[House Hearing, 107 Congress]
[From the U.S. Government Publishing Office]
CURRENT ISSUES BEFORE THE FINANCIAL ACCOUNTING STANDARDS BOARD
=======================================================================
HEARING
before the
SUBCOMMITTEE ON
COMMERCE, TRADE, AND CONSUMER PROTECTION
of the
COMMITTEE ON ENERGY AND COMMERCE
HOUSE OF REPRESENTATIVES
ONE HUNDRED SEVENTH CONGRESS
FIRST SESSION
__________
JULY 31, 2001
__________
Serial No. 107-48
__________
Printed for the use of the Committee on Energy and Commerce
Available via the World Wide Web: http://www.access.gpo.gov/congress/
house
__________
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COMMITTEE ON ENERGY AND COMMERCE
W.J. ``BILLY'' TAUZIN, Louisiana, Chairman
MICHAEL BILIRAKIS, Florida JOHN D. DINGELL, Michigan
JOE BARTON, Texas HENRY A. WAXMAN, California
FRED UPTON, Michigan EDWARD J. MARKEY, Massachusetts
CLIFF STEARNS, Florida RALPH M. HALL, Texas
PAUL E. GILLMOR, Ohio RICK BOUCHER, Virginia
JAMES C. GREENWOOD, Pennsylvania EDOLPHUS TOWNS, New York
CHRISTOPHER COX, California FRANK PALLONE, Jr., New Jersey
NATHAN DEAL, Georgia SHERROD BROWN, Ohio
STEVE LARGENT, Oklahoma BART GORDON, Tennessee
RICHARD BURR, North Carolina PETER DEUTSCH, Florida
ED WHITFIELD, Kentucky BOBBY L. RUSH, Illinois
GREG GANSKE, Iowa ANNA G. ESHOO, California
CHARLIE NORWOOD, Georgia BART STUPAK, Michigan
BARBARA CUBIN, Wyoming ELIOT L. ENGEL, New York
JOHN SHIMKUS, Illinois TOM SAWYER, Ohio
HEATHER WILSON, New Mexico ALBERT R. WYNN, Maryland
JOHN B. SHADEGG, Arizona GENE GREEN, Texas
CHARLES ``CHIP'' PICKERING, KAREN McCARTHY, Missouri
Mississippi TED STRICKLAND, Ohio
VITO FOSSELLA, New York DIANA DeGETTE, Colorado
ROY BLUNT, Missouri THOMAS M. BARRETT, Wisconsin
TOM DAVIS, Virginia BILL LUTHER, Minnesota
ED BRYANT, Tennessee LOIS CAPPS, California
ROBERT L. EHRLICH, Jr., Maryland MICHAEL F. DOYLE, Pennsylvania
STEVE BUYER, Indiana CHRISTOPHER JOHN, Louisiana
GEORGE RADANOVICH, California JANE HARMAN, California
CHARLES F. BASS, New Hampshire
JOSEPH R. PITTS, Pennsylvania
MARY BONO, California
GREG WALDEN, Oregon
LEE TERRY, Nebraska
David V. Marventano, Staff Director
James D. Barnette, General Counsel
Reid P.F. Stuntz, Minority Staff Director and Chief Counsel
______
Subcommittee on Commerce, Trade, and Consumer Protection
CLIFF STEARNS, Florida, Chairman
NATHAN DEAL, Georgia EDOLPHUS TOWNS, New York
Vice Chairman DIANA DeGETTE, Colorado
ED WHITFIELD, Kentucky LOIS CAPPS, California
BARBARA CUBIN, Wyoming MICHAEL F. DOYLE, Pennsylvania
JOHN SHIMKUS, Illinois CHRISTOPHER JOHN, Louisiana
JOHN B. SHADEGG, Arizona JANE HARMAN, California
ED BRYANT, Tennessee HENRY A. WAXMAN, California
STEVE BUYER, Indiana EDWARD J. MARKEY, Massachusetts
GEORGE RADANOVICH, California BART GORDON, Tennessee
CHARLES F. BASS, New Hampshire PETER DEUTSCH, Florida
JOSEPH R. PITTS, Pennsylvania BOBBY L. RUSH, Illinois
GREG WALDEN, Oregon ANNA G. ESHOO, California
LEE TERRY, Nebraska JOHN D. DINGELL, Michigan,
W.J. ``BILLY'' TAUZIN, Louisiana (Ex Officio)
(Ex Officio)
(ii)
C O N T E N T S
__________
Page
Testimony of:
Jenkins, Edmund L., Chairman, Financial Accounting Standards
Board...................................................... 14
Leisenring, James J., Board Member, International Accounting
Standards Board............................................ 23
Rogstad, Barry K., President, American Business Conference... 24
(iii)
CURRENT ISSUES BEFORE THE FINANCIAL ACCOUNTING STANDARDS BOARD
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TUESDAY, JULY 31, 2001
House of Representatives,
Committee on Energy and Commerce,
Subcommittee on Commerce, Trade,
and Consumer Protection,
Washington, DC.
The subcommittee met, pursuant to notice, at 10:06 a.m., in
room 2123, Rayburn House Office Building, Hon. Cliff Stearns
(chairman) presiding.
Members present: Representatives Stearns, Shimkus, Btyant,
Walden, Terry, Bass, Tauzin (ex officio), Towns, Harman, Rush,
and Eshoo.
Staff present: Ramsen Betfarhad, majority counsel; Brian
McCullough, professional staff; Shannon Vildostegui,
professional staff; David Cavicke, majority counsel; Will
Carty, legislative clerk; and Consuela Washington, majority
counsel.
Mr. Stearns. Good morning. The subcommittee will come to
order and I welcome our witnesses this morning.
One of the more important areas of our committee's
jurisdiction is over accounting standards. This is, sort of,
something that is dry, but this is very important, as we are
going to find out today and as we look at what has happened in
the past.
The general public, of course, is not excited as they might
be, but this is our jurisdiction and it is fundamental to the
health of our economy that we maintain the most accurate and
transparent reporting system. The need for reliable financial
reporting is growing more important with each passing year.
Whether people are aware of it or not, accounting standards
affect most of our systems and, thus, necessitate that we
maintain the highest accounting standards practicable.
Americans are increasingly preparing for their future
financial needs by investing in public companies through
retirement plans and individual accounts. More than half of all
of Americans are now invested in the equity markets in one form
or another. Since most Americans have a stake, directly or
indirectly, in equity markets, reliable and accurate
information on finance is very important on publicly traded
companies, and the emerging global economy also dictates that
we maintain high standards.
Geographical boundaries are no longer a barrier to trade
and commerce in our evolving digital world. While this has
opened new doors for U.S.-based companies, it also means that
our companies face increased competition in a global
marketplace.
While one of the benefits of this dynamic is a greater and
more efficient flow of capital across borders, it requires us
to constantly monitor our reporting standards to ensure our
standards attract capital rather than present a barrier.
And the competitive landscape is not confined to the large
publicly traded companies. Private companies seeking capital
are increasingly able to solicit foreign investment.
I strongly support our structure of an independent standard
setter. The transparency of our accounting standards and
reporting system are primary to the decisionmaking process of
investors and I think they would agree.
I find the results of FASB, or the Financial Accounting
Standards Board's business combinations project and the related
accounting treatment for intangible assets, as outlined in
statements 141 and 142, speak well for having a private,
independent standards setting broad. FASB should be commended
for an open process that included several public hearings and
working with all parties to understand their concerns regarding
business combinations.
What FASB has accomplished is a tall order, considering
that less than 2 years ago interested parties were vociferously
debating business acquisition and we had one case where the
acquire had reflected only 5 percent of the acquisition cost as
expenses or costs.
Although the resolution of the project is extremely
important, I do have a broader question: I wonder whether our
model or system of accounting is keeping pace with an economy
that is rapidly changing and whether changes to the existing
system will accurately reflect the financial position of a
company. The question raises more serious concerns when placed
in the context of the international standards.
Obviously, achieving universally accepted standards that
provide efficiency and comparability across borders has
undeniable merit. Although I would like to think accounting
standards and the structure of the IASB would be free from
politicalization, we have seen some difficulties arise in many
efforts to reach global agreements with our foreign
counterparts.
I support the structure and process and perhaps the fact
that it is private will reduce potential hurdles. Nonetheless,
I have several questions regarding the impact of international
standards on U.S. businesses and U.S. GAAP standards.
Transparent international standards will be an invaluable
change but only if it is available to all businesses.
Finally, my colleagues, I would be remiss if I did not
raise the issue of pro forma verses GAAP, the General Accepted
Accounting Principles, reporting of financial data by publicly
traded companies with today's witnesses. I find value in both
types of reporting, yet I would like to see two things
transpire regarding pro forma reporting.
First, some level of standardization should be applied to
pro forma reporting so that an individual investor, such as
myself, could make heads or tails out of that reporting system.
I think FASB can play a constructive role in this regard. I do
appreciate that pro forma reporting should be flexible enough
to be responsive to a particular company's or industry's
dynamics. However, if every company comes up with its own
definitions, the utility of pro forma reporting is diminished
for a small investor as he or she has no frame of reference to
compare the pro forma results with, and this takes me to my
second point.
The pro forma statements, I believe, should be released
simultaneously with a company's 10-Q filing with the SEC. The
simultaneous release of those results will accord a small
investor the opportunity to truly understand and appreciate the
pro forma results.
Furthermore, I would recommend that each company provide
for a comprehensive reconciliation table between its pro forma
and 10-Q reported results. I think this issue is of a
substantial import to the small investor and I think FASB has a
key role in adding some structure to pro forma reporting.
In conclusion, I would add that our accounting standards
are the best in the world and I respect FASB for their efforts
to constantly improve them in the face of this changing world
global economy. I look forward to our dialog with FASB and IASB
and look forward to their testimony.
And with that, the distinguished gentleman from New York,
the ranking member, Mr. Towns?
Mr. Towns. Thank you very much, Mr. Chairman, for holding
this hearing.
Let me begin by also commending Mr. Tauzin, the chairman of
the full committee, for his hard work on the January 2001
memorandum of understanding that preserves our jurisdiction
over FASB and the setting of accounting standards and I would
like to thank him for that as well, and you, too, Mr. Chairman.
I welcome all the speakers and I am looking forward to
hearing from them today. I am hopeful that we will hear an
overview about the board's involvement in this ever-changing
world over the next few years, for both investors and the
private sector. The protection of the consumers of this country
depends on the high standards the board sets for the many
investors in the financial industry. After all, performance
levels for the institutions governed by FASB require strong
standards as well as leadership. That is the regulatory
responsibility that I and the members of this subcommittee will
expect from the board.
I was also pleased that, under the leadership of former SEC
Chairman Arthur Levitt, many in the accounting and consulting
industry came to an agreement with the Securities and Exchange
Commission last year regarding the necessary protections for
American investors.
Mr. Chairman, FASB affects so many investors and
organizations in my home State of New York. I always want both
consumers and the business community to understand the
important responsibility the board has to the American public.
I hope that all parties involved in setting standards will work
together for a better future.
I yield back the balance of my time and I look forward to
hearing from the witnesses.
Mr. Stearns. The gentleman yields back the balance of his
time.
The gentleman from Illinois?
Mr. Shimkus. Thank you, Mr. Chairman, and I appreciate the
hearing.
Sometimes I wish my sister was with me. I have five of them
so I do not wish that very often, but one is an accountant and
these are the days that I long for her to be at my side to help
go through some of the vocabulary.
I appreciate the independence of both the organizations and
I think it is critical. I also appreciate the move to increase
transparency which I think is the ultimate goal of what we need
to apply here, and as we change in this age, we were talking
about the stubby pencils and erasers, and, obviously, we are in
a different era and standards have to change to meet the new
standards.
I am also concerned about this linkage. We do have
oversight. We appreciate you coming. I want to make sure that
we are not legislating or impacting on what the independent
organizations do. We do have a role to play in consumer
protection, but I think good will and work done by both parties
can assure that we can perform our role as you perform yours.
It will be interesting to listen to the discussions on
these two statements; the two methods of limiting pooling and
purchasing, along with the good will and intangible assets. I
hope to learn a little bit more about that. And I am going to
take this great big testimony of a gazillion pages, Mr.
Jenkins, and give it as a gift to my sister for some light
reading in the evening.
So with that, Mr. Chairman, I yield back my time.
Mr. Stearns. I thank the gentleman.
The gentleman from New Hampshire? Mr. Bass, no statement?
Mr. Walden? No statement? All right.
The chairman of the full committee is recognized.
Chairman Tauzin. How is that for timing?
Mr. Stearns. That is perfect.
Chairman Tauzin. Let me first thank you for holding this
important oversight hearing today.
Although accounting remains largely in the background of
public policymaking, it occasionally warrants the focused
attention of Congress and, in particular, the committee that
would raise those questions about its impact on commerce.
Indeed, the committee has searched its jurisdiction over FASB
precisely because this organization's role in accounting
standards setting is extremely important to commerce, in
general, but most importantly to the evolving new economy that
is characterized by the high-tech sector, in particular, where
accounting rules and accounting customs are challenged in a
dramatic new way.
The direct relationship between accounting and the changing
economy is best illustrated by the issues encountered during
FASB's recent work to revise the standards on accounting for
business combinations. And while FASB's initial proposal last
year had the laudable goal of improving financial transparency,
it did not sufficiently address practical problems created by
applying the old world brick and mortar's accounting standards
to businesses in the digital economy, where literally eyeballs
might be worth more than actual brick and mortar investments.
Intellectual property and technological innovations do not
necessarily depreciate the same way assembly line machines and
warehouses depreciate. Thus when FASB initially proposed
eliminating the so-called pooling accounting method for
business combinations, often used by the rapidly growing new
economy companies with substantial intangible assets, in favor
of the so-called purchase method, failed to provide an adequate
guidance for identifying and valuing those intangible assets.
During the hearings on these standards in the last
Congress, I asked FASB to resist eliminating pooling unless
purchase-method accounting was improved to address the
realities of today's economy. This included addressing the
method of accounting for intangibles. I am pleased to see that
FASB has made a good deal of progress since the last time Mr.
Jenkins testified before the committee, and the recently issued
standards attempted to address the concerns, in fact, raised by
this committee last year.
I would like to commend FASB for modernizing appraisals of
intangible assets to reflect the realities of many information-
based companies. I first want to tell you that that is no easy
task and I am cautiously optimistic, however, that the approach
you have taken may, in fact, work for us. You clearly worked
hard to acquire and act upon the best information before
issuing the final standard and I appreciate that, but I have
some remaining concerns about the application of the new
standards.
Are the triggering incidents accurate and precise or are
they gray areas? Are the impairment tests too burdensome? What
are the costs associated with the new system? In particular,
how will small and middle-sized companies handle the cost and
the administrative requirements associated with a new approach?
I hope, Mr. Jenkins, you will answer some of those questions
today in your testimony.
In addition to the new standards for business combinations,
we are going to hear a bit about the development of the IASB,
the International Accounting Standards Board. With a charter to
achieve a single set of global accounting standards, the IASB's
mission is neither small nor easy. International consistency in
accounting standards is becoming increasingly important in the
global economy; Mr. Chairman, as important as the question of
international standards on privacy that I know you have focused
on so mightily in the last few hearings.
However, the desire of the international harmonization must
be balanced with our domestic need for accurate and transparent
account as is provided by the U.S. GAAP and the need to retain
our international competitiveness. I suggest the U.S. will not
easily stray from GAAP unless an alternative is acceptable and
necessary. Congress and this committee, in particular, will
play a strong oversight role in the adopting of international
standards by the U.S., and I hope to gain some reassurance that
FASB will be active in pushing for strong, harmonized standards
that will not undermine our system nor put our companies at a
disadvantage with their international competitors.
Again, I want to thank the chairman for this important
hearing.
And, again, Mr. Jenkins, I want to thank you and the board
for listening, I think, very well and for taking very seriously
our concerns last year and for, as I said, making, I think,
extraordinary progress on answering those concerns.
Thank you, Mr. Chairman.
Mr. Stearns. Thank you.
And I say to the chairman earlier, both Mr. Towns and I,
had praised your leadership in that FASB jurisdiction was
retained in our committee and we recognize that.
The gentlelady from California, Ms. Eshoo?
Ms. Eshoo. Thank you, Mr. Chairman.
And good morning to our distinguished panel that are here
with us this morning.
While there really is not a current issue, at least in my
view, that is created a need for the hearing, I still think
that it is very important that we track with one another to
hear from certainly the distinguished chairman of the FASB
board, and it is good to see you here this morning, as well as
our other guests.
I also want to commend the Financial Accounting Standards
Board for its recently completed work with regard to business
combinations and I always look forward to working with you on
issues that will come before you.
When I first came to the Congress I made the assumption
that every Member of Congress, on the other side of the Capitol
and here, knew what FASB was, and I quickly found out that I
was just about the only one that did. And so, I set out on a
course where I had to educate members first, as I was trying to
educate myself about how the Congress worked.
It was an issue. And I introduced legislation recognizing
that FASB was an independent body, and I still think that that
is a very, very important element for every single Member of
Congress to respect. But also understanding that the decisions
that are made by this accounting standards board do have an
effect on our national economy, and Congress certainly weighs
in on that.
At that time the issue was relative to stock options. And I
worked for 2 years, and as we were just reorganizing for the
next Congress the news came about the decision that the FASB
board had taken. And I was delighted about the decision that
was made then. So very early on I came to work on issues that
FASB works on as well.
I think that FASB and its members understand, perhaps,
better today than when I first arrived to the Congress that,
while the body is independent, that we do weigh in and that we
have a keen interest in a whole number of areas.
Why? I think the chairman of the full committee has
delineated some of the reasons. We want companies to have the
ability to not only retain their employees, but that it is very
new in a knowledge-based economy. And so, in many ways we are
partners, in other ways that may be viewed that we are
adversarial, but always we have a, I think, responsibility, in
terms of oversight to be tracking with one another.
I think that our efforts have gone a long way in bringing
about a full and public debate; most recently on the business
combinations issue. So I think that just as there is the sand
in the oyster, where it is aggravating, as it were, that we
want to bring about some pearls. And I guess what we call that
in Congress is a workable, consensus solution, whatever those
words might mean.
I have expressed concern about FASB's perception regarding
its process of private sector standard setting and I have also
been an advocate for always protecting its independence. God
help us if the Congress gets into writing accounting standards;
that is not what we need, and I do not think that is what our
role is. I admire and respect the work its leadership and the
staff devote to developing proposals and standards, and I
applaud that commitment.
The perspective and the education hearings such as this one
have given us, have allowed to conduct worthwhile oversight,
especially in the area of the new economy. And while we are
having a somewhat tough time, the new economy is not going to
go away; it is here to stay. So I think that the charting for
our course together is really a very important one.
So once again, Mr. Chairman, thank you for calling a
hearing. And whatever may come up during it, I think we are
going to make good use of that information.
And once again welcome to Chairman Jenkins and the others
that are here today. I appreciate that and I always look
forward to working with you.
Thank you.
Mr. Stearns. I thank the gentlelady.
The gentlelady from California, Ms. Harman?
Ms. Harman. Thank you, Mr. Chairman.
I want to congratulate you, again, for holding another
oversight hearing. It is very useful, especially for the
rookies on this committee, to have the chance to learn about
some of these things before we have to deal with all of the
various disasters that befall us and them.
I want to point out to my friend and colleague, Ms. Eshoo,
that I did know what FASB stands for before I came to Congress.
I was a corporate lawyer in my last life. Some wish that I
would return to that very quickly, but I am, at least, intent
on trying to add what I can here.
I would just say to FASB that the recent changes were
enormously welcome to the business world and to us in Congress;
very helpful.
In the future, I think, FASB will be challenged again in
several respects. One is internationally. I think it is very
important to make certain that the rules we have domestically
fit appropriately in the international marketplace.
And in that regard, I know that there is another
organization, but I do not know how to pronounce its acronym,
the International Accounting Standards Board. Is that IASB? No.
I-A-S-B, all right. Well, shows what I know. But anyway, that
is one board, I just coined a new phrase. That is another area
that will constantly require attention and perhaps change.
And finally, I would make a comment about the digital
economy. I am not sure it is new anymore. I think it is getting
old; certainly, those of us trying to figure out what it does
are getting old.
But the way I would see this is, it is constantly required
of those of us in government or in independent agencies to
figure out digital solutions to the issues that the digital
economy faces. We were all trained in the analog world, or
those of us slightly older than our children were trained in
the analog world. And it is often hard for us to think about
how a proposed solution can work in a digital economy.
So I see two new challenges for FASB. One is constantly to
reassess its role in the international economy. And the second
is to think digitally and think about how accounting solutions
work with those in an economy that interacts with them on a
digital basis.
Thank you, Mr. Chairman. I look forward to learning more
under your tutelage. I yield back.
[The prepared statement of Hon. Jane Harman follows:]
Prepared Statement of Hon. Jane Harman, a Representative in Congress
from the State of California
Mr. Chairman, it is clear that the Financial Accounting Services
Board, which has the responsibility to set and improve accounting and
reporting standards for all private and public companies funded by the
private sector, serves an important purpose.
With an increasing number of Americans becoming equity owners in
American businesses, the FASB's role in providing clear and accurate
information for consumers has become even more relevant to the average
American than it was in the past.
Therefore, because Congress has oversight authority over FASB, we
must take the necessary steps to ensure the effectiveness of the FASB
for consumers and other users of financial information.
One of the primary issues for this hearing- the recently issued
standard on business combinations holds special significance because it
affects methods of accounting for mergers and acquisitions. With an
increasing number of mergers and acquisitions, consumers and others
need accurate information to make investment decisions and to track
future returns on their investments.
I am looking forward to hearing the testimony from our panel of
witnesses today and to learn more about why the FASB decided to require
all business combinations initiated after June 30 to be accounted for
with the purchase method as opposed to the pooling of interests method.
I am also interested in other efforts by the FASB to improve
accounting and reporting standards to benefit consumers.
Finally, our world has become much smaller and other markets
clearly have an effect on our own. The same attention which is given to
our own markets should be applied on an international level, and I know
that the FASB has been a proponent of developing high quality
international accounting standards. Congress also has a responsibility
to insure that the FASB is taking the proper steps to influence the
policy and standards of the International Accounting Standards Board
(IASB).
Mr. Chairman, thank you for holding this important hearing and
these are issues, which we must continue to monitor to insure that
consumers receive the information they need to make the best decisions
possible regarding their investments. Ultimately, this will be good for
the American public and the American economy.
Mr. Stearns. Thank you, gentlelady.
And I believe those are all the opening statements for
members.
[Additional statement submitted for the record follows:]
Prepared Statement of Hon. John D. Dingell, a Representative in
Congress from the State of Michigan
Due to the press of other House business, including work on the
patients' rights legislation and the Rules Committee hearing on pending
energy legislation, I was unable to attend yesterday's hearing. I thank
the distinguished Ranking Member of the Subcommittee, Mr. Towns, for
extending my regrets and I also thank the distinguished Subcommittee
Chairman, Mr. Stearns, for granting my request to submit a statement
for the hearing record. I appreciate the opportunity to work with both
of my colleagues on this and other issues.
The work of the Financial Accounting Standards Board (FASB), though
obscure by many standards, is vital to the fair and efficient operation
of our capital markets and the conduct of commerce and trade.
The Securities Act of 1933 and the Securities Exchange Act of 1934
established a system of fair, honest, reliable, and transparent
disclosure as the keystone of our markets. The Securities and Exchange
Commission (SEC) was given responsibility for administering those
statutes for the protection of investors and the public interest. The
SEC has always looked to the private sector for leadership in
establishing and improving financial accounting and reporting standards
for publicly held companies, and in 1973, formally gave that
responsibility to FASB.
It's a tough job but one that FASB has performed admirably and in
the public interest. In the process, FASB has had several near-death
experiences. For example, the banks tried to have FASB abolished for
suggesting that banks should mark certain financial assets to market
just like everybody else. Then the bankers tried to rein in the SEC and
FASB efforts to improve accounting for derivatives and hedging and the
disclosure of registrants' derivatives and market risks.
More broadly, Corporate America has tried to have FASB abolished
for suggesting that stock options are an expense that should be
reflected on balance sheets. Yet in a speech two summers ago, Alan
Greenspan, the Federal Reserve Board chairman, said stock options
helped ``impede judgments about prospective earnings'' and, over the
last five years, had caused companies to overstate profit growth by one
to two percentage points each year. Moreover, an article in the Sunday,
July 29, 2001, New York Times, ``Disposing the Myth That Options Help
Shareholders,'' reports on research showing stock options repricings to
be an egregious transfer of wealth from shareholders to managements.
We expect FASB to tackle these difficult issues in an open and
deliberate manner that provides extensive due process. We do not expect
FASB to duck issues because they are controversial or because there is
no industry consensus on the subject. Sometimes the industry consensus
is to do the wrong thing. We expect FASB to listen to all of its
constituents and work with them; consensus will follow. We expect FASB
to exercise strong leadership in these matters.
In that regard, I appreciate the contributions made by the
witnesses. I agree with the outcome on business combinations although I
have some reservations about the ability to game the impairment test.
This matter merits close scrutiny by FASB and by the regulators.
Former Secretary of the Treasury Lawrence H. Summers once observed:
``The single most important innovation shaping the [American capital]
market was the idea of generally accepted accounting principles. We
need something similar internationally.'' I agree. Therefore, I look
forward to hearing more in the future about the work of the
International Accounting Standards Board (IASB) toward establishing
high quality standards to govern global transactions. Such efforts have
fizzled in the past. I hope that the IASB can succeed where others have
failed.
In June, the Wall Street Journal reported that the SEC was
investigating whether a handful of companies may have announced
deceptive financial results to the public by touting misleading ``pro
forma'' earnings in their quarterly news releases. It appears as if
some companies are intentionally trying to deceive investors by issuing
news releases highlighting pro forma earnings, which conveniently omit
items that would reduce earnings. The real results are then filed weeks
later with the SEC in the company's quarterly or annual earnings
report. Sounds like fraud to me. I urge the SEC to take appropriate
action promptly to curb this abuse. I associate myself with the
concerns expressed by Chairman Stearns at the hearing and would be
pleased to work with him to solve this problem.
I also want to work with Chairman Stearns and Ranking Member Towns,
as well as the Financial Services Committee, on accounting fraud. I am
inserting in the hearing record with my statement a recent press
report, ``SEC List of Accounting-Fraud Probes Grows,'' Wall Street
Journal, Friday, July 6, 2001, indicating that the SEC has a record
nearly 260 accounting investigations under way. This suggests that
companies and accountants are subverting GAAP and the rules laid down
by FASB and the SEC. At my request, the General Accounting Office has
agreed to examine the governance system of the accounting profession
and the issues raised by the outbreak of record levels of accounting
fraud. (I am enclosing copies of those two letters for the record.)
Lastly, I commend full Committee Chairman Tauzin for his
negotiations on the memorandum of understanding that preserved this
Committee's jurisdiction over accounting standards. This Committee,
particularly its Subcommittee on Oversight and Investigations which I
chaired, has a long and distinguished history on accounting matters.
Under our stewardship, the quality of information we receive from U.S.
companies exceeds that of almost any other nation. We can be proud of
that.
______
[Friday, July 6, 2001--The Wall Street Journal]
SEC List of Accounting-Fraud Probes Grows
By Michael Schroeder, Staff Reporter of The Wall Street Journal
WASHINGTON--The Securities and Exchange Commission's list of
companies under investigation for possible accounting fraud is growing
longer, just as the agency's limited resources are being stretched more
than ever before.
SEC officials say they have nearly 260 accounting investigations
under way, a big jump from recent years. They aren't just small firms--
the chief focus of the SEC's enforcement actions historically. Some 15%
of the probes, or about 40, are focusing on companies that are among,
the nation's 500 biggest.
``If we had nothing else to do, the accounting investigations alone
could keep us busy for the next five or 10 years,'' Richard Walker, the
SEC's enforcement chief, said in an interview. ``The size and magnitude
are crushing.''
The drumbeat of headline-grabbing accounting scandals, at firms led
by Cendant Corp., Sunbeam Corp. and Rite Aid Corp., is also getting
attention on Capitol Hill. Lawmakers are beginning to call for more SEC
resources to combat fraud. The SEC's division of corporation finance
has the staffing to review only a tiny fraction of earnings statements
filed by public companies, and until this year it has been swamped by
the huge crush of technology initial public offerings of stock.The
current crackdown on accounting misdeeds began in mid-1998. The SEC's
then-chairman, Arthur Levitt, beefed up policing efforts, approved new
auditor-independence rules and issued new accounting guidance to curb
bookkeeping practices used to inflate revenue. Last year, the regulator
brought 100 financial-fraud actions, and there has been a 28% increase
in accounting-related cases in the past three years.
The most visible indicator of improper accounting--and source of
new investigations--is the growing number of restated financial
reports. Restatements ballooned to 233 last year, twice the number in
1997, according to a recent study by Arthur Andersen LLP. Of those,
only 9% resulted from new accounting methods required by the SEC.
Xerox Corp. is an example of the major companies being scrutinized.
In recently' restating its results for the past three years, Xerox
conceded it had ``misapplied'' a range of accepted accounting rules in
a variety of Ways, including improperly using a $100 million reserve to
offset unrelated expenses. To correct the reserve error, Xerox cut its
1998 and 1999 pretax profit by $100 million, while adding $6 million to
2000's pretax figure. Xerox's acknowledgment of problems hasn't
dissuaded the SEC from conducting a broad inquiry into its accounting
practices.
Recently, ConAgra Foods Inc. said its restatement is the subject of
an SEC investigation. ConAgra announced that a subsidiary, which sells
seed, fertilizer and chemicals, recorded fictitious sales, among other,
accounting possible violations. The company said the revisions would
reduce pretax earnings for fiscal 1998, 1999 and 2000 by a total of
about $123 million. For fiscal 2001, the company said its revenue will
rise $350 million.
The pressure to assure maximum compensation, which is tied to share
price, is tempting more financial executives to play games to manage
earnings--such as recognizing revenue too early or improperly setting
up reserves, SEC officials say. Companies fear that missing Wall
Street's quarterly earnings targets even by a few pennies can send a
stock price tumbling.
The accounting industry argues that the number of restatements and
accounting-fraud cases is minuscule as a percentage of the 13,000
public companies that file annual financial reports. But regulators
believe the accounting violations may be even more pervasive than the
statistics suggest.
``Is it an ice cube or an iceberg?'' said Lynn Turner, the SEC's
chief accountant. ``There's definitely something there below the water
line.''
The SEC relies on the press, company whistleblowers and its
investigators for leads. While the regulator investigates most alleged
frauds after word of a company's accounting problems has leaked and
battered its stock price, SEC accountants are focusing on ferreting out
questionable accounting in financial statements earlier.
With the cooling of the IPO market, the SEC is using its freed-up
resources to ramp up its review of annual financial reports. During the
fiscal year ended Sept. 30, 2000, the SEC reviewed about 1,100 of the
13,000 annual reports filed on form 10K with the agency, or about eight
of every 100. This year's goal: one of every four annual reports.
``The commission's resources have been absorbed during the last two
years by the hot IPO market, leaving little time for more random
selection of annual reports and other filings,'' said Robert Bayless,
the division's chief accountant.
Accounting-fraud cases, which typically take at least a couple of
years to prepare, often rest on complicated and hard-to-prove
allegations. The largest cases are handled by the SEC's special
accounting-fraud unit staffed by eight attorneys and seven forensic
accountants. An additional 60 accountants in Washington and the
regional offices also work on cases. Because of limited resources, the
SEC doesn't pursue scores of less-egregious cases involving violations
caused by negligence.
Rep. John LaFalce (D., N.Y.), ranking member of the House
financial-services committee, said recently that his panel will look
into the accounting-fraud issue and has called for a 200% to 300%
increase in the SEC's enforcement staff to bolster oversight. Such an
increase would boost the SEC's total $423 million annual budget this
year by as much as $400 million.
Critics also complain that the SEC would also be less burdened if
the accounting industry did a better job of policing auditors,
ostensibly the first line of defense in the fight against fraud. Last
year, the SEC worked with industry groups to improve self-regulation
and the disciplinary peer-review process, but progress has been slow.
At the request of Rep. John Dingell, (D., Mich.) the General
Accounting Office, an independent research arm of Congress, has agreed
to study whether the various accounting regulatory groups should be
replaced by one full-time self-regulatory organization.
Jonathan Weil contributed to this article.
______
Congress of the United States
House of Representatives
January 17, 2001
The Honorable David M. Walker
Comptroller General
U.S. General Accounting Office
441 G Street, N.W.
Washington, D.C. 20548
Dear Mr. Walker: In September 1996, the General Accounting Office
(GAO) released a seminal two-volume report, The Accounting Profession--
Major Issues: Progress and Concerns (GAO/AIMD-96-98), in response to my
request concerning the status of recommendations made to the accounting
profession over the prior two decades by major study groups to improve
accounting and auditing standards and the performance of independent
audits under the federal securities laws. GAO's principal finding was
that, while the accounting profession had been responsive in making
changes to improve financial reporting and auditing of public
companies, the actions of the profession had not been totally
effective. The most significant weaknesses were found in the areas of
auditor independence, auditor responsibility for detecting fraud and
reporting on internal controls, public participation in standard
setting, the timeliness and relevancy of accounting standards, and
maintaining the independence of FASB.
Recent events, in particular last year's bitter fight over
maintaining auditor independence, suggest that GAO needs to take
another look at the accounting profession. The AICPA's move to block
funding for the Public Oversight Board (POB) to conduct the special
reviews requested by the Securities and Exchange Commission raises a
number of troubling questions about the integrity and effectiveness of
the profession's current governance system. Critics also contend that
the peer review process is too clubby and too slow and that
disciplinary actions are inadequate and ineffective. This is difficult
to judge since the process is not transparent, thereby compounding the
growing suspicions about ineptitude and collusion.
In 1998, the POB appointed a panel of eight members, charging it to
thoroughly examine the audit model. In his remarks to the panel at its
public hearings, SEC Chairman Levitt asked: ``has the accounting
profession become so big and complex that perhaps we need a full-time
SRO [self-regulatory organization]? Are the alphabet of regulatory
bodies . . . really workable?'' The Panel on Audit Effectiveness (the
so-called O'Malley Panel) submitted its report and recommendations on
August 31, 2000. I am transmitting Chapter 6--Governance of the
Auditing Profession, and requesting that GAO answer Chairman Levitt's
question by reviewing the current governance structure, the Panel's
proposed system of governance (which appears to call for retention of
the current list of entities reporting to an enhanced POB), the status
of the profession's response to the Panel's recommendations, and the
likelihood that the reforms, if implemented, will be effective.
This is a matter of great importance affecting the reliability of
financial statements, and I thank you for your prompt attention to my
request.
Sincerely,
John D. Dingell
Ranking Member
Enclosure
cc: The Honorable W. J. ``Billy'' Tauzin, Chairman
Committee on Energy and Commerce
______
General Accounting Office
May 23, 2001
The Honorable John D. Dingell
Ranking Member
Committee on Energy and Commerce
United States House of Representatives
Subject: Auditing Profession's Governance System
Dear Mr. Dingell: We previously met with your staff to gain a
further understanding of your needs concerning your request for a GAO
study of the auditing profession's governance system. It was agreed
that we would proceed with a design phase given the number of
components of the auditing profession's governance system and the broad
range of the Panel on Audit Effectiveness' recommendations affecting
the governance system. A design phase will enable us to obtain a more
complete understanding of the governance system and will allow for the
time we will need to access the various senior representatives of each
of the system components. The purpose of this letter is to set forth
the study objectives and provide you with a completion date for the
design phase. We agreed with your staff that the overall objectives of
our work will be to:
obtain an understanding of the structure and operation of the
auditing profession's current governance system;
obtain an understanding of the governance system proposed by
the Panel on Audit Effectiveness and how it addresses
limitations identified by the Panel;
determine whether the Panel's recommendations have been
accepted, how the system components are working together to
implement reforms, their current status, and timeframe for
implementation; and
obtain views of the Panel and senior representatives of each
system component regarding critical factors to successful
implementation of recommended reforms and any gaps in the
recommended reforms.
The design phase will be completed by August 2001. We will remain
in contact with your staff, and at the end of the design phase, we will
provide you with a projected completion date for the total study. If
you should have any questions, please contact Cheryl Clark at (202)
512-9377 or [email protected], or Robert Gramling at (202) 512-6535 or
[email protected].
Sincerely yours,
Jeffey C. Steinhoff
Managing Director, Financial Management and Assurance
______
U.S. House of Representatives
Committee on Energy and Commerce
June 7, 2001
The Honorable David M. Walker
Comptroller General
U.S. General Accounting Office
441 G Street, N.W.
Washington, D.C. 20548
Dear Mr. Walker: I am writing to acknowledge receipt of your letter
of May 23, 2001, agreeing to my January 17, 2001, request for a General
Accounting Office (GAO) study of the auditing profession's governance
system. I am generally comfortable with both your study objectives--
some specific comments are set forth below--and the August 2001
timetable for completion of the design phase of GAO's work.
Under my chairmanship, the Committee on Energy and Commerce's
Subcommittee on Oversight and Investigations held over 30 hearings on
the accounting profession. The GAO's two-volume 1996 report, The
Accounting Profession (GAO/AIMD-96-98), prepared in response to my
March 1994 request, remains one of the most-requested reports in GAO
history and has made a major contribution to the public debate on
important accounting issues. Therefore, I retain my interest in these
matters, despite the fact that the Committee on Energy and Commerce no
longer has a direct role in them. As you know, a recommendation by
House Rules Committee Republicans and the House GOP Conference to shift
most of the Committee on Energy and Commerce's historic jurisdiction
over securities and exchanges to a newly created Financial Services
Committee was narrowly approved by the House earlier this year. I
believe that decision was unwise, but these important responsibilities
have been shifted. Therefore, I am copying the Chairman and Ranking
Member of the Financial Services Committee on this letter as I am sure
that they will be interested in your report. On January 20, 2001,
Speaker Hastert inserted in the Congressional Record at H67 a
memorandum of understanding (MOU) to clarify this jurisdictional
situation. Among other things, the MOU spells out that the Committee on
Energy and Commerce will retain jurisdiction over the issue of the
setting of accounting standards by the Financial Accounting Standards
Board, thus requiring the two committees to work closely on accounting
issues and ensuring that the Energy and Commerce Committee's
considerable expertise will continue to be brought to bear on these
issues.
While I am satisfied with the general objectives set forth in your
letter, I also request that these specific critical issues be addressed
in your report within those objectives:
The adequacy and effectiveness of the Securities and Exchange
Commission's (SEC) oversight of the profession's governance
system. See, e.g., enclosed February 9, 2001, letter from SEC
Chief Accountant Lynn E. Turner to Public Oversight Board
Chairman Charles A. Bowsher.
The adequacy and effectiveness of the response of the
governance system to the recent string of major accounting
debacles, using Livent, Waste Management, MicroStrategy,
Cendant, Sunbeam, Rite Aid, and Xerox as case studies.
The adequacy and effectiveness of the response of the
governance system to the sharp increase in misleading and
fraudulent accounting. Please update your February 4, 2000
letter report, Review of Reporting Under Section 10A. Given the
level of accounting chicanery in the five years since 10A went
into effect (1996), one might expect auditor's fraud reports to
be piling up at the SEC. However, GAO reported that only six
such reports had been filed through December 14, 1999. Are
auditors still missing in action?
The adequacy and effectiveness of the response of the
governance system to complaints that ``going-concern'' clauses,
in which auditors raise substantial doubt about a company's
ability to stay in business for at least 12 months, were rare
among the dot-com companies that shut down or filed for
bankruptcy last year. See, e.g., enclosed article `` `Going
Concerns': Did Accountants Fail To Flag Problems at Dot-Com
Casualties?'' Wall Street Journal, Friday, February 9, 2001.
The Financial Services Subcommittee on Capital Markets is
conducting an inquiry into the Wall Street shills who passed
themselves off as ``independent'' analysts and how their
heavily compromised research and recommendations hurt retail
investors--an investigation that I strongly support--but Wall
Street analysts are not the only expert sentries who were
asleep at their sentry posts or abandoned them altogether.
The adequacy and effectiveness of the response of the governance
system with respect to oversight, review, and reporting on the quality
control systems that accounting firms are supposed to have implemented
to ensure compliance with SEC and firm independence regulations. See,
e.g., enclosed article ``Opening the Books on Corporate Auditors,''
Washington Post, Sunday, June 3, 2001, on the thorny issues that
continue to cast a shadow over the integrity of the profession and its
audit function. The SEC's new disclosure requirements are making a
tremendous contribution to the public debate on how best to maintain
auditor independence in order to safeguard.the integrity of our
financial reporting system. How has the governance system responded?
Thank you for your cooperation and attention to my request. The
importance of this work cannot be overstated. I look forward to hearing
back from GAO at the end of its design phase, and I thank you for the
significant contribution that GAO makes to the public interest and the
protection of investors.
Sincerely,
John D. Dingell
Ranking Member
Enclosures
cc: The Honorable W. J. ``Billy'' Tauzin, Chairman
Committee on Energy and Commerce
The Honorable Michael G. Oxley, Chairman
Committee on Financial Services
The Honorable John J. LaFalce, Ranking Member
Committee on Financial Services
Mr. Stearns. And now, we welcome our panel: Mr. Edmund
Jenkins, who is chairman of Financial Accounting Standards
Board; Mr. James Leisenring, member of board, International
Accounting Standards Board; and Mr. Barry Rogstad, president of
the American Business Conference. And we welcome you gentlemen
and we look forward to your opening statement.
Mr. Jenkins?
STATEMENTS OF EDMUND L. JENKINS, CHAIRMAN, FINANCIAL
ACCOUNTING STANDARDS BOARD; JAMES J. LEISENRING, BOARD MEMBER,
INTERNATIONAL ACCOUNTING STANDARDS BOARD; AND BARRY K. ROGSTAD,
PRESIDENT, AMERICAN BUSINESS CONFERENCE
Mr. Jenkins. Thank you, Mr. Chairman, members of the
subcommittee.
I am Ed Jenkins and chair of the Financial Accounting
Standards Board, or as I like to say it Ms. Harman, the FASB.
I am pleased to be here with you today. I do understand the
important oversight role of this subcommittee. And I appreciate
the comments that were made by you, Mr. Chairman, and your
colleagues this morning about the FASB's independence and the
role that we play in our capital markets. That is very
important to us.
This morning I plan to discuss the mission and due process
of the FASB and our two recently issued financial statements on
improving the transparency of the accounting and reporting for
business combinations. In addition, I will provide a very brief
overview of the FASB's involvement in the area of international
accounting standards study. I have very brief prepared remarks,
and I would respectfully request that the full text of my
statement and all supporting materials be entered in to the
record.
Mr. Stearns. By unanimous consent, so ordered.
Mr. Jenkins. Thank you.
The FASB is an independent organization, as you have
recognized, that is funded entirely by the private sector. Our
mission is to set accounting and reporting standards to protect
the consumers of financial information; most notably investors
and creditors. Those consumers rely heavily on credible,
transparent and comparable financial information for effective
participation in our capital markets.
The FASB's authority with respect to public enterprises
comes from the U.S. Securities and Exchange Commission. The SEC
has the statutory authority to establish financial accounting
and reporting standards for publicly held enterprises, but for
over 60 years the SEC has looked to the private sector for
leadership in establishing and improving standards.
Because the actions of the FASB effect so many
organizations, our decisionmaking process must be thorough. The
FASB carefully considers the views of all interested parties:
consumers, preparers and auditors of financial information.
Our rules of procedure require an extensive due process
that was modeled on the Federal Administrative Procedure Act,
but is broader and more open. It involves public meetings,
public hearings and exposure of our proposed standards to
external scrutiny and public comment. The board makes final
decisions only after carefully considering and understanding
the views of all parties.
Earlier in July the FASB issued two final statements:
number 144 on business combinations and number 142 on goodwill
and other intangible assets. The issuance of these two
statements is the end result of a public due process that began
in 1996, included the issuance of four documents for public
comment, over 70 public meetings, 4 days of our own public
hearings, company field tests and field visits, and the careful
analysis and public discussion of over 600 comment letters
received from a broad range of consumers, companies, auditors
and other constituents.
Statement 141 will significantly improve the transparency
of the accounting and reporting for business combinations by
requiring all business combinations to be accounted for under a
single method: the purchase method; the use of the pooling of
interest method is no longer permitted. The purchase method
provides investors with information necessary to determine the
true cost of one company buying another. And as a result, it
provides a sound basis for consumers to track future returns on
that investment.
Statement 142 will improve the purchase method in a number
of ways. Most significantly the statement requires that
goodwill no longer be amortized to earnings, but instead be
tested for impairment. That improvement will provide consumers
with greater transparency with respect to the economic value of
goodwill and the amount and timing of its impact on companies'
earnings.
Another significant development effecting the allocation of
FASB resources over the past several years has been the
increased attention to the globalization of the financial
markets. This has placed heightened interest and emphasis on
the quality of international accounting standards and the
process for developing those standards. In order for companies
from around the globe to share equal access to the capital
markets, financial reporting must provide greater comparability
and credibility. These issues have underscored the need for a
single set of high-quality accounting standards.
A single set of high-quality accounting standards cannot be
achieved without first establishing a high-quality global
standard-setting structure. Without such a structure, the
continued independent process of the various national and
international standard setters can only result in increasing
divergencies among national financial reporting regimes and
between national and international accounting standards.
Since 1997, the FASB has been actively working with other
accounting standards, securities regulators and other
interested parties around the world to develop such a
structure. The result of those efforts has led to the recent
creation of the new standard setting body named the
International Accounting Standards Board, the IASB. The IASB is
based in London. It has a private sector structure and a due
process very similar to the FASB. The IASB began its operations
earlier this year and it is currently in the process of
establishing its initial agenda.
Mr. Leisenring will comment further on the structure and
process of the IASB, I am sure.
For the FASB, we are committed to having a close,
constructive and an active relationship with the IASB and with
other national standard setters in achieving convergence of
high-quality financial reporting standards around the world.
I just want to stop here and emphasize that the key to
convergence is high quality. It is not convergence at any cost.
It is not convergence to lowest common denominator. And it is
certainly not convergence to diluting the quality of the
standards we have at the present time in the United States.
We plan on working in partnership with the IASB in
contributing to projects that are international in scope and
have important implications for our U.S. constituents.
In closing, I believe that the improved transparency
resulting from our new standards on business combinations and
the thorough and open due process that the board followed in
developing those statements illustrates the benefits and the
strengths of independent private sector accounting standard
setting. Those benefits and strengths will well serve the FASB
and the IAMB too as we work in partnership to develop sound and
consistent global standards for the world's capital markets.
For over 28 years the FASB has proven, and will continue to
prove, invaluable to the efficiency of the capital markets and
to the continued confidence of investors and creditors; the
consumers of financial information.
Thank you very much, Mr. Chairman. I very much appreciate
this opportunity to be here today, and I would be pleased to
respond to questions.
[The prepared statement of Edmund L. Jenkins follows:]
Prepared Statement of Edmund L. Jenkins, Chairman, Financial Accounting
Standards Board
SUMMARY
On July 20, 2001, the Financial Accounting Standards Board
(``FASB'' or ``Board'') issued two final Statements--No. 141, Business
Combinations, and No. 142, Goodwill and Other Intangible Assets.
Statement 141 will significantly improve the transparency of the
accounting and reporting for business combinations by requiring that
all business combinations be accounted for under a single method--the
purchase method. Use of the pooling-of-interests method (``pooling
method'') is no longer permitted. The purchase method provides
investors with the information necessary to determine the true cost of
one company buying another and, as a result, provides a basis for
investors to track future returns on the investment. Statement 141
requires that the purchase method of accounting be used for all
business combinations initiated after June 30, 2001.
Statement 142 will improve the purchase method in a number of ways.
Most significantly, the Statement requires that goodwill no longer be
amortized to earnings, but instead be tested for impairment. That
improvement will provide investors with greater transparency with
respect to the economic value of goodwill and the amount and timing of
its impact on companies' earnings. Statement 142 requires that
amortization of goodwill cease upon initial application of the
Statement, which, for most companies, will be January 1, 2002.
Mr. Chairman, Members of the Subcommittee, I am Edmund Jenkins,
chairman of the Financial Accounting Standards Board. I am pleased to
be here today. I understand the important oversight role of this
Subcommittee.
This morning I plan to discuss the mission and due process of the
FASB and our two recently issued final Statements to improve the
transparency of the accounting and reporting for business combinations.
In addition, I will provide an overview of the FASB's involvement in
the area of international accounting standard setting. I have brief
prepared remarks, and I would respectfully request that the full text
of my statement and all supporting materials be entered into the public
record.
WHAT IS THE FASB AND WHAT DOES IT DO?
The FASB is an independent private-sector organization. We are not
part of the federal government and receive no federal funding. We are
funded entirely from private-sector sources, primarily voluntary
contributions and sales of publications.
Our mission is to establish and improve standards of financial
accounting and reporting for both public and private enterprises. Those
standards are essential to the efficient functioning of the economy
because investors and creditors rely heavily on credible, transparent,
and comparable financial information.
The FASB's authority with respect to public enterprises comes from
the US Securities and Exchange Commission (``SEC''). The SEC has the
statutory authority to establish financial accounting and reporting
standards for publicly held enterprises. For over 60 years, the SEC has
looked to the private sector for leadership in establishing and
improving those standards. Therefore, the FASB may be viewed as an
independent private-sector alternative to government regulation.
The focus of the FASB is on consumers--users of financial
information such as investors, creditors, and others. We attempt to
ensure that corporate financial reports give consumers an informative
picture of an enterprise's financial condition and activities and do
not color the image to influence behavior in any particular direction.
To quote a February 2000 letter from the Financial Accounting
Policy Committee of the Association for Investment Management and
Research, the leading organization of investment professionals in the
US with over 40,000 members:
The `lifeblood' of United States capital markets is financial
information that is: (1) comparable from firm to firm; (2)
relevant to investment and financing decisions; (3) a reliable
and faithful depiction of economic reality; and (4) neutral,
favoring neither supplier nor user of capital, neither buyer
nor seller of securities.
The notion of neutrality is a fundamental element of our standard-
setting process. The FASB's Rules of Procedure explicitly require that
the Board be objective in its decision making to ensure the neutrality
of information resulting from its standards.
Neutrality is an essential criterion by which to judge financial
reporting standards, because information that is not neutral loses
credibility and value. For example, surely, we would all agree there
would be little value to Congress or the federal government of
purposely altered and manipulated information about the rate of
inflation or about unemployment.
Similarly, to create or to tolerate financial reporting standards
that bias or distort financial information to favor a particular
transaction, industry, or special interest group undermines the proper
functioning of the capital markets and impairs investors' capital
allocation decisions.
As former SEC Chairman Richard C. Breeden stated in testimony
before Congress almost a decade ago:
The purpose of accounting standards is to assure that
financial information is presented in a way that enables
decision-makers to make informed judgments. To the extent that
accounting standards are subverted to achieve objectives
unrelated to fair and accurate presentation, they fail in their
purpose.
More recently, in an October 1997 speech, former SEC Chairman
Arthur Levitt stated:
It is compellingly clear to me that the objectivity and
fairness of standards-setting can only be guaranteed if the
process is insulated from political agendas, special interests,
and bureaucratic convenience. If that independence is
compromised, or perceived to be compromised, we would pay a
heavy price in declining investor confidence in the markets.
The FASB sets standards only if, in the Board's independent
judgment after carefully considering the input from all interested
parties, there is a significant need for the standard and the costs the
standard imposes are justified by the overall benefits. The objective,
and implicit benefit, of issuing an accounting standard is increased
credibility and representational faithfulness of financial reporting.
However, the value of that improvement to financial reporting is
usually impossible to measure and the Board's assessment of an
accounting standard's benefit to companies that prepare financial
reports and to investors and creditors that use financial reports is
unavoidably subjective.
The US capital markets are the deepest, most liquid, and most
efficient markets in the world. The unparalleled success and
competitive advantage of the US capital markets are due, in no small
part, to the high-quality and continually improving US financial
accounting and reporting standards. As Federal Reserve System Chairman
Alan Greenspan stated in a June 4, 1998 letter to former SEC Chairman
Levitt:
Transparent accounting plays an important role in maintaining
the vibrancy of our financial markets . . . An integral part of
this process involves the Financial Accounting Standards Board
(FASB) working directly with its constituents to develop
appropriate accounting standards that reflect the needs of the
marketplace.
WHAT PROCESS DOES THE FASB FOLLOW IN DEVELOPING ACCOUNTING STANDARDS?
Because the actions of the FASB affect so many organizations, its
decision-making process must be thorough. The FASB carefully considers
the views of all interested parties--consumers, preparers, and auditors
of financial information. Our Rules of Procedure require an extensive
due process that was modeled on the Federal Administrative Procedure
Act, but it is broader and more open in several ways. It involves
public meetings, public hearings, and exposure of our proposed
standards to external scrutiny and public comment. The Board makes
final decisions only after carefully considering and understanding the
views of all parties.
The FASB's due process for developing a new financial reporting
standard is best illustrated by describing the process followed in
developing Statements 141 and 142:
Following the Board's extensive agenda decision process, we
decided to add the project on business combinations to the
Board's technical agenda in 1996. (Attachment 2 includes a
detailed description of how topics are added to the FASB's
technical agenda.)
When we began the project in 1996, we established a business
combinations task force comprising individuals from a number of
organizations representing a wide range of the Board's
constituents. (Attachment 13 lists the members and their
affiliations.) The first public meeting of the task force was
held in February 1997.
In June 1997, we published for public comment a Special Report
that contained some of the Board's initial tentative decisions
about the project's scope, direction, and content. We received
54 comment letters in response to the Special Report.
In November 1998, we held a second public business
combinations task force meeting to discuss issues related to
the project.
In December 1998, we published for public comment, in
participation with other members of an international
organization consisting of representatives from the accounting-
standard-setting bodies of Australia, Canada, New Zealand, the
United Kingdom, and the International Accounting Standards
Committee (``IASC'') (collectively the ``G4+1''), a Position
Paper that addressed a number of issues related to the methods
of accounting for business combinations. We received 148
comment letters in response to the G4+1 Position Paper.
From 1996 through 1999 we held over 40 public meetings to
address the issues associated with the methods of accounting
for business combinations and the accounting for goodwill and
other purchased intangible assets and to consider constituent
comments.
After each meeting, we updated a summary of all of the Board's
decisions. The updated summary was available on the FASB
website and was sent by mail to anyone who requested it.
Our weekly newsletter, Action Alert, announced each meeting in
advance and reported a summary of the results of each meeting.
(In addition, press reports of some of the meetings were
available in certain business publications.)
In September 1999, we published for public comment an Exposure
Draft that contained proposed changes to the existing standards
of accounting for business combinations and intangible assets.
We received approximately 200 comment letters in response to
the 1999 Exposure Draft.
In connection with the issuance of the 1999 Exposure Draft, we
prepared and issued a number of explanatory documents to assist
constituents in understanding the Board's proposed decisions
including a FASB Viewpoints, Why Eliminate the Pooling Method?
(Attachment 6). All of the documents were available on the FASB
website and were sent by mail to anyone who requested them.
We held four days of public hearings in February 2000 (two
days in San Francisco and two days in New York City) to discuss
the 1999 Exposure Draft with interested parties. More than 40
individuals and organizations testified.
In March 2000, we held a third public business combinations
task force meeting to discuss issues raised by constituents in
the comment letters and public hearings.
In October and November 2000, we conducted field visits with
14 companies in a variety of industries to discuss a goodwill
impairment approach developed by the FASB staff in response to
constituent input.
In November 2000, we held a fourth public business
combinations task force meeting to discuss the results of the
field visits and the potential need for issuance of a revised
Exposure Draft proposing changes to the 1999 Exposure Draft's
provisions for accounting for goodwill.
We held over 15 public meetings during 2000 to consider
constituent input received in response to the 1999 Exposure
Draft.
In February 2001, we published for public comment a revised
Exposure Draft that contained proposed changes to the 1999
Exposure Draft's provisions for accounting for goodwill. We
received approximately 200 comment letters in response to the
2001 revised Exposure Draft.
In connection with the issuance of the 2001 revised Exposure
Draft, we prepared and issued to the public a FASB Viewpoints,
Why Did the Board Change Its Mind on Goodwill Amortization?
(Attachment 9). The document was available on the FASB website
and was sent by mail to anyone who requested it.
We held over 10 public meetings during 2001 to address the
issues raised by constituents in response to the 2001 revised
Exposure Draft and to continue to address issues raised by
constituents in response to the 1999 Exposure Draft.
In May 2001, the Board completed its public deliberations of
all the substantive issues raised by constituents in response
to both the 1999 Exposure Draft and the 2001 revised Exposure
Draft. The Board reviewed the entire package of decisions made
in connection with its public deliberations and unanimously
supported the issuance of two final Statements--Statements 141
and 142, replacing Accounting Principles Board (``APB'')
Opinion No. 16, Business Combinations (``Opinion 16''), and APB
Opinion No. 17, Intangible Assets (``Opinion 17''),
respectively.
In June 2001, we issued the FASB's monthly newsletter, Status
Report, which included an article entitled Conversations with
Constituents. The purpose of the article was to provide
constituent perspectives on the impact of Statements 141 and
142. In addition, the FASB website contained up-to-date details
of all of the Board's significant decisions to be contained in
the two Statements.
In July 2001, the Board issued Statements 141 and 142 to the
public.
WHAT WAS WRONG WITH THE ACCOUNTING FOR BUSINESS COMBINATIONS?
Prior to the issuance of Statements 141 and 142, the accounting for
business combinations was governed by the requirements of Opinions 16
and 17, which were issued in 1970 by the APB, a former standard-setting
group of the American Institute of Certified Public Accountants.
Under Opinion 16, business combinations were accounted for using
one of two methods, the pooling method or the purchase method. Use of
the pooling method was required whenever 12 criteria were met;
otherwise, the purchase method was to be used. Because those 12
criteria did not distinguish economically dissimilar transactions,
business combinations that were similar were accounted for using
different methods that produced dramatically different financial
statement results. Consequently:
Analysts and other consumers of financial statements indicated
that it was difficult to compare the financial results of
companies because different methods of accounting for business
combinations were used.
Because intangible assets are an increasingly important
economic resource for many companies and are an increasing
proportion of the assets acquired in many business
combinations, consumers of financial statements also indicated
a need for better information about those assets. While the
purchase method recognizes all intangible assets acquired in a
business combination (either separately or as goodwill), only
those intangible assets previously recorded by the acquired
entity are recognized when the pooling method is used.
Company managements indicated that the differences between the
pooling and purchase methods of accounting for business
combinations affected competition in markets for mergers and
acquisitions.
Under Opinion 17, all intangible assets acquired in a business
combination, including goodwill, were required to be amortized or
charged to earnings over the useful economic life of the asset.
Consumers, including analysts and other users of financial statements,
as well as company managements, noted that intangible assets, including
goodwill, are an increasing proportion of the assets acquired in many
transactions. As a result, better information about those assets was
needed. Consumers of financial statements also indicated that they did
not regard goodwill amortization expense as being useful information in
analyzing investments.
WHAT DO STATEMENTS 141 AND 142 REQUIRE?
The provisions of Statements 141 and 142 reflect a significantly
different approach to the accounting for business combinations than was
taken in Opinions 16 and 17. The most significant of those changes are:
Statement 141 requires that all business combinations be
accounted for by a single method--the purchase method. Thus all
business combinations will be accounted for in the same way
that other asset acquisitions are accounted for--based on the
values exchanged.
In contrast to Opinion 16, which required separate recognition
of intangible assets that can be identified and named,
Statement 141 requires that intangible assets be recognized as
assets apart from goodwill if they meet one of two criteria--
the contractual-legal criterion or the separability criterion.
To assist in identifying acquired intangible assets, Statement
141 also provides an illustrative list of intangible assets
that meet either of those criteria.
In addition to the disclosure requirements in Opinion 16,
Statement 141 requires disclosure of the primary reasons for a
business combination and the allocation of the purchase price
paid to the assets acquired and liabilities assumed by major
balance sheet caption. When the amounts of goodwill and
intangible assets acquired are significant in relation to the
purchase price paid, disclosure of other information about
those assets is required, such as the amount of goodwill by
reportable segment and the amount of the purchase price
assigned to each major intangible asset class.
Acquiring companies usually integrate acquired companies into
their operations, and thus the acquirers' expectations of
benefits from the resulting synergies usually are reflected in
the premium that they pay to acquire those companies. However,
the transaction-based approach to accounting for goodwill under
Opinion 17 treated the acquired entity as if it remained a
stand-alone entity rather than being integrated with the
acquiring entity; as a result, the portion of the premium
related to expected synergies (goodwill) was not accounted for
appropriately. Statement 142 adopts a more aggregate view of
goodwill and bases the accounting for goodwill on the units of
the combined entity into which an acquired entity is integrated
(those units are referred to as reporting units).
Opinion 17 presumed that goodwill and all other intangible
assets were wasting assets (that is, finite lived), and thus
the amounts assigned to them should be amortized in determining
net income; Opinion 17 also mandated an arbitrary ceiling of 40
years for that amortization. Statement 142 does not presume
that those assets are wasting assets. Instead, goodwill and
intangible assets that have indefinite useful lives will not be
amortized but rather will be tested at least annually for
impairment. Intangible assets that have finite useful lives
will continue to be amortized over their useful lives, but
without the constraint of an arbitrary ceiling.
Previous standards, including Opinion 17, provided little
guidance about how to determine and measure goodwill
impairment; as a result, the accounting for goodwill
impairments was not consistent and not comparable and yielded
information of questionable usefulness. Statement 142 provides
specific guidance for testing goodwill for impairment. Goodwill
will be tested for impairment at least annually using a two-
step process that begins with an estimation of the fair value
of a reporting unit. The first step is a screen for potential
impairment, and the second step measures the amount of
impairment, if any. However, if certain criteria are met, the
requirement to test goodwill for impairment annually can be
satisfied without a remeasurement of the fair value of a
reporting unit.
In addition, Statement 142 provides specific guidance on
testing intangible assets that will not be amortized for
impairment and thus removes those intangible assets from the
scope of other impairment guidance. Intangible assets that are
not amortized will be tested for impairment at least annually
by comparing the fair value of those assets with their recorded
amounts.
Statement 142 requires disclosure of information about
goodwill and other intangible assets in the years subsequent to
their acquisition that was not previously required. Required
disclosures include information about the changes in the
carrying amount of goodwill from period to period (in the
aggregate and by reportable segment), the carrying amount of
intangible assets by major intangible asset class for those
assets subject to amortization and for those not subject to
amortization, and the estimated intangible asset amortization
expense for the next five years.
HOW WILL STATEMENTS 141 AND 142 IMPROVE FINANCIAL REPORTING?
The changes to accounting for business combinations required by
Statements 141 and 142 will significantly improve financial reporting
for the benefit of the public--investors, creditors, and other
consumers of financial statements--as well as companies that prepare
and audit those reports. More specifically, application of Statements
141 and 142 will result in financial statements that:
Better reflect the investment made in an acquired entity--the
purchase method records a business combination based on the
values exchanged, thus, consumers are provided information
about the total purchase price paid to acquire another company,
which allows for more meaningful evaluation of the subsequent
performance of that investment. Similar information is not
provided when the pooling method is used.
Improve the comparability of reported financial information--
all business combinations are accounted for using a single
method, thus, consumers are able to compare the financial
results of companies that engage in business combinations on an
apples-to-apples basis. That is because the assets acquired and
liabilities assumed in all business combinations are recognized
and measured in the same way regardless of the nature of the
consideration exchanged for them.
Provide more complete financial information--the explicit
criteria for recognition of intangible assets apart from
goodwill, the required nonamortization and impairment testing
for goodwill and certain intangible assets, and the expanded
disclosure requirements provide consumers with more information
about the assets acquired in business combinations. That
additional information should, among other things, provide
consumers with a better understanding of the resources acquired
and the expectations about and changes in those resources over
time, and improve their ability to assess future profitability
and cash flows.
Reduce certain transaction costs--requiring the purchase
method of accounting for all business combinations reduces the
costs incurred by companies in positioning themselves to meet
the criteria for using the pooling method, such as the monetary
and nonmonetary costs of taking actions they might not
otherwise have taken or refraining from actions they might
otherwise have taken.
WHEN DO COMPANIES HAVE TO BEGIN FOLLOWING THE REQUIREMENTS OF
STATEMENTS 141 AND 142?
The provisions of Statement 141 apply to all business combinations
initiated after June 30, 2001. Statement 141 also applies to all
business combinations accounted for using the purchase method for which
the date of acquisition is July 1, 2001, or later.
Statement 141 does not apply, however, to combinations of two or
more not-for-profit organizations, the acquisition of a for-profit
company by a not-for-profit organization, and combinations of two or
more mutual enterprises. All of those combinations are being considered
in a separate Board project.
The provisions of Statement 142 are required to be applied starting
with fiscal years beginning after December 15, 2001. Early adoption is
permitted for companies with fiscal years beginning after March 15,
2001, provided that the first interim financial statements have not
previously been issued. Statement 142 is required to be applied at the
beginning of a company's fiscal year and to be applied to all goodwill
and other intangible assets recorded in its financial statements at
that date.
There is one exception to the date at which Statement 142 becomes
effective: Goodwill and intangible assets acquired by companies after
June 30, 2001, will be subject immediately to the nonamortization and
amortization provisions of Statement 142.
WHAT IS THE FASB'S INVOLVEMENT IN INTERNATIONAL ACCOUNTING STANDARD
SETTING?
Among the significant developments affecting the FASB over the past
several years has been the increased attention to the globalization of
the financial markets. This has placed heightened interest and emphasis
on the quality of international accounting standards and the process
for developing those standards. In order for companies from around the
globe to share equal access to the capital markets, financial reporting
must provide greater comparability and credibility. These issues have
underscored the need for a single set of high-quality accounting
standards.
In 1999, the FASB and our parent entity the Financial Accounting
Foundation (``FAF'') published a report, International Accounting
Standard Setting: A Vision for the Future (the ``FAF-FASB Vision'')
(Attachment 14). The FAF-FASB Vision identified the establishment of a
high quality global standard-setting structure as essential to the
future success of a truly international financial reporting system in
which a single set of accounting standards could be used world-wide.
Without such a structure, the continued independent processes of the
various national and international standard setters would only result
in increasing divergences among national financial reporting regimes
and between national and international accounting standards. That would
increase the difficulties of meeting market demands for international
comparability. Continued differences would augment the risks and
uncertainties surrounding cross-border investment opportunities and
would raise questions about the relative quality of one set of
standards compared to another.
In its vision, the FASB identified the restructuring of the
existing London-based international accounting standard setter, the
IASC, as one way in which a quality global standard setter might be
established. The IASC had begun the process of reorganizing itself to
create a new global standard-setting structure in 1997. It appointed a
Strategy Working Party (``SWP'') to develop the IASC's strategy and
structure. That SWP included a FASB member and an FAF trustee. In
November 1999, the SWP published a report, Recommendations on Shaping
IASC for the Future, which was unanimously supported by the IASC board.
The recommendations describe a private sector structure with many of
the characteristics of the existing FAF-FASB structure and in many ways
consistent with the ideal structure described in the FAF-FASB Vision.
In December 1999, the IASC began implementing the SWP's
recommendations. In May 2000, the IASC established a group of trustees
responsible for overseeing a new standard-setting body, named the
International Accounting Standards Board (``IASB''). In January 2001,
the IASC trustees selected the initial members of the IASB. Two members
of the IASC trustees are or were members of the FAF trustees, and two
members of the IASB are former members of the FASB. One of those
members will be responsible for maintaining liaison between the FASB
and the IASB.
While the FASB's primary focus has always been and will continue to
be on US accounting standards, it has for many years been an important
contributor to the convergence of international accounting standards.
The business combinations project resulting in the issuance of
Statements 141 and 142 is the most recent example of our continued
support of that effort. The Accounting Standards Board (``AcSB'') of
the Canadian Institute of Chartered Accountants has been conducting a
project on business combinations concurrently with the FASB project
with the goal of converging North American accounting standards related
to business combinations. The AcSB will soon issue final standards that
prohibit the use of the pooling method and are similar in most other
material respects with Statements 141 and 142.
During the past year, the FASB also continued to support the
convergence effort through our participation in the G4+1. Carrying on
its mission of encouraging dialogue and collaboration among
participating nations, the G4+1 published two reports last year. The
first was on a new approach to lease accounting and the second focused
on share-based payments. Following the recent formation of the IASB,
the G4+1 disbanded in anticipation that much of its past work will be
addressed in the future through the IASB.
Yet another example of FASB participation in the global accounting
arena over the past year was the December 2000 publication of a Special
Report on the fair value of financial instruments. The Special Report
was published in collaboration with several national standard setters
from around the globe and the IASC that were brought together through a
Joint Working Group of standard setters. The Special Report recommends
far-reaching changes to accounting practices for financial instruments
and similar items, including measurement of virtually all financial
instruments at fair value and the elimination of special accounting for
instruments used in hedging relationships.
As the FASB participates in the critical task of developing sound
and consistent global standards, we look forward to a close,
constructive and active relationship with the IASB and other national
standard setters in achieving convergence of high quality financial
reporting standards around the world. We are particularly pleased that
two former FASB members are members of the IASB. (Attachment 15 is an
interview with the two former FASB members discussing their
perspectives on the IASB). We plan on continuing to work in partnership
with the IASB and contributing to projects that are international in
scope and have important implications for our US constituents.
In closing, I believe the improved transparency that will result
from Statements 141 and 142, and the thorough and open due process that
the Board followed in developing those Statements, illustrates the
benefits and the strengths of independent private sector accounting
standard setting. Those benefits and strengths will well serve the FASB
and the IASB as we work in partnership to develop sound and consistent
global standards for the world's capital markets. For over 28 years the
FASB has proven, and will continue to prove, invaluable to the
efficiency of the capital markets and to the continued confidence of
investors--the consumers of financial information.
Thank you, Mr. Chairman. I very much appreciate this opportunity
and would be pleased to respond to any questions.
[Additional materal submitted is retained in subcommittee files:]
Mr. Stearns. Thank you, Mr. Jenkins.
Mr. Leisenring?
STATEMENT OF JAMES J. LEISENRING
Mr. Leisenring. Good morning, Mr. Chairman.
Mr. Stearns. Good morning.
Mr. Leisenring. And members of the subcommittee.
My name is Jim Leisenring and I am a member of the
International Accounting Standards Board, IASB. My specific
responsibilities with the IASB includes serving as that board's
liaison board member for the Financial Accounting Standards
Board, or FASB.
I have submitted to you information concerning the
organizational structure of the IASB, together with a list of
trustees of the foundation and the membership of the IASB
advisory group's Standards Advisory Council. I would
respectfully request that those materials be submitted to the
subcommittee that I submitted to be part of the official
hearing.
Mr. Stearns. By unanimous consent, so ordered.
Mr. Leisenring. Thank you.
And you will note, in looking at those materials, that the
structure and the board's required due processes are very
similar to those required by the FASB, though they are not
identical.
As you are probably aware, the IASB has been in the process
of getting organized, primarily focusing on attracting a
technical staff and analyzing potential agenda projects. Our
staffing is essentially complete, and over the next few weeks
those who have agreed to work for the IASB will become
available to begin the staff work on the initial agenda
projects.
Efforts of the IASB are expected to be in cooperation with
various domestic standard setting organizations including, of
course, the FASB. The FASB has been very generous in sharing
their expertise and particularly helpful to the IASB. These
efforts are widely recognized around the world, and I believe
very much appreciated.
The cooperation between the IASB and the FASB should be
expected because we have a shared objective: the creation of a
single set of accounting standards suitable or useful
domestically and internationally.
While each board must reach their own conclusion on the
issues addressed, with appropriate procedures in place it is
anticipated we will be able to substantially converge
accounting standards. I must emphasize a point that Mr. Jenkins
made, however, the convergence must not be accomplished by the
search for the lowest common denominator, but rather a search
for superior standards. As a result, financial reporting would
improve internationally and in domestic jurisdictions as well.
I thank you for your interest in the IASB and in inviting
me to this hearing. I am confident the IASB will also, in time,
earn the high esteem in which you hold the FASB. I look forward
to responding to your questions.
[The prepared statement of James J. Leisenring follows:]
Prepared Statement of James J. Leisenring, Member of the Board,
International Accounting Standards Board
Mr. Chairman, Members of the Subcommittee, I am James J.
Leisenring, a Member of the Board of the International Accounting
Standards Board (``IASB'') and the IASB's liaison to the Financial
Accounting Standards Board.
I have a brief oral statement, and I would respectfully request
that my (attached) supporting materials submitted to the Subcommittee
be made a part of the official hearing record.
Thank you, Mr. Chairman. I would be happy to respond to any
questions.
Mr. Stearns. I thank the gentlemen.
Mr. Rogstad, your opening statement?
STATEMENT OF BARRY K. ROGSTAD
Mr. Rogstad. Thank you, Mr. Chairman, members of the
subcommittee.
I am Barry Rogstad, president of the American Business
Conference. ABC is a nonpartisan coalition of mid-size chief
executives of a fast-growing companies. And before coming to
ABC, I served as chief economist and managing partner of
strategic international consulting services for Coopers &
Lybrand.
I congratulate the subcommittee for holding this hearing.
Oversight of the FASB is a wholly legitimate responsibility to
the Congress. Congress created the SEC and charged the
commission with the setting of accounting standards. The SEC in
turn endowed the FASB with operational responsibilities for
setting those standards. Thus there is a chain of
accountability emanating from Congress through the SEC to the
FASB. I find the critics of congressional oversight of the FASB
forget this important fact and I think it needs to be stated.
I think, to be sure, past Congresses have not always
exercised the oversight authority with much vigor. That is
because the FASB typically has acted in ways that have not
carried much political urgency. That has changed. Looking
ahead, I think it is safe to say that the subcommittee can
anticipate exercising its oversight authority with ever greater
diligence as more and more Americans invest in the equities
markets and as the changing nature of the international economy
forces the FASB to address highly controversial issues such as
stock options accounting under the rubric of international
accounting harmonization.
Now for the purposes of today's hearing, I was asked to
focus my testimony to an evaluation of the effectiveness of the
FASB process with respect to the recently concluded business
combinations and intangible assets project.
The members of the American Business Conference have a
long-standing interest in the health and stability of the
Nation's capital market. Central to their successful
performance is the private sector standard-setting process of
which the FASB is the central custodian. This process has
served our Nation well, and the focus of all participants in
the capital market should be on its continued viability.
The ABC has had significant involvement with the FASB on
numerous issues. Since Mr. Ed Jenkins became FASB chairman, we
have sustained a dialog on the broader FASB agenda as well as
the business combination project. It is from all of these
discussions that I draw my testimony this morning.
The stated mission of the FASB, as Mr. Jenkins has just
said, is to establish and improve standards of financial
accounting and reporting for the guidance in education of the
public, including issuers, auditors and users of financial
information.
This challenging task is made more daunting by the
increased emphasis in our economy on intangible assets and the
acknowledged inadequacy of the traditional historical cost
accounting model to capture today's business and economic
reality.
There is also one other important change impacting the FASB
process. With 50 percent of households now equity owners in
American businesses, Main Street and Wall Street have become
closely aligned. This growing constituency of users of
financial statements understands the significance of accounting
standards on the performance of financial markets. This has
important ramifications for the FASB and the Congress.
Confronted with this reality, FASB will find it increasingly
difficult to separate its deliberations from any public policy
considerations. The Congress, for its part, will face increased
pressure to intervene and move beyond its traditional oversight
role.
Strengthening the FASB process is essential, from my
perspective, if for no other reason than to ensure these two
external forces are properly addressed. My view of the role of
FASB is one of consensus-builder across the users of financial
statements. The board has a responsibility to put forward a
proposed standard and the reasons underlying the required
changes. It then seeks views of interested party and uses these
views to evolve a position that represents the best possible
technical accounting and business judgment. Achieving the
broadest possible consensus across the dominant viewpoints is
essential to the ultimate acceptance and utility of the
finalized standards.
The FASB process, as it applied to the business
combinations project, in my judgment, did not perform well. We
wrote a number of memorandums on these observations during the
conduct of the project throughout the process. In our judgment,
FASB reached interim conclusions that to the objective reader
of the record could not be justified. Lack of transparency in
the process generated significant frustrations among user
groups; in particular, many of us in the business community.
Given our perception of FASB's intransigence, I am talking
about the middle of this project now, we reluctantly initiated
discussions with Members of Congress responsible for
congressional oversight of the FASB. This action led to a
letter of concern from 10 members of the Senate and the
introduction of legislation in the House calling for a
moratorium on the FASB project.
It is important to emphasize to this committee the degree
of discomfort that I personally felt about involving the
Congress in this issue. We felt the FASB process had broken
down and the only recourse was through a congressional
oversight function. The acknowledged danger of our action was
the potential for congressional involvement in the standard-
setting process itself.
Faced with these circumstances, it was important for the
FASB to reconsider its position. To its credit, it initiated
steps designed to achieve what I referred to throughout the
process as a win-win outcome; a win for the FASB meant a
standard that conforms to sound technical accounting basis and
addressed the requirements of all users of financial
statements, a win for users in general and the business
community in particular meant a standard that correctly
portrayed business in economic reality and facilitated
efficient and effective reporting.
FASB did reconsider its position. It now appears the
results of the project have achieved the desirable win-win
results. Much of the credit goes to Chairman Jenkins for his
management skills and willingness to reconsider positions
already taken.
FASB's response focused on consideration of a major change
to purchase accounting methodology: the substitution of an
impairment approach to goodwill in place of required use of
fixed appreciation schedules. This was a major breakthrough
and, because it was controversial, required courage on the part
of the FASB.
I was privileged to be part of the team that met with FASB
last September to discuss the proposed impairment test that
would apply to goodwill. The FASB expanded this proposal and
discussed it with users through interviews and provided another
opportunity for user input during the comment period last May.
This impairment approach to accounting for purchased
goodwill is a major part of the final standard recently
published by the FASB. It represents a technically correct and
workable approach to the challenge of how to account for
business combinations. FASB is to be congratulated for this
breakthrough.
Did the FASB process, as used in the business combinations
project, produce a good result? Yes.
Did this experience demonstrate a profound need to
strengthen the FASB process itself to ensure successful
outcomes in the future? Yes.
And I say that in the sense that I think the process needs
to work more routinely. By that I mean it should always rely on
extra outside pressure, either from the business community or
the Congress. And most importantly a routine process should not
require the extraordinary leadership of the chairman.
My major recommendations to the FASB would be to focus on
consensus building across user groups. FASB, to its credit, has
been attempting to involve users much earlier in the process.
This emphasis needs to be continued. Of prime significance,
however, is the need for the FASB to document its decision
process, showing, in particular, how it balanced technical
considerations in the views of interveners in reaching its
positions. This process, I believe, requires greater
transparency and the sustaining of a dialog until the necessary
consensus is achieved. It was the failure on this issue that
led to the breakdown of the process during the business
combinations project.
It is clear to this observer that FASB does have the
capacity to develop among the users the financial statements
generally accepted standards on highly controversial subjects.
Based on our experience with the business combinations project,
it is also clear that the FASB process needs to be
significantly improved. Absent this, in my judgment, FASB will
not have sufficient support to always succeed in the long-term.
The stakes are very high and we in the ABC look forward to
working with the FASB to ensure that its process continues to
produce win-win outcomes in the future.
Thank you, Mr. Chairman.
[The prepared statement of Barry K. Rogstad follows:]
Prepared Statement of Barry K. Rogstad, President, American Business
Conference
Mr. Chairman and Members of the Committee.
I am Barry Rogstad, president of the American Business Conference
(ABC). ABC is a nonpartisan coalition of chief executives of fast-
growing, mid-size companies. Before coming to ABC, I served as chief
economist and Managing Partner for International Consulting at Coopers
& Lybrand.
I congratulate the Subcommittee for holding this hearing. Oversight
of the Financial Accounting Standards Board (FASB) is a wholly
legitimate responsibility of Congress. Congress created the Securities
and Exchange Commission and charged the Commission with the setting of
accounting standards. The SEC, in turn, endowed the FASB with
operational responsibility for setting those standards. Thus, there is
a chain of accountability emanating from Congress, through the SEC, to
the FASB. Critics of Congressional oversight of the FASB forget this
important fact.
To be sure, past Congresses have not always exercised the oversight
authority with much vigor. That is because the FASB typically has acted
in ways that have not carried much political urgency. That has changed.
Looking ahead, I think it is safe to say that this Subcommittee can
anticipate exercising its oversight authority with ever greater
diligence, as more and more Americans invest in the equities markets
and as the changing nature of the international economy forces the FASB
to address highly controversial issues - such as stock options
accounting - under the rubric of international accounting
harmonization.
For the purposes of today's hearing, I have been asked to confine
my testimony to an evaluation of the effectiveness of the FASB process
with respect to the recently concluded project on Business Combinations
and Intangible Assets.
The members of ABC have a long-standing interest in the health and
stability of the Nation's capital markets. Central to their successful
performance is the private sector standard setting process, of which
the FASB is the central custodian. This process has served our nation
well, and the focus of all participants in the capital markets should
be on its continued viability.
The ABC has had significant involvement with the FASB on numerous
issues. Since Mr. Ed Jenkins became FASB Chairman, we have sustained a
dialogue on the broader FASB agenda as well as the business combination
project. These discussions, together with our significant participation
in the business combination project form the basis of the remainder of
my testimony.
This testimony constitutes my personal views, since time does not
permit its formal approval by ABC management. However, I do believe it
incorporates the views of the members of the ABC.
The stated mission of the Financial Accounting Standards Board is
to establish and improve standards of financial accounting and
reporting for the guidance and education of the public, including
issuers, auditors, and users of financial information. This challenging
task is made more daunting by the increased emphasis in our economy on
intangible assets, and the acknowledged inadequacy of the traditional
historical cost accounting model to capture today's business and
economic reality.
There is also one other important change impacting the FASB
process. With fifty percent of households now equity owners in American
businesses, Main Street and Wall Street have become closely aligned.
This growing constituency of users of financial statements understands
the significance of accounting standards on the performance of
financial markets.
This has important ramifications for the FASB and for the Congress.
Confronted with this reality, FASB will find it increasingly difficult
to separate its deliberations from any public policy considerations.
The Congress will face increased pressure to intervene, and move beyond
its traditional oversight role. Strengthening the FASB process is
essential if for no other reason than to insure these two external
forces are properly addressed.
My view of the role of FASB is one of consensus builder across the
users of financial statements. The Board has a responsibility to put
forward a proposed standard and the reasons underlying the required
changes. It then seeks views of interested parties, and uses these
views to evolve a position that represents the best possible technical
accounting and business judgment. Achieving the broadest possible
consensus across the dominant viewpoints is essential to the ultimate
acceptance and utility of the finalized standards.
The FASB process as it applied to the Business Combinations Project
did not perform well. FASB reached interim conclusions that to the
objective reader of the record could not be justified. Lack of
transparency in the process generated significant frustrations among
user groups, in particular many of us in the business community. Given
our perception of FASB intransigence, we reluctantly initiated
discussions with members of Congress responsible for Congressional
oversight of the FASB. This action led to a letter of concern from ten
members of the Senate, and the introduction of legislation in the House
calling for a moratorium on the FASB project.
It is important to emphasize to this committee the degree of
discomfort I felt about involving the Congress in this issue. The
members of ABC as well as my Washington colleagues who were involved in
the effort shared that concern. We felt the FASB process had broken
down and the only recourse was to the Congressional oversight function.
The acknowledged danger of our action was the potential for
Congressional involvement in the standard setting process itself.
Faced with these circumstances, it was important for the FASB to
reconsider its position. It initiated steps designed to achieve what I
referred to throughout the process as a win-win outcome. A win for the
FASB meant a standard that conformed to sound technical accounting
basis and addressed the requirements of all users of financial
statements. A win for users in general, and the business community in
particular, meant a standard that correctly portrayed business and
economic reality and facilitated efficient and effective reporting.
FASB did reconsider its position. It now appears the results of the
project have achieved this desirable win-win result. Much of the credit
goes to Chairman Jenkins for his management skills and willingness to
reconsider positions already taken.
It was always clear to this observer that FASB wanted to eliminate
the pooling of interests approach to accounting for business
combinations. If the FASB were to place sole reliance on the purchase
accounting option, then it had to be sure that the methodology
addressed all of the key technical and operational issues. Merely to
list the issues involved indicates the importance of the discussion:
goodwill amortization, valuation of intangibles, separation of
identifiable intangible assets from goodwill, and the associated
effects on reported earnings.
FASB 's response focused on consideration of a major change to
purchase accounting methodology: the substitution of an impairment
approach to goodwill in place of required use of fixed depreciation
schedules. This was a major breakthrough and, because it was
controversial, required courage on the part of the FASB. I was
privileged to be part of a team that met with FASB last September to
discuss a proposed impairment test that would apply to goodwill. The
FASB expanded this proposal, and discussed it with users through
interviews and another opportunity for user input during a comment
period in March of this year. ABC together with two of its members,
NASDAQ and Grant Thornton, conducted a survey of businesses to provide
FASB with as many views as possible.
This impairment approach to accounting for purchased goodwill is a
major part of the final standard recently published by the FASB. It
represents a technically correct and workable approach to the challenge
of how to account for business combinations. FASB is to be
congratulated for this breakthrough.
Did the FASB process as used in the business combinations project
produce a good result? Yes. Did this experience demonstrate a profound
need to strengthen the FASB process to insure successful outcomes in
the future? Yes.
My major recommendation to the FASB would be to focus on consensus
building across user groups. FASB, to its credit, has been attempting
to involve users much earlier in the process. This emphasis needs to be
continued. Of prime significance, however, is the need for the FASB to
document its decision process showing in particular, how it balanced
technical considerations and the views of interveners in reaching its
positions. This process, I believe, requires greater transparency and
the sustaining of a dialogue until the necessary consensus is achieved.
It was a failure on this issue that led to the breakdown of the process
during the business combination project.
It is clear to this observer that the FASB does have the capacity
to develop among the users of financial statements generally accepted
standards on highly controversial subjects. Based on our experience
with the business combinations project it is also clear that the FASB
process needs to be significantly improved. Absent this, FASB will not
have sufficient support to succeed in the long term.
The stakes are very high. We in the ABC look forward to working
with the FASB to insure that its process continues to produce win-win
outcomes in the future.
Thank you. I would be pleased to answer any questions.
Mr. Stearns. I thank you. I will be first with my
questions.
Probably the world will little note nor long remember what
we say here this morning. With the exception of a few, maybe
Ms. Harman, most of us do not have the corporate experience to
understand the accounting process. But there has been a lot in
the newspapers and most of us have invested in stocks and we
rely generally on these accounting procedures and when we talk
to the stockbroker, we assume that he is working off the same
set of books as other corporations are, so you can compare. But
lo and behold, we find out that has not been true and that is
why FASB issued its June 27 and July 20, the report came out on
dealing with the standards 141 and 142.
Not getting too arcane or esoteric here, I say to my
colleagues, this hearing is important because we are trying to
say, as Mr. Rogstad has said, 50 percent of Americans are now
invested in equities. They are talking to their brokers and
their broker has to know if these standards from company to
company are meaningful.
So, Mr. Jenkins, the first question is, this is a little
past history, a prologue: A company buys another company under
the pooling standards and the expense for this company
evaporates and they continue to build and the expense to buy
evaporates. And so the investor says, ``Gee whiz, that
company's making money hand over fist.'' But none of the
expenses are showing. So you stepped in and have these new
standards 141 and 142.
So my question to you: Tell me today how it is going to
differ for company A and B: A buys B and let's say B costs $10
billion; what happened in the old days and what is going to
happen? Is this too new? I know it is too new, but give me some
comfort on what is going to happen in the new day where this
purchase of $10 billion is going to show up so that the
investor and the broker will say, ``Oh, yeah, there is some
expense for purchasing this company.''
Mr. Jenkins. Thank you, Mr. Chairman, I will be happy to
try to respond to that.
Mr. Stearns. Very, you know, you have to make it very
layman oriented.
Mr. Jenkins. The key is the investment that one company
makes in another when they acquire it.
Mr. Stearns. Right.
Mr. Jenkins. In your example company A acquires company B
and company A used $10 billion worth of consideration to buy
company B.
Mr. Stearns. Right.
Mr. Jenkins. Under the old pooling of interest method, the
company that was bought would not be recorded as an investment
at $10 million, it would be recorded at whatever company B had
shown on its books.
Mr. Stearns. What its book value was.
Mr. Jenkins. What its book value was. And let's say it was
$500 million.
Mr. Stearns. Right.
Mr. Jenkins. If we have an example that was like that.
Mr. Stearns. So the rest would be goodwill.
Mr. Jenkins. The rest would not be even goodwill in the
pool.
Mr. Stearns. Nothing.
Mr. Jenkins. It would be nothing.
Mr. Stearns. Let's see, $10 billion, now you are down to
$500 million.
Mr. Jenkins. That is about a difference of----
Mr. Stearns. So you show the expense of $500 million.
Mr. Jenkins. You would have $500 million on the company's
books and $9.5 billion would just, kind of, disappear.
Mr. Stearns. Where would it go? Would it show anywhere?
Mr. Jenkins. Does not get recorded at all under the pooling
of interest method. Does not get recorded at all.
Mr. Stearns. So corporation America has this enormous
expansion acquisition program and, lo and behold, maybe 0.5
percent or 1 percent or, you know, very little of it shows up
and each company keeps rolling on.
Mr. Jenkins. Yes. The problem is that then this company,
the earnings of company B look pretty good when measured
against $500 million, but they might not look quite so good if
they were measured against $10 billion.
Mr. Stearns. $10 billion.
Mr. Jenkins. $10 billion.
Mr. Stearns. Right.
Mr. Jenkins. So what our new standard does is it does away
with this pooling of interest methodology. It says every
business combination, every acquisition, regardless of the form
of consideration used to acquire it, whether it is stock or
cash or debt or whatever, needs to be recorded at the full
value of the consideration paid.
Mr. Stearns. Okay. So if A buys B for $10 billion, then it
has to show the entire $10 billion as expense.
Mr. Jenkins. Right, and that is where the transparency
comes in. That is the transparency we have been looking for;
what did you actually put out in consideration for this
company? Well, let's reflect this on the financial statements
and then subsequent performance can be measured against the
totality of that investment rather than some other number.
Mr. Stearns. Has this procedure of pooling gone back to
John D. Rockefeller? Has he been doing it? Did he do it, too?
Mr. Jenkins. No, he did some other things, I think, that
maybe we do not need to get into today.
Mr. Stearns. Right.
Mr. Jenkins. I do not think he used pooling of interest
accounting.
Mr. Stearns. How long has pooling been going on?
Mr. Jenkins. Well, for a long time.
Mr. Stearns. Ten years? Twenty years?
Mr. Jenkins. No, no. No, no much longer. The standard that
we just replaced.
Mr. Stearns. A hundred years.
Mr. Jenkins. It has been in existence since 1970.
Mr. Stearns. Okay.
Mr. Jenkins. And it was designed to, the project was
designed to approve abuses in pooling of interest accounting
that existed at that date.
Mr. Stearns. And so, Ernst and Young and Pricewaterhouse,
all of them accept pooling as a standard procedure; that this
huge $10 billion is an advantage, and they all accepted that as
a-okay?
Mr. Jenkins. Well, in their defense, that was the standard
and that was required. In fact, if you met certain standards--
--
Mr. Stearns. But would not these accounting firms have some
kind of feeling, like, ``Gee whiz, we just evaporated $9.5
billion''? Would not they come to you and say, ``Gee whiz, this
is not right''? 1971, I mean, why did it take so long?
Mr. Jenkins. Well, it took a long time because it was a
very controversial subject. Many companies liked the idea of
recording the $500 million instead of the $10 billion.
Mr. Stearns. Okay.
Now, let's go to a new problem. It appears, based upon
newspaper reports, that corporations are involved with what is
called a pro forma approach to accounting; that is, basically,
that they are going to provide earnings based upon pro forma
and that will show, in some cases, a corporation has a profit.
But, lo and behold, when they give the SEC their P&L statement,
it shows a loss.
But the pro forma will come out, sometimes it might be
printed at the same time, but it will come out 2 or 3 months
later. Well, meanwhile, all the stockbrokers look at this
profit from company A and say, ``Gee whiz, it is making
money,'' so the stock goes up. Whereas a lot of the people who
are in the know realize we just had a $250 million or a $1
billion loss.
So how did that happen? And is it, in the same sense, that
this has just been generally accepted accounting procedures? Or
why do not you just take me through that scenario?
Mr. Jenkins. This phenomenon of so-called pro forma
earnings is relatively recent. I would say in the last 6 years
it has begun.
Mr. Stearns. Maybe since the dot-com type stuff.
Mr. Jenkins. Yes, and earlier that was certain, kind of,
corporate restructuring charges and so on.
The first thing I would like to say is that the
presentation of pro forma information, the type your talking
about, is not permitted under our standards within the context
of financial statements.
Mr. Stearns. So there are no standards for pro forma
reporting in America?
Mr. Jenkins. That is correct, Mr. Chairman.
Mr. Stearns. Okay. So every corporation can make up their
own standards and issue their own report.
Mr. Jenkins. They can.
Mr. Stearns. Okay.
Mr. Jenkins. And what I think is important is that the
earnings and the earnings per share information that comes from
generally accepted accounting principles, from our financial
reporting standards, is the benchmark.
Mr. Stearns. Right. That is what the SEC wants to see.
Mr. Jenkins. Right. And that is what shown in this 10-Q.
Mr. Stearns. When you do a pro forma, does not Ernst and
Young and Pricewaterhouse, do they have they have their name on
it at all?
Mr. Jenkins. No.
Mr. Stearns. No. So no one backs up the information except
the corporation.
Mr. Jenkins. That is correct.
Mr. Stearns. Okay.
Mr. Jenkins. And I believe and I think this gets to a
similar point that you made in your opening remarks, but I
believe that because GAAP reporting is the benchmark, that when
pro forma information is presented, that the GAAP information
needs to be presented at the same time.
Mr. Stearns. Simultaneously. So that is your
recommendation?
Mr. Jenkins. Yes. So that the difference between the pro
forma earnings and the GAAP, the general accepted earnings, are
available to all investors or all customers in financial
information.
Mr. Stearns. Well, do you think the average investor or
broker is aware that the pro forma report he gets is really
something that the corporations make up with no standard
accounting procedures? Do you think, I mean, do we need to
educate Americans to point out that when you have corporation A
say, ``We had a profit,'' that is all based upon their own
standards, whereas accepted standards show they had loss, a
huge loss? I mean, do we need to get that out or is it known by
investors?
Mr. Jenkins. I cannot really speak for all investors, but I
think that the idea that I just suggested, and I think it is
consistent with yours, of showing this information at the same
time.
Mr. Stearns. At the same time, okay.
Mr. Jenkins. Or at least disclosing the information at the
same time in the same place, is, in of itself, an educational
process.
Mr. Stearns. We will probably have a second round. We do
not have a lot of members.
What role does the SEC have in the pro forma report? Any?
Mr. Jenkins. The SEC could exercise jurisdiction over, as I
understand it, over any type of information that is presented.
Mr. Stearns. But they do not. They have done no
jurisdiction.
Mr. Jenkins. What they have said, to the best of my
understanding, is that when you present pro forma information,
you should describe how you have computed it.
Mr. Stearns. Okay. Just quickly, any one of you gentlemen
would like to comment on the conversation Mr. Jenkins and I
have had, maybe just anything you wish to add?
Mr. Leisenring. I would add that internationally the
problem seems to be increasing. The notion of pro forma
earnings seems to be something that America can export. It is
probably going to cause the same confusion elsewhere that you
are concerned about here. But I think you have to look very
closely at what is attempting to be accomplished.
People are trying to suggest that they want to be measured
by a different paradigm than a pool basis accounting earnings
under generally accepted accounting principles. There may be
some justification for that concern, which is why FASB and
others are looking at alternative measures of performance for
disclosure and things that might be useful to investors and
potential investors.
But the benchmark has and remains to be earnings and I
think, increasingly, at least informed investors and their
agents, are fairly aware that some of these other presentations
are, sort of, earnings before undesirable items or some other
paradigm such as that. And, historically, a good many people
interested in promulgating that sort of measure have been
people that would not have had earnings, as you suggested,
under the traditional approach.
But I think we cannot just dismiss it as only shenanigans
and look at the deeper cause of the fact that there are some
problems.
Mr. Stearns. I am not even saying, I am just trying to
understand.
Mr. Leisenring. No, I understand.
Mr. Stearns. I am not saying it is shenanigans, and I am
just saying that there might be a legitimate reason for a pro
forma. But I say it is confusing and I think that we need some
kind of standard so that we can compare what it means.
Mr. Leisenring. And that is why the FASB, I think, has put
a lot of effort over the last few years into attempting to
explore those alternative measures.
Mr. Stearns. Do you have anything, Mr. Rogstad?
Mr. Rogstad. I would just add to everything that has just
been said two things: No. 1, I think that what users are
looking for is to try to figure out what are the earnings from
operations of a business. What business are you in?
Mr. Stearns. What is your turn on investment?
Mr. Rogstad. What are the earnings on that business?
There are two other things that influence that that FASB's
very much engaged in how you report to it. No. 1 is this whole
relationship between the income statement and the balance
sheet, which is what intangible assets and this amortization
versus impairment test is all about. And second, there is the
question, a lot of companies today are reporting positive
earnings, the vast majority of which is coming from their
investments in other companies as opposed from their own
operations. It is pretty important for an investor to delineate
those issues. So some of the pressures for pro forma reporting,
I think, come from that.
I think I would emphasize, however, it is much more
desirable for these issues to be dealt with within the FASB
framework. I think that is why the FASB framework, in its
continued development, is absolutely important.
Mr. Stearns. Do you think FASB should oversee this and come
up with standards for pro forma?
Mr. Rogstad. I think I do agree with that. I think the
notion that, in fact, any business can use its own discretion
as to the process in which it reports this, the final
requirement here is so that users can make comparability
decisions across an array of investments. If we have everybody
reporting on a different basis, I think that outcome is not
facilitated.
Mr. Stearns. I appreciate your candid comments.
Yes?
Mr. Jenkins. If I may comment, tomorrow at our public board
meeting we usually hold every Wednesday, we are going to
discuss the scope of two potential projects that bear on this
issue. One will be a potential project to look at how we might
improve disclosures with respect to intangible assets,
intangible assets particularly that are developed internally,
like that result from a company's own research and development
efforts.
We also are going to consider a separate project that would
relate to what I refer to as performance metrics that may not
be pro forma earnings in its entirety, but it is things that
get at the issue of a company's performance and what might be
expected in the future. It is things like quality of product,
time to market, backlog, other performance-related issues.
The FASB, as Mr. Leisenring just mentioned, has been
working on this area for some time. It really is an outgoing
effort of a committee that I chaired back in the early 1990's
that issued a report in 1994 called ``Business Reporting Model:
Focusing On The Information Needs Of Users.'' And the FASB has
earlier this year published this document. It is called
``Improving Business Reporting: Insights Into Enhancing
Voluntary Disclosures.'' It calls for more discipline, and yet
more voluntary disclosure of performance metrics to supplement
financial information.
We also have just issued in April this special report
called ``Business And Financial Reporting: Challenges From The
New Economy'' that really focuses on the challenges of
providing better information about intangibles.
So we are going to be considering the potential scope of
two projects in this area that would clearly bear on these
issues that you are raising this morning, Mr. Chairman.
Mr. Stearns. Thank you. My time has expired.
The gentleman from New York?
Mr. Towns. Thank you very much, Mr. Chairman.
Mr. Jenkins, I congratulate FASB for the successful
completion of its business combinations project. I believe that
your process was open and fair, and that the SEC and Congress
exercise appropriate oversight. The Finance Subcommittee, on
which I served as ranking member, held a hearing on this issue
last May.
While most of your constituents are happy with the end
results, some questions remains. Let me get to the question.
My question is, could you please explain how the impairment
tests will be implemented, and what safeguards have been put in
place to make sure that the tests cannot be gamed? Some critics
complain that the tests can be used to distort values.
Mr. Jenkins. I will be glad to respond to your question,
Congressman.
The impairment tests relies on determining the fair values
that are involved in the company's operation. The first step is
to decide where this goodwill that you have acquired resides
within the various operations of a company. Usually it will
reside in one or more operating segment of the company. The
FASB standards already require the disclosure of a significant
amount of information about segments, so the basic information
is already there and reported publicly, in most cases. In some
cases, it will be necessary to go to a level below that, but in
most cases we think the operating segment will be where this
goodwill resides.
There is an initial requirement to measure the fair value
of that, what we call reporting unit, at the time that an
acquisition is made. That serves as benchmark for subsequent
measurements. And the methodology that is used in that initial
fair value needs to be documented and retained by the company.
Subsequently, each year, at least each year, and in the
case where there are other indicators of, let's say, adverse
events, to summarize, the tests may need to be performed more
often than once a year. But each year the fair value of that
reporting unit and every reporting units that contains goodwill
needs to be determined and evaluated against the fair value of
the individual underlying assets, excluding the goodwill. To
the extent that the fair value of the reporting unit is less
than the fair value of the underlying assets and liabilities,
excluding goodwill, goodwill is impaired and must be written
down.
So it does require fair value determinations, which can be
subjective. And yet, there is a very sufficient methodology in
the marketplace today to determine fair value.
We went through an extensive due process in testing this
methodology. Mr. Rogstad has said in his statement, he
participated in a presentation to us on similar methodology,
one we developed from that presentation and others. We have
discussed this with many business corporations and entities in
the process of reaching our final conclusions. And we believe
we have an operational test for goodwill impairment.
Can it be gamed? Well, that depends in part on the
diligence and dedication of companies themselves and their
auditors.
We have many estimates that we use in accounting. Almost
everything in accounting is estimate.
Mr. Towns. I was doing fine up to that point.
Mr. Jenkins. So there is judgment involved in almost
everything, maybe even cash today is an estimate. I do not
know. But certainly everything else is the value of your
inventory. We have had a requirement in accounting for many,
many years that you can never carry an asset at more than what
it is worth. And while we do not adjust to that worth if it is
up, we have always had what we called impairment tests for
inventory. We have loss reserves for receivables. We have
impairment tests for buildings and equipment. And this is a
similar approach but actually a more rigorous and well-
documented approach than we, perhaps, have in other areas.
Mr. Towns. Is there anything Congress can do other than
pray?
Mr. Jenkins. Well, prayer is always in order, I believe.
But in addition, I think you can urge your constituents, as we
will urge ours, and basically our constituencies are the same,
I believe, to apply this standard in good faith, in an
objective way and with rigor.
Mr. Towns. Thank you very much.
Mr. Rogstad, let me ask you, it appears to be your
testimony that FASB should not act until the industry has
achieved consensus on an issue. Isn't this a recipe for
gridlock?
If Congress waited for the industry's consensus on issues
like energy, health, telecommunications, we would never
legislate a thing around here. We would just be sitting here,
twiddling our thumbs.
Isn't it more reasonable to ask FASB to exercise leadership
on accounting standards, while meeting with and listening to
its constituent groups and making the necessary revisions?
Otherwise, you will probably never achieve timely improvements
to accounting standards.
Mr. Rogstad. Congressman Towns, I think it is the level of
consensus that I am referring to here. Obviously, these are
areas of incredible complexity. The notion that all users are
going to ever agree on all aspects of this is not what I am
talking about here. And there is a degree of healthy regulatory
tension, part of which is always divides different views on
some of these subjects.
I do believe, however, and what I was trying to say in my
prepared statement was, that we did reach a point in this
process that FASB appeared to be heading in a direction that,
as I noted, a reading of the record, as it is stated in public
there at that point in time, was very difficult to say, ``How
did you arrive at a central tendency, never mind a very
detailed consensus, a just mainstream central tendency of where
this project was going?'' based on all the intervener
statements that had been made at that point in time.
I think how FASB got to the point that they were stating at
that juncture was not transparent. It is the consideration
process, to pick up on Mr. Jenkins' word, that I did not think
was transparent at that point, that caused everybody to reload
and take another look at this.
You do have to gradually converge toward a central tendency
here, which is what I mean by consensus. And I think FASB, in
the second half of this project, did that in a very, very
notable way.
But in the middle, to repeat, I thought there was not, on
the basis of major statements by whole classes of interveners
across accounting firms, across policy officials, across
businesses, across financial institutions, there was just
disparity all over the place, and very difficult to see that
central tendency. And I think you have to start there and move
a process forward based on that level of consensus. And I think
that it is a level of detail, sir, I think.
Mr. Towns. Mr. Chairman, I know my time has expired, but
could I just have a minute to ask Mr. Jenkins to respond to Mr.
Rogstad's claim that FASB's process is broken and needs to be
repaired?
Mr. Jenkins. I would be very happy, and I appreciate the
opportunity to do that.
I particularly object to Mr. Rogstad's claim that we were
intransigent at any point in this project. That simply, in my
judgment, is not the case.
There is no group that we met with more often or listened
to more careful than the American Business Conference. I cannot
right now tell you how many times during the course of this
project that I met with Mr. Rogstad and with his associates,
with his members. They came to the FASB on more than one
occasion and we listened carefully to them.
The routine of our process, that Mr. Rogstad suggests we
need to improve, contemplates change during the course of a
project. That is why we issue documents for exposure and
comment, so that we can hear and make changes accordingly. You
cannot find a final standard at the FASB that is exactly the
same, usually in some fairly significant way, from the exposure
draft or drafts.
We do make changes. That is evidence of the involvement and
the process of working together with all of our constituencies.
If we knew enough before we issued a document for exposure and
comment to be 100 percent confident that we had the right
answer, we would not bother with the exposure draft, not would
we bother with public hearings and the extensive process, nor
would we bother with educational measures. This is part of our
normal process, and we do listen and learn.
And on the basic issue of eliminating pooling of interest
accounting, the basic issue, we did receive strong support from
our constituencies at the exposure draft period of time. The
issue then turned to focus on this goodwill issue, which we
resolved as a result of continuing our full, open due process.
Thank you.
Mr. Towns. Mr. Chairman, allow me to request that the
material be part of the record, submitted and become a part of
the record. Mr. Jenkins indicated, in fact, that he had all
this information, material for the record, because of the fact
there were several meetings, several discussions, and we would
like to have this be part of the record.
Mr. Stearns. Mr. Jenkins, do you understand he is asking
that the references that you have alluded to, he would like to
make that part of the record, if that is possible?
Mr. Jenkins. With respect to the meetings with the American
Business Conference?
Mr. Towns. Yes, that is correct.
Mr. Jenkins. We would be glad to provide that information
to you, yes.
Mr. Stearns. Okay.
The gentleman's time has expired.
The gentleman from Illinois?
Mr. Shimkus. Thank you, Mr. Chairman. I am just going to
start and then I will go into my questions.
Mr. Rogstad, in your testimony you say, ``Did the FASB
process, as used in the business combinations project, produce
a good result?'' And you say, the answer, yes. And then you
also go on to say, ``It could be more improved.'' Much like
what we do here in Washington; it gets pretty messy in how we
eventually move something, but the ultimately objective is
whether you get a product that works. And I would suggest that,
even though this process got to a slow start, it was fairly
satisfactorily concluded by most of the major parties.
And I do have a question about the role of, actually a
caution of the role of how much you would encourage elected
officials to be actively intervening in rulemaking. You might
get what you wish, which is an active role by public
policymakers that spin on the whim of, sometimes on public
perception, where your profession is a, what we are talking
about is numbers and decimal points and stuff that do not have
to carry the whim of public emotion at the time. There is a
fine line, and I would just be cautious.
Let me go to the international arena. Part of this
subcommittee also has a trade jurisdiction. And, Mr. Leisenring
and Mr. Jenkins, first of all, is the EU attempting at all to
have some interplay in the financial accounting systems of the
EU members, and how does that reflect on what we are doing
here?
I am very cautious and skeptical of EU and how, because of
its merging, has created additional barriers to trade for us,
along with our allies in the EU. How does this play out in the
financial accounting market?
Mr. Leisenring. The EU has historically had a significant
involvement in financial reporting, within the countries within
Europe. They have had a series of directives and they are much
more law-driven toward their financial reporting than we have
been in the United States.
The EU, however, has seemed to embrace fairly
enthusiastically the notion of international accounting
standards. They have proposed legislation that has not passed
as yet, but proposed and is highly anticipated that it will,
that would require all European companies that are what we
would call public companies, the same as SEC registrants,
across Europe to comply with the international accounting
standards by the year 2005. That would seem to drop the
barriers and the differences across Europe and be a rather
fundamental breakthrough.
That is the good news side of it. There is a least a
cautionary side, and your skepticism, Congressman, I personally
find well taken. They have done that and made that endorsement,
but done it also by forming a committee that is going to look
at the product of the board that I serve on, International
Accounting Standards Board, to access the suitability of those
standards.
If, as they describe it, that committee's work is to
provide insight and input of the deliberative process,
participate in the due process, as we have been talking about
on the other project, I think it would be very constructive. If
it is intended to do something other than that, it raises the
warning flags that you are worried about.
I think we do not know how they will behave in that regard.
They are certainly going to get a significant amount of
pressure from the IASB, the FASB, the Accounting Standards
Board in Great Britain, the Canadians, the Australians, the
Germans, all of them are not or share the same concerns.
So, I do not think within the private sector that there is
an enthusiasm for this group, but it is a reality that we are
going to deal with, and hope that they are constructive part of
the process.
Mr. Shimkus. Mr. Jenkins, do you want to respond?
Mr. Jenkins. I would share Mr. Leisenring's comments there.
The thing I would add is that the deadline that they have
proposed to impose of 2005 in my judgment is premature,
particularly since it would require the adoption of
international accounting standards by companies within the
European community, even those companies that currently report
under U.S. generally accepted accounting standards.
Many of them do that as an efficient way of accessing our
capital market. They would then be required to revert to
international standards, and presumably reconcile the U.S.
standards, a costly exercise, and one that probably does not
provide full U.S. transparency.
Beyond that, while I think the structure is in place and
the process is there to develop strong, high-quality standards
going forward, my judgment, the totality of the existing
international standards are not the sufficient quality to be
used in U.S. reporting or as a substitute for U.S. financial
statements. And therefore I would be reluctant to endorse a
process that would require the use of IS at this point in time.
In order to adopt the standards by 2005, companies, in
effect, have to begin doing this in 2003 just to get the 3
years of required information recorded. We are not going to
have very many new international standards of high quality by
2003, just 2 years from now.
Mr. Leisenring. If I may, Congressman, I just agree with
Mr. Jenkins comment. So that you do not believe there is any
disagreement, I agree about his comment about the totality of
international standards, at the present time not suitable.
Mr. Shimkus. And I would just finish by saying, you know, I
am concerned that there is a higher, there may be a higher cost
of capital through the differing standards, and if ours are
more stringent, and that is the unlevel playing field that is
hard to figure out when we are talking about crunching of
numbers and evaluating portfolios versus actual trade.
With that, Mr. Chairman, I yield back my time.
Mr. Stearns. I thank the gentleman.
The gentlelady from California?
Ms. Eshoo. Thank you, Mr. Chairman.
I have several questions, and I also have some amendments
up at the Rules Committee, so I am sure you want this to move
quickly and I will move through the questions, and if you can
keep them as brief as possible, but obviously with some
answers.
I am curious about the IASB and how there will be a
harmonization with what we have.
And I think that some of the questions that members have
asked were directed in this area. Will they have the same open
and transparent procedures as FASB in setting their agenda and
formulating their rules and will they have the same due process
requirements?
Mr. Leisenring. The short answer to that is yes.
Ms. Eshoo. Is yes.
Mr. Leisenring. An identical, as I said no, but public
meetings, required exposure periods, public hearings, the same
activity level, conducted perhaps differently because the
international circumstance make it difficult, for example, with
the Japanese and the Chinese and the Australians to
simultaneously participate in the hearings, so.
Ms. Eshoo. Will the rule issued by one body be superseded
by another?
Mr. Leisenring. Let's keep it in the United States. The
FASB absolutely has the authority to issue standards through
the SEC and the ICPA in the United States. The goal is to make
the differences between those standards become so trivial that
it is not consequential. But there is no authority for the IASB
to issue something that overrules the FASB or vice versa,
because the FASB has its own jurisdiction and the IASB has none
other than to the extent people in other countries are allowed
to use non-domestic standards for cross-border financing.
Ms. Eshoo. So the restructuring of the IASB is being done
for what reasons? I mean, it is probably obvious, but I mean,
if they cannot supersede, it is meant to harmonize, how is that
different from how it is operated?
Mr. Leisenring. Well, I think Mr. Jenkins can comment on
this from their exclusive perspective. I think, as long as you
accept that the objectives of the FASB is a comparable
information or a decision useful to investors, that they can
discriminate between investment and alternatives because of the
quality of the information they have, it does not seem like
borders ought to change that in a world where capital flows are
so easily done across continents, much less across borders.
There is no real jurisdiction or authority to accomplish that,
if it is not done by a private sector organization, like the
IASC.
You could argue that the FASB which, I think is widely
regarded by everyone in the world, as setting the highest level
of accounting standards, should have done the accounting
standards the world was willing to adopt. I can assure you,
Congresswoman, that is not the case. They are not ready to just
say, ``The American way is the way we want to do it.''
Now they may end up with a very similar answer, but they
seem to want to have their own participation in that process.
So I think we all made a conscious decisions that if you agree
on the objectives of getting a single set of high-quality
standards, the alternative organization in partnership with the
FASB and other standard setters is a more efficient way to get
there, than to try and, for example, reorganize the FASB and
make it look a little more international.
Ms. Eshoo. I especially thank you for your answer. I
especially appreciate the ``Restructuring In Brief.'' I mean,
it is here at the podium and as others were asking questions, I
went over it.
Just a couple of curiosity questions about it. On the first
page, it talks about the supervision, the restructuring, the
blue ribbon nominating committee, and it is blue ribbon,
because it is chaired by the former chairman of the SEC, Arthur
Levitt.
How is the board funded? It says fund-raising here. And so,
does each company contribute? Where does the money come from?
Mr. Leisenring. It would be nice if it would. But no, the
funding actually of the IASB is very similar now, is very
similar under the restructuring as the FASB's. There is a
significant amount of private contribution.
Ms. Eshoo. From whom, though? I mean, just give us an idea
of who.
Mr. Leisenring. Each of the five largest accounting firms
promised a significant amount of money over 5 years. A great
many major corporations around the world have similarly done
the same thing, financial institutions.
Ms. Eshoo. I am not saying it to aggravate you. Just a
curiosity question.
Mr. Leisenring. No, no. Financial institutions. I actually
have never seen the donor list. I know of some that have said
to me, ``We have contributed so much,'' and they are names that
you would know in the United States and they are the same
people that contribute to the FASB.
Ms. Eshoo. In the same memo there is some mention about the
need to provide competitive salaries to attract high-caliber
candidates for board positions and that the proposed salaries
will generally match the level of members of FASB in the United
States. What is that level?
Mr. Jenkins. The current level for an FASB board member is
$420,000 annually.
Ms. Eshoo. And is that considered a full-time position?
Mr. Jenkins. Yes. Yes. The FASB, in order to have----
Ms. Eshoo. I think there would be a lot of members here
interested in serving on the board, Mr. Jenkins.
Mr. Jenkins. Well, it should not be a surprise.
I will tell you that members do not join the FASB for the
money. But in order to be independent and objective in our
decisionmaking----
Ms. Eshoo. Nor do we want to be or serve as Members of
Congress for the money either.
Mr. Jenkins. Exactly.
We need to be independent, and, therefore, we are full-
time. The ISB is structured, in a nutshell, if you want a short
answer, the new FASB structure is virtually identical to the
FASB structure. It is designed to give independence, private
sector approach, and to significantly improve on the old
structure which was not independent and objective. The members
were part-time. If you wanted to be an FASB member, you had to
pay to be an ISB member, if you had to pay, or your
organization had to pay; that is hardly a way to get objective
decisionmaking accomplished. Their due process was lacking, and
therefore their standards did not have the credibility that
hopefully ours do.
The restructuring, which took a long time, was designed to
accomplish that, and I think it has, and that is why I have
great hopes for it.
Ms. Eshoo. Well, I once again appreciate, not only the
opportunity that the hearing represents to hear you and to ask
questions, but I also recognize that there are tensions of
values between the FASB and the Congress. I view them as being
healthy. They are not going to go away. We as human beings in
our interactions with one another are not always going to see
eye to eye. But wherever there are either standards and/or
representation relative to our national economy and our
international economy, we are going to be working together.
So I look forward to that future and I thank the chairman
for having this general oversight hearing.
Mr. Stearns. I thank the gentlelady.
The gentleman from Chicago, Mr. Rush?
Mr. Rush. Thank you, Mr. Chairman.
Mr. Chairman and witnesses, I want to begin by apologizing.
I know I missed some of the testimony; I was at a number of
conflicting appointments this morning, meetings this morning.
And so some of these questions might have been asked and
answered already, but please indulge me, if you will.
Mr. Rogstad, in your testimony, you mentioned the
importance of FASB performance consensus building across user
groups in determining new accounting principles. You also note
the ever-increasing number of households that own stocks. What
would FASB do to make sure that this large contingent of
household investors, that they be included in your consensus-
building process?
Mr. Rogstad. I think, Congressman, that those groups are
increasingly represented by an organization that represent
classes of investors, shareholders, securities industry in
general, and I think that there is, and there was in this
process, ample testimony and submissions for the record and for
FASB's consideration that incorporated the views and growing
importance of the views of this rapidly growing component of
the population that has great interest in the financial
markets.
Mr. Rush. What would be the profile of the input from
consumers? Would that profile be more organized, in terms of
consumer interest groups, or would that profile be more
individuals that appear before you?
Mr. Rogstad. I would probably let Chairman Jenkins answer
that better than I could.
Mr. Jenkins. I would say that we do have contact with and
receive inputs and carry on due process with consumer groups
and, therefore, with consumers. Some place in the thick stack
of materials that we provided you for this meeting are excerpts
from comment letters that we received on our process on
business combinations and other evidence that, I think, that
our process is exhausted and is working. And these letters were
received during the first exposure draft in our process.
But, for example, we heard from the Consumer Federation of
America, that represents 260 consumer groups, and they wrote in
support of FASB's decisions to eliminate pooling of interest
accounting.
Nel Minow, who is from Chicago, Congressman Rush, and who
you know and I know, as well, since I come from Chicago as
well, editor of the Corporate Library and a consumer advocate
has long weighed in on financial reporting issues and in
support of transparency of information and so on.
We have Sarah Teslik, who represents perhaps more
institutional investors, but does so from the focus of
investors in mutual funds, in 401(k) plans, in pension plans,
where a vast majority of this 50 percent of equity ownership by
individuals resides. They do not probably own those shares
directly, but they do through one of these other vehicles. So
Sarah Teslik, from the Council of Institutional Investors,
another group that we have interchange and due process with
and, again, supported our work on business combinations. Those
would just be some examples.
Mr. Rush. Well, as have been indicated by you and by
others, Mr. Jenkins, we know that more and more Americans are
depending on stocks for their retirements, particularly, and
also long-term investments. I guess, as a segue into your
comments, do you think that the information that these
investors are getting is, are they more accessible now? Is the
information more easily understood now? Are you getting that
kind of feedback from your comments and your interaction with
these consumers, these investors?
Mr. Jenkins. I think, in total, when you look at not only
financial reporting, but you look at other forms of
communication and information, would be web sites that
companies have today where they are reporting a significant
amount of information, the study that I referred to that we did
and reported on, I am not sure whether you were here when I
commented on it earlier, the study that we did earlier this
year about the voluntary disclosures of information encompass
all kinds of public disclosures, not just financial reports,
but it focused on web sites, it focused on access that
investors have to corporate meetings with analysts that are now
open to telephone discussions so an investor can call up and
listen to these meetings. There is a great deal going on and
much more information.
The issues is whether that information is presented in the
proper context that it can be understood. And that is why I
called for a presentation of this information in conjunction
with the reporting of GAAP financial information so that
investors can see the difference between the two and hopefully
reconcile and, therefore, understand these kinds of performance
metrics and other things that are being reported.
Mr. Stearns. Thank the gentleman.
We are going to go another round, Mr. Rush, if you want to
stay and if Mr. Towns comes back.
I want to direct my questions to Mr. Leisenring, dealing
with two issues: business combination and stock options
accounting. Now when I talked to Mr. Jenkins about what he was
talking about with pooling, did you have that problem? Do
corporations in Europe have that problem that you need to issue
the same type of regulation, the 141 and 142 standards?
Mr. Leisenring. Well, it is not, of course, just Europe. If
you were talking about Australia and New Zealand, they never
allow pooling.
Mr. Stearns. They never allow pooling. Okay. Did they allow
it in Europe?
Mr. Leisenring. At the present time it depends on which
country in Europe you are talking about because it is very
varied. So I think it is easier to focus on the international
standards versus the FASB.
And the international standard has been viewed as being far
more restrictive on the ability to employ what they called
uniting of interests, but it meant the same thing.
Mr. Stearns. Which is pooling.
Mr. Leisenring. I am not sure that that is an accurate
reading of what necessarily happened in practice everywhere.
Mr. Stearns. But it is not prevalent in the international.
Mr. Leisenring. It is less prevalent than it was in the
United States, I believe. That does not change the conceptual
basis for having what is clearly anomalous accounting, as Mr.
Jenkins has described. And there are some high-profile
combinations that have the----
Mr. Stearns. So you can still do it in the international
scene.
Mr. Leisenring. The international----
Mr. Stearns. Even though Mr. Jenkins has issued these,
promulgated these new standards, it does not apply to Europe,
obviously, or apply to the international scene. So some
corporations can still do pooling?
Mr. Leisenring. Absolutely.
Mr. Stearns. Okay. Now, do they also do the pro forma type
of presentation prior to their audited GAAP?
Mr. Leisenring. There is not the same amount of disclosure
of information that you would consider to be other than the
GAAP-reported information in other parts of the world. But it
is increasing. There is more of it, by the same types of
companies and probably for the same reasons.
But one of the things that is not as focused
internationally is quarterly financial reporting; in fact, that
is the exception not the rule. So that they do not have as much
periodic reporting, which seems to drive much of this and the
short-term fixation on stock pricing in the United States. So
it has not been as widespread, but it is not. We cannot say
that it does not happen, because it does in certain countries.
To the point of pooling, yes, they can still do pooling and
will be able to for some period of time. But the IASB's agenda
includes a project intended to look at exactly the same
questions that FASB has. And I believe there will be no
sympathy for maintaining a pooling of interest notion.
Mr. Stearns. So you expect to issue standards in your
organization much like FASB does?
Mr. Leisenring. It would be----
Mr. Stearns. Ninety percent sure.
Mr. Leisenring. [continuing] inappropriate for me to
speculate on a group I have never watched yet actually come
down and promulgate a standard how they will come out. But I
believe from the discussions that we have had at the board
meeting last week, there is only a couple of jurisdictions with
sympathy for retaining pooling of interest.
Mr. Stearns. These are the board members that make $600,000
instead of $400,000.
Mr. Leisenring. Yes. It is the strength of the dollar, has
given me a 4.62 percent pay cut already this year, according to
the paper this morning, because I am paid in pounds.
Mr. Stearns. Oh, I see. Okay.
Do you agree with Mr. Rogstad when he said that there
should be some standards put on these pro forma?
Mr. Leisenring. There is not any doubt in my mind that the
information is potentially misleading.
Mr. Stearns. Just yes or no.
Mr. Leisenring. Whether or not a private standard-setting
organization can do that or not, I think I would have to defer
to some lawyers. I am not sure of our ability to have
jurisdiction over press releases.
Mr. Stearns. No, no, no, the question is, as a member of
the board, do you think, like Mr. Rogstad said, that there
should be some standards for the pro forma; just yes or no?
Mr. Leisenring. Highly desirable, yes.
Mr. Stearns. Okay. Let me just quickly, in the time I have
left, talk about stock options, how they get dealt with in
terms of showing up on the books on the international scene,
and then we will talk to Mr. Jenkins.
I am an employee of a large corporation and I have stock.
Let's say I had a stock valued at $10,000 and then I sell it 2
years later for $50,000, so a $40,000 profit as an employee.
Where is the controversy in here? And is there anything you are
doing to solve the problem?
Mr. Leisenring. I do not think the controversy is with the
stock you own or its changes in price. The controversy
historically in the United States, and I predict will be
internationally, is over accounting for the granting of an
option.
Mr. Stearns. Okay.
Mr. Leisenring. And to acquire the stock at some perhaps
set price or some variable price.
The international standards are nonexistent.
Mr. Stearns. Okay. So I have an option to buy $10,000 worth
of stock, 10,000 shares at $1, and the stock is now at $5. It
is not even shown on the books or anything?
Mr. Leisenring. There are no international standards with
respect to stock options.
Mr. Stearns. Okay.
Mr. Leisenring. Now there are jurisdictions that do, in
fact, account for stock options. I am not quite sure why, I
guess it is cultural. The Germans have issued an exposure draft
just 2 weeks ago that would require grant a fair value for all
stock options; a proposal very similar to the one the FASB
suggested several years ago. The International Accounting
Standards Board has voted to put share-based compensation on
its agenda. It is a widespread concern, particularly in Europe.
Mr. Stearns. What is the concern?
Mr. Leisenring. The concern is that there are absolutely no
standards for accounting, and the standards in the United
States, even the standards in the United States prior to the
FASB's recent project, are nonexistent internationally.
Mr. Stearns. So what does it mean as an investor and I look
at the P&L statement in a European company? Is there some case
that by not having it in there it would help the P&L statement
look better?
Mr. Leisenring. Let's back up.
Mr. Stearns. I mean, I just do not have the accounting
experience to know.
Mr. Leisenring. There are three possibilities. One that we
know for sure, in the international community where you will
not have the body of information that you have in the United
States because of the issuance of statement 123. While it did
not require recognition of stock option expense, the disclosure
would provide a user a way of compensating, excuse the pun, for
not having compensation expense in the income statement.
However, internationally you could have two other
possibilities. In the United States we have always expensed, or
have for 30 years, certain types of stock options. That is not
true internationally.
Mr. Stearns. Just never shows on the books, the expense
forms.
Mr. Leisenring. Not internationally. Those options are
relatively rare on the grand scheme of things compared to the
type of options that also do not show on the books anywhere in
the United States.
So you can have a situation exactly comparable to the
United States in terms of measurement, if you had a certain
type of option you would have a more lenient treatment, no
compensation internationally, where you would have compensation
in the United States, but in all circumstances internationally
you would not have the body of information about the options
granted that exist in the United States.
One of the reasons for the project internationally is that
however it comes out, it has not even caught up to where the
United States is. And as you probably know, I do not personally
believe that the United States accounting is particularly
exemplary.
Mr. Stearns. Okay.
Mr. Jenkins, anything you want to add to that, and then I
will close?
Mr. Jenkins. I basically agree with Mr. Leisenring in his
explanation of the status. In most countries, and certainly in
the international standards, because there is no accounting,
even stock schemes that result in the payment of cash instead
of stock, at the end of the day, still do not get counted for
as expense.
They would under our existing standards. And there are many
other cases where we would have some compensation but you would
not otherwise. Our disclosures are now providing much better
information to investors on stock compensation than they did.
I am pleased that the IASB intends to take up a project in
this area, in the hopes that they will be able to come closer
to where we are today.
Mr. Stearns. Thank you. My time has expired.
The ranking member, Mr. Towns?
Mr. Towns. Mr. Chairman, I will only ask unanimous consent
to put Mr. Dingell's statement in the record. I am asking for
him to be able to add a statement for the record.
Mr. Stearns. With unanimous consent, so ordered.
Mr. Towns. The ranking committee is tied up this morning
continuing negotiation with the patients' bill of rights
legislation in the Rules Committee hearing, and the pending
energy legislation and, therefore is unable to attend today's
hearing.
He has, however, has asked you to note for the record the
strong support for FASB and its work and the work of this
subcommittee and request the ability to submit a statement for
the record on this extremely important issue.
Mr. Stearns. By unanimous consent, so ordered.
Mr. Rush, do you have any additional questions?
Mr. Rush. Mr. Chairman, I just have one or two additional
questions here.
Mr. Jenkins, an impairment test, I am not sure if you
addressed that, for intangible assets. And I guess the general
consensus is that all tangible assets may not be depreciated.
Mr. Jenkins. Certain intangibles and goodwill need not be
depreciated.
Mr. Rush. Okay. Now, we are in the midst of a slowing
economy now. Can you tell me what the varying effect on an
impairment principle, based on the fact that this economy is
slowing down?
Mr. Jenkins. It is possible because there would be, yes.
The impairment test is based on the determined fair value of
the particular intangible or goodwill intangible, and at the
end of the day fair value basically is the discounted value of
future cash-flows.
To the extent that the economy is turning down, and that
that is predicted to last for an extensive period of time, then
the future cash-flows might be less, and, therefore, that would
lead to a lower fair value. Now, that alone would not be a
write-down, but if that fair value was less than what you had
the intangible on the books for, it would lead to a partial
write-down of that intangible.
On the other hand, if you believe that the slow-down is not
going to be long-lasting and it is a dip then and you can
support that based on your understanding of the marketplace,
then the current dip might not have an adverse effect on the
impairment test.
Mr. Rush. Just a final question, Mr. Chairman.
What is the level of public input for the IASB? Is there a
comparable level as it relates to FASB?
Mr. Leisenring. Congressman Rush, that is difficult to
answer because the IASB as such has only been in existence
since April 1 and has issued no exposure drafts or anything. So
in terms of the way it is structured now, I would anticipate
the answer to your question, yes, it will be very comparable.
Historically, the predecessor organization had an open due
process. They had open meetings. They had exposure drafts. The
level of public involvement considering worldwide was not high.
It was concentrated in certain jurisdictions, and particularly
was not high from the United States.
It is increasingly more from the United States. And because
of the legislation that we talked about earlier in your
absence, by the European Commission requiring European
companies to use those standards by 2005 that comes about, I
suspect, there will be a lot more involvement from Europe.
So I think it will end up to very similar. I would be
disappointed if it was not, and I anticipate that it will be.
Mr. Jenkins. It is designed to be the same. It is up to the
constituents as to whether they choose to take advantage of the
process.
Mr. Rush. Okay. thank you so much.
I yield back, Mr. Chairman.
Mr. Stearns. I thank the gentleman.
Our hearing is completed.
Mr. Rogstad, yes, sir?
Mr. Rogstad. My Chairman, might I ask permission to
introduce into the record a memorandum that we wrote in July of
last year, which spelled out the issues that underscored, at
that time, our concerns with the process? I realize this was a
charged conversation.
Mr. Stearns. No, I welcome that.
Mr. Rogstad. We just laid that all out.
Mr. Stearns. No. You mentioned that earlier about this
process. And so, we would appreciate that.
Mr. Rogstad. I would like to add as part of the record.
Because I think it did document a concern at that point in
time, which all of our motivation is to make sure we never get
back to again. So I would like to have that.
Mr. Stearns. By unanimous consent, so ordered.
When was the memo dated?
Mr. Rogstad. I believe, July 20, 2000.
Mr. Stearns. Okay.
Mr. Jenkins. And, Mr. Chairman, we responded to that memo,
and I would appreciate the opportunity to put that into the
record.
Mr. Stearns. By unanimous consent, so ordered. We will have
the whole record in its entirety.
Let me conclude by saying, I appreciate the three of you
coming here voluntarily to help out. We have had, I think, a
pretty good debate upon some of the recent actions that your
organizations have been involved with. I think it goes to the
point that with a global economy on the horizon or presently
that we are in, updating standards to reflect the realities of
what exists is very important. And you folks are on the cutting
edge and we need your help here. And, I think, for the members,
including myself, it has been very edifying. So thank you very
much.
The committee is adjourned.
[Whereupon, at 11:58 a.m., the subcommittee was adjourned.]