I wonder if we need a third dimension — one in addition to relevance and reliability. That would be precision of a measurement.

Anybody else have thoughts?

“The second document, “An Analysis of IFRS in Practice,” examines how a sampling of foreign companies have used IFRS in their filings with the SEC, and summarized areas that drew comments from the SEC’s Division of Corporate Finance as part of its disclosure review program. The SEC staff looked at accounting principles, presentation of financial statements, and accounting for assets, liabilities, shareholders’ equity, revenue, expenses, broad transactions, and certain industry-specific matters. The staff paid attention to matters such as transparency and clarity of disclosures, compliance with applicable accounting standards, and the comparability of financial statements.

“The SEC staff found that company financial statements generally appeared to comply with IFRS requirements, but not always, and it said the transparency and clarity of the financial statements could be enhanced.”

My guess is that these two documents will be useful to academics both as teaching tools and as quotable materials in some research papers.  They may also motivate additional academic research questions.

1.) Materiality: Materiality continues to be viewed as an entity-specific concept; however, one of the goals of the project is to facilitate a behavioral change in management so that they focus more on applying materiality in disclosures (both in removing immaterial ones and using the general principle of disclosing all material information). The board is also considering developing ranges of disclosures (i.e. a minimum disclosure set and a heavy disclosure set) to help investors understand the continuum of possible disclosure length for certain items.

2.) Relevance: There was a comment made about alternative measurement disclosures and how those should be rarely needed since presumably the prevailing measurement is used in the financial statements. The current draft states the goal of alternative measurement disclosure as “disclosing measures that could be relevant to users” but theoretically many different measurement bases could be relevant for small groups of users. The discussion focused on how to refine the description of users. One solution discussed was using the language “likely relevant to most users”.

3.) Faithful representation and verifiability: There was a discussion on disclosing information that is relevant but hard to verify. This relates somewhat to the PCAOB proposal to have auditors verify certain forward-looking information. One of the questions that came up is how much do investors even distinguish between unaudited information and audited information. Also, how much do investors care if certain information is unaudited in the financials vs. relying on faithful representation of management?

4.) Financial statement presentation tie-in: There was a mention of how this project might relate to the financial presentation project currently on hold. For instance, the concept of disaggregating financial statement line-items raises the question of effective aggregation in the financial statements themselves. The example used was with pension components which are combined in the financials but require detailed disaggregation disclosures.

There is still no working draft but just some food for thought moving forward.

According to the article, the regulation is expected by the end of this year.  If the current version is adopted, “public companies that make products containing tin, tantalum, tungsten, and gold will be subject to the rule, no matter how much, or how little, of these metals they use.”  The rule will likely require annual disclosures.

This seems to be related to Lisa’s prior post on say on pay.  By forcing more disclosures, someone on Capitol Hill hopes to change some social outcome.  The CFO article mentions an ironic twist.  The intent of the law was to stop people from using illegitimate minerals from the Congo.  However, in an effort to minimize financial reporting risk, companies might stop using legitimate Congo exports as well, which in turn could actually hurt the people the law was intended to help.

On a different note, who the heck stuck this little tidbit into a financial reform bill?

The government has instituted this idea with executive compensation. In 2006, they instituted detailed disclosures around compensation policies and processes. Since then, continuing rises in compensation and the idea that misguided compensation incentives contributed to excessive risk-taking have gained increasing public interest. The government responded by expanding the use of Say-on-pay (SOP) votes. These are nonbinding “yes” or “no” shareholder votes on executive compensation packages. The hope was that the disclosures coupled with the active involvement of shareholders would drive compensation reforms. The 2011 proxy season marked the first year that SOP votes were used extensively in the US.

Here are some results:
• 37 companies in the Russell 3000 (<2%) had SOP failures (proposals receive < 50% support).
o Of those, 50% had double-digit negative 3-year returns
• The Energy sector had the lowest approval rate.
• Of interest, the financial services sector had the 2nd highest approval rate.
• The average company received 90% approval votes from their shareholders.
• Mean compensation was up 16% (to $11M) and median was up 33% for an S&P 500 CEO.
• Institutional Shareholder Services recommended “no” votes on 13% of companies (recommendations followed in 10% of those cases)
• 95% of S&P 500 companies elected to hold SOP votes annually. Management recommended annual votes at only 50% of companies.

From the government’s perspective, there are some bright spots. Companies with both extremely poor performance and high compensation packages had failed votes. Shareholders went against management recommendations at many companies by electing annual votes. There is an overall feeling that companies are engaging in more active dialogue with shareholders over compensation. But for the overall goal of reforming executive compensation amounts, the results are not very promising. It will be interesting to see how the SOP voting results trend in future years. But when we expand the idea of cost/benefit constraints to larger-scale social benefits beyond decision-usefulness, it certainly can add more confusion to an already subjective concept.

This got me thinking – I know that the standards I teach in intermediate and theory assume going concern.  What special accounting treatments are necessary when a company is not a going concern?  Do we have special GAAP for debtor-in-possession companies?  I think I feel a search of the codification coming on.  Although perhaps this GAAP is tied to bankruptcy law and therefore not found in FASB guidance.  Any ideas?

Second, I also recalled a funny comment letter I read in the 2,800+ for the proposed Financial Instruments ASU in May 2010. The letter was from an unaffiliated party and contained a simple question “why do you even bother soliciting comments on this when you know exactly what each party will say?” Of course it was phrased in less elegant terms. I do think it works in both directions: investor groups proclaim that every incremental disclosure is hugely beneficial and preparers proclaim that every disclosure will cost millions of dollars and take three years to implement. It reminds me of the story of the boy who cried wolf. Every disclosure has a true cost and benefit but how can we tease those out of the conjectures? If the answer is we cannot, then how are we performing an analysis on cost-benefit constraints of new disclosures?

The good news is that taken together, investors and preparers may balance each other out to some degree in standard-setting. On the surface, the PCAOB has indicated a preference for serving investor needs and rightfully they should. But the danger is in assuming that what investors say will serve them accurately portrays what will actually be of use to their decisions. An auditor discussion and analysis section is proposed because the audit opinion has become boilerplate. But a disclosure framework is being proposed partially because management’s discussion has become boilerplate. There seems to be a pattern of recurring solutions to recurring problems. Not that some benefit can’t come from those solutions, but do those benefits justify the associated costs and efforts?

This project was, until late last year, slated to be finished in July 2011. However, given the majors changes that have been raised during redeliberations, the boards have concluded that they are likely to end up with a document that would require re-exposure.

Given that they have not yet finished their redeliberations of the original exposure draft, it is difficult to say how far back this will push a likely completion date. The current plan is to finish redeliberations in Q3 of 2011. They would then need to finalize and ballot a new exposure draft. Assuming a 3-month exposure period and a few months for deliberations given the new feedback, and then another round of votes, I think it is safe to assume that this will push completion into 2012 at the earliest. However, the best place to find out more is to monitor the leasing project page.

You can read the full press release from the FASB here.

The immediate precursor of cuneiform writing was a system of tokens. These small clay objects of many shapes–cones, spheres, disks, cylinders, etc.–served as counters in the prehistoric Near East and can be traced to the Neolithic period, starting about 8000 B.C. They evolved to meet the needs of the economy, at first keeping track of the products of farming, then expanding in the urban age to keep track of goods manufactured in workshops. The development of tokens was tied to the rise of social structures, emerging with rank leadership and coming to a climax with state formation.

This “accounting leads to writing” meme appeared anew (to me, anyway) in a recent article on Slate.com about the khipu, a system of knotted cords used in the Inca empire.  The khipu started as a surprisingly successful accounting tool:

No one disputes that the Incas were great collectors of information. When a battalion of Spanish conquistadors, led by the ruthless Francisco Pizarro, arrived in 1532, the invaders were awed by the Inca state’s organization. Years’ worth of food and textiles were carefully stockpiled in storehouses. To keep track of all this stuff, the empire employed khipucamayocs, a specially trained caste of khipu readers. The great 16th-century Spanish chronicler Pedro Cieza de León recalled that these men were so skilled that “not even a pair of sandals” escaped their annual tallies. The Spaniards, who were no slouches themselves in the bureaucracy department—Pizarro’s landing party included 12 notaries—observed that the Incas were remarkably skilled with numbers. For many years during the 16th century, says Frank Salomon, a professor of anthropology at the University of Wisconsin, Inca khipucamayocs and Spanish accountants would square off in court during lawsuits, with the khipu numbers usually deemed more accurate.

The article argues that the khipu then transformed into a form of writing:

In 1981, however, the husband-and-wife, archeologist-and-mathematician team of Robert and Marcia Ascher put the Inca Paradox [as the only advanced civilization without writing] into doubt. By closely analyzing the position, size, and color of the knots in 200 khipus, they demonstrated that about 20 percent of them showed “non-arithmetical” properties. These cords, the Aschers argued, seemed to have been encoded with numbers that might also represent other information—possibly some form of narrative.

For more western history, John Alexander has an excellent and very brief History of Accounting that traces the history of accounting from ancient days to the early 20th century.  He identifies several key advances in accounting, each driven by a demand for more complex recordkeeping, and made possible by improvements in math, literacy and technology.

From the development of cuneiform up through the medieval period, recordkeeping consisted of little more than lists of holdings, productions and transactions:

The renowned Code of Hammurabi, handed down during the first dynasty of Babylonia (2285 – 2242 B.C.), for example, required that an agent selling goods for a merchant give the merchant a price quotation under seal or face invalidation of a questioned agreement. Thus it is believed that most transactions were recorded and subscribed by the parties during this period….

Government and banking accounts in ancient Rome evolved from records traditionally kept by the heads of families, wherein daily entry of household receipts and payments were kept in an adversaria or daybook, and monthly postings were made to a cashbook known as a codex accepti et expensi. These household expenses were important in Rome because citizens were required to submit regular statements of assets and liabilities, used as a basis for taxation and even determination of civil rights….

The oldest surviving accounting record in the English language is the Pipe Roll, or “Great Roll of the Exchequer,” which provides an annual description of rents, fines and taxes due the King of England, from A.D. 1130 through 1830. Compiled from valuations in the Domesday Book and from statements of sheriffs and others collecting for the royal treasury, the Pipe Roll was the final record on parchment of a “proffer” system which extensively used a wooden stick as a basis of account-keeping. Twice a year, at Easter and Michaelmas (September 29), the various county sheriffs were called before the Exchequer at Westminster. At Easter, a sheriff would pay about half of the total annual assessments his county owed. In accepting a sheriff’s payment on account (the proffer), the treasurer would have a wooden tally stick prepared and cut as a record of the transaction….

While lists of transactions and holdings are themselves simple, ensuring the integrity of the data was not. Even the earliest reporting systems included elaborate internal controls to ensure that the data was recorded accurately, and was not altered afterwards. For example:

Mesopotamia: In a typical transaction of the time, the parties might seek out the scribe at the gates to the city. They would describe their agreement to the scribe, who would take from his supply a small quantity of specially prepared clay on which to record the transaction. Clay was plentiful in this area, while papyrus was scarce and expensive.

The moist clay was molded into a size and shape adequate to contain the terms of the agreement. Using a wooden rod with a triangular end, the scribe recorded the names of the contracting parties, the goods and money exchanged and any other promises made. The parties then “signed” their names to the tablet by impressing their respective seals. In an age of mass illiteracy, men carried their signatures around their necks in the form of stone amulets engraved with the wearer’s mark, and were buried with them at death. Often the seals included the owner’s name and religious symbols, such as the picture and name of the gods worshipped by the owner. After these impressions from the amulets were made, the scribe would dry the tablet in the sun or in a kiln for important transactions which needed a more permanent record. Sometimes a clay layer about as thick as a pie crust was fashioned and wrapped around the tablet like an envelope.

For extra security, the whole transaction would be rewritten on this outer “crust,” in effect making a carbon copy of the original. Attempted alterations of the envelope could be detected by comparing it with its contents, and the original could not be altered without cracking off and destroying the outer shell….

Egypt: Egyptian bookkeepers associated with each storehouse kept meticulous records, which were checked by an elaborate internal verification system. These early accountants had good reason to be honest and accurate, because irregularities disclosed by royal audits were punishable by fine, mutilation or death….

Medieval England: After the amount of the sheriff’s proffer had been carved, a diagonal cross cut was made an inch or two from the thicker end of the tally, and the whole stick was split down the middle into two identically notched parts of unequal length. The flat sides of both pieces were inscribed in Latin to show that they related to the same debt, and as additional protection, the cross cuts were made at various angles on different tallies, so that no “foil” or shorter piece could possibly be fitted to any “stock” but its own. The sheriff then departed with the stock as his receipt for payments rendered, and the foil was kept by the treasurer for the Exchequer archives.

At Michaelmas, each sheriff returns for the final accounting, at which he pays the whole year’s revenues. The treasurer reads the amount due from the Pipe Roll, and the sheriff must justify any unusual expenses claimed. Final settlement occurs at a table covered by a checkered cloth, for which the Exchequer is named. “Counters” are placed on the squares to visually represent the amount due the king from that county. Another row of counters represents the Easter payment, which is verified by fitting together the sheriff’s tally stock with the Exchequer’s foil to demonstrate that the notches and cuttings correspond.