EY to Pay $4 Million to Settle SEC Allegations

http://online.wsj.com/articles/ernst-young-to-pay-4-million-to-settle-sec-allegations-1405365560

Ernst & Young LLP agreed to pay $4 million to the SEC for violations of auditor-independence rules that were committed by E & Y’s Washington Council. The Washington Council had some meetings with congressional staff, asked to have some specific language inserted into bills, and also asked third parties to go approach a U.S. Senator (whatever that means), all on behalf of some of their audit clients. Unfortunately, the names of the clients were not revealed.

It seems as though E & Y tried to reach a little too far in their attempt to influence Washington and their decision making process. The fact remains that the Big 4 have been doing this for years. In 2012, Reuters reported that the Big 4 spent a combined $9.4 million in 2011 on in-house and outside lobbyists, which is more than any year since 2002. 2002 is a red letter year, as most of you probably know, because of the Enron and Arthur Andersen debacle, which brought the Big 5 down to the Big 4. A large, significant portion of the money contributed by the Big 4 goes towards influencing the PCAOB. Being a former employee of one of the Big 4 firms, I would think that the lobbying money would be to lessen regulation over the auditing standards. The Big 4 want to maintain their position as the go-to auditors for as long as they possibly can. Senators in Washington probably have a greater tendency, if at all, to try and level the playing field as best they can between the Big 4 and every other accounting firm in the world.

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FASB Going Nowhere Fast with the IASB

CFO.com did a report to give an update regarding the state of the FASB convergence to an across the board, no pun intended, set of accounting standards with the IASB.

“The Financial Accounting Standards Board is advocating an approach to international accounting that has been a “miserable failure” for 25 years, Ian Mackintosh, the vice chairman of the International Accounting Standards Board, said earlier this week.”

The FASB seems to be having trouble in regards to the convergence of accounting standards for three key topics: converged leasing, financial instruments, and insurance.  The FASB would like the IASB to be the world benchmark for accounting standards.  However, the FASB would also like to have the ability to use their own standards regarding certain accounting issues, such as the ones mentioned earlier.  The old adage applies – have your cake and eat it too.

While there are a number of differences between international accounting standards (IAS) and US generally accepted accounting principles (GAAP), the accounting community generally views the international standards to be less complex, and therefore having less “wiggle room”, than GAAP.

It’s not difficult to understand why the FASB has been hesitant to move forward with the convergence.  For one thing, many companies rely heavily on certain aspects of GAAP that are not included in IAS, such as LIFO inventory valuation.  Companies could potentially have to completely rearrange their business models to be in line with the IAS.  The FASB would most likely face the backlash from multiple US companies for that alone.

Another reason for the FASB’s hesitation in moving forward with the convergence is out of the fear in repeating history.  The two of the biggest accounting scandals (in terms of dollars) in history occurred right here in the US: Enron and Worldcom.  The results of the Enron and Worldcom scandals included increase of government regulation, weakening of the US dollar, and, most importantly, damaging investors’ confidence and any faith they had in corporate honesty.  

The FASB and IASB have been working on the convergence for over two decades.  The differences between the two set of standards are still extensive.  Right now, it looks as though the convergence is a long way off.

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Master’s in Accounting May Help Give You an Edge

The article is a short one. Essentially, the article states that a survey was conducted which shows that employers are now even more likely to hire individuals with a Master’s in Accounting degree than they have been in years past.

“Out of 565 employers from around the world, 45 percent plan to hire master of accounting graduates this year, according to a survey from the Graduate Management Admission Council. In last year’s survey, only 36 percent of employers planned to hire business school graduates with this degree.”

I think this shift is primarily for the CPA license. For an aspiring CPA, a Master’s in Accounting is practically a requirement for licensure, given the 150 hour rule in most states. Many accounting firms and other companies will only consider you for employment if you either have a CPA license or on track to obtaining a license. While the accounting firms and other companies realize that the CPA license means that you most likely have a better working knowledge of accounting than an accountant without a CPA license, the primary benefit of having a CPA license is that you are eligible to represent your employer before the IRS. While those just starting out probably won’t encounter a hearing before the IRS in the first year on the job, companies are always thinking ahead to the future. They want to hire individuals that could potentially move all the way to the top. Not having a CPA license might, and probably will, prevent accountants from moving up the company ladder. The Chief Financial Officer (CFO) of a company is regarded as the apex of accounting positions and I can’t recall meeting any CFO that didn’t have a CPA license. For accounting firms, in addition to the benefit mentioned above, an auditor with a CPA license means that the firm can potentially charge the client more for the services.

On a related separate note, I prepared for the CPA exam using the Becker Professional Education software. The instructors in the videos make a point to remind you about all the money you can potentially make by obtaining your CPA license. While I do agree that money is a fuel for choices, I think the people over at Becker could find another way to encourage you in preparing for the CPA exam. That last statement probably just ensured that I will never be hired by the people at Becker. I think Becker could place more emphasis on the importance of the job we do as accountants for the greater good of the company.

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Interesting Take on Accounting and Art

The author of the article essentially took a look at what accounting, in the public’s eye, meant then, and what it means now. Accounting, as depicted in the painting by Dutch painter Jan Gossaert, was viewed with admiration by the public at large.  While accounting has changed a great deal from those times, it is still powerful enough to gain the attention of the public when it matters.  However, many people still view accounting as a drag.

Anyone who is an accountant will tell you that when they tell people what they do for a living, it usually comes with a response that is a mix of saddened sympathy and requests for help in filing taxes. As the author of the article points out, many individuals in the United States (and other parts of the world as well) view accountants as nothing more than bean-counters who can occasionally put the economy into distress, usually due to fraud.  It’s hard to say when that point of view came in to play.  The author suggests that as accounting (financial responsibility) became more advanced, it was no longer seen as a “shared practice and value,” but rather a specific profession.  As individuals and companies garnered more wealth through advancing economies, the accountants were there to keep them in check.  You often see images depicted in popular culture of individuals that are about to make, or have already made, poor financial decisions, and there is usually an accountant standing nearby wagging their finger.  While individuals may gain wealth, accountants are there to remind them to be responsible.

I think part of the negative view of accounting today comes from many individuals experience with it. For all business degrees, and several non-business degrees, an Accounting I course is part of the required curriculum.  Many students go in to the course with notion that they can just go to class, study one or two nights before the test, and everything will be fine.  Accounting is NOT designed that way.  It’s a skill.  Many students don’t grasp the fact that it cannot be learned through intuition or straight memorization.  As a result, many students end up resenting accounting.

I also think that our society has really taken a hold of the notion that you should “follow your passion.” That is to say, you should do what you enjoy.  I think a lot of people misinterpret this.  I enjoy accounting, but I also enjoy music, traveling, food, and a list of other things.  And I am sure every other accountant in the world would say something to that effect.  My joys in life are not boiled down to one “thing.”  I think a lot people believe that their profession defines who they are, and in many ways, this is true.  However, in far more ways, this is false.  In a perfect world, people would view accountants as strong, analytical business professionals with passionate lives that extend beyond the office.  Maybe one day…

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FASB to Lessen Complexity

After getting some feedback from stakeholders, the Financial Accounting Standards Board (FASB) is going to make an effort to try and reduce the complex nature of financial statements.

As part of this effort, the first project will be to simply the way inventory is measured at lower of cost and net realizable value. As the accounting guidelines are now, a company should consider “net realizable value, replacement cost, and net realizable value less a normal profit margin when measuring inventory.”

The second project will be to eliminate the extraordinary items from the income statement. The current accounting guidelines state that “organizations to evaluate whether an event or transaction is an extraordinary item; and if it is an extraordinary item – to separately present and disclose the item.”

I can definitely understand the need to simply the inventory valuation. Inventory is often one of the largest, if not the largest, accounts on the balance sheet. Giving a company to much leeway in determining the value of their inventory could lead to some manipulation. However, sometimes there is not a surefire way to determine the value of an item. For example, an antique dealer may have paid a certain amount for an item, but the realizable value of that item is partially subjective. That’s a very specific example, but that does not take away from the fact that most companies have to use their own judgment in determining the value of their inventory. This move to narrow the inventory valuation methods down to two will ultimately benefit the investors by removing an additional element, normal profit margin, that is essentially just an estimate.

The second project is a little more cloudy. Accountants spend a considerable amount of time trying to determine if an event is considered extraordinary in nature. FASB statement No. 145 offers guidance as to what should be considered an extraordinary item. The problem that I think the FASB is trying address is the difficulty accountants have in distinguishing between nonrecurring items and extraordinary items. Most of the accounting literature tends to lump the one-time items into a category and attempts to determine which one of those items is likely to occur again down the road. To distinguish between those two categories is important because one group can be listed above the bottom line (extraordinary items) and the other group can be listed below the bottom line, usually after taxes (nonrecurring items). While I’ve described to the accounting treatment of the above items, I haven’t given any clear examples of either, and that’s the point. Some accountants may consider an event as extraordinary and others might consider it nonrecurring. It seems as though the IFRS does not recognize the concept of extraordinary items for this very reason.

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Capitalization and the Hertz Corporation

The audit committee of the American car rental company, Hertz Corporation, announced through a filing this past Friday, June 6, that some accounting errors will require them to restate their 2011 financial reports, and potentially their 2012 and 2013 financial reports as well.  As no surprise, this has made some people (i.e. investors) very upset and the stock price of Hertz’s shares have taken a hit as a result.  Hertz claims that errors were discovered related to “allowances for uncollectable amounts with respect to renter obligations for damaged vehicles and restoration obligations at the end of facility leases.”  What investors are probably asking now is whether PWC, Hertz’s external auditors, and Hertz’s managers should have had reasonable awareness of the problems earlier, and how the problems were discovered in the first place.

“Hertz said it needed to do more work related to evaluating the capitalization and depreciation timing for “certain non-fleet expenditures.” The company said adjustments, including for allowances for doubtful accounts in Brazil, would likely reduce its 2011 net income by as much as $9.8 million, to $174 million” (http://in.reuters.com/article/2014/06/06/hertz-restatement-idINL3N0ON2ZA20140606).

If capitalization versus expensing is the root cause here, the impact of choosing one over the other can have a profound impact on a company’s financials.  The biggest issue relates to net income and timing.  In a general sense, a company that capitalizes costs will show higher profitability in the early years as opposed to expensing costs.  On the other hand, if that same company had expensed their costs in the early years, they would show a higher profitability in the later years, assuming all other financial factors remain stable.  In other words, the accounting treatment of a significant purchase can sometimes mean the difference between a year-end income statement that’s in the black and one that’s in the red.

Distinguishing between whether to capitalize or expense is no day at the beach either.  While there are a number of criteria that go in to determining whether to capitalize or expense costs, the key objective is to distinguish the expenditures that produce future benefits (capitalize) from those that produce benefits only in the current period (expense).  The accountants and auditors of Hertz may have potentially used poor judgement in determining the classification of some of their costs.  At this point, we will have to wait until more facts come out.