Compromising Accounting Principles: A History Lesson (and a Mea Culpa)

(I apologize to anyone who has read an earlier version of this post. Due to a problem with my blogging software, it was not sent out to subscribers. Therefore, I am re-posting it.)

First, the Mea Culpa

Over the year that I have been writing my blog, I have been fortunate to receive kind words every now and then from readers.  Writing alone, being provocative at times, and hitting the "publish" button perhaps too soon to meet a self-imposed deadline often combine to give me an uneasy feeling that I could be sitting way out on a high limb.  It was inevitable that at times I have been accused of being wrong, but never unfair -- until now.

I recently received from two readers similarly critical missives concerning some not-so-nice things I wrote about Jim Leisenring, former FASB and current IASB member. One of the commenters, identifying himself as "Guest," wrote:

"That's a pretty unfair attack on Leisenring with no appropriate context regarding the background of FAS 133. The alternative to FAS 133 was virtually no recognition of derivatives in financial statements. Is it perfect? No. Were compromises made? Absolutely. But it was better than what was there before. And it certainly doesn't indicate a pattern of Jim "capitulating to the majority." If you've ever met Jim [actually, I have], then you know he's not real concerned with what the majority thinks." (comment in brackets is mine)

After thinking about these comments for a few days and discussing it with my genious wife, I have decided that I owe an apology. When I gratuitously remarked that I was not surprised by Jim Leisenring's decision to "capitulate" on IFRS 3(R) because of his past participation in FAS 133, I crossed a line.

The Point I Was Really Trying to Make

Now that I hope I have cleared that up to the satisfaction of all, I want to address the related issue raised by Guest, which should have been the real point of my criticism.  I do not believe that compromising one's principles in crafting accounting standards in the name of incremental progress can be expected to produce a net benefit for investors.

Merely being "better than it was before" (to quote Guest) may still be far from good enough, and there is plenty of U.S. GAAP history to back that up. The table below is a partial list of standards where compromises clearly must have occurred, and serious consequences ensued:

Statement	What Gained	What Lost and Consequences
FAS 87 - pensions	Balance sheet recognition of some pension liabilities.	Timely recognition of gains and losses in pension plans. Plans were mismanaged because of FAS 87.  The toll in shareholder value destruction and lost pension benefits has been enormous.
FAS 13 - leases	On-balance sheet treatment of some leases	Most leases can still be classified as "operating." Managements have misspent vast sums over the past 30 years on financial advisers and auditors because FAS 13 invites unnecessarily complex and inefficient lease contracts.
FAS 133 - derivatives and hedge accounting	Fair valuation of derivatives	Complex and unprincipled hedge accounting rules distort values of other assets and liabilities, or permit deferral of gains and losses from holding derivatives. Managements engage in costly and inefficient accounting hedges that may not result in appropriate hedges of economic risks. The value destruction caused by Fannie Mae's misapplication of FAS 133 may be enough by itself to regard FAS 133 as having failed.
FAS 115 - marketable securities	Current values for some investments whose market value is readily determinable	Securities classified as available-for-sale or held-to maturity categories are mismanaged because ofFAS 115. The held-to-maturity category unreasonably deprives investors of current value information.
FAS 123 - stock options	Grant date present value of options granted to employees	Because of FAS 123's option for footnote disclosure without income statement recognition, excess stock options were granted to employees.
FAS 114 - loan impairment	Consistent measurement of impaired loans	Measurements are still based on historic interest rates, and the criteria for timing of loan loss recognition provide inappropriate discretion to manage earnings. As a result, investors have been deprived of accurate and timely information; management makes inefficient decisions on delinquent loans out of a desire to manage reported earnings.
FAS 141, 142 - business combinations	Elimination of pooling of interests and amortization of goodwill	Costly goodwill impairment test on a number that provides minimal information to investors. As a result, excess financial statement preparation, auditing and consulting costs are incurred.
FAS 95 - statement of cash flows	Converting inconsistent funds flow statements to more consistent cash flow statements.	The direct method of presentation is rarely used, depriving investors of information regarding actual operating receipts and disbursements.  Subsequent attempts to revise this glaring flaw in FAS 95 have failed.

What would have happened in each of these cases if those who those who gave up the fight in the name of incremental progress refused to yield the high ground?  For example, how would derivatives and non-derivative marketable securities be accounted for today if compromises had not been made ten and fifteen years ago? Fair value is still the only plausible answer. The lost momentum of compromise with closure reigns forever and a day.  In the case of FAS 133, it's been 10 years and counting.  As for lease accounting, it's been 30 years and even getting a second wind no less; the FASB has recently announced that it is limiting the scope of the project to revise lease accounting rules, which has already dragged on for far too long.  I may be able to add to my list of compromises with negative examples, and I cannot think of a single compromise that ended up as a standard making those who compromised eventually look like heroes instead of patsies.

My point is that the absence of patience and fortitude can leave its stain on accounting standards for generations.  The IASB's process leading to IFRS 3(R) tells me that the lessons of history demonstrating the futility of compromise go unheeded by the putative heirs to U.S. GAAP.

I have read from numerous sources that adoption of IFRS in the U.S. is regarded to be "inevitable." I don't know about that, but I am convinced that uneconomic mergers doing immeasurable harm to both shareholders and work forces will occur because of IFRS3(R)'s loosey-goosey business combination standards. Even more important, if the non-U.S. members of the IASB come to understand that we in the U.S. are effectively committed to allowing sausage-factory-style accounting standard setting in our capital markets, we will be doomed to a steady diet of sausage.

That's why Jim Leisenring should not have voted for IFRS 3(R). 

Comments

[Independent Accountant]

I disagree with "Guest". Your comments were well taken. Stand your ground.

[Topaza]

Thanks for writing this.