In this two minute video, my colleagues Peter Hogarth and Katie Woods highlight some of the things to look out for in the IASB's discussion paper on revenue recognition, which is due out within the next few weeks. As we mentioned in August last year, this one could be important for you. When changes are made to revenue recognition policies, it often leads to the market amending its conclusions about share values.
The standard setters have gone right back to the drawing board on this one to come up with first principles. But there are a couple of different options being considered, so they really need to know what you think. You can share your views with me too, either by commenting here, or by email.
To play the clip, click on the arrow in the picture.
It is eight months since we first heard the words “credit crunch”. Now they are uttered daily. Official reports analysing the market turbulence and recommending actions to limit the impact of the credit crunch have started to appear. One of these landed on my desk recently.
A report on enhancing market and institutional resilience has been published by the Financial Stability Forum (senior international financial representatives promoting international financial stability) in response to a request from the G7 finance ministers. It was prepared following extensive collaboration and fact-finding with different sectors involved in the credit crisis. The report is very action-oriented. It lists 67 recommendations grouped under five headings, with development for each assigned to specific organisations against a suggested timeline for action. The headings are:
• Strengthening prudential oversight of capital, liquidity and risk management • Enhancing transparency and valuation • Changes in the role and uses of credit ratings • Strengthening the authorities’ responsiveness to risks • Robust arrangements for dealing with stress in the financial system.
The IASB, which itself, interestingly, is a member of the FSF, has been charged with improving accounting standards, and the FSF has put forward three recommendations:
• Improve the accounting and disclosure standards for off-balance sheet vehicles on an accelerated basis and work with other standard setters toward international convergence. • Strengthen standards to achieve better disclosures about valuations, methodologies and the uncertainty associated with valuations. • Enhance guidance on valuing financial instruments when markets are no longer active. To this end, set up an expert advisory panel.
The FSF’s report has been strongly endorsed by the G7 finance ministers who have committed to its implementation. They have urged the IASB to step up the pace and initiate action on the recommendations within 100 days.
The FSF has made challenging recommendations and will be monitoring the IASB’s progress.
We won’t see an end to the credit crunch overnight and there is no doubt that it has created debate around a number of significant issues, including those noted above. These are complex matters. The timescales envisaged for IASB action are short compared to normal due process, including for the exposure of their proposals. This presents challenge for everyone involved in the standard-setting process (not just the IASB, but also those interested in commenting on the proposals). The aim should be to achieve an outcome that is balanced between clear principles and rules (where detailed rules prove necessary).
I would be very interested in your views, either by commenting here or by email.
There are some problems in accounting that refuse to go away. Deferred tax, goodwill and the impact of changing prices have been debated for decades, and accounting for pensions is another subject ripe for debate. The IASB issued a discussion paper in March representing new proposals for significant change in this area.
The discussion paper is not a fundamental review of IAS 19. Instead it aims to eliminate some of the deferred recognition and smoothing mechanisms currently permitted or required, and to address perceived problems for plans that have features both of defined benefit and defined contribution.
Some would argue that eliminating the deferred recognition options, (particularly the so-called ‘corridor approach’ to recognising actuarial gains and losses) is an overdue and much needed fix. Immediate recognition of actuarial gains and losses is permitted by IAS 19, but only as a relatively recent option. Hence, many companies’ balance sheets drawn up under IFRS include a number that bears little resemblance to the surplus or deficit in the pension plan.
Equally, many would say that recognising an expected rate of return on plan assets in the income statement, irrespective of the actual return, doesn’t reflect reality. Furthermore, if estimates prove to be on the high side, a company may reflect the bad news directly in equity instead of the income statement .
Having concluded that smoothing tools are not appropriate, the discussion paper then addresses where to recognise the resulting, potentially highly volatile and large, pension expense. A common feature of the proposed alternatives is that more components of pension expense, including some of the experience gains and losses and changes to assumptions that may currently be recognised directly in equity, would be reflected in the income statement. This could increase or decrease profit or loss, and would depend largely on how good actuaries’ predictions were .
Finally, the IASB proposes a radical new approach to plans that have features both of defined benefit and defined contribution, which it calls ‘contribution based plans’. An example of such a plan, common in the US, is a plan in which benefits are based on contributions plus the yield on treasury bills. This has proved to be a particularly troublesome topic for the IASB. The IFRIC published a draft interpretation, ‘Employee benefit plans with a promised return on contributions or notional contributions’, almost four years ago, but it has never been finalised and practice remains mixed. The discussion paper proposes fair value measurement for these plans’ obligations. If this means exit price, it might be equivalent to the cost of buying an annuity from an insurance company, which could be considerably higher than the amount at which these liabilities are typically measured.
The discussion paper doesn’t address measurement of defined benefit plans, which is intended to be discussed in a ‘phase 2’ of the project. A discussion paper issued in January by the EFRAG and certain European standard setters as part of the Pro-active Accounting Activities in Europe (PAAinE) initiative has suggested that pension obligations should be measured using a risk free rate rather than the corporate bond rates used currently. Some actuaries estimate that this change could add as much as 25 per cent to pension plan liabilities and significantly increase reported deficits. But if the fair value model proposed by the IASB for contribution based plans was to be applied instead, the impact could be even greater.
This is only the first tentative step towards a new accounting standard. So what will come next? Some concerns are already being expressed about proposals for measuring contribution based plans. The IASB and FASB’s joint board meeting in April discussed whether the scope of the project might be reduced or longer-term changes put on hold - given the burden of other projects. Undoubtedly, this could be a very long journey, but those who want to influence the debate will need to get involved now. I would be very interested in your views, either by commenting below or by email.
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