Are Accounting Standards Becoming Less Complicated?

Recently I found myself doing a double-take upon seeing the headline “FASB Looks to Uncomplicated Accounting—A Little, At Least.” Accounting standards becoming… less complicated? Having spent three years in public accounting, I can attest that, as financial times have changed (Enron, SOX, globalization, GAAP convergence to IFRS, compliance with numerous governing bodies, PCAOB inspections, peer reviews, technology, etc), accounting standards have become more complex, and oversight of both preparers and auditors has become more rigorous. As a result, the financial reporting process has become more costly for organizations and, by extension, investors. In response to various stakeholders’ concerns, the FASB launched an initiative to reduce complexity in accounting standards in July 2014.

The original projects identified at the initiative’s launch include:

1. Simplifying the Measurement of Inventory— Companies are currently required to consider net realizable value, replacement cost, and net realizable value less a normal profit margin when measuring inventory. This project would require inventory to be measured at the lower of cost and net realizable value.
2. Simplifying Income Statement Presentation by Eliminating Extraordinary Items— Reporting entities are currently required to evaluate whether an event or transaction is an extraordinary item. If it is deemed to be an extraordinary item, GAAP currently requires separate presentation and disclosure. Identification of “unusual and/or infrequent” events is rife with judgment. The FASB proposes to remove the extraordinary items concept from GAAP.

Additional projects under the simplification initiative were added to the FASB Board’s agenda in August 2014:

1. Balance sheet classification of debt— Although the current/non-current classification seems simple, many of the required judgments are tricky. The FASB has proposed to replace the fact pattern decision process with a principle-based process based on contractual terms of debt and the company’s compliance with debt covenants.
2. Presentation of debt issuance costs— Companies report debt discount or premium and debt issuance costs (such as legal fees, accounting fees, underwriting fees, etc) separately in their financial statements. This project seeks to align the presentation as one figure of debt proceeds net of issuance costs. The proposed change would align GAAP with existing IFRS treatment on this issue.
3. Measurement date of defined benefit plan assets— Companies measure defined benefit plan assets and obligations as of the date of the employer’s year-end date, in order to align with financial statement reporting periods. This project seeks to align the measurement date with the third party report valuation date.
4. Accounting for income taxes—
   1. Companies must currently separate deferred tax assets and liabilities into current and non-current based on the classification of the related asset or liability. This proposal would classify all deferred tax assets and liabilities as non-current.
   2. Companies are currently prohibited from recognizing income taxes on intra-entity differences between tax basis and financial reporting cost basis. The FASB has proposed to eliminate this standard and ease the recording of intra-company taxes by requiring income tax only when the transfer occurs.

The inventory measurement and extraordinary items simplification, provided they are approved, would be applied prospectively after December 15, 2015, with early adoption permitted. The FASB’s initiative comes at an opportune time, as accounting standards have become more lengthy and complex, so has the cost and difficulty of financial reporting. The objective of the simplification project is to improve the usefulness and transparency of financial information. The Board plans to assess further suggestions/proposals submitted by various stakeholders. The simplification projects should also assist financial analysts, investors, and other parties that regularly rely on historical financial statements to form judgments regarding ongoing cash flows, risk, and growth prospects of an underlying firm. We will continue to monitor the FASB’s status in this ongoing process.

Related Links

• Article: Assessing the Quality of Earnings
• Services: Financial Reporting Valuation Services
• FASB Project Landing Page