Who owns mutual funds?

Source: Investment Company institute, Mutual Fund Shareholders: People Behind the Growth , copyright © 1996

AcSEC Software Proposal to Have Major Effect

T he American Institute of CPAs accounting standards executive committee issued an exposure draft of a Statement of Position, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use . The ED proposes that certain costs be capitalized as long-lived assets, although many companies have been expensing these costs.

"Companies would have to set up cost accumulation mechanisms they might not have," Philip D. Ameen, chairman of the AcSEC internal-use software costs task force, told the Journal . "Larger companies likely have such mechanisms in place for inventories or capital projects and would only have to make modifications to adapt these to software." Ameen said this was the case at General Electric, where he is vice-president and comptroller. A smaller company, however, might have to take a close look at cost accumulation methods.

Ameen said the exposure draft might not receive the volume of comment letters it deserves. "People just dont realize how widespread the implications are," he said. "The entire underlying concept of this statement is controversial." The ED touches on ongoing controversies over soft assets, and the Financial Accounting Standards Board has expressed some concern about the long-lived asset classification proposed in the draft. Ameen said he believes some companies will object to the ED because they are also expensing these costs for tax purposes. "The possible implications on cash flow will concern some enterprises."

Finely honed definitions
The proposed statement would not change existing FASB pronouncements; costs for non-internal-use software would not be affected. CPAs and companies may want especially to look at appendix A, which gives 20 examples of what is and is not an internal-use situation. An example of internal-use costs: an entity develops software that helps it improve cash management, which may allow the entity to earn more revenue. An example of a non-internal-use cost: An entity sells software required to operate its products, such as video cassette recorders or voice-mail systems.

A more detailed discussion of this ED will appear in an upcoming issue of the Journal.

One free copy of the ED (product no. 800108JA) may be ordered from the AICPA Order Department, 800-862-4272. It is also on the Accountants Forum in the accounting library and on the AICPA Web site (http:// www.aicpa.org) in the accounting standards area. Comments are due by April 17.

Help is a mouse-click away
More details on business ethics can be found at KPMGs ethics Web site: http://www.us.kpmg.com/ethics . Online is Integrity , a newsletter that explains, for example, how to create a positive ethical climate at a company and how to set up a useful business ethics process. Also online are sample case studies in business ethics. The site explains how the existence of an in-house ethics program can mitigate a companys fine if the entity is convicted in federal court of criminal misconduct. There are also details on how KPMG assesses a companys business practices. Information on the site can help the CFO "take stock and fix a problem"before it hits the financial statement," says Ponemon.

FASB Makes Small Businesses Larger

I t aint over till its over. In the November issue, the Journal reported that a Financial Accounting Standards Board exposure draft would exempt businesses with less than $10 million in assets from Statement no. 107, Disclosures about Fair Value of Financial Instruments ("FASB Comes Through for Small Business," page 4). At that time, it was expected this figure would not change during the exposure process. However, the FASB has voted unanimously to raise the small business exemption limit to $100 million.

"Along the way, some issues changed everyones minds," John Hepp, a FASB project manager, told the Journal . According to Hepp, the FASB staff realized that a criterion for exemption based on the amount of financial instruments rather than on total assets would be more pertinent. Using total assets as the criterion works against entities such as grocers, whose asset size is determined by merchandise inventory, not financial instruments. A criterion based on financial instruments was considered but ultimately rejected because a total asset criterion is easier to apply and could accomplish much of the same effect. "We were trying to keep the exemption simpler to apply than the statement itself."

Also, Hepp said a larger total asset criterion addresses some of the concerns of smaller banks and financial institutions. Many bankers had argued for a $150 million total asset cutoff, similar to that required by the Federal Deposit Insurance Corporation for certain disclosures. After considering the composition of assets at smaller financial institutions, the board decided that even entities approaching $100 million could be exempted.

John Hepp emphasized that the FASB was not attempting to draw a line rigidly defining what is or is not a small business. The $100 million figure may only be applicable in this particular instance.

Derivatives rule still in
Hepp emphasized that entities of any size holding derivatives (defined by Statement no. 119, Disclosure about Derivative Financial Instruments and Fair Value of Financial Instruments ) must still apply Statement no. 107. However, that definition includes loan commitments. This would have prevented even small banks and their clients from taking advantage of the exemption. Therefore, loan commitments are exempted from the definition of a derivative for the purpose of this amendment. This exclusion is consistent with the definition of a derivative in the FASB ED Accounting for Derivative and Similar Financial Instruments and for Hedging Activities .

The FASB has made it clear that the amendment is temporary and may be superseded as the board resolves fair value issues on other projects. To order the amendment, Statement no. 126, Exemption from Certain Required Disclosures about Financial Instruments from Certain Nonpublic Entities (product code no. S126; $11.50), call the FASB at 203-847-0700, ext. 555.

Choosing the Next FASB Chairman

E veryone in the accounting world knows of the Financial Accounting Standards Board. But very few people know how the board members are selected or what qualifies a person to be a board member. Dennis Beresfords term as the FASBs chairman will end June 30, and, given the term limits of the position, he is not eligible to be considered for reappointment. Therefore, this is a particularly useful time to share with the public the process for selecting the next chairman and the characteristics and qualifications that are essential for membership on the board in general and its chairman in particular.

The responsibility for selecting the members of the FASB is the mandate of the board of trustees of the Financial Accounting Foundation (FAF). The trustees also are responsible for securing the FASBs funding and for overseeing its activities, although by charter they are not involved in technical issues. The foundation is totally independent from any other organization and acts to ensure that the FASB remains free of outside influence. Selecting the members of the FASB is its most important role in the standard-setting process.

The 16 men and women who serve on the FAF come from the highest levels of business, public accounting, government, academia, financial analysis and the public at large. Among the trustees are chief executive officers of the largest public accounting firms, the former comptroller general of the United States, a former vice-chairman of the Federal Reserve, a former chairman of the Securities and Exchange Commission, senior executives of some of the major financial institutions of the United States, directors of major public companies and the CEO of the worlds largest private retirement system.

The process of finding the new chairman of the FASB is organized and directed by the FAFs eight-member selection committee, which I chair. The selection committee is responsible for identifying possible candidates, screening rsums, interviewing candidates and recommending a candidate for selection to the board of trustees of the foundation, which will vote on the candidate.

Qualities needed by a board member
The trustees have agreed on the qualities necessary for members of the board, including the chairman:

• Knowledge of financial accounting and reporting. All candidates for membership on the FASB should have a reasonable level of knowledge and technical competence in financial accounting and reporting, regardless of their background. Such knowledge is essential to a board members credibility both inside and outside the organization and to the FASBs effectiveness and efficiency.
• High level of intellect applied with integrity and discipline. The ability to absorb and objectively analyze complex information and make lucid decisions is crucial. Rigorous effort, discipline, intellectual integrity and consistency of approach are hallmarks of the qualified board member.
• Judicial temperament. Of great importance is the ability to consider impartially the evidence on all sides of issues, to call for additional evidence if that seems necessary and then to reach a decision within a reasonable period of time.
• Ability to work in a collegial atmosphere. The FASB is a collegial body, characterized by group decision making that requires give and take in order to arrive at timely, workable solutions to problems. The objective of providing guidance for preparers, auditors and users of financial reports must take precedence over the personal philosophies of individual members. Members must be able and willing to articulate clearly their views on the issues and be prepared to make reasonable compromises that will lead to improvement of financial accounting standards.
• Communication skills. Board members should be able to communicate effectively in board meetings, dialogues with fellow board members and the technical staff, speeches and other contacts with persons outside the FASB. Their internal memoranda, speeches, articles, correspondence with constituents and other written communication all require tact and clarity.
• Awareness of the financial reporting environment. While the FASB deals with technical accounting issues, its decisions must be made in the context of trends and events in the business community and economy as a whole. A member of the FASB should have a broad understanding of the environment in which the board operates.
• Commitment to the FASBs mission. A candidate for membership on the board should be committed to the FASBs mission as a private-sector, self-regulatory organization and to the hard work required to fulfill it.

The FASB chairman
Clearly, the individual selected to chair the board must possess all the qualities required of other board members as well as distinctive leadership attributes. The chairman must exhibit the ability to set a sensible course toward a reasonable objective and to direct an organization in following the course. The capacity to steer around obstacles, compensate for setbacks that may occur and change course in order to reach the destination demands intellectual rigor and flexibility of mind.

The FAF selection committee also looks for a candidates ability to inspire colleagues and other team members to maximum effort and the related ability to mediate among conflicting claims on resources. The chairman also represents the organization as the principal public spokesperson. In addition to this important external role, internally the chairman must possess the ability to conduct orderly, productive meetings and ensure that reports and recommendations of the staff are properly presented and the views of all board members adequately heard. Since the "one member, one vote" rule prevails at the board, the capacity to achieve consensus among different viewpoints in order to reach agreement on decisions is clearly essential.

In keeping with the unique character of the FASB, certain leadership and intellectual qualities are required of the chairman. These encompass the patience and desire to steer a diverse group of strong-minded individuals toward consensus, as well as the instinct and will to build positive relationships with constituents. Leadership in identifying new issues in the changing business and financial environment must be combined with an international perspective on financial reporting in todays global marketplace. Not least important, the chairman must possess acute political sensitivity and an instinct for anticipating problems of a political nature not only with regard to the Securities and Exchange Commission, other government agencies and the Congress but also with regard to conflicting needs and wishes within the private sector.

The selection process
The FAF trustees are pursuing a rigorous process to select the FASB chairman. First, they agreed on the qualities that the chairman should possess. Representatives of the SEC, members of the FASB Advisory Council and other appropriate constituent groups reviewed these qualities with the hope of eliciting candidates for the selection committee to consider. We also have engaged an executive recruiting firm, Spencer Stuart, to help in identifying candidates. Dennis Beresford has been asked to serve as an ex-officio member of the committee and will participate in committee and one-on-one interviews with candidates.

Trustees who are not members of the selection committee itself also are welcome to participate in every aspect of the selection process. All current FASB members have been invited to meet individually with the selection committee to express their views and discuss their possible interest in being considered for the chairmanship. Committee members will then review candidate recommendations and interview those deemed appropriate for further consideration. Once we agree on a recommended candidate, the committee will complete reference checks and confirm that the candidate will accept the position if it is offered. We expect to make a recommendation to the board of trustees by its April 1997 meeting.

Although we have made some initial progress in the search for a new FASB chairman, the real work is just beginning. Some suggestions about candidates who should be considered have been received from constituents, and more would be welcome.

The FASB's future
In solving problems, the FASB needs to be able to look back to where it has been and forward to where it is going. The chairman should be a strong proponent of long-range, evolutionary change vs. the "quick fix." One of the strengths that has sustained the FASB is the careful and thorough due process that has evolved for dealing with difficult and contentious technical issues. An equally important strength has been the capable and dedicated individuals we have been able to attract to serve as board members and in other capacities. The trustees recognize that all members of the business community have a significant stake in this decision and are dedicated to extending those strengths into the future through a careful and thorough selection process.

Heralded Fraud SAS Released

A fter deliberating under the watchful eyes of both the accounting community and the popular press, the American Institute of CPAs auditing standards board has issued a groundbreaking statement on auditing standards. "SAS no. 82, Consideration of Fraud in a Financial Statement Audit, provides a benchmark for what auditors need to do to fulfill their responsibilities related to consideration of fraud in an audit," David Landsittel, ASB fraud task force chairman, told the Journal. "I am hopeful that the standard will enhance the likelihood of detection of material misstatement due to fraud, further enabling the CPA profession to serve the public interest and increase the value of our services."

Whats new
A special report in the Journal (June96, page 17), announcing the issuance of the fraud exposure draft, discussed the major issues in the proposed statement. "There were no major changes in structure or focus in the final statement," said Landsittel, "but I dont want to undersell the important input we got." The ASB received comment letters from small and large firms as well as state CPA societies and others. "The input was very helpful in identifying areas where clarification was required. We also received some helpful comments on audits of smaller entities, especially from the Institutes private companies practice section technical issues committee. We made some changes to ensure that the standard was workable for smaller clients."

Everything the CPA needs to know
An article on SAS no. 82, discussing it in more detail, will appear in the April Journal. The Institute also is publishing a practice aid, Fraud: Practical Guidance for Considering Fraud in a Financial Statement, which will be available at the end of the month. SAS no. 82 (product no. 060675JA) is now available. The practice aid (product no. 008883JA) is $59 for members if ordered before publication and $74 thereafter. The Institute also will be making available a range of other guidance products, which will be described in a leaflet included with each copy of SAS no. 82.

I n private letter ruling (PLR) 9644053, the Internal Revenue Service said a divorcing couple could use an annuity to equalize the division of their property without selling their principal asset.

A husband and wife, residents of a community property state, proposed a marital property settlement in anticipation of their divorce. Their primary asset was an interest in the A&B corporation, the husbands employer. Both husband and wife believed selling the A&B stock would have a substantial disruptive effect on A&Bs operations, so they agreed the husband would resign from A&B and the wife would receive all the companys stock and a portion of other community property. The husband would receive the majority of the other community property.

The couple also agreed to use a trust as an annuity to equalize the distribution of the property because a significant portion of the value of all community property was the A&B stock. According to the trust agreement, all of the property transferred to the trust would become the husbands separate property. During the husbands life, the trustee would distribute as much of the trust income and principal as the trustee deemed appropriate for the husbands happiness, enjoyment, comfort, travel, living expenses, support, maintenance, education and health. IRS temporary regulations said no gain or loss would be recognized if the transfer of property took place within six years of the divorce and any transfer occurring after six years would be presumed to be unrelated to the divorce.

In PLR 9644053, the IRS said that because the husband and wife did not anticipate that the A&B stock would generate enough cash to enable the wife to pay the annuity to the husband within six years, a valid business reason existed to spread the payments out over the husbands lifetime. Thus, the transfers of property and cash between the husband and wife would be tax-free under IRC section 1041.

Observation: Even though the husband and wife resided in a community property state, divorcing couples in other states also can take advantage of the annuity method in equalizing their marital assets.

—Michael Lynch, CPA, Esq., associate professor of accounting at Bryant College, Smithfield, Rhode Island.

ISO 9000 certification signifies that a companys processes conform to a series of quality system standards developed by the International Organization for Standardization (ISO), based in Geneva, Switzerland. Many businesses, both foreign and domestic, and governments require their suppliers to be ISO 9000 certified.

The IRS position paper likens ISO certification to an initial entry into a new market or business. It cites court cases dealing with obtaining a seat on a stock exchange, admission to the bar or acquiring hospital privileges. The IRS does not analyze certification in the context of maintaining existing customers and markets, which motivates many if not most certifications. The position paper also cites the U.S. Supreme Courts holding in Indopco v. Commissioner (503 U.S., 112 S.Ct. 1039, 1992) that certain legal and professional fees incurred by a target company to facilitate a friendly merger created significant long-term benefits and thus should be capitalized. The IRS has used Indopco to support capitalization for a broad range of expenses, such as environmental cleanup costs.

Observation: Interestingly, the paper does not address amortization of capitalized costs. A taxpayer faced with an IRS proposed adjustment seeking capitalization of ISO certification costs may want to negotiate a short amortization term. Also, the IRS decision to capitalize ISO 9000 costs could impose significant administrative burdens on some businesses and have the effect of increasing the cost of certification—a competitive disadvantage not faced by non-U.S. companies.

—Tracy Hollingsworth, Esq., staff director of tax councils at Manufacturers Alliance, Arlington, Virginia.

—Robert Willens, CPA, managing director at Lehman Brothers, New York City.