Accounting for Complex Financial Structures
According to a Bureau of National Affairs report, complexity in accounting principals and practices is one of the top challenges to accounting professionals and businesses. The knowledge economy and global marketplace have spawned larger, more diverse, and more complex organizations. Accounting standards and practices have increased in complexity in proportion to the organizations for which they are written. The Financial Accounting Standards Board (FASB) in the United States is the organization that is primarily responsible for writing accounting standards for both public and private companies in the United States. The FASB maintains Generally Accepted Accounting Principals (GAAP) for use by public and private businesses to prepare their financial statements. The FASB has been criticized by various stakeholders for adding to the complexity of accounting standards in the United States. The FASB has been working on an internal codification project that will reorganize GAAP into a much more user-friendly and accessible format. The FASB is also working with other American boards and entities to reduce redundancy in the writing and interpretation of accounting principals. The FASB and the Securities and Exchange Commission (SEC) teamed up in 2007 to address the issue of complexity in accounting and financial reporting and are addressing major issues that have been raised by stakeholders in the public and private sectors. International Financial Reporting Standards (IFRS’s) are being converged with U.S. GAAP standards to eliminate the need for two different sets of accounting standards in the United States. The topics covered in this article highlight some of the challenges that complex accounting practices are posing to public and private businesses in the United States. This article also highlights a number of steps that are being taken to reduce complexity in accounting for complex organizations.
Keywords Accounting Complexity; Convergence with U.S. GAAP; FASB Codification Project; Financial Restatements; International Financial Reporting Standards (IFRS)
Accounting: Accounting for Complex Financial Structures
The topic of complexity as related to accounting is like the chicken-or-the-egg scenario. Is complexity related to accounting as the result of the complexity of today's organizational structure, or have the rules just become more complicated in an effort to account for complex organizations? The answer to this question lies somewhere in the middle. Certainly the nature of American corporations has changed rapidly and radically over the years, and accounting rules have struggled to keep up. The following comments were made in 2006 by then SEC commissioner Cynthia Glassman.
The economy continues to evolve at a rapid pace, while reporting standards and mechanisms are in a "catch-up" mode. "Advances in technology, including the emergence of the Internet, faster and more ubiquitous communication and other technological developments, have changed the way companies do business, as well as changing the types of financial arrangements and instruments that businesses utilize. As the business world has become more complex, so have financial reports and accounting standards" (Glassman, 2006).
The comments by Commissioner Glassman indicate that accounting rules are being written in response to the changing nature of American and global business.
According to the Bureau of National Affairs' (BNA) Accounting Policy & Practice Series(tm), "The advisory board members—high level corporate accountants from Corning, Microsoft, and Eli Lilly and Co., as well leading academics and advisors —named complexity as a key topic when asked to name top [accounting] issues for 2007" ("Surviving Complexity," 2007). This article focuses on the complexity of today's accounting standards and how organizations are responding to the myriad changes that affect their financial and accounting practices.
The following comments underscore just how big the issue of complexity is for those who must interpret accounting rules in today's economy. The comments were delivered to the FASB and the SEC by a committee from Financial Executives International (FEI).
- Every effort should be made to work with stakeholders "to end the proliferation of detailed rules"; the general consensus from FEI and its subcommittee, the Committee on Corporate Reporting (CCR), is that accountants are struggling to understand and keep up with the deluge of new accounting standards.
- "Over the past ten years, the Board (FASB) has issued a significant number of standards that are among the most complex we have ever encountered. These standards have caused significant difficulties in practice due to one or more of the following: Scopes that are broad and hard to comprehend; complex accounting principles that require extensive supplemental interpretive guidance; and measurement principles that presume a level of valuation capabilities that do not exist uniformly across the preparer community" (Difabio, 2007).
Globalization, the rise of multinational corporations, compliance, government oversight, and mergers and acquisitions have greatly impacted accounting practices at public companies. "Accountants, investment bankers, and clients are structuring financial instruments around the provisions of highly technical, complex accounting pronouncements. The game is based on whether the security falls either inside or outside of the established principle. The predictable recipe resulting from this cookbook is what one observes in Enron, WorldCom, Adelphia, and so on" (McCarthy, 2004).
Currently, regulatory and financial reporting is much more demanding for public companies than for private companies—as are the stakeholders who have the most invested in sound accounting practices and accurate reporting of company financials. Common stakeholders for public and private companies include employees, customers, partners, and boards of directors. Private companies' biggest stakeholders are company owners and banks and institutions that finance the company's growth. Public companies' stakeholders include executive managers, investors, and creditors.
Private companies, while not subject to the same government oversight as public companies, are faced with increasingly complex accounting rules as well. GAAP for public companies are increasingly diverging from the GAAP standards for private companies.
In reference to the proliferation of complex accounting principals, one critic points out that the FASB is rewriting accounting standards to support publicly traded companies, which constitute the minority of businesses in the United States.
"To whom is FASB pandering when it promulgates these principles? The answer is the international accounting firms, their multinational public clients, and the relative few financial analysts and investment bankers that say they need this kind of information. Understand this phenomenon for what it is. The historical record of economic activity in the United States is being replaced with a system tailored to these specific constituencies" (McCarthy, 2004).
Privately held companies still comprise the vast majority of businesses in the United States, and many are convinced the FASB is rewriting accounting standards to support the minority of businesses (public companies).
To fully understand how and why accounting standards are changing so rapidly, one must also look at the changing nature of American business as it moves steadily to a knowledge-based economy. Many of the standard industrial age accounting practices do not accurately address the changing nature of American and international business. In today's knowledge economy, businesses have fewer tangible, "hard" assets on their balance sheets. More typically, today's corporation derives much of its value from intangible assets such as customer relationships, intellectual property, brand recognition, and other knowledge-based activities.
The shear number and breadth of current accounting standards contributes to the difficulty and complexity for public and private companies to stay on top of current accounting procedures. "The proliferation of codified accounting principles has, in large part, led to the distress that the profession currently is experiencing. Codified principles issued by the Accounting Principles Board (APB), then by FASB, have led to a 'cookbook' approach to financial reporting" (McCarthy, 2004).
Few investors and other stakeholders would disagree that corporations have become complex entities. Many corporations (U.S.-based and others) have operations in many different countries. Operations continue around the clock in different time zones, and many corporations rely on far-flung but highly integrated supply chains. Investment capital is readily available along with a more diverse set of creditors and investors. The vast changes that globalization and the “flattening” of the world have initiated are reflected in the financial and accounting standards that have attempted to keep pace with these changes.
This article investigates the current topic of reducing financial reporting complexity that is being studied by the SEC, FASB, and the U.S. Treasury Department. Topics include
- SEC efforts to study practices that will reduce complexity in the creation and application of accounting principals.
- increasing numbers of financial restatements.
- what information investors and owners really want on financial statements.
This article concludes with a look at the move toward the adoption of IFRS’s, the future role of the FASB, and some of the implications affecting private companies.
The FASB is the specified private-sector organization that determines financial reporting and accounting standards.
Financial statements should be
- responsive to a changing economic environment.
- useful to public and others for decision-making.
- promote, whenever possible, convergence with existing standards.
This article investigates...
(The entire section is 4599 words.)