Translating the Standards

PAs working in the corporate sector often are charged with the tricky task of absorbing complicated new accounting standards and then sorting out how the literature applies to their organizations’ operations. At Prudential, USX Corp. and Chase Manhattan Bank, CPAs are part of a critical effort to understand new standards and how to make them work. No matter what industry segment they work in, those on the front lines in this arena recommend a step-by-step approach that helps them analyze and anticipate the impact of new guidance.

STEP 1: ASSIGN MONITORS

Many companies designate departments of professionals to monitor and translate new financial reporting guidelines and other pronouncements. For example, at USX Corp., a holding company for its steel and oil and gas businesses, a three-person accounting research group spends considerable time studying new accounting releases and developments. The group follows all publications from the FASB, the SEC, the AICPA accounting standards executive committee, the FASB emerging issues task force and any other relevant bodies, according to assistant controller Albert G. Adkins, who is an AcSEC member.

At Prudential, a five-person accounting policy group monitors new standards and decides how to implement them. Members usually have become familiar with the standards through the exposure drafts, and may even have studied the ED closely enough to comment, says Vice-President and Assistant Comptroller Neal Stern. Among the other responsibilities of the accounting policy group are recommendation of accounting treatment for products and transactions, consultation on financial reporting matters and participation in projects with financial statement implications.

For accounting professionals, staying informed about the standards is actually the simplest job, given all the resources available. According to Adkins, the tough job is translating—and sometimes justifying—a pronouncement’s impact on others within the company. That effort involves determining the potential effect of the standard and creating an implementation plan.

STEP 2: ANALYZE RELEVANCE

After company accounting policy staff study a standard, they evaluate whether it will have a significant impact on the business. If a standard is expected to affect operations at Prudential, it is assigned to a project manager within Stern’s accounting policy group. That manager circulates a summary memorandum to the accounting policy working group, a body made up of liaisons in each of the company’s business groups and core areas. The liaisons “are financial professionals who are involved in areas such as financial reporting or planning but who may not be involved in accounting theory to the same extent as the accounting policy group,” Stern says. The working group reports to Stern’s project manager on how a standard may affect a particular area or operation.

The amount of internal information that is necessary to gather depends on the standard. For example, at Prudential, in anticipation of FASB Statement no. 133, Accounting for Derivative Instruments and Hedging Activities, Stern’s group circulated a detailed questionnaire asking, among other things, whether the recipient’s division had a product that might have an embedded derivative. The standard requires companies to recognize all derivatives—including those embedded in various kinds of financial contracts—as either assets or liabilities in the statement of financial position and to measure the derivative instruments at fair value, a potentially daunting task. Prudential’s questionnaire also asked for comment on the policy group’s proposed time line for implementation of the standard, which is effective for fiscal years beginning after June 15, 1999.

Sometimes feedback from other departments will reveal nonfinancial colleagues’ reactions to a standard. “FASB Statement no. 133 makes absolutely no sense to business people,” says David M. Morris, director of corporate accounting policy at Chase Manhattan Bank and also an AcSEC member. In an effort to standardize the accounting for all derivative instruments, the standard requires recognition on the balance sheet at fair value of previously unrecognized derivative instruments, such as interest rate swaps used to hedge historical-cost-based assets and liabilities accounted for using accrual accounting, a step that many non-CPAs find inconsistent and illogical when compared to current practice. (See “It’s Time to Simplify Accounting Standards,” Mar.99, page 65.) On the other hand, AICPA SOP no. 98-1, Accounting for the Costs of Computer Software Developed or Obtained for Internal Use, “makes a kind of intuitive sense to them,” he says, since it applies the idea of capitalization—an accepted premise—to internally developed software. In helping to implement a standard, it’s important to gauge not only how well other internal users will understand the accounting but also to understand how they will react to its logic and the consequent effect on their operations.

STEP 3: CREATE AWARENESS

To promote understanding, available information about new accounting guidelines is disseminated throughout the company. In addition, the group at USX creates its own written summaries—general discussions of two to five pages depending on the expected impact on the company—that offer observations and explanations specific to company operations. These summaries are sent directly to about a dozen people, up to the CFO level and including group financial vice-presidents, who in turn may send them on to others in their organizations.

At Prudential, such summaries become part of the company’s accounting policy release series, which analyzes impacts and options. For example, if a standard allows some choices in application methods, the summaries might comment on which are best, based on discussions with people in affected parts of the organization. Entries in the series also synopsize proposed adoption plans.

After creating a draft summary, Stern’s group at Prudential asks for comments, usually within two weeks, from liaisons within the company and from the company auditors and may modify its choices if, for example, information from the liaisons leads them to believe there could be a more appropriate alternative. After finalization, the accounting policy releases are published in an accounting policy database that is available to anyone in the company who has access to Lotus Notes.

STEP 4: GAUGE IMPACT

Some standards are easily integrated into a company’s financial reporting systems; others require changes that will cost time and money. Once the CPAs have gathered information about effects in various areas, they try to understand a standard’s broader impact.

Statement no. 133 has been a particularly challenging standard because derivatives are used in a variety of transactions and industries. The implications and implementation at a financial services entity such as Chase “will fundamentally change the way we do business,” Morris says. The changes required under Statement no. 133 do not reflect “the way we run our business or the way we hedge. It changes all our processes. For example, under Statement no. 133, synthetically converting a fixed interest rate liability to a floating interest rate using an interest rate swap has totally different accounting than synthetically converting a floating interest rate liability to a fixed interest rate using an interest rate swap. This seems arbitrary to non-CPAs, whether they’re senior management or in operations.” To understand the potential effects, “the process involves informing the people who are directly—and even tangentially—affected about the effects and discovering their ultimate impact.”

At Prudential, Stern does not expect to produce a final summary for Statement no. 133 until the end of this year. “We are still trying to figure out the process for getting data on embedded derivatives and setting up a good way to feed that data to the financial statements. The issue of embedded derivatives is a tough one for insurance companies. Many of the insurance industry’s new, sophisticated products may fall under that definition.” At USX, the accounting research group received an implementation guideline of more than 500 pages for Statement no. 133 from its independent accountant; it took a significant amount of time for the internal staff to craft an understandable summary to use within the company.

Even a seemingly logical standard can require internal negotiations. In responding to SOP 98-1 on internally developed software, the Prudential accounting staff had to confer with its working group to develop capitalization standards, materiality thresholds and amortization schedules, and their opinions weren’t always the same. “People in some areas wanted a lower materiality standard, for example, but we must consider costs and benefits on an enterprisewide basis.”

STEP 5: GAIN ACCEPTANCE

An important step is to work with executives throughout an organization to ensure implementation is done accurately and efficiently. Despite efforts to prepare and educate nonfinancial colleagues, industry CPAs frequently are expected to be apologists for accounting and other standards. “People in other divisions question the logic of the standards all the time,” Stern says. “They want to do something that makes sense intuitively, but we sometimes have to tell them it’s not GAAP. On occasion, I have to remind people that I didn’t write the opinion.”

Adkins of USX solves the problem by allowing for an ongoing question-and-answer dialogue between the people in his department and others in the company. “We spend time trying to explain what we think is behind the theory,” he says.

For Stern, it’s sometimes useful to get reinforcement from the outside auditors. “We tell our nonfinancial colleagues we have to gain an understanding of the standard and implement it, but that doesn’t always mean we like it. When there is a controversy, we sometimes take questions to our outside auditors, who can supplement our research with their resources and experience in practice. Often, this helps internal ‘clients’ gain a better understanding of our conclusions.”