Comment Letters to FASB on Proposal to Defer Effective Date of OCI Reclassification Presentation
ASU 2011-05, which was issued in June, required that firms report comprehensive income within a performance statement and prominently display on the face of the income statement the affected line items from recycling. It was this latter requirement that caused heartburn for some preparers, and as Bob Lipe blogged here, the FASB exposed a proposal to defer the effective date. After a short exposure period, the FASB voted this week in favor of the deferral.
Who knew that reclassifying AOCI into income could be so complicated for preparers? As it turns out, some AOCI items can flow through multiple income statement line items when recycled (cost of goods sold, depreciation/amortization, and virtually all SG&A expenses), and information in a decentralized system is not always gathered in a manner that companies can readily allocate the amount to different line items. The requirement seems particularly costly when recycled items are capitalized. For example, the problem is articulated in a comment letter from Gregg Nelson, a VP from IBM, as follows:
“… certain pension-related costs reclassified out of OCI are included in cost pools and subsequently capitalized as inventory or PP&E. These amounts immediately lose their nature, and the OCI portion related to capitalization is not tracked. Thus, when inventory is subsequently sold or PP&E is depreciated, a portion of the cost of sales / depreciation would include amounts previously reclassified from OCI. We are uncertain whether the intent of ASU 2011-05 … was for entities to track such amounts. If this is a requirement, we would certainly question the usefulness of this information and the cost/benefit of identifying and tracking this information. This capability does not exist in our financial systems today.”
During the brief comment period, the FASB received 37 comment letters. The letters can be categorized as coming from the following groups:
A) Companies, Preparers, or Preparer Organizations – 25 letters
B) Audit firms – 8 letters
C) CPA organizations or Societies – 2 letters
D) User Organizations – 1 letter
E) Individual with no affiliation – 1 letter
It’s interesting to note how few letters come from financial statement users. This lack of user input is typical and a reason why the FASB has established various user groups to get more feedback from this important stakeholder. Also, academics are relatively under-represented. One might believe that academics could provide a unique and unbiased perspective on many issues faced by the Board.
The ED posed three questions for respondents to answer. The first question was whether respondents agreed with the proposal to defer the effective date for OCI reclassification presentation. Of the 37 letters, 36 stated they agreed with the deferral. The one letter that expressed disagreement was from the CFA Institute – the only user group that responded – but even this was only a partial dissent, as I’ll explain later.
Questions 2 and 3 asked for alternatives that the Board should consider for presenting reclassified OCI that would be more cost effective and if so, how these alternatives would serve the needs of users. Only two of the letters indicated that the FASB should continue to require that firms prominently display the effects of recycling on the face of the income statement. Thirty-two letters strongly opposed the requirement and generally indicated that footnote disclosure would be adequate (3 letters expressed no opinion).
Besides the significant cost of tracking the AOCI amounts to earnings, respondents who disagreed with the requirement indicated that the reclassifications are almost always immaterial (further suggesting that costs exceed benefits), the income statement would be complicated with greater clutter, and the requirement diverges from IFRS. In addition, many respondents questioned the demand for such reporting because they are not asked for this information by investors and analysts.
The only outlier from this predominant view comes from the CFA Institute and its Corporate Disclosure Policy Council. Kurt Schacht and Gerald White lay out a well-reasoned response to the ED that includes several interesting points (the entire letter can be read here). The first point made in the letter is somewhat flawed, which is that they disagreed with the deferral of the effective date because they interpreted the ED to mean that the FASB would simply delay and never revisit the presentation requirement. However, Board deliberations clearly indicate that the Board never intended that the deferral would be permanent. They then proceed to provide support for the deferral if it is limited to a one year time frame. Other than this misinterpretation, however, I believe Messiers Schacht and White make many interesting, and valid, arguments. They point out that OCI reporting in the first place is a concession to preparers, and if preparers are unable to provide information on reclassifications, then perhaps we should do away with it entirely. Second, they articulate frustration with interpreting economic events that are initially presented in OCI when they occur and allocated in piecemeal to net income in subsequent periods when they do not occur. They argue against the position that prominent display of OCI reclassification would confuse investors with clutter but rather, claim that the disclosures result in greater transparency and that, like every other standard, immaterial items would not need to be presented.
What struck me when reading these letters is that we still don’t really know what we want to accomplish with OCI reporting and recycling. This was a topic at the most recent FASB/IASB Issues Conference. A comment letter from Richard D. Levy, Executive VP and Controller for Well Fargo, stated the issue succinctly as follows:
“The first step in evaluating how to present reclassification adjustments should be to understand what the balances are intended to represent and to define a principle or characteristics for items qualifying for inclusion in OCI. The FASB has not provided a formal definition of what OCI is intended to represent, and instead relies on existing guidance, which was created over many years and through several independent projects. We believe that questions raised in the deliberations related to the classification and measurement component of the Financial Instruments ED and through ongoing international convergence efforts have increased the focus on the importance of clarity regarding the intended purpose of OCI. These issues are fundamental to understanding comprehensive income and should be resolved before the issuance of further guidance.”
As the statement above indicates, the fundamental issue with what OCI reporting is supposed to accomplish continually crops up across other projects, like Financial Instruments and Insurance Contracts. The issue of reclassification presentation is related to the broader issue of the overall objective of OCI reporting and recycling. Although not explicitly asked for in the ED, several comment letters urged the FASB to take on this more fundamental issue (Ford, E&Y, Wells Fargo, Allstate Insurance, Grant Thornton, and CFA Institute).