cash is received"; the health club has received an asset (from a non-owner), and it has no obligation to return cash at a later date, or even to provide services, under any circumstances.

The SEC, however, enunciated a different point of view in SAB 101, which can now be found in Topic 13 of the SAB Codification:

"Unless the up-front fee is in exchange for products delivered or services performed that represent the culmination of a separate earnings process, the deferral of revenue is appropriate. … [T]he staff does not view the activities completed by the [registrant (i.e., selling the membership) as a discrete earnings event.]"

The implication of this illustration is that revenue recognition under GAAP involves more than just the receipt of assets that you don't have to pay back; an implicit performance obligation to provide the customer with future services is deemed to exist, even though the customer has no legally enforceable right to receive the services.

In other words, current revenue recognition practices are dependent on factors that don't play into whether or not the definition of an asset or liability has been met for recognition, its subsequent measurement, or conditions for its derecognition. This disconnect of revenue recognition from the balance sheet, has led to a jagged path of positions hatched industry-by-industry, over decades of political wrangling with issuers and auditors. The resulting complexities, subtleties and inconsistencies within the revenue recognition rules are, at their very best, second only to the tangled web that is financial instruments accounting.

The Epic Revenue Recognition Project

The FASB/IASB joint project on revenue recognition seems to have been initiated as a good faith attempt by them to recapture the high ground after SAB 101 on a topic that arguably is the most consequential to the most financial statement issuers. After seven years (yes, the project was proposed back in January 2002) of consideration, the Boards' position has evolved essentially to these major positions as expressed in a discussion paper for which the comment deadline expired six months ago:

• The scope is limited to arrangements whereby an entity exchanges promises with a customer, leading to rights and obligations.  
• Increases in rights or decreases in obligations to customers are recognized as revenue.
• Performance obligations are to be initially measured by the transaction price, or an allocation of the arrangement consideration; subsequent measurement is still unsettled, but is likely to be a function of the initial measurement (as opposed to a market-based valuation).

The good news is that a new standard would supplant all extant revenue recognition guidance, and become the sole source of guidance on revenue recognition. The bad news is that it won't change much else. I see three major flaws.

First, revenue recognition should be nothing more than a question of income statement classification. If the FASB were fully committed to a balance sheet approach to financial reporting, it would plainly acknowledge and implement the principle that net income is merely a number derived from the changes in assets and liabilities during a period that resulted from transactions with non-owners. Hence, the only revenue recognition problem is determining which of those changes should be reported on the income statement as "revenues."   As it is invariably the case with both Boards, a piecemeal approach is being taken to avoid the larger contentious debate of accounting for rights and obligations in general

Second, nothing worthwhile can come from including constructive performance obligations in the conceptual definition of a liability. The health club initiation fee example is the most straightforward example I can think of to illustrate this. The timing of services provided will cease to be a criteria, but the Boards are not willing to throw out the notion of a constructive obligation from their respective conceptual frameworks:

 "Sometimes an entity establishes a practice of providng particular goods or services, such as a warranty service.  Even if neither the contract nor the law explicity requires such a service, the entity by its customary business practice may have implicitly or constructively created an obligation that would be enforceable." (para. 3.6]

An "enforceable" constructive obligation?  I don't know what that means.  I imagine that what they are trying to say, but too embarassed to say directly is this: even though no legal obligation exists, an entity would harm itself by more than it would benefit if it just took a customer's money and ran.  Thus, economic forces make a constructive obligation "enforceable."  

I might be less cynical about the reasons for wanting to recognize constructive obligations if we actually had effective financial reporting gatekeepers. How many auditors will call a potential constructive obligation the way they see it – as opposed to the way management sees it? Investors don't need that kind of financial reporting any more, and their returns don't need to be burdened with the considerable costs of amortizing upfront fees over some fuzzy measure of the expected relationship period. 

Third, measurement of customer-related assets and obligations by allocating arrangement consideration to them is a step backwards from the FASB's putative goal of measuring financial assets and liabilities at their fair values. I presume that the FASB is legitimately concerned about introducing more subjectivity into measurement of assets and liabilities; and more fundamentally, they are rightly concerned that exit values for liabilities will inevitably generate Day 1 gains for vendors.

I can't say that there is a sure-fire solution to fair value measurement's subjectivity, for that will always be present in any approach to current valuation.  But, there is a straightforward way around the problem of Day 1 gains. Consider, for example, a one-year fire insurance policy with a $1,000 up-front premium. If an exit value approach were taken to measure the performance obligation on Day 1 (i.e., the obligation to stand ready to pay for the insured's loss should a fire occur), it would likely cost the insurance company less than $1,000 to cede the liability to a reinsurer; hence, the Day 1 gain the Boards are worried about.

But, here is, yet one more time, the compelling economic logic of replacement cost measurements. As I have stated in numerous prior posts, a liability is most appropriately measured by the replacement cost of the corresponding insurance asset in the possession of the policyholder. That number would, by definition, still be $1,000 on Day 1. Presto change-o, the problem of Day 1 gains disappears!

Summing Up

Revenue recognition is arguably the most significant project the FASB and IASB can undertake. But momentum, such as it was, appears to have stalled following the issuance a full year ago of that discussion paper purporting to contain the Boards' "preliminary views."  I believe this is because the standards setters keep bumping up against inevitable logical inconsistencies. First and foremost, is that the predilection for exit values is birthing a frightening brood of financial reporting anomalies. Here are five that come to mind without thinking about it for more than 30 seconds:

• Day 1 expensing of transaction costs when acquiring financial assets or applying the "acquisition method" to a business combination;
• Assigning an exit value to a leased asset that, by contract, cannot be transferred.
• Recording gains on the completion of a manufactured good before it is sold (specifically scoped out of the discussion paper).
• Liabilities that cannot be transferred.
• Asset markets that are either illiquid, or temporarily taken over by distressed sellers. 

I have been told by someone with access to inside information that FASB chair Bob Herz is a replacement cost guy deep down; but, he can't seem to muster the political momentum to alter course away from exit prices. The way I see it, if we continue to reject replacement cost, we are doomed to chasing our tails: (1) try exit values; (2) become discouraged as the logical inconsistencies destroy representational faithfulness; (3) give up and settle for reporting computer-generated random numbers seeded by an historic cost.

As significant as the revenue project is, a reasoned solution is being lost by a destructive problem solving strategy that the late Nobel laureate Herbert Simon and his co-author Allen Newell called "means-ends analysis"  in their 1972 treatise, Human Problem Solving. The danger is that dogged "forward progress" on a portion of a problem may actually set back the solution of the larger problem to which it is apart. After eight years of hemming and hawing, the FASB surely must realize that its approach is clearly not working. Rather than continue to propose partial fixes to flawed models, it would be better off postponing the project until it establishes more pragmatic definitions and measurements for assets and liabilities.   

If it could only solve the larger problem, the problem of revenue recognition would practically solve itself.

Going to School on Revenue Recognition

I'm a night owl, but once I hit the sack, I'm out like a light for 8-9 hours. In fact, the two things I would say that I do best are type fast and sleep like a log. One recent night was a rare exception, though. I woke up only about two hours into my hibernation and couldn't fall back asleep. After about another hour, I gave up. It was too late to have a toodle, so I decamped to my office and turned on the computer.

The first thing on the web to catch my eye was a blurb in the Chronicle of Higher Education, in which it was reported that the revenue recognition policies of the Apollo Group Inc., the parent company of the University of Phoenix, were the subject of an "informal inquiry" by the SEC's Division of Enforcement. Apollo has declined to provide any further specifics, but their share price declined about 18% around the time of the announcement. Hmm.

I decided to look further into this for three reasons: (1) I thought it might help me get to sleep; (2) I was in the midst of preparing to lead a one-day workshop on revenue recognition, so I could actually benefit by a review of some of the rules; and (3) Apollo's headquarters are in Phoenix, where I live.

What I Found – Before I Went Back to Bed

The first thing I did was to download Apollo's most recent 10-K and to read their description of critical accounting policies on revenue recognition. I also pulled 15 years worth of financial statements in spreadsheet format from a data service.

Here is what I found after a few minutes of perusal:

• Students are billed on a course-by-course basis. But, judging by the ratio of the allowance for doubtful accounts to gross student accounts receivable, 29%, it appears that a significant number of student accounts are eventually written off as uncollectible.
• Upon the first day of attendance, Apollo records a receivable and deferred revenue in the amount of the billing. As I will explain later, I was surprised to learn this; 'executory contracts' are usually not recognized (with the notable exception of capital lease accounting).
• Tuition revenue is recognized pro rata over the duration of the course, which is generally 6 - 9 weeks. As we say in the trade, it appears that Apollo has adopted a 'proportional performance' revenue recognition model. A more conservative choice would be a 'completed performance' model.
• Apollo recently changed its refund policy whereby students who attend 60% or less of a course are eligible for a refund for the portion of the course they did not attend.
• Apollo prepared its statement of cash flows under the direct method through 1997. They switched to the indirect method in 1998. I would have thought that a 'preferability letter' for such a change would have been included in the 1998 10-K, but I was unable to locate one.

What Could the SEC Be Looking At?

It appears that the SEC Enforcement Division received a referral from the Division of Corporation Finance, which reviewed Apollo's most recently filed 10-K, issued a comment letter, and received a reply from Apollo. Corp Fin's comments addressed, among other things, Apollo's revenue recognition policy for refunds, and whether bad debt expense and revenue were both overstated (i.e., certain amounts of bad debt expense should have been treated as reductions in revenue).

My own questions start at a much more basic level than Corp Fin's comments: when, if ever, it would be appropriate for Apollo to recognize revenue prior to the receipt of payment?

Accounting for the Students Who Pay in Arrears

The general rule in GAAP is that revenue cannot be recognized until it is earned, and realized or realizable (see Statement of Financial Accounting Concepts No. 5). The SEC staff has interpreted this general rule in Topic 13 of the Codification of Staff Accounting Bulletins (SAB Topic 13) to mean that four criteria must be met in order for revenue to be recognized. I won't go into all of them, but the last criteria is that "collectibility is reasonably assured." If the probability is 29% that a student won't pay Apollo, can it be said that collectibility is reasonably assured?

Apollo and its auditors might respond by stating that 71% of the billings to students are reasonably assured; moreover, Apollo has accumulated an extensive history of course delivery that enables them to reliably estimate the allowance at 29%.

But, there is no language in SAB Topic 13 that specifically allows Apollo to combine similar arrangements for the purpose of determining whether collectability is reasonably assured. SAB Topic 13 does provides that one can estimate future liabilities for warranties and returns by aggregating similar customer arrangements and estimating an average for the group; however, it did not specifically provide that those procedures were available for non-payments of enforceable claims. Notwithstanding, historic experience may not be all that helpful in determining the non-payment rate in the current economic environment. For companies with low non-payment rates, maybe, but for companies with a 29% payment rate, perhaps not.

I suppose it would have been clearer if SAB Topic 13 stated what was to be accomplished by providing that collectibility must be reasonably assured; and/or had specifically prohibited combining accounts when evaluating the criteria. Nonetheless, the following example may serve to illuminate the SEC's intent.

Take two companies, A and B; they are equally profitable and differ principally in collectibility rate of accounts receivable. Company A estimates its allowance for doubtful accounts to be 2% of gross accounts receivable, and B's allowance is 30%. Both companies discover, after the fact, that the real allowance was only two-thirds of what it should have been: that is, 3% for A and 45% for B. The premature recognition of earnings by Company A may or may not be material, but for B, it will be as cataclysmic to the income statement as was the AZ Cardinals loss last Sunday on a final-play touchdown pass to my son. It could be permissible to estimate an allowance for doubtful accounts for a group of similar arrangements, but it does not seem appropriate to determine that collectibility is reasonably assured on the same basis.

When is Revenue from a Course Earned?

While collectability may be an issue for some arrangements with students, many of Apollo's students pay in advance. The comment in this section apply to all arrangements, regardless of the timing and/or uncertainty of cash flows.

SAB Topic 13 provides that revenue should not be recognized for "delivered elements" (i.e., classes in Apollo's vernacular) if remaining elements to be delivered to the customer are "…essential to the functionality of the delivered … services." The staff created an exception to this rule for undelivered elements that are "inconsequential" or "perfunctory," but it is not applicable if failure to complete the activities would result in the customer receiving a full or partial refund … (or a right to a refund…)." Stated from a balance sheet perspective, the underlying principle is that one is generally precluded from recognizing a receivable that is not backed by an enforceable right to collect it.

I am unfamiliar with the way courses are conducted by Apollo, but I assume that they all end with an evaluation leading to a final grade. In my experience, students will not pay for a course that doesn't provide them with a grade. Grading is an essential function of the service provided; therefore, it would seem that SEC guidance would require Apollo to defer revenue related to a course until a grade is given to the student.

But, to be fair, I did check the revenue recognition policies of a number of other public companies in the same industry as Apollo, and they all recognize revenue in some ratable fashion as courses progress. For me, that is just one more reason why the SEC's investigation of Apollo's revenue recognition practice is significant. It could better the practices of an entire industry.  (And, by the way, numerous competitors have non-collectibility rates that are roughly the same as Apollo's.)

Accounting for Students Who Drop a Course

The question that the SEC seems to be homing in on is whether Apollo has properly allowed for refunds to students who may drop the course before the 60% point. That also happens to be the only revenue recognition issue that analysts were asking about in Apollo's fourth quarter earnings conference call.

It could be that the analysts and the SEC are both missing the boat. The SEC may believe that Apollo should allocate a portion of the deferred revenue to an estimated liability for refunds. That would initially affect balance sheet classification of liabilities, and it may affect the pattern by which revenue hits the income statement; but it doesn't seem to be that big a deal to me. Yet, it must be said that Apollo's stock price did take an 18% hit around the time of the announcement of the SEC investigation.  If the accounting for the new refund policy is the reason for the stock price drop, then so be it.   

Other Red Flags

I have two final thoughts regarding items that I noticed in my relatively brief perusal of the financial statements. First, even though the ratio of the allowance for doubtful accounts to accounts receivable is around 30%, the ratio of the allowance to receivables for which Apollo actually has enforceable rights could be significantly higher.

That's because Apollo has a practice of recognizing receivables for which it has no enforceable rights. Recall that Apollo recognizes a receivable and deferred revenue for the price of a course when the student shows up for the first day of class. I suppose Apollo is reasoning that both parties have gone down the road somewhat, but it pretty much looks like an executory contract to me. Be that as it may, the SEC should be asking whether the allowance for doubtful accounts is based on the total reported balance of accounts receivable, or just the portion representing enforceable rights. It makes no sense to me to create an allowance for doubtful accounts (and an offset to bad debt expense) on a 'receivable' that is not owed, and may never become owed if the student drops the course. If Apollo sees it the same way, the ratio of doubtful accounts to enforceable student receivables could be significantly higher than even the 29% reported.

Second, regarding the change in the method of presenting cash flows, it would be a pretty big stretch for an auditor to maintain that the switch in accounting was to a preferable method; the FASB has stated in SFAS 95 that the direct method is the approach they encourage issuers to employ as "the more comprehensive and presumably useful." (para. 119) I sure would like to see the SEC ask Apollo and their auditors about that one.

And, perhaps, here is a Hanukah present to the FASB: Apollo could be their poster child for why the direct method for presentation of cash flows should be required. Would 18% of total shareholder value have been destroyed in one fell swoop, had Apollo reported cash flows to investors using the direct method? Perhaps not, because trends in the amount of cash collected from customers would have been disclosed.  The direct method of presenting the statement of cash flows reduces the criticality that investors accurately evaluate the quality of an issuer's revenue recognition policies.  

Winding Up

My goal for this posting was simply to raise interesting questions about Apollo's revenue recognition policies. I want to explicitly state that my intention is not to pass judgment on any of Apollo's choices, even though the market may have spoken to that effect by devaluing Apollo's shares.

Indeed, there are many more questions suggested by this case, and they go beyond the specific effects on Apollo. For example, one could consider whether the revenue recognition rules applicable to Apollo's arrangements with students are themselves representationally faithful or appropriate. We might also ask whether a different result would obtain if the revenue recognition rules under IFRS were applied. Finally, and perhaps most interesting, we could ask how the revenue recognition project being undertaken by the FASB and the IASB jointly has the potential to improve the quality of financial reporting by companies like Apollo. Unfortunately, I am not confident that the proposed approach would be an improvement, but that's for another post.

To Head in the Right Direction on IFRS, the SEC Should Make a U-Turn

In my first post with results of our IFRS opinion survey, I focused on three questions that indicated respondents' overall attitude towards IFRS adoption without getting too deep into the specifics. In this second and final post, I am going to peel the onion a couple of layers deeper: (1) down to the touted benefits of IFRS as compared to GAAP; and (2) the policy question of convergence—irrespective of IFRS adoption.

If you would prefer to be given an executive summary before (or without) reading further, it is this: (1) IFRS is not perceived to be better, in the respects examined, than GAAP; and (2) continued efforts to bring the two bases of accounting closer together are not expected to be worthwhile—unless you are a Big Four auditor or work at a Fortune 500 company. Bottom line: the SEC should make a U-turn on its roadmap proposal.

Benefits of IFRS—Or More Accurately, Complete Lack Thereof

One of the clearest messages to come out of our survey, which I described in my first post, was that only 23% of all respondents believe that the benefits of IFRS adoption would exceed the costs. Of that minority, a disproportionate number work for the Big Four or the Fortune 500 ("B4+F500"). These two groups comprise slightly more than 1/8 of the respondents, but are about 1/4 of the minority view.

Some of the survey questions peel the onion on the benefit side of the cost-benefit tradeoff: the two most touted benefits of IFRS relative to GAAP being greater comparability, and enhanced relevance and reliability. For example, we asked whether the greater latitude afforded to issuers of financial statements by IFRS affects the relative value of financial statements prepared according to IFRS ("value" is a broader concept than comparability or relevance and reliability):

 

One of the most lopsided results of the survey is the almost 5:1 verdict against the information value of the management judgment afforded by IFRS. Even the B4+F500 are on the same side on this question, albeit by a lesser (approx. 1.5:1) margin.

I should point out that I did not intend for this question to be a referendum on "principles-based accounting standards." I interpret the responses as expressing a preference for detailed guidance when no universal principle or objective has been provided as a benchmark. Such is most often the case with both IFRS and U.S. GAAP. As an analogy, detailed rules and interpretive guidance has been the modus operandi of the SEC, and perhaps its most distinctive characteristic as compared to other national regulators. Notwithstanding the hiccups of the last decade, which I believe are more broadly attributable to an apalling lack of effectiveness on the part of the private sector gatekeepers, it has been the detailed rules and guidance toward the objective of full disclosure, combined with a narrow focus on investor protection, that has made our capital markets the global benchmark.

Specifically in regard to comparability, proponents of IFRS adoption claim that U.S. companies should experience greater access to global capital markets if those companies were to report under IFRS. One may suppose that analysts would be able to make comparisons among potential investments more efficiently. However, only 42% of respondents believe that IFRS adoption within the next ten years would positively affect comparability, and less than 10% would characterize the effect on comparability to be "significant":

 

The above chart also indicates that, once again, that the B4+F500 are disproportionately represented within the minority view.

Regarding relevance and reliability, only 21% of respondents are of the opinion that IFRS would enhance relevance and reliability:

The Value of Convergence, Or More Accurately, Lack Thereof

Even before the SEC's IFRS Roadmap proposal, the Big Four strategy has been to browbeat the rest of us into submission with incessant mantra-like repetition of "IFRS is inevitable." A variation on that shtick, "apple pie" characterization of convergence. Our survey results indicate "cow pie" may be more apt:

It appears that hardly anyone, save the B4+F500, are of the opinion that convergence efforts over the past several years has significantly improved U.S. GAAP; and 58% believe that the process has either been a dud or has somewhat diminished U.S. GAAP.

So, the answer to the convergence policy question, "What's in it for us, the U.S. investor?" seems to be—not much. Indeed, although it is impossible to tell to what extent convergence has retarded the already glacial pace of standard setting in the U.S., it is safe to assume that projects like financial statement presentation, leasing, loan fair value and even revenue recognition could be much closer to completion without the helpful input of the French, et. al.

There does not seem to be a great deal of optimism regarding future convergence efforts, either. Only 32% of respondents disagree with the statement that a single set of accounting standards is a realistic goal:

Moreover, a whopping 70% of respondents (including the B4+F500) don't think that the boards will resolve all of the significant differences between GAAP and IFRS:

I suspect that "convergence" is less a defined term than it is a marketing gimmick. If you think I am being too cynical, kindly recall that the "convergence" euphemism replaced the even more mellifluous term, "harmonization." Neither term of art can be matched to a corresponding dictionary definition that remotely indicates the underlying policy objective. At their best, they are metaphors for … who knows? Now that even the IFRS proponents have been forced to admit that identical standards is no longer a possibility, it is high time to get more specific about what "convergence" is intended to accomplish. Getting "close enough for government work" is a better match for processes that have taken place to-date, but respondents (including, for once, B4+F500) don't even expect even that amorphous objective to be met.

Final Words 

Given my oft-mentioned preferences against IFRS adoption, one would not be unreasonable to be skeptical of any claim of absence of bias in my analysis. That's just one reason why the entire database of responses is available here.

You could also make a valid point that, in addition to the caveats mentioned in the companion post, academics are over-represented among the respondents and investors are under-represented. As to the academics, the data does not indicate to me that the views of academics are radically different than any other group, save the B4+F500 zealots. Others have also remarked that my survey may be the most comprehensive data available thus far on the opinions of academics regarding IFRS. I also can't see that academics as a group have ecoomic incentives that would cause them to support or oppose IFRS adoption, but that may be a reflection of my own biases.

As to under-representation of investors, it remains a mystery as to why they appear so reluctant to weigh in on the issue of IFRS adoption. For example, the CFA Institute surveyed approximately 97,000 of its members worldwide. Their response rate was 1.6%. 1,576 responses sound like a lot, but the potential for non-response bias must be very high. I have no way of knowing how many persons viewed our invitation to be surveyed, but I am guessing that our response rate was more on the order of 10%.

Sarbanes-Oxley and Smaller Reporting Companies: There is a Better Way

I apologize for the long interval between this and my last posting – especially to those of you who have privately thanked me for material just boring enough, and long enough, to induce a good night's sleep. Tax blogs, I am told, are much too potent unless one is planning to spend an entire holiday weekend in bed.

This long-awaited naturopathic sleep remedy is based on Floyd Norris' recent critique of efforts to roll back some of the provisions of the Sarbanes-Oxley Act. Roughly in descending order of offensiveness, we have movements afoot to:

1. Place the FASB under the supervision of a systemic risk agency, which would in turn be heavily influenced by the banking interests who still blame fair value accounting for the financial crisis;
2. Rescind for companies that have a public float of less than $750 million the requirement that an auditor attest to management's assertions regarding the effectiveness of internal controls (S-OX 404(b));
3. Challenge the constitutional legitimacy of the PCAOB; and
4. A House of Representatives committee vote to exempt the 6,000 'smaller reporting companies' (i.e., market cap. < $75 million) from complying with S-OX 404(b).

If I had been writing a blog back in 2002 as S-OX was being rushed to a vote in spasms and fits of self-righteous bipartisanship (did blogs actually exist?), I would have predicted something like this would be happening about now. Having nothing whatsoever to do with the philosophical leanings of the party in the majority, such is the formula by which U.S. political dramas are scripted. Declarations of war (figuratively and literally) through zealous and hastily enacted statutes are inevitably followed within just a few years by reversals to more moderate positions. Regarding the securities laws (and holding the frightening prospect of IFRS adoption aside), we are clearly in a period of moderation, albeit more misguided than usual.

While I echo Norris' sentiments on the first three items, I had only a few weeks ago expressed my glee that requiring smaller public companies to comply with S-OX 404(b) might soon be trashed. I had previously observed that S-OX 404(b) attestations have appeared to devolve into a go-through-the-motions exercise. Those suspicions are validated to some extent by a recent ruling against defendant Deloitte on a motion for summary judgment in a lawsuit alleging that Deloitte failed to adequately report on internal control deficiencies at WAMU. Jim Peterson of the Re: Balance blog avidly follows the solvency tightrope that each of the Big Four is walking as they try to fend off litigation arising out of 'traditional' public company audits. His view is that auditors should walk away from S-OX 404(b) work while they are still ahead. 

There Must be a Better Way

Even though S-OX could have, and should have, been more tightly focused on measures to prevent another Enron or WorldCom from happening, something was missing in the securities laws for providing reasonable assurance that management public companies, both large and small, are taking their financial reporting responsibilities seriously enough. I just don't agree that S-OX 404(b) was the right way to go about it.  Notwithstanding other merits of a financial reporting regulation, a windfall to gatekeepers, especially those sharing the blame for a lack of confidence in the system, is a reason for any reasonable person to be suspicious. 

Given that change is in the offing, now may be the time to bring back my old war horse, mandatory audit firm rotation. The resistance to mandatory audit firm rotation in the wake of Enron and WorldCom came from the AICPA, which couldn't bear the thought of auditors being audited by other auditors. Their main stated argument had been that switching costs would be too high, as audit efficiencies in the client's environment take a few years to be realized.

Even accepting the AICPA's excuse, which I absolutely do not, it is a fact that the vast majority of audits of smaller firms are much more straightforward. That should mean that the successor auditors can, relatively speaking, take over from predecessors without breaking stride. I would like to suggest to Mary Schapiro that, instead of pushing against the bipartisan will of Congress to let smaller reporting companies out of S-OX 404(b), she should promote mandatory audit firm rotation. There is nothing to suggest that it will impose anywhere near the scale of costs engendered by S-OX 404. With little at risk, it could actually transform audits from a make-the-client-happy exercise to one that moves the U.S. toward the forefront of global capital markets just in terms of basic integrity.

Let's pick 2,000 smaller reporting companies at random and require that they switch auditors within a year; another 2,000 next year, and 2,000 the year after that. If done right, there should be a wealth of data for the SEC and academics alike to analyze. For the next time we take a whirl on the regulate/moderate merry-go-round, we will at least have some hard evidence to take along.

(By the way, I recommend that you try Kevin LaCroix's D&O Diary blog for excellent non-technical summaries of current developments in securities litigation.)

And Our IFRS Survey Says…

This is the first of a series to discuss the results of our IFRS opinion survey. The idea for a survey originated with yours truly, and I was moved to do so (more like propellled with outrage) by the ersatz pro-IFRS "research" coming out of the Big Four and the AICPA propaganda machines. I also decided to seek a collaborator from the ranks of academia through the AECM listserv, and I consider myself very fortunate that Pat Walters, herself an IFRS proponent, volunteered to work with me. Pat's association with this effort should lend, at the absolute minimum, a semblance of balance; which is, ironically, completely absent from published views of the Big Four and their shills.

But, thankfully, I can report that not all CPAs have behaved like pigs at the trough. We owe a huge debt of gratitude to Gaylen Hansen, who has provided us with a clear-eyed compilation of the response letters to the SEC's Roadmap proposal; and to Grant Thornton for their survey, which was published as we were conducting ours. GT asked a question of import ("Ideally, who should set U.S. accounting standards?") properly, and received proper responses from CFOs and senior comptrollers in return. GT reports that only 18% of more than 800 respondents from public companies are of the opinion that the IASB should be setting accounting standards for U.S. companies.

Full Disclosure and Caveats

We received a total of 289 responses. We can't beat GT on sheer number of responses, but we did ask a broader set of questions regarding the perceived relationships between IFRS and GAAP: (1) quality differences; (2) costs and benefits of IFRS adoption; and (3) how the SEC should act on its Roadmap proposal. You can view all of our response data in a spreadsheet format here, and the text of the online questionnaire here. Twenty-seven responses came from non-U.S. residents and 13 from students. Our analysis excludes these two groups, and the tabulation at the end of this post breaks down the respondents we analyzed by all of their occupations.

Before we proceed to the major takeaways from our survey, two further caveats are in order.

First, we sure were hoping to generate a larger number of responses. GT excepted though, our level of participation is well within the range of other "studies" conducted by the IFRS proponents, including the number of comment letters received by the SEC in response to the Cox-instigated Roadmap Proposal. We left our survey open for three weeks; the SEC's comment period extended for months.  

Second, one should always take with a grain of salt unsolicited responses, as opposed to a random sample. But, no study that we are aware of has employed a more open self-selection process than ours. For example, I was solicited for Deloitte's survey apparently because I subscribed to one of their IFRS information services; if that was Deloitte's only method for soliciting responses, the self-selection bias therefrom is self-evident.

The Major Takeaways from Our Survey

As with GT, we asked for opinions regarding IFRS adoption; and our results were very similar to theirs:

My initial interpretation was that 71% of respondents do not agree with the proposition that IFRS should replace U.S. GAAP. Pat pointed out that this may be somewhat of an overstatement—since we don't know why 16% of respondents "neither agree nor disagree." Those respondents, according to Pat, could very well be indifferent to the prospect of IFRS adoption. My own take on that is: if one took the trouble to take the survey and to answer the question, then indifference would not be the most likely sentiment being expressed. Nevertheless, Pat and I agree to this interpretation:  respondents who disagreed with the proposition outnumbered those who agreed by a margin of about 5:3. Anyway you look at it, especially in light of GT's results, it should give the SEC pause before proposing to supplant the FASB with the IASB.  That's as mildly as I can put it.

When I took a closer look at the answers to this question, I was not surprised to see that the frequency distribution of responses from Fortune 500 companies and the Big Four appeared to be negatively correlated with all of the other occupations. To evaluate their impact on the full results, I decided to disaggregate each question by three subgroups: (1) Fortune 500 + Big 4; (2) academics; and (3) everyone else. The chart below repeats the results from above and adds these subgroups:

 

See that tall blue bar on the left? That's Big 4 and Fortune 500 money talking. Notice also that academics (the ascetic purists J), are the least inclined to adopt IFRS (as indicated by the short green bar on the left).

Given these results, it should come as no surprise that a significant majority of respondents do not believe that the benefits to investors of IFRS adoption would exceed the costs of conversion:

77% of all US respondents do not believe that benefits to investors will exceed the cost of conversion. Indeed, although a majority of the Fortune 500 accountants and Big Four auditors believe that the SEC should adopt IFRS, only 44% believe that the benefits to investors would exceed the cost of adoption. Figure that one out.

The bottom-line question we asked pertain to how the US should approach adoption of, or convergence, to IFRS:

These results are, admittedly, somewhat difficult to interpret with precision, but they clearly indicate that few respondents would like to see IFRS adopted before 2014. Moreover, 54% of respondents (including the Fortune 500 and Big 4) would either prefer not to adopt IFRS, or to adopt it starting with 2020 at the earliest. Although an in-depth analysis of the "other" category of responses was not undertaken, my brief analysis strongly indicates that a comfortable majority of the "other" responses more closely resemble those who stated a specific preference to either delay in IFRS adoption beyond 2020, or to abandon IFRS altogether.  If you don't believe me, you can look at the data for yourself.

And, as one might expect, the Fortune 500 accountants and Big Four auditors were strongly in favor of relatively fast-paced IFRS adoption, although it must be said that less than 10% favored adoption by 2012-2013. But, take those folks out, and you have even less interest among respondents for adopting IFRS anytime soon … or ever.

Act II

Thus far, I have discussed the results of only three of the ten questions that we asked about IFRS vs. U.S. GAAP. I promise you, more drama is to come. Also, Pat has agreed to write a guest post with the working title, "How the Survey Result Informs an IFRS Proponent." I'm sincerely looking forward to that.

The Speak-No-Evil FASB

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My previous post lambasted the FASB for shilling the SEC's whacky proposal to measure the year-end value of oil and gas reserves at average prices for the year – instead of the year-end price. Since then, I had two follow-on thoughts; the first one I'll mention is not related to the cheeky title of today's post, but it leads into the one that is.

A More Reasonable Way to 'Modernize' Oil and Gas Disclosures

A week ago, I forgot to mention that there really is a reasonable way to enhance the measurements of year-end values of oil and gas reserves, the ostensible goal of the SEC's recent actions.   But, it has nothing at all in common with the SEC/FASB approach of using averages.  What I have in mind is 'sensitivity analysis.'

Investors can use information about the current value of reserves today, but they also can use information concerning risk of changes in value. Financial reporting rarely reports that kind of information, but there have been movements in that direction of late, and by the SEC no less. Most prominently, Item 305 of Regulation S-K requires quantitative measures of market risk sensitive financial instruments, which often takes the form of some version of a sensitivty analysis.  In addition, Financial Reporting Release No. 60, urges companies to provide a sensitivity analysis covering assumptions underlying critical accounting policies.

So why not provide a sensitivity analysis regarding the value of oil and gas reserves? It doesn't have to be complicated, and the resulting disclosure could be as clear and simple as the following:

Using end-of-year energy prices, the present value of proven reserves is $100 million as of December 31, 20x0. Energy prices during the year ranged from 80 to 130 percent of the year-end prices. If the lowest (highest) energy prices during the year were substituted in our year-end present value calcultions, the lower end of the range would result in a $50 million valuation, and the higher end of the range would result in a $130 million valuation. The range of valuations is not proportional to the range of prices for the following reasons: [would be listed here.]

Sensitivity analysis of valuations can always be informative, but particularly so in the extractive industries. A significant portion of the value of the investment in a project can be traced to 'real options'; e.g., to invest in additional development if prices rise, or to shut down operations until such time as commodity prices recover. In fact, in the three decades since the SEC came out with its original version of oil and gas disclosures, the topic of 'real options' has gone from esoteric to an essential component of any capital budgeting decision by the larger players in the extractive industries. By the same token, investors are in a better position to value options (especially those that are not recognized on the balance sheet) if they can more reliably estimate the volatility of a project's value.

Covering Ears, Eyes and Mouths

Maybe you like my suggestion to add sensitivity analysis to the present value of reserves disclosures, or maybe you don't. Whatever your opinion, you should definitely be incredulous that the FASB appears unwilling to give any alternative to the SEC's hatchet job so much as lip service.

Now that the ball is in the FASB's court, one must ask whether all of them have truly put their brains in neutral, or whether they have even considered alternatives to the SEC's approach.  If they have chosen to put their brains in gear, we certainly can't tell from their proposing document or any other public comments. At least at the SEC, dissenting board members give speeches that reveal their own preferences and reasoning. It appears that FASB members, perhaps as a matter of basic economic incentives (i.e., money), don't dare to do the same. Based on the way the last investor representative on the board was treated, it's pretty safe to assume that, if you are not a go-with-the-flow sort of chap, chances of getting your $500,000/year position renewed for a second five-year term are slim to none.

Here's my prediction as to what is going to happen with the ED. The Board is going to vote 3 -2 in favor of measuring the value of proven reserves at average prices. Two board members, Linsmeier and Siegel, are going to furnish compelling dissents, and maybe another financial columnist will celebrate the dynamic duo for the strength of character they displayed while others around them were busy shilling. But in the final analysis, after-the-fact minority dissents will have no effect on anything real or important. As my father too-often said, "If all you have to stand on are your principles, then you may as well remain seated."

Yes, minutes of open meetings report board members' comments leading up to exposure documents, but who reads them? I might if I were to have trouble falling asleep at night. Why aren't formal dissents registered in exposure drafts? Why don't board members, as SEC commissioners often do, provide their individual views when they go around making speeches? For true 'due process' to occur, we need more open public debate on the issues. Commenters on FASB proposals need to have some idea of the level of consensus within the board.

I suspect that every single FASB member thinks that measuring the value of proven reserves by average, instead of current, prices is a significant step in the opposite direction from quality financial reporting. So, perhaps I am being unfair in calling on only Tom Linsmeier and Marc Siegel to carry the flag of reason and investors' interests. But, no good deed goes unpunished. That's what they deserve for taking principled stands in the past – even if, thus far, they have amounted to little more than empty gestures.

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FASB Proposed Changes to Oil and Gas Disclosures: A Crude Sham

Before I discuss the sordid details of a recent FASB proposal, please take a moment to read this hypothetical: 

What if the FASB were to issue a proposal to require companies holding marketable equity securities of oil companies to calculate and report their investment as the number of shares owned multipled by the average share price over the past year.  The average share price would be calculated from the closing share prices on the first day of each of the past twelve months.  (In other words, changes to share prices over the last month of the year would not be counted.)

Assume that the FASB issued its proposal to respond to concerns of financial statement issuers with significant holdings of oil and gas shares that reporting full year-to-year fluctuations in investment values would not constitute "meaningful" information to investors. 

Incredible?  Yes.  Impossible?  No. As I am about to describe, something very close to my hypothetical scenario has left the station and is unlikely to be stopped before pooping on the financial statements of oil and gas producers.

In an earlier post, I imparted the common-sense view that the historical-cost based financial statements of oil and gas producers bear almost no relation to a firm's value; because, the historic cost of a producing field, however measured, bears no relation to the value of that field.  There are a number of reasons for this, having to do with the luck of the draw or the price for the output that will be obtained from extracting the field's reserves over ensuing decades. To make a long story short, that's why disclosures are critical in the oil and gas industry. 

In particular, two disclosures are critical, and it should come as no surprise that oil and gas companies go to great lengths to 'manage' them: (1) the quantities of oil and gas that can't be seen, but are estimated to be in the ground; and (2) a standarized calculation of the amount that the "proved" portion of those in-the-ground reserves are worth.  The former is technically an SEC-required disclosure, and the latter, which I will refer to as the  "present value of proved reserves" is to be found in the FASB's rules.

"Modernizing" Oil and Gas Disclosures

In December of last year, the SEC issued a final rulemaking release to update the three-decades-old oil and gas disclosure requirements for current practices and changes in technology.  As I described in two previous posts (here and here), numerous important and overdue changes to the disclosure rules were made.  But there were also numerous sops to the oil and gas industry.  Among the biggest gifts was the SEC's statement of intention to get the FASB to muddy up oil and gas valuations -- pretty much in the manner I described in my hypothetical scenario -- by substituting a crude estimation of averages prices for year-end energy prices. The only differences from my scenario are that the measurements are made in disclosures of reserve values, and that they affect the investee's financial reporting (as opposed to the investor's in my hypothetical). 

Just as they were commanded, the FASB did indeed issue with great alacrity its own proposal to alter the net present value calculation along the dubious lines specified by the SEC.  The FASB's "basis for conclusions"?  Here ya go: 

"After taking into consideration more than 70 comment letters from financial statement users, preparers, auditors and other constitutents, the SEC refined its proosed rule on oil and gas reporting and issued the Final Rule on December 31, 2008."

There is some brief discussion of other specifics, but with respect to the change in measuring the net present value of proved reserves, there is absolutely nothing more.   And even what is provided is grossly misleading.  Of the 70 comment letters, virtually all came from oil and gas producers, lawyers representing oil and gas producers, engineers working for oil and gas producers, auditors whose largest clients are oil and gas producers, and consultants whose clients are oil and gas producers. 

I could not find a single comment from an investor (even notice the weasel term "financial statement users" in the above quotation) among the list of comment letters posted on the SEC's website.  A more accurate description from the FASB of their thinking (or lack thereof) would have been something like this: "The Cox-led SEC did their thing, and that's good enough fer us. Cuz they're the SEC.  We got nuthin else to say about 'due process' or any other process."

But in case you are wondering what the FASB is proposing to swallow -- hook, line and sinker -- here it is from the SEC's proposing release:

"Some believed that reliance on a single-day spot price is subject to significant volatility and results in frequent adjustment of reserves. [footnote omitted] These commenters expressed the view that variations in single-day prices provide temporary alterations in reserve quantities that are not meaningful or may lead investors to incorrect conclusions, do not represent the general price trend, and do not provide a meaningful basis for determination of reserve or enterprise value." [italics supplied by me]

Some Unsolicited Advice to the FASB

And, so, FASB, I'm going to pretend that you have not switched off your brains on this, and provide you with some unsolicited advice.

First, your job is not to help financial statement users predict a "general price trend."  If future prices of oil could be predicted by past prices, then any person who can perform that trick is in the wrong business—unless they are already oil speculators. I have vivid memories of consulting for an oil and gas producer during a year in which they sold their entire production forward, because they speculated that prices would go down. Unfortunately for everyone involved in their ostensible "hedge," oil prices rose -- a lot. The operations managers I was working with, whose bonuses and shareholdings depended on oil revenues, were not pleased with the 'economists' at corporate headquarters who conjured that one up.  And, those guys were privy to the best public and non-public information money could buy.

Second, beware of the use of the term "meaningful."  To put it as gently as I can, the fundamental attributes of financial information are its relevance and reliability.  For example, subsitute either: (1) "relevant," or (2) "reliable," or (3) "relevant and reliable" in the above quotation for "meaningful" and see if it makes any sense.  It doesn't, of course.  More bluntly, you should treat "meaningful" as if it doesn't exist when discussing the properties of accounting information.  I suspect that "meaningful" owes its popularity to the fuzzy psycho-babble of the hippie generation (that would be me). SEC literature is already infested with "meaningful," and you need to put a stop to it before it infects accounting standards.

Finally, FASB, you should stiffen your backbone, clear your conscience and earn a gold star for bucking the single-minded, monied special interests.  You omitted any reason for concluding that an average price should be substituted for the period-end price, because there is none possible.  There is nothing you have ever done, and nothing that you could now say to rationalize the product of an SEC administration that would have babbled and blurted anything for the benefit of its political backers. 

If the new SEC honchos are still intent on mucking up oil and gas disclosures, they have the statutory authority to do it without any assistance from the FASB.  Gratuitous shilling shouldn't have to cost investors $500,000 per vote.

Announcing Our IFRS Survey!

This is a brief announcement of an online IFRS survey that I have prepared with Pat Walters of Fordham University. 

I invited Pat to collaborate with me because we have divergent views on the questions being asked.  Thus, I hope that together we have achieved a modicum of balance in the survey's design--particularly in the phrasing of the questions and response choices offered.  There are only 12 multiple-choice questions, and afterwards, I cordially invtie you to express your own opinions regarding its design by posting a comment to this blog post. 

We are also trying to reach many more stakeholders than any other survey has reached to-date on the IFRS adoption/convergence question.  To that end, we hope you will choose to email the link at the bottom of this post to anyone else whom you think might have an interest in taking it.

Pat and I thank you in advance for clicking here to take the survey, or by pasting this ugly link in your web browser:

http://www.surveymonkey.com/s.aspx?sm=pF0E3UgdSV_2bHMQvdAnXv8w_3d_3d

S-OX 404(b) for Non-Accelerated Filers: A Political Crime Waiting to Happen

Section 404(a) of the Sarbanes-Oxley Act, together with SEC rules implementing the provisions of the Act, require management to assess and report on the effectiveness of internal control over financial reporting (ICFR). It took a few years for the SEC to phase everybody in, but all public companies, large and small, are now subject to the requirement.

As pretty much everyone knows, however, S-0X 404 doesn't stop with a management report. Auditors get in on the action in Section 404(b). Therein is the lucrative requirement that an independent auditor attest to management's assessment regarding the effectiveness of their internal controls over financial reporting (ICFR). One person testifying before Congress has called the provisions of S-OX 404(b) the largest windfall to audit firm partners in history, and as I will soon describe, 6,000 more public companies await a new 'service' for which the benefits are, to be charitable, unclear.

Why S-OX 404(b) is Little More than Chicken Salad for Auditors

The corporate corruption scandals that got politicians moving on the Sarbanes-Oxley Act of 2002 were the result of fraud by CEOs and CFOs. ICFR can have little to no impact on the actions of the top executives, because they always possess the power to override internal controls, or sometimes to orchestrate collusive schemes that circumvent those controls. Thus, Section 404 cannot possibly do much to mitigate these particular sources of fraud risk; and there is no better example of that than Enron itself. I have been told (but have not verified) that Enron was the only public company to disclose with much pride and pomp that it paid its world-class, independent auditor to perform a separate evaluation of internal controls. Andersen's report was, of course, clean as a whistle.  

No one should doubt as well, that Enron's relationship with its auditors wasn't much cozier than the norm, either. No matter who the client is, and especially if it is a big one, material weakness are generally only reported after an error has occurred; i.e., after a control has obviously failed. Thus, all the machinations to test ICFR, and prevent a control from failing, don't add much beyond the testing of account balances that occurs as part of the regular financial statement audit.

So, it remains questionable at best, that S-OX 404(b) has created a safer environment for investors to trade their shares. Auditors, on the other hand have been champing at their bits, waiting for the SEC to throw them some fresh meat: the 6,000-odd smaller public firms (technically, "non-accelerated filers) who are not yet required to pay for an ICFR report.

Chicken Salad Days Appear on the Horizon

The auditors received some good news on that front a few days ago when the SEC announced that the stay of execution for non-accelerated filers would be extended only until their annual reports for fiscal years ending on or after June 15, 2010. Chair Schapiro and one other commissioner also issued statements to 'assure investors' that no further extensions would be granted.

Indeed, the SEC's Office of Economic Analysis has completed the last of the SEC's go-through-the-motions machinations to steer S-OX 404(b) through the gauntlet of thousands of irate registrants who resent the additional audit fees imposed upon them -- and the additional hoops they must jump through. And, what did OEA's report have to say? As it turns out, not much at all. Although changes to SEC and PCAOB guidance may have reduced the cost of S-OX 404(b) implementation for companies that currently must comply, OEA did not even address the key question: whether the costs of complying with S-0X 404(b) has been less than the benefits, or whether benefits can be expected to exceed the costs of compliance for the 6,000 companies in line to be plucked. It must surely be the case for non-accelerated filers that initial implementation costs are most onerous, especially in an economic down cycle. But nothing so obvious and significant was to be found in the OEA's report.

The Skinny on the Costs and Benefits of Section 404(b)

If I were writing OEA's report, I might have begun and ended with the following modest, albeit virtually dispositive, back-of-the envelope calculation: The total value of all public traded equities in the U.S. is very approximately $14 trillion, based on information available from indexes published by Wilshire Associates. Let's conservatively assume that each and every non-accelerated filer has a total market cap of $75 million, which is the maximum market cap for a non-accelerated filer. Even under that very conservative assumption, 6,000 non-accelerated filers comprise (at the very most) only 3.2% of aggregate equity values.

In the best of worlds (i.e., assuming that there is real information in an auditor's attestation report) can the new fees that auditors will charge these 6,000 smaller companies provide loss protection that will cover the billions of dollars in aggregate fees? Don't bet on it.

In fairness, the SEC would say that their hands are tied; S-OX directs the SEC to require ICFR attestation reports from all public companies. So, what should really happen is for Congress to wake up and amend S-OX to permanently exempt non-accelerated filers from the requirements of Section 404(b). Will it happen? Don't bet on that one, either.

What upsets me the most is that chair Schapiro is once again catering to the wishes of the Big Four instead of affecting much needed reform, as she has pledged to do. Schapiro should use her bully pulpit to inform Congress that they have created an obvious case of excess regulation. Notwithstanding the sorry fact that S-OX 404(b) has devolved into a waste of time for all issuers, to extend it to non-accelerated filers would be nothing less than criminal.

Instead, of rushing to require ICFR audits, why don't we just sit back and wait to see how many non-accelerated filers will voluntarily submit to an examination of their ICFR – just like Enron did. 

 

IFRS Adoption Critics: More Silent Majority than Vocal Minority

Given my public record of opposition to IFRS adoption, you might be surprised to know that I have taught courses on IFRS for over ten years, beginning in Switzerland and the UK. If anybody is interested, I will be presenting a two-day IFRS/GAAP comparison courses in Chicago and Vegas this November; and I gladly collaborate on the delivery of those courses with representatives of two Big Four firms.

I try to stay away from blatant self-promotion in the body of a blog post, but I wanted to make the point that I am not an IFRS newbie, and have thought about the problems of which I blog for years. I also strongly believe that certain aspects of IFRS are much stronger than U.S. GAAP.

The larger point, however, is that I actually do have a significant stake in IFRS adoption; yet, for reasons only a psychiatrist might be capable of explaining, I persist in my financially self-destructive rants.

Imagine you're my shrink. As I lie on your couch, I tell you that my attitudes toward IFRS adoption are rooted in my childhood. (Surprise!) Both my parents fled from Nazi Germany, but my Dad was involuntarily detoured in a Nuremberg prison and Dachau concentration camp before managing to finally extricate himself from miscreants' clutches.

After immigrating via the UK to the USA, Dad soon thereafter entered the military (he was drafted after first volunteering and being turned away). He was returned to Germany on D-Day +30 as a POW interrogator. It's a long and unique story, which late in life he wrote about in a book that I posted on line.

Obviously (I try not to use that word very much), my dad's perspectives on life were shaped by these experiences. As to their effect on me, his bitterness rarely came to the surface, except indirectly when he was motivated to speak out against some proximate injustice. Dad was non-violent in actions and manner, but his words were sharp and he didn't give a hoot what others thought of his pithiness and directness. He was only self-conscious about his thick German accent (think Henry Kissinger). Also, I'm sure that his "attitude" and accent did not help his career aspirations at AT&T. Anyway, I think that is the font of my self-destructive outspokenness.

I bring this up now, as I am about to present you with a quote from a kindred spirit, and former Big Four auditor, who shall remain nameless; his nom de email is SuperHeater, and I have no idea what that is supposed to mean, but I have a pretty good idea that his brief turn as a Big Four auditor shaped his perspectives. Here's an excerpt from one of his war stories:

"I knew I needed to leave [the Big Four firm I was working for] after about three months. I had questioned a client (politely) about how they arrived at a $90,000 bad debt reserve on an A/R balance of $10,000,000 for unsecured receivables where the aging detail showed items 500 days old. I was told by the assistant controller that the 'CFO knows our customers, and knows what invoices they'll pay.'

The in-charge senior associate told me, 'I don't care if it's adequate, I care that it's there'- so much for adequate audit evidence and professional skepticism.

The following day I was summoned to meet with the partner on the job (who happened to be the HR partner) in order to be told 'the client had a complaint,' but offered no details. As the client was a trucking company that financed their equipment and was surely trying not to violate the current asset requirement of their debt instruments I suppose that's not hard to figure out. I'd like to say that was my only eye-opening experience, but it wasn't. There were screaming 'seniors' and days when testing exceptions were explained away with 'this appears to be a one-off transaction, P/f/p' rather than expanding the test sample as indicated by the audit plan."

I don't receive many substantive comments on my posts, (roughly two per post), but they are about 95 percent supportive. (BTW, those who have chosen to express their disagreement with my points of view are invariably respectful.) Thus, I want to at least surmise that SuperHeater's sentiments (with certain colorful features omitted) are generally in the same direction as those of a large proportion of my readers. In addition, the comments about how the market for auditing staff will shift after IFRS adoption is a fresh perspective for me.

"Having spent an unpleasant year at KPMG as an older, nontraditional hire and observed their methods and now currently employed at an enterprise where Deloitte is an IT contractor, I remain convinced that the only people who think IFRS adoption (either wholesale, convergence or some other method) is desirable are the Big 4, major transnational corporations and the SEC.

Additionally, the cheerleaders' affection for IFRS has absolutely nothing to do with any intrinsic superior quality, simplicity, brevity or any other (supposed but immeasurable) attribute of IFRS; it's about the ease and profitability of the cheerleaders' enterprises. The transnationals have a similar perspective; the SEC is a study in "regulatory capture", with its bureaucrats giving speeches and missing the likes of Enron, Worldcom, Adelphia & Madoff.

However, the leader of the pack is the Big Four. Like most modern propagandists, they furiously release marketing information disguised as objective technical analysis. I personally think the IFRS' "ordained clergy" are easily identified by the use of the word "robust." We are supposed defer to the presumed expertise of Big 4 partners and senior managers about the arcana of accountancy-especially when they use nebulous language and speak with the authority of historicity with constant references to IFRS as "inevitable."

For years the Big 4 have envied their clients who outsource their production to places like India, China, and other lands, where there's plenty of high intellects looking for opportunity. As the birthrate has fallen in America, it has been harder to represent the typical associate's position as something more glamorous than the fraternity hazing it resembles. The Big 4 have copied the outsourcing on their IT side, where there's no credentialing impediments; but on the attest side – well, that's different. Sure, you can staff an office full of staff and senior associates from other countries; language barriers don't matter that much when you don't speak to the client that much. Also, we know they'll work like the dickens because they're working for permanent US residency and having family half a world away creates less desire for time off.

However, when you get to be a manager, you need to have that CPA-and the exam is hard. Harder still, when you don't speak English, let alone when you have to learn a new book of rules. Do away with GAAP, you do away with the need to comb among potential US born associates with their tender egos, high debt loads and social and esteem needs. Once we're on IFRS, the Big Four becomes a truly global enterprise; picking off bright minds from lands of less opportunity-obtaining a deep inventory of intellectual capital at distress sale prices. Perhaps at the Big Four, the "A" in CPA stands for arbitrageur. I suppose it's a losing battle, because in the end, some very deep and mercenary pockets are driving this surrender of US commercial sovereignty. Now we know why Mr. Niemeier was passed over for the CA job."

The supporters of IFRS adoption have long-dismissed detractors like myself, Charles Niemeier and SuperHeater as comprising nothing more than a "vocal minority." The tepid-to-hostile feedback on the Roadmap should have put that libel to bed, but the recent remarks of chief accountant Kroeker and SEC chair Schapiro indicate that they are willing and able to follow Christopher Cox's oft-repeated example of plowing straight through reasoning critics behind nothing more than a blast of hot air.

I'll soon be posting a link to an online survey of attitudes towards IFRS adoption. Whatever the truth is, I want it to be more clearly evident.