The Law, et al


Financial services legal news and updates from around the globe.

Standards-setters Scrutinizing Lease Accounting

The IASB and FASB are addressing concerns about the accounting treatment of the more than US $750 billion of leases worldwide.

The International Accounting Standards Board (IASB) and the U.S. Financial Accounting Standards Board (FASB) are seeking comments before July 17 on their discussion paper, Leases: Preliminary Views (PDF). This public outreach is the first step in developing a single global approach to accounting for all types of business leases; the target completion date is mid-2011.

“Leasing is an important source of finance to business,” the paper explains. “Therefore, it is important that lease accounting provides investors with a complete and understandable picture of leasing activities.” Important indeed. According to the authoritative 2009 World Leasing Yearbook, total global leasing activity totaled more than US $750 billion in 2007, the latest year for which aggregate data are available. Yet the full potential financial impact of many of those leases do not appear on any balance sheet, the IASB and the FASB note.

International Financial Reporting Standards (IFRS) developed by the IASB and U.S. Generally Accepted Accounting Principles (GAAP) promulgated by the FASB currently require a lessee’s statement of financial position to recognize the assets and liabilities that accrue from finance leases (capital leases in GAAP parlance). For operating leases, however, the lessee is required only to record lease payment expenses over the lease term. Finance leases are those that transfer to the lessee substantially all the risks and rewards incidental to ownership of the asset; all other leases are operating leases.

Investors and other users of financial statements have complained to the standards-setting bodies that all lease contracts in effect create assets and liabilities that should be recognized as such in financial statements prepared during the lease terms. The U.S. Securities and Exchange Commission (SEC) identified the “inadequacies of existing lease accounting standards” in its June 2005 Report and Recommendations Pursuant to Section 401(c) of the Sarbanes-Oxley Act of 2002 Arrangements with Off-Balance Sheet Implications, Special Purpose Entities, and Transparency of Filings by Issuers (PDF).

The differing rules for finance and operating leases result in very different accounting treatment of what appear to be very similar transactions. Consequently, although investors routinely attempt to “normalize” the balance sheets of entities with leasing activities for comparative purposes, the discussion paper notes, the relevant information in financial statement footnotes is generally insufficient to make reliable adjustments. The differing accounting treatment of leases also provides opportunities to structure transactions so as to achieve the balance sheet outcomes desired by management.

The discussion paper suggests that future lease accounting be based on the principle that all leases — finance and operating alike — give rise to liabilities for future rental payments and assets in the form of the right to use property, and this should be recognized in the lessee’s statement of financial position. This approach, notes the IASB and the FASB, would not only create more financial transparency but also ensure that leases are accounted for consistently across national borders, economic sectors, and industries.
 

IASB Amends Fair-value Disclosure Requirements 

Board issues guidance and moves to improve accountability in response to international pressure.

The International Accounting Standards Board (IASB) has amended disclosure requirements about fair-value measurements and announced plans to improve the public accountability of the standard-setting body. The amendments to International Financial Reporting Standard (IFRS) 7, Financial Instruments: Disclosure, move the standard closer to U.S. accounting standards by establishing a three-level hierarchy for fair-value measurement disclosures:

  • Level 1 assets can be valued based on a simple price quote in an active market.
  • Level 2 assets are estimated based on observable market prices and inputs.
  • Level 3 assets, which are considered illiquid, must be valued based on management’s best estimate from mathematical models.

“The additional disclosure requirements and the three-level hierarchy will help to increase the clarity of information,” says IASB Chairman Sir David Tweedie. “The amendments will also enhance the disclosures about the liquidity risks associated with financial instruments.” The amendments apply to annual periods beginning on or after Jan. 1, 2009.

The IASB’s action come on the heels of pressure from political leaders and regulators worldwide to have a greater say in how international accounting standards are developed. In November, the G20 countries called on the IASB to improve accountability and global representation. In response, the IASB will form a monitoring board comprising representatives of national regulatory bodies to oversee the activities of the Trustees of the International Accounting Standards Committee Foundation (IASCF). The IASCF trustees oversee the IASB.

 Although the IASB will retain autonomy, the new monitoring board will be responsible for ensuring that the IASCF trustees carry out their duties appropriately and for approving appointments and reappointments of trustees. Members of the board will include representatives from the European Commission, the Japan Financial Services Agency, the U.S. Securities and Exchange Commission, and the Emerging Markets and Technical Committees of the International Organization of Securities Commissions. The Basel Committee on Banking Supervision will have observer status.

In addition, the IASB will expand from 14 members to 16 by 2012 in a move to ensure more diverse geographical representation. There will be four members from Asia and Oceania, four from Europe, four from North America, one from Africa, and one from South America, plus two members who can be appointed from any area. The IASCF also announced members of a reconstituted Standards Advisory Council, which now includes greater representation from investors and financial analysts, as well as other stakeholders. More information on the IASB’s changes is available at www.iasb.org.
 

PAIB Committee Releases Sustainability Framework

A Web tool helps organizations apply sustainability principles to business processes.

The International Federation of Accountants (IFAC) has developed a Web-based Sustainability Framework to help professional accountants and their organizations integrate sustainability with their management cycle and business processes. The framework, created by IFAC’s Professional Accountants in Business (PAIB) Committee defines the different facets of sustainability to help professional accountants understand the aspects they may encounter that may be important to their organization.

 According to IFAC, sustainable development is intended to reverse the erosion of natural resources and improve the environmental, social, and economic performance of organizations. Sustainability has three dimensions for organizations: economic viability, social responsibility, and environmental responsibility. The tool is built around four perspectives: business strategy, internal management, financial investors, and other stakeholders.

 Business strategy. The framework advocates a strategic approach that makes sustainable development part of strategic discussions, objectives, and targets. This approach should be integrated with governance and risk management. According to the PAIB Committee, a strategic approach supported by management is the only way to ensure that it is included in all the ways that it does business.

 Internal management. The framework covers performance and change management areas that organizations can use to deliver on their strategy and sustainability objectives. These areas include performance evaluation and measurement, changing behaviors, and establishing sustainability and environmental accounting alongside traditional financial accounting. The focus is on short-term ways organizations can improve energy efficiency and cut waste.

Financial investors. The framework advises organizations on how to incorporate environmental and other sustainability issues into financial statements. It also discusses enhanced reporting for investors in financial reports.

Other stakeholders. This element of the framework is intended to make sustainability efforts more transparent. Deliverables include separate sustainability or corporate social responsibility reports and sustainability assurance.
 

COSO Publishes Monitoring Guidance

Latest guidance discusses how improved monitoring can enhance the efficiency and effectiveness of internal control.

The Committee of Sponsoring Organizations of the Treadway Commission (COSO) has published new guidance to help organizations better monitor the effectiveness of their internal control system and take timely corrective actions if needed. The three-volume Guidance on Monitoring Internal Control, developed by COSO and authored by Grant Thornton LLP, relates to all areas of internal control.

 COSO’s latest guidance expounds on the basic principles contained in the organization’s Internal Control–Integrated Framework and its 2006 Internal Control Over Financial Reporting–Guidance for Smaller Public Companies by assisting all organizations in implementing effective and efficient monitoring. The new publication suggests that organizations of all sizes can best achieve the principles established in the 2006 guidance through monitoring that is based on three broad elements: establishing a foundation for monitoring, designing and executing monitoring procedures, and assessing and reporting results. To achieve these goals, organizations may choose from a variety of monitoring procedures:

  • Periodic evaluation and testing of controls by internal auditing.
  • Continuous monitoring programs built into information systems.
  • Analysis of and follow-up on operating reports or metrics that might identify anomalies indicative of a control failure.
  • Supervisory reviews of controls.
  • Self-assessments by boards and management regarding the tone they set in the organization and the effectiveness of their oversight.
  • Audit committee inquiries of internal and external auditors.
  • Quality assurance reviews of the internal audit department.

To begin the monitoring process, COSO recommends that management encourage those responsible for control systems to read the guidance and consider whether monitoring procedures have been incorporated into certain areas and, if not, to consider how to best implement them. COSO also recommends that management instruct appropriate personnel to address four fundamental questions:

  1. Have we identified the meaningful risks to our objectives (e.g., risks related to producing accurate, timely, and complete financial statements)?
  2. Which controls will best support a conclusion regarding the effectiveness of internal control in those risk areas?
  3. What information will be persuasive in telling us whether the controls are continuing to operate effectively?
  4. Are we currently performing effective monitoring that is not well-utilized in the evaluation of internal control?

COSO’s guidance also addresses characteristics associated with the evaluator’s objectivity, as well as the period of time and the circumstances by which an organization can rely on adequately designed indirect information to conclude that internal control remains effective. In addition, it covers how to determine the sufficiency of information used in monitoring to ensure the results can support conclusions about internal control, and ways that the organization can make monitoring more efficient without reducing its effectiveness.

 The introduction to Guidance on Monitoring Internal Control can be downloaded free of charge from COSO’s Web site, and the complete guidance can be purchased in electronic and print format from the CPA2Biz Web site. The COSO site also features a WebEx discussion of the monitoring guidance.